Editor’s note: In August 2014, PCT hosted its third annual Mergers & Acquisitions Virtual Conference. The full-day event featured presentations from four M&A experts, as well as informational sessions from the event’s six platinum sponsors (Arrow Exterminators, Massey Services, Rentokil, Rollins, Steritech and Terminix).
The articles on the following pages cover a variety of M&A topics, some of which were covered during the virtual conference and some that were written specifically for this issue. Stay tuned for information on future PCT virtual conferences in the months ahead, which you can attend from the comfort of your home or office!
Mergers and acquisitions are challenging transactions for the parties sitting on both sides of the table. If you’re selling your business, even a small mistake can cause you to leave money on the table. If you’re buying, you can end up paying far too much if you “don’t know what you don’t know” about the business.
Paul Giannamore, managing director of The Potomac Company, who has advised clients on more than $20 billion in merger and acquisition (M&A) transactions for clients ranging from small, family-owned businesses to large global corporations, outlines four fundamental mistakes that he has seen cost buyers and sellers dearly. His insights could help you prepare for a more beneficial business exchange.
Mistake #1: Not knowing what you don’t know
If you are an independent pest management business owner and you decide to sell, it will most likely be to a large corporation that acquires businesses regularly.
So while you may engage in this type of negotiation only once in your life, your acquirer has likely done it scores, or even hundreds, of times. You will be sitting across the table from some extremely savvy negotiators. This is often called the “seller’s disadvantage.” The buyers typically have formal training and experience in M&A, while the seller simply doesn’t.
But the uneven distribution of expertise is only one part of what makes the M&A battlefield so treacherous to the seller, says Giannamore. What makes it worse is that the acquisition of your business will change virtually everything for you, while, to the buyer, it’s just another day at the office.
Giannamore explains, “If representatives on the buying side make a mistake in the transaction, it will probably result in a reprimand from their boss. If you, as the seller, make a mistake, it can affect you, your employees and your family for the rest of your lives. Every penny contemplated in this deal directly affects your bottom line, yet you lack the negotiating expertise of your counterparts. The deck is stacked against you before talks even begin.”
Giannamore points to a psychological concept known as the Dunning-Kruger effect, a cognitive bias that leads unskilled individuals to believe that their abilities are much stronger than they actually are. The Dunning-Kruger effect says that people tend to overestimate their own skill level as they underestimate the skill level of others.
“The basic premise is that we don’t know what we don’t know, yet we’re confident that we will bring the situation to a successful conclusion,” says Giannamore. “Some of the most successful business people are the worst offenders. They are wildly successful in building their businesses but then wildly unsuccessful in selling them.”
By way of example, Giannamore shares the story of a bright, capable business owner who was delighted to negotiate a $79 million deal when he had been willing to go as low as $70 million. Had he known the buyer intended to go as high as $100 million, he would not have left $21 million on the table.
On the buyer side, not knowing what you don’t know is more about whether you have done your homework on the business you’re looking to acquire. Have you ferreted out all of the weaknesses in addition to understanding the strengths of the company? You don’t want to pay top dollar for a business only to discover after the transaction that the company has legal, tax, customer or other costly issues.
Mistake #2: Believing the fallacy of the objective price
Valuation is a critical component of the acquisition process. What’s important to understand is that the value of a business varies from buyer to buyer depending on their strategic purpose. In other words, all valuations are subjective rather than objective.
Businesses are typically acquired for one (or more) of four reasons: (1) to acquire new capabilities or add to existing ones, (2) to establish a new business model or enter a new industry, (3) to lower costs or (4) to improve market position. These strategies drive the value of a business to its potential buyers.
When you ask yourself why a particular company wants to buy your business, you begin a process of discovery that helps you determine just how valuable your business might be. Don’t look to a mathematical formula, because a formula can’t account for differences in the buyer’s intentions.
“It might seem easier to use transaction multiples to arrive at a valuation of your business, but these figures are difficult to interpret and they don’t really tell you anything; they certainly don’t drive deals,” says Giannamore. Multiples can be misleading, he explains, since they represent averages rather than individual deals.
“Buyers don’t base their valuations on multiples,” he continues. “They each have their own complex model that takes into account their various interests and the values they place on each of those. We never know for sure what goes on behind the scenes. Determining the price happens at the bargaining table.”
Mistake #3: Not controlling the process
Whether you are a buyer or seller, maintaining control over the process maximizes your bargaining leverage. This control entails knowing your advantages and disadvantages, and presenting your side of the negotiation in the best possible light while uncovering information about the other party that can help you. In large part, controlling the process is dependent upon your ability to balance the four key components of leverage: competition, necessity, desire and time. A brief review of each of these components follows:
Competition creates positive leverage for the seller when managed correctly. When several buyers bid simultaneously, they are pressured to pay more, giving the seller a financial and psychological edge. If you are the seller, it’s important to entertain all of the bids at once rather than in a serial manner. This maximizes the opportunity for aggressive competition while minimizing the chances that you accept a less than optimal bid simply because it comes across your desk first.
Necessity swings the leverage needle toward the buyer. If a business owner is selling out of necessity — i.e., circumstances are forcing him or her to sell — buyers can take advantage of the situation by offering less than they might have under different circumstances.
Desire creates negative leverage for the party who wants the deal more. For example, if the acquisition would ensure the buyer’s entrée into a new target geographic market, the seller has leverage to push for a higher price. Alternately, if a seller is overly eager, buyers will tend to lowball their offers.
“The disparity of desire creates a substantial advantage for the cooler party,” says Giannamore. “Used correctly, it un-levels the playing field. However, it’s up to you as the buyer or seller to ferret out desire on the other party’s part. If you’re the seller, you should know that sophisticated acquirers are adept at hiding their true level of desire.”
Time is an extremely powerful negotiating tool — one that cuts across all other negotiating considerations. A party acting in response to a deadline often takes a very different action than if there were no time constraints. For example, if you have set a deadline for yourself of completing the deal before you leave for an extended vacation, you might make concessions you would not have otherwise made to hit that target date. The negotiation advantage here goes to the counterparty.
On the other hand, if you set no time limitations at all, the deal could drag on forever — or you could lose the advantage. For example, if you as the seller don’t set a deadline for buyers to submit their bids, offers will straggle in, and you will lose leverage because you won’t have the opportunity to compare them side-by-side. The moral? Manage time thoughtfully!
Mistake #4: Not knowing what you have… or don’t have
Giannamore points out the importance of the seller’s knowing the value of their business early in the process. “Know what you have far in advance of going to market,” he advises. “Too many people wait until it’s too late to do anything. When you are proactive, you enable yourself to address issues that can dramatically affect the value of your business.”
A good preliminary valuation (steer clear of so-called “free appraisals” as they are neither reliable nor free, warns Giannamore) will reveal the value of your business, the spectrum of likely purchase prices from strategic acquirers and the issues — employment agreements, customer agreements, tax issues, revenue quality, pricing, leverage, incentive structures, etc. — that may need your attention to ensure your company is positioned to sell.
It’s smart to bring your advisers into the loop early on as well, says Giannamore, to help you address those issues and prepare for what’s ahead. Be sure to include specialists — an accountant, a lawyer and an investment banker, for example — as well as a point person who will “run the show.”
“Having skilled professionals on your side will help you avoid mistakes and achieve the best outcome,” Giannamore concludes.
The author is a frequent contributor to PCT. She can be reached at firstname.lastname@example.org.