Over the years, my team and I have been involved in many types of M&A transactions, capital-raising assignments, and strategic undertakings for our clients. I thought it would be interesting to share some of the recurring themes and lessons learned from the perspective of the founders and CEOs whom we have worked with during the sale process. This touches on some of the biggest surprises that can arise when you decide to sell your company.
Surprise #1: Deal Valuations Matter, but Legal Terms Can Be Equally Important and Sometimes More Important Than the Valuation
Understandably, founders and CEOs place a significant focus on the valuation offered by the acquirer. However, it is not until they are well into the negotiation of the purchase agreement that they begin to really appreciate the importance of the deal terms. By deal terms, we are referring to representations and warranties (reps and warranties) and indemnification provisions contained in the purchase agreement between the buyer and the seller.
Sometimes these terms might appear to be the exclusive domain of attorneys, and the part of the purchase agreement where deal terms are explicitly spelled out is sometimes referred to as “lawyer land,” but every CEO and founder needs to pay close attention. It is here where the buyer could come back after the deal has closed and ask for money from you and the other shareholders.
For example, in one of our sale transactions, a private equity firm was insisting that intellectual property and employee benefit claims be a fundamental representation. That means that even if the statute of limitations had expired the acquirer could seek to obtain the entire purchase price from the sellers. When we could not resolve this issue through negotiations, we advised our client to terminate the proceedings. Within a week, the acquirer conceded the point and eventually closed the transaction.
Key Takeaway: Your investment banker should take the extra time needed to negotiate a letter of intent carefully and thoughtfully with the final bidder that is appropriately detailed and fleshes out the key deal terms, especially with respect to the indemnification framework and representations and warranties. Doing so will ensure that you and the buyer are on the same page regarding both valuation and the other key deal terms.
Surprise #2: The “Best Buyer” May Not Really Be the Best Buyer at All and May Not Even Participate in Your Sale Process
We often say that we wish we had a nickel for every time the supposed “best buyer” or “most logical buyer” ended up not buying our client, despite the initial hope that the buyer would be the ultimate winner in the sale process. By “best buyer” or “most logical buyer,” we are referring to the idea that a particular buyer is viewed by the company’s management as being an ideal acquirer of the selling company for any number of reasons, including, for instance, that our client believes that it would be a strategic, profitable, and highly synergistic add-on to the acquirer’s business. But, sadly, very frequently the “best buyer” ends up:
- not even being interested in the company;
- not being willing to pay an equal or higher price that other buyers are willing to pay;
- being distracted by internal priorities such as integrating a previously acquired company;
- or being busy evaluating other acquisition opportunities.
In addition, it is important to know that very frequently the first parties to express interest in buying your company are often not the ones to ultimately acquire your company at the end of the day.
Key Takeaway: You never really know who is going to buy your company, so it is wise to make sure that your banker does not just focus solely on the “best buyers” or “most logical buyers” during the deal outreach process. Do not let your ideas about the “best buyers” cause you to allow those parties who may have contacted you earliest to get too far ahead of other potential buyers. Doing so will result in a disjointed, poorly synchronized, and potentially unsuccessful sale process.
Surprise #3: The Variety and Range of Bids and Other Deal Terms Can Be Very Broad and Different
Many founders and CEOs have expressed surprise at the range of valuations offered by different buyers for their companies. It is critical to think broadly about the different buyer types and to tailor the company story to each group of buyers.
Furthermore, creating the most comprehensive list of “hidden” company assets creates more opportunities to generate interest from different groups of buyers. Finally, remember to customize your synergy model for each buyer as one size does not fit all.
Key Takeaway: To maximize your chances of getting the best deal for your company, your investment banker should take several key steps. First, they should think broadly and strategically about the universe of potential buyers with particular attention paid to those buyers that could pay a high valuation for your company. This list could include strategic buyers directly in your industry as well as strategic buyers in adjacent industries and private equity firms looking to make acquisitions in your industry. Second, your banker should sequence outreach to buyers in such a way that allows all the interested parties sufficient time to participate in the M&A process. This may mean contacting international buyers ahead of other potential buyers so that they have sufficient time to analyze your company and make a compelling offer. If your banker strategizes, customizes, and tiers their outreach to potential buyers, they will be maximizing your chances of getting the best valuation and the best deal terms.
Surprise #4: It Can Sometimes Take a Long Time for International Buyers to Come to the Table
We once had a brilliant CEO tell us that he was getting tired of waiting for a group of foreign buyers to decide whether they were interested in buying his company. These buyers had asked for information and were analyzing it, but were not moving fast enough in our client’s opinion. He suggested that we “draw a line in the sand” and tell the various international buyers that if they did not express interest by a certain date, they would be excluded from our sale process.
Fortunately, we were able to convince him that doing so would not be in his best interests or those of the other shareholders because we believed that the foreign buyers were sincerely interested and would eventually prove themselves to be excellent potential buyers. These buyers simply needed more time to evaluate and understand the company. As it turned out, a foreign buyer offered a significantly higher valuation for our client than any of the domestic buyers in the process and acquired them.
Key Takeaway: Your banker needs to have global relationships with potential international buyers and must include them in the process in a thoughtful way, which often involves early outreach so that all the buyers, both international and domestic, are ready to submit bids for your company at (approximately) the same time. Doing so will ensure that you have the best bids from the broadest range of interested parties and maximizes your chances of getting the most favorable terms.
Surprise #5: Cash is King, or Is It?
If all of the legal terms were identical, would you rather accept an offer of $80 million in cash for your company with no earn-out or an offer of $70 million in cash and a $30 million earn-out?
When bidding on a company, buyers often offer a combination of cash, stock, and contingent consideration; the latter term refers to structures like earn-outs that offer additional compensation that may be earned if certain agreed-upon targets are achieved in a period of time after the transaction is completed. These earn-out targets may be based on metrics such as revenues, gross profit, operating profit, number of units sold, or any of a range of other metrics that the buyer and seller agree to as part of the sale transaction.
Certainly, some CEOs and shareholders want only cash, and we totally understand that, but consider how you would answer the question at the beginning of this paragraph if you and your team felt that the $30 million earn-out could definitely be achieved within 12 months after you had been acquired.
In that case, you would receive a total of $100 million with the earn-out compared to a total of $80 million with the other offer. We would note that this is of course a decision for the CEO, major shareholders, and the board and that there are a range of factors to consider. But we would also point out that a number of former clients have done exceptionally well by deciding to take offers that had contingent considerations such as earn-outs in them.
Key Takeaway: We advise CEOs and founders to keep an open mind about the various offers the company receives and to carefully consider the different components of the overall valuation because the “best deal” may not be the all-cash offer you receive.
Surprise #6: The Buyer of Your Company Might Actually Want You to Stay for a While After the Deal Is Completed
To be sure, most buyers will want senior management and key personnel at the acquired company to stay on for a period of time, usually six to 12 months, after the acquisition. However, if you are leading a high-growth, disruptive company, then the “standard” rules may not apply. I would advise your company to be prepared for this possibility.
For example, we have found that a number of buyers of our clients actually want certain key personnel, often the CEO and CTO, to stay on well beyond the typical six- to 12-month period (like two to three years) and take leadership of the business unit inside the acquirer after the deal. In one of our sale processes, the buyer wanted to combine our client with an internal business unit and have our CEO run the combined business. In another one of our sale transactions, the buyer offered the CEO of our client a very senior job running all of the e-commerce operations for the global business, which included our client’s former company and a great deal more.
Key Takeaway: You and certain key members of your senior team may well be wanted by the acquirer for your leadership, know-how, and skillset. The acquirer may make it worth your while to stay on longer at the combined company than CEOs and founders typically do after M&A transactions are completed.
I hope that this article provided insight into some of the biggest surprises experienced by the CEOs and founders our team has worked with during the M&A transaction process. Understanding these potential factors and being prepared to address them will position your company to be successfully acquired under the best possible terms and valuations.
Stephen Day is the Co-Founder and Managing Director at Navidar.