They are a test of wills and a battle for control between two parties with completely opposing interests. If you are an owner or a CEO of a middle-market sheet metal company, defined as one with an expected transaction price between $2 million and $250 million, you must accept the nature of the negotiating process. You must feel comfortable in this type of environment or you are doomed to failure.
This article will discuss the six negotiating strategies and techniques that should make for successful negotiations.
1. Assert your dominanceYou want to convey to the buyer that your objectives and will are going to prevail during the acquisition process. This dominance should be established early on, as it is far easier to establish dominance at the outset than it is to retake it from a dominant acquirer.
One side is the boss in all negotiations. This means that on substantive issues, you want the buyer to feel that he or she must concede to you or risk losing the deal. This is obviously not easy for a middle-market seller, as the acquirer will likely be much larger than the seller.
Buyers are used to prevailing in these matters. You need an experienced, aggressive, determined negotiator to bend will and force them to play your game. This type of negotiator will convince acquirers that these negotiations will be different.
2. Reps, warranties and indemnification issuesAlthough this subject is too complex and covers too many legal and investment banking considerations to cover in detail here, there are a number of points that you should be aware of. Fundamentally, most buyers are used to a rep, warranty and covenant package (the “reps”) that encompasses a “my watch, your watch” concept.
This approach says that anything that happened while the seller owned the company is the seller’s responsibility, regardless of when the issue manifests itself. And any issue that occurs while the buyer owns the company is his or her problem. The fundamental flaw with this concept is that one of the major reasons that owners sell their companies is to escape the risk inherent in the equity-ownership position.
Under the “my watch, your watch” concept, a selling owner is still potentially responsible for all of his company’s pre-closing actions during the post-closing indemnification period, even if the issue had not matured or was not known at the time of closing. Conversely, when the seller’s adviser developed a value for the company, it was based on factors known at the time.
If issues positively affecting value had occurred but were not yet known, they would not have been factored into the expected transaction price. So even though these positive factors matured under the “watch” of the seller, he or she will not get a post-closing price adjustment for their impact on the company’s true value. Since the seller doesn’t get the benefit from any unknown positive factors, he shouldn’t get the downside risk of any unknown negative factors.
Unfortunately, the “my watch, your watch” concept is the norm. Most advisers and attorneys accept it as the way a deal should be structured. Others believe the majority of the seller’s representatives should be limited to some form of “knowledge,” except for a few representatives where absolute guarantees should and can be given to buyers.
Such knowledge qualifiers will limit sellers’ exposure to those things the person is aware of.
Your indemnification exposure for violation of the reps will be on the personal level, and therefore not limited by the protection of the corporate veil. It is conceivable that violations of the reps could cause sellers losses that exceed the sale price. This exposure is usually limited by placing a ceiling on the seller’s indemnifications. The ceiling will vary depending on the deal environment at that time and the unique characteristics of each company, however the ceiling for the seller’s exposure should not exceed 15 percent to 35 percent of the total price.
3. Letter-of-intent issuesAll acquirers should be brought together simultaneously to leverage one buyer against the other to achieve the maximum selling price and deal terms before the execution of the letter. At this stage, most investment bankers select the company with whom to negotiate a definitive purchase agreement. Their decision is usually based on only the level of the purchaser’s price and the composition of the deal consideration.
Other factors should be evaluated in making this decision. Prior to selecting the acquirer to enter into the letter of intent with, all the prospective buyers’ philosophies and general positions regarding the reps and indemnifications should be discussed, as the seller’s exposure in these areas can be more important than the deal price itself, in certain cases.
The letter provides for an exclusivity period to negotiate a deal with the selected buyer - usually 45-90 days. During this period, the seller can neither solicit nor have conversations with any other prospective acquirer.
4. Know your adversaryA successful negotiator will know the personal and team goals of all members of the buyer’s team. This includes the principals, investment bankers and legal counsel. Not only must you know the team goals, you must determine if any of the members’ personal goals are in conflict with the team goals. They often are. You also must become familiar with the style and determine the negotiating strategy of the acquirer.
Armed with this knowledge, negotiators should be able to establish or revise, if necessary, the negotiating battle plan. Experienced negotiators will know the adversary so thoroughly that they will know how they will react to every move. This ability to stay one or two steps ahead on all negotiating issues will help ensure eventual success.
5. Obtain the drafting rights to the definitive purchase agreementThe drafting rights to this agreement are extremely important. A seller’s ability to obtain control of these rights is critical to eventual success. If a seller doesn’t secure them, it assures that he or she will be getting canned acquisition documents, which are likely to be structured in the buyer’s favor. This means the seller will have to expend considerable negotiating capital to just get back to a fair starting point to negotiate a reasonable agreement.
After sellers obtain the drafting rights, it is in their best interest to prepare a reasonably fair first draft of the agreement. Sellers never want to make excessive demands they’re unlikely to obtain. They will be able to realize a much more favorable deal by developing a negotiating pattern sustaining major positions.
This negotiating approach will allow acquirers to know that you are reasonable but have minimum flexibility after you define your position. You want to get buyers used to conceding the major points that you demand.
6. Focus on winning the war, not the battleThis requires you to have a clear definition of what victory is in this negotiating war. It is essential that sellers clearly define pricing objectives, desired deal structure, the composition of the transaction and the acceptable level of exposure in the reps and related indemnifications before the negotiating process starts.
Negotiations are not a science. They are the most critical part of the acquisition process. Negotiations will determine if a sale is a success or failure. The way to assure your success in the negotiating process is to follow the strategies and techniques discussed in this article and to make sure that your lead negotiator is an experienced, knowledgeable and aggressive veteran of the negotiating wars.
George Spilka is president of George Spilka and Associates, a Pittsburgh-based merger and acquisition consulting firm that specializes in middle-market, closely held corporations. They have a broad-based service that advises clients through the entire acquisition process. These firms include a diverse group of contractors, distributors and manufacturing companies throughout North America.
For more information, write Castle Town Square S., Suite 301, Allison Park, PA 15101. Also call (412) 486-8189, fax (412) 486-3697 or e-mail firstname.lastname@example.org; seewww.georgespilka.comon the Internet.