In the previous parts of this article, I discussed three common misconceptions about M&A investment bankers: The importance of knowing a lot of buyers, the value of industry experience, and the use of "magic words." I will now delve into yet another common misconception – how the “ask price” is determined.
Misconception: The Investment Banker Determines the 'Ask Price'
Finding the investment banker with the best methodology for determining the value of a company is another misconception held far too often by many business owners. And when I say, “best methodology,” I mean the “highest price,” of course, and all too often that results in hiring the one who lied the highest.
Understanding the expected valuation of a company is important for business owners and executives; so, conducting a valuation is a worthwhile exercise. But it is only an academic exercise! The best way to determine the value of something is to discover what someone will pay for it. And the best way to discover what someone will pay for the company is to run an orderly process that clears the market.
Reality: How the Investment Banker Handles the 'Ask Price' Is Imperative
The flip side of determining the ask price is handling the “What does your client want?" question. I call that the “ask price question." The ask price question is often asked by buyers for two reasons. The first reason is simple: Why not?! Asking what someone wants can’t hurt. The worse they can say is “no.”
The second reason is perhaps more important: Probing. The buyer asks the question in order to ascertain the relative strength (or weakness) of the investment banker. It’s a test. I know it’s a test because I ask the exact same question whenever I represent a buyer and I am talking to an investment banker representing a seller.
An experienced, prepared investment banker will have an immediate answer when asked, “So, how much does your client want?” Someone who is unprepared will stammer and stutter and will talk without saying much. This is dangerous because an unprepared investment banker might crack under pressure and cough up a number. And if your investment banker is doing that, you run the risk of leaving money on the table. Here’s my answer:
“We put together a detailed book that contains all the information you’ll need to make an offer, please review it and put together a deal that you can close, being mindful that we are talking with other buyers.”
If the buyer pushes me – and many will push – I have a further, more detailed answer: “I’m not going to give you a number for a couple of reasons. First, I don’t want you to think I’m going to use your bid as a stalking horse and wave it in front of other buyers saying, 'This is the number to beat.' Second, if I give you a number and you submit an offer using that number, but you were willing to pay more, I’ve done two things. I’ve left money on the table for my client, but more important for you, if another buyer bids higher than you, I’ve just given you bad advice.”
My approach usually settles the issue because I’ve deftly signaled to the buyer my level of sophistication in these matters.
Instead of asking, “What is my company worth and why is your methodology better than the other investment bankers'?” business owners should inquire how the investment banker will answer the ask price question.
In the final Part 5 of this article series, I will discuss the misconception that selling a company is similar to selling a house.