Knowing what to expect helps owner/entrepreneurs produce better dealmaking results and avoid getting boxed into bad situations. Savvy buy-siders try to keep owners focused on the glory (and gloss over what could be gory) while reeling them in. Not until the hook is set and backing out would be painful do their technicians hammer on the issues that become costly adjustments.
Whether the deal is for the sale of a business, the purchase of another, raising debt or equity, buying out a partner or striking a strategic alliance, the process always becomes more complicated than originally envisioned. While there is no shortage of capital for independent private companies and family owned businesses, actually completing fair deals and keeping everybody happy is the hard part. Here are some insights on what to expect and how to protect your interests.
Timing is rarely convenient for owners who haven’t been actively planning for a deal. The trigger for action is often an incoming call which is either flattering or frightening. A respected industry leader wants to talk about doing something together or a major revenue source begins to stumble. A new product line takes off and draws attention or a partner wants out when cash flow can’t support more borrowing or the hit to equity.
The discipline of tidying-up before a turn at the dealmaking table will minimize surprises, reduce anxiety and may be the only way to be able to close the deal. If you can’t do that, at least recognize it and begin to deal with issues on your own terms so that you don’t hand control of them to someone else unless you want that to happen.
In many instances, the historical financial results and some measure of management’s plans have been shared under a confidentiality agreement before the principals sit down together. In an auction sale process, the buy-side will have been required to provide a valuation range in order to be invited to talk. For an investment or credit facility, review of background information is common for determining level of interest in meeting with management.
Financial fundamentals always matter. Since the earnings proxy so commonly has adjustments or a story attached, the focus of conversation about earnings should be on their make-up and quality so that approached to valuation can be validated. While relative value is a multiple of EBITDA, price is a dollar value and structure determines how price translates into after tax proceeds. The difference between 6.0x and 8.0x and 10.0x is a function of market position and quality of management within a framework of opportunity size and deal competition. Size of company is a major factor in valuation.
The buy-side will determine what they will pay for an acquisition (price amount, not multiple) or how to backstop an investment (liquidation preference to cover downside and supercharge upside). Lenders will focus on the measure of availability and cap with the protection of fixed charges coverage and selective veto power.
This all gets a little trickier if the recent fundamentals (most importantly earnings) don’t support the sell-side or issuer valuation expectations or the credit request. If these problems can be overcome, they may require compromise and creative structuring.
Most published accounts of deals are biased because people like to talk about their successes rather than the tough issues that kept other deals from getting to the finish line. Taking an objective view to anticipate and resolve the trapdoor issues before or at the outset of negotiations pays great dividends before the power-leverage shifts away from the business owner. Signing a general letter of intent or term sheet and hoping for the best inevitably leads to disappointment. Avoid getting backed into a corner by clarifying dealbreakers early.
Tell-tale signs of an owner’s mindset often limit value or discourage interest without their even knowing it. This is generally less damaging in a change of control deal, but can sink an equity investment or strategic alliance when the other party recognizes the danger of reliance on an entrepreneur who isn’t ready or capable of the psychological adjustment to serve the best interests of all the owners. More deals die because the money loses faith in the owner than for any other reason.
Chances are that the other party is a more frequent participant in the type of transaction on the table. If they are a public company or private equity firm or bank, they usually have less flexibility in what they can live with than independent business owners can readily appreciate. The rigidity is evidenced more by terms than by pricing. Entrepreneurs are more comfortable living with risk than investors and lenders governed by an independent board or approval committee with fiduciary responsibility.
A corporate financial advisor with a track record of success in helping business owners address all of these concerns can be worth their weight in gold. When you decide to go to the dealmaking table, give us a chance to help you make it as rewarding as possible.