Originally published in Blakes Bulletin on Business Law, January 2007
Sources estimate that in 2006, approximately 50% of the North American companies that were sold, were sold at auction. This trend is expected to continue. The theory is that running an auction maximizes the seller’s chances of receiving the highest price for its business and the best transaction terms. Given that auctions are becoming commonplace in M&A transactions, we’ve set out below some guidelines – for both buyers and sellers – to help ensure successful auctions.
Owners or managers who are considering selling their business should ensure that the target business is perfectly primed for sale. This means eliminating or minimizing issues that may cause concern for potential buyers. In addition, sellers need to consider the most efficient and effective method of disclosing any issues – whether in the confidential information memorandum, the materials that are posted in the data room or in the course of formal management presentations or in other discussions. Surprises, particularly in an auction situation, tend to create greater issues.
A business that is subject to obvious legal or financial issues (even if the seller believes them to be minor) can result in the expenditure of considerable management time to explain why the matter is not a significant issue for a buyer. It may even result in a delay in completing the transaction, and could eliminate certain desirable buyers. As an example, in a recent transaction, the target business was in the process of remediating certain minor environmental issues. Unfortunately, these matters were not completed prior to the commencement of due diligence by the buyer and the seller’s disclosure regarding these matters was not entirely clear. The result was that the seller spent significant time providing additional due diligence materials, held lengthy and unnecessary discussions, and retained additional environmental consultants. This culminated in a request by the buyer for additional closing conditions and a broad environmental indemnity. All of this could likely have been avoided with better preparation.
For sellers, preparation also involves a careful consideration of what elements of the deal are important. If price is the most important factor, this should be clearly communicated to potential buyers. If there are qualitative factors that are equally important (retention of employees, for example), sellers should let the buyers know early so that those matters may be addressed in the bid. Buyers won’t know unless you tell them.
For buyers, thorough research regarding the target business and the industry in which it operates is key. Buyers who "do their homework" may ultimately do better in an auction process than their counterparts who fail to do so.
Before the expression of interest is submitted, buyers should know as much as possible about the target’s business, its customers, suppliers, strengths, weaknesses, opportunities and risks. It is only through this kind of preparation that a buyer can complete its analysis and make a rational bid. In addition, buyers should be willing to ask pointed questions regarding the target business, so that they can understand the issues that matter most to the management team and avoid wasting time. Finally, buyers should try to avoid using the auction process to "get up to speed" – if they do, they may already be too far behind.
While it may be tempting, sellers should avoid inviting too many bidders into the auction process. Some advisors believe that the only way to obtain the highest price is to conduct a frenetic auction and engage as many bidders as possible. However, some serious contenders may be unwilling to dedicate the resources necessary to participate in the auction process if they are aware that there are many other potential bidders. We suggest that sellers and their advisors carefully examine the current marketplace and similar prior transactions to consider narrowing the list of invitees to the auction. The focus should be on those potential bidders that already have good contacts within the industry, have a similar client base or offer similar product lines. A more focused approach may lead to a better result for all concerned.
Buyers should not spread their resources too thin and should avoid submitting a bid in an attempt to buy time. Buyers should allocate sufficient resources and time to a potential transaction in order to get the job done right. If they are unable to do so, they may wish to consider "taking a pass on this one", rather than taking the risk of submitting an expression of interest or a bid without a thorough understanding of the target and the industry in which it operates. Finally, buyers should focus on the key elements that the seller has communicated are important to it – whether it is maximizing shareholder value, continuity of management and employees, minimizing deal risk or something else.
For buyers, it is a good management discipline to decide at the outset of the process whether the business that is for sale is worth the time and effort that it will be necessary to expend in order to win the auction. If it is, they should be prepared to go the distance; potential buyers should be willing to continue to dedicate time and resources to a transaction, even in situations where they are not selected as the winning bidder in an early round. Buyers may find that the seller comes back to them when a bidder who has not done as much "homework" suddenly disappears because they adjusted their original offer.
Similarly, sellers must be prepared to dedicate significant resources if they wish to sell their business by way of an auction. This means preparing a comprehensive marketing document or confidential information memorandum at the beginning of the process. It also means having a well organized, complete and updated data room so that buyers are not surprised by disclosures later on in the process. Avoid the temptation of putting a business up for sale to see what "we can get for it". If the business is for sale, prepare it for sale and be prepared to sell it when the process is complete.
Put Your Best Foot Forward
Buyers should avoid the temptation to bid high and then re-negotiate, as sellers are frustrated by buyers who try to renegotiate the deal in later rounds. In today’s very competitive (i.e., seller-friendly) environment, this is a risky strategy, both in terms of the deal at hand and for future transactions.
Sellers should be wary of buyers who bid high in initial rounds only to re-negotiate after they have secured exclusivity. If a buyer attempts to renegotiate fundamental aspects of its bid, you should be prepared to switch to another bidder quickly. Sellers may want to negotiate "outs" to their exclusivity clauses in order to be prepared for such circumstances.
As a buyer, you should be as flexible as possible with financing and other conditions. Obviously, sellers prefer to be subject to as few closing conditions as possible to avoid the situation that an announced deal is not completed. Therefore, a buyer that is able to obtain bridge financing for the transaction (with permanent financing to follow after closing) may increase its chances of being the successful bidder. In addition, financial buyers may wish to consider including a co-bidder that offers broader and deeper industry expertise and financing contacts if they need it. Sellers that display an attitude of flexibility and a willingness to complete the transaction on an expedited basis will be attractive to most buyers.
Sellers should try to be as flexible as possible with respect to comments made by bidders regarding the purchase and sale agreement. If you have communicated to bidders that maximizing value is the most important factor, you should try to avoid the temptation to focus too much on contract terms that do not have a financial impact.
Be Aware of Deal Trends
Buyers should be familiar with current trends in contract terms. Buyers, particularly those who are participating in an auction in a new marketplace, should become familiar with what deal terms are (and are not) customary in that market. Key contract terms that should be considered are survival periods, closing conditions, deductibles/thresholds and indemnity caps. While offering deal terms that are "market" may not win you the deal, the failure to do so may result in you being knocked out of the process.
Generally, sellers should prepare and distribute a template purchase and sale agreement and request that a mark-up of the agreement be provided by the buyer with its bid. While it is certainly in the seller’s interest to ensure that the draft agreement that is distributed to buyers is seller-friendly, sellers should avoid the temptation to make the document too one-sided, as this may simply extend the process. In addition, sellers should avoid imposing aggressive timing that may hinder buyers (particularly strategic buyers) who tend to be more cautious.
Experts suggest that, at least for the foreseeable future, auctions are here to stay. Whether as a buyer or a seller, taking steps to manage the auction process effectively will ensure that both buyers and sellers are best positioned to participate successfully.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.