Invest to Exit by Dr. Tom McKaskill - HTML preview

10

Setting up the Exit Deal

nlike conventional sale strategies which prepare a business for sale by preparing an information memorandum and then advertising it for sale, the strategic sale needs a lot more preparation if the best result is to be achieved. Unlike a conventional process where the invitation to bid casts a wide net, normally through multiple private and public channels, the strategic sale focuses on a set of identified potential buyers. These potential buyers have been selected because they have the highest chance of exploiting the strategic value being sold.

Only a small number of potential buyers are explored, generally because each one requires some effort to bring into the process. Not only are they contacted in advance of the business being available for sale, but time is spent with each one to ensure that they fully understand the potential being developed and how that could translate into a strategic opportunity for the buyer. Because of the unusual nature of this process, the issues which the seller has to deal with are somewhat different to a conventional sale.

If you have some underlying asset or capability which can leverage a very large revenue opportunity for a national or global corporation, it should not be difficult to get their attention. The uncertainty most entrepreneurs experience in seeking out potential buyers is they don’t know who the best buyers may be and are not sure how to get them interested. However, once you have identified the best potential buyers, the task becomes significantly easier.

The end game is to be acquired by a large corporation who can exploit your strategic value. Clearly, the highest price will be paid by those corporations who have the capability, capacity and product/market space which can best exploit the asset or capability. They will be even more interested in acquiring the business if you can structure your business to reduce risks in the acquisition, speed up the integration process and then provide a structure which can rapidly deploy your product or service. You simply need to let them know what a great fit you would be for their business.

It is very common for large corporations to acquire small emerging firms within their industry in order to secure new innovations or specialized processes or knowledge. This being the case, the vendor who wants to identify a strategic buyer need look no further than the large corporations within their own industry. Almost without exception, the best buyers will come from within your industry and will havesimilar customers and competing or complementary products or services – thus they aren’t that difficult to identify.

The ideal strategic buyer will normally have complementary or similar products, sell into the same or similar customers, use similar marketing and sales processes and have a track record of undertaking acquisitions. To be a good strategic target, they should also have a similar culture and have a good track record of meeting their investment objectives from prior acquisitions. With this set of criteria, the entrepreneur can readily develop a list of preferred prospective buyers. Given that a large portion of acquisitions occur where there is a formal or informal relationship between the parties, the next task of the entrepreneur is to develop closer links to the prospective acquirers.

The first step is to get in front of them. You should always keep in mind that the best acquirers are also frequent acquirers and will have a unit within their organization whose task it is to identity, evaluate and acquire firms which can contribute to their corporate strategy. Therefore, there are people inside the prospective buyers who are likely to want to talk to you. Your job is to make contact and encourage them to give you a meeting.

You can achieve this through a variety of channels. You could of course just contact them directly and ask for a meeting explaining that you have a firm which might be of interest to them at some time in the future and you simply want to understand their acquisition criteria and process. While this may not seem possible, it is surprising how effective this can be.

You can always approach their local subsidiary managers and explain what you want to do and get them to recommend you. If you are already in the same industry, you might well know someone who works for the target corporation. Contact them and ask for an introduction. You may also find out the names of their Directors and approach one of them either directly or through a contact. An approach might also be made through your professional service provider.

Most companies within your industry will attend a variety of trade events, exhibitions, conferences and industry charity functions. You can use these to make contact with a senior manager of a potential buyer and use that opportunity to find out how to approach the M&A group, CFO or CEO. If you find that the right person is always too busy, ask to meet them when they are attending one of the industry functions. They will normally respect the fact that you are making a lot of effort to meet them and will set some time aside for a meeting.

The purpose of the initial meeting is to simply get on their future acquisition radar. Once you have their interest, it will be easier to set up subsequent visits where you can spend more time explaining what you have which would interest them and how you are able to facilitate them making significant revenue out of an acquisition of your business.

The aim of the entrepreneur should be to educate the prospective buyer on the future potential of the firm as part of their acquisition strategy. You will also want to take the opportunity to suggest ways in which the prospective acquirer might exploit the firm’s underlying assets or capabilities. Once the relationship is established, the major task of securing a future potential buyer has been achieved.

If you don’t want to make the approach under the guise of selling your business, try making an approach to their business development executives explaining that you are looking to find a strategic partner to help exploit your innovations. Explain that you are making the approach to them because of the fit with their existing business and the fact that you are looking for a business which will have a vested interest in working with you, that is, they have much to gain out of the partnership. The business development staff will see the possibilities in an acquisition and alert their M&A department. You haven’t offered your business for sale but you have achieved your objective of getting their attention.

If you fear that competitors will take advantage of the pre-sale time to raid your employees and customers, you need a strategy to counter that threat. Clearly at some point you will need to ratchet up the level of activity as you get closer to seriously engaging potential buyers and this will increase the danger. What you need to do is engage potential buyers whileprojecting the image that you are not for sale.

Many business owners have insufficient competitive advantage to withstand a determined attack from a close competitor. A small chink in the amour might be sufficient for an aggressive competitor to undermine the sales message or create uncertainty in the minds of employees.

A prospective customer evaluating alternative products might hesitate to buy from a business for sale as they may have concerns about continuing supply and support. As well, current employees might be concerned about their future with the company if they hear that there could be an ownership change. This is very fertile ground for a competitor seeking to poach good staff. The business owner is now trapped. Any move they make to sell their business could disrupt their business, reduce their current sales and profits and potentially damage their sale price.

The firm which has strategic value is in a somewhat better position than most as their value is not necessarily eroded by a reduction in growth or profit, however, they could still have their reputation damaged or lose good staff.

There are a number of possible approaches to this impasse. Firstly, the business owner should indicate consistently over time that they would always be willing to discuss the purchase of the business to a corporation that had the capability and capacity to develop the business more than the current owners. If the new owner could better support the customers and provide better career paths for the employees, then this would be a good solution for both customers and staff. Sucha message is more likely to have a positive than a negative impact on the market.

Another approach is to develop relationships with all the major potential buyers so that an open discussion of the trading environment can take place. Companies working in the same market often have a lot of issues and challenges in common and these discussions can be used as a basis for sharing information. During these conversations, the business owner should take the opportunity to point out how and where their competitive advantage lies and in what way the businesses complement each other rather than compete. Where possible, the owner should seek opportunities to work together on joint bids to show how the combined entity gains revenue. What is being demonstrated is what the competitor or partner could gain through an acquisition.

While maintaining that the business is not for sale, the owner might also suggest other business or hobby ventures they might pursue or personal situations which are demanding more of their time. The objective of this strategy is to demonstrate how an acquisition would benefit the buyer as well as be received positively by the seller. While the offer can always be rejected, it is far better to have offers coming than to have to go cap in hand looking for a buyer.

It is very difficult to extract the maximum value on the sale of a business if you have only one potential buyer. Generally speaking, the only way you can do this is to be in a position where you don’t need to sell but you are willing to so if your terms and conditions are fully met. Simply by being hard to get, by having a business which gives you satisfaction and not having any great desire to do anything else will provide a basis where you force the keen buyer to do all the running. However, if your business is in trouble and the only potential buyer can afford to wait, you will almost certainly be a fire sale and lose much of the value of your business on sale.

So while one potential buyer is possible, common sense would suggest that several are much better. The question is, how many is likely to create an optimum exit? The real issue here is how well you have selected your potential buyers rather than how many. Many possible buyers where none have a burning desire or need for the acquisition is almost certainly worse than one keen buyer. Thus an important component of preparation for sale is to ferret out those companies which have the highest need for what you can offer but are also in a position where they have the willingness and capability to go through with the acquisition process.

There are some simple rules of thumb when it comes to identifying possible buyers. Most buyers are larger companies within the same industry; they typically have acquisition experience and deal with similar or complementary products. By doing some industry analysis and working with professional M&A advisors, it is not difficult to narrow down a list of possible suitors. The next stage would be to establish contact with them to ascertain their appetite for new acquisitions, especially for a business like your own.

In the end, you need at least two keen, active potential buyers, each of which has a clearly expressed need to acquire a business like yours. However, sometimes timing does not always work in your favour. At the time you wish to sell, they might be involved in other projects, fighting internal fires, be subject to external threats or have used up their acquisition funds. Thus you cannot really depend on just a couple of potential starters. What you really need is at least 6 to 8 active interested buyers. With a little bit of luck, you will be able to deal with most of them. In the worst case, you can be confident that you will have at least two left with which to negotiate. Your back up plan should be the ability to delay until circumstances bring more potential buyers into the process.

Also be very careful not to have too many potential buyers. The best ones may simply pull out or they may decide the costs of participating in the process are too high. In the end, it very much depends on your ability to help potential buyers understand what you bring to the table and in creating some level of competitive tension at deal time.

Many entrepreneurs fear giving away company secrets during a due diligence process involved in selling their business only to find that the potential buyer has pulled out and then uses that information to compete against them. Since most firms don’t have the luxury of unique, patented or protected assets or processes, this is a very reasonable position to take. Where you have strategic value, this is often based on IP or deep expertise which is usually more difficult to copy, even so, imagine how foolish you would feel if you gave away the very competitive advantage which had created the sale value. However, you still need to get through the due diligence process for the honest buyer.

What you need to do is to balance the need of the potential buyer to be able to assess the quality and impact of your confidential information with your desire not to give away the store to the dishonest scavenger. To do this you need to have a process which gets rid of the latter but keeps the former in play. Thus how much can you provide to satisfy the serious punter while protecting yourself against the dishonest or opportunistic competitor?

Of course this is not much of a problem when you have strong registered IP. While patent protection is said to be only worth what you are willing to spend to protect it, remember you will sell out to a large corporation. In the end what you have is a gorilla buying your IP. Nothing protects IP better than a gorilla sized corporation ready to defend it. I always let my potential buyers know that the ultimate buyer will be a gorilla and that they will do whatever it takes to protect the competitive advantage they are securing through the acquisition. In this situation, it is not worth the competitors wasting their time stealing your IP. However, not all IP and intellectual capital is well protected.

Your best protection against the theft of confidential information during the sale process is to be very well prepared for the due diligence investigation. This information can then be released in stages subject to your own due diligence on the potential buyer. You should be looking for commitment from the buyer at each stage of the investigation. Buyers who are only fishing will not want to spend much effort in the process and will soon fall away. You should balance their effort with your own. As they require meetings with management, you should request similar meetings with theirs. If they ask for more detailed information, you should request similar data from them. If they are not prepared to share information, you can probably assume that they are not serious and terminate the discussions. You can also have them sign a non-disclosure document with damages for use of confidential information.

Your second level of protection is to withhold sensitive information but have it examined and verified by an independent and credible third party. You can cite performance data, market statistics and forecasts but hold back the detail. This data would then only be released to the successful bidder as a final condition of the sale but could be done in such a way that, if validated, the sale would be concluded.

Your best strategy against this type of invasion is to have pre-selected the potential buyers. If you have determined that the potential buyer has a real need for your business, is capable of funding the acquisition and has the capability and capacity to make it work, then you should be dealing with genuine buyers who would rather buy than copy. By ensuring you have several willing potential buyers and being well prepared for due diligence, you can also speed up the sale process and dramatically reduce the exposure period. In the end, you will have to take some level of risk to get the deal done, but with some investigation you can determine the ethical values of your potential buyers. Make sure you steer clear of the doubtful ones.

I know of many entrepreneurs who have lost value on the sale of their business when the buyer has strung them out through the negotiation and due diligence process. The disruption to the business due to due diligence activities and the distraction of focus caused by the tension in negotiations often leads to a fall in revenue and a lowering of profits. Only by recognizing this impact, whether deliberate on the part of the buyer or not, can the entrepreneur mitigate the damage.

Not all buyers are honest and scrupulous and not all are well prepared for the buying process. It is not uncommon for the sale process to be drawn out with a subsequent loss of focus on the business. This rarely works to the advantage of the seller. In fact, it is not unknown for potential buyers to use such tactics to wear down the vendor in order to achieve a lower price.

While some delays are unavoidable and tension and distraction are a normal part of the process, the smart entrepreneur prepares in advance for this eventuality. There is no question that it is hard to go through the sale process without significantly using up senior executive time as there will be some elements of the negotiation and due diligence process which simply cannot be delegated. Knowing this in advance, the vendor should put in place a succession plan so that essential operations can be undertaken by other than the senior management team.

Preparation for due diligence is an obvious step in selling a business. The last thing you want to be doing is hunting through storage cabinets looking for old documents or compiling essential employment or financial data which is standard in a due diligence checklist. The vast bulk of due diligence information can be assembled in advance and kept up to date for when a deal is on the table. While the buyer is busy doing the analysis, you can be back running your business.

By far the best way to keep a deal in play and progressing is to ensure that you have multiple potential buyers. If you are well prepared, have good advisors and have done your homework to identify those potential buyers who would have the most to gain through an acquisition, you have much greater control over the timeline of a sale process. Those buyers who are not prepared themselves or not willing to meet the deadlines will simply drop out of the process, but you do need to have a number of potential buyers to play that hand.

If you can clearly see that a buyer is deliberately using delaying tactics to wear you down and reduce the price, you are almost certainly going to be better off by pulling out of the negotiation. That tactic alone may well bring them up to the mark. The greatest danger in any sale process is to be in a position where you have to sell, you are unprepared and you have only one potential buyer. Planning the sale well in advance, being prepared and having several potential buyers is the only way that you can really ensure you get the maximum value on sale.

If you are a conventional business, you should be able to estimate what you can sell your business for using an EBIT multiple valuation. But what if you are seeking a strategic sale? The value that is placed on your business is what the buyer can achieve in terms of new incremental revenue and profits. To achiev e the best price, you need them to undertake a thorough analysis of the potential worth of the opportunity. How do you get them to do this?

The key to a premium on sale is to have several prospective buyers bid for the opportunity of buying your business. In the ideal scenario, you want a group of prospective buyers who have a very clear understanding for how they can exploit your business to generate new revenue. If you approach them with no prior relationship and where they have never considered how they would exploit the acquisition, they have little time in the bidding process to ascertain exactly how they would utilise your assets or capabilities to generate new revenue. Where they have little opportunity to understand how they might take advantage of the acquisition, you will certainly not get the best price you can.

Prospective buyers need to have time to work out how to best exploit the opportunity and this may take them some time. They need to develop a scenario for scaling up the business, possibly develop new internal capabilities, open up new sales channels or interfac new products with their existing offerings. What you want them to do before they come to the bargaining table is to work out just how much new revenue and profit they could gain if they were the successful bidder. If the numbers are very attractive, they may be willing to bid up the price to ensure they are the successful buyer and, of course, they would rather that their competitors were denied the opportunity.

Most large corporations arealways on the look out for ways to increase their revenue and improve their competitive advantage. If you have something which could do this, you might approach their business development group rather than their M&A group. Your approach to them will be to discuss how you might work together in a strategic partnership to pursue new revenue where you provide the intellectual capital, asset or capability which is to be marketed and they contribute their marketing and distribution capability to make it happen. Your approach is, however, conditioned on the fact that, because of your limited capacity to support such a venture, you can only support one partner although you are interested in exploring this opportunity with a number of large corporations. You request each one to undertake an internal assessment of the opportunity and then provide you with a convincing argument as to why they should be the selected partner.

Also remember that large corporations often have an active M&A section who are always scanning for potential acquisitions. If you have already identified your potential buyers, it makes sense to get on their potential acquisition map where they will start to evaluate the attractiveness of acquiring you. Once you have made contact with them, you can start priming the pump by providing updated information aboutyour business. You can also stimulate a conversation around how your strategic assets or capabilities could be exploited inside their business.

This process provides time for each potential partner to work though how they would best exploit the opportunity and to work out just how much additional revenue they could generate through the relationship. Soon they will discover that they can make significant market gains but that they will be limited by your capacity to support an aggressive rollout. When they try to convince you of their worthiness to be your partner, they will also have to show their hand. What you hope is that this will stimulate them to move the discussion to an acquisition conversation. You now have an idea of what you are worth to them but you also have several well informed potential buyers in the frame.

“It is our mission and strategy to get this company bigger in size and over a period of time, one of the biggest companies on the ASX,” Wallis said. “We always have a four or five acquisitions that we look at any point in time.”

If you do end up going direct to their M&A group, then ensure that you give them enough time and the supporting data to enable them to do the revenue calculations. There is little point in forcing the pace if it only results in them reducing their offer due to higher levels of uncertainty on their part.

I am a very strong advocate of the entrepreneur managing the relationship with the potential buyers and playing an active role in doing the deal to sell their business. Instead of handing the problem over to someone who does not really understand the intricacies of the business, the entrepreneur should take charge of the process of indentifying buyers and negotiating the deal. It is the entrepreneur who best understands how the business works, what risks are inherent in the business and how value can be extracted by the buyer. Unless the buyer can fully appreciate how to exploit the potential in the business, the seller won’t get anything like full value for the business. It is highly unlikely that an external party can fully represent the business potential in the same way that a knowledgeable entrepreneur can.

In a strategic investment, it is still the entrepreneur who is best positioned to identify strategic buyers, make contact with them and assist them to understand how best to exploit the opportunity. However, an investor who understands the strategic sale process well, can ensure that the process is systematically and exhaustively undertaken.

Unfortunately, not all entrepreneurs have the time, motivation or skill to undertake the process of identifying and contacting potential buyers and then negotiating the deal. This then becomes a team effort. How should the investor manage this process? It is important that all the stakeholders understand the process which they are going to undertake to set up a strategic sale. The sale team would include the key investors, the senior management team and the professional advisors. They should all understand the strategic selling process and the legal, financial and operational steps needed to be taken.

The most important factor in achieving a premium price for a business is the selection of the pool of potential buyers. If the owner does not feel competent or able to do that, this should be outsourced to a professional advisor, however, the entrepreneur should clearly articulate to the advisor how potential in the business can be exploited. Rather than leave the process of recruiting buyers to chance once the business is put on the selling block, time should be spent identifying and contacting possible buyers. In the end, it is the ability of the buyer to understand how to extract value from the firm which determines how much they will pay. By educating possible buyers on how the potential in the firm can be exploited, the entrepreneur is creating a knowledgeable pool of possible buyers. The entrepreneur should develop a list of potential buyers in conjunction with the advisor. An advisor can then make contact with them and assist to build a relationship between the firm and the potential buyers.

Unless the benefits are obvious, there is still the problem of educating the potential buyers to the size of the opportunity and how they might exploit it. If the entrepreneur is unable or not suited to this task, the investor needs to find someone who can. This could be an external consultant, the investor, or one of the professional advisors. The selected person should have a thorough grounding in the strategic assets or capabilities, the work which the firm has undertaken to prepare it for a buyer and the manner in which a buyer could best exploit it.

When it comes to negotiating the deal, it is worth having experience on your side of the table. Most small firms with potential are purchased by large corporate entities. They will certainly have very experienced M&A advisors. Our advocacy system would suggest that they will work hard for the buyer to get the lowest price. You need your own knowledgeable advocates to work equally hard for you. Make sure your team fully understands the work you have done to prepare the firm and of the potential which could be extracted by the right buyer.

The best deals are done by knowledgeable and passionate entrepreneurs faced with keen and well informed buyers, each assisted by good professional advisors.

Building a positive reputation can help with introductions to those corporations who may be potential acquires but will also help them gain approval from their own stakeholders and industry analysts.

Getting known within an industry is actually not that difficult. The majority of industries have their own industry association, conferences, education programs, charity events and trade journals. There are normally specialized magazines which focus on certain industries. By getting the firm’s executives involved in the industry association and industry events, the business highlights itself in the public domain. Additional exposure can come through speaking engagements at industry events, writing articles or cases for industry and trade journals and magazines and competing in industry or national competitions.

In undertaking these activities, the entrepreneur has the objective of getting on the radar of acquiring executives and corporations. By saying what your business does which is unique, you can bring this to the attention of industry participants. Many larger corporations continually scan for potential acquisitions and you simply have to bring yourself to their attention so that they consider you. If they have an interest, they will start monitoring your activities and are likely to proceed to developa relationship with the business, perhaps informally, but with the intention of finding out more about your products, markets and management team.

You should get to know the trade journalists and the market analysts in your sector or from the sector in which you expec