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Time to sell the business? Six strategies for a successful transaction
January 1, 2008
7 Min Read
Getting the most for your company is not for the fainthearted. Start by arming yourself with these techniques and keep the upper hand.
Acquisition negotiations are confrontational by their nature. In the most fundamental sense, they are a test of wills and a battle for control between two parties with opposing interests. If you are an owner or a CEO of a middle-market company (defined as a company with a transaction price between $2 million and $250 million), you must accept the extremely confrontational nature of the negotiating process. You must feel comfortable in this type of environment, or you are doomed to failure.
This article will discuss various negotiating strategies and techniques, which, if followed, should make a negotiator successful.
1. Assert your dominance. You want to convey to the acquirer that your objectives and will are going to prevail on the substantive issues. This dominance should be established early in the process, as it is far easier to establish dominance at the outset than it is to retake it from a dominant acquirer.
My philosophy is that one side is basically the boss in all negotiations. This means that on substantive issues, you want the acquirer to feel that he must concede to you, or risk losing the deal. Obviously, this is not easy for a middle-market seller, as the acquirer is used to prevailing in these matters. Correspondingly, you need an experienced, aggressive, determined negotiator to bend an acquirer’s will. This type of negotiator will convince the acquirer that these negotiations will be different from those with which he is familiar.
2. Reps, warranties, and indemnification issues. Fundamentally, acquirers are used to a rep, warranty, and covenant package (the “reps”) that basically encompasses a “my watch, your watch” concept. This approach says that anything that happened while the seller owned the company is the seller’s responsibility, regardless of when the issue manifests itself. And any issue that occurs while the acquirer owns the company is its problem.
The fundamental flaw with this concept is that one of the major reasons owners sell their companies is to escape the risk inherent in the equity ownership position. Under the “my watch, your watch” concept, a selling owner is still potentially responsible for all of his company’s preclosing actions during the postclosing indemnification period, even if the issue had not matured or was not known to him at the time of the closing. However, unknown positive occurrences before the closing could not have been factored into the transaction price. So even though these positive factors matured under the “watch” of the seller, he will not get any benefit from them. Correspondingly, since the seller doesn’t get the benefit of any unknown positive factors, he shouldn’t get the downside risk of any unknown negative factors.
Unfortunately, the “my watch, your watch” concept is the norm. Most advisors and attorneys accept it as the way a deal should be structured. I don’t. I believe the majority of the seller’s reps should be limited to some form of knowledge, except for a few reps where absolute guarantees should and can be given an acquirer. The knowledge qualifier will limit a seller’s exposure to those things he is aware of. This is what he should expect, and it is also what is fair. Although this position is not customary, it can usually be sustained by a tough, experienced negotiator.
A seller’s indemnification exposure for violation of the reps will be on the personal level, and therefore not limited by the protection of the corporate veil. It is conceivable that violations could cause a seller a loss that exceeds the sale price. This exposure is usually limited by placing a ceiling on the seller’s indemnifications. The ceiling will vary depending on the deal environment and the unique characteristics of the company; however, the seller’s exposure should not exceed 15-35% of the deal price.
3. Letter of intent (LOI) issues. All potential acquirers should be brought together simultaneously to leverage one buyer against the other to achieve the maximum selling price and deal terms before the execution of the LOI. At this stage of the process, most investment bankers select the company with whom to negotiate a definitive purchase agreement. Their decision is usually based on only the level of the acquirer’s price and the composition of the deal consideration.
I believe other factors should also be evaluated before making this decision. Prior to selecting the acquirer with which to enter into an LOI, the prospective acquirer’s general philosophies and positions regarding the reps and indemnifications should be discussed, as the seller’s exposure in these areas can be more important than the deal price itself. Therefore, the reps and indemnifications should be a significant factor in selecting the most attractive acquirer.
The LOI provides for an exclusivity period to negotiate a deal with the selected acquirer for a specified time period, usually 45-90 days. During this exclusivity period, the seller can neither solicit nor have conversations with any other prospective acquirer. Although most investment bankers don’t require this, my firm requires our clients’ exclusivity period be terminable at their sole discretion if the selected acquirer asks for a price reduction or a change in the composition of the transaction consideration. This is essential to protect a seller’s legitimate interests.
4. Know your adversary. A successful negotiator will know the personal and team goals of all members of the acquirer’s negotiating team. This includes the principals, investment bankers, and legal counsel. Not only must you know the team goals, but you also must determine if any of the members’ personal goals are in conflict with the team goals. They often are. Plus, you must become familiar with the style and determine the negotiating strategy of the acquirer.
Armed with this knowledge, a negotiator should be able to develop his or her negotiating battle plan. An experienced negotiator knows his adversary so thoroughly that he knows how he or she will react to his every move, such that he will have already determined the countermove to combat the acquirer’s reaction to his initial move.
5. Obtain the drafting rights to the definitive purchase agreement (DPA). The drafting rights to the DPA are extremely important. A seller’s ability to obtain control of these rights is critical to his eventual success. If he doesn’t, it ensures that he will be getting the acquirer’s canned acquisition documents, which are likely to be structured unreasonably in the acquirer’s favor.
After a seller obtains the drafting rights, he should prepare a reasonably fair first draft of the agreement. A seller never wants to make excessive demands that can’t be obtained, but he must be able to sustain his position on the major issues. If a seller develops a negotiating pattern of sustaining his major positions, a more favorable deal will be realized. To achieve this, his starting position must be reasonable. This negotiating approach tells the acquirer that the seller has minimum flexibility, after he defines his significant positions. A seller wants the acquirer accustomed to conceding the major points.
6. Focus on winning the war, not the battle. This requires that you have a clear definition of what victory is in this negotiating war. Therefore, it is essential the seller clearly defines his pricing objectives, his desired deal structure, the composition of the transaction consideration, and the acceptable level of exposure in the reps and related indemnifications before the negotiating process starts. If the seller remains focused on these goals, he can make any concessions the acquirer requests that do not prevent him from sustaining the basic positions needed to win the war. Correspondingly, a seller should be willing to concede nonessential issues in return for concessions that facilitate the achievement of his overall acquisition goals.
Negotiations are not only the most critical part of the acquisition process; they are the very essence of it. They will determine if a sale is a success or failure. The way to ensure your success is to follow the strategies and techniques discussed in this article and to make sure that your lead negotiator is an experienced, knowledgeable, and aggressive veteran of the negotiating wars.
Author George Spilka ([email protected]) is president of George Spilka & Assoc. (Allison Park, PA; www.georgespilka.com), a national acquisition consulting firm that specializes in middle-market, closely held corporations. Spilka has been advising clients since 1978.
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