Negotiating and closing the deal

Iain Campbell and Ben Brierley are directors of FC Corporate Finance, a mergers and acquisitions boutique serving the mid-market in the UK, Europe and MENA region, operating across all verticals but with particular experience in technology, the IT channel and passenger transport.

This is the latest in a series of articles we have written based on our experience of making acquisitions in the SME and mid-market space. These ones look at the issues faced by the acquiror in negotiating the terms of the deal and managing it through to completion.

As we mentioned in a previous article, regardless of whether a prospective acquisition has arisen through targetted searching by the prospective acquiror or by an approach from the sellers or their advisers, it will virtually always be incumbent of the acquiror to make an offer. In mid-market deals it is almost unheard of for the sellers’ advisers to give any initial indication as to price expectation. The most that’s likely to be given is some indications around deal structure and even then these tend to be so aspirational or disingenuous as to be no use – eg 100% cash consideration, fixed, all upfront and the sellers all retire completely on day one.

As the buyer you have to make the first move and it’s always a tricky one. It’s certain that however the process is being managed and playing out and whatever you say, the sellers’ advisers will always believe that your first offer will be lower than the highest price you would be prepared to pay. There’s always at least one more round of bidding coming. Even if it’s a very formal process that looks like it’s a sealed bid auction that will set the price, it isn’t.

The auction (if it works) is just helping the sellers’ advisers to work out who they want to have further negotiations with. As the buyer, you want to be in it to win it but you need to stick to your acquisition pricing/deal structuring model if you have one (and we certainly think you should have one and almost always stick to it) and the moment of truth has arrived when you need to decide what to do.

In TV overseas property shows, more often than not the buyers make a “cheeky” opening offer, the sellers counter-offer, the buyers counter-offer and it goes back and forth a few times until they split the last £500 and agree a deal, all within the space of five minutes.

To a corporate finance adviser that’s horrendous. A bit like when you take your client to meet the shareholder/directors in a mid-market company that’s for sale and your client says “how long has it been on the market”? Negotiating a corporate acquisition is a bit more complicated and a lot more subtle.

If the sellers have something good to sell and they have decent corporate finance advisers, you may find yourself in a tightly-managed, timetable-driven process involving multiple competing bidders. Alternatively, the sellers’ corporate finance advisers will look to convince you that you are in such a process even though you actually aren’t, and in reality, they are struggling to get an auction going.

If as a buyer you get the chance to acquire a target that you really, really want, and especially if it’s being formally marketed in a well-run process and someone else is likely to buy it if you don’t get it, the cheeky offer (or “lowball” offer as it is often referred to in the corporate finance trade) is maybe too risky. To stay in the process, maybe you have to start quite near your valuation even if it’s a valuation that reflects a premium because the target is special-to-you. However, the sellers’ adviser will still assume you have left room to increase your offer and you will probably have to do so. Not overpaying in this situation will be particularly challenging.

On the other hand, if it’s a less competitive process, perhaps because you as a prospective buyer have made a targetted approach or because the sellers’ adviser hasn’t managed to get enough traction to drive it hard, a well-advised seller who is committed to selling won’t want to risk scaring a buyer away by outright rejecting a reasonable offer or trying to get it increased too far, having to back down and then proceed with a process having shown weakness right at the start. Doing that is asking for a price chip later.

In our last article we looked at how a buyer’s bidding strategy might vary depending on the circumstances around the sale of a business, such as how the sale process is being managed, what’s driving the sellers’ exit and how fast the sellers need or want to achieve the exit. It follows from all of this that it’s very important to form the best view you can of how much competition you have in your quest to acquire the target and how keen that competition will be.

As the price negotiations get into the final round or two, what usually happens is:

1. The buyer resists a higher price by pointing out all the things that are negative about the target and its business. We don’t know why people do this. Our negotiation approach when we are on sell-side and we get presented with this by a buyer is usually just to say “well if you think our clients’ company is rubbish, don’t buy it”. Well OK, we don’t usually use the word “rubbish”, we use a different one, but you get the idea; and
2. The seller gets obsessive about normalised EBITDA and appropriate EBITDA multiples and how the buyer isn’t using the correct normalised EBITDA number or the correct multiple. Our approach acting buy-side for a trade buyer is normally not to engage much on this basis. Acting for the buyer we will always have normalised the EBITDA properly and reached an informed view about multiples. As we have said in previous articles, sellers’ advisers are becoming ridiculous these days in their approach to normalisation, to the extent that a number of leading advisers in the UK (by market share at least) routinely exclude all directors’ remuneration in normalisation, even where the directors are very hands-on.

• And comparable multiples are by nature a matter of judgement and therefore subjective. If you are buying a Kia there’s no point in the salesperson telling you when you haggle on the price that it’s the exact same thing as a similar-specification Mercedes. It isn’t.

Towards the end of the initial price negotiations, some buyers try to persuade the sellers and their advisers to take into account non-financial factors, such as:

1. How well the buyer will look after the acquired company and its employees post completion, or;
2. How quickly the buyer can take decisions, undertake due diligence and achieve completion.

We don’t normally bother trying this type of stuff when we are acting buy-side and when we are acting sell-side and are presented with it we mostly discount it.

The first of the above two examples is to a large extent misguided because once the sellers have sold their company, they have sold it. It won’t normally be possible for pre-sale representations from the buyer about how it will behave in relation to the acquired company and its employees going forward to be made legally binding and enforceable.

In any event our experience is that in private discussions giving us our instructions, sellers are almost always motivated by price and the deal structure around them receiving that price to the exclusion of everything else, even though they may say otherwise in discussions with others.

Our experience in relation to buyers who say they have a USP in being able to complete a deal quickly is that they almost always move at a broadly similar pace as everyone else. We don’t put much store by it.

Our key tips for getting deals agreed on terms that add value are:

1. Have good alternative targets so in initial negotiations where you haven’t yet burned lots of time and money you simply don’t need to do the deal;
2. If you do have to do the deal, don’t let it show. Accept there is a risk you will lose the deal. If you are totally risk-averse, you shouldn’t be making acquisitions in the first place;
3. Ideally have a valuation model, use it to derive your value, and go in a bit less;
4. Only be prepared to increase your offer modestly;
5. If you do have to increase, try to have as much as possible of the increased price contingent on performance or structured otherwise than in cash at completion;
6. Be patient, brave and prepared to let negotiations break down and go quite for a bit, maybe even twice, if you think you can. This is the only way you will find the sellers’ best deal.

Once heads of agreement are signed, the deal price and structure are in theory agreed but you could still be months from completion and the terms might be revisited. Almost always when this happens it’s a downwards price or adverse terms renegotiation at the instigation of the buyer and usually the alleged justification is issues identified in due diligence. Buyers have different approaches to this. If the sellers are in the mindset of having passed the point of no return then maybe as buyer you can be aggressive in pushing through a price reduction that has little technical justification. Some buyers do this as a matter of course.

We have certainly dealt with private equity types who genuinely believe the purpose of due diligence is to work out the price reduction. However, if you as the buyer are heavily committed on time and costs and your exclusivity is running out, you had better be sure you have read the room right before trying to push through an unwarranted price renegotiation.

Whilst FC Corporate Finance operates across nearly all sectors, over the years we have acted for companies doing multiple deals in the same sectors – for example we have been doing a lot in IT and technology of late. If we have a buy-side client that has an ambitious acquisition programme in the same vertical, we always advise being very cautious about renegotiating deals. Especially if you are doing sizeable deals, the industry players all know each other and word will get around. If you are too aggressive then you might get a benefit on a particular deal but at the cost of other sellers wanting to deal with you on something else. In these circumstances you should only be looking to renegotiate the deal when there’s a compelling reason, such as:

1. Current financial performance being materially below expectations. Though if it’s looking from your due diligence work like a temporary blip then this might not be grounds for adjustment at all;
2. Due diligence indicates that forecasts are likely to be missed significantly, particularly in the earliest years;
3. Major overstatement of asset values, particularly working capital assets, and especially inventory;
4. There has recently been the loss of one or more major suppliers, customers or contracts, or such a loss is in prospect or threatened;
5. (Topical these days) industrial action or threatened industrial action;
6. Concerns over pension risk in a defined-benefit scheme;
7. Fundamental historic non-compliance. Examples of this would be incorrect VAT treatment of supplies, failure to comply with off-payroll working regulations, failure to pay minimum wage or paid holidays. Notwithstanding the availability of tax indemnities, issues in this category could be of such significance as to merit fundamental renegotiation of the deal. It may be that a share acquisition has to be done as a trade and assets deal instead so liabilities are left behind. Even if you do this, the cost of complying properly going forward may have such an effect on earnings that you need to have a very substantial price reduction and may be so significant as to render the target unviable as an acquisition; and
8. Significant adverse changes in the economy or the target’s market sector

Subject to any attempt or requirement to renegotiate deal price and structure, the negotiations that take place between heads of agreement and completion will largely focus on the detail of the legal documentation, including warranties and indemnities, limitations thereon and acceptable disclosure. Sometimes these will focus on assigning risk relating to specific problems that have arisen in due diligence. Most of these negotiations are, frankly, rather pointless and tiresome. The buyer’s solicitor will always produce a draft that’s heavily one-sided in the buyer’s favour then a great amount of time is spend having the same debate and rehearsing the same arguments that end up with the reasonable compromise that will be the final documentation. We have been trying for years to find a better way but we have limited capacity to fight the system. What we do do when acting buy-side is:

1. Have a detailed briefing/instruction meeting with our client’s lawyers and try to get pointless bias that won’t stay in kept out of the drafts;
2. Review the drafts ourselves before they are sent across;
3. Control the negotiations and attend most or all the legal negotiating meetings;
4. Keep abreast of the outstanding points and the timetable. If our own side’s lawyers are holding out on issues that are holding up completion we will:
   1. Try to come up with innovative and persuasive ways of solving the issues; and/or
   2. If we think our own side are being unreasonable, advise the client and get authority to move things along.

However, we cannot as we say change the system. If the lawyers insist on having an all day meeting about the usual stuff we have all heard a thousand times before, like who is deemed to have constructive knowledge and whom they will be deemed to have made enquiries of, then provided it isn’t going to cause excessive delay we let the lawyers have a meeting or two (that we don’t waste time attending so we can do something else more useful on the deal instead) then when they get to, or close to, where they were always going to get to, we come back in and if need be help to negotiate and agree any outstanding points. Unless perhaps you are acting for a sizeable corporate with good in-house M&A resource, clients in-person should be nowhere near these sorts of meetings and negotiations.

In a deal where the buyer is simultaneously raising finance to fund the deal, there are three or more people in the marriage, and as would be expected things are more challenging. Acting for a funding institution, instructed by the funder but paid for by the buyer, is lawyer-heaven. If the lawyers for buyer or seller are being uncommercial and excessively zealous, their client is likely ultimately to reel them in. It’s different if it’s the funder’s lawyers, especially a large bank. Typically, the bank’s team will say that they have to follow fully the advice of their lawyers and that everyone has to agree what they say. This encourages them, of course and causes issues that as a minimum will delay the deal and increased costs.

One area that often ends up soaking up disproportionate negotiating bandwidth is the service or consultancy contacts of sellers who are staying. Usually that is only covered in the most general terms in heads of agreement but once it comes to negotiating the contracts the sellers push for more and more concessions and add-ons for their personal benefit, often knowing that it’s not a great cost in the scheme of things.  If the buyer is too aggressive in resisting this type of thing it may harden attitudes on bigger issues, but there have to be limits and the negotiating time spent on personal contracts has to be proportionate. There can be similar issues if the sellers personally own a commercial property they are going to rent to the target post-acquisition.

Sometimes our clients instruct us to press ahead to try to complete deals lightning fast, but when we ask them why they can’t give an explanation that’s rational. They just do. Our experience is that during the period between agreement of heads of terms and completion, time is generally the friend of the buyer and the enemy of the seller. This may seem counter-intuitive as there will almost always be a time-limited exclusivity period that is intended to be for the buyer’s benefit, and the buyer will be exposed on costs if the period expires and another buyer comes in and steals the deal. Whilst this can happen, our experience is that it usually doesn’t, and that if a deal has good momentum and the parties are engaging seriously and showing commitment, exclusivity typically is extended once or twice. Even if exclusivity expires, the buyer will typically be well ahead of any rivals in terms of process, especially if there has been an extension or two to exclusivity previously.

The reason time can be good for the buyer is that, whilst it is entirely possible that everything will go swimmingly well for the target during the heads-to-completion phase, Murphy’s law says it won’t. The longer Murphy has to strike, the more opportunity the buyer has to take whatever goes wrong into account in deciding if it needs to renegotiate or even, in an extreme case, pull out of the deal and dodge a bullet.

With the exception of possible dynamic issue in certain type of deal structures – like agreeing a working capital figure at completion and basing warranties and indemnities on the working capital figures, the deal should be completely agreed at least several days in advance of the completion meeting and all that’s happening in those last few days should just be tidying up and collating the documentation (and possibly funding stuff if the buyer is raising finance). For corporate finance veterans who can remember them, the days where outstanding points were negotiated in a multi-day completion meeting are long gone, and if you are still doing that, you’re doing it wrong. If you go to a completion meeting with material points unresolved, you are signalling that you are prepared to compromise, and that’s what will happen.

FC Corporate Finance Limited

Iain Campbell (Director) – email ic@fccorporatefinance.com

Ben Brierley (Director) – email bb@fccorporatefinance.com

FC Corporate Finance Limited is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Institute of Chartered Accountants of Scotland. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide.