The Perils of Going It Alone
Experienced M&A advisors have seen it all – and that experience can be the key to successfully closing a deal.
Most business owners negotiate dozens of agreements over the course of their careers. And many have been involved in some capacity in an acquisition transaction. Still, given that there are few things as important to the owner of a company as its sale, it is surprising that upon receiving an unsolicited approach for their own company, they often extrapolate that completing a deal should be a relatively straightforward matter, not so different than these other contract negotiations.
We see the following sequence of events happen time and time again:
When a large industry player expresses unsolicited interest in buying their company, it is quite simply flattering. Consequently, the owner is mesmerized by the prospect of a quick and smooth transaction process that avoids the time, effort and expense required to conduct a broad marketing process involving multiple potential buyers. The thinking is that a strategic buyer who “is in the business” will appreciate the full value of their company and have limited due diligence requirements, and thus all that is needed to complete the deal is some perfunctory legal documentation. The only advisor needed is their long-standing lawyer.
Here is how this actually plays out…
First the buyer expresses admiration for the business and describes the myriad benefits of a combination (faster growth, new customers, economies of scale, etc.). They may even insist on an in-person meeting at the facility followed by dinner and drinks to foster a personal connection;
Next, they request some summary financial and operational information and ask a few follow-up questions; and
Then they explain their general approach to acquisitions, provide some high-level terms, and before you know it, the outline of a deal seems to be taking shape.
With such an eager and seemingly logical buyer in hand, closing seems almost inevitable. The business owner worries that involving an M&A advisor at this point will upset the cozy relationship developing with the buyer and is convinced it will extend the timeline. Besides, at this point, it appears that all that remains is to confirm some information and negotiate the legal documentation, and with their long-serving lawyer, this seems manageable.
And it would be wonderful if this story has a happy ending, but it always takes a turn for the worse. First, the buyer will demand exclusivity well before having invested real resources to deserve such a preferred position. Nonetheless most business owners are hard-pressed under the circumstances to push back, so they concede whatever leverage they had. Then, far along in the exclusivity period, the buyer will propose a material change to the terms. This can come in many forms:
- They might reduce the purchase price or propose an earn-out as they concluded that the “true” earnings are lower than presented.
- They might require an elevated level of working capital to remain in the business (effectively lowering the purchase price).
- They might express concern about ongoing litigation and want holdbacks to the purchase price.
- They might propose a structure that has significant adverse tax implications for you.
- They might reveal that the transaction is actually subject to financing.
But in all cases, you realize that the outline of the deal you thought was “done” was in fact just an outline and you didn’t realize all of the material elements of the transaction that were never mentioned, let alone agreed, and the sophisticated buyer capitalizes on your inexperience.
Business owners who find themselves in this position follow one of these three courses of action:
- They make a material concession on price or terms, either too invested or too proud to admit that that they significantly overestimated how close they were to the finish line and accept an unattractive deal;
- They walk-away, reassess their objectives and start over, justifying the time invested and business disruption as a “learning experience”; or
- They engage a financial advisor to try to salvage the deal and/or create competition.
How an advisor can help (even in the midst of advanced discussions)
It is no surprise that a non-competitive situation is highly valued by all buyers. It is not just that, without the threat of another party offering a superior value and better terms, a seller will have little leverage in the negotiations. The issue is that many first-time sellers do not know what they do not know. As a result, buyers are tactical in focusing initially on the positive with the intention of introducing issues and concerns later in the process, which obviously disadvantages the seller. We characterize this type of warm, unsolicited approach from a buyer as a calculated strategy to obtain the option to purchase the business at terms to be determined and subject to comprehensive due diligence.
Accordingly, in these situations where there have been some prior discussions between buyer and seller, an experienced M&A advisor adds tremendous value by leveling the playing field and enabling sellers to reassert control of the process, protecting them from a variety of potential pitfalls. The specific areas where an M&A advisor can make a difference include:
Identifying business issues and developing solutions
In the rush to move forward with a deal, sellers often assume that an eager buyer will focus less on the current performance and potential issues in the business and offer a purchase price based primarily on “strategic value”. However, buyers – especially post-pandemic – are highly focused on identifying issues that may affect value and using this information to adjust the terms of the deal to the detriment of the seller, such as significant customer concentration, or questionable accounting practices, or over-reliance on the owner or long-standing unfilled vacancies in the management team. Moreover, the identification of one issue will cause a buyer to be hyper-vigilant in searching for other issues. An experienced M&A advisor will immediately recognize these issues and propose solutions to mitigate any negative impact on the transaction before they are identified by a buyer.
Identifying unspoken issues
Seasoned buyers are aware that most sellers are not familiar with the strategies utilized to improve the economics of the transaction for the benefit of the buyer. For this reason, buyers often prefer to deal directly with sellers to avoid close scrutiny of their deal and maintain an advantageous position. An experienced advisor will “read between the lines” and call out the issues with proposed transaction terms while they are still being considered and negotiate a better outcome for the seller. Examples of such unstated issues include: no mention of the target net working capital or adjustment mechanism, the tax implications and treatment of liabilities of an asset purchase vs a stock purchase or the tax disadvantages of an earnout that is predicated on continued employment.
Identifying the conditionality of a proposal
Another crucial role of an experienced advisor is to understand the certainty a proposed transaction might actually close. Assessing certain key transaction dynamics, such as (1) the sources of equity and debt financing supporting a proposal and the likelihood such financing will be secured, (2) the nature of internal approvals required to complete a transaction (such as an investment committee or board of directors) and external consents and (3) the scope of the due diligence exercise (include contacting customers) will be invaluable at the outset to ensure there is a credible path to completing the transaction and to protect a seller from sharing sensitive information unnecessarily or prematurely. In addition, the advisor will insist on milestones to ensure the timetable is being followed with momentum and terminate exclusivity if appropriate. Sellers trying to “go it alone” are generally not equipped with the market knowledge to make the determination of transaction certainty and can accordingly waste significant resources on a suspect buyer.
Creating a credible competitive threat
We have heard the various reasons from business owners to explain their reluctance to introduce an investment banker into the bilateral discussions with a potential buyer:
- It will delay the process…
- It will unnerve the buyer…
- It is expensive…
- My lawyer can handle the negotiations…
One truth we have learned from decades in the M&A business is that no buyer has paid $1 more for an acquisition than they needed to in order to complete the transaction. An experienced M&A advisor will have the skills to navigate these concerns about timing and the tone of the discussions and, importantly, does not in all cases need to aggressively push the buyer on price and terms, but rather can be working in the background to develop marketing materials, researching buyers, arranging a data room as a way to constantly remind the buyer that the seller is prepared to embark on a broaden marketing process at a moment’s notice.
The price of peace of mind
We recognize that selling their company provides business owners with the opportunity to monetize decades of hard work and our expertise is ensuring this happens. On a regular basis we are engaged by private business owners who thought they had everything under control – until they suddenly didn’t. Without exception, these clients appreciate the immediate value we add by changing the transaction dynamics such that they are no longer always on the defensive. In addition, they welcome the reality check on the overall suitability of the buyer and on their ability to complete a deal. By helping position the business properly, calling out non-market provisions and negotiating intelligently, an M&A advisor’s specialized expertise can keep a buyer “honest” and increase the likelihood that a deal will achieve the seller’s objectives.