Executive Summary
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Advisers advise, principals decide. Advisers may not understand industry-specific risks and are therefore badly placed to make judgments on some risk issues. Be prepared to debate with your own advisers and to overrule them if your knowledge is superior, no matter how much they are being paid.
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Don’t buy a dog and bark yourself. Corporate sales are complex and risky. Appoint experienced advisers and get them to manage the process under your control.
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Information. The importance of information cannot be overemphasized. Buyers are motivated by fear and greed: The quality, tone, and flow of information critically impact both motives.
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Valuation. Agree what the walkaway price is with your advisers before starting a process, review it constantly, and be prepared to walk away if necessary.
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Competitive tension. The best deals are achieved where more than one buyer with cash (but not an uncontrollable host) wants to purchase a business. Use this rivalry to maximize the bids received and to eliminate risks that might prevent the buyer from delivering the deal.
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Blunderbuss versus rifle shot. Most businesses have a limited target population of buyers who may pay a strategic premium. The approach when marketing needs to favor those most likely to pay the best price.
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Financial bidders are active. In the past 20 years more businesses worldwide have probably been sold to private equity firms than any other type of acquirer. Use them to create competitive tension.
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Auctions have to be managed. Theory and practice suggest that many tactics in auctions are counterintuitive. Think through what you are going to do and clearly communicate it to potential purchasers.
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Say nothing. There are always matters that are uncertain in any deal. Staff are always unsettled by uncertainty. It is best to say nothing at all to them, but if you do decide to explain what is happening, you must be completely honest. But remember, any ambiguity is interpreted negatively.
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Only the fittest survive. Transactions are long and often tedious. Do not let boredom, fatigue, or lack of patience deflect you from your final goal, especially when the winning line is near.
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The one that got away. The world is full of people who nearly did the best deal ever. To achieve success, you need to give and take; it is not a war, it is a negotiation.
Introduction
All corporations seem complex to those looking in from the outside. The cocktail of relationships, contracts, and assets coming together to generate value is different in every company, and the process of realizing the value embedded in that cocktail requires planning, foresight, and pragmatic judgment. Failure to sell a business that has been publicly put up for sale can destroy huge amounts of value. Each situation is unique and no text can provide a comprehensive guide, any more than you could write the complete guide to sailing in all weathers. This article will deal with general principles and strategies, not technical details. Furthermore, it will address the question of how to sell a business, not why you should sell a business.
Advisers—What They Do, What They Don’t Do
It would be perverse not to believe that corporate finance advice is valuable. Here is one casual, empirical data point that supports this view: Private equity firms, many themselves ex-corporate financiers, and whose core business is buying and selling companies, almost always use advisers. The question is not whether to appoint advisers; it is what should they be tasked with doing, and what is the limit of their role. Their role is not to make decisions. They are there to limit the number of decisions the vendor has to make regarding the key commercial factors that make deals happen. Good advisers should be prepared to debate decisions and use their experience to guide their clients toward the paths of least resistance. However, only the owners can make the final decisions.
Having described what advisers don’t do, the natural question is: So what do they do? The answer to this is—pretty much everything except making the final commercial decisions. Expect advisers to prepare, collate, and analyze data that will be presented to potential purchasers. They should project manage every aspect of the sale process, providing a clear and coherent strategy to achieve a successful outcome with an acceptable level of risk. This is the necessary skill set of any adviser and it enables the company to concentrate on delivering to its customers, not preparing itself for sale. As the saying goes, “Don’t buy a dog and bark yourself.”
The added value in corporate finance comes in three ways. First is the ephemeral thing called judgment. As one partner of a major British practice used to describe it, having a good “bullshit detector” helps. Second is the ability to take the burden away from the client. Advisers should do all the heavy lifting, leaving their clients to concentrate on the business itself and the key decisions. Finally, and of crucial importance in many deals, advisers need to be able to access the right people in the right places who may wish to acquire the business.
Information—What You Say, and How You Say It
In 2001 three US economists, Akerlof, Steiglitz, and Spencer shared the Nobel Prize in economics. Their body of work deals with an area formally known as “information asymmetry,” or more colloquially: What do you do when I know things you don’t know? This section tries to answer a simple question: If a purchaser can’t tell a good car from a bad car, how can a seller get a premium for a good car? The same problem arises when you are selling a company, only more so. Companies are the most complex things that are traded, and selling one may transfer all the future and historical risks and rewards to the new owner. If you cannot persuade the new owner that the net value of those risks and rewards is quantifiable and positive, you won’t sell the business. This is one of the commonest areas in which transactions fail. A failure to think through the strategy of managing and transmitting information results in transactions falling apart further down the line, as purchasers narrow the information asymmetry in due diligence and find that what they were told originally is not what they found to be true subsequently.
There are a number of ways to deal with information asymmetry. The simplest and crudest solution is to ignore the issue entirely. Provide limited data and tell purchasers to rely on their own judgment. In essence, this is what happens in an unsolicited hostile takeover, and may well be the reason that so many hostile approaches subsequently turn out to be failures.
To bridge the asymmetry you can either transmit information (under a suitable confidentiality agreement) or agree to take residual risks away from the purchaser by, for example, giving warranties. At the extremes, the negotiating positions are either: “We will give you access to do whatever due diligence you like, but we are not warranting anything,” or “We will warrant that the information we give to you is materially correct, but you are not getting any more access than that.” The approach to this question needs to be decided early on since it flows through the entire transaction approach and materially influences the form of legal agreement that will emerge at the end of the process. It is also important to communicate your approach to purchasers clearly and consistently. If you do not, they will impose their view on you and purchasers will seek both a belt and suspenders: full access, and full warranties.
Valuation … Is in the Eye of the Beholder
In theory, the value of any asset is the present value of its future cash flows. To maximize value, you need to show the maximum future cash flow and the minimum cost of capital. This leads to the infamous “hockey stick” projections—projections that reverse a declining trend and rise thereafter. These are fed into a spreadsheet and out pops a valuation. The danger of believing your own propaganda is that you set unrealistic targets. You must aim high, but not every attempt can be a world record.
In addition to DCF (discounted cash flow) valuations, advisers should prepare a variety of analyses. Comparable transactions that have occurred recently and analysis of comparable quoted companies valuations are the most frequently seen.
Another way to discover what advisers think your business is really worth is to look at where their fee proposal starts to generate significant uplift. Where fees are correlated to value, you can often work out the implicit valuation of any adviser from their fee proposal.
It is frequently contended that the most important output of the theoretical valuation process is not the maximum number calculated, but that it validates a “walkaway” price—the price at which the vendor will simply stop the process and refuse to sell. This number needs to be at the forefront of your mind in any negotiation. It also needs to be refreshed periodically if the prospects for the business or its markets change materially.
It is also important to remember that all these analyses are simply checking out the potential valuation. To actually achieve a transaction at a particular valuation, you normally need competitive tension or a compelling strategic premium.
Competitive Tension—Creating Fear, Encouraging Greed
Once you have surveyed the landscape, the task is to identify and communicate with those purchasers most likely to place a valuation on the business that they can afford to pay and which exceeds the walkaway price. When considering the number of parties to approach to create a market, again there are two extremes: blunderbuss or rifle shot.
The blunderbuss approach says that since you never know who might be looking for a business like yours, you should maximize the probability of hitting the target by firing as widely as possible. The downside is that circulating information widely makes a confidential process most unlikely.
The rifle shot approach targets a limited number of buyers, maximizing the probability of reaching those specific purchasers wishing to acquire the business. You risk missing a purchaser that you don’t know of, but the process can be managed much more efficiently in a small and tightly controlled market.
Whichever approach is used, maximum tension requires only a few, well-funded potential purchasers to emerge from the initial marketing. There is not much to gain from an auction with seven purchasers compared to an auction with six, but it is much harder to efficiently manage a large number of parties. The number of parties taken into the final process needs to be consistent with the information strategy adopted. It’s no use offering open access with no warranties to a large number of bidders; it is unmanageable in practice.
The special case of a market with one buyer presents different challenges. Here there are different ways to motivate a deal. In a market of one, you have to adopt either the “takeaway sale,” or enter a courtship.
The takeaway sale is a tactic used by realtors and used car salesmen across the globe. You quickly show your wares and then you rapidly remove them. The message is clear: It is a once in a lifetime opportunity to buy this house/car/company, and it won’t come again; act quickly. This is a risky approach. If the purchaser doesn’t believe you, your negotiating position can be seriously undermined if they react with a studied show of indifference to the opportunity presented. However when it does work, it can produce spectacular results because a strategic premium is paid by the purchaser.
Courtship is subtler and has its own risks and rewards. It involves exploring possibilities and exchanging information and plans to build a consensus on the way forward and what that means in terms of valuation. When the logic of bringing two companies together is compelling, two questions often arise: First, which is the diner and which is the dinner? Second, even if the cake is bigger, you still have to negotiate how it is going to be shared. A courtship strategy requires a significant investment of senior management time and emotion.
The biggest risk in a failed courtship is, as we all know, the effect of a broken heart. The impact on corporations of a failed courtship should not be underestimated: It can paralyze a corporation just as surely as it can turn a teenager into a gibbering wreck.
Financial Purchasers—Elephants or Dung Beetles
Financial buyers come in many forms and provide liquidity to many different markets. The private equity (PE) industry contains both large strategic purchasers (elephants) and opportunists, who seek to snap up companies when no strategic purchaser emerges (dung beetles). Whichever strategy they are pursuing, and despite being much misunderstood and maligned, over the past 20 years financial purchasers have acquired more companies than trade acquirers. Any vendor who does not consider the PE market as a potential purchaser may be missing, at a minimum, a valuable source of competitive tension, and possibly the optimal purchaser.
Auctions—Theory and Practice
In a traditional, so-called English auction, bidding stops when the last but one bidder drops out. The vendor receives fractionally more than the second highest bidder was willing to pay. There are various ways to attempt to capture the value that the highest bidder might have paid. For example, a reverse auction (also known as a Dutch or clock auction) operates by the price declining until it is accepted by a bidder. This results in the so-called winner’s curse—the only thing that the purchaser knows for certain is that they paid more than anyone else would have.
A counterintuitive solution to the problem was proposed by US economist William Vickrey. In a Vickrey auction, sealed bids are received and the asset is sold to the highest bidder, but at the price bid by the second highest bidder. This system ensures that each bidder bids their own true valuation, rather than speculating on the possible bids of other parties. The theoretical underpinnings are outside the scope of this chapter, but Vickrey was (jointly) awarded the 1996 Nobel Prize in economics for his work in this area.
Information from the first round of bids can be used to intensify informed competitive tension in subsequent rounds. For example, in a group of four second-round bidders, all the bidders might be informed of the value of the third highest bid received in round one. This tells the two highest bidders that they were one of two, but not who was highest. It tells the third highest bidder that they were third, and similarly tells the fourth highest that they are playing catch-up. The information provided by the first-round bids gives each party a clear steer on their position in the process and a strong guide regarding the landscape of the bids.
In practice much of auction theory is of only partial relevance to any corporate sale because the theory is predicated on the assumption that completion of the transaction occurs simultaneously with acceptance of the bid. In practice, of course, there is usually confirmatory due diligence and negotiation of legal agreements to follow.
Defending the Price
Whereas the auction process is designed to drive up the price, the period between accepting an offer and completion is usually defensive. The purchaser may try to find a justification to “chip” the price, and will rarely give any credit for positive variances against any plans they have relied on in the bid. The standard negotiating position of any purchaser when faced with positive information is, “We anticipated improvements in our original bid.”
Negative variances are rarely anticipated in a bid and often result in variations to the terms of the indicative offer. Be aware that the legal status of an indicative offer varies from country to country. Whereas most UK and US acquirers view indicative offers relatively lightly, many non-Anglo-Saxon countries view the making of any offer, however qualified it may be, as significant and, in some jurisdictions, potentially legally binding. It helps to understand this when judging both the offers received and the ability to meet any timetable that you might have set for purchasers.
A contract race may alleviate exposure to price chipping, but it requires purchasers to risk paying significant fees in pursuit of a transaction that they have (on average) around a 50% possibility of completing. They may not wish to play that game. Furthermore, the process may increase acquisition risk for the purchaser due to the uncertainty caused to the business, resulting in a reduced final price.
The ability to defend the price depends on the relationship between the purchasers’ and vendors’ teams, and the effective implementation of the information strategy agreed at the start of the process. If the “hockey stick” projections are not being met, expect a conversation about price to occur.
Dealing with Staff
Companies are possibly the only assets you can sell where the value of the asset is dependent on the goodwill of the people employed in the business. It is extremely difficult to maintain complete secrecy in any transaction. The requirement to collate information not routinely produced often causes questions to be asked. Similarly, e-mails and telephone calls from unfamiliar advisers may trigger suspicion. Uncertainty invariably causes discontent, and transactions involve great uncertainties. Against this background, it is generally advisable to say nothing to staff unless required to do so. Any ambiguous information is often interpreted negatively, causing even more speculation and disruption. The alternative is to communicate honestly, including all the unknowns and uncertainties, giving legitimacy to the speculation but fanning the uncertainty.
Once a deal is certain, communication with staff must form a key part of the post-transaction integration plan.
Making It Happen
Any transaction involves extensive amounts of work and lengthy negotiations peppered with key decisions. There are periods of little apparent activity followed by periods characterized by long meetings that often drag into the night. Transactions are done by people, not by processes, and it is of utmost importance that the key decision-makers do not let boredom, frustration, or fatigue cloud their judgment. Many deals have failed because the principals or their advisers could not keep their head when the finish line was in sight.
Risks often seem more significant when you stare at them for too long. At the end of any transaction there are often negotiations regarding matters that no senior manager would normally consider material. Principals need to use commercial judgment to cut through any of these issues that are holding up a deal.
Finally, the world of mergers and acquisitions (M&A) is full of people who nearly did the best deal ever. M&A is often spoken about using the language of conflict, with winners and losers. In fact, it is about negotiation, a process that requires give and take. There is no point in beating your “opponent” at the negotiating table if all you end up with is a large bill for an aborted transaction.
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