In Episode 4 of What’s Next Hosted by Acuity Advisors, Chris Kramer and Chase Hoover talk about what to do if you are approached out of the blue by a serious buyer offering to acquire your business. They’ll talk about how to respond initially, why it’s important to get a good team in your corner quickly, and how you can maximize the value of that offer without having to bring in any other bidders.
Hello, and welcome back to What’s Next, hosted by Acuity Advisors, the show where we help middle market business owners understand and monetize the value of what they’ve built. I’m your host, Chase Hoover. And I’m back today with my co-host Chris Kramer. Chris, tell me what we’re going to be talking about today.
Well, good morning Chase. Today we’re going to talk about what a business owner should do if they’ve been approached by a buyer. So we hear more and more that business owners are getting contacted in various ways by potential buyers for the businesses. That used to be a little less common. Now it’s more common than ever. And I think it’s in part because private equity funds, corporate buyers and others are more and more able through technology, through the ability to look at websites, through industry contacts, etc., to reach out and approach a buyer, and talk about whether they’re ready to sell or interested in starting a discussion.
Right. So sometimes before you have the plan or the time to do your succession planning, your succession plan or a potential one sort of finds you. And like you said, we hear all the time from our clients, something akin to, “Well, I had no intention of selling. I wasn’t thinking about it yet. Until one day out of the blue my biggest competitor (or someone else in our industry) said, ‘Hey, we’ll pay a big number, a pretty penny for the business.'” And that’s sort of changes everything, right?
So if you’re in a similar situation, or find yourself in that situation with a deal you weren’t really expecting, and thinking, hey, this may be worth exploring, how do I figure out if it is or isn’t, we’re going to spend some time talking today about what steps you’ll want to take fairly quickly and what questions you want to get answered before you move forward.
Yeah, there are really two primary reasons why you have to be a little bit cautious when have has approached you and you want to move forward with them. And the first one, of course, is you may not be ready from a planning perspective, from a perspective of making sure that you’re positioning the company in the best light, that you’ve reviewed all of the things on a preliminary basis that they’re going to be looking at in terms of your financial statements, your documents, your contracts, just any number of things around the business.
And I think the second one is really to understand if they’re the right buyer. It might be the terms of the deal, but it might also be corporate culture, etc. And oftentimes, we ask a business owner why wouldn’t you perhaps explore an auction process or test the market, so to speak, in terms of contacting other buyers. Generally, if you were selling any other significant asset, you wouldn’t necessarily sell it to the first person that made you an offer. That said, if the offer is compelling enough, and there are instances -and we’ll share a couple with you later on – where the right buyer is actually the one that made the offer or made the inquiry, then it’s perfectly legitimate and perhaps prudent to go forward with one buyer. And Chase will tell you a little bit about what you ought to do as a first step in order to help that process along.
Yeah. And not only that, before I do that, the other reason you may not want to auction or market the company let’s say, is if it is that right buyer, you think there’s a decent chance that it is, auctioning the company and performing a marketing process does carry some amount of risk to it. If you’re in a particularly insulated industry where the players all know each other, if you’ve got a banker reaching out and saying, “Hey, I’ve got a potential opportunity to acquire this business,” there’s a decent chance that folks are going to be able to figure out that it’s your business, even if everything’s done confidentially. So there are benefits, certainly in terms of privacy and confidentiality to doing it in a more negotiated way.
Now that said, if you have been approached by a buyer and you’re relatively confident, or at least suspect, that they might be the right buyer, what are some of the things you want to do fairly quickly before you take any real meaningful committed steps?
Well, the first thing that we would advise you to do is to get a group of really competent and trusted advisors in your corner and up to speed as quickly as possible. So in our minds, that’s probably a lawyer, an investment banker, and somebody who understands your personal and corporate tax situation. Reason being, letters of intent, which are sort of the milestone where you’ve agreed to move forward with the buyer, contain a lot of key terms other than price, including things that are going to impact deal structure. For instance, what the net proceeds of the transaction look like to you or to your seller group after you’re done paying your requisite taxes, and how all the other deal terms around your employment post transaction, any equity that you’re going to retain, or any other structural concerns, really come to bear on you in this deal. And so you don’t want to really even be seriously negotiating or considering what the buyer is or isn’t ready to offer you on those fronts without experts in your corner to tell you how it’s going to shake out.
Yeah, there’s another great reason why you want a good team and that is it signifies to the buyer that you’re not only serious about pursuing the transaction, but that they’re going to have a better likelihood of actually closing a transaction. Because oftentimes, buyers will see representation with competent advisors as a net positive to the transaction. They may also, by the way, feel like they’re going to pay a little bit more, but we’re going to negotiate obviously very stringently on the seller’s behalf. And they’re probably right about that. But at the end of the day, they’re going to invest a lot of time and energy in the process. And when you have a good advisor on your side, it’s generally seen as a positive to the buyers as well.
So if you have that team on board, what’s the first thing that you ought to do? And I would say that in addition to the planning that we briefly discussed tax-wise and some pre-diligence, you definitely want to manage that initial data exchange, and you want to formulate and present and massage and characterize, and any number of other adjectives you want to use, the data in a favorable light. You don’t want to just blanket comply with a document request list. You want to present the information in a favorable light so that you can put the best foot forward of the company while still addressing some of the buyer’s initial data requests.
Right. So I would categorize that as basically playing offense. Because if a buyer comes along and says, “Hey, we’re really interested. We’d like to put together an offer for you. And before we do that, please provide X, Y, Z information,” and you just provide it to them in its raw or whatever form you have it in, there may be sort of information gaps or background gaps that they’re going to fill in on their own.
So let’s say they see something in your historical performance. They’re not sure why it is the way it is. Maybe you’ve helped them answer it, maybe you haven’t. They’re not likely to potentially view that in the most favorable light on their own, or just unprompted. Whereas if you’re saying, “Hey, we’re going to comply with items 1, 2, 4, 5, 7, and 9 on your list. And by the way, you should understand as you’re reviewing them, that you’re going to notice this, you’re going to notice that. And here’s why they’re that way.” You’re going to cut some of the back and forth and potentially some of the misunderstanding out of that initial negotiation process, and things are already going to go smoother as a result.
I’ll give you a quick example. I was working with a business owner recently who’d been approached with an informal, very tentative offer, but with a fair amount in a detail from a pretty serious buyer in their industry. And that business owner, that potential seller was referred to us. And within about 24 hours of being retained and receiving the data that the buyer already had to put together their initial informal offer, we actually noticed some, call them incorrect items or misunderstandings, misinterpretations of this business owner’s performance to the material downside. Said simply, the buyer thought they were less profitable than they actually were. And they were still pretty interested and willing to move forward at a value that was potentially going to work for them.
Yeah, there’s a good analogy there with playing the offense. The other way I would characterize it as avoiding surprise. And the way you avoid surprise is of course you play offense. But also, you set the expectation, or that first impression of the data is either through what we are wanting the buyer to perceive, or with commentary that explains it so that it doesn’t get negatively received.
And so in the example Chase gave, had we been involved a little bit earlier, we doubt there would’ve been the mischaracterization or misinterpretation. There were some aspects about the numbers, for example in this particular case, the margins were much higher than the industry margins. And what we would’ve done before the fact, and actually did after the fact, is explain why. And there were some very good reasons why the margins were as high as they were.
So it’s a little bit of both, but certainly when you’re deeper in the process you want to avoid surprise. And a lot of it is controlling the messaging, if you will.
Right. So we’ve talked about at sort of this initial data exchange and playing offense, but let’s say that by the time things are getting serious, there’s actually an offer already on the table, and it’s either in the form of an initial LOI or what we call an indication of interest, which is basically a pre-LOI document that sets forth very high level, what the buyer’s envisioning in terms of the transaction, price, structure, etc. What are some of the things that we ought to do, or that we’ve done in the past Chris, to help the seller in those situations?
Yeah. So let’s assume for a minute that you’re not interested in “shopping the company.” You’ve got a buyer, and this is a great example. Because we were retained a few years back to help a business owner who wanted to sell, or actually didn’t want to sell, wasn’t sure they wanted to sell, and they were approached by a buyer. And it turns out that the buyer was a very good buyer from a not only culture perspective, obviously the financial wherewithal was there, but they were going to be able to pay a premium even though this was a very well-run and saleable and highly valued company. They were going to be willing to pay a premium primarily because they were going to be able to take this primary product line worldwide that our client had and they had the resources and the wherewithal to do that. So we already knew that they were going to be the right buyer.
But what we did in addition to characterizing the information in a favorable light is that we wrote a series of memos that explained and articulated all of the reasons why our client was superior to any other available company in its space that may or may not have been on the market. So we were setting the stage for an expectation that they were going to pay a significant premium to be able to fold our brand up under theirs.
Then what happened was we got the initial offer and it was actually a very attractive offer, but it wasn’t quite what the sellers wanted. So we wrote another memo. And of course, when I say a memo, it was with support, with data, with detail, and with analysis, not just “this is what we want.” And that memo basically set forth a very deep appreciation for their initial offer, but a very clear message that it was falling short of our expectations with some good rationale as to why. And they came back with a subsequent offer that in that case was about 15% above the initial offer. We had pushed the envelope pretty significantly. Our client, the sellers, were satisfied that they were getting a premium valuation. And we ended up signing a letter of intent at that higher amount.
Right. So to summarize all that, basically what was done there was creating and negotiating leverage without actually meaningfully threatening or pursuing a true auction. Because the whole notion of leverage is difficult to create if the buyer is confident or suspects that they’re the only interested party.
Yeah. The big risk to the buyer there was not that we were going to shop the company, but that they were going to lose out on the deal, because then that’s a little bit different. It’s a subtle difference, but they had in their own modeling, a very, very clear understanding of the benefit to them. And that was far in excess of any premium that any other buyer was going to pay. And so it caused them to say, “Look, it’s not that we care that another company’s going to get this. It’s that we care that we’re going to lose out on it.” And that was the leverage that we needed in that case.
Right. So how about in the somewhat unlikely, but definitely possible situation where a seller has actually received a bonafide letter of intent without actually retaining a banker or a lawyer. And now they’re sort of looking around saying, “Gosh, the buyer’s asking me to sign this.” What can they still do with advisory help in that situation?
Yeah. Well, similar to what we discussed, I mean, we can either characterize or recharacterize the information. We can run any number of analyses around the market comparable data that we can gather, our knowledge of what other deals have been transacted at. We can do an accretion dilution analysis if it’s a public company, which means the most that they could pay and still not affect their stock price. And I guess most importantly is we can play poker, which is what the negotiation becomes at the end of the day. And in an M&A transaction, you’re really talking about playing poker at a three-dimensional level.
And so I think I’m a pretty good poker player in general, but certainly when it comes to a deal, the team has to understand, I think, what the parameters are. And oftentimes you can create a pretty good poker pot out of a pretty marginal poker hand and vice versa. So I think it’s an assessment of all the factors, and really trying to read the buyer, and see what they’ll pay and where their hot buttons are, and how you can finally get to a signed letter of intent.
Yeah. Well, thanks, Chris. I think that was a great primer on what to do if you’re approached by a serious buyer, and how a team of good advisors can help you navigate that important moment and get to assigned LOI.
Stay tuned for a follow-up episode, where we dive into what happens after that LOI gets signed and the due diligence process begins. Until then, thanks for tuning in.
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