How to Read an Information MemorandumMedium

A hundred pages written by the seller's adviser to make a business look sellable. Everything in it is true and it is not the whole truth.

5 min read · 861 words

Who wrote it, and why that is the first fact

An information memorandum is prepared by the seller's adviser to sell a business. It is not a prospectus — no regulator approved it, no auditor signed it, and no liability regime governs it in the way one governs a public offering document.

That does not make it dishonest. Almost everything in one is factually accurate, because a misstatement discovered in diligence destroys the process and can create liability under the sale agreement. What it is, precisely, is selective: true facts, chosen, ordered and framed by somebody paid on completion.

So the reading method is not to look for lies. It is to work out what question each section was built to answer, and what question it was built to avoid.

The process it belongs to is the sell-side auction.

The order to read it in

1. The adjusted earnings bridge. Almost always in an appendix. It is the transaction.
2. Historical financials, before the forecast.
3. Customer concentration and contract lengths.
4. The management case, last — because by then you can see what it assumes.

1. The adjusted earnings bridge

Every information memorandum presents an adjusted figure, and every buyer will pay a multiple of it. The bridge from statutory profit to that number is the single most important page in the book, and it is rarely at the front.

Typical adjustments, each of which needs testing:

• Owner's remuneration normalised to a market salary — usually legitimate, and the size tells you how the business was run.
• One-off costs — a restructuring, a legal case, a failed project. Look at how many years in a row contain one-offs; a business with exceptional items every year has a category of ordinary cost it prefers to call exceptional.
• Run-rate effect of actions already taken, such as a price rise implemented in the final quarter annualised across the year.
• Pro forma acquisitions, counted for a full year.
• Standalone costs, added rather than removed, in a carve-out — and this is where sellers and buyers differ most.

Rebuild the number with only the adjustments you accept, and apply the multiple to that. The difference between your figure and the seller's, multiplied by the multiple, is usually larger than everything else you will negotiate.

2. The historical numbers, and which years appear

Three years is conventional. Ask why these three. A business shown from a weak year to a strong one has a flattering growth rate that a different start date would not produce, and the choice of period is a decision made by somebody with an interest.

Look for the quarterly or monthly series if it is there. Annual figures hide the shape, and a business whose growth all occurred in one quarter eighteen months ago is a different business from one growing steadily.

3. Customers, contracts and concentration

• How much revenue comes from the largest few customers. Frequently presented as a percentage from the top ten, which conceals whether one of them is most of it.
• Contract length and renewal dates. A large customer whose contract expires four months after completion is a fact that belongs on the first page and is usually in an appendix.
• Change-of-control clauses. Which customers can walk away because the business was sold — see the share purchase, where these become conditions.
• Churn, and whether it is measured by customers or by revenue. The two differ and the friendlier one is usually shown.

4. The management case

A forecast prepared by people who will be paid if the business sells, and who may be investing alongside the buyer. That does not make it wrong; it makes it a document with a direction.

Two tests. First, compare the forecast growth with the historical growth — a plan that inflects upwards at the moment of sale needs a reason that is in the document. Second, look at what the plan assumes about investment: a forecast with rising margins and falling capital expenditure is describing a business that improves while being starved.

5. Vendor due diligence

The seller commissions its own reports and gives them to every bidder. It genuinely saves time and standardises what everybody knows. It is also written by advisers engaged by the seller, and the reliance letters that let a buyer depend on them are negotiated separately and sometimes not given at all.

Read the scope section. What a report did not examine is as informative as what it found.

What is not in it

The absences are the point, and the common ones are consistent:

• Working capital seasonality, which decides how much cash the buyer needs on day one.
• Deferred maintenance and capital expenditure that has been delayed.
• Employee matters — pensions, disputes, key-person dependency.
• Anything that will surface in diligence anyway, which the seller has decided to let the buyer find rather than to feature.

The four questions to leave with

1. What is the earnings figure with only the adjustments I accept?
2. Which customer, if it left, would change the answer?
3. What does the forecast assume that the history does not support?
4. What did the vendor reports not look at?