One of the principal goals of an investment banking process is to bring buyer choice options to the table for seller clients. A classic investment process should lead to several high value, qualified buyers meeting with management. Of course, a premium valuation is key, but often just as important is the opportunity to select a buyer that has the best culture and legacy fit.
One other reason to have choices is so that there is a strong "backup" buyer, or buyers, in place in the event something goes astray with the initial winning buyer during due diligence, legal and pre-integration. Unfortunately, this happens more often than clients might expect. While most of our transactions are consummated with the original buyer, there are several reasons why a deal could go off the rails. Every one of the examples below has actually happened in our M&A practice.
Bumped for a bigger, better deal. Buyers have limited bandwidth and there are times when they might jump ship for a more attractive deal, leaving our clients out in the cold or on a waiting list. Letters of Intent are not binding and generally have easy to execute termination clauses.
Problems with financing. Buyers may have some early indication at the start of the LOI period that they can secure necessary financing for a deal, but this is usually very preliminary. During due diligence it is possible that lenders and other financing sources cannot get comfortable with the transaction.
Discovery of unfavorable core business issues. As buyers dive deeper into due diligence, it sometimes happens that they learn things about the business and/or industry that cause them to get cold feet. This is separate from any misrepresentation type issues. The execution of an LOI is based on some reasonable level of knowledge but not the kind of complete knowledge that comes out of a thorough due diligence process.
Re-trading. Unfortunately, there are buyers that will look to exploit deal momentum and re-trade the valuation, based on spurious quality of earnings audit claims. Without backup options, sellers may have to swallow hard and take these valuation hits.
Onerous closing conditions. Aside from valuation re-trading, buyers may lob in, late-stage, undesirable closing conditions. Some examples we have seen include: signing then telling staff and clients about the deal then closing weeks after signing; insisting on customer contract assignment where they are not legally required; good standing calls with a large number of customers, beyond the customary three to five such calls.
Accounting and legal disparities. Accounting disputes could range from inventory
valuation to vacation accrual policies. And of course, the ever-fraught working
capital issue, where the buyer is being unreasonable. In a 100-page purchase
agreement, there are more potential legal sticking points than can be brough up
here. While we always lobby our buyers to produce legal documents that are "straight
down the middle", there are buyer lawyers who want to show off and push things
as favorably as possible for their clients.
Delays. Buyers sometimes move slower than planned, which can lead to seller client frustration and deal fatigue. We have also had situations where, during an overly long due diligence process, our client's business performed so well, that is was worth terminating the in place LOI and going to a backup buyer to re-negotiate a higher valuation.
Inherently, seller leverage declines dramatically right after an LOI is signed with a buyer. The seller is locked into an exclusive, no-shop period, often 90 days or more. The seller has invested a lot in the process and is motivated to get a deal done. Buyers can exploit this, even if unintentionally. Having a strong backup buyer can help shift some leverage to the seller.
We make a point to stay in touch with backup buyers, gauge their interest and let them know we appreciate their participation in our deal process.
In the cases where we do move to a backup buyer, they are usually thrilled to have another opportunity for a deal and are eager to be especially fair. We share with them the issues that scotched the original deal, to coach them to avoid these if they want to get a deal done with our client.
For sellers who don't use an investment banker and get sucked into a single suitor negotiation, they don't usually have a backup buyer option. This is one reason we caution owners not to get stuck in an over the transom, single suitor buyer situation. In fact, when owners receive a tempting offer overture, our advice is that this is the perfect time to reach out to a high quality investment banking firm.
So having a backup buyer is like having a backup generator. You would prefer to not have to use this, but in case of a problem, it is always good to have.
Posted by Jeff Wright