vs. Negotiated Sale
When the time
comes to sell a company,
which method produces the optimal results—an auction or a negotiated
sale? Which method is most appropriate? The most timely? What are the
pros and cons of each approach?
auction method is most effective for transactions in which the value is
based on the company's financial performance such as operating income.
The negotiated sale is most effective for transactions in which the
value is based on strategic assets such as a unique technology or
market position. The negotiated sale also works best for smaller deals,
less than $30 million.
drawback with an auction is that the highest bidder only has to pay a
small amount more than the second-highest bid. This may not result in
the optimal price for the seller. The buyer might actually be willing
to pay significantly more.
about the case when there is only one buyer? Or, when one buyer is
clearly a much better buyer than the others? Which method is best? It
is difficult to run an effective auction with only one or two buyers;
the negotiated sale is a more effective method in this situation.
the auction process the investment bank provides descriptive
information to probable buyers and asks for indications of interest and
preliminary valuations. Offers are due by a specific date. From these
offers the investment bank selects the handful of buyers with the best
value ranges and the highest likelihood of completing a transaction.
Those companies proceed with due diligence in order to make final
These buyers are invited to enter the second round of
bidding. They visit the company, meet with management, and are then
asked to make a final bid according to a letter outlining the bidding
procedures. A sample purchase agreement is included with the letter and
any changes to the purchase agreement are considered in the context of
the bid. In other words, if a buyer wants to change the purchase terms,
it will affect the attractiveness of its bid.
selects the best buyer, the parties sign the purchase agreement and the
closing occurs within a month or two. An auction process typically
takes between four and five months to complete.
a negotiated sale, the investment banker positions the company,
researches the market, contacts potential buyers, and provides
information to the buyers. The buyers usually request additional
information and meet with management. The investment banker then
proceeds to negotiate the price and terms with each buyer. He
negotiates as if each buyer were the only buyer. It is important to get
offers from several buyers to keep the process competitive. It is also
important to receive these offers at about the same point in time.
(This can take some skill on the part of the investment banker.) The
negotiator goes back and forth between the buyers and endeavors to get
each buyer to put forth their very best offer.
offers more flexibility than an auction. The seller can bend to the
time constraints and resource limitations of a particular buyer.
Typically there will be two or three, or at most five firms, who will
respond with a high degree of interest. The reason is that most
companies are truly strategic only to a handful of potential buyers.
The universe of buyers is small, although it does take a significant
effort to identify these companies. Some may be from outside the
primary market and are using the acquisition for market entry.
financially-valued transactions utilize the auction method. A
financially-valued transaction is one in which the value is a function
of a company's net profits or operating income (EBITDA). The auction
process works well for large companies and for medium-sized firms with
operating earnings greater than $3 million. In these transactions
buyers are large companies that have dedicated acquisition teams and
the resources to respond to the strict auction time lines.
of the most positive aspects of the auction method is that it can get a
transaction closed in a relatively quick time line, approximately four
or five months. This may be an important consideration for many
With auctions, price is the primary consideration. If
terms are important, a negotiated sale may be more effective. For
example, the management team may prefer to work for one buyer rather
than with another. In a negotiated transaction, it is easier to
consider a diversity of terms for each buyer.
As noted above,
auction theory maintains that the second highest bid plus a slight
premium will win the auction. This is okay if the top two bids are
close, but if the selling company is worth significantly more to the
top bidder, they are getting a bargain and the seller is not obtaining
the best price. In other words, the winner only has to beat the number
two bid by only a small amount.
The auction process can turn off
some buyers. An auction often makes buyers jump through hoops and
buyers may feel that they are in danger of overpaying. It is not a
perfect process; however, it can get a transaction completed in a
reasonable time frame.
For strategic transactions, the auction
process is probably not the best sale approach. A buyer cannot make a
realistic preliminary offer for a strategic acquisition. Unless the
buyer is already quite familiar with the seller, there is no way the
buyer can assess the strategic value without an in-depth evaluation of
the target. Secondly, the buyers for transactions under $30 million are
smaller and midsized companies that do not have M&A teams or
devoted resources to respond to the time strictures of an auction.
Sale—Pros and Cons
key to negotiating the sale of a company with strategic value is to
clearly understand how each buyer perceives the value of the strategic
assets. One buyer may desire the seller's innovative technology.
Another buyer may desire the seller's unique market position. A third
buyer may desire the seller's customer base. It is critical to
understand how each buyer views the strategic assets as well as how
they value those assets.
In most strategic transaction there
are only a few buyers and the range of value can be significant. For
example, in the acquisition of a small software company the strategic
value may be $3 million to one buyer, $4 million to another buyer and
$9 million to a third buyer.
The best buyers for a small firm
with strategic value are not usually the big companies. A small
acquisition of $5 million or $15 million will be much more important to
a smaller buyer, one with revenues between $25 million and $175
million. However, these smaller firms are rarely experienced acquirers.
They may be deterred by the auction process. The negotiated sale also
works well when there is a diversity of buyers, perhaps a couple of
large firms as well as a few small buyers.
What about the case
in which there is only one buyer? I have actually negotiated a number
of transactions in which there was only one buyer. The buyer does not
know that there are no other buyers. I negotiate these transactions
from an assumed position of strength. Understanding how the buyer can
utilize the seller’s key technology is essential to negotiating the
best price in these cases.
The negotiated sale requires more
work than an auction. There may be protracted negotiations with several
parties. It takes effort to remember the nuances of how each buyer
judges the key assets or technology.
In addition, a negotiated sale
may take a longer period of time, perhaps six or seven months. I have
closed a few sales in record time (three to four months), but in these
cases speed was more important than price. A negotiated sale will
generally take two months longer than the auction process.
A Few Points on Negotiating
the sale of a company with strategic value is essentially a high-stakes
poker game. There is no concrete rationale for value. Value depends on
the strategic importance to a particular buyer. Perception is more
important than analysis. Perceiving value is accomplished by thoughtful
and judicious questioning throughout the sale process. And remember, I
do not need to negotiate value, I negotiate price.
may receive a lowball offer early in the process. If we receive such an
offer, I may comment to other buyers that we have an offer in hand.
They do not have to know that it is a low offer.
is the quintessential negotiating tool. It enables one to see problems
in advance. Experience enables one to figure out what the other side
really wants, not just what they say they want.
order to choose the most effective sale process, it is essential to
understand whether value will be based on financial performance or on
the company’s strategic assets. Do not assume that the process that
works well for large deals is also best for smaller deals. The auction
method is excellent for large transactions and for financially valued
transactions. For strategic transactions or smaller deals, the
negotiated sale is the best approach to ensure that the seller achieves
the highest price and the best terms.