How sellers can attract the best buyers.
Sept-Oct 1995 | Mergers & Acquisitions Journal. 30.n2 (): 32(6)| by Leonard S. Caronia.
Full Text:COPYRIGHT Investment Dealers' Digest Inc. 1995 Understanding what makes different buyers tick and keeping them interested are keys to rewarding sales of businesses.
The process of selling a company or divesting a business should be designed to lead to one key objective. That is to end up with three or four competing bidders that are ready to commit to a transaction at pretty much the same point in time. The seller should keep that objective in mind at all times to help determine whether the process is leading to the desired conclusion. A well-planned process actually begins with preparations for the sale and advances through a series of steps until the transaction is completed. Step one is for the business owner to make sure, before launching the sale process, that it has considered all other options. This step is particularly important for privately held companies but it can include divestitures as well. Sometimes the owner doesn't' have to sell to accomplish what it wants. On a personal basis, the owner may want to take money out of the company, pass on ownership to heirs or management, or solve an estate problem. Strategically, the company may need a larger critical mass or new strategic component such as another company that adds a technical capability or a distribution system. Although the first thought often is that the company must be sold to accomplish all those things, there are lots of alternatives. The company may be recapitalized with long-term debt in a way that can get money out, and there are ways to pass the ownership on to the heirs while still getting capital out. Strategic investments can be made or financial equity investors can be brought in without giving up total ownership. But if the decision to sell is made - let's say the owner just wants to get all the cash out and retire step two is to get the right kind of valuation. In many ways, the valuation is the most important building block in the owner's follow-up decisions, including who the business should be sold to, who should be contacted as prospective buyers, how they should be contacted, what the information memorandum should look like, and what conversations should be held with prospective buyers. The problem with getting the right valuation is that different people can develop different valuations for the same business within a large range of numbers. None of them may be incorrect and, in fact, all may be correct depending on the benchmarks being used. Yet none of them may be the right valuation. The right valuation is really a stream of cash flows or earnings that are discounted back. But it's still not that simple because there is a real question as to what stream of cash flows is being looked at. The answer depends on how the company would be managed in the future and exactly what path it would take. On one path, the company would be run without significant change. The owner will not inject new capital, bring in new strategic investors, or take increased risks. This owner plans to run the business as is. That path is going to produce a certain stream of income, which, if discounted back, will provide a certain kind of valuation. On another path, the owner might decide to leverage the company significantly, manage it for true cash flow, and refuse to fund more speculative growth opportunities. That is a different path and it is going to produce a completely different set of numbers which, when discounted back to present value, will develop a different value. Still other paths are involved in a sale and the one taken can depend on the identity of the buyer. If the buyer is a leading competitor that can gain synergies it not only gets the revenues and the gross profits but it can eliminate a significant portion of the sales, general, and administrative costs. Again, that produces a different set of incomes and different values. But assume the buyer is in a related field and wants to be in the seller's line of business because it is similar. It doesn't offer the same synergies as a direct competitor but it can do some things. It might not be able to eliminate all of the duplicate SG&A costs because it might have to keep the seller's sales force, but it can eliminate some of the general and administrative costs such as legal and accounting expenses. The buyer may be able to increase revenues through product extension. That is another path. To be right, the valuation must be dependent on the determined path. The expert called in to do the valuation might outline the path to the seller and the seller in turn must choose which path or paths the company could take, including the most viable transaction formats available to the business. The seller should be asking a lot of questions about the sale paths. Is a leveraged buyout the best path? Is the business salable to a competitor? If a competitor buys the business, can it really save money, increase revenues, or add product lines? If it can, what cash flow could be generated from that? How much money will the buyer save? How much will it increase revenue? That should lead to an assessment of the logical groups of buyers and another set of paths that can quantify the benefits for each category. So, with the right kind of valuation, the seller can develop a range of values associated with the different categories of prospective buyers that it wants to start thinking about contacting. At this stage, the seller can start listing the advantages and disadvantages in each targeted buyer category. Does the owner want to sell to management? In a sale to management, how much of a discount must the owner take because the business might be worth more on a different path to a strategic buyer? Does the owner want to take the risk of disclosing all the numbers to competitors? If the owner decides not to sell, or the bidder is just tire-kicking, the competitor will know the seller's best customers or the product lines with the highest margins. The seller now is in position to know what the tradeoffs are, including whether there is a big price differential between going to competitors and not going to competitors. If the difference is small, the best judgment might be to leave the competitors off the list and keep the business data from them. But if the real value of your company is in consolidation with a competitor, the seller must figure out how to approach the competitor and at the same time minimize disclosure risks. The seller must be careful in developing the list of specific buyers. Sellers tend to draw what they consider a list of logical buyers by just writing down the names of competitors or anyone who had ever written a letter expressing interest in buying the company. A more sensible way is to build on the previous exercises by coming up with the most logical buyers for each path. Which financial buyers are comfortable in the seller's industry? Which competitors have the financial resources to pay for the transaction and which have the best fit? Which companies would regard the target business as a product extension that can be marketed with their existing sales forces? Or, is it best to go on yet another path and seek an overseas buyer? Developing a Contact Plan When the specific names of likely buyers are determined, it's a good idea for the seller to have a contact plan for each. That requires some research to find the best contact method and at the same time affirm that the targeted bidder indeed is a qualified buyer. If an m&a intermediary is hired, the seller should want to know in advance what its contact plan is. Just sending out a letter and hoping something happens is not the best plan. In a sale to another privately owned company, a call to the owner probably will get the attention. At a larger corporation, the head of corporate development may or may not be the right person. The research should determine that. But in any event, the seller that wants to interest a large corporation needs an internal sponsor for that transaction or it just doesn't take hold. After all of this detailed preparatory work, it is time to draft the information memorandum - based on the precept that the valuation is really a building block. The memorandum has to do certain things and present standard information but it doesn't have to be simply a show-and-tell book. If the seller has done the right valuations and plotted the paths correctly, it has thought more about the deal than the buyers have and that should be reflected in a creative information document. The memorandum should be organized in a fashion that highlights what different categories of buyers can do with the business, e.g., an international buyer, a company seeking a product line extension, a direct competitor, a financial buyer interested in an exit strategy. In addressing cost savings, the memorandum doesn't have to say that an administrative department can be cut out but it can break out the numbers to highlight administrative expenses and discuss how buyers may be able to enhance profitability by eliminating redundancies. The same format can be followed with manufacturing and sales. Details need not be extensive at this point but should offer sufficient information to tell contacted parties why they should be buyers. That would include as much data that the seller feels comfortable in disclosing which can quantify the cost savings or the revenue enhancements. When the bidders start doing their own models, they will use those disclosures to help determine whether the acquisition makes sense and what price they might be willing to pay. If the memorandum has helped to accomplish the primary objective - which is creation of bidding competition - the acquirers may not only be willing to pay the price but convinced that they have to pay it. A couple of analogous issues, that are often deferred or even forgotten about, should be dealt with before launching into negotiations. One is the seller's management. Management buy-outs are being done again and the managers could very well be a bidder for the business, perhaps in conjunction with a financial buyer or an investment banker. As a result, the owner must act to ensure that management does not become an employee group, a buyer, and a seller at the same time. There are a lot of ways to resolve the problem. One is to give management a purchase price and tell it to meet it. Another way is to analyze the calculations from the previous alternate paths. If the price to management is significantly different in value from what the paths suggest strategic buyers will pay, the owner should just tell management no. As an alternative, the owner can offer management some incentive for helping to sell the company above a certain threshold price. Whatever the choice, the owner must analyze the management option and clear it early on. The time for tax planning is now. There are all kinds of tax issues, including whether stock or assets are sold. And if there is cash on the balance sheet, there is a question of whether to include it in the purchase price or pay it out as a dividend before closing. Often tax issues get lumped into the negotiations after the letter of intent is signed and the selling owners can lose all of their flexibility. If the owner and its tax adviser can deal with the tax consequences early, the seller is in a position to tell buyers at the first contacts how it wants the transaction structured. The owner now is ready to begin the contact plan. It is useful if the seller remembers the basic objective of getting three or four competing buyers ready at about the same point in time. Everything has been aimed at that goal - selection of the right buyers, an information memorandum that is going to help them identify the benefits, and the right information that will help them quantify those benefits. While there is no set way to handle the contacts, it is a good idea for the owner or the intermediary to call the person believed to be the appropriate contact at the potential bidder. After the company is identified and its interest in selling is disclosed, the contact should be asked if her or she is interested in reviewing the materials. If the answer is yes, fax a confidentiality letter as soon as possible, but no more than three days later. When that letter comes back, the information memorandum goes out. Over the next two to three weeks or so, the owner should be prepared to answer questions about details in the information memorandum and related matters. Sometimes, the other side will want to talk price, although that is usually the province of financial buyers. At this point the strategic or corporate buyers aren't thinking so much about price. They are looking for fit and just trying to understand the business. But eventually the process will get to the price discussions. Here is where the cover letter that went with the information memorandum is important. It should have established the process and the timetable for completing the deal, not the whole process but enough of it to get down to the desired group of three or four bidders. Deadline dates for various parts of the process should be set. This is critical because the objective isn't just having three or four competing buyers. The seller wants three or four that are competing buyers and are ready at the same point. If they are ready at different points, the seller is losing all of the value of competition. For example, the letter will set a specific date for the bidders to express indications of interest with a price range. That helps to enable the seller to start screening the likely buyers and relate them to the results suggested by the various paths. One aim here is to decide whether to limit the bidding to a few prospective buyers that will be invited to see the facility, meet management, and receive additional detailed information. So, the quid pro quo for the bidder's giving the price indication is that the bidder gets to the next step, which is visiting the management and facilities of the seller. The bidder also knows that a cutting process is underway, and the seller can use it to try to get the price range up. My experience has been that if the seller has provided the right information to let the bidder identify the benefits and has stimulated competition the price ends up at the top of the submitted ranges, not at the low end. But competition is essential in getting there. One warning is that the bidder's first letter of indication of interest may not be the final one and it may go through several iterations. The seller might not be satisfied with the indicated price range or some other terms and should ask the bidder to try again. Sometimes the seller may get three or four indications of interest before receiving the official one. The seller then selects a group of the best bidders and clears the way for the next stage, which is the due diligence visit. Preparation is vital. The owner must think through what the bidders want to hear and present it as crisply as possible. We usually handle these visits in half-day sessions with a plant tour and a meeting in the morning and maybe lunch in the afternoon. No one seems to be able to survive these things all day. And the seller must remember that this is the bidder's first chance to meet the management. Coaching the Management Management needs to give a scripted presentation, so we work with them on it. That doesn't mean that it is dishonest but there are certain things that buyers are going to want to hear regarding marketing, finance, manufacturing, distribution, and whatever the other key elements of the business are. We will outline those points that need to be covered. Expect a good bit of Q&A once the presentations have been made. One helpful aid that we suggest is a binder that the visitors can take away with them. It is not like the information memorandum but, rather, a series of narratives supplementing what was presented at the meeting. For example, the sales manager may talk about the target's distribution system around the country, how many states it is in, and where sales are concentrated. This helps the presenter to reference the material and it gives the bidder's people a hard copy of what they have heard. If the business owner has done the job properly, that binder can be very useful. After identifying the various valuation paths and what prospective buyers can do with the company, the seller has now given them the necessary information to quantify, justify, and defend the value that they want to pay. They are going to have to convince somebody back in the corporate office that it is worth the price, and that information should be in that binder. It shouldn't be a case of sending the information after the meeting. It ought to be right in that binder that they walk away with at the end of the meeting. What usually follows in the next three weeks or so is a lot of questions and requests for additional information and additional material. And there is a lot of price discussion. At this stage the letter of intent comes into play. The request for the letter and the setting of a specific date to receive it probably should be made before the due diligence meeting ends. That helps keep the competitive dynamics going in line with the objective of having three or four ready bidders in the final round. Each bidder knows the timetable and that everybody is being kept on the same track. The art of this business is keeping everybody moving at the same pace. However, some people just won't be able to keep pace because key people are out of the country or they have other legitimate problems. These deviations may have to be accommodated in the timetable, but should be minimized At the other end, some bidders will want to shortcut the process with perhaps a preemptive offer. In most cases preemptive offers are not good, although there may be exceptions, and generally the owner should discourage them. So, again the art is keeping everybody in place. The importance of the letter of intent is that it shows that the companies that have signed them are truly interested in buying the business, because otherwise they would not have spent the time on it. So, this is the courtship period. The bidders are either telling the owner wonderful things about the business or saying that they have problems but can get past them. However, the tone is one of courtship. This "good feeling" environment provides the time to deal with a point that probably causes more deals to fail than price does. That is representations and warranties. They are rarely negotiated at this stage, but they should be because the stakes are so high for the seller. Private sellers, especially, have this vision that they are going to sell their company, get a check, deposit it, and walk away. But if they have missed the point on reps and warranties, they may find out that they aren't walking away. What they are being asked to do is to personally represent and personally warrant a whole variety of things with potentially expensive price tags: that receivables are collected; that customers aren't going to be leaving; that financial performance isn't going to be adversely affected by a number of items; that inventory is marketable and salable and worth every cent that is carried on the books; that there are no contingent liabilities whatsoever; that nobody is ever going to sue for anything that happened prior to closing. The owner without enough money to personally backstop these matters instead will be required to put a substantial portion of the sale proceeds in escrow. That begins to break down deals. The time to negotiate those points is during the letter of intent stage, during the courtship. In fact, we sometimes draft out how we want the reps and warranties to be structured and present them to the bidder on behalf of company being sold, not by the owner individually. The bidder receives unlimited due diligence to get comfortable with the idea. If the buyer can't get comfortable on a specific item, we might be willing to talk about an escrow arrangement for that issue. But the key is that the seller has defined the philosophy and the structure of the reps and warranties in advance. Sometimes we send that proposed structure as soon as a potential bidder says that it is still interested after the management visit and plant tour. We don't put it on a take-it-or-leave-it basis - that our reps and warranties have to be accepted before we will enter into a letter of intent. We present our desired reps and warranties and their proposed structure and ask that if the bidder decides to present a letter of intent, we would like it to include a comment on which are unacceptable. This may kill some bids early on. But if there is going to be a big problem, the seller wants to know about it early rather that later. For example, the seller may find itself in a situation in which it has turned away all but one buyer, only to find out that it doesn't have a deal that it can live with. Selecting a buyer, after all this work, is really the easy piece. It's deciding on which is the best deal. That is the scientific part of the process, but don't forget the art this late in the game. The art is picking an alternate buyer and working very hard to keep it at a backstop position. Never tell all the bidders to go away. Deals do fall apart and if an alternate isn't in the wings, the seller has to go back to ground zero. Work with the alternate, keep in touch with its people, and be honest with them. Tell them that if the deal falls apart, they are next in line. Some buyers will take a hard attitude about being second fiddle and say forget it, we are out. Other buyers are very happy to be in that backstop position. The attitudes have to be determined. I think a key part of selecting a preferred buyer is also selecting a second buyer. RELATED ARTICLE: GETTING THEM HOOKED A well-managed sale process should wind up with three or four competing bidders ready to deliver a commitment at the same time. That's when the seller of a business comes away with the best price and terms. Getting to that point means the seller should be in control of the process, but before it can set the agenda, intense preparation is needed. Before going to market, the seller should identify likely buyers, classify them - e.g., financial, direct competitor, related business, etc. - and determine why each wants to acquire the business. At the heart is a series of valuations that quantifies the worth of the target to each and produces a range of anticipated prices. Follow-up marketing is based on letting each bidder know how the company fits its needs. Leonard S. Caronia is Director of Coopers & Lybrand's Midwest Corporate Finance Group. This article was adapted from his presentation to the Midwest Conference on Mergers and Acquisitions in November 1994 in Chicago. Gale Document Number:A17527898
© 2007 Gale, a part of The Thomson Corporation. Thomson and Star Logo are trademarks and are registered trademarks used herein under license