Introduction to M&A deals and basic types of sales processes
Establishment of a successful business is a long-term process. The market has limited absorption capacity for new businesses and that is why a major part of new companies bankrupt within a year or two from their establishment. Jumping in a running business is typically an easier option for businessmen and investors. The new owner may adjust the company to its own conceptions step-by-step, and still many of the complicated initial phases of running new business are skipped. From the opposite point of view, when somebody intends to leave the business, selling it as it is to somebody else may be much easier than going through the generational switch to young generation of the family or ultimate termination and formal liquidation of the company, including making employees redundant and monetizing the remaining assets of the company.
In this first episode, we would like to share with you some useful piece of information regarding types of sales processes. Basically, there are two types of sale process:
- Exclusive process
- So called auction
An exclusive process is when a Buyer and Seller are negotiating on an exclusive basis. It means, that in the exclusivity period, the Seller will not engage in negotiations with another potential Buyer. Not all owners of their companies want to make big fuzz around their divestment in the company and tend to prefer (especially in the smaller markets like Slovak one) a more confidential and less publicly known exclusive process with only selected or “cherry-picked” investors. This is also the case when a Company is acquired by one or several of its employees or managers – this is called a Management buy-out (MBO).
An exclusive process is recommended when only one or very limited number of potential Buyers are interested in your business or when the Seller is very sensitive about the whole process and / or has already selected the “right” investor for his business.
While exclusivity is favorable for a Buyer, a Seller is in a better negotiating position when there are multiple potential Buyers bidding against each other and thus pushing the potential purchase price to higher levels. Before choosing an exclusive process be sure there are no other potential and willing Buyers interested in your business in the broader area. An M&A advisor can prepare a quick search to evaluate this option and test the appetite of investors on the relevant markets.
If this is the case, it is better to structure the process as an auction to keep upward pressure on the purchase price because of multiple bidders engaging in the potential deal.
When engaging in an exclusive process you need to commit that in the exclusivity period, you will not start any negotiations with another potential Buyer. As you are committed to one party only, consider asking compensation for that exclusivity. This compensation is called an earnest payment. An earnest payment is a security deposit made by the Buyer to demonstrate that he is serious and willing to complete the transaction. If the deal is successful, the deposit is netted against the final purchase price. If the offer is rejected, the deposit is usually returned, but all depends on what has been negotiated. An earnest payment is still rarely used in CEE region and is more common in more developed western markets. From our experience, so called break-up fee is applied as a sanction for the potential Buyer in case he changes his mind and steps-out of the transaction for no good reason. This break-up fee is to cover up costs of Seller associated with e. g. preparation of data room, preparing documents for the due diligence process etc.
When there is no exclusivity for only one potential Buyer, the process is structured as an auction process. It cannot be compared with a public auction of let’s say artworks, where all is online and public. Rather some selected Buyers have the opportunity to bid on your Company, after signing a non-disclosure agreement. It is ultimately the Seller´s choice who will be selected for the final rounds of negotiations and eventually get a short exclusivity period to close the deal.
In most cases a broker or M&A advisor manages the auction process on behalf of the Seller. In an auction process the timeline and rules are more strict. If you share information with one Buyer, you will need to share the same information with all other Buyers as well.
For an auction process you need to prepare sufficient sell-side documentation, such as a Teaser, a Confidential Information Memorandum, and a virtual data room. While the preparation takes more time, the actual sales process is faster as there is a strict deadline when all Buyers need to submit their final binding offer. The timeline in an exclusive process is limited to the exclusivity period, but in practice this is often extended multiple times.
Our lessons learnt from deals assisted:
- Smaller market tends to prefer exclusive deals to auction deals – there are several reasons including psychological ones of the Seller (an idea “to sell his business in a way that even own employees would not know this”)
- Sellers are not prepared for the transaction and are not willing to invest too much effort into this crucial phase; In the later stage the preparation of e. g. tax optimal sales structure is not possible or could become a dealbreaker
- Sellers involve advisors sometimes in a later stage when the “deal is baked” and often regret this choice due to badly negotiated terms
- Buyers do not accept highvalue break-up fees in the Letter of intent or Non-binding offers and try to avoid this
- Sellers tend to search for a foreign and wealthy investor to avoid spreading the information among their business partners and competitors about their company being onsale
Our advisors have been engaged in many transactions, both on Seller´s side and Buyer´s side, both in exclusive and auction processes, and are ready to talk with you about possibilities and recommendations in more detail.