Avoiding the Exclusive Negotiations Trap
Competitive tension is essential to exert control over the sale process and present an enforceable timeline to bidders.
We often hear business owners say, “A competitor just approached me about buying my business. I’ll just sit down with him and cut a deal.” The assumption is that this approach will be quick, easy and quiet. It rarely works out that way. Although successful transactions ultimately close with a single buyer (and are, hence, exclusive), only under unusual circumstances is it a best practice to begin the process while entertaining only one potential buyer.
A dangerous variation of this trap is an M&A sale process where the seller tries to close a deal with a succession of potential bidders, moving on to the next potential buyer as negotiations with the prior bidder break down. This approach projects weakness and inexperience to the potential buyer, while perpetuating the window of vulnerability and all its inherent risks. The simple fact that multiple bidders are involved in the sale process is often not enough to create competitive tension and, ultimately, drive a higher selling price.
What’s worse is that it’s difficult to re-engage those potential bidders that have had a bite at the apple if it is later decided that an advisor should be hired to run a structured sale process. Any prior failed process taints all potential bidders who were involved, limiting future options.
Delaying Exclusivity is Key
Because there are a myriad of risks in navigating from an initial indication to a binding offer, the best sale process defers exclusive negotiations as late in the process as possible. Once competitive tension is gone from the process, the exclusive party behaves very differently and negotiating leverage shifts. Ideally, no exclusive commitment is made to any party until two conditions are met:
- All aspects of their proposal are acceptable.
- No conditions (due diligence, documentation, financing, approvals, etc.) are attached to the “offer.”
We once encountered a situation where a client received nearly identical bids from European strategic bidders. Although one had a larger earn-out component, the headline prices were a dead tie. We went back to the bidders and offered them both an opportunity to re-bid. One bidder increased the purchase price within a couple of hours of our call, well into the evening for their European headquarters. Once most of the definitive agreement terms were settled, with some minor points on the earn-out still outstanding, we provided the bidder exclusivity. The buyer who had until then been accommodating and keen, became intransigent and positional. Despite the late change in behavior, exclusivity was granted at such an advanced stage that there was almost nothing for the acquirer to re-trade. The deal was a great success for the seller, who collected 98% of their maximum earn-out.
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This overnight Jekyll-Hyde transformation highlights that the discipline of competitive tension is not theoretical. Nothing else about the situation itself had changed: we were working on the same transaction with the same bidder and the same person. The change to exclusive status profoundly altered the dynamics of this transaction.
Are Exclusive Negotiations Ever Advised?
Only in rare circumstances is an exclusive process appropriate from the outset. Exclusive negotiations are only advisable when:
- The favored party is the only logical bidder for the business or asset. In this case, the favored party will clearly be the highest bidder for strategic, structural, legal or regulatory reasons.
- The favored party refuses to participate in a competitive process.
- Confidentiality is of utmost importance and the leak risk from contacting other bidders is unacceptable.
In any event, if exclusivity is granted, urgency and momentum must be maintained. Any exclusivity period should expire after a short time frame. To ensure enforceable timelines in an exclusive negotiation, establish clear milestones that the bidder must meet to retain exclusive rights. Examples include, deadlines for completion of various due diligence phases, mark-up of definitive agreement, etc.
Before making this determination, it is important to conduct an in-depth market analysis of potential acquirers, both locally and, more importantly, abroad. Having access to somebody with experience becomes even more crucial in such an exclusive negotiation because of the heightened completion and valuation risks. It’s particularly helpful in these circumstances to have a perspective on the particular acquirer’s background to determine whether they have a history of grinding and re-trading.
Implications of an Unsuccessful Exclusive Negotiation
A failed transaction can have dire consequences for the future saleability of your business and the likelihood of completing a sale. Unfortunately, the ramifications of a failed transaction are often irreversible.
We recently spoke to a business owner who had wanted to sell for some time. In our initial meeting we learned they had been approached a few years prior by a competitor that was owned by a private equity fund and was likely the most logical buyer for the business. The process progressed to the due diligence stage.
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During the exclusive negotiations, the acquirer started to employ grinding tactics. The acquirer took a radical and unsupportable position on a previous accounting reserve assumption that had the effect of cutting the seller’s EBITDA (and, hence, the valuation) in half. Eventually, the owner was forced to terminate the negotiations. Making matters worse, after this failed negotiation, the owner went to the next most logical bidder and entered into another exclusive negotiation. These talks also failed to produce an agreement.
By the time we met with the owner, about a year had passed since the second failed sale attempt. Two of the most logical acquirers in an already thin buyer universe had already attempted and failed to acquire the business. We knew the history of failed negotiations had tainted those parties.
We were asked if we could help, but like most successful investment banks, we can only accept mandates where we are highly confident we can meet our clients’ objectives. We had to pass on the assignment. It is unfortunate that the owner was not able to create a process with competitive tension, which would have increased the chances of a successful sale.
You Have One “At Bat”
With any given bidder, you have only one timing window to negotiate from a position of strength, a window that closes quickly once discussions start. It is very difficult to re-engage with a potential buyer after negotiations break down without projecting weakness. The only exception to this is a material positive change in the business and the passage of a minimum of 18 to 36 months, depending on the circumstance.
Competitive tension is essential to exert control over the sale process and present an enforceable timeline to bidders. In only the most unusual circumstances is it advisable to engage exclusively with one bidder before they have completed their due diligence and transaction terms have been settled in all material respects.