Selling a Business: The Negotiations
15 November 2021: Selling a Business/The NegotiationsThe negotiation process that is a crucial part of selling a business can seem like a hostile battle for territory – one that will have a winner and a loser. But it shouldn’t be. Both sides are making an effort to get the best result from the transaction; the seller wants the highest price and the buyer wants the best value. It would stand to reason, though, that both buyer and seller would realize that a collaborative approach might result in the best outcome. This is particularly true in light of our discussion last week pertaining to financing the deal. Specifically, the fact that something north of 80% of small and lower Middle Market business include some aspect of seller financing.
The Seller’s PredicamentBecause the vast majority of such deals keeps the seller involved – from a financial interest standpoint – it should quickly become apparent that both parties have an interest in the other party’s satisfaction with the outcome of the transaction. This is generally much easier to accomplish if the negotiations are handled professionally. By that I mean “by professionals” – people that know what the heck they’re doing in the mergers and acquisitions arena. When selling a business, introducing professionals into the negotiations almost always results in a lowering of emotional temperatures at the parties’ level. If these professionals include, at minimum, a qualified professional business broker or M&A advisor as the seller’s representative, they can set the tone for the entire process by properly advising their client and managing that client’s expectations from the outset. If the seller’s expectations are unrealistic, any actual negotiations that may eventually commence will be fraught from the get-go. To wit, if the seller expects an unrealistically high valuation (price) – and most of them do – or if the seller expects 100% cash at closing – as many of them do – or if the seller expects everyone involved on the buyer side to take their word for all statements about the business’ condition – as some of them do – the seller is guaranteed to be disappointed in most offers. This disappointment can often lead to antagonism between the parties. _____________________________________________________________________________
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Seller’s Price ExpectationThe first and most important issue to address is the business’ value. Does the seller’s asking price – the seller’s “expectation” – bear any resemblance, however remote, to the value of their business? If not, this is the first area in which antagonism can be nurtured. But even before a potential seller takes the field, a price expectation that is too high – and they usually are – will result in few, if any, legitimate buyers materializing in the first place, leading for the seller to rising frustrations, loss of appetite, facial tics and head lice. (Well, maybe not head lice.) It is thus critical that the seller have some realistic idea what their business is really worth – not what their golf partner or bartender said it was worth. “Managing the client’s expectations…”
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Seller’s Closing ExpectationThe second area of concern is a seller’s expectation that they will walk away from the closing table with 100% of their proceeds. As we discussed previously, most sellers will be required to participate in the financing of the acquisition, either directly via a note or indirectly via an earn-out. This reality alone should temper the seller’s price expectations. After all, the seller, with skin still in the game, wants the buyer to succeed. The likelihood of an all-cash buyer showing up is roughly equivalent to the likelihood of China and India abandoning coal because the West thinks it’s getting too warm in Glasgow or Santa Monica. Even in the Main Street market, financing will be part of nearly every business acquisition – with the possible exception of the very smallest of businesses. Simple math will illustrate whether the business can support the acquisition financing, the buyer’s family and the buyer’s need for a return on his or her investment. If, under the pricing and terms the seller wants, it can’t, why would anyone be interested in the business at the seller’s price? With the seller providing some of that financing, both parties have an interest in the buyer’s success. “Managing the client’s expectations…”
Seller’s Process ExpectationWhen selling a business, the third area of concern is the seller’s expectation of the manner and speed with which the due diligence is likely to be conducted. We’ve often watched sellers bridle at the level of examination buyers expect to do before committing several million bucks to acquire a business. It shouldn’t surprise anyone that a buyer contemplating such an investment wants to confirm everything in the broker-provided Offering Memorandum as well as everything the seller has been saying – especially all the rosy projections. The seller should EXPECT to be asked to provide bank statements, copies of contracts, employment records, tax documents, utility bills, etc. In fact, if the seller is providing some financing via an earn-out, it shouldn’t surprise anyone that the buyer might ask when the seller last had a full physical examination! (One wit in our network suggests advising clients that the due diligence process in the acquisition a business is akin to a proctology exam. Though I suspect it will make the point unambiguously, I suggest using this analogy sparingly.) The due diligence performed by a serious buyer can – and likely will – feel extremely invasive to the seller. But the seller should expect this. We often prepare our sellers for this intrusive process by asking, “If you were about to drop $4 million of your hard-earned bucks and bet the proverbial farm on a business, wouldn’t you turn over every single rock to see what was under it?” When we have an ethical seller, that question usually takes the wind out of any argument and almost always results in the seller being extremely cooperative in the process. Empathy! Of course, if the seller continues to object to the buyer’s thorough examination, we start to wonder, “what’s our boy hiding?” But that’s another story…
The Bottom LineWhen selling a business, the buyer and seller would seem to have competing interests in the negotiations of a business acquisition but in most instances, that’s not the case. Most buyers will want the seller to stay on with the business during a transition period, even if no earn-out is involved. This motivates the buyer to incentivize the seller which, in turn, generally leads to reasonable terms and pricing in any offers. Likewise, most lenders will want the seller to stay on for a certain period because, assuming the business is sound to begin with, the lender has confidence in the seller’s ongoing ability to manage the business should any trouble pop up – a condition that will mean the lender is more likely to be repaid. And, because financing business acquisitions are perceived by lenders to be FAR riskier than financing the purchase of a home, most lenders lend a much lower percentage of the acquisition price of a business than they will of a home. This means that, unless a really deep pocket with a rarely-seen level of urgency shows up, the seller will, to some extent, be involved in the business for some time post closing. Managing the client’s expectations in this regard should engender a level of reasonableness – at least on the part of the seller. Now the buyer, on the other hand… If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
Searching For…This week’s “Searching For” item illustrates the frenzy in the healthcare market, about which we’ve posted often. We have a buyer looking for businesses in the home health, hospice, behavioral health, specialty pharmacy spaces (and related businesses) with Discretionary Earnings of between $750,000 and $5 million located anywhere in the United States. If any of you know of something that might fit, please let me know.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.