The art of corporate finance negotiation (Part 3)

This is the third blog in a series of 5 that our Partner and Head of Corporate Finance, Paul Mason, has written, based on his experience of negotiating deals successfully over many years.

Part 1 (Every conversation is part of the negotiation) can be found here.

Part 2 (Negotiate the ‘Heads’) can be found here.

Don’t sweep it under the carpet (Part 3)

A lengthy, onerous and – bluntly – painful part of a transaction, after agreeing ‘Heads’, will be some form of ‘due diligence’.  This is where the prospective buyer seeks to remedy the massive “knowledge gap” between themselves and the seller.  The seller is always going to know more about the business which they have built up and lived with than a prospective buyer.  Due diligence is the process by which questions are asked, answers are provided and clarified and the prospective buyer reaches a point whereby they can make an informed decision on whether to purchase, and on what terms.

The working assumption for any seller has to be that bad news will come out during due diligence.  Whether this is financial or operational underperformance, litigation risk, or something murky in the company’s history, any assumption that it can (or should) be hidden is a foolish one.

Bad news has one of three consequences:

1. It can cause a deal to collapse;

2. It can erode the buyer’s price (or weaken the structure) versus the previous agreed deal; or

3. It can be accepted without material impact.

When advising sellers, we always want to find a way to push any bad news into that third category, which requires careful management of timing and delivery.  Hiding it amongst good news might work occasionally for politicians, but it rarely works in M&A, especially if the buyer is suitably advised and experienced.

Reflecting on the last blog post about negotiating the Heads, it is often (but not always) best for sellers to bring out the headlines of any bad news story into the open before Heads.  Whilst this can risk reducing the headline price or deal structure, at least the sellers are agreeing to enter into the next stage knowing a more realistic and deliverable deal is on the table.  There isn’t the false comfort of an inflated price, which is invariably going to suffer significant erosion when the bad news emerges.  Secondly, establishing trust requires honesty and integrity: having bad news teased out can damage this important principle.

There can be a fear that tabling bad news early will turn off a potential buyer to the point where they walk away.  Conversely, waiting until they are emotionally “in” and heavily invested in a process will surely make them less likely to back out?  Unfortunately, emotion is rarely something we want to encourage in M&A if we want to get the right deal.  The tactic of leaving bad news until the 11th hour is a gamble that I very rarely condone.

In the penultimate, fourth part of this blog series I will look at how to act during a deal and advice for managing difficult and tense negotiations.

If you are looking to purchase or sell a business, contact Paul today on 0131 558 5800 or email paul.mason@chiene.co.uk.

Read part 4 – Be consistent and… be consistent

The art of corporate finance negotiation (Part 2)

This is the second blog in a series of 5 that our Partner and Head of Corporate Finance, Paul Mason, has written, based on his experience of negotiating deals successfully over many years.

Part 1 (Every conversation is part of the negotiation) can be found here.

Negotiate the ‘Heads’ (Part 2)

Irrespective of how amicable the transaction might be at the outset, make sure you agree a comprehensive set of Heads of Terms, which both buyer and seller understand and believe represent all the pertinent aspects of the deal.

The purpose of ‘Heads’ (a.k.a. a ‘letter of intent’, an ‘expression of interest’ or a ‘non-binding offer’) are three-fold:

1. They explain the key features of the deal;

2. They seek to flush out potentially contentious points early; and

3. They serve as a future reference point in the event of any subsequent dispute.

It is the same process as sketching out a picture, before lifting up the paintbrush: you want to position the elements of the scene correctly, without getting bogged down in intricate detail at this stage.

What are the consequences of failing to negotiate Heads, or missing out items that are important to you?   At best, you might be able to include or refine the points later in the process, but probably at the cost of goodwill, or a necessary “horse trade” for something the other side wants in exchange.  At worst, you might find that a missing item is an immovable “red line” for the other party – something that is beyond their ability to offer and becomes a reason why the deal falls over later in the process, having incurred more expense to get to the point of failure.

I have advised on some transactions where it was felt that Heads weren’t necessary.  The parties knew each other and trusted each other implicitly.  But still, having that reference point proved useful when everyone inevitably “couldn’t see the wood for the trees”.  Being able to remind ourselves of what was fundamental at the outset can help us all accelerate through those periods when we would otherwise become bogged down.

In the next, third part of this blog series I will look at how to manage (and how to mismanage) bad news during a deal.

If you are looking to purchase or sell a business, contact Paul today on 0131 558 5800 or email paul.mason@chiene.co.uk.

Read part 3 – Don’t Sweep it Under the Carpet