After receiving much criticism over my last piece, The M&A process is fundamentally flawed, for diagnosing a problem without suggesting a cure, I thought I would pen this epilogue. My thesis is that broad auction processes for private mid-market companies involving hundreds of prospective buyers armed with plenty of price guidance but a dearth of unimpeachable facts and figures are generating sub-optimal outcomes.
A more appropriate approach to selling a business, in my humble opinion, is to structure a transaction process designed to create a true auction environment that yields a market-clearing price. After all, regardless of what the banker pitches, the market will bear what the market will bear. If one is truly a seller and has confidence the process cleared the market, then they should be happy to sell on the terms that result. As such, the odds of a failed process should decline markedly.
So what are the key elements of creating an auction environment without driving buyers to opt out in the eleventh hour? First, it is the quality of prospective acquirers included in the process, not the quantity that matters. Quality buyers have a strategic rationale to own the target, the financial wherewithal to consummate an acquisition of target’s size, and a team that has successfully closed transactions of similar ilk.
Generally, this group will include corporate buyers that are either direct competitors or companies which operate in adjacent markets but share customers or manufacturing and/or technical capabilities. Some of these corporate buyers, indeed some of the best, will undoubtedly be private equity-owned with a mandate to grow through acquisitions, known in industry parlance as quasi-strategics. As for the literally hundreds of other private equity players that could have an interest in the target, I recommend narrowing the field to those with a specific investment thesis consistent with the target’s business plan or those backing an executive with substantive experience in the target’s industry sector. While the allure of stumbling across a “dumb money” private equity buyer that can be duped into overpaying for an asset can be appealing, it is likely a fantasy, and, in my firm’s experience, including such buyers in the process has much more often caused negative consequences as opposed to positive ones.
Once the right prospective buyer universe has been selected, the key is to educate prospective buyers on the opportunity – the good, the bad and the ugly – so they can arrive at their own initial valuation conclusions, without any price guidance. These initial valuations will separate the wheat from the chaff, and really demonstrate which buyers fully understand and value the opportunity. Those buyers with the greatest strategic rationale are most likely to buy into, and likely augment, the growth trajectory of the target and understand, quantify and hopefully mitigate some of the risks inherent to all businesses.
Now, with just a handful of highly-qualified prospective buyers at the table, the key is to figure out for which among them is the target a must-have or just a nice-to-have. Spend your time with the must-have buyers and manage them through a tightly orchestrated diligence process to get them to their best and final offers, all the while with the knowledge that other parties are preparing to do the same. In this scenario, the process should yield the best buyer for the asset at the maximum price it is willing to pay for the asset— with a very high probability of closing on the timetable proposed.
All too often investment bankers pat themselves on the backs for the number of books they put out on a deal, the quantity of indications of interest they receive, or the number of hours wasted in management presentations. But none of those metrics are germane to the ultimate outcome – did we achieve a market clearing price with a greater than 90% probability of closing. Educate the client that the process will create a market and the market will determine the price. Involve a smaller number of high-quality prospective buyers who understand the sector and have a strategic rationale for owning the target. Flood the best buyers with information, both positive and negative, to inform their thinking. Identify the groups that must have the asset and drive them through a tightly orchestrated process. Do this and the odds of a successful closing with the first bride at the alter will increase dramatically, and everyone involved will feel good about both the process and the outcome.