- July 22, 2019
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
- M&A deals involve extensive negotiations at every phase of the process.As M&A is a rigorous and costly process, negotiations are required on both the sides of the deal to ensure the deal certainty.
- From the sourcing stage till the pre-LOI stage, the buyer and seller come together because there is a strategic alignment between both the parties but at this point of time, the seller is also involved in multiple discussions with other vendors.This is because the seller has not received any price bids from the buyer for it to take an initial step.
- The following negotiations takes place at each phase of the M&A deal.
Negotiations at Term sheet stage
- When the buyer agrees to proceed forward with the deal, he comes up with a term sheet that provides details like purchase price, deal structure, how much stake is the buyer interested to invest, how the consideration will be paid and whether any external financing is required.
- The most extensive negotiations happens at the valuations part.Generally the buyer will value the target company based on its future cash flows, its growth and risk associated with cash flows to arrive at an Enterprise value.The buyer decides to quote an conservative price for the deal where as seller would be more interested in maximizing the final price to get maximum earnings.It is to be noted that the negotiation should not involve only on the purchase price but also on the payment conditions and also how the deal is structured.In many cases, the final purchase price might be low but the terms of the deal will be very attractive.Conditions like time taken to close the deal can be an important factor.
- Exclusivity and confidentiality part of the deal will also involve extensive negotiations.The buyer generally will require a longer exclusivity time period from the term sheet stage to close the due diligence process.The seller on the other side will look to limit this time period as there is an opportunity costs of losing other prospective buyers.The seller will also account for the time lost when the buyer terminates the deal during due diligence stage itself.Confidentiality part of the deal includes information on the seller that cannot be shared by the buyer in public domain or to any persons other than those involved in the deal.Both the confidentiality and exclusivity part of the term sheet is binding where as the remaining parts of the contract is non binding.
- The term sheet stage also includes the adjustments in purchase price subjected to the due diligence findings and the target Working capital that needs to be maintained by the seller at closing of the deal.
- The conditions to signing and closing is also included in the term sheet which requires the approvals from the boards of both the companies, regulatory approvals and shall have no adverse material change in the value of the target.
- The seller has the maximum bargaining power at the LOI stage because at this point of time, it has not allowed access to any of its information to the buyer.Hence the seller the term sheet to include all the relevant information for it to take the right decision.The buyer on the other hand would want to have these details in a very general manner and would like to exert more negotiations post due diligence stage.The negotiation leverage of the seller starts to decline once it allows the buyer access to the data room.Once the due diligence is complete, the buyer gets access to detailed information of the target which would help it to negotiate favorably.
Negotiations at Definitive agreement stage
- Unlike the term sheet, the definitive agreement is binding and final on both the parties and overrides all other binding provisions.This happens after the buyer completes the due diligence and submits its report to the board which approves the deal to proceed for next steps.
- The due diligence findings helps the buyer to identify the risks in the deal, synergy opportunities that the deal presents to the buyer and the steps that the buyer needs to take to mitigate the risks identified and maximise the synergy opportunities. This is generally done by including Representations, Warranties and Indemnification.
- Representation are the facts declared by the seller about the target company.In addition, the seller also gives a warranty to support the Representation.In the event of the representations breach, the buyer can transfer the risk on the seller and indemnify it for the losses suffered.This is done by allocating a part of the final purchase price through an escrow provision. In this case, the negotiations would involve the time period till the reps would be in effect, threshold value post which the buyer can ask for a claim and the size of basket along with the cap for the claim.Some reps are included as Fundamentals reps which provides basic information on the target entity, like share capital structure and the legal structure of entity.These reps are more important than normal reps and have a higher standing time.Normal reps are valid for 2 years post closing where as fundamental reps continue to exist till 6 years post closing.Calculation of Working capital peg also involves extensive part of the negotiations.
- Covenants that the seller needs to adhere to between the signing and closing of the deal requires negotiations on the list of activities that the seller is permitted to do and which requires the approval of the buyer.
- Most of the decisions taken by the buyer and seller are generally emotional and impulsive due to the high pressure situations involved.Hence it is important that rational and logical approach is followed to arrive at a decision. Here, the important step is to understand the person involved in negotiation at the other side and their habits which would help in presenting the arguments at an effective manner.For instance, founder can be very arrogant because they want to show their dominance during the group meeting involving the target management and the bankers.At the same time, they would be more receptive to suggestions when discussed privately. In these situations, it is better to have negotiations privately in order to get a favorable outcome.
- Researching on the target and its management is more important prior to negotiations.Hence it is extremely important to conduct a detailed due diligence so that the findings can be shared as a negotiation point.For instance, post due diligence, the buyer identifies a risk in target customer base.One of its largest customers is facing internal issues and this could have an effect on the cash flows projections in the target sales pipeline.The buyer can share this finding with the seller and ask for an adjustment in final purchase price.
- Never outrightly reject any argument during the negotiations as this would result in conflicts.It is better to lend a patient hearing to the arguments and then explain the reason why it cannot be accepted.This would help in resolving issues amicably.
- Assess the strengths, weakness and threats of both the parties, the strategic benefits the deal presents to each party and to what extent they are ready to move ahead with this deal.Understand the intent behind the parties for closing the deal and leverage it while negotiating.In some cases, the seller might be looking for an investor for its business or feels that the time is the best for exit.In such cases, the seller can further negotiate for a lower price to close the deal.
- Evaluate the target company in detail and have a fool proof valuations done along with the key drivers responsible for the valuation.This would help in further negotiations for any adjustments on purchase price based on changes in the value drivers.
- Based on the detailed analysis, the buyer should be ready with an opening bid and walk away price for the target. The buyer should be ready to walk away from the deal when the ask price is not within the range and not worry about the significant time and cost spent on the deal.
- M&A deal negotiations are the most challenging and interesting part in the entire transaction. Though both the parties are at the opposite sides negotiating for the maximum benefits, both the parties are also committed in closing the deal.Hence it is extremely important that the negotiations should happen as a step by step process so that both parties can present their best proposals.
- Time is a significant component in negotiations.Too much delay can cause frustrations especially for the seller and a decisions taken too quickly are fraught with errors.
- Due diligence findings form an important component of the negotiation process.Hence any additional findings should reset the final valuations which would result in revisiting the negotiations process.
- A successful negotiations process will go a long way in the success of the deal.When mastered and performed effectively, it can increase the success of the deal.
- By effectively managing the risk through the legal framework, by planning the negotiation tactics and strategy, and by preparing and managing the M&A process effectively, one can maximize the chances of success in an M&A event.