Financial Modeling for M&A transactions

Introduction

Financial modeling is an extremely valuable tool used by companies, financial experts and even investors to carefully examine and forecast certain aspects of a business activity. This tool is particularly useful because it can be adapted to a specific phase of the business cycle and to the size of the company.

One of the most popular and complex types of models are merger and acquisition (M&A) models, which are used to evaluate a transaction between companies. More specifically, there are two main types of M&A models. One is used to analyse the fair value of the company after the transaction, the other to analyse the fair value of the transaction itself, and it often compares this to a specific target that a company sets.

Although all M&A models are complex, the second type is even more so because in order to achieve a successful outcome, the two financial models of the companies need to be considered and then combined into a new “post-transaction” model.

Unique aspects of financial models for M&A

The most unique aspect of M&A models is the calculation of synergies and the estimation of how they might affect the price and outcome of the transaction. Synergies are defined as the efficiencies that result from the transaction, leading to a reduction in costs, an increase in revenues or a saving in time.

What makes estimating synergies extremely difficult is that they do not necessarily result from material or structural changes, but also from network effects, efficiency of scales and scope, brand loyalty, lock-in strategies and many other factors.

For example, a multinational enterprise that owns several cereal brands has an extremely high synergy effect if it wants to buy another cereal brand. This is because it already has the network, structure and market share to sell the new product immediately without incurring significant start-up losses.

If, on the other hand, an entrepreneur wanted to buy a cereal brand, he would have to fight for market share individually while building a solid structure, which makes the investment less profitable.

For this reason, it is often the case that the buyer with the highest synergies is willing to pay the highest price for a given business. Therefore, the correct assessment of synergies is a crucial step in any M&A model.

My financial modeling process

Due to the importance of synergies and the complexity of their estimation, I have developed and optimised my own financial modeling process to ensure an error-free result that fully meets the client’s expectations.

My financial modeling process is divided into 7 steps, starting with an initial meeting with the client and ending with a final summary of the entire model that can be presented to investors or the board.

More specifically, my 7-step financial modeling process includes the following:

1. Define the important reporting KPIs and how detailed the M&A model should be

Since a model is only useful if it meets the client’s needs and expectations, the first step is to sit down with them and determine all the important Key Performance Indicators (KPIs) that model. Also, since all my models are customised to the company, the client can decide how detailed each section of the model should be.

2. Understand both the acquiree and target companies’ business model

The second step is to research and examine the business model of both companies. This process is essential to ensure that the synergy effects are estimated as accurately as possible.

3. Collect related data and build the assumption sheet

The next step is to collect as much relevant data as possible to ensure that all calculations and forecasts are correct. In addition, it is important to prepare a financial document called an ‘assumption sheet’, which contains all the assumptions needed for the model to work.

4. Develop a preliminary version 0.1 of the model

The fourth step is to create a preliminary 0.1 version to show to clients and get initial feedback. In addition, thanks to version 0.1, it is possible to check that all the formulae are correct and that there are no errors in the structure of the model.

5. Align, test and improve till Version 1.0 is achieved

After the preliminary version has been approved by the client, it is necessary to align, test and improve it even further until the final 1.0 version is achieved.

6. Build different scenarios

When requested by the client, it is possible to implement related analyses to broaden the scope of the model or to specifically focus on a stage of the project or investment.

7. Create a report or pitch

Finally, the last step is producing a summary document that highlights all KPIs and relevant points in an easy-to-understand form. Furthermore, when requested by the client, it is possible to build an on-demand pitch for the model which can be directly shows to investors or directors.

The M&A Financial model

When it comes to creating a successful and insightful merger and acquisition model, my 7-step process never fails. Due to the features of my financial modeling process, the end result always provides all the information a company needs to evaluate a merger.

First, all my M&A models include a full set of financial statements. So even if one of the two companies is on a deferred income or expenses basis, you can see the impact and the differences between the cash flow statement and the income statement to make more informed decisions.

Secondly, the M&A model also includes a comparison between the pre- and post-merger period, showing the strengths and gains resulting from the model, changes in market structure, efficiencies and synergies, and more.

In addition, my financial models also include a section on how the merger should be financed to ensure that there is no reduction in equity or very high liabilities. To this end, I carefully examine the cost of capital and the options for raising the required funds.

Finally, the model includes a section discussing the valuation of the overall transaction and whether it would be beneficial for the company to go through with it.

Related Analysis

Even if a merger and acquisition model covers all the essential bases for an informed decision on whether to proceed with a merger, it is often useful to supplement it with additional analyses to broaden the scope of the model and/or focus on a particular part of it.

In particular, it is very common for companies to request a sensitivity or scenario analysis based on the M&A model. A sensitivity analysis looks at how KPIs change when a parameter or assumption of the model changes. For example, companies are always interested in how the valuation of the project changes if the weighted average cost of capital changes.

Scenario analysis, on the other hand, is used to simulate different situations where more than one parameter or assumption changes at the same time. For example, a company might be interested in tracking what would happen if the synergy effects were fully amortised over only a few years. In this scenario, the company might see a decrease in equity, an increase in costs and an overall decrease in efficiency.

In addition, many companies also request an additional fundraising or valuation analysis for a more specific part of the merger to get more precise details.

My Services

Because M&A modeling is such an extensive and complex topic, I offer two different services with different scopes.

The basic service includes an initial meeting to discuss all the basic aspects of the model, then the model itself created using my 7-step financial modeling process, and a final summary and report.

The other package, on the other hand, includes all the features of the basic offering and much more. This offering is designed to let me assist the client as a financial expert and partner, guiding them through all aspects of the model, from creation to financial pitch to investors and directors. So, this package also includes individual coaching, consultations and investor support.

Tailored Financial Model
Full set of financial statement
Personal video calls & online workshops

Video calls and exclusive support throughout the whole process
Coordinate with the team to collect relevant data and establishing assumptions
Deep level of details and a wide range of KPIs
Organised and professional presentation of the final results as a member of the team