Why and how to draft a Confidential Information Memorandum?

Finance is not all about numbers. In some cases, soft skills such as writing, pitching, negotiating and selling are more valuable assets.

In the case of mergers and acquisitions (“M&A”), selling a business involves following a thorough process and drafting formal documents such as the confidential information memorandum (“CIM”). This document is also used in investment banking, private equity and other sell-side roles.

The purpose of the CIM is to attract the interest of potential buyers. It is a marketing document used by bankers and M&A advisors to convey important information about a business such as its operations, finances, management team, products & services, target markets, competitors and other data to a prospective buyer.

Drafting a CIM requires strategic thinking and writing skills. The main challenge is to position the business at its best without going overboard.

That being said, we will discuss the process of drafting a CIM, how investment and private equity bankers use it, along with some tangible examples.

What is a CIM

The CIM, also known as Offering Memorandum (“OM”) or Information Memorandum (“IM”), is used in investment banking as part of the sale process to attract interest from potential investors. It is a marketing document that gives detailed information about the target business to the acquirer. The goal of the CIM is not only to sell the company, but to sell it at its maximum value. Usually, it is the investment banker or the M&A advisor that prepares the CIM.

However, before drafting a CIM, the M&A advisor will start with an overview of the business through a “Teaser”. This will be a 5-page document highlighting enough information to grab the investor’s attention, which is less time consuming. At this stage, the objective is to attract potential buyers and to move the process along, before investing time and resources to drafting the full CIM. Most of the relevant information, at this stage, will be obtained through the client himself.

Once potential purchasers have expressed a desire to move forward with the process, a non-disclosure agreement (“NDA”) will be drafted by the sell-side lawyer and signed by all parties to the transaction. Then, the CIM will be drafted.

The M&A advisor can draft a CIM in deals involving debt such as a leveraged buy-out (“LBO”) to advise the lender and the acquirer. However, the CIM can also be drafted in distressed and restructuring deals to advise the debtor. Sometimes, a short memo will suffice, such as in equity deals.

What a CIM is not

With that said, it is important to understand what a CIM is not.

1. A CIM is not a legally binding document. It is a marketing document which goal is to present the target company at its optimal position to attract interest from acquirers. It is up to the investor to read between the lines of the CIM and spot additional strengths and weaknesses or potential underlying risk factors. Experience will therefore play a major role, which will be required in many buy-side roles.

2. Also, the CIM does not disclose anything about business valuation. The business valuation of the business is an entirely separate process. It will usually start further along the M&A process; once an initial commitment from the seller has been expressed.

3. Finally, the CIM is not a pitch book. A pitch book is comparable to a service offering. It has the intent to sell the service or, in this case, the CIM. Drafting the CIM means that the M&A engagement has already been approved by the client.

Skills needed to draft and read a CIM

You should now grasp that the CIM is foremost a marketing document. This means that soft skills such as writing, presenting, and strategic positioning are far more predominant than technical financial modelling skills. Yet, both are important, whether you are on the sell-side or the buy-side of the transaction. However, the seller will not want to spend time on complex financial models when no preliminary interest has been demonstrated on the open market.

Another skill to master, on the buy-side, is efficient reading. As mentioned previously, the acquirer needs to spot potential risks and underlying elements from the CIM. Of course, it is always possible to spot undisclosed risks or elements during the due diligence process. However, rejecting the unattractive deals at the beginning saves a lot of time.

 Moving forward along the buying process means rejecting a collection of other unattractive deals.

Contents of the CIM

The contents of the CIM varies from one advisory firm to the next, but the main information conveyed stays the same.

1. Executive Summary;      

2. Investment Thesis or Transaction Objectives;     

3. Overview of the Target Company’s operations; 

4. Summary of the Industry;

5. Overview of the Market;

6. Products and Services;

7. Supply Chain Management;       

8. Revenue Profile;

9. Employee Profile;           

10. Customer Profile;

11. Facilities, Equipment and Intangible assets;

12. Analysis of historical results and future projections;

13. Management Structure and Strength of management team;

14. Risk factors (often missed out);

15. A summary of the auction process including the proposed structure of the deal and timing for receipts of expressions of interest or letters of intent; and

16. Appendices.

Appendices will usually include, but not limited to:

• Proposed terms of the debt financing – repayment, interest rates, maturity, covenants, mortgage, debt default, other; and

• Sources and uses of funds.

The process to drafting a CIM

Capturing preliminary information

The first step to drafting a confidential information memorandum or CIM is capturing relevant information about the business from management. Management is a unique source of data since it possesses intimate knowledge about the state of the business, such as:

• Economic and industry performance;

• Operational strengths, weaknesses and opportunities;

• Main business challenges and opportunities;

• Internal processes;

• Competitors;

• Human resources;

• Customer diversification;

• Contracts;

• Lawsuits; and

• Financial statements and income tax schedules.

This preliminary information will set the stage to the story telling. It is important to keep in mind that we are trying to portray the business at its optimal state. Each element of information must add value and illustrate the business as being an authority in its field. It is crucial that all valuable attributes of the business are highlighted in the CIM to get the best terms, highest possible price and attract the best investor or buyer.

It is also important to keep track of any economical data such as trends, growth rates, customer segmentation, revenue segmentation (in %) and so forth because they will have a direct impact on the financial projections.

There are 2 types of investors that we can attract in an M&A deal.

1. The strategic investor: This buyer possesses either a wide knowledge about the industry, a strong network and can act as an advisor for the business. He usually is an active partner in the business, which means he has a right to participate and vote in the strategic decisions of the business.

2. The financial investor: This investor brings in a big inflow of money when he invests. However, as opposed to the strategic investor, he usually takes a more passive role within the operations of the business. He usually is not entitled to dictate the operations of the business. Rather, he is seeking an ROI (Return-On-Investment) on his buy-in and usually seeks dividend payments.

Depending on whether management is seeking a strategic business partner or is simply seeking money to operate, the CIM will need to attract the right investor.

Capturing missing elements

Because of the confidential nature of the information exchanged as well as time constraints, not all relevant data will be captured during the kick-off meeting with management. Further research will need to be made. This normally is the case for:

• Industry trends and statistics;

• Growth drivers;

• Economic outlook and expert forecasts;

• Market shares and market size;

• Product demand, trend, growth and competition; and

• Types of customers and untouched segments.

Many resources are available to do so such as Statistics Canada, Bloomberg, Professional Associations, Bank of Canada and much more.

Structuring the data

Once the right data has been collected, it is time to structure it with a thorough plan. The goal is to not scatter the information, but rather present it in a logical way so that each subsection adds to the next. Here is an example of a structured plan:

Once the relevant information has been properly structured, it is time to strategically draft the CIM.

Respecting the order for efficient writing

Although a CIM can be written in many different ways, a certain methodology always helps to be more efficient:

1. Leave the financial statement analysis and projections for the end;

2. Start with high level sections such as the business overview and management team, which are more straight-forward;

3. The market and industry analysis will take a large part of your time. This will involve a lot of copy-pasting and editing of information. The key is to highlight the favorable elements of your research, such as the forecast CAGR, strong demand for products and services, strongest geographical markets, and other positive trends; and

4. The executive summary should tie all sections together. It would therefore be easier to draft it after having completed all other sections, because the information will be ready and available to summarize.

Use charts and graphs

1 picture is often worth a thousand words. Using charts, pie-charts and graphs helps to anchor the idea as well as the analysis for the reader. It is also easier to compare results over time and demonstrate the growth with expanding curve lines. Here are a few example over useful illustrations that should be included in a CIM.

1.       Historical Revenue and EBITDA CAGR

2.       Forecasted Revenue and EBITDA CAGR

3.       Revenue segmentation

4.       Market trends

Build the financial projections

The first step to building financial projections is analyzing historical results, which are found in the historical financial statements. Once you have spotted the key trends and variables, you will use them as inputs into your financial model.

The key to building a strong financial model is supporting the hypotheses and underlying variables with strong sources of information. This final step is intrinsically linked with all the data collection and market research done previously.

The key financial projection components are:                                                                     

1. Historical revenue growth;

2. EBITDA (Earnings before interest, taxes, depreciation and amortization) growth

3. Free cash flow growth;

4. Working capital requirements;

5. CAPEX (Capital expenditures) requirements;                                                       

6. Volume and Economics such as units sold, inflation rate, industry growth rate;                    

7. Price Sensitivity and premiums over time;                                                                            

8. Cost of Goods Sold (COGS);                                                                        

9. Fixed and Variable Expenses;                                                                     

10. Margins & KPIs (Key Performance Indicators); and

11. Industry benchmark and comparable transactions.                                                           

How to strategically read the Confidential Information Memorandum?

Just as in drafting the CIM, efficiently reading it will save the investor or the buy-side advisor a lot of time. You should be able to make a decision within a 10-15 min read.

The difference between reading and drafting a CIM is huge. In the former, the financials will dictate whether or not the read is worth your time, as opposed to the latter, where financials should be tackled further along the process when an interest from the potential buyer is manifested after reading the executive summary.

Follow these steps

1. Start with the executive summary to quickly get a snapshot of the company’s operations, industry and the important financial KPIs such as revenues, EBITDA, free cash flow. With that in mind, you will already know if this is a good investment of your time.

2. Continue with the financial statement analysis and projections. As opposed to drafting the CIM, the financials will communicate if the business is profitable or not and therefore, should be prioritized before other sections. Spend time understanding revenue growth, EBITDA margins, Working capital and Capex requirements and free cash flow (“FCF”).

3. Once you are comfortable with the financials, move on to the market and industry analysis. Make sure to understand how the company operates, what are the growth indicators for the industry, what is the market size, the customer and product segmentation.

4. You can then complete the reading with all other relevant sections such as the management team, key employees, supply chain management.

Conclusion

Whether you are a seller, a lender or a purchaser, the CIM will definitely be a document that will need to be drafted and read thoroughly. A lot of example of CIMs can be found online. It takes time and perseverance to become an expert at collecting the right data, spotting underlying trends and risks as well as positioning the business at its best light within the CIM.

With that said, would you like to know what should be included in each section of the CIM?