Dave Kauppi is an M&A Advisor and author of "Selling Your Software Company - An Insider's Guide to Achieving Strategic Value."
The Buyer's Secret to M&A is Buy Low, Sell High
We have all seen the commercials and advertisements for the book or online course on flipping houses. The number one principle in each of these, it seems, involves buying below market. One course even touts knocking on doors and making a low ball offer enough times and someone will take your bid. Well, guess what? The number one key to making a successful company acquisition is to buy at an attractive price. The investment banks and merger and acquisition firms are engaged to drive up the selling price by getting several qualified buyers involved in a soft auction.
Experienced Buyers Court Many Business Sellers
Buyers Want to Limit the Bidding Process
Buyers want to avoid this process, so, more often than not, they will make several unsolicited inquiries on potential targets that are not currently for sale or involved with a merger and acquisition firm or investment banker. Typically this buyer has engaged in dozens of prior M&A transactions. The target business owner has likely never sold a company before. So right off the bat, there is a huge disparity in the experience level between buyer and seller. The greater the complexity of the process, the greater the advantage that goes to the one with superior experience. As my dad used to say, "When a man with money meets a man with experience, the man with experience walks away with the money and the man with money gains some valuable experience."
In Mergers and Acquisitions: Experience Wins
The Man With Experience Walks Away With the Money
Selling a business is a very complex process, not so much like quantum physics complex but more experientially complex. Let me try an example of the value of experience to illustrate my point. Have you ever tried mounting a new door? The first time I did it, it took me several hours. each step was new to me and I was not competent at any of them. After recognizing my limitations, I hired a handyman that had installed many doors before. He finished my next door install in about 45 minutes. For a business owner, your business sale is your first door. That door is likely your largest asset.
If you compare selling a business, with the door mounting project, I had a couple of hundred dollars at risk. In selling a business, poor execution by the seller could result in leaving hundreds of thousands to millions of dollars on the table (depending on the business size and strategic value potential). In my door mounting project, I did not have an opponent that was contesting my successful completion of the project. In a business sale, you have a very worthy opponent that wants to pay you the lowest price and will be doing everything possible to accomplish that outcome. A business sale is a zero-sum game and every dollar that the buyer saves in his purchase is a dollar removed from your business selling price.
I'll Do It Myself, Thank You
Business owners are smart and very competent at running their companies. They believe that this competence will directly translate into executing their business sale on their own. The vast majority of business owners that are approached with the unsolicited offer elect to manage the process themselves. We will often get a call from one of these business owners after they have received an unsolicited inquiry to buy their company. If their company fits our criteria we will do our best to secure an engagement agreement to do the M&A work. The owner's response is usually something like, "Well I just want to see how this plays out."
Keep Your Eye on the Ball
Keep Your Eye on the Ball
In one of these exclusive buyer scenarios, below is a representative description of " how this plays out."
- Make no mistake about it, the buyer is more knowledgeable about the value of the target business than the owner of that business. He has no intention of paying a market price and is trying to exclusively engage as the only buyer. That is why in the unsolicited offer they contact businesses that are not formally for sale.
- The owner imagines that he is going to cash out at a large number even though the buyer has made no concrete offers.
A Single Buyer Trumps a Seller
If the target company engages, the buyer has already won because the biggest influence on business selling price outside of the underlying financials is a competitive bidding process among three or more qualified bidders. Business owners already have a full-time job and therefore can only process an offer serially and not competitively. So they negotiate with a single buyer until the deal is completed or the deal blows up.
The other big imbalance is in the art of the deal. There are countless deal elements that the seller has little or no experience whereas the buyer has potentially dozens of prior acquisitions under his belt. Mistakes made in this process will erode the value the seller realizes from the deal.
The Buyer Keeps Kicking the Tires
- Even though the buyer has yet to provide a written offer or a letter of intent, he begins an exhaustive brain drain on the seller and keeps a steady flow of data requests coming. Why would the seller agree to provide confidential company information without knowing what price he will receive upon successful completion of the transaction?
- The buyer does not seem to have any sense of urgency to complete his data gathering. Do you know why? The buyer is doing the same dance with 3 or 4 other prospective acquisitions. So the buyer is doing a competitive bidding process with multiple sellers in order to achieve a downward purchase price movement.
- When the seller finally digs in and insists on an offer, the buyer submits an indication of interest that is designed to be open to interpretation (to the buyer's favor) as a more formal due diligence process is undertaken.
- As the process stretches out the seller begins to establish some time parameters with the buyer.
The Buyer's Team Attacks Your Company's Value
- Next comes a process that the inexperienced seller has not anticipated. The buyer brings in what they often refer to as independent third party consultants to evaluate your business. First of all, they are the furthest thing from independent. Secondly, they are under instructions from their employer to find real or imaginary warts and to present a corresponding deal price adjustment.
- It doesn't stop there. Remember the letter of intent that was written with wiggle room in the buyer's favor? Now the experts put a large net working capital requirement for the date of closing. The expert will pronounce that a net working capital surplus of $400,000 is required at closing. The historical level has been $200,000. So the effect of this requirement is to lower the purchase price the seller thought he was going to get by $200 K.
- The scalping has just begun. Deep into this process (often 6 months in) the buyer's team introduces the requirement for seller financing, over reaching reps and warranties, and a hold back escrow requirement of $150 K.
- If the seller gives in, he likely has settled for a value 20% or more less than the original offer. The original offer, however, was a low-ball offer to begin with. If he capitulates, he may be accepting a price that is substantially below what a soft auction process conducted by an M&A firm would have produced.
The Seller Gives In
- The other alternative is that the seller walks away from the deal after investing six months of time into the process. The buyer is counting on the seller protecting his investment in the process and settling for a deeply discounted transaction value.
- The business has likely suffered during the process because the owner devoted much of his time to selling the business and spent less time running the business. The damage will likely continue on for some time due to the loss of momentum.
- Remember that the buyer was engaged in the same process with 2 or 3 other prospective acquisitions and is counting on at least one of them trying to salvage what has now become a a bargain sale.
A Poor M&A Process Results in Dollars Down the Drain
Don't Let This Happen to You
Don't be sort of or kind of for sale. Either you are for sale or you are not for sale. If you are not for sale, kindly send the buyer packing. If you are for sale, hire a competent merger and acquisition firm and throw this buyer into the mix of target buyers. This is usually a list of 300 to 1,000 strategic buyers and private equity groups. As the process unfolds, it is unlikely that this first buyer makes it very far into the process because he was trying to buy at a bargain and not at the market. If you complete the process with a single buyer that approached you, the odds are that he got a bargain purchase and you left a wheelbarrow full of money on the table.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2017 Dave Kauppi
Dave Kauppi (author) from Hinsdale, IL on January 31, 2019:
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