Designing the Deal: An Insider’s Guide

Mergers & Acquisitions Supplement - Mergers & Acquisitions Supplement

Competition, necessity, desire and timing are important components of gaining leverage at the bargaining table.

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January 13, 2016
Jordan Fox
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Strategic insight, combined with careful planning, is immensely important for PCOs endeavoring to buy a new company or sell their own. The majority of missteps that take place in a merger or acquisition transaction are due to improper planning.

Those are among the ideas mergers and acquisitions advisor Paul Giannamore emphasizes when he consults with PCOs who are considering entering the buying or selling market. Based in Philadelphia, he is managing director of the Pest Control Group of the Potomac Company, a private investment banking firm.

In a recent PCT-sponsored M&A Virtual Conference, Giannamore illustrated his points by quoting from “The Art of War,” the classic military text by Sun Tzu, an ancient Chinese general: “When your strategic planning is deep and far reaching, you gain much, so you win before you fight. When your strategic thinking is shallow and nearsighted, you can gain little. So you lose before doing battle. Much strategy prevails over little strategy, and those without strategy cannot be but defeated. Therefore the victorious warriors win first and then go to war, while the defeated warriors go to war first and then seek to win.”

According to Giannamore, Sun Tzu’s thoughts are appropriate when working on an M&A deal. “Overall, when thinking about a possible deal,” he said, “buyers and sellers tend to get excited about the small details of deal making, such as stock vs. asset, holdbacks and tax ramifications. But none of these mean anything at all if you don’t maximize the sale price of the business and to do that you’ve got to use proper sell-side strategy.”

To emphasize his point, he posed this scenario:

“The typical seller will often negotiate directly with only one buyer and that’s a horrible move. When you negotiate directly with only one buyer you’re involved in ‘cross-table negotiations’ only.”

“But the most sophisticated sellers in the pest control industry, or any other industry, for that matter, will create an ‘auction’ process by inviting several potential acquirers to sit on the same side of the table and negotiate among themselves. Let the acquirers duke it out for a bit before you get involved, then you’re able to use both ‘cross-table’ as well as ‘same-side-of-table’ negotiations to exert pressure on all acquirers simultaneously.

“In this case, if the selling company can influence leverage from the very beginning of the process, it will be in a better position to strike a favorable deal. The purchase price can be influenced by how well the seller owns the process, and setting up a competitive bid process from the get-go will play right into the seller’s hands…and ultimately to his pockets.”

Giannamore said competition, necessity, desire and timing are important components of gaining leverage at the bargaining table.

COMPETITION. “At the end of the day, competition creates leverage for the seller. When he or she initiates the process by sending a confidential information memo, or offering, to several potential acquirers, they’ll know they’re in a bidding process. Competition will put pressure on them. No matter how sophisticated they may be, they can make mistakes and dramatically overpay for the business. But the seller shouldn’t count on them making mistakes and instead use the formal, competitive process to force the buyers into an auction situation.”

He said a seller also should endeavor to have all the competing bids on the table at the same time. “If he’s gone to three or four potential acquirers and one has responded with a positive and enticing letter of intent but the others have yet to do so, the seller needs to know as soon as possible about what is going on with the others,” he explained. “As offers often have deadlines, the letter of intent might “explode” or terminate if not accepted within a matter of days. If you don’t cause all acquirers to submit bids at the same time you might find yourself in a very stressful situation.

It’s very difficult to have a bird in hand and try to determine what the bird in the bush may or may not look like, but it’s well worth the effort to quickly find out.”

NECESSITY. Necessity, another factor in creating leverage for or against a seller, often includes life events that make it necessary for an owner to sell his or her company. These can include an owner becoming ill or passing away, a costly divorce being experienced by an owner or a company that’s going broke because the owner turned it over to incompetent children.

“It’s a good idea for an acquirer to watch the market carefully and keep tabs on those necessity factors,” he said. “A buyer armed with that knowledge shouldn’t be afraid to make a low-ball offer. And a seller needs to do everything in his power to shield the fact that he’s desperate, otherwise, every buyer out there will use it against him.”

The typical seller will often negotiate directly with only one buyer and that’s a horrible move.” — Paul Giannamore

DESIRE. Desire is yet another factor in determining leverage and is similar to necessity, said Giannamore. “Every transaction is motivated by desire. When the seller wants to sell more than the acquirer wants to buy, or vice versa, that can prove to increase leverage for one side over the other, so it’s important for each party to somehow play that down.”

TIMING. Giannamore stated that timing is one tool that sellers typically don’t employ in a formal selling process, but absolutely should. “They’ve got no timeline. Instead, they’ll start negotiating and then start lying about non-existent offers, especially the more desperate they become.

“What the sellers should do is take control of the timeline. To be the process setters. To make sure that those potential acquirers on the other side of the table are on their timeline. To make sure that the other side’s timeline doesn’t impact theirs.”

In stressing the importance of planning, Giannamore said that sellers need at least three months of careful thought and actions prior to going on the market. “If you’re a seller you just can’t wake up one morning thinking about it and go on the market the following morning. You need to think through the process and take some significant actions,” he said.

“Have you drafted enforceable non-compete covenants? Are your P&L statements in good shape? Do you have confidentiality agreements with your employees in place? Do you understand the cash flow generated by your company? Are there any big companies coming into your territory? Have you vetted potential acquirers? All this should be put in play before you go out into the market.”

It’s important too, he said, for you as a seller to do some significant self-analysis of your company’s status before going to the negotiating table. “What are the advantages you’ve built into your operation? What are the disadvantages? You need to learn how to neutralize those disadvantages and emphasize the advantages by leveraging the controlled auction process,” Giannamore said.

You, as a seller, always have a lot more leverage than a buyer — if you’re doing the right thing, he explained. “If you effectively plan and understand the fair market value of your business, and if you understand the potential investment value of your company and then take it to market, your leverage will increase. As it will when you are negotiating simultaneously with all the acquirers you’ve contacted — and they know they’re competing with the others and know they could lose the deal.”

Giannamore cautioned, however, to make sure that you’ve fully negotiated price and all other material terms of the transaction prior to signing the letter of intent. Upon signing, your leverage as seller dramatically decreases as you’ll be required to take the business off the market and drive toward a close with one acquirer.

“Obviously, the importance of careful thought and planning can not be overstated,” he said.