CHAPTER 17

Initial Meetings with Buyers, Pricing the Company, and Pacing the Negotiations

Savannah, GA—1988 The Perennial Question

In the middle of one of our quarterly partner meetings, I was making people crazy, I suppose. My question was not a particularly difficult one, but I could not seem to get a straight answer to it, even now though I already could sense why the answer was a tough one.

“How the hell do you announce the asking price of the company you are trying to sell?” (I am still learning my new trade). I look around the table of my more experienced peers, and sooner or later, they take turns answering it.

Each one has a different take. Gerald suggested that the best approach is to name the highest conceivable price you can justify and then hang on for dear life. Dunn, a more easygoing type, believed expert valuations are the answer, and he always got one before proceeding with a deal. “An expert valuation takes the guesswork out of it,” Dunn suggested.

Philip, of course, said, “Let the buyers go first, suggesting a price and then attack.” Philip, admittedly, a bit of a cynic, believes that prospective buyers always will lowball a price but, once they have done so, the seller and his Middle Market investment banker will have a baseline and things can only get better from there. I admit there is merit to Philip’s position, but there are problems with it too. What if the buyer simply refuses to “go first?” Somebody has to go first, right?

I suspected that each of these answers is problematic, but what did I know? Gerald, Dunn, and Philip had been doing deals fulltime.

Strange Role Reversals and First Meetings

After having been identified and contacted, the buyer has executed the non-disclosure agreement (NDA), received the Information Memorandum, and is looking forward to a first meeting. Typically, first meetings take place in the investment banker’s offices, in deference to confidentiality concerns. These meetings will sometimes involve other members of the seller’s management team, and maybe a more or less formal seller’s management presentation ... and that is okay too, even especially desirable, provided the seller has included his team in the knowledge that the business is for sale or seeking financing, which he almost always should do if they are important to the transaction.

The role reversals at these first meetings never fail to amaze me. One might well assume that the buyer does the buying and the seller does the selling. But more often than not, the prospective buyer does most of the selling, pitching his firm as the ideal acquirer of the seller’s business. This probably reflects a sort of anticipatory negotiation, an attempt at “softening up” the seller, and an attempt to gain an edge in the auction (perceived or real) at the outset. We all quite naturally do all in our power to make a good first impression in business interactions of all types. Why should it be any different for prospective buyers in their first meetings with the seller? And there is much to be gained from this situation.

First Meetings: A Friendly and Professional Seller

There is a certain irony in the fact that the prospective buyer’s interest in “selling” himself and his company should actually encourage the seller and his investment banker to refrain from their own “selling,” at least in any obvious fashion. The seller’s demeanor in this first meeting should be open, honest, and very friendly, but it also should be reasonably reserved. Any overt attempt by the seller to sell his company risks being interpreted as anxiousness, while signaling to the buyer that he may as well stop selling himself (e.g., the seller seems maybe a little too desperate or needy). It likely will throw the buyer off balance in the midst of his own “pitch,” and if they interrupt that pitch prematurely, the seller and his investment banker run the risk of not fully understanding the buyer’s motivations to acquire.

Every prospective buyer knows he would not be in the meeting with the seller unless the seller was interested in being acquired. That goes without saying. Thus, the seller need indicate little more than that. He should listen, mostly. And answer factual questions, and of course be friendly, and present the company in a factual and best light—but that does not mean overt selling.

Even in these very earliest moments of the overall auction process, impressions are being made that will inform the parties throughout the proceedings. The first meeting, in essence, constitutes a preliminary negotiation, no matter how you cut it. Sellers also should avoid any response that appears contrived, stiff, or disingenuous; these will only put prospective buyers on guard. Advice to sellers: Be relaxed above all. Being open and forthright, albeit reserved, may seem discomforting at first. Take comfort in a paraphrased dictum of legendary GE CEO Jack Welsh: “You might as well tell the truth, since everyone knows it anyway.”

The Potted Plant Investment Banker

And what is the role of the investment banker in these first meetings? It is principally to be polite, observant, and above all, quiet. Investment bankers should do their level best to shut up in these first meetings, because these meetings are about the prospective buyer and the seller, not the investment banker. An investment banker who attempts to demonstrate his brilliance by dominating, upstaging, or “selling” his client is at best annoying and at worst, quite often, very destructive of his client’s prospects. In fact, in these first meetings, investment bankers would do very well to impersonate an attractive potted plant. Be polite, of course, and facilitate the introductions, as required. Be willing to make friendly small talk. But that is generally quite enough! There will be plenty for the investment banker to do later. In the meantime, he best serves his client’s interests by remaining highly observant. He is likely to learn a great deal more by actively listening to and observing the interactions of prospective buyer and seller in these initial meetings than by being a full participant in them.

Investment bankers should pay particular attention to the prospective buyer’s body language: Does it reaffirm or contradict what the buyer is saying? The prospective buyer very likely will be more forthcoming in introductory meetings than at any subsequent time as negotiations heat up. The prospective buyer’s “selling points” in the introductory meeting will prove quite useful later in negotiations, as the seller and his investment banker recapitulate and re-emphasize back to the buyer the virtues he or she extolled in acquiring the seller’s company and the likely benefits he or she perceives in doing so. So the investment banker will pay particular attention to what the buyer tells the seller about his own company.

• How useful is that information to the seller and the investment banker as they consider how well—or not—the seller’s company might meld with the buyer’s own objectives?

• What does the buyer’s presentation of himself and his company say about his personality, leadership, and managerial capabilities?

• Of equal concern: what kind of negotiator is he likely to be: bombastic, hard-nosed, or fair-minded?

The initial seller/buyer introductory meeting offers one of the single most important opportunities to gain insights into the buyer. We all, always, can listen more, and listen more effectively, not least investment bankers representing sellers in transactions of singular significance in their financial lives. Be an effective listener, a simple observer.

Pricing the Company: The Inevitable Question

There comes a time in this first meeting between the seller and the buyer when the inevitable question arises in one form or another. “How much do you want for the company?” the buyer will ask, in those words or something like them. The question usually comes up near the end of the meeting. Middle Market investment bankers would do well to position themselves close enough to the seller to “kick the client in the shin,” by prior arrangement of course. Under no circumstances should the seller answer the “How much?” question.

The investment banker who prefers not to kick clients (an awful thought) will advise his clients in advance of the first seller/buyer meeting how to answer the “How much?” question:

“I prefer to leave those discussions to my bankers. That is why I hired them and paid them these outrageous fees. They should do something to earn their keep.” Well, there’s no need for that to be the literal response. But the substance of it offers a reasonable and humorous and polite approximation. The client-seller should not allow himself to be drawn into a discussion, however preliminary, about pricing. Humorously demurring from an answer without over-scripting things is best, establishing that the seller is not a wimp, is in control, and is a “good guy” with a sense of humor, to boot.

Pricing the Company: The Right Answer

Even a professional investment banker who is a valuation expert should avoid the temptation to place a price on the company. Most of the time, pricing the company would be a mistake, because a buyer will pay investment value for a company, an amount that reflects what the company is uniquely worth to him and only to him. There is simply no way to determine maximum investment value of a particular buyer in the absence of a real or perceived auction process. In the absence of an auction, it is all but certain that any price the seller or his investment banker would put on the company would over- or under-shoot, perhaps substantially, the value an individual buyer would place on it. In other words, nothing whatsoever is to be gained by pricing the company.

That does not change one critical fact: once the “How much?” question has been raised, an answer of some sort must follow. When the question is posed to the investment banker,¹ the investment banker’s sincere, “I do not really know,” should be followed by quick explanation that investment bankers, like the sellers they represent, have no way of knowing investment value when a company is first put up for sale. Although I would not suggest actually using the corny phrase, he is simply a “seeker of the truth,” and it is hard to argue with that, for sure.

But a prospective buyer may balk at, “I do not know.” In fact he may very well say, “I am out of here. There is no way that I am going to participate in an auction,” or something to that effect. The object now is to keep him in the game, and an approach that is fair and relies on the truth—and is almost always successful with less experienced buyers (experienced buyers already know they are in an auction)—is to point out to him that the highest price rarely wins the deal, because a multiplicity of possible consideration types, deal structures, and miscellaneous terms will make each offer very different from the next for reasons having little to do with “price.” The investment banker might also point out that his clients, having invested considerable effort in building their companies, undoubtedly will factor “chemistry” and “fit” into their decisions, which usually is true, at least in the early stages. Almost always, these answers will keep prospective buyers in the game. Who does not think in their hearts that they are creative enough to offer a deal that is the best one out of a group? Reassurances from the investment banker that the buyer will have several bites at the apple in that the banker will work with him in developing alternative creative offers can go a long way too towards quelling buyer anxiety.

So how much does the seller really want for the company? As I have said several times, he and his investment banker will not actually know at first, (other than a broad range) because they cannot know the value buyers individually would place upon it—and that is the simple truth. As a result, the seller and his investment banker should not price the company, at least not rigidly; they may suggest ranges based on comparable transactions. As a valid method of priming the pump, the investment banker may share with a buyer a suitable range of transactions involving companies similar to the seller’s own to justify a range of valuation, as long as this in no way limits an upper value to the deal at hand. And why should these transactions not reflect the best of the bunch?

The above pricing conversation exchange accomplishes several things if done well. First it establishes both seller and investment banker as “good guys”—flexible, straightforward, and, possibly, easy to deal with when actual negotiations commence. And even though the existence of an auction initially may perturb a buyer, he very likely understands that he would demand no less, were he the seller. Furthermore, the auction process presents an infinitely superior alternative to a seller’s arbitrary demand for an unsupported price.

A QUICK DIGRESSION FOR BUYERS ONLY From the buy-side point of view, the opportunity—and challenge—to present a creative offer with a compelling structure and mix of considerations actually does benefit buyers in competitive auctions, precisely because sellers cannot precisely compare the value of multiple qualitative and to a degree quantitative deal points presented across several offers. When experienced sales-side investment bankers represent a buyer in a Middle Market negotiated auction, they often welcome the chance to encourage the buyer’s creativity. For example, more creativity routinely “trades off” for fewer deal dollars, especially when tax structure is an important deal element.

Should a Company Ever Be Priced, and to What Degree?

As there are exceptions to every rule, there are occasions when a business should, indeed, be priced. Pricing the company may be warranted when selling a technology or a business for which few suitable bidders are likely to emerge. In the end, perhaps only one suitable bidder will materialize. Investment bankers strongly dislike such scenarios, but they do arise nevertheless.

When an investment banker cannot launch an auction, despite his or her best efforts, she should attempt to establish a valuation based upon whatever comparables and company-specific factors are available. In addition, in the case of early stage companies or possible recapitalization transactions with private equity groups (PEGs), where much of the value is put on future performance, he or she should establish a value for the company based upon its discounted cash flows, or DCFs (see Chapter 24). This is one of those rare occasions when the use of DCF methodology on the sales side is appropriate.

In addition, and this is usually very difficult, the investment banker also should attempt to establish what the investment value of the company might or should be to the lone buyer, by attempting to quantify the synergies that the acquisition will produce for the buyer. There are occasions when there is enough information to do this. This approach is called “leading the horse to water,” to use yet another cliche. An investment banker who wishes to establish the potential investment value of the company from the buyer’s perspective must do substantial intelligence-gathering and rigorous analysis concerning the buyer’s business. In some respects, the seller’s investment banker is “doing the buyer’s work for him,” but sometimes this is necessary. The buyer may not have done that kind of detailed homework. Should the investment banker present a rigorously-researched and analyzed investment value of the seller’s company to the buyer, the buyer himself may prove unwilling to acknowledge (at least overtly) the merits of the argument—this being, of course, a negotiation. Even so, when this work is done thoroughly and conscientiously, both the buyer and the investment banker will know it, and the result inevitably will influence the negotiation process. Furthermore, the buyer will now be compelled to explain why the bankers assumptions are wrong and that in itself may provide even more useful intelligence that the banker might use in another round.

Encourage All Offers, No Matter How Low . . .Getting Them into the Tent

Job number one for sales-side investment bankers is to set things in motion. This includes eliciting every potential offer from buyers, no matter how low that offer may be. As soon as the investment banker has two or more offers in hand, he or she has something to work with. Any buyer’s first offer establishes a reference point for the seller and the seller’s investment banker as to where the company’s value might stand with that buyer. Only rarely will that first offer not be able to be improved. With offers in hand, the parties start talking, and the auction takes on a momentum of its own.

Neither the seller nor the investment banker should take umbrage against a lowball offer. In fact, they should be delighted to get all offers. On a really lowball offer, a good response is, “Thanks, we really appreciate your interest, and we will present this to our client, but we think this may very low based on what we know and what we think we will see from other offers.”

Any offer is useful. Perhaps it is an all-cash offer? Perhaps it incorporates a particularly generous earnout or royalty, potentially providing excellent post-transaction compensation to the seller? But the most important fact is that any single provision in an otherwise unacceptable offer can be used by comparison to improve the terms of competing offers and can be incorporated into developing a final purchase price from at least one other buyer. The object is to get the buyers into the tent. Once in, they will either aid the improvement of other offers or begin to get serious about winning the deal.

The Truth, the Whole (?) Truth, and Nothing but the Truth

Successful negotiations are predicated upon the credibility and trustworthiness of the negotiators. But while I have discussed this before in an earlier chapter let me address it again in the context of this one. Sellers and their investment bankers should understand that there is a difference between the truth and the “whole” truth. In every negotiation, seller and prospective buyers alike have the right to withhold certain critical information. The prospective buyer, obviously, is not under any obligation at any time to disclose his or her top-line offer, unless and until he/she chooses to do so. On the other hand, when an investment banker discloses different deal elements from competing offers for the purpose of encouraging prospective buyers to improve their terms, the banker is under no obligation to disclose in their entirety the offer or offers in which those terms were contained.

For example, when a seller receives a fairly low $10 million all-cash offer from one prospective buyer, his investment banker quite rightfully can advise another prospective buyer (who has offered $15 million, including $7 million in cash) that an offer with $10 million in cash in it already is on the table. The investment banker might tell a third prospective buyer that he already has a $15 million offer in hand. Each one of these is an accurate representation of fact within the negotiations process.

Timing, Sequencing, and Pacing the Deal while Pricing the Company

When an early and aggressive prospective buyer becomes active right from the start of the auction process, investment bankers do have mixed feelings. Such buyers can raise timing problems. The effectiveness and the success of the negotiated auction depends upon several buyers competing over time, thereby proposing deal terms that are increasingly favorable to the seller. When aggressive prospective buyers actively seek to speed up the process for their own purposes, or accidentally threaten to short-circuit it in their eagerness, investment bankers should do all that they can to manage the negotiated auction so that the most potential buyers will have time to participate to the fullest.

Sometimes sellers and their investment bankers are admonished by prospective buyers to maintain a sense of urgency in doing the deal. Actually this (a sense of urgency) is also the common and rather cliched advice typically offered by less-experienced investment bankers, as well. In every transaction, there will be a time to go slow and a time to move fast. In general, though, the early stages tend to be best handled at a slow pace, and only the later stages at “sense of urgency” pace.

But again, it is true that prospective buyers who come early to the table may become discouraged if—in their estimation—the process drags on too long. But if remedying this entails accelerating the process past the point of allowing most of the field of prospective buyers to participate fully in establishing the investment value of the company, do not do it. Again, admittedly, investment bankers are confronted by a balancing act; that’s why sellers pay them big money. How should one slow down prospective buyers demanding greater urgency at the expense of the auction? Once again, try honesty. Communicate to such buyers the seller’s appreciation of their early proposal and of their patience as other prospective buyers put together their own bids. All squawking aside, such buyers understand that sellers are within their rights to give all prospective buyers a reasonable amount of time to submit an offer.

Once all buyers have had a chance to submit their respective offers, the seller and his investment banker may choose to “dial up” that sense of urgency a few notches to speed through a few rounds of offers and counteroffers to the end game. As I said, sometimes urgency is appropriate (usually in later deal making stages) and sometimes it is not. But be prepared for things to take usually much longer than you would expect. Deals for large sums of money and major elements of inherent uncertainty happen that way. Fits and starts, speed followed by slowness followed by speed.

Chapter Highlights

• Do not price the seller’s company initially, but do provide a range of potential values for it.

• Emphasize to prospective buyers that the highest “price” rarely wins so as to encourage buyers to be creative participants in the negotiated auction, pricing, and establishment of terms of sale.

• Avoid using the term “auction” when dealing with prospective buyers; “auction” is a “bad” word, however implicit in the nature of the proceedings.

• Pricing is actually a function of the negotiated auction.

• Politely accept all prospective buyers’ offers to get everyone in the tent.

• Combine elements of different offers to create optimal terms for the sale of the business.

• Auction pacing is usually slow in the beginning. Toward the end of negotiations, the pace may well quicken, but every deal is different.

• It always takes longer to consummate a deal than one expects going in. Investment bankers need to manage the seller’s, the potential buyers’, and their own expectations throughout the process.

Note

1 The prospective buyer generally will pose the question once again, to an investment banker directly, after the client has left the room. Having the opportunity to do so again, and to talk with the investment banker directly, can make things less awkward for everyone. It also more or less establishes the investment banker as an intermediary through whom the buyer must work from the launching of the sale through the conclusion of the negotiations.