of middle market companies with a transaction value up to $200 million
have limited access to reliable information that can provide insight
into the proper pricing and structuring of middle market transactions.
Major business periodicals principally report on large public deals
with transaction prices from $200 million to several billion. The
pricing and structure of these deals bears no resemblance to middle
market transactions. Correspondingly, they provide no insight as to
what a selling middle market owner should expect. The problem is compounded
by the generally poor quality of advice available to these owners.
Prospective sellers often turn to seminars sponsored by financial
advisory firms. Most of these tend to play on the ego and naiveté
of the selling owner about the middle market acquisition process.
Consequently, they often entrap owners in delusions of wealth that
are unfortunately transformed to feelings of frustration and anger
when hollow assertions cannot be translated into reality.
However the prudent middle
market owner will be able to convert their company into the wealth
that they have diligently worked to build. They don't operate under
misconceptions and delusions; instead, they understand their shortcomings
and knowledge gaps and most importantly are willing to pay the price
required to convert their company into the "gold mine" that it can
be. These owners don't operate under the 12 common misconceptions
that are discussed below.
Seller Must Finance A Significant Portion Of The Acquisition Price.
Many acquisition 'experts" state
that a selling owner should only expect to get 40-50% of their transaction
price in cash at closing.
This is nonsense. Acquirers are
trying to "steal" a seller's company. Notes are often the conduit
used by an acquirer to collect for alleged breaches of representations
and warranties. This is accomplished by not paying the notes and forcing
the seller to file suit for collection. To demonstrate the absurdity
of this misconception, my Firm has not consummated any transaction
during the last 10 years, where the cash component was less than 88%
of the total transaction price. In fact, over 80% of the transactions
closed were for all-cash. These are the type of results that selling
owners with respectable companies have a right to expect.
2. Historical Earnings Or Book Value Are Major Determinants
Of The Transaction Price.
This misconception is espoused by acquirers
to justify substandard offers. Historical earnings or book value are
usually used as a price justification during:
company had temporary problems that have since been resolved,
growing companies whose long-term future is much brighter than
If you are being represented by
a top negotiator who is an experienced acquisition advisor, only one
thing governs a transaction price, that being the expected future
earnings and the risk in achieving those earnings from the business
foundation provided an acquirer.
3. Acquirers Make
Realistic Offers At A Price That Justifies The Deal.
The capitalist system dictates that an acquirer buy a company as cheaply
as possible. An acquirer will first evaluate the sophistication of
the seller's advisory team. This forms the basis of their judgment
of the seller's ability to find a synergistic acquirer and force such
acquirer to pay a premium price. This judgment dictates the aggressiveness
and equity of the acquirer's initial offer.
4. The Deal Is Basically
Completed When A Price Is Established.
The price is established at the Letter of Intent ("LOI") stage. However,
this is only the beginning of the deal not the end. The negotiation
of the Definitive Purchase Agreement ("DPA") and the ancillary agreements
must still be completed. These documents define all conditions legally
governing the sale. The DPA contains the critical representations,
warranties and indemnifications. These "non-financial" areas conceivably
can have a greater impact on the deal than the transaction price itself.
In 1993, my Firm spent 5 months negotiating a DPA for a client. During
that period, the transaction price (which had been negotiated as a
premium-priced all-cash deal) was never in contention or even discussed.
However I refused to complete the deal, until a strong DPA was obtained
that completely protected my client against post-closing issues and
litigation. Circumstances that developed after the deal proved that
the time required to negotiate these "non-financial" issues was well-spent.
5. Negotiations Should
Proceed Smoothly In A Non-Adversarial Manner.
To the contrary, if negotiations flow smoothly and amicably, the seller
is usually not getting a premium price or protective terms. Acquirers
of middle market companies are not known for initially making their
best offer or even a fair one. In most deals, if negotiations are
not eventually pushed to the absolute breaking point, a seller can
be certain that they have not received a premium price.
6. A Seller Doesn't
Need An Acquisition Advisor To Guide Them Through The Transaction.
Brokers generally try to complete a transaction at any price. Typically,
they are not familiar with how to conduct an international search
for a synergistic acquirer, nor with how to aggressively negotiate
a deal that assures a seller a premium price. In addition, brokers
usually are not aware of all the ramifications of the critical representations,
warranties and indemnification issues. A seller requires an acquisition
consulting or investment banking firm that will guide and direct them
through the entire process. This includes planning the sale, the valuation,
the search for a synergistic acquirer, and the conduct of negotiations
leading to a closing. The acquisition advisory firm must be concerned
only with the seller's best interest, and not with simply closing
a transaction at any price. A deal must not be consummated, unless
the seller is getting a premium-priced, principally all-cash deal
with a strong, protective Definitive Purchase Agreement.
7. Financial Buyers Pay A Fair Price For Your Company.
The expected incremental future
earnings dictates the acquisition price. Synergistic benefits
related to an acquisition increase the incremental future earnings
realized by an acquirer. These benefits make the companies' combined
profitability after a sale higher than the total for the two operating
separately. Financial buyers bring no synergy to a deal and, therefore,
are incapable of paying a premium price. This is compounded by the
fact that most financial sponsors of buyout groups (the major institutional
sources of capital) demand an unreasonable rate of return on their
investment. This comes out of the seller's pocket in the form of a
substandard transaction price (usually 10-25% less than normalized
8. The Acquirer Does
Not Need To Divulge Meaningful Information To The Seller.
Acquirers should not be given a "free look" at a company. Many companies
feign interest in an acquisition to obtain information about the selling
company and its business. If an acquirer wants to investigate your
company, in addition to signing a Confidentiality Agreement (of limited
practical benefit); they should provide your advisor with 3 years'
financial statements, before a site visit is permitted. A seller's
truly proprietary information should not be divulged to a prospective
acquirer, until a LOI has been executed.
9. Planning The Sale
Doesn't Increase The Transaction Price.
Certain factors should be addressed prior to the sale, if a seller
is to get a premium price. These have nothing to do with increasing
short-term profits or cleaning-up the balance sheet. The multiple
applied to expected future earnings or cash flow will vary depending
on the long-term growth projected for the selling company and the
strength of its business foundation at the time of acquisition. Having
a knowledgeable acquisition advisory firm investigate and strengthen
the seller's business foundation will increase the transaction price.
10. The Seller Or
Their Accountant Can Establish The Expected Transaction Price.
There is limited meaningful empirical date available on middle market
transaction prices, even to acquisition consulting and investment
banking firms. Correspondingly, the valuation of middle market companies
is more of an art than a science. The validity of any valuation depends
on the expertise and market familiarity of the professional who performs
the valuation. That person must devote all their time to middle market
acquisitions and have many years of experience to season their judgment.
Only then can they provide a knowledgeable opinion of a seller's market
11. The Seller's Generalist
Attorney Can Handle The Legal Aspects Of The Deal.
An acquisition is an extremely complex transaction. Problems in drafting
the DPA and, to a lesser extent, the ancillary agreements can place
a seller at serious risk to lose part or all of the transaction price
subsequent to the closing. An acquisition usually requires a law firm
that has specialists in mergers and acquisitions, labor law, and environmental
law, amongst others. It is impossible for a small law firm to have
substantial expertise in all of these specialty areas. This expertise
is essential, if a seller is to be protected against post-closing
12. Pricing Of Middle
Market Deals Is Significantly Affected By The Economy.
My experience is that economic conditions have little, if any, impact
on middle market acquisitions, if a synergistic acquirer is located.
In a normal recession, a middle market transaction price will decrease
by less than 3%, if at all. A synergistic acquirer will usually purchase
a seller when it is available, if the company provides access to a
market niche they covet. To do otherwise, could mean missing the opportunity
to purchase it. During the last recession, mid-1990 to the end of
1991, my Firm closed 6 deals per professional person for the 18 month
period ending 12-31-91. All deals were fully-priced; over 75% were
It is essential for a prospective
seller to locate the best acquisition advisory firm. The seller's
major decision is determining what firm can produce the greatest benefits.
Cost should be of secondary concern, because the right firm can be
the difference between success and failure. This firm should be able
to increase the transaction price by 10-15%, as they will not operate
under the common misconceptions previously described. This will enable
a selling owner to reap the benefits that they rightfully deserve.