SELLING A COMPANY. HOW TO ROLL OUT AN M&A PROJECT
The importance of preparing the ground for negotiations and then conducting the talks is often underestimated. Instead, negotiations tend to be perceived as a good moment for drawing up a contract focused on a single piece of information that is crucial to both parties, i.e. the price for the shares. Little attention is paid to equally important matters, such as how to adequately address the risks associated with the acquisition or investment processes. The same applies to the expected transaction parameters which should be reflected in the respective provisions of the contract.
Prior to development of appropriate documentation, we should gather all the required information, as well as identify associated risks that are likely to materialize in relation to the acquired company. On top of that, we should also specify key interests that we want to protect. Next, these issues (risks or interests) must be accurately defined in the transaction documentation.
It also makes sense to break the whole process down into two stages. The first stage happens when both sides sign the document defining the fundamental and jointly agreed terms and conditions of the transaction, a so-called letter of intent, often referred to as a term sheet. During the second stage, the final contract between the parties is developed after a due diligence process.
ROLE OF AN M&A CONTRACT
Even before we get on with development of the documentation, it is vital that we collect the information on the expectations of the parties, as well as on the M&A target. Only then we can appropriately address these issues. Agreeing upon the price and repayment schedule constitutes the pivotal element of the contract and an end in itself. That said, reaching an agreement on these terms and conditions does not mean that the negotiations are over. To think that would be a great mistake. Determining the objective of the investment and the parameters of the company that we are buying are of equal importance, one of the reasons being that we want to make sure that what we are buying is exactly what we are willing to buy for an agreed price.
Therefore, when drawing up a contract we need to think of both the price and the significant risks that need to be properly defined at a later stage. Failure to accomplish the objective of our investment is an example of such a risk (e.g. the company fails to generate the expected results in the nearest future or other circumstances occur, depriving the company of the qualities attributed to it). The contract is not complete until the parties’ rights in the event of emergence of any of the defined risks have been specified and the price has been set.
In other words, the objective of the process is not only to define how much we are willing to pay for the company or what funds we can invest, but also under what circumstances we are allowed to pull out of the investment. In extreme cases, we talk about a difference between loss of 100 percent of invested means and withdrawal of 90 percent of the investment based on an appropriately developed M&A contract.
NEGOTIATIONS AND THE HUMAN FACTOR
There is time before development of a letter of intent for both parties to make sure whether they are indeed interested in a possible transaction. At the same time, participants in the process need to get to know and trust each other – they should “click”.
The letter of intent must list the key items of the transaction, i.e. price, payment method and structure of the transaction. In this step, the parties ensure that they have understood each other and are ready to confirm the agreed terms and conditions of the transaction. During the development and negotiations of a letter of intent, the parties get the opportunity to observe each other, as well as agree on further rules and prospects concerning the transaction negotiations.
At the same time, we need to bear in mind that development of this kind of document requires contribution from competent consultants. Failure to make sure that the right contractual provisions are in place could result in a situation where the seller cannot leave the negotiating table without negative legal consequences for themselves, while the buyer gets stuck with their valuable asset, reluctant to close the deal on the negotiated terms.
In the view of the above, one cannot overestimate the value of a competent team of negotiators.
Meanwhile, a professional representative of the parties needs to make certain that both parties to the transaction (i.e. entrepreneurs) understand what is communicated to them.
In the case of the companies that choose to do business without legal assistance (in Poland, many economic entities do without lawyers, with varying degrees of success), we must add another stage to the process so that an advisor can educate the client on the role of a lawyer, consultant and, in some cases, contractual provisions. The level of awareness among management boards of financing-seeking companies varies and can often be quite surprising.
Moreover, the “older” the company, the more its owner (who often happens to be its founder, too) grows emotionally attached to it and finds it harder to accept advice from a team of consultants, frequently ten years his/her juniors.
Aside from such extreme cases, it still needs to be emphasized that selling a company is a process strongly dependent on its participants and these are only humans. American M&A expert and blogger Javier Enrile goes as far as to advise abandoning any hope for a rational behaviour from the parties involved in the negotiations. According to Enrile, decisions and behaviours displayed during negotiations are triggered by unpredictable urges arising from participants’ deeply ingrained habits, fear or personal needs. Briefly, common sense is NOT something that we should expect from negotiation participants. It would be hard to argue with that based on general experience associated with transactions. What is more, as soon as we learn to expect such irrational or emotional dimension to negotiations, we can astutely use it to our advantage whenever we come across it during the talks. By carefully observing the habits of the parties, we can steer the individual stages of the talks in the right direction or address certain emotional needs of the other party.
To sum up, embarking on the process of selling a company requires preparation and some serious thinking about: objectives of the parties, experience in the scope of addressing the opponent’s needs and, last but not the least, clever approach to risks, as well as meeting both legal business objectives of this kind of a transaction. This means that professional legal and business advice will always be required in this process; hence the need for a carefully selected team that will run the process of acquisition (or withdrawal from a company).
In our next post, we will share more details about the practical aspect of the transaction. Stay tuned.