Mergers and Acquisitions For Dummies (59 page)

Buyers don't pay more “just because.” They pay prices they can support.

Don't assume Buyers have unlimited amounts of money.
Even if they did, they wouldn't be willing to pay unlimited prices for your company. A wise Buyer carefully measures the relative value of an investment, comparing it against other options, before proceeding with a deal.

Make sure the company is a noncommodity

First and foremost, if the company you're selling is going to garner a compelling valuation, it needs to have some sort of intangible quality, a super-special secret sauce. This quality that sets it apart may take the form of a recognizable brand name, outsized revenue and profits, great growth, a hot industry, or anything that differentiates the company from the drab and boring competition and provides something unique and different for Buyers. If a company is little more than a commodity — one of many faceless companies offering similar and interchangeable products — getting a favorable valuation can be a challenging proposition.

What also works is if your company has its very own Ahab, someone who has been pursuing it for years and is willing to do anything — and perhaps pay a high price — to obtain that elusive sperm whale of a company.

Gotta have competition: Shop around

If you're negotiating with one potential Buyer, you're at the mercy of that Buyer. Even a company that offers a unique and differentiating product (see the preceding section) will have a challenging time convincing a Buyer to pay a premium price if that Buyer is the only suitor.

Speak to as many Buyers as possible. The more the merrier. And if a Buyer balks at being part of a process that involves competition, don't view the loss of that potential suitor as a problem. That Buyer probably would not be willing to pay a premium price.

Provide a road map of value for Buyer

Seller needs to show Buyer where the value is, especially in down markets. Seller should clearly and explicitly point out the
value proposition
(how the company will create value for Buyer) and not expect Buyer to figure this out on his own.

Although it may be a bit of guesswork, Seller should make some assumptions as to how the deal can improve Buyer's bottom line and provide those assumptions to Buyer. Buyers may grumble that Seller has reverse engineered their financials, but this step helps signal that Seller has a grasp of the business's value to Buyer.

Make it easy to do a deal

Don't dwell on minor details. Counteroffers should be simple with a minimum of moving parts. If you want to get a deal done, refrain from introducing new elements into an offer. Instead, work from a Buyer's offer, making adjustments to that offer rather than making wholesale changes.

Focus on the main deal issues and avoid getting tripped up by minor and inconsequential details. Don't let nonissues get in the way of getting a deal done.

When Buyer and Seller Disagree: Bridging a Valuation Gap

Disagreements about the price of the company are sure to pop up in any sale process. In fact, I can't think of a single deal I've worked on where valuation wasn't the central issue of disagreement. But you have a few options for reaching a valuation agreement, including structuring an earn-out, using a note, accepting stock, and selling only part of the company. The following sections explore these alternatives in more detail.

If you're a Seller thinking about agreeing to any or all of these arrangements, I still heartily recommend getting some cash at closing. Sellers who agree to put 100 percent of the sale proceeds in contingent payments (earn-out, note, stock) are effectively agreeing to put 100 percent of the sale price at risk. Get some dough at closing!

Using an earn-out to prove valuation

In my estimation, the venerable earn-out is probably the most common method of bridging a valuation gap between Buyer and Seller.

The
earn-out
allows Seller to prove the company is worth a higher valuation by agreeing to get paid a higher price only if the company achieves certain agreed-to goals. Buyer pays that higher price only if the company achieves financial results that warrant a higher price, thus providing him some protection. Essentially, Buyer tells Seller, “Okay, if you really think the future prospects of the business are as rosy as you say, put your money where your mouth is.”

The earn-out is especially useful for Sellers who want be paid for the future performance of the company. You can structure earn-outs in an almost unlimited manner. See Chapter 21 in the Part of Tens for some examples of earn-outs.

Settling a valuation disagreement with a Seller note

As I discuss elsewhere in this book, Sellers can help Buyers with the financing by agreeing to take part or all of the proceeds in the form of a note that Buyer pays off at some future date. In addition to helping Buyer acquire the company with less money down, the note provides Buyer with the benefit of the time value of money. In other words, $5 million in three years is worth less than $5 million today. A Seller willing to wait for payment is providing a benefit to Buyer.

Paying for a company with stock

In certain circumstances, Buyer may want to use stock to pay for all or part of an acquisition. And in certain circumstances, Seller may be wise to accept that stock, though she should speak with her tax advisor about the tax ramifications of that arrangement.

Issuing stock allows Buyer to make an acquisition without using cash or borrowing money (or by using less cash and borrowing less money). The downside for Seller is that the stock obviously isn't the same as cash. Seller has to convert that stock into cash by finding a Buyer for it.

Although Buyers may be tempted to issue more stock as a way of financing an acquisition, they should carefully consider the effects of diluting their stock in that way. Is issuing more stock really the best course of action, or does borrowing money to finance the acquisition make more sense?

The pluses and minuses of accepting stock as a form of consideration really boil down to the issue of liquidity: How easily can Seller sell that stock? Here are a few issues Sellers should consider when thinking about accepting Buyer's stock:

Is the stock traded on a public exchange, and if so, which exchange? If stock isn't publicly traded, the owner of that stock may be severely limited in his ability to convert that stock into cash. If Seller doesn't anticipate needing that cash anytime in the foreseeable future, perhaps she can risk owning illiquid stock. But accepting illiquid stock doesn't make sense if Seller needs the cash soon.

Sellers looking at accepting nonpublicly traded stock should consider Buyer's prospects of eventually going public. If those prospects are limited, Seller may be in for a long-term ownership position in a private company.