Business Valuation
Apr 29, 2023
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This guide explains what confidential information memorandums (CIMs) are in mergers and acquisitions and their place in the M&A process. This guide also explains what is typically included and excluded from a CIM. Here are some key takeaways about confidential information memorandums:
In mergers & acquisitions (M&A) transactions, confidential information memorandums (CIMs) are a type of document that is used to provide potential buyers with key information about a company, including financial data and details on the business’ operations. CIMs are typically created by an investment banker or M&A advisor and sent out to prospective buyers.
CIMs are meant to be highly confidential documents and should not be shared without the permission of the company being sold. The specifics of what information will be included in a CIM can vary depending on the transaction but may include financial data such as income statements, balance sheets and cash flow statements, as well as pertinent business information such as ownership structure and supplier/customer contracts. CIM’s also often give insights into the industry the business operates in as well as into sales and marketing efforts.
The purpose of a CIM is to give prospective buyers all of the necessary details they need in order to make an informed decision on whether or not to pursue an acquisition. As such, it is important for CIMs to provide enough detailed information for potential buyers to evaluate their options before committing to a purchase. As a result, CIMs should contain comprehensive information about the company’s operations and financial standing in order for potential buyers to understand its value proposition and make an informed decision.
The prospective buyer will use information from the CIM in order to value the company and decide on a price range that makes sense to offer for the seller’s business.
To understand confidential information memorandums, you need to understand the M&A process. The term M&A process refers to the steps that a seller takes to sell their business or that a buyer takes to acquire another business.
During the M&A process, when a seller is looking to put their business up for sale, they are concerned with confidentiality.
The vast majority of M&A deals involve privately held businesses. These businesses don’t publish detailed financial information that the public can see, like publicly traded companies do.
In order for a prospective buyer to make an informed decision about the business they will be buying, they will need access to information the business owners would not want to become public.
The seller wants to keep the details about how their business operates as well as the fact they are looking to sell a secret—but the buyer wants as much information as possible about the business they are buying.
To understand confidential information memorandums, you first need to understand why confidentiality is important to a seller in the M&A process.
If word were to get out that the founder was looking to sell the business, and that business’ information were to get released to the public, unintentionally, here are some potential negative side effects:
Because of these reasons sellers have to be apprehensive at this stage, the M&A process has evolved to take considerations for the seller’s confidentiality into account.
Here are a few measures commonly taken in M&A transactions to ensure confidentiality for the seller.
Normally, when a business owner wants to put a business up for sale, they will go through an intermediary (usually an investment bank or an M&A firm). These businesses act as intermediaries between the buyer and seller.
When the seller lists their business for sale, they create a one- or two-slide document that gives high-level information about their business that keeps the seller’s identity confidential. This document is called a teaser. The teaser is distributed by the intermediaries to prospective buyers. If those buyers are interested in the seller’s business based on the information they learn from the teaser, they will request more information from the seller. They will need this information in order to value the business and determine what it is worth, as well as to assess the business more qualitatively. This process almost always involves signing a non-disclosure agreement. The confidential information memorandum is what the prospective buyer receives in exchange for signing that NDA.
The information in the CIM is used in their valuation and assessment of the business for sale so that the prospective buyer can determine a price range for an offer that makes sense.
Now that we’ve seen how CIM’s fit into the M&A process and their role in facilitating confidentiality in the deal, we’ll look at what to include in a confidential information memorandum.
Now that we understand what a confidential information memorandum is and its role in the M&A process, we’ll look at what should be included in a CIM.
Naturally, each business will have unique information it will want to convey to potential buyers. The better the information that a prospective buyer has about your business, the better they will be able to conduct their financial valuation and qualitative assessment of your business. In other words, the more information they have the better an offer they can make. This is true up until a point and the next section will look at what should be excluded from a CIM.
Typically, a CIM is prepared with the help of an investment bank or M&A advisor, so entrepreneurs normally don’t write this document alone. These advisors will have input and guidance into what should be included in the CIM.
However, here are some things that should be included in confidential information memorandums for clarity. Normally, these topics would make up sections in the document.
1. Business Model – This document should explain how your business model works, what makes it unique, how your offer or value proposition is different than competitors, and give insights into how to scale the business further from here.
2. List of Products or Services – Use this section to explain what you are selling and explain how this works. This section should include a list of your company’s products or services and it should also break down these products or services by the percentage of revenue they account for. If your business uses suppliers or outsources part of the services it delivers you can also list these suppliers and partners here. This may or may not make sense depending on the nature of your business, the size of the suppliers/contractors, or the degree to which you are concerned about confidentiality. This would be a good conversation to have with the investment bank or the advisor helping you to create your CIM.
3. Customer Acquisition – This section should explain how your business makes money. How do you acquire new customers? What does it cost to acquire a new customer. What is your return on ad spend (ROAS). If you can, when you are calculating ROAS, use lifetime gross profit per customer. It’s also beneficial to include how much market share your company has. Some strategic buyers look for this specifically. It’s also important to include your recurring revenue and churn rates here. Additionally, buyers will want to determine if your business is channel dependent. Do you get all of your website traffic from Facebook ads? Channel dependency is a big reason why a buyer would decrease their purchase price or structure some compensation in the form of an earnout. You will want to take measures to make sure your business is not channel dependent before you try and sell the company.
4. Defensibility/Economic Moat – What gives your business a defensible growth position? Does your business have patents or trademarks? Are the costs to grow substantial? Give some thought to what makes your market position defensible and spell it out for the buyer.
5. Detailed Financials – You should include financial statements for the last three to five years as well as future projections for the next two years. They will need financial information to properly value your business.
6. Organizational Structure – This section is important to use as a way to show that the business is not dependent on the founders. Here, you should include an overview of your management team that has bios for each team member and shows their compensation. Talk about each managers responsibility over their domain. If your business is personnel heavy, then you could try to show how an acquisition could improve margins or efficiency through cutting jobs or through adding expertise or through implementing professional management practices. Exclude the names and the contact information of each manager. You can list them by their job title and use the bio section to give insights into previous work experience, education, and career growth at your business.
7. Customer Information – This section is intended to describe your business’ customers. What market do you serve. Give prospective buyers an idea of who your customer avatar is. Do you have enterprise customers? (As a side note, never include the names or contact information for these accounts.) You could use this section to talk about how you intend to expand and how you could reach new customers with a capital investment. Could prospective buyers do more? Could they enter new markets or target new customers through this acquisition?
8. Industry Overview – This section is supposed to provide prospective buyers with information about the industry you operate in. Is your industry growing or declining? How quickly? You could use this section to talk about what is changing in your industry and how your business intends to capitalize on this.
Now that we understand the role of a confidential information memorandum in the M&A process and what should be included in a CIM, we will look at what should be excluded from the document.
Why should we exclude anything?
The answer is that we can’t know the true intentions of a business or investment group just because they approach us claiming to be prospective buyers.
When thinking through what should be excluded from a CIM, we need to think about what would jeopardize our business if it were to get out. This concept will pertain to some businesses more than others. As a simple example, if you owned a soft drink company, you wouldn’t want to put your exact recipe formula in the CIM. Potential buyers would be able to see almost everything about your company, except that piece of proprietary information. They shouldn’t see something like that until the wire transfer clears. Certain businesses will have more to be excluded from a CIM than others. These businesses may include businesses making food or drink products, software or technology companies, pharmaceutical companies, and companies with cutting-edge R&D or valuable proprietary information.
Along these lines, a list of things to exclude from a confidential information memorandum would include proprietary algorithms, recipes, formulas, and active ingredients (in pharmaceuticals).
This is not an exhaustive list. The point is to think through what a competitor or a business with an ulterior motive, under the guise of a prospective buyer would get in exchange for signing an NDA. You would want to take into consideration what can’t be “unseen.”
After reviewing the CIM a prospective buyer will use this information to come up with a price range that would make sense to pay for this business. This will be dependent on the nature of the business, what makes it unique, as well as the type of prospective buyer (see Financial Vs Strategic Buyers for more info on this).
After the prospective buyer has this price range, they will typically begin negotiating.
If the seller and the buyer agree on a potential deal, then these negotiations will normally conclude with the prospective buyer drafting a Letter of Intent (LOI). This LOI serves to crystalize the discussions up until this point, formally summarizing the deal on the table. The letter of intent is a partially-binding document which is for the most part, typically non-binding, except for the fact that it gives the prospective buyer a period of exclusivity with which to conduct their Due Diligence of the business. During the due diligence phase, they will look to vet and verify the information they have received in the confidential information memorandum.
