Ask The Expert: The Art of the Acquisition
David Liu, managing director and co-head of digital media and Internet investment banking at Jefferies, a division of Leucadia National Corp., has worked on more than 100 transactions. In his first piece he talked about how companies should think about pricing themselves during an acquisition and how to approach potential buyers. In this second piece, we get his opinion as a banker on how companies should think about negotiations with potential buyers and how they can optimize their outcomes.
Besides the core value of a company, how is a company valued in an acquisition?
I believe that the value of any company has two core elements: The first is what I call the “intrinsic” value of company. This is the aggregation of the company’s assets (i.e., financials, market position, brand, team, etc.). In other words, what is the company objectively worth? The answer can be found by answering questions such as, “What are the comparables with public companies or other recent acquisitions?”; “Who are the companies that see strategic value in the product, tech, or new market?” (We covered this in my last post.) That’s what I refer to as the company’s intrinsic value.
The second element is one that many overlook and, in my experience, can be a much larger driver of value if optimized correctly. The second part of the company’s value comes from the actual deal process. A lot of entrepreneurs put more emphasis on the first half but not the second and as a result they are under-optimizing. I don’t think they realize that things like competitive heat around a process can substantially appreciate the value of a company – particularly when animal spirits take over and buyers start to bid with what appears to be reckless abandon. We commonly refer to this as “deal heat”. In other words, the value of the company changes based on the dynamics of the negotiation, what the buyer believes the company is worth and other externalities that may be driving a buyer to increase their offer.
What are the kinds of things that create deal heat?
Unfortunately, there is no one-size-fits-all nor is there a “Deal Heat for Dummies” manual. As I said in the last post, every process involves both different quantity and varied quality of buyers so you need to think about each situation uniquely. For example, a buyer who really wants to or needs to compete fiercely with another company and knows the competitor is also bidding on the same seller can drive the price way beyond whatever the intrinsic value of the company is. That’s how you get these sale prices at levels that appear crazy.
One other way I think about the value of a company in a sale is it is one part science, and one part art. The first part, or intrinsic part, is determined scientifically through analysis while the second part is extracted during the course of the process. You should note, however, that even though every sale has these components of value, the mix is different in every acquisition process because every situation is unique.
How do you as a seller approach buyers?
We all know the saying “companies are bought not sold.” What this means is you typically get acquired if a buyer chases a target, but not vice versa. But that’s just the simplified, dumbed down version of how it works. The reality is that there are many other ways this can happen.
The best approach really does depend on the buyer. You need to understand each buyer and their unique buying traits. For instance, for some, you can give them a call and say, “Hey this company is available.” Some buyers like that because it’s direct and allows them to prioritize their opportunities. But some buyers really don’t like that invitation at all and get put off immediately. They think: “If you’re calling me it’s being shopped from here to kingdom come or, even worse, it’s a crap company and you are just trying to sell me a bag of goods.” All buyers view these approaches differently so be mindful of your approach. I like to draw M&A analogies to the dating game because in many aspects it’s not all that different. Some guys and gals like it when the other is very direct and forward on a date. Others immediately run for the hills.
How do you get leverage as a seller to increase the offer?
At the end of the day, the only real leverage you have as a seller is competition. Either real competition in a bidding war or the threat of competition. If a buyer knows an enemy is bidding on the same company that can really amp up interest very quickly. Sometimes, just the prospect of a competitor bidding on the target is enough to drive a buyer to pay a higher price.
So, you don’t even have to have a real threat but just the perceived threat of competition. Some of the highest valuation deals I’ve done have had this threat. In other words, I tell the buyer “You pay us something and you can take us off the table.” Some buyers really like that because at the end of the day no one wants to get caught up in a bidding war.
What is an unconventional approach to the deal process that you’ve seen work?
One process tactic I have used is a preemptive bid. In this case, buyers want to engage in a “pre-process” and take the target off the table before the race has begun. They obviously do this because the buyer believes they can buy the business at a cheaper price than in an auction process. It’s an approach that many people don’t like because it seems to defy the conventional wisdom of creating competition through an auction but I have found it to work really well in certain cases. Why would a buyer ever engage with a seller before you shop it to other buyers, given there’s a chance they could overbid against themselves? Because of fear of loss. Some buyers are willing to pay this premium to insure against potential loss. Interestingly, I see this happen a lot in other sectors. For instance, it’s similar to a sports team signing a player to a long-term deal before the player goes onto the free agent market. They don’t want to risk losing to others in a bidding war.
Why would a seller ever agree to selling ahead of a full blown auction?
Because a pre-process could allow a seller to get a higher expected value than that which would come from a process with multiple buyers once you factor in the probabilities of success. A bird in hand is worth more than two in the bush!
Finally, this strategy also touches upon two things I’ve noticed human beings really love and can’t resist. The first is free. That’s probably one of the most intoxicating words anyone can hear. The second is exclusivity. It makes one feel special and exclusive. People love the red carpet treatment and are sometimes willing to bend over backwards for that. Most buyers have core principles that have made them successful that they generally won’t break. Such as not bidding against themselves or holding off on spending money on advisors until they know there is a deal to be done. I have found that when you dangle exclusivity, particularly in concert with a pre-process, interesting things can happen and buyers’ principles become less rigid.
How do you get multiple buyers involved?
The natural expectation by both buyers and sellers is that there are always multiple buyers involved. However, the challenge is how does one keep all of them engaged to create a robust competitive process? I’ve found it’s about managing multiple conversations and frankly giving each buyer a realistic chance of winning. It’s important to give each buyer hope they can win while still being transparent about their chances. Because as soon as they feel they’re wasting their time, they’re gone.
How do you give them hope while still operating in good faith?
It’s tricky. Despite what a seller or their advisor may communicate to a prospective buyer, most buyers assume the company is speaking with multiple parties. So you have to give enough signals and validate with action to keep them engaged. A buyer needs to feel the deal is theirs to lose.
How do you as a seller not get distracted by the acquisition process from running your business?
It’s hard because usually the CEO is the best advocate and so the best chance for the company to get a good price. As such he or she has to be involved in the process. But one way to mitigate the distraction is to try figure out if a deal is possible as soon as possible. Using matrimony as an analogy, try to figure out really quickly whether you want to get married? I believe that the best way to manage management’s time is to a have very short courtship period prior to the engagement and then have a long engagement. Try to determine what a buyer needs from you in order to make a non-binding offer and do it as early in the courtship process as you can.
How do you keep a deal process from dragging on too long?
What you want to try to do is keep the initial diligence period as short as possible and get to a Letter of Intent (“LOI”). You want to give the buyer enough info such that they will give you a non-binding LOI but not so much that if the deal falls apart you didn’t feel like you showed them the crown jewels. The LOI is also critical in determining if their valuation is even remotely in the region of acceptability. If their offer is way below expectations, the process can end there. After you get the LOI then you can spend the time to get to a signed definitive agreement.
What other things can sellers do?
Sellers can send a formal process letter stipulating to buyers the requirement to submit a bid by a certain deadline. (It doesn’t always work this way but this is one approach.) Then buyers would send you in writing their proposed valuation, structure of the deal, basic terms – any of which could be a deal killer. If the valuation is good but the structure is bad you can throw that buyer out of the process. Every seller has their own list of deal killers and this is an easy way to get them all on the table.
The overarching idea here is that no one process is the same. There are many different ways to go about the acquisition process and so one needs to really needs to develop the right situational strategy. It can be stressful because the implications of each step can be enormous for your company but it can also be very rewarding. It can also be a fun process!