An overview to selling a business for the VC backed entrepreneur (by John Chapman)
Trade sales play a central role in exiting VC backed firms and, at times, have proven more lucrative than an IPO, both for the institutional investor and the management team. If the sale process is not handled well some of the value built by management may be left on the table. What are the parameters of “value” in a trade sale and how are they to be optimised? What should the entrepreneur understand about the process leading up to a successful trade sale and what should he expect from his investors? Objectives and options – the Quality Buyer A couple of clarifications before we begin: •
Selling a business is not a clean cut thing – the seller always has significant residual risks. These need to be addressed during negotiations with the same care given to price. The sale process places significant additional burdens on a company and can disrupt or damage its operations.
In high level terms, the objective of a sale is to maximize consideration received, while minimizing residual risks for the seller AND minimizing incremental risks to the business’s on-going operations during the sale process. To that end, the seller must take a series of steps to generate strong buyer interest and a position of strength for negotiations. That position of strength is derived from having quality alternatives, in this case knowledgeable, experienced buyers who believe they can succeed in completing the acquisition and are committed to doing so at terms acceptable to the seller. Note, a buyer with money and a business rationale for the acquisition does not make a quality buyer. All acquirers have limited resources in two areas that are essential to the completion of a deal, buying power and decision maker time. Hence, a chance at quality comes when the buyer also has key members of management who are persuaded of the importance of the acquisition to them. Time and risk - the Process A well structured process must 1) put the right information in the right hands at the right time, 2) convince potential acquirers they understand the opportunity and its risks and 3) set a pace such that well considered offers are made by quality buyers within a narrow time frame. Only then is the seller in a position to make a choice among executable options. Article - short guide to a sale for an entrepreneur 30 III 05
Interaction between seller and buyers generally moves from a non-binding agreement on key terms to a binding agreement and then closing. The commitment of the parties grows with each step, but only at closing, when ownership has passed and consideration has been paid, is a deal “done”. Until “done” the deal is fragile and the process can be disrupted. As a seller we need to work to eliminate potential disruptions that can come from us. The most common are unplanned or last minute delays, need to correct information already provided, and new discoveries, particularly negative, about the business. Each of these undermines a buyer’s confidence in what he has been told and the process we are asking him to conform to. They increase the risk of a buyer deciding to withdraw, reducing the price offered or asking for higher guarantees. They also decrease the seller’s overall credibility in negotiations. Exposure to disruptions beyond our immediate control can only be minimized by our not wasting time. Time brings risk. Those limited resources of money and decision maker’s time will be called on by other opportunities or obligations and may be re-deployed. That said, the screw must not be over-tightened. There is an appropriate level of responsiveness that can be asked of a buyer (more another time). Serving facts and assertions Being complete in our understanding of what we want to sell and communicating that with clarity (see Achieving transparency below) helps potential acquirers reach their decision to buy. Central elements in this step include the preparation of an “Information Memorandum” and a “Data Room”. The former covers everything a buyer should have as the basis for a well founded, detailed, but non-binding offer to buy. It tells a lot, but does not tell all and blends a selection of facts and assertions. As distinct from a Placement Memorandum or a Business Plan, the Information Memorandum is designed to help the buyer assess the business potential of the “object” in the context of their own operations. Emphasis is on synergy potential and moving the buyer’s thinking beyond the stand-alone value of an acquisition opportunity to what some call its strategic value, which includes the value of synergies. The assertions made in the Information Memorandum need to be confirmed in the Data-Room. The Data-Room tells almost all, being a well organized, readily accessible and complete presentation of company documentation. Only information of a highly sensitive or competitive nature might be withheld from the data room. If withheld, the buyer must be told its general nature, the rationale for its exclusion and when it will be made available. Article - short guide to a sale for an entrepreneur 30 III 05
Understanding buyer interest Buyer interest needs to be understood in terms of the business logic for an acquisition from their, the buyer’s, perspective. Sounds straightforward but can be hard to express in practice. It is important that a complete buyers list be drawn up, each name accompanied by a statement regarding the business need our company addresses for the buyer and our estimate of the magnitude of the value (e.g. synergies) the buyer arguably could derive. We should, bottom line, have our own view whether what we are offering is a “must have”, or a “nice-to-have” for each of the possible buyers on our list. Having a view on value a buyer can derive also puts us in a position to estimate the high end of the range of values a buyer can justify paying (more another time). Assuring resources and allocating responsibilities The sale process encompasses a number of time consuming steps, most notably the pre-marketing preparation of information (Information Memorandum and Data Room), approaching of potential acquirers, ongoing follow-up (including the fielding of questions, not all of which must be answered at the time they are asked), supervision of access to company management and Data Room, evaluation of offers, negotiations of terms with multiple parties, just to mention a few. The people tasked with these things should be not be doing them for the first time, nor should they have priority daily operational responsibilities. Phasing information distribution Confidential information should be doled out as a function of buyers´ legitimate need for it in connection with decisions regarding their interest in an acquisition and their commitment to the process. Buyers express commitment by delivering what is asked for (e.g. a detailed indicative offer) in the agreed time frame. They need summary of information regarding the target to qualify their interest (Information Memorandum) and detailed information (Data Room) to verify claims made in the Information Memorandum. Achieving transparency The true scope of what is for sale, that which the acquirer will find himself with post-closing, is rarely easy to define. Not infrequently, deal boundaries can become unclear around such topics as future tax liabilities, key staff retention, client contracts with “change-of-control” clauses, etc. Buyers cannot legitimately ask that future business risks be covered by the seller, but they can ask for a serious effort to eliminate ambiguities about the present. The greater that effort and the clearer the boundaries of a deal, the greater the buyer’s confidence and readiness to make concessions in the area of guarantees. Article - short guide to a sale for an entrepreneur 30 III 05
Setting the Pace Think of the sale process in terms of a dance. Unlike a dance in a ballroom, however, the seller’s right to lead is not ruled by convention, but by his ability to convince the buyer he is in command. This means the seller must convey he is ready, competent, committed and in a position to choose among alternatives. We’ve discussed getting ready and defined the quality buyer. Conveying competence is best done through action, not words. It is shown in how a buyer is approached (who is contacted and by whom), the scope and quality of an Information Memorandum, in the realistic but not generous nature of deadlines set, etc. And then there are the games some buyers will play. Experienced buyers of businesses can play games with a seller. Knowing how to handle these is essential if a seller is to remain in command of the process (more another time). Role of the VC Just as during the business building phase of a company’s life, the VC´s role is to assure the right skills are available to address the key tasks at hand. Additionally, they should assure undivided focus on daily operations and sale process. When a trade sale is being contemplated a deal team should be established and led by an investor representative. That team will include key management, but almost certainly will be strengthened with externally sourced professionals tasked with driving the process through to closing (more another time in the form of a case study). Conclusions A well run sales process can result in a highly attractive mix of consideration (cash, future contingent payments, etc.), residual liabilities and minimal impact on a company’s daily operations. However, the process can damage the business’s operations if clear lines are not drawn between those responsible for daily operations and those responsible for the sale process. Furthermore, special skills are needed to manage the sale process. These are rarely present at the level of management, and even if they are, management’s first responsibility is to driving the business.
Article - short guide to a sale for an entrepreneur 30 III 05