A FINANCIAL QUARTERBACK                                     View PDF

By Dewey Hammond

"A billion here, a billion there, and pretty soon you're talking about real money." While the money may not be quite that big in a middle market M&A transaction, the late Senator Everett Dirksen’s famous line makes a point that every business owner considering selling his or her business should understand. Hiring an experienced financial advisor or investment banker offers many benefits, including reducing risk, saving time for management, and maintaining confidentiality. However, the business owner's main motive is usually to maximize value.

There are two ways in which an investment banker directly enhances economic value. The first is simply by managing an efficient sales process—identifying parties likely to place a high value on the company, focusing attention on key value drivers of the business, creating a competitive atmosphere, and logically addressing perceived risk factors. A second and perhaps less obvious way a financial advisor can put extra money in shareholders’ pockets is through what I call "negotiating around the edges."

Let me illustrate with a hypothetical transaction including real issues from deals in which our team has acted as financial advisor to sellers of businesses:

Say a business owner wants to sell a growing niche manufacturing company with $28 million in revenue and $4.0 million of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). By running an efficient process, we get a top offer of $24.8 million, which equates to a 6.2 x EBITDA multiple--a realistic multiple for a quality business with good fundamentals even in today’s market. It's fair to assume that if this business were sold in a "one-off" negotiation with a single buyer and no financial advisor, the price might be $21.2 million (5.5 x EBITDA).

[NOTE: in a deal that took place soon after the publication of this article, we were able to help achieve a price increase of 17% in one-off negotiation with a single buyer in the space of a 3-hour negotiation preceded by a week of preparation.  The success was due to primarily to 3 factors: (1) properly presenting the target’s financial information, (2) properly positioning the target based on the buyer’s strategic goals, (3) subtly invoking the possible threat of competition from alternative buyers.]

Thus, the value added by our process would be the price difference—in this case, a substantial $3.6 million.

Now, let’s look at "negotiating around the edges." Even after a basic price is agreed upon, the overall economics of the deal are far from set. An experienced and persistent investment banker may be able to obtain the following additional value for owners/shareholders:

• $125,000 from modification of a working capital adjustment
• $350,000 increase in value of buyer’s stock to be received
• $90,000 from salary increase over the term of employment contracts
• $280,000 expected increase from refining the terms of an earn-out provision
• $55,000 in value of property retained that is not necessary for the business

These six items add up to $900,000, resulting in a total transaction value of $25.7 million. The total increase in value is $4.5 million, or 17.5% of the transaction value—14% primarily from the process and 3.5% from "negotiating around the edges."

Before examining these negotiated issues in more detail, let’s step back briefly and examine the essence of negotiating and what makes for a successful negotiation. In their classic book Getting to Yes, Robert Fisher and William Ury state that there are three main goals in any negotiation:

• Produce a wise agreement
• Reach that agreement efficiently
• Improve or at least don’t damage the relationship of the parties

This is certainly true for an M&A negotiation. While there are differences in negotiating styles and methods, it is hard to argue with these goals.

How do you get there? Much of the success of complex negotiations depends on preparation. A good intermediary works hard to understand not only the strengths and weaknesses of the business being sold, but also the specific objectives and concerns of each side. This up-front work provides a framework for an experienced negotiator to:

Develop a bottom line and/or a backup plan. Fisher and Ury place so much importance on this element that they coined the term "BATNA", which stands for "Best Alternative To a Negotiated Agreement". It is important for a negotiator not only to know his own party’s BATNA, but to assess the BATNA of the other side as well.

Use objective criteria to propose creative solutions. If a negotiator has taken the time to understand objectives rather than just positions, there are often opportunities to craft creative solutions that, in effect, increase the size of the pie. While trade-offs and compromises are an integral part of most negotiations, it is particularly rewarding to find ways to create value for one party that do not carry a corresponding cost to the other party.

Seek common ground and build trust. Since the complex negotiation of an M&A transaction often takes place over several weeks (or even months), it is important to build momentum that gives both parties the confidence to keep working toward a deal. This means making progress early, even if it is nothing more than reaching agreement on the process, time frame, and the key issues that need to be addressed. Ideally, every negotiating session should move the ball closer to the goal line.

Let’s use working capital to illustrate these concepts. A letter of intent (LOI) is likely to spell out in some detail the price to be paid, the form of the consideration (cash, note, stock, etc.) and the basic terms of an employment agreement and non-compete. If the consideration is not all cash, the LOI will probably also address the expected capital structure of the buyer (i.e., how he or she will finance the deal). However, the LOI will probably be vague on working capital, perhaps providing that "the seller will deliver at closing a level of working capital adequate to support the ongoing operations of the business." Since the dollar amount is not fixed, this issue must be negotiated further.

One party may commence the negotiation on this point by proposing to fix required working capital based on its level at a particular date—say, at the end of the month just prior to the execution of the LOI. But since working capital in some businesses can fluctuate significantly, that amount could be more or less than what really is required. This issue is an example of how objective standards can be very helpful. Analyzing past levels of working capital relative to revenue and industry standards can give the parties a framework to focus the dialogue on the objectives of each side rather than positions that can carry the weight of emotions and personalities.

It is crucial to manage M&A negotiations well. The stakes are high. Not only are the dollar amounts large, but the results are permanent—you can only sell your business once. This complex negotiating process involves multiple parties and a multitude of interrelated issues. Despite these pressures, it is almost always in the best interests of both sides to maintain a healthy relationship going forward. When a financial intermediary quarterbacks the negotiations, keeps the focus on transaction objectives, and takes the heat when negotiations get tense, the odds of preserving a positive working relationship between the principals are greatly improved.

By bringing experience from past transactions, expertise in the substantive issues involved, and the ability to invest time in the process, an investment banker is well-positioned to help business owners maximize value in M&A negotiations.

© 2010 FourBridges Capital Advisors

FourBridges Capital Advisors is a middle market investment bank providing sell-side, buy-side, capital raising, restructuring, and strategic advisory services primarily to closely-held and family-owned businesses. FourBridges is based in Chattanooga, Tennessee and serves clients across the Southeast, including Atlanta, Nashville, Birmingham, Memphis, Knoxville, and Huntsville.

Past performance is no guarantee of future results and there can be no guarantee that these types of results will be duplicated in the future.