Les Nemethy's  Instablog

The sale of a company is typically not one negotiation, but a series of negotiations -  from negotiating the confidentiality agreement, to negotiating the term sheet and then the Sale and Purchase Agreement. There are often unexpected negotiations mid-course as well, such as may be necessary when the seller’s company does not meet the budget, or there is a currency exchange fluctuation or loss of a contract, which changes the value of the company. Negotiation is therefore one of the key competencies required for anyone selling a company, particularly for M&A professionals. And yet, at times I am shocked at how much money people leave on the table, simply through being unaware of, or not practicing, basic negotiation techniques.

What are some of these techniques?

1. Before negotiating key points, get to know your negotiating partner. Ask lots of questions. What makes your investor tick? Why does he want to invest in your company in particular? What are his emotional drivers? What are his thoughts on the timing of the transaction? Has he made any acquisitions in the past? (If so, you might find out their valuations.) What is their internal decision-making structure? Who really calls the shots? Ask yourself whether this is the type of person or investor to whom you’d want to entrust your company.
2. Let your negotiating partner make the first offer: Always, without fail, seek to encourage your negotiating partner to make the first offer, on any particular issue. This often brings surprising results. Your negotiating partner, for example, might value your company at more than what you thought it was possibly worth.If you must make the first offer, make it at the highest end of the defensible spectrum
3. If purchase price is what you are negotiating, for example, then start with the highest price you could conceivably defend for the sale of your company. Don’t be shy!
4. Concede in small increments. If you concede in large increments, your negotiating partner will sense a capitulation. By conceding in small increments, and even smaller increments as you go along, your negotiating partner will get the signal that there is not that much room for negotiation.
5. After asking a crucial question, hold your tongue! Silence is uncomfortable. It creates a vacuum and nature abhors a vacuum. It’s amazing how many times, after I ask a key question (e.g. what is your valuation of the company?), there is a long silence. My own client has even answered the question, rather than the investor, so discomfited was he by the silence. A friend of mine, also an M&A advisor, developed a habit of stomping on the foot of his own client whenever his client spoke out of turn—until he broke the toe of his client! Of course, I am not advocating physical violence, but perhaps the story drives home the importance of staying silent at important junctures.
6. Every term of the deal also depends on every other deal. There are dozens, if not hundreds, of points that must be negotiated in an M&A transaction, in addition to price: scheduling of payments, representations and warranties, salary packages, non-competition agreements, to name a few.
7. For example, stricter representations and warranties will warrant a higher price, and vica versa. So do not get boxed in by agreeing to a certain price, only to find that the investor is negotiating an excessively stiff set of representations and warranties. You can use the above techniques for each of the many points to be negotiated in the course of selling your company.

Negotiating techniques will take you part, but not all of the way, in negotiating the sale of your company. These techniques are little tricks of the trade that help you improve price, terms and conditions. But one issue that you may wish to ask yourself even before applying the above techniques: is this an investor to whom you would wish to entrust your company? Might there be reputational risks to you by doing a transaction with a particular investor? Is he likely to honour contractual agreements, such as for deferred payment? Is he likely to be litigious, for example on representations and warranties?

If you apply the negotiation techniques well, but fundamentally misjudge character, you may win the negotiation battle (e.g. close your deal), but lose the war.

Mezzanine financing may be used both as a way of raising expansion capital for an enterprise or for financing the acquisition of an enterprise.  As the name implies, in the financial mix of a firm, mezzanine financing is located between the “ground floor” of equity and the “first floor” of debt (e.g.  mezzanine finance is a hybrid instrument containing features of both debt and equity). In this article we will take a look at some of the issues it involves.

1.      What is mezzanine financing?

There is no single formula for this hybrid instrument:  it could be preferred equity with a guaranteed level of dividend, convertible to straight equity at the option of the preferred equity holder, or some form of debt, also convertible into straight equity.  The conversion option gives the owner of the mezzanine instrument a higher degree of security than if he were a straight equity holder (e.g. higher priority in the event of the liquidation of the firm and priority in payment of dividends or interest compared to straight equity holders), while allowing the investor access to the benefits that an equity holder has (e.g. conversion of debt or preferred shares into straight equity prior to a liquidity event). A mezzanine holder will typically rank subsequent to secured or even to unsecured debt holders, often holding the shares of the common shareholders as security.

A mezzanine financier will typically negotiate various put or call options in order to help ensure the liquidity of his holding, help acquire control in case the company dramatically underperforms and help ensure an eventual exit.

2.      What kind of returns are typical for mezzanine financing in Central Europe today?

Given that the degree of risk for a mezzanine holder is lower than for the owner of plain equity, yet higher than for a holder of plain debt, it stands to reason that the rate of return is usually also somewhere between that of straight debt and equity.  For example, if holders of straight equity in a particular venture would expect returns of 25% or more and holders of debt would expect 6-12%, then a holder of a mezzanine interest might expect a return in the range of 15-20%.  The precise yield would depend obviously on the debt/equity mix and the degree of risk absorbed by the mezzanine holder (e.g. whether the preferred dividends, if any, are 5% or 10% of the value of the mezzanine instrument, the precise nature of the put or call options, the strike price at which the instrument might be convertible into straight equity and the overall leverage level).

3.      Why is mezzanine financing so much more expensive than straight debt? 

Mezzanine lenders typically do not have a registered security interest in the assets of a company. This means that, in the event of default, repayment of the mezzanine may commence after all senior obligations have been satisfied.

Another factor, and one of the difficulties faced by companies issuing mezzanine instruments, is the financial sophistication required in pricing the value of the embedded put or call options, or other aspects of the mezzanine financing, where the provider of mezzanine financing is typically much better equipped than the company making use of such financing.

4.      When should the owner of a business consider mezzanine financing?

Mezzanine financing allows business owners to obtain financing or growth capital that permits higher leverage (e.g. an additional level of financing to straight debt), without burdening the company with extremely high debt service obligations (e.g. mezzanine holders may be paid by preferred dividends, payable only when the company is profitable).  Such high leverage financing will either not require collateral against the company’s assets or, if so, the collateral will be subordinated to more senior debt holders.

Mezzanine financing may require less cash payment of interest or dividend than junk bond financing, as the mezzanine financier may rely on his equity conversion option to boost his overall return, thus conserving cash flow for the company.

Mezzanine financing might be more appropriate than straight debt where there is a considerable degree of volatility in expected cash flows (cheaper debt might be available if the company and lenders foresee steadily increasing cash flows).

5.      When should the buyer of a business consider mezzanine financing?

Private equity funds, management buyouts and other types of acquisitions that like to use leverage are frequent users of mezzanine financing.  Mezzanine financiers are typically comfortable piggy backing on the due diligence of a private equity purchaser on a business and allowing the private equity firm to take the driver’s seat in managing the acquired company, at least while the business plan is being met. 

In conclusion, mezzanine financing is not for everyone. It requires considerable financial sophistication in order to correctly price returns.  However, for the financially sophisticated, it opens up a new source of financing and is a creative way of allocating risks and returns between the different stakeholders of a company.

This article is designed to assist company owners in understanding what is involved in preparing an Information Memorandum (IM), during the process of selling a company.  It deals with four questions: 

·         First, what is an IM? 

·         Second, why prepare an IM? 

·         Third, how should a company go about preparing an IM? 

·         And fourth, how is an IM likely to be used by investors?

What is an IM?

An IM is a document provided by a company to prospective investors after the investors have reviewed a brief Information Summary, or “teaser”, and signed a Confidentiality Agreement.

Some business owners and financial advisors look at an IM as a marketing document which provides a selective overview of the attractive features of a company.  In some countries, mostly Anglo-Saxon jurisdictions, an IM by law must contain a full, true and complete disclosure of all information which may materially affect the value of a company.  Other jurisdictions may not regulate IMs as closely.

A company and its financial advisor must strike a balance when preparing an IM.  The document should be a marketing document, in the sense that it should motivate investors to want to invest in the company - but it should be devoid of hype, exaggeration, or omission, and provide a complete disclosure of material facts.    Hype or exaggeration will only diminish the credibility of the company and its management in the eyes of investors, and may also create legal liability for the company preparing the IM and its advisors. 

Why prepare an IM?

In general, an IM allows the owners of a company to present a comprehensive, accurate, and attractive picture of a company. The alternative is simply to respond to investors' questions, but this typically does not allow the company to provide a comprehensive overview, and make it difficult to present the information in the best light.

An IM also helps to ensure that all investors receive the same information.  This is particularly crucial when a seller is running a competitive process.  The more information that finds its way into the IM, the less need there is for investors to pose written questions, saving time for both buyer and seller. 

From an investor’s point of view, a good IM demonstrates the professionalism and motivation to sell of the sellers, as well as the quality of the management—all important factors when deciding whether to bid for a company.

How should a company go about preparing an IM?

Preparing an IM requires a high level of internal organisation.  The CEO or business owner should lead a small team of experts in the main areas (e.g. sales/marketing, legal and finance) that will need to be covered in the IM.  Deliverables and deadlines should be decided for each member of the team. When this process is complete, the final version of the IM should be reviewed by the owner, CEO, and all members of the team, to ensure consistency, completeness and accuracy.

When we prepare an IM, we generally aim to provide investors with details of clients, market position, operations, finance, risks etc. -- information sufficient for them to prepare a non-binding bid, with an indication of the bidder’s valuation of the company.  A good method is for the sellers and advisors to ask themselves what information they would require if they were buying the company.  Given that the IM is designed to solicit a non-binding offer on the company, with valuation, the omission of one or more key facts may give a distorted valuation, and provide an investor an opportunity to renegotiate their offer.

How is the IM likely to be used by investors?

An IM is the most efficient way of providing a large volume of information about a company to investors. Even though there may be one person or a small group of people performing due diligence on the company at its premises, there is also a need to communicate with a wider range of decision-makers (e.g. investment committees or boards) that may never appear on site.  The IM is by far the best way to do this. 

Conclusion

In conclusion, a high-quality IM is critical when selling a company:  in the same way as a CV may go through many drafts in order to present the candidate in the best possible light, so too, an investment of time in producing a quality IM pays off. You do not get a second chance to make a first impression.