A couple columns ago, I wrote about “letters of intent” and what they should include.
This month, I’d like to go one step forward or one step back, depending on how you view it, and talk about some secrets for negotiating the best acquisition deal. Many thanks to TEC resource specialist Terry Gambill, an expert on this subject.
The hot button for sellers is almost always price. Unfortunately, too many potential deals fall apart because price gets in the way of otherwise reasonable terms.
Terry provides this example. Let’s say a seller is asking $2 million for the business. The buyer has had it appraised at $1 million. If price is going to be the differentiator, then let’s face it: these two parties won’t make a deal.
Consider this alternative. The buyer puts $100,000 down, and $400,000 in five one-year notes at no interest ($80,000 a year).
The kicker? The buyer gives $1.5 million as 5 percent of sales over the next five years as well. Net result? The owner gets the asking price, yet the present value of the cash the buyer pays over the next five years is a little more than $1 million.
Most importantly, the seller shares the risk. The buyer’s exposure is only 5 percent if the business would fail over the next five years. The bottom line is that the buyer, using this approach, can be more price flexible, without forfeiting significant cash flow.
The types of terms used to accomplish buyouts are varied and include: earn-outs, consulting agreements, royalties, seller notes, and step payouts based on company sales incentives. Gambill says that regardless of the terms, you should keep in mind four important points:
1. Minimize the amount of cash due at closing, while making future payments based upon company performance.
2. Ideal terms require contingent payments. Simply stated, if the company stops performing according to requirements of the deal, then the buyer doesn’t continue to make payments. To make this work, contingent payments must have a sunset date.
3. If the seller negotiates a consulting contract, make sure that this is a part of the deal, not in addition to it.
4. If inventory is a part of the deal, make sure it is purchased on consignment. This has a positive impact on cash flow and reduces due diligence costs.
The major point here is that it is much easier to reduce risk through the creative use of purchase terms rather than negotiating for a lower price.
The basic idea is to get the seller to share the future with the buyer. A deal done on price alone precludes this from happening.
Gambill offer some age-old advice that applies to every acquisition experience:
• You must be willing to walk away from any deal being negotiated. This is especially important after you are well into due diligence and discover a major problem.
• Don’t let price become the focal point of the discussion. The seller’s ego is often tied up in the asking price. The discussions will stall if you can’t move off the price issue.
• Early on, find ways to politely say “no” to the seller. You don’t want to polarize the negotiations, but you want to also psychologically establish strengths as a buyer.
• Inflated egos are more typical of sellers, but buyers have them, too. Nothing will scotch a deal faster than an ego that gets in the way of an otherwise healthy negotiation.
• Contrary to popular belief, attorneys and accountants do not make the best deal negotiators, although their back room presence is often critical. Their expertise in interpreting the legal ramifications of the deal and its financial consequences provide insights that are invaluable to the buyer’s decision-making process.
• Spend the money on a professional negotiator. This can pay dividends if, after the sale, you continue to rely upon the owner. For one thing, you will avoid the “bad guy” image that tends to accompany acquisition negotiations, and at the end of the day, you can always come in as the “white hat” rescuer of the deal with a final proposal.
• Don’t rush the deal. It’s much better to take your time and build a personable relationship with the seller. In the long run, this will lead to more flexibility when it comes to defining and agreeing upon terms.
• Do what you can to avoid auction situations. It’s difficult to negotiate when the seller has two or three potential buyers competing against one another. Price is what levels this kind of playing field, and that situation reduces your opportunity to establish flexible terms.
• Make sure you are clear about why the seller is selling, especially if he or she wants to remain on after the sale. Careful due diligence should verify seller intentions, but you don’t want to find out that you’ve inherited a situation pointing to a dismal or seriously flawed business future.
Over the years, our TEC members have developed some additional words of wisdom that pay off in acquisition negotiations: keep your emotions out of the deal; set a walk-away price; let the seller do most of the talking; don’t talk about what you don’t like about the business; do talk about what you like about the business; don’t make promises you have no intention of keeping; know in detail the liabilities you will be assuming; know in detail the strength of the customer base; know in detail the strength of competition.
Finally, it’s true that the process of negotiating an acquisition is an art, not a science. It requires immeasurable patience and fortitude, and a desire to produce a win-win outcome for both the seller and the buyer. Until next month, here’s to a good acquisition for you and your business.
