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Optimizing the Sale Process
David Reilly
Cronus Partners
As discussed in a recent column (January/February issue of Orthopedic Design & Technology), there is an optimal time to sell a business, and it is not when a buyer approaches with an irrefutable “offer.” Many owners contemplating a sale limit discussions to parties with whom they are familiar or by whom they have been approached in the past. However, mis-timing a transaction can lead to value deterioration and rarely achieves the results of a well-conceived and managed process. The most unlikely of buyers often ends up being the most aggressive and/or attractive.
Many steps should be taken to achieve the best sale results. Following are some highlights.
Orchestrate a Proactive, Confidential Process
It might seem that a sequential process would lead to the optimal outcome, because those most likely to deliver maximum value could be approached first, reducing market exposure. However, the sale of a business entails many variables that influence value and terms that are dependent on each specific buyer. How would an owner have any confidence that, of the myriad terms and conditions in a transaction, the “best” was obtained if a handful of companies are approached sequentially? Because market exposure is far more a function of time than number, exposure increases as the process is extended for each additional buyer. By pursuing a transaction with only those that approach, substantial opportunity and transaction costs could be needlessly incurred.
Always Maintain Leverage
Buyers do not like negotiating against themselves, and an owner’s prerogative not to sell is not leverage. Even if a buyer offers highly attractive terms in a letter of intent (LOI), a seller would find it difficult closing a transaction without the critical negotiating leverage of at least one bona fide backup. While customary, granting a period of exclusivity should be postponed until parties have reached specific milestones. The buyer must believe you have options with other buyers in order to close at the price initially agreed upon and under the most favorable terms and conditions in the definitive documentation. Merely informing a buyer that other buyers exist provides little, if any, leverage. Real leverage comes from running a highly organized process that leaves no doubt in any buyer’s mind that other qualified acquirers have also been assessing and negotiating the opportunity.
Position, Position, Position
Every company is unique, and buyers’ decisions are based on the perceived opportunity and risks of an acquisition. A seller’s valuation and terms usually are not maximized if the opportunities and risks are not presented in a manner familiar to the audience. An attractively positioned confidential information memorandum and well-prepared data room are critical in managing expectations, enhancing valuation, facilitating negotiation of definitive documentation and schedules, and avoiding surprises.
Proper positioning, or re-casting, of the historical and projected financial performance of the business is essential in maximizing value. Pro forma financials can include a variety of arcane accounting and other legitimate adjustments that have substantial impact. Overlooked items can lead to understating financial potential substantially, compounded by the effect of valuation multiples. Inflated or unsubstantiated items can jeopardize a transaction by compromising credibility.
Prepare Upfront to Save Time Later
Even well-run businesses in highly regulated industries rarely are in a position to undergo a buyer’s due diligence process. A seller forfeits the opportunity to inspire trust and confidence if it approaches the due diligence process on an ad hoc basis. A buyer should not have to wait for a seller to respond to legitimate questions or address internal issues in the midst of the process. Delays caused by the seller lead to legitimate requests for exclusivity extensions, and time is a seller’s enemy. However, it is dangerous to rush forward once a price is agreed upon, assuming the details can wait. If the key details are not negotiated up front, not only does it become very difficult to compare one offer to another, but significant leverage on open key terms may be lost.
In negotiating a transaction, the variables are extensive, including valuation, form of consideration, earn-outs, structure, timing, financing contingencies, balance sheet adjustments, representations and warranties, indemnification, hold-backs/escrows, employee matters, covenants, conditions precedent, due diligence process, etc. For example, it is customary for merger and acquisitions (M&A) transactions to contain post-closing adjustments to protect both the buyer and seller from any material differences between the expected levels of adjusted net worth and the actual level at closing. This frequently becomes a major point of contention when not negotiated at the outset, and the impact is most significant in the sale of a seasonal, cyclical or rapidly growing business.
Focus on the Business, Not a Transaction
Given the anxiety associated with selling and the intensity of the process, owners frequently become distracted from operations. Shareholders and management must remain focused on advancing the business, ensuring that operations will perform during the process. Sellers also must determine the optimal time to involve key employees in the process, as well as provide the protection needed to keep them motivated through closing. Underperforming between LOI and closing can raise concerns over credibility of the forecast on which valuation was based and lead to renegotiation.
Obtain Experienced M&A Advisors
Accountants, lawyers and commercial bankers often are trusted advisors for entrepreneurs and their families, but all possess different skill sets from M&A advisors. These advisors are schooled in and devoted to corporate finance, initiating and negotiating transactions with motivated partners and acting as quarterback with the legal and accounting teams to the benefit of the company and its owners. Entrepreneurs are experts in creating valuable companies; M&A advisors are experts in harnessing the value entrepreneurs create.
