I have worked on both buy-side and sell-side mandates for over thirty years. And like everything else, the process has changed. Today, it is far more intense than it ever was, be it due diligence, contract negotiations or haggling over the closing balance sheet.
Seeing it from both sides is invaluable. The chain of command within a buyer’s organisation is more unforgiving than ever. Jobs and careers are at stake. Reputations can be won or lost. Relationships can be fractured. And that goes for the outsourced experts too, such as the accounting, tax and legal advisers. These people have a significant impact on the constructive energy within a deal. They can drain it or support it. Too often they drain it.
Five insights I’ve learned from sale mandates in 2020:
1) Flawed judgement around materiality
If I am to take one fundamental learning from working either alongside or opposite a buyer’s external expert adviser, it is their repeated failure to understand materiality within the deal process. Too often I have experienced flawed judgement around materiality that hinders the process and can lead to deal failure because a seller has just had enough.
This is where an experienced transaction advisor must step in – be they on the buy or sell side. All parties must agree on materiality upfront. But this is not just related to quantum, it also relates to timing. Buyers should focus on the big picture stuff first. It signals you are thinking strategically and will value your acquisition. Don’t start by challenging the policy to bring pets into the office, as I once witnessed.
My advice to sellers is to have this discussion upfront. Agree rules of engagement and insist they are applied to the buyer’s expert advisors.
2) Be prepared for repetition
Inevitably there will be overlaps in scope between the accounting, tax, legal and commercial due diligence teams. You will be asked the same question more than once. And despite the most sophisticated digital data room set up, you must be prepared to breathe through the frustration you will feel.
It is rare for the different due diligence teams to share the detail. They will share contentious issues that make it to a roundtable discussion. But when they are working separately and remotely accessing the data room, they will fire off a question to the seller rather than checking it internally. There are two reasons for this. One—they are professionally liable for any negligence on their part, so they need the primary research; Two—they are usually working to a tight timetable.
So, sellers must just be prepared for the frustration of dealing with multiple questions from multiple inquisitors that often are the same. Just ensure your answers are consistent!
3) Understand that price and payment may change
So, you have agreed a ‘deal’ in principle. You are already working out the distribution of proceeds to the shareholders and considering the after-tax capital gain.
Then comes a couple of surprises. The buyer is insisting on a cash-free debt-free deal and that sufficient working capital is left in the business. That’s okay you think – we have no debt and I want to take the cash anyway, that’s great. And we always have enough working capital so what’s the problem?
The problem is around definition. For example, the buyer is not talking just about bank debt, but also ‘debt-like’ items like long service leave or staff bonuses. And a buyer’s calculation of what working capital is required may come as a shock. Adjusting an agreed sale price for these items can have a material impact on the final price paid. So, don’t wait until the final negotiations to learn how the buyer calculates these adjustments. Ask for their model upfront at the time the EOI is being discussed.
Then there is the timing of payments. Ignoring structural payments such as earn outs or deferred fixed payments, there is the issue of an escrow amount. The buyer will want to keep back a percentage of the payment due on financial close to cover any unforeseen adjustments. This can be anywhere from 5% to 15% and held back, in full or in part, from anywhere from six to eighteen months. Sellers should not be bullied by the external lawyers into agreeing on an unreasonable escrow. It should relate to the materiality of the deal and also the risk profile of the business.
4) Know when you have got a good deal
We have negotiated a good price and terms of payment and have signed an EOI which grants the buyer exclusivity for 90 days. The marketing process had gone well, and we had choices, there was more than one serious buyer. Our results are continuing to strengthen, it is probable we will exceed this year’s budget, the one we included in the IM.
But now due diligence is starting to get us down. We feel the questioning is puerile and the buyer isn’t thinking strategically or addressing our concerns regarding integration and how we tell our staff and customers. A couple of thorny issues have surfaced, which may mean we need to give indemnities.
This is when some of the shareholders may say, let’s trade on and sell for an even bigger valuation in one to two years. This situation is not unusual and can be very tempting. It requires a very steady hand from the leadership of the seller. Upfront when advising sell-side clients, I always get them to discuss valuation, what they are seeking and why they are seeking it. But often if an offer comes in that exceeds their expectation, it can trigger dysfunctional behaviour in the greedy. You need to be ready for this.
If, as a seller, the offer has met your expectations don’t let the process to get to financial close make you change your expectations of value. The two, the offer and the process, are not related. There are far too many stories of deals being broken for this reason and fortunes lost.
5) Timing is everything in balancing risk and return
I have made this comment many times. But in the last year or so it has been proved true in spades.
If it is your intent to sell and your business has demonstrated a consistent track record of profitability and steady growth, and it has sustainable scale, do you need to wait? Ordinarily no.
But some may say let’s bank another year’s revenue and profit growth and get even more for the business. In this case it is not your intent to sell, it is to grow and take the risk of that growth. Unfortunately, too many business owners who have had years of steady growth forget the element of risk and think that growth will be automatically banked. You cannot assume that growth in revenue and/or profitability is ordained.
If you are ready to sell and the market is ready to buy – why take the risk of delay, particularly if your expectations can be met.
The usual response to this is that we want more. So, ask yourself – how much is enough? From my experience it is the truly smart business owners who know when to bank what they have built.