Occasionally we get asked, “Why should a business owner hire an M&A advisor to help sell a business?” In some circumstances, entrepreneurs think they’ve received good offers, so they decide to negotiate themselves. Even though the entrepreneurs may realize they’re neither properly equipped nor sufficiently knowledgeable to do deals properly, they don’t want to pay for advice and don’t realize what’s involved with such a transaction.
Here is one example of why it’s not a good idea to go it alone. I once sold a business in the plastic fabrication industry. The owner met with me to hear how we would organize the sale process.
When I got to the part where we would put together a list of potential buyers, he stopped me. “I know who’s going to buy this company,” he said. “The President of XYZ Inc. phones me the first day of each quarter to tell me he wants to buy my company. His company is a supplier of raw materials, but we don’t buy from him. And it has a subsidiary that competes with us. When he buys us, he’ll not only be getting a new customer but also eliminating a competitor. And it gets better. XYZ is owned by a private equity firm who want to grow through acquisitions.”
I asked why I was being interviewed since he was so confident he knew the purchaser. He replied, “I don’t know anything about selling a business. I make plastic parts. I don’t know what a company is worth or how to do a valuation. I assume selling a company is a time-consuming process. There’s going to be a bunch of legal and accounting stuff I don’t understand. I’m not interested in nor qualified to negotiate. And on top of it all, running my business is a full-time job.”
I told him he’d pretty much summarized my pitch to many an entrepreneur. He smiled and then said, “You know, I actually believe all that, but the real reason I’m hiring an agent is because once the President of XYZ hears I’ve started a formal sale process, he’s going to go crazy. I will get an offer so rich, it will pay the agent’s fees several times over.”
Luckily, we got the mandate and he’d called it exactly. XYZ bought his business at a 50% premium to the price our client agreed was fair and acceptable before we started the process.
The primary reasons an entrepreneur should use an agent are:
1. Avoid the proprietary deal
A proprietary deal occurs when a business is sold directly to one party without going to the market to get multiple offers. These happen frequently, but usually result in lower prices because there are no competitive forces at work. Also, knowing there are other potential buyers in the background will make buyers think twice about grinding down the price during negotiations and due diligence.
2. Properly educate buyers about company information
A vendor’s agent will prepare a confidential information memorandum to summarize all relevant information buyers require to understand the business and its historical financial information. This is time-consuming and tedious, yet required by potential buyers. It also is essential to prepare for due diligence.
3. Negotiation of transaction specific details
Selling a business is a complicated transaction with many variables. Few entrepreneurs are versed in the intricacies of undertaking an M&A transaction. Buyers may show up with a complicated spreadsheet showing a discounted cash flow valuation that they purport determines the price for the company. Most vendors aren’t equipped to negotiate such a document. There are also legal representations and warranties that can put a lot of potential liability on the vendor. And financial issues such as the Working Capital Adjustment can swing the after-tax proceeds paid to the vendor by millions of dollars in some cases. Having a professional advising the vendor on these and other matters will mitigate potential risks and maximize after-tax proceeds.
4. Good cop, bad cop
Selling a business is an antagonistic activity. The buyer wants to pay as little as possible, with as much protection as possible, while the vendor wants the highest price possible while providing little or no assurances. Somewhere in the middle is a deal. On top of it all some of the payment price will be held back for a period of time, so the vendor wants to be on reasonably good terms with the buyer once the company is sold to make sure holdbacks get paid. This is where the agent can be valuable. The agent can deal with many contentious issues while the entrepreneur can say she has to take her agent’s advice. Blame the disagreement on the agent.
5. Preparation of due diligence materials
Vendors are usually amazed and infuriated with the amount of information required by buyers when a company is sold. The vendor’s agent starts accumulating this info from the earliest days of preparing the Information Memorandum and stores in it a secure, online dataroom. Once a letter of intent is signed, the dataroom is made available to the prospective buyer.