Overview of the M&A Sale Process
The M&A sale process is the transitioning of a business in the hands of one owner, to another. The sales process for a mid-market business can take anywhere from as little as four months, to well over a year. Other daunting statistics show that 80% of all businesses listed for sale never sell at all.
There are several steps that must take place for the sale process to be effectively executed. For the seller, the process may be an emotional one. Once it has been decided that a business will be sold in an external transfer to a third party, a typical M&A sales process for mid-market businesses usually contains five major steps. These include:
- The preparation phases
- The market phases
- The diligence phase
- The negotiation phase
- The transition phase
Each phase is distinct in its own nature, but nonetheless vital to the process. The process is also very fluid and these phases can overlap in timing and execution. An M&A advisor (investment banker, M&A intermediary) will usually lead the process and their role is to transition through each phase with the least amount of complications. In most successful M&A sales, the advisor has played a major role in executing the necessary components. On the flip side, an overruling management that restricts the advisor ability to lead each phase can hindered the process. The following is a summary of each phase of the sales process as it is conducted under a controlled auction.
The Preparation PhaseBefore the process starts, the seller and their advisors must prepare the business to be sold. In other words, the business must look attractive to buyers, and in the interest of the seller, be positioned to attain its maximum value. Key activities that are undertaken in the preparation phase would include:
- Preparation of a Confidential Information Memorandum
- Strategy and number of potential buyers to approach
- Research and preparation of a prospective buyers list
- Preparation of virtual data room
This phase is the underlying foundation to a successful M&A process. Some companies spend anywhere between one to three months to prepare these materials. Buyers will judge the financials first but take a holistic approach in deciding to submit an offer. Once the advisor and management agree the pieces are in place, they will initiate what is called the marketing phase.
The Marketing PhaseOnce the preparation phase is completed, the advisor will begin contacting the entities from the prospective buyers list. The advisor approaches each buyer and interested parties will be presented with an investment teaser that provides an overview of the opportunity. Each potential buyer will then begin their own process of analyzing the prospect of purchasing the company and the potential fit with their acquisition criteria. Interested parties will sign a confidentiality agreement (or non-disclosure agreement (NDA), which ensures that all information migrating between buyer and seller, is confidential between both parties. Once the NDA is executed, the confidential information memorandum (CIM) is sent to allow the buyers to analyze risk, benefits, and terms of the investment.
Buyers that decide to pursue the acquisition will present an indication of interest (IOI), which provide initial parameters on valuation and deal structure. Depending on the number of companies that review the business, this period will generally last for one to two months. Also, the type of sales process being employed will determine how the M&A advisors will create competitive tensions between the various prospective purchasers.
The Diligence PhaseOnce the marketing phase ends, the M&A process generally becomes more formal. At this stage, it is clear to the seller, which buyers are still interested, and a range of valuations and deal structure for the transaction becomes more apparent. The seller and their advisor can create a shortlist in which they selects only the buyers that are approved to continue with the process.
At this stage the buyers will undergo a detailed diligence of the business. This is primarily an investigation of operational, financial, and legal history of the business. Due diligence will also highlight any particular flaws, or hidden benefits of purchasing the business. The diligence phase is thorough and will often scrutinize a business by using tax agents, lawyers, accountants, and bankers. The buyer will often go through a series of questions, which attempt to reduce the chances of the investment being a failed one. It is at this phase where serious buyers begin gaining momentum.
Formal management presentations take place from the seller to the entire team of buyers that further highlight the positive aspects of investing into the business. These presentations go beyond the marketing materials and will incorporate all aspects of the business. The shortlisted buyers are also allowed entry into the facilities, and the sites of business. After this one to three month period each buyer submits a binding letter of intent (LOI) that allows the seller and the advisor to determine the best fit to meet the seller’s objectives. Buyers go through final negotiations prior to selection, and ultimately one acquirer is selected as the winner of the bid.
Negotiation PhaseOnce the winning bid is determined, the acquirer and the seller have to begin a complex negotiation phase that will hand over the business. At this point many of the operational, business and financial aspects of the deal aren’t yet hammered out. The purchase price and high-level deal structure outlined in the LOI is only the initial agreement between the buyer and seller. In other words, small but important details between buyer and seller are needed to be determined. In this phase, the buyer and seller will negotiation and complete the following agreements:
- Purchase and sale agreement - The purchase and sale agreement (PSA) is the settlement of the entire sale as followed within the boundaries of the original Letter of Intent (LOI). PSA will set out in detail among other things, the amount and timing of the purchase price, seller’s and buyer’s representations and warranties, purchase price adjustments, the form of transaction (i.e. share or asset purchase) and dispute resolution and arbitration protocol.
- Transitional service agreement - A traditional service agreement is when the seller will provide transitional support to the buyer. This can include, but is not limited to accounting, human resources, and other management positions. At a minimum, TSA's should include a description of services covered, the fee for the general scope of services and additional charges for services beyond the scope.
- Non-competition agreement - A non-competition agreement stipulates that the seller cannot engage in direct or indirect competition with the buyer during a specified term. The violation of a non-competition agreement is usually followed by legal action from the buyer.
- Vendor financing agreements (if any) - Vendor financing generally occurs when there is a gap between the purchase price and the financeable asset base of the seller. Vendor financing agreements will contemplate security arrangements in place to protect the seller against the risk of default, and the amount, timing and interest rate associated with the financing.
Transition PhaseThe final phase involves the transitioning of the business from the seller to the buyer after the business has been sold. A strong transitional service agreement (TSA) can generally limit conflict and assist with a smooth hand. The objective of the seller at this point is to ensure that all of their corporate knowledge, relationships and responsibilities are transferred to the new acquirer.
Exit Options - Preparation PhaseDeveloping an exit strategy is an essential part of running any business and the best option in any given situation may differ depending on an owner’s visions for his or her own future. In addition to maximizing price, a business owner may be interested in achieving other factors as well - preserving the legacy of the business, continued growth for existing management, and/or continued influence over business decisions after the sale. An optimal exit strategy for any business will balance the often competing interests of the seller. In general, exit options can be broken down into three general categories as follows:
Internal TransferInternal transfer options generally allow the business to be transferred into hands of those who are more familiar with the existing operations, such as current management, employees, or family members. Because of this, there is a lower likelihood of a change in management and a lower likelihood that new management will take the company in a drastically different direction after the transfer. A common downside of an internal transfer, however, is pricing. In exchange for the benefits listed above, owners often must sacrifice optimal pricing and/or an immediate cash payout.
Once a business owner has decided that internal transfer is an exit strategy that he or she would like to pursue, the business owner has a number of options to choose from. He or she may choose to transfer to a family member, shareholders, management, or employees.
Family MemberTransfer to family members has a number of rewards. An obvious advantage is that the business stays in the family. This means that if a business owner has had time to properly groom the intended successor, the value and culture of the business can remain relatively unchanged upon transfer. Successors who take over a family business likely value the business beyond just the earning that the business can generate. A family successor who has spent sufficient time in the company prior to the transfer - whether as an employee or as management-in-training - can also give employees and management a sense of familiarity and thus, comfort. If it’s done right, this type of transfer minimizes the anxiety and unrest among employees that often come with a transfer of ownership.
There are, however, large risks involved in an internal transfer to a family member. First, this type of transfer can be the most emotionally charged. Jealousies and family rivalries are often magnified when such a large asset is at stake. If trouble arises at the management level, a business and its employees may be adversely affected in their performance and profits as well.
Another disadvantage of an internal transfer to a family member involves valuation. Oftentimes the objective of obtaining the highest value is sacrificed for the advantages listed above. Additionally, depending on the arrangement involved, a business owner selling to a family member sometimes may see little or no cash at all upon transfer.
Other Existing ShareholdersTransferring to already existing shareholders is another type of internal transfer. It shares similar benefits to an internal transfer to family members - the successor is familiar with the business, the successor can have ample time prior to the transfer to serve in employee and/or management-in-training roles, and is more likely to value the business’s culture and values than an outside buyer might.
A shareholder transfer has some advantages over a family member transfer as it may decrease the likelihood of family rivalries surfacing to affect the business. Additionally, a shareholder transfer can oftentimes be easily facilitated through a shareholder agreement.
Similar downsides remain, however, with a shareholder transfer. For example, a shareholder transfer will likely not maximize the sale purchase price. Additionally, because shareholder rights in the transfer will be embodied in a shareholder agreement, the owner must take care that the transfer is well-planned in order to avoid potential disputes down the line. Similar to an internal transfer to a family member, a shareholder transfer may fail to provide all cash at the closing.
ManagementAn internal transfer to the management team is another option. This type of transfer, call a management buyout (MBO) is designed to maximize efficiency, as the management team is often the one most familiar with the business. As a result, transition can be seamless. Additionally, where maintaining confidentiality is very important to the seller, an internal transfer to the management team can minimizes risks of information leaks.
Similar to other internal transfer options, however, an MBO may often fail to obtain the best price and fail to provide cash upon closing. Additionally, owners transferring the company to management likely will likely not see full proceeds on closing. Vendor financing may be required to effectuate a management buyout but bank financing is accessible for strong management team that can deliver a seamless transition post closing.
Employees (ESOP)An Employee Stock Option Plan (ESOP) is another well-established internal transfer option. An ESOP sets up a stock equity plan for employees to gain ownership over the business. ESOPs differs from MBO in the fact that an ESOP is open to a larger pool of employees and the exit for the owner is not as immediate. Essentially, an ESOP allows the original business owner to make a gradual exit over time while at the same time maximizing employee productivity and company profitability. Because employees know they will eventually have an ownership stake in the business, employees will be incentivized to work hard to maximize their own profits. An ESOP may also have positive tax consequences for the business and its shareholders.
Like other internal transfer options, an ESOP will not maximize the sale price of the business. Also with an ESOP, a seller will often have to wait years to get cash out from the sale and, depending on how the ESOP is structured, may only see profits from the sale if the business continues to do well.
External TransferExternal transfers are transfers to outside buyers - third parties or the general public. External transfers tend to be less personal and the seller will end up with less (or no) control than in an internal transfer, but have the potential to maximize the sale price of a business. A business owner who decides on an external transfer as an exit option should take ample time to position the company to be favorable to potential buyers, whether third-parties or the public.
Third-party SaleA third-party sale is the sale of the company to strategic buyer, private equity group or individual investor. Third-party acquirers take into account the synergies of a potential acquisition and, as a result, these prospective buyers may be willing to pay a premium for the business. Additionally, sellers in a third-party sale are more likely to receive more cash at the closing.
There are, however, some downsides to a third-party sale. First, the structure of a third-party sale is usually more complicated than an internal transfer. Because the buyer is a third-party and the transaction is arms-length, the buyer would be especially interested in negotiating terms to minimize their risk of investment. This is sometimes accomplished through a vendor financing or earn-out, both of which are ways a buyer may seek to ensure a smooth transition post acquisition.
Buyers will also require representations and warranties from a seller related to the information that the buyer is relying on when evaluating the company purchase. Buyers also require ancillary agreements such as non-competition and management agreement where certain key executives stay for a set number of years after the acquisition to ensure customer retention. Additionally, a sale to a third-party is often a longer process with, sometimes, tougher negotiations. A drawn-out process may open the business up to information leaks and confidentiality issues.
Public Offering (IPO)Public offerings, or IPOs, are the most publicized type of exit options for business. In an initial public offering (IPO), a business sells shares of the company on the public market. An ideal IPO candidate would need consistent high revenues, earnings and growth. In particular, because investors often look at industry benchmarks to determine a company’s financial strength, the business should have a strong record of performing well within their industry.
Additionally, a business preparing for an IPO must be careful to comply with rigorous governmental regulations, including Sarbanes-Oxley regulations. This often means a need to reassess corporate governance, business structure as well as financial reporting.
Most mid-market business are not ideal candidates for an IPO and it is the least likely exit option.
LiquidateLiquidation is the least appealing exit strategy and only pursued when other options are not available. A business owner who pursues liquidation would sell off assets, pay off liabilities, and take the rest of the profits (if any) for himself or herself. A business liquidation can be straightforward and fast, with an opportunity to quickly monetize the assets of the business. However, this type of exit option often brings lower net proceeds due to liquidation costs. Additionally, liquidating a business requires loss of jobs and severance costs. This is not an exit option that is willing executed by business owners.
ConclusionExit option for mid-market businesses may change over time and will differ depending on what the business owner wants out of the business. A business owner seeking to maximize value should start evaluating exit options early, so as to tailor the business to make the exit transition a smooth and profitable one.
Summary of Prospective Buyer Types - Preparation Phase
Perhaps the most crucial facet of a business sale is understanding the range of different types of prospective buyers. The following factors would have an impact on selecting the most appropriate buyer type:
- Importance to the seller of maximizing purchase price vs. ease of transition;
- Attributes of the business (size, industry, attractiveness, strengthen of management team, etc.);
- Transaction structure (full vs. partial sale)
Strategic BuyersStrategic buyer would be any corporation pursuing an acquisition to achieve one of the following strategies:
- Remove a competitor;
- Expand horizontally into new geographies or product/service lines;
- Expand vertically toward the customer or supplier; or
- Enhance the operations of the acquirer by gain the assets (technology, products, distribution channels, workforce, etc.) of the target.
A strategic buyer is better suited for a seller who wishes to exit quickly and maximize the dollar value on the sale. It is not suited for a seller who wishes to remain in the business, or wants to retain some autonomy. A strategic buyer has sufficient resources to absorb the seller, and will usually move quickly on realizing some of the synergies from acquisition. This usually entails the elimination of redundant overhead and assets, which may be difficult for a seller to adapt to.
Financial BuyersPrivate equity (PE) groups are financial buyers that invests in private companies of all sizes. Private equity firms will acquire various levels of equity (from minority to control) of companies with the goal of selling this equity - three to five years later to achieve an investment return. Hence, PE firms are primarily driven to maximize their IRRs on exit.
The funding for these investments comes primarily from a group of investors known as limited partners (LPs). Typical LPs include endowments, pension funds, sovereign wealth funds, wealthy individuals, and large corporations. Funding pledged by these LPs is pooled into individual PE funds which are managed by general partners who are co-owners of a PE firm.
These PE firms use the money in their respective funds to make investments in a broad range of public and private companies with the hope of selling them some day for large profits.
There are typically a wide mix of pros and cons of selling your business to a PE buyer. Private equity are usually pursued by sellers that want a partial exit or are looking for a partner that can provide either financial or strategic resources to facilitate accelerated growth. Shareholders of a company looking for a more immediate exit should heavy weight their prospective buyer list with strategic buyers more so than private equity firms.
Post-acquisition, PE firms usually take on a more active role in company oversight, for instance, putting Managing Directors and even more junior investment partners on the portfolio company’s board. They may also recruit new or supplemental company management they believe can add value to the business by helping the company set strategic direction. Active involvement in company management by PE firms can be beneficial as it presents existing management with new perspectives but on the flipside, it can lead to clashes if the two parties fail to agree. Having a PE firm on board can also allow a company to leverage its financial expertise for add-on acquisitions as well as better management of the company’s capital structure.
Existing ManagementExisting company management could also emerge as a key buyer for businesses. This purchase is known as a management buyout (MBO). In an MBO, the purchase of the exit shareholder’s equity can be funded by a combination of senior or subordinated debt (called a leveraged buyout), vendor financing or by an equity injection from a private equity group. The interest burden tied to the additional debt taken on by the company could presents a key risk with this type of transaction.
A challenge in an MBO is that during the selling process the balance of negotiating power could shift towards the management team since they are insiders and should be well versed in positives or negatives to the potential valuation of the business. The transfer of ownership to management can also be gradually phased out to facilitate smoother transition since this represents an internal sale. However, the MBO may restrict the buyer field to just one party resulting in sellers becoming highly sensitive to concerns that they are not getting the best value for the deal.
Individual InvestorsIndividual investors differ from larger, institutional buyer types as they invest on their own behalf. They generally consist of high net worth individuals or family investment offices looking for a business that is financially healthy with a sound return on an investment. Like financial buyers, individual investors seek private companies with potential for future growth and existing competitive advantages.
These buyers will invest capital in their operations, and realize a return on investment upon exit via a direct sale. The individual investor typically focuses on managing wealth at hand to ensure sustainability for current and future generations. There is also a great deal of emphasis on portfolio diversification to minimize concentration risk in accordance with the individual or family’s goals and objectives. In many cases, individual investors may drive a hard bargain when it comes to price due to the fewer financing options available and may even expect the seller to finance a portion of the purchase.
Additionally, deal negotiations may be needlessly prolonged due to inexperience on the buyer's part. They are however less aggressive with their business strategy, seeking to make fewer and far less drastic changes, ensuring the stability of business operations. Individual investors are also usually more involved in the day to day operations and have a direct stake in the business, resulting in better aligned management and shareholder goals.
Decision Tree on Selection of Most Appropriate BuyerThe following decision tree can be used when assessing which buyer types might be most appropriate.
The ultimate decision does not preclude involving all types of buyers in the process, but it does demonstrate which parties would best fit the sales process, give the objectives of the seller and the attributes of the business.
Choosing an M&A Advisor: Guide to Professional Designations
In choosing a professional advisor, business owners must be careful to pick a trustworthy professional who has their best interests in mind and can execute. One way to gauge a financial advisor’s ability is by his or her professional designations. Obtaining a professional designation requires additional education and testing in a specific field of expertise. Professional designations are an important indicator of the caliber of a financial advisor, though a diligent business owner should also consider additional criteria in evaluating individuals that will provide advice on potentially the largest financial transaction of their lives.
The four most recognized financial designations are Chartered Financial Analyst (CFA), Chartered Accountants (CA) (Canada or UK), Certified Public Accountants (CPA) and Master of Business Administration (MBA). These designations are widely accepted as the highest standard for professionals with regards to the advanced financial knowledge often needed to navigate through the complexities of a mid-market transaction.
There are a number of specialized designation that complement the more recognized financial designations noted above. Obtaining a level of specialty beyond a MBA, CA, CFA or CPA demonstrates the added commitment of the professional to his or her craft.
There are however a growing number of for-profit, weekend designation programs that has led to a dangerous level of confusion in the marketplace. It is important to evaluate the prestige of the organization offering the designation, depth of content and rigor in obtaining the certification. The following compilation of speciality designations is not an endorsement, but merely a summary of the various organizations that provide accreditation to professionals in the areas of exit planning, business valuation and mid-market investment banking.
Exit Planning Designations
Certified Exit Planning Advisor (CEPA)
CEPA is a designation obtained from the Exit Planning Institute (EPI). EPI has offered the five-day certification program since 2007 and it is currently the most widely accepted and endorsed professional exit planning program in the world. CEPAs are trained and educated to identify and address potential exit planning issues, build a comprehensive exit strategy and educate business owners on important exit planning topics. Graduates of EPI’s CEPA Program also continue to benefit from continuing education and access to industry forms and templates.
Certified Business Exit Consultant (CBEC)
CBEC is a professional designation offered by Pinnacle Equity Solutions. Pinnacle’s program consists of a five-day learning program followed by a four-week marketing and sales program designed to get newly certified members hands-on exit planning experience. Graduates of Pinnacle’s program continue receiving monthly training sessions on practice management and technical exit planning training.
A Certified Exit Planner (CExP)
The CExP designation is provided by Business Enterprise Institute (BEI). BEI’s program consists of a two-day training session, 10 online courses, and a two-part exit planning exam. A CExP is required to also hold another accepted professional designation or equivalent professional experience. Graduates of BEI’s program are required to complete 30 continuing education hours per year to maintain their CExP designation. BEI program standards are also backed by an independent, non-profit, Board of Standards Corporation.
Business Valuation Designations
Chartered Business Valuator (CBV)
CBV is a professional valuator who has received their designation from the Canadian Institute of Chartered Business Valuators (CICBV), an accrediting body in the field of business valuation in Canada. CBVs specialize in quantifying the worth of a business, including its intangible assets, brand and intellectual property. To earn the designation, candidate must have a degree from a post-secondary academic institution or university, gain valuation experience at place of employment, complete a number of required courses and pass the Membership Qualification Entrance exam.
Certified Valuation Analyst (CVA)
CVA is a professional accredited in the field of business valuation. CVAs members receive their designation from theNational Association of Certified Valuators and Analysts (NACVA). NACVA is a professional association of over 31,000 CPAs and other valuation experts. This designation is obtained after completing a sample Case Study or Fair Market Value report, an optional five-day training program and submission of two personal and two business references.
Certified Business Appraiser (CBA)
CBA is a professional accredited in business appraisal and has received a designation from the Institute of Business Appraisers (IBA). The IBA was established in 1978 and is the oldest professional association devoted solely to the appraisal of closely-held businesses. Prerequisites to obtain the CBA include possession of a 4-year college degree or equivalent, completion of a comprehensive workshop, passing a 5 hour written exam, and submission of two appraisal reports.
Accredited Senior Appraiser (ASA)
ASA is a professional appraiser who has received a designation from the American Society of Appraisers (ASA) and has five years of full-time appraisal experience. The American Society of Appraisers is a non-profit international organization dedicated to appraisal professionals. To receive a designation, ASAs must pass the ASA Online Ethics Exam, a 15-hour National Uniform Standards of Professional Appraisal Practice, and submit three letters of reference.
Accredited in Business Valuation (ABV)
ABV professional appraisers earn this designation from the American Institute of CPAs, the recognized national professional organization for certified accountants. All ABV credential holders are CPAs and additionally have passed an ABC Examination, fulfilled required business experience requirements and completed 75 hours of valuation-related education credits.
Master Certified Business Appraiser (MCBA)
MCBA is a professional who has received this professional designation from the Institute of Business Appraisers (IBA). IBAs possess post-graduate degrees and a minimum of fifteen years full-time experience as a business appraiser. IBAs additionally must provide three letters of reference attesting to the appraiser’s analytical skills and work product, professional and ethical character and contribution to the appraisal profession.
Mid-Market Investment Banking Designations
Corporate Finance (CF) Qualification
CF professionals receive this designation from the Institute of Chartered Accountants in England and Wales (ICAEW), a world leading professional organization for accountancy, finance and business professionals. CF professionals are certified ICAEW Chartered Accountants or Certificate in Corporate Finance holders who have obtained their Diploma in Corporate Finance from ICAEW and additionally have a minimum of three years of experience in corporate finance.
Certified Merger and Acquisition Advisor (CM&AA)
CM&AA is a professional who specializes in middle market corporate financial advisory and transaction services and who has obtained a designation from the Alliance of Merger Acquisition Advisors (AMAA), a professional group of more than 800 professional services firms that focuses on middle market mergers acquisitions. CMAAs are required to complete a 5-day course covering various in-depth M&A topics.
Chartered Merger and Acquisition Professional (CMAP)
CMAP is a professional specializing in middle market mergers acquisitions who has received a designation from the Middle Market Investment Banking Association (MMIBA). As a prerequisite criteria to obtain CMAP credentials, candidates must be accomplished in business, finance, account, economics or business management demonstrated by either a college or university degree, another acceptable designation or M&A related experience. MMIBA’s CMAP Certification program consists of a five-day Mergers Acquisitions workshop and a four-hour CMAP Certification Exam.
Merger & Acquisition Master Intermediary (M&AMI)
M&AMI is a professional specializing in middle-market mergers acquisitions and received a designation from M&A Source, a professional organization specializing in lower middle market M&A transactions. M&AMIs represent clients in mergers acquisitions, advice clients in valuation and facilitate necessary financing for mergers acquisitions. Successful M&AMI candidates require both educational credits and the successful completion of multiple middle-market transactions.
Designations are not a litmus test to base the ultimate decision of selecting an advisor. They can be useful though in the initial evaluation of professional competency. It is also important to remember that not all designations are equal. Business owners should maintain a level of scrutiny in determining if an individual, regardless of credentials, will help them achieve their desired objectives.
Understanding of the Sale Process - Auction Types
There are a number of different auction types that can be employed for the sale of a mid-market business. These auction types are most usually distinguished by the number of prospective buyers approached and also the tactic used in execution. The most appropriate one to use is based on the assessing the three objectives of the seller including ability to maximize sales price, desire to maintain confidentiality and speed of completing a transaction.
Typically, in the middle market there are three types of auctions used in the sales processes:
- Broad Auction - this process offers the best chance of maximizing value but usually takes the longest to complete. Given the nature of this process, confidentiality will not be maintained.
- Controlled (or Targeted) Auction - under the controlled auction there are a one step or two step variation. This process type allows a seller to maintain confidentiality and can drive higher valuations but it will take time to complete a transaction.
- Negotiated Sale - this process will be the most expeditious and confidential but the ability to maximize value is often compromised.
Broad AuctionAs the name gives away a broad auction is a sale that opens up your business to the full universe of potential buyers. This increases competition can maximize value if there is competitive bidding between interested parties. In order to initiate a broad auction, an M&A intermediary will be contacting dozens or hundreds of prospective buyers, including direct competitors. No potential buyer will be excluded. This type of auction is designated for a company that is fairly established and can generate large amounts of interest in a sale. The process of a broad auction can be lengthy as each potential bid is carefully evaluated for the acquisition of the business. This process may also be the most costly due to the additional marketing and effort involved.
Here are some of the pros associated with a Broad Auction:
- This process is the most accurate test of market value because it does not exclude any prospective buyers;
- Maximizes the likelihood of receiving the highest offer;
- Creates strong sense of competition between all prospective buyers; and
- Give the wide reach, the chance of uncovering covert prospective buyers increases.
- Impossible to maintain confidentiality and runs the risk of competitors entering process only to obtain competitive intelligence;
- May drive away interest from most logical buyers who are reluctant to enter into a highly competitive auction process;
- Possibility of business disruptions from market rumors and significant company resources required to field requests from larger number of participants; and
- A failed auction may hurt reputation and any future attempts at an exit.
Controlled (Targeted) Auction ProcessThe controlled auction is the most commonly used auction type for many mid-market business sales because it presents a balance between the number of prospective buyers involved that can maximize value while minimizing the risk in breaches of confidentiality.
In controlled auction process a limited number of logical buyers are approached to submit purchase offers for an acquisition target. The process unfolds in a carefully planned sequence designed to build and maintain a strong negotiating position. In a controlled auction, the opportunity is presented to a select group of qualified buyers in a manner that simulates a market. A controlled auction process is a time-tested method to maximize value when selling a business. The primary objective of a controlled auction is to generate the best possible purchase price and terms by creating competitive bidding tension.
Pros in a controlled process:
- Ability to garner better competitive pricing;
- The seller is able to maintain control and negotiating power through the use of structured timelines;
- A seller will be able to compare various offers and deal structures; and
- This process avoids the 'shopped deal’ perception because on a handful of logical buyer are involved.
- Some prospective buyers may not be willing to participate in an auction process;
- There is risk that the best prospective buyers have not been contacted to be involved in the process; and
- Value may not be maximize with the exclusion of covert or hidden buyers.
One-Step VariationIn a one-step auction process, M&A intermediaries approach a handful of synergistic buyers or private equity firms; usually 5 to 20 different parties. The prospective bidders are provided with a confidential information memorandum subject to a non disclosure agreement. All interested parties review the same information within a fairly short time frame. The prospective acquirers are asked to place an offer for the business through an LOI knowing that there are other potential bidders. The M&A advisor's goal it to try to receive multiple offers within a few weeks of each other to foster competition and comparison between the offers. After the offers are reviewed, the advisor will try to negotiate higher purchase prices and better terms with the parties before ultimately proceeding exclusively with one party into due diligence and further negotiation of a purchase and sale agreement.
It is usually communicated to the prospective buyer that the sales process is a not full blown auction with only a limited number of other potential bidders. This is due to the fact that, although the target may be a quality company, it is not a premiere acquisition candidate with characteristics that would evoke buyers to enter into a competitive auction. If it was known to the buyers that there were other competitive bids, many buyers would likely walk from the process rather than enter into a bidding war.
One-step auction processes can be like herding cat. The M&A advisor tries to effectively create an auction process by setting deadlines but in the absence of a very motivated strategic acquirer, prospective buyers can sometimes dictates the timing of presenting their offers to purchase.
Two-Step VariationA two-step auction is more formal than the one-step auction because each phase of the sales process will have a ridge deadlines for prospective buyers to adhere to. Use of this process requires a highly attractive acquisition target that will motivate buyers to follow a formal auction in hopes of winning the bidding process. All rules and key dates for the auction are fully communicated to the buyer at the beginning of the process. The major differences from a one-step process are that the buyers are aware that they will be involved in a rigid auction and the number of prospective buyers is larger given the desirability of the target. This larger pool of buyers also increase the risk in breaches of confidentiality.
As the name suggests, the process follow two-steps. In the first step, prospective buyers will provide a written expression of interest that outlines valuation and deal structure based on a review of limited information presented in a confidential information memorandum.
Based on review of the valuation and the terms in the expression of interest, the seller and their advisors will selected a limited number (6-12) of top prospects to participate in the second step. These prospects will receive more detailed information and will be invited to management presentations. Shortly thereafter, the buyers will be asked for formal offer and often times intermediaries will provide seller friendly purchase agreements to the buyer for their insertion of price and terms.
Negotiated SaleA negotiated sale is a process that includes only a limited number of potential buyers, and usually includes one interested party with a high probability to close the transaction. The benefits of a negotiated sale are confidentially, efficiency, and the speed of the sales process. Negotiated sales usually come about from unsolicited offers by logical buyers, or initiated by investment bankers who already have a relationship with potential buyers and see an immediate fit with a company for sale.
A negotiated sale is not as disruptive to operations as a controlled auction process because it is more discreet.
Here are some pros of a negotiated sale:
- If you have been approached by a logical buyer that will benefit from operational synergies, a negotiated sale shows good faith and trust while building a relationship with the soon to be acquirer.
- The negotiated offer could meet your purchase price expectations and terms without the need to entertain many other offers.
- Moving ahead with a negotiated sale does not preclude you from declining the offer if the deal doesn't make sense.
- You won't have any comparative offers to really assess if you are receiving fair market value. Will you be able to sleep at night not knowing for certain that you received the best price for your business?
- You will have less negotiating power because the buyer knows they are the only one at the table. The initial offer in the LOI might look great, but during due diligence the buyer might grind down the price given your lack of other alternatives.