7 typical mistakes of seller during the M&A deal process
Sergey Goncharevich, Managing Partner of Capital Times Investment Advisory
How often did you find yourself selling a business or attracting a financial partner? For most sellers it’s a single, once-in-a-lifetime deal. Therefore one must handle it in a particular manner avoiding making mistakes. Every mistake in M&A deal can cost a million to dozens of millions of dollars. Thorough groundwork before the deal allows for increasing the company’s value and preventing price discounting. Though each transaction is unique and mistakes are numerous, we’ll try to go into the most common ones.
In this article we are going to cover the 7 typical seller's mistakes in the M&A deal process.
- Unpreparedness for the deal
Any project involving multiple parties, particularly M&A transaction, requires prior preparation and working out, which takes time. In order to ensure the mutually beneficial deal closure it is important to evaluate the market, conduct the target company audit involving external consultants, if necessary, estimate and review the potential risks. Preliminary stage takes a couple of months, while the transaction itself can last up to a year. Failure to estimate the realistic duration of the deal can backfire the seller. He risks getting a lower price for it in a rush to sell his asset, or making errors, the consequences of which would have to be corrected even longer. For example refusal to conduct Vendor Due Diligence often causes the assets price drop, so the buyer will reasonably claim the price cut upon discovering errors and inaccuracies. Though setting this practice aside allows for buying one some time at the initial stage, the transaction can ultimately be delayed by the buyer who will carefully review the business, which will lead to obtaining all the documents in course of the deal.
On the other hand, there is a possibility that the seller himself is the one who delays the transaction. The seller’s team must immediately respond to the Due Diligence requests respecting the deal pace. However, the longer the M&A process the greater the chance of a deal break.
- Lack of quality communication between the deal participants.
For both sides the entire M&A negotiation requires consensus. It is essential to realise which party is more interested in the deal - the buyer or the seller? How many investors are willing to purchase this asset? Are you in a position to agree on key non-financial conditions in return for the price rebate? The dynamics and logics of negotiation will be directly reliant on this knowledge.
Granted that the seller is well informed he will have a deep understanding of the competitive market, a non-illusory perception of the price at which he intends to sell the asset, and therefore will rationalize why his business should be priced that way. His position should be grounded on sound financial projections and achievable expectations.
Chances are that, if the buyer does not attend to the company’s future development, the beneficial deal is not likely. In merging with the buyer the seller must be capable of creating synergy and strategic compatibility. Whatever be the viewpoint of the seller one should be prepared for reasonable compromise and avoid ratcheting up tensions.
- Poorly developed NDAs, disclosure of data schedule and letter of intent.
Non-disclosure agreement (NDA) - is a confidentiality agreement. By entering into negotiations, the investor requests company data, the disclosure of which might lead to drop in competitive advantages and financial losses without NDA. Particularly if the strategic competitor is a buyer.
A well-developed offer contains a number of prohibitions for the buyer. In particular, a restriction on contacts with employees, customers and contractors, a ban on poaching or hiring the seller's employees for a certain period of time if the transaction fell through.
The sales strategy involves a timetable for the disclosure of key and sensitive data on ongoing major contracts, intellectual property, transactions, staff, etc. It goes without saying that data sharing with investor should be fragmented as the good plan will secure the seller from breach of guarantees and liabilities provided by purchase agreement. To stop the client playing spy games and slowing the negotiation process, this paper must be carefully crafted and validated.
Another significant mistake made by the seller is the absence of clear consensus on principal terms and conditions in the letter of intent (LOI). As long as this LOI is not signed the seller can drive a bargain and dictate his terms. While after the signing, the ball is in the investor’s court whereas he often demands exclusivity restricting the buyer to negotiate with other bidders for a certain period of time. The LOI shall include namely the price and payment method, as well as the mechanism of price correction; the scope and duration of exclusivity mandate; non-binding character of definitions; remedies for breach of the agreement etc.
Elaborate letter of intent or preliminary agreement notably speeds up the duration of the transaction and increases the probability of its successful completion.
- Absence of virtual database or an incomplete documents list.
All data necessary for the transaction must be kept in cloud storage. Nowadays it is available in Virtual Data Rooms which not only provide participants with remote access to documents at any time, but also guarantee a high level of protection. Organized information stored in a single place allows the seller to complete due diligence faster, whilst examination of the hard copies can take months.
The ability to evaluate deficiencies in advance and eliminate faults or shortcomings is another undeniable value of the Virtual Data Room. For instance, it helps to ensure the provision of all the required information in full volume: the signed agreements, recorded modifications, duly documented protocols and resolutions of meetings of shareholders and directors etc. By and large investors are extremely observant to these details, and defects in documents can cause the price discounting.
Moreover, a thorough analysis of the buyer and his representatives behavior in the virtual data room enables us to understand what documents are of most interest and predict their possible arguments in negotiating price discount.
- Unsuitable approach to personnel issues.
Even the rumors about the forthcoming sale may trigger the dismissal of top employees. After all they create the asset’s value. Losing workers may result in a drop of efficiency, decrease in financial metrics (which are already contained in the forecast of the company), loss in existing customer loyalty, etc. The seller must take care of the future of his workers and encourage them to remain in their employment. For this the most relevant staff points are to be discussed with investor. That is, the buyer’s strategy to retain and empower the employees; settlement of company’s share options; necessity to build up a "buyout reserve" to compensate staff upon the end of a deal closure, etc.
Furthermore, the company team has to be engaged in the selling process and aware about their opportunities. 90% of all resignations arise due to a misconception of employees prospects, therefore constructive feedback and clear dialogue with the investor minimizes the likelihood of personal losses.
- A superficial discussion of the additional payment provisions with respect to potential earnings.
Based on financial performance or upon completing certain milestones, the seller's shareholders can charge extra fees upon the completion of the sale. This is, actually, one of the fair techniques for settling disputes between the seller and the buyer over estimation discrepancies. However, in order for the procedure of obtaining such reimbursement to be smooth, it is important to properly develop the main points of the agreement. The key points of negotiations are:
- realistic financial metrics according to which the seller is eligible for additional fees. Buyers tend to focus on profit indicators or EBITDA, while sellers choose metrics less likely to be exploited, such as gross revenue;
- payments schedule, their nature and maximum amount;
- mandatory milestone fees;
- provisions to protect the seller from the unethical actions of the buyer (for example, if the buyer did not make reasonable efforts to manage the business, artificially reducing profits);
- who will accept the extra cost obligation if the investor sells the company, etc.
- Unwillingness to hire a financial advisor or inconsistency in their service terms.
The main determinants why mergers and acquisitions fail are excessive commitment to the negotiation process and lack of expertise among company owners. Basically all of the above errors ultimately derive from this one.
Financial advisor takes over a wide range of commitments - from searching the prospective investors to assessing the synergy achieved after the deal closure. The seller saves time on documents and presentations prepping, selling strategy development by staying, however, deeply involved in the process. The owner meanwhile can thoroughly administer the business which is also crucial for a beneficial transaction. Disregarding daily business operations can lead to a decrease in financial performance, which in turn may sabotage the deal or encourage investors to question the offer.
As a mediator, an experienced financial advisor directs the work of all project participants. One of our latest projects, for example, featured 48 legal consultants from one party!
Beside planning the investment offer, execution and structuring the deal, as well as consulting the client at all stages, the financial advisor performs another essential function - makes the sale competitive. There are at least two companies willing to purchase an existing business even in a crisis time, and the advisor's mission is to identify such potential buyers. Healthy competition always plays into the seller’s hands, adding value to his assets.
Conclusion: The investor can, certainly, try to seal the deal on his own, but the number of pitfalls is so high that the chances of selling his asset with profit and making no typical errors are very low. We advise not to let things take their own course and entrust the sales process to experts in order to justify the expectations and make the transaction efficient and secure.