05/02/2020

What to do when a big wolf comes knocking on the door


Roger Esler, Corporate Finance Director at Dow Schofield Watts, considers the prevalence of unsolicited approaches by trade buyers to business owners, and how they should react to properly evaluate and optimise such interest and to mitigate the risks involved.

Unsolicited approaches by large acquisitive trade buyers have always been a feature of the corporate market. A knock on the door can be compelling: an eager, well heeled buyer that has sought out your business and could be willing to pay a premium to own it without the hassle of you running a sale process. However, it can also bear a considerable risk if not managed properly.

Since the recession, strategic plans have become much better formulated as corporates sought to optimise their balance sheets and define clearly their criteria for acquisition and divestment. For private equity-backed businesses, large multinationals and PLCs this has, in broad terms, resulted in a very selective approach to making acquisitions, where interest is peaked by clear strategic fit and the availability of synergies. Indiscriminate, volume-driven acquisition strategies are now something of a rarity.

Merger and acquisition activity, be it driven by trade deals or private equity, has been strong for a number of years driven by high valuations, excellent availability of capital, favourable exchange rates and very low capital tax rates for sellers. There have been many conventional business sale processes of course, but with such well formulated acquisition strategies and perhaps a dampening of appetite for owners to put their businesses on the trade market during the period of acute Brexit uncertainty. Some corporate buyers have simply got on with it, knocking on the door of their preferred targets and inviting themselves in.

So how should business owners respond to a knock on the door?

Discussions built of straw

Some unsolicited approaches are direct – principal to principal – but many are through advisers or other intermediaries, some of whom might claim to represent a strategic buyer but be reluctant to disclose who.

Releasing confidential and commercially sensitive information to an intermediary without knowing who the ultimate recipient will be, carries considerable risk. Some business owners have found, to their cost, that the information ends up with multiple “buyers”, some of whom are competitors, or even seen it paraded on websites under “businesses for sale”.

No buyer with any integrity will decline to identify itself in such a context. Some unscrupulous intermediaries on the other hand, will happily gather confidential information to see what they can make of it.

Negotiations made of sticks

Private businesses disclose minimal information publicly: the website and historical accounts are generally about it and are often so out of date that they are not an accurate basis for a valuation. A competitive sale process is quite different as it involves a detailed Information Memorandum.

An unsolicited buyer’s initial goal is legal exclusivity, and some will try and achieve this without putting forward an offer. Even where a typical “debt free/cash free” headline offer is made, it might have a very limited foundation if based on minimal information and, ironically, be flattered by the owners negotiating a high valuation hurdle to permit entry. However, they are without necessarily having assessed whether they could support such a valuation through due diligence.

Furthermore, agreeing a headline value and allowing access to the business without knowing how that translates into a share valuation after debt. Cash and working capital are taken into account or, indeed, how the deal is to be funded, results in considerable risk to the sellers.

How to ensure there is a robust foundation and deliverable deal

Firstly, know your suitor and look them in the eye. Make an assessment of its strategic rationale, access to funding, acquisition history, valuations paid and reputation and – critically – its competitive threat to your business. The confidentiality agreement should be with the principal, never just with an intermediary. Beware the letter or email saying that they “act for a highly acquisitive corporate” and then refuse to tell you who it is!

Secondly, reach an objective view of your business’ value and consider the key information that supports this, e.g. forecasts, property valuation, IP.

If this is not in the public domain then, after an initial understanding of the buyer’s approach to value (e.g. multiple of profit), a release of limited, value critical information to support initial negotiations could be well merited.

Importantly, unsolicited offers should come with a premium, to be high enough to dissuade the seller from running a competitive sale process and/or persuade the owners to sell when they might not have been planning to do so.

Thirdly, when a headline “enterprise value” is agreed, drill into the detail. It is the share valuation that ultimately matters and that is a function of how debt, cash and working capital are treated in those calculations.

Seasonality and cyclicality impact those balances and there are several methodologies that can be applied to arrive at the final number that goes in the contract. It is also critical to agree on a deal structure, including – earn outs, deferred payments, and how the cash consideration is to be funded.

A buyer that needs to go to the market to raise finance for the deal represents a higher risk proposition and the fundraising will have timetable implications.

Fourthly, agree on comprehensive Heads of Terms with the buyer before granting exclusivity and access to detailed information. These should include all the aspects of the deal discussed above as well as other material aspects, e.g. form of warranties and excluded non-business assets.

Fifthly, be prepared for detailed due diligence, notably financial and legal, running over several weeks. The vast majority of buyers are thorough and rigorous in their approach to due diligence and sellers need to be mindful of how this should be managed to avoid disruption and to withhold very sensitive information until late in the process.

Lastly, seek professional corporate finance advice to get the best possible deal and to avoid unnecessary commercial risk, distraction and disappointment.

After all, building a good, sturdy house needs an architect and a builder as well as the right materials. Optimising and then delivering a business sale is no different.

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