The Denver Post | BUSINESS
By GARY MILLER | firstname.lastname@example.org | GEM Strategy Management
PUBLISHED: October 27, 2019 at 6:00 am
I recently witnessed a business sale that went “south” and has not closed as a result of mistakes made by the lead negotiator during the negotiation process. A transaction that was supposed to close in Q4 has been pushed back to sometime next year. Below are some of the mistakes made. The lead negotiator DID NOT:
- Negotiate the transaction process and deadlines before negotiating the substance of the sale. As a result, with no process deadlines in place, the buyer controlled the momentum and the pace of the transaction process from the outset. Deadlines work. They are powerful because they force action. Deadlines force people to choose either one option or the other. A deadline’s implicit threat is that lack of action has unpredictable consequences.
- Obtain a signed letter of intent (LOI) after providing a comprehensive confidential information memorandum (CIM) to the buyer before he started the negotiations. Had the negotiator clearly established the need for a signed LOI before negotiations would begin, the negotiator would have known the major deal points and well-defined elements of the deal structure.
- Establish the price and terms of the deal initially. By contrast, the lead negotiator allowed the buyer to “anchor” a “low-ball” purchase price and deal structure from the outset. Anchoring is an attempt to establish a reference point (the anchor) around which negotiation will revolve and will often use this reference point to make negotiation adjustments.
- Identify the major deal terms (deal points) that needed to be negotiated before the buyer captured control of the negotiating process and anchored the purchase price. In addition, the buyer had developed an acquisition formula that they used in previous acquisitions and made it clear that they would not deviate from most of the formula as it “had worked well” in the past.
- Use various negotiating techniques such as “trading off” (“I will give you this, if your give me that”) and limiting concessions without receiving something in return. In fact, the lead negotiator did not win one deal point from the buyer. As the negotiations drug on, the buyer’s interest level waned and the closing was postponed until sometime next year, if it closes at all.
The following four steps will help prevent those mistakes listed above.
Step 1. Don’t begin negotiations until you have a signed LOI.
An LOI details the buyer’s proposal and gives the seller a first look at the major deal points including very detailed deal terms and conditions. The details of deal terms of any transaction are crucial. I much prefer a detailed LOI vs. a general Term Sheet. Difficult or contentious issues are flushed out immediately, allowing the seller to plan his/her negotiating strategy. Typical issues are:
- The amount and length of the escrow hold back for indemnification claims. The typical scenario for a seller is 10% or 20% for 12 months, but it can be longer;
- The exclusive nature of the escrow hold back for breaches of the Asset Purchase Agreement;
- The conditions to closing (a seller will want to limit these to ensure that it can actually close the transaction quickly);
- The adjustments to the price (sellers want to avoid downward adjustment mechanisms;
- The nature of the representations and warranties. A seller wants materiality, intellectual property, financial and liability representations, and warranties as thinned down as possible;
- The scope and exclusions of the indemnity;
- The provisions for termination of the acquisition agreement; and,
- The treatment of any litigation, if any.
Step 2. Be clear about what your negotiation needs to achieve.
- Know the issues that absolutely must be addressed for the deal to close successfully. Some call these deal-breakers or walk-away deal points. Perhaps you have a price you’re not willing to go below. You don’t want to be unreasonable, but if you clarify limits before entering negotiations, you’ll know when to say “yes” and when to say “no”.
- What’s being purchased. The assets of your business (an asset sale) or your business entity and all its assets and liabilities (an entity sale).
- The purchase price, which will likely be 70-90% of the asking price.
- How the price will be paid, including how much will be paid at closing.
- How the price will be allocated among the IRS-defined asset classes.
- How to address issues discovered during due diligence, whether through price concessions or actions that rectify conditions of concern.
- How to handle the transition period, including how and when to contact customers or clients; whether employees will be rehired; how and when the sale announcement will be made; how suppliers, vendors and distributors will be notified; how work-in-progress will be completed; and, how unknown liabilities that become apparent after the sale will be addressed.
- Your post-sale involvement with the business, including the transition period, compensation, post-sale decision authority, and a non-compete covenant.
- How contingencies will be addressed/removed, including acceptable transfer of leases, contracts and other assets.
Step 3. Once you begin negotiating details, consider this advice:
- Use your objectives as steering devices. If you need to concede on one point, negotiate an offsetting advantage on another point, particularly in price negotiations. If you need to settle for a lower price, your advisors can help you balance the concession by structuring the price for greater tax advantages.
- Do not increase your asking price. You may begin to think your business is worth more than you asked, but don’t try to increase the price during negotiations.
- Do not get complacent about protecting your interests. By this stage in the game you may almost feel in partnership with your buyer. Still, don’t let your guard down.
- Do not issue ultimatums or seize one-sided victories. It’s safe to assume if you’ve gotten this far, you both want the deal to close. So, aim for a win-win conclusion by offsetting each of your necessary demands with a compensating buyer advantage. Work together to address the issues necessary to meet both your objectives.
Step 4. Be ready to keep negotiations moving.
Delays are deal killers — especially during the negotiation process. During negotiations you will need to call a few timeouts in order to obtain input from your advisors regarding legalities and tax implications. But, obtain the necessary information in the same day, if possible. Delays either dampen interest or heighten concern – neither of which supports the kind of healthy negotiations that lead to a victorious closing day.
Most of these “Do’s and Don’ts” are basic to the negotiating process, but in the sheer magnitude and emotion of business negotiations, even practiced M&A advisers lose sight of some obvious negotiating techniques that can lead to successful outcomes of a transaction.
Gary Miller is CEO of GEM Strategy Management Inc., a M&A consulting firm that advises small and medium sized businesses throughout the U.S. He represents business owners when selling their companies or buying companies and raising capital. He is a frequent keynote speaker at conferences and workshops on mergers and acquisitions. Reach Gary at 303.409.7740 or email@example.com.