There are a number of different auction types that can be employed for the sale of a mid-market business. These auction types are distinguished by the number of prospective buyers approached and also the tactic used in execution. The most appropriate approach to use is based on assessing 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 sale process:
- Broad Auction — this process offers the best chance of maximizing value, but usually takes the longest to complete. Given the nature of this process, risks of confidentiality breaches are higher.
- Controlled (or Targeted) Auction — under the controlled auction there are one step or two step variations. 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.
All three methods can be effective, depending on the objectives of the seller.
As the name might indicate, a broad auction is a sale that opens up your business to the full universe of potential buyers. This increases competition and 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 designed 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
- Given the wide reach, the chance of uncovering covert prospective buyers increases.
Here are some of the cons:
- Difficult (but not impossible) to maintain confidentiality. Also runs the risk of competitors entering process only to obtain competitive intelligence;
- May drive away interest from the 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 a larger number of participants; and
- A failed auction may hurt reputation and any future attempts at an exit.
Controlled (Targeted) Auction Process
The 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 a 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 that is 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 only a handful of logical buyers are involved.
- Some prospective buyers may not be willing to participate in an auction process;
- There is some risk that the best prospective buyers have not been contacted to be involved in the process; and
- Value may not be maximized with the exclusion of covert or hidden buyers.
The controlled or targeted auction process usually follows one of the following variations:
In 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 timeframe. 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 is to receive multiple offers within a few weeks of each other in order 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 ultimately into further negotiation of a purchase and sale agreement. It is usually communicated to the prospective buyer that the sales process is a not a 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 cats. 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 dictate the timing of presenting their offers to purchase.
A two-step auction is more formal than the one-step auction because each phase of the sales process will have a ridged deadline 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 follows 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 the review of the valuation and the terms in the expression of interest, the seller and their advisors will select a limited number (6-12) of top prospects to participate in the second step. In the next step, these prospects will receive more detailed information and will be invited to management presentations. Shortly thereafter, the buyers will be asked for a formal offer, and often times intermediaries will provide seller-friendly purchase agreements to the buyer for their insertion of price and terms.
A 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 are 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.
On the flip side, some of the cons of a negotiated sale are:
- 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 that 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.
The most important thing to keep in mind when choosing which option works best for you is this question: what do I need from the sale? If you already have an idea of what companies are interested in your business, perhaps focusing the sale in a targeted sales process is best for you. However, if you have a unique or niche business, perhaps utilizing a broad auction will drive the highest bid for your established business. Your business advisor can help you with this decision, if you are unsure which of these options will work best for you, but now you can come to the table prepared to discuss the details.