How to Handle a Merger Deal with Roland Frasier and Ryan Deiss

Especially these days with differences, generational differences in expectations of and work habits of Gen Z people versus Millennials versus Baby boomers and Gen Xers. It's, you know, that's just one thing to consider. But like, if you get a company that skews younger merging with a company that skews older, you're going to have some generational cultural conflict.

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Hey, everybody.

Welcome to another episode of Business Lunch with Ryan Deiss and me, Roland Frazier, your hosts. Today we are going to chat a little bit about the mergers and the acquisitions, also known as M and A. Ryan, you, I think you had somebody reach out. Is that what we were talking about earlier?

Yeah, I mean, well, it seems like there's a theme, right. And I don't know if it's just where the, where the market is right now. We're finding more and more of like, whether it's founders, board members or just people that we know in the space who are actively, they're not necessarily looking to sell. But I'm seeing more people on the buy side. So I don't, I don't know if this is, you know, entrepreneurs feeling like if the market turns a little bit, maybe there's some deals to be had or what. But the general theme that we're seeing is more people looking at doing mergers in particular. Right. So I'll kind of set the stage and, and we can talk about this particular type of deal. I can't for confidential, confidentiality reasons. There's the word talk about the company yet, but we got a client and they're doing let's say, around 7 million a year in revenue and really, really solid margins. Let's say they're dropping 30% to the bottom line. They are talking to another group and kind of a friendly, you know, not direct competitors, but in a similar space and, you know, have a really good relationship. This other group's doing around, you know, million, million and a half dollars. Also really great 50% margins because it's so small. And they've been going back and forth talking about how ways that we can work together. And ultimately it was like, well, maybe we should just merge. And so this client was like, how should I be approaching this? So I'd love to get your perspective on as the bigger company. Right. Approaching another business. Right. How would you approach it if you're advising the larger company? And then I want to flip it and just say, how would you approach it if you were advising the smaller company?

Sure.

And you and I chatted briefly about this earlier. It is a buyout. A merger is a buyout. So it's. There's generally always a survivor and someone who gets absorbed. And so it's very rare that you would have a merger and then change the brand of both companies. So the things to think about, which I think, like, if we're looking at the acquiring company is going to be pri. Is. Is most likely to be the survivor, the larger company. So the things that as far as you want to, like kind of general overview or you want to talk about in terms of who owns what, what. What was your thinking as far as what you wanted?

Yeah, just, I mean, so somebody says, you know, I'm doing about $7 million. I, you know, merge, aka buy, you know, the smaller company. You know, how should. What's kind of the first step to think about that? Is it, you know, well, we got to value both businesses and see where, where we are. And then this business over here, the smaller one, they get a pro rata equity in this. Like, just how do you, how does one even begin to think about it and process that?

That stuff comes way later. I think the first thing that you're thinking about is why, what is it that we think we're going to get as a result of doing this? Because very often what the expectation is that you're going to get from it is not. I think it's like 63% of the time that it's not realized. Last time I looked at a stat on it. So mergers are. I think that stat is skewed by investment bankers that encourage people to do deals to make investment banking fees that maybe those people shouldn't do. But let's say that, that in this scenario, the very first thing I would say is, what is it that we expect to gain from doing this? And can we quantify that in terms of what is that going to be in terms of ROI on the investment of merger? And even if you're just giving stock up, you are still diluting the existing owners. And so there is a payment that is equal to the value of the dilution that occurs. So a lot of people are like, well, it doesn't cost anything if we use stock. Well, it kind of does. So you have to be careful about that. Why is the first thing, what specifically do we intend to gain from this and how realistic do we think it is that that will actually happen? Very often everybody creates these forecasts of everything that's going to happen that assume these gian assumptions that just don't take place. And so I think being realistic about those assumptions too, then it's going to be, is it a cultural fit? Because if you have a pirate ship merging with a summer camp kumbaya, you know, philosophy, then that's not going to work. And especially these days with differences, generational differences in expectations of and work habits of Gen Z people versus Millennials versus baby boomers and Gen Xers, it's, you know, that's just one thing to consider. But like, if you get a company that skews younger merging with a company that skews older, you're going to have some generational cultural conflict. Maybe there's diversity conflict. Maybe one company has been all focused about hiring people that support existing management's philosophy. And so there's not a lot of diversity there. And you have another company that's been focused on dei, diversity, equity and inclusion. And those people come in, that's going to be a clash. Even inclusion itself. How much are we a culture that gets told what to do by management? Or is there actual inclusion and equity where the opinions of everyone are factored in and considered and processed and, you know, so like, what are the work habits? All of those things. Like, look at what Elon Musk recently did with Twitter. He's like, hey man, it's time to get serious. We're going to get down to work. If you don't think you can cut it. Our culture now is work and get crap done. And a whole bunch of people left because they were like, that's not what I want. I signed up for you Know, foosball and cereal bars. You know, it's just, it's like that's going to be important. And that I think is probably the thing that, that kills most of the deals that I see is that they're just, they shouldn't have gotten together in the first place. So getting those things out of the way and then saying, what does post integration life look like if we do this? Let's do a pre mortem on what would have happened if it doesn't work.

Can I go back and address? So, so let's say in this case, I don't know all the details about this, but let's say that both companies agree. Like, yeah, we are a cultural just bullseye. You know, people could basically bounce back and forth between these companies. They would almost, you know, they wouldn't really know the difference. Or, you know, realistically in this case, I think one of the companies is so small that probably doesn't matter as much anyway that there might be three people coming over. So this is part of the reason I like talking about this is because it's a relatively simple deal, but it still has all the pieces. So, so let's say cultural alignment check. In terms of the reason to do the deal in this case, the larger company was planning on launching a product that would have potentially been competing with smaller company with their main product. And bigger company has a lot of products. Smaller company really just has one. And so it was kind of one of these, we're going to be doing this thing. And smaller companies saying, well, if you're going to do it, what if we did it together? Right? And so you don't have to create it from scratch. We already have this. And maybe smaller company, they would really like to be a part of something bigger they like and they respect the brand, they bring some additional management. There's some synergies there and division of labor that everybody kind of agrees would be good. But mostly what would be integrated is this. There's this product over here that's doing $1 million a year, dropping a half a million to the bottom line. That's what SmallCo has. Big Co wants to do this. They see this as being a possible head start, plus some leadership coming in to run it all. They got to give up a piece of the bigger pie to get it right. That's kind of what they're thinking. We'd have to do this anyway. You know, we'd have to hire people to go and you know, in this case we get it overnight, instant money. All we Got to give up is, you know, some equity. So that's kind of where they are. So we check the first two boxes, hypothetically. Now what. What's the next step?

Yeah. Then it would be post integration. What does it look like once we've done this, let's do a pre mortem on what would have happened if this didn't work out.

What are.

All the way.

Break that down for me. This is basically a collaboratively. Let's decide ahead of time all the ways in which this is going to blow up in our face and we're going to hate each other.

Correct. Yeah. And address that. Address the.

Are there any frameworks around that, like, is there a way to think about it or is it just a creative exercise?

I imagine that there are frameworks on it. I'm not familiar with them and haven't done the research. What is generally to me a brainstorming exercise of what could go wrong. And then let's take a look at all of those things and say, what's the likelihood that that might happen? And then what would we do? What could we do now that would lessen the likelihood so that we would likely avoid that thing? That. It's just kind of straight inversion thinking.

Yeah. And so in this one, let's say, and what I've seen, because you and I have been a part of a number of mergers and stuff like that, generally when these things go south, assuming it's not just a complete culture clash or something like that, it's that this new thing that got integrated in, nothing happened with it. Right. It wasn't a big enough thing for the new. So then the new one, kind of like the thing that was integrated sort of starts to die on the vine and there isn't the growth that everybody was hoping for. And so the person that kind of the smaller company that was integrated, they feel like, wow, I'm not seeing the growth as a part of the bigger deal and the asset that I have is kind of dying a little bit. So they're like, I'm going to integrate this thing and kind of be worth nothing. So are there ways sometimes to think about what are some options if you say these are some bad things that happened? Do you try to look at saying, well, if we don't hit these goals, then let's just unwind it and everybody get their toys back, you know, and go badly.

What are.

What are some possible things that you've seen that once you've identified, okay, this could be an issue like that to maybe make people feel better about it.

Yeah. And that. So that's the next step is to say, well, how do we accommodate the possibility of these things happening? And there's a couple of things that I think makes sense to do. One would be is there a breakup process and a formula for determining what's going to happen if it doesn't work? And so the worst case scenario of that is let's just undo the deal. And if we do undo the deal, then what does that look like? How do we make that happen in a way that would be acceptable to everyone, knowing that what we thought we were going to accomplish, what we hoped we were going to accomplish, didn't actually materialize? And therefore there wasn't really a good reason for us to get together because neither of us is getting what we want. So let's go back to how we were then. There are intermediate steps that you could do as well. And we're talking about this in companies we have right now. As recently as before. This podcast is things changed from what we thought was originally the way it was originally going to happen. So what adjustments could we make that might be acceptable to everybody so that we'd say, okay, well if it changed in this way, then what's a fair change in perhaps the equity that was given? Maybe there's an equity adjustment, maybe there's a cash adjustment, if there's some financing, maybe there's an adjustment to the note, there might be an adjustment to the valuation based on things that come up. And that that's very typical in acquisitions anyway. There's always the possibility of having an earn out that says that if things go this way, then there's going to be some extra payments that come. So I think being relatively conservative on the front end gives you more flexibility to do that as well. But having those things thought about and I don't think there's like in terms of a framework, I guess a framework would be why are we doing this? What specific, specifically our assumptions that are going to, you know, that surround the deal in terms of going in and what's going to happen once we're done, what's the time that we're likely to receive those in? What happens if things don't work out completely and we need to unwind the deal and what are the things that might be adjusted in the event that certain of those assumptions aren't met? And then what are the specific mechanisms that we will build into the agreement to make those adjustments part of the deal? Not something that everybody then asked to agree on after the fact Yeah, I like that.

Because it almost forces you to come up with a point of no return.

Yes. Right.

Because all these reach a certain point where it's, you know, hey, once we've done this, I mean, you can think about a retail location, right? You know.

Yeah.

Once we've done this integration and, you know, we've ripped your sign off the building and we put our sign up there, it's going to be tough to go back from that. You know, once we. Once we've decided, okay, you know, we don't need this whole department that you have anymore, so we're going to let all those people go because you're going to get integrated here, and we've got redundancies. There's a bit of a point of no return there. If it doesn't work out, you can't just be like, oh, here's all your stuff back. It's like, here's my stuff back, but there's nobody here to run it anymore.

Right.

And so I think being really clear as you're talking through the possible downsides, like, what points of no return does this inform? And it doesn't. And what I think is great about this is it kind of forces you to do business with that potential negative reality. Because entrepreneurs can be so freaking optimistic. Well, of course this is all going to work out. But if you think, force yourself collaboratively to swim in the very real potential, that this could go really badly in a lot of different ways and to varying degrees. What does that mean? That's where maybe you look at it and you go, boy, if this happens, like, I'm freaking done. Like, I'm done for. Like, my business is gone. I don't know how I'm gonna make money. Like, this would sort of be an existential issue. You've got to look at it and say, okay, am I getting enough money on the front end? You know, or we. If you're the. If you're the selling company or if you're the acquiring company, you know, are we risking a small enough that we could sustain this kind of a loss, you know, where we could stomach it? And if the answer is no, you got to ask yourself, is that really a bet we're willing to take? If the potential downside is absolute death and destruction, even if it's only like 10, 15%, you know, are you playing the entrepreneurial equivalent of Russian roulette? If the answer is yes, boy, maybe you just keep going on your own path for a little bit longer.

Right? So. So.

But let's say We've gone through that and we have come up with some things where we generally agree that you know what, even if this isn't ideal, even doesn't work out, everybody feels good about the ripcords that can be pulled to get out of the deal or that they generally feel good about the acceptable risk. We've done business with all the potential, you know, all those possible eventualities. Then what?

Then you start to document the deal.

Yeah. And that's, and that's when we're getting really crystal clear at what point are this is a thing that came up like at what point are we signing NDAs and really beginning to look at the financial and you know, I don't.

Think you sign NDAs until you're going to get confidential information. So I think that that first part of, of the conversations around why are we doing this and what do we hope to get out of it and what does it look like? I think you can have all of those before you get into the nitty gritty because that confidential information you don't really want to share until you're fairly certain you're going to move forward with the deal. So you wouldn't even like, I mean if you know that high level stuff in terms of what are sales and what is profit. I'm not sure that you really need to get there until you get to an loi. I mean I'm going to take somebod their word obviously Lois aren't binding so you know, we should be able to get to effectively a term sheet before we need to go and look at confidential information. So having not signed one and knowing what we know about what you just said, I don't see that I would sign one until I got to customer lists or actual confidential information like that, like detailed financials, you know that I don't, I, I'm, I'm kind of anti NDA anyway. So I generally will push back when people ask and say just don't tell me anything that you, we haven't talked about that you wouldn't share with anybody else. Let's figure out if it may make sense to do this first and then let's get some general terms and if we agree on all that then show me your confidential information and I'll show you mine.

I think that's so important especially if you are entertaining a merger which again would be a buyout from a larger company because some less scrupulous companies will use the, you know, the concept of well maybe we would like to buy you to basically get A free look under the hood to determine if they want to do this.

And like a good example of that is even with a very reputable company, one of the companies that we had an exit to, we never revealed our customer list, despite multiple asks, until the deal was closed. So they wanted to talk to customers. And so we basically said, how many do you need to talk to? We'll do a randomized Nth name and give you, give you that number that you need to talk to. But we're not giving you the full list because it's not done, Deal's not done until the money's in the bank and the, you know, then the glasses are clean. So we're gonna, we're gonna wait on that. And I would recommend everybody, you know, keep your confidential information confidential as long as you can, because precious and private.

And can be used against you. I think that is so incredibly important. So, I mean, it's fine to say when you're in those, especially in those early stages, it's fine to say, let's say our revenue is this, and let's say our profitability is this, then what? Because it's all going to be based on, eventually the real number is going to come out and the valuation is going to be based on the real thing. And so if it's off, then, you know, we can figure that out. But, but yeah, I think that's so incredibly important. So it's at this point now, you know, there's going to be a term sheet, letter of intent kind of thing, loi that, that happens at this point because we've had all the conversations, we've had the post mortem, you know, we've done it now it's at this point when we're going to just write up a simple letter of intent. Right. And then maybe then and only then is it, okay, let's set up a, you know, a deal room, you know, let's start looking at the more sensitive confidential information and only that which is truly essential to understand.

Yeah, because you sign, you'll sign the loi and then you're going to go into diligence, right. So when you get into your due diligence, you've got legal due diligence, commercial due diligence, and financial due diligence at that point, then there should be a data room that's set up so that you can access it and look at those things that you need to look at that are going to be confidential, which you wouldn't do until you had the NDA signed. But Even then, I would recommend that the formula for Coke or KFC doesn't go in there. Maybe the suppliers do, you know, but not the formula, not the secret sauce. Don't put that in there. Don't give that until the whole thing is signed, sealed and delivered.

Yep.

So if I can recap just number one, we got to make sure this cultural alignment. Got to make sure that, you know, all the reasons that we, you know, a deal would work out that. That everybody agrees on what those are. Yeah, I think it's two.

Two things. Just so. So the. The first thing I think is, is why. Which I think is different from the assumptions. Right.

Yeah.

Why. Why is a. Is a bigger thing. Why do we want to merge? What is the thing that we're going after, our goal that is causing us to want to do this anyway? And can we do it inside or outside? All of that comes before. Let us make some assumptions. So I'd put that as the number one, topmost thing.

Yeah. And because if we're not clear on that, then there's no point in really diving into anything else. Right, Right. Everything else at that point, that initial. This is the overarching reason that we want to do this.

Everything.

It will never be as good as that. Everything else will only be essentially like what you're basically doing when you do that. If you think about the scales, Right. It's like you're taking a giant rock and you're like, putting on one of the scales. Okay. This is why we want to do this and everything else. Okay. Why might we not want to do this? Well, the culture is close, but it's not dead on. So we're going to put a couple pebbles over here on the other side. We're going to talk about the risks and what happens to go sideways. The risk isn't massive, but there's definitely some risks. So let's go ahead and drop all those over there.

Okay.

Here's the deal structure itself. You know, the deal structure itself is, you know, we're going to get some. You know, this company's going to have to. If, let's say I found the buyer, like, we're the acquirer, like, we're going to have to come out of pocket. Not a ton. We're definitely going to have to come out of pocket, like a little bit from a cash perspective. So a couple more pebbles over here, we're going to get diluted a bit more. And all of it is just, you know, evening out and seeing is that initial stone that you put on there. For the Y, is it still heavier than all the other stuff?

Right.

And if at any point in time it's not, which could come up pre loi could come up during due diligence. That's when you're done with the deal. But it's very rare that something is going to be discovered during discussions or during due diligence that makes you even more excited about the deal than you were before.

Right.

I'm not saying it can't happen, but in general, that very first. Why that very first step, that is the stone that gets put on one of the scales and it is unlikely that any more will be added to that side. Everything else is just about being hypercritical. Like is this still worth doing? And I would say if it's even close, don't do it.

Right.

I mean mentally, if you're picturing those scales and it's like a little bit wobbly and one's probably shouldn't do the deal because as you said, most of them don't work out as well. You know, we've had enough mergers and buyouts that have been fine. We've had some that didn't work out at all and we had to unwind. I don't know that we've necessarily had any that have worked out even better than we imagined. I think in most cases optimistic entrepreneurs ability to imagine this glorious after a deal is done is almost always going to outpace reality. That's probably a good thing, but it's also probably something to be guarded against.

Yeah, I think that's a good point.

So to our founders board friend, we'll get into more details on this. It's one of the nice things about being in founders board is we get to work one on one. But I wanted to talk through that because like I said, I know this isn't the only person out there thinking about a merger from being a larger company, looking at possibly acquiring a smaller one, or maybe being a smaller company, saying hey, as we shift into this kind of different wobbly economic time, maybe it, maybe it'd be nice to be a part of something a little bigger than what I'm doing right now. So hopefully if you're thinking about either of those things, hopefully this discussion was helpful. Anything else you'd add?

I think that's it.

Amazing stuff. Well, thanks so much.

Thank you guys for listening. If you found this helpful, please refer it to a friend. Anybody that might be thinking about things like this. Certainly there's a lot of people, anybody that you know that thinking about merging or merging, being merged with that could be helpful. We would love for you to share this with them and we will see you the next time on Business Lunch.

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