In Part 1 and Part 2 of this article series, I discussed two misconceptions about M&A; the importance of your investment banker knowing a lot of buyers and the value of industry experience. I will now cover the third misconception: magic words.
Misconception: Expecting an Investment Banker to Use 'Magic Words'
The “magic words” phenomenon is something I've discussed previously in the article, "Investment Bankers Aren't Magicians." Investment bankers do not possess some sort of magical ability to get a buyer to pay more. If you are looking for an investment banker who essentially has some sort of extraordinary ability to get a buyer to increase their bids, you’ll be disappointed. Instead, a strong valuation is the intersection of buyer demand, seller motivation, the tenor of the times, the strength of the underlying business, and the abilities of the investment banker to create and manage competition resulting from an orderly process.
I get contacted on a fairly regular basis by business owners who say they have a buyer on the hook and they just want someone to help wrap up the details and get a good deal. Essentially, they say, “Bill, I have a buyer. I did the hard work; I just need you to button up the deal, so I’ll just pay hourlies. I’m not paying a success fee because I did the hard work of finding the buyer…but, uh, the offer is low. If you’re so good, get the buyer to pay more!”
More often than not in these situations, the owner is responding to a “random sample of one” offer. That is to say, a buyer who contacted the owner and tossed an offer over the proverbial transom. As I’ve said many times, the demand from buyers far outstrips the supply of sellers. In M&A, finding a buyer who has expressed some level of interest is easy. Getting a deal done that makes sense for the seller is the tricky bit.
Further, no matter the skill of the investment banker, trying to negotiate a deal when only one buyer is in the mix is very difficult. Here’s how that negotiation looks:
Investment banker: Thank you for your interest. My client would like to do a deal with you, but your offer is light. Very light. If you can increase your price, we would be more interested. Could you resubmit your offer with a higher valuation?
Absent competition and options, trying to craft a better deal with that solitary buyer is very difficult. The seller has no other readily available options and the buyer knows it. A well-run, orderly process is a boon to the seller because it provides options to the seller. And when an investment banker contacts the buyer, the buyer will know a process is being run. That means competition. So, if a buyer really wants to acquire the company, their offer will be reflective of that competition.
Reality: Expect an Investment Banker to Use Techniques to Enhance Value
Instead of expecting an investment banker to have some sort of special negotiating ability unknown to others, the focus should be on what techniques will be used to enhance the value of a company. Buyers typically value a company on some sort of multiple of EBITDA, but when very strong valuations occur, the buyer has a compelling need to make the acquisition because of something other than the profitability of the company. Here are some examples on enhancers to valuations:
- Rapid growth
- Strong EBITDA margins (10%+)
- Minimal Capex requirements
- Strong inventory and accounting systems
- State of the art facilities, warehouse or distribution center
- Reduction of customer concentration
- Expansion opportunities (geographic, products, customers)
- Buying/sourcing/pricing expertise
- Inventory management
- Fragmented industry
- Barriers to entry
- Low regulatory risk
- Cutting edge use of technology
This list is not inclusive of every single enhancer to valuation, but, instead, lists just a few of the possible attributes a buyer may find of value. Let me explain how this works.
A few years ago, I was selling a company that had “summer” profits; in some years it had profits, in some years it didn’t. The company was located in the Midwest and had an underutilized but state of the art distribution facility. The buyer sold similar products, but, more importantly, was operating out of a cramped, decrepit facility on the east coast. One way or another, the buyer was going to have to make a multi-million dollar investment in facilities.
Acquiring my client solved that problem for the buyer. In addition to picking up the revenue, profits, products and brand names of the seller, the buyer was able to move its existing business into the seller’s facility. The price they paid might seem high as compared to others who valued the seller strictly in terms of the bottom line, but for this one buyer, paying a seemingly high price made all the sense in the world. They were able to bake into their offer some of the money that they were going to spend on a new facility.
No one has a magic ability to get buyers to pay more. A strong valuation is the result of competition from a well-run, orderly process and an investment banker who is able to identify and communicate key attributes that might be of additional value to different buyers.
Instead of asking, “How are you different from other investment bankers?" or "What skill do you have that others don’t?”; business owners should ask what specific attributes of the company might be of added value to buyers.
Coming up in Part 4, I will discuss the misconceptions and realities involving the “ask price.”