The merger process, from start to finish, can run anywhere from three months on the short end to 12 months on the high end. As Internet start-ups increasingly combine their operations with more established companies, deals have become riskier and more complex in nature. A successful transaction today not only requires mastery of financial structuring but also a keen ability to align diverse constituencies toward a common vision. While most everyone recognizes the time consuming aspect of doing a deal, repeat entrepreneurs and sophisticated sellers alike realize that the sale of a company is a complex art and usually engage the services of an intermediary or broker. The broker, in partnership with the company’s management, must be uniquely qualified to play the role of facilitator, devil’s advocate and friend. From my experience as an investment banker leading our firm’s hospitality technology practice area, I have found that very few software entrepreneurs approach the merger process with a clear understanding of the sequence of events that lead to the completion of a successful transaction. This article attempts to provide a realistic assessment of the four main steps (milestones) in any merger process, drawing from our firm’s involvement as the sell side advisor to several smaller, privately held application software firms in the hospitality space.

Prepare an Offering Memorandum
The first step is to prepare a prospectus or offering memorandum (OM). The broker uses this document as the calling card to solicit interest from prospective buyers. Distinct from a business plan, the OM succinctly encapsulates the company’s intellectual property assets and the underlying technology architecture behind the product or product suite, while summarizing the qualifications of the management team from the perspective of a potential acquirer. A well-written OM reads like a sales document, highlighting the unique selling points of the company and piquing the reader’s interest for a closer look. Fundamentally, any interested partner will need to clearly understand the seller’s motivation. In the case of venture-backed companies such as MCORP, a property management system vendor and past client, the investor’s desire for liquidity and a return on investment sparked the sales process. On the other end of the spectrum are the bootstrapped or self-financed partnerships where the owner’s desire to retire or move on drives the merger process.

Prioritize a Buyer List
The next step is to prioritize the list of prospective acquirers who will receive the offering memorandum. Compiling a comprehensive buyer list is a joint effort between the client and the investment banker and takes into account the operating, marketing and strategic synergies of a transaction as well as a buyer’s acquisition currency (cash or stock) and past acquisition history. The challenge here is to manage the document distribution process closely to ensure our client’s privacy while ensuring maximum exposure to qualified buyers. This has proven to be a difficult balancing act, especially in the tightly knit, competitive world of hospitality software sales. The professionalism and sensitivity of an investment banker is crucial here, as one false move not only jeopardizes a transaction but also could serve to tarnish a company’s brand name. Chronologix Software, developers of the SpaSoft software product and a past client, remained adamant that we confine our buyer distribution list to complementary (not competitive) strategic players in their segment of the leisure scheduling software market.

Perform a Valuation
Software entrepreneurs struggle the most with the next step, the financial valuation performed by the objective third party. Every investment banker will admit that valuation is a subjective process and that the only price that matters in the end is the one that the buyer is willing to pay for the company. To assess the company’s stand-alone enterprise value, an investment banker will employ a variety of tools, beginning with simple discounted cash flow analysis to a more rigorous review of comparable software transactions. In our experience this is an iterative process, which often requires that we work closely with the client company to revise detailed financial projections over a three-to-five year horizon. These revenue and cost figures are key components as the buyer evaluates the level of cost savings under various acquisition scenarios. Despite the methodology used, there is undoubtedly a disconnect between the entrepreneurs personal perception of value and the maximum price a strategic or financial buyer would be willing to pay. In the case of another client, a leading developer of inventory control software for F&B, valuation expectations were a key impediment to getting the deal done.

Begin Negotiations
Lastly comes the glamorous part of dealmaking—the negotiation stage. The process begins with a letter of intent (LOI), which confines the negotiation to one party for a fixed period of time. The guiding principle here is that everything is negotiable, starting with the format of the deal structure through to the options vesting and the length of the employment agreements for key management personnel. While I have not been party to the Gordon Gekko version of Wall Street negotiation tactics, I did have to sit through a tense full-day session on price negotiations in the suite of a Las Vegas hotel to get a deal done. During this exclusivity period, key deal terms are summarized into a term sheet.

The presence of a term sheet is music to a banker’s ears and also a clear sign that a live deal has entered the due diligence stage. Here, there are countless other financial and legal professionals who must get involved to protect the sellers’ interests. Technology due diligence is usually driven by and financed by the buyer, whereas financial due diligence is an expense that the seller usually bears. The depth of review depends entirely on the comfort level between both parties with the proposed transaction. In the case of SpaSoft, long protracted discussions between lawyers and accountants rang up costs and almost compromised the transaction. From the banker’s perspective, a deal is never done until the merger contract is executed and our success fee is paid.

The landscape in hospitality technology is changing rapidly as the deals get larger and more complex. Amidst all this change, the technology buyers’ appetite for profitable software companies continues to grow and the leadership of every company should actively consider pursuing a merger strategy to maximize shareholder value.

Rohit N. Mehrotra is a vice president with The Platinum Group, a merger and acquisition advisory firm focused on hospitality technology companies. He can be reached at rmehrotra@platinumgroup.com or at (212) 736-4300.