Mergers and Acquisitions For Dummies (57 page)

Be wary of lawyers, usually young and relatively inexperienced lawyers, out to make their bones — that is, to prove to their superiors that they're tough, hard-nosed lawyers. These lawyers tend to be a feisty sort and break many, if not all, of the nearby tips about negotiating. Their focus seems to be to prove they won't yield on a single point and therefore will beat the other side into submitting to every demand. This take-it-or-leave-it approach is a major impediment to getting a deal done because it usually results in the other side leaving.

Surviving Unforeseen Twists and Turns

Here's another key point for anyone who wants to get into M&A deal-making: The process isn't linear. Expect the unexpected.

Deal-makers need to have a plan, but they also have to be able to adjust and adapt to the curveballs the changing environment throws. The plan is important, even imperative, but you can't become a slave to it. As long as you always keep the end goal of closing a deal in your sights, you can successfully navigate the winding M&A road.

Getting a deal gone sideways back on track

A negotiation has a rhythm, a regular flow of information, phone calls, and e-mails where messages are returned in a timely fashion. If this rhythm is broken (extended periods of time elapse with no communication from the other side or communication is stilted, clipped, and forced), you may have a negotiating partner who is getting cold feet and a deal that's going
sideways
(off the rails).

“An extended period of time” is subjective; how much is too much depends on the situation. When you're not sure, trust your gut instinct.

If you find yourself in a situation where your negotiating partner has gone silent (or “radio silent,” as some jokingly refer to the phenomenon), you have a couple options to try to get the discussions back on track.

First, you need to break the buzz — do something different from the usual deal-centric message. Constant professional communication can be stupefying. You need to do something to snap the other person out of the haze of kindly professional correspondence, which is so easy to ignore. Send an e-mail with a link to a relevant article or op-ed column. Offer to play golf or tennis or meet for a drink, invite the other guy to a professional event, or anything other than the usual “Please call me; we need to discuss something.”

Keep your message succinct. Avoid leaving long voice mails. If someone isn't responding to your correspondence, that person probably isn't going to listen to a two-minute message. If all else fails, offer a mea culpa. Simply ask whether you've done anything wrong. Ask the person to contact you, even if they have bad news.

Bad news is better than no news. At least with bad news, you have a chance at crafting a solution, or if that fails, of moving on to the next prospect.

Negotiating in good faith

Negotiating in good faith
is a term that you may hear bandied about during the M&A process. In my view, negotiating in good faith is a code of honor. It means you follow through on what you say you'll do, and that after you agree on an issue, you don't go back and try to renegotiate that point again.

When someone fails to negotiate in good faith, that person is poisoning the well. Backtracking on a settled issue only serves to throw all the other settled issues into question. That's akin to trying to reason with a child who agrees to one thing and then capriciously changes her mind if she senses she has a weak position somewhere else.

Thwarting backtrackers is why I'm a big fan of bundling negotiating points and using conditional concessions (see “Offer a conditional if-then agreement” earlier in this chapter). The conditional concession allows you to withdraw the concession if the other side refuses to accept their part of the bargain.

Of course, sometimes events occur during a negotiation that require one side or the other to go back on part of the deal. For a Seller, these events are typically called
material changes.
Material changes include losing a major client, being sued, coming under a federal investigation, and other changes that materially affect the business. If Seller's business takes a turn for the worse, especially if the change renders Buyer unable to close a deal, Buyer should let Seller know. In fact, both sides should immediately disclose any major bad news that may affect the closing of the deal.

All negotiators should hold themselves to a higher standard. Barring adverse material changes, you shouldn't ask for a change in a negotiated term after you've already agreed to it. Honor your commitments and don't allow the other side to renegotiate previously settled terms.

Chapter 12

Crunching the Numbers: Establishing Valuation and Selling Price

In This Chapter

Looking at a company's value

Settling on an asking price

Addressing differences in valuation

Considering renegotiation

U
nlocking the mysteries of how to know what to pay for a company was one of the reasons I became interested in entrepreneurship. Valuation is at the core of mergers and acquisitions. After all, if both sides can't agree to price, no deal happens.

In this chapter, I introduce you to the concept of valuation: how to determine it, why it's important, why Buyers pay what they pay, and how Sellers can create a more compelling valuation.

What's a Company Worth? Determining Valuation

Valuation
(the price one party will pay another for a business) is based on what you can negotiate. That's why I include some negotiating thoughts in Chapter 11. And, as with most negotiations, valuation is more art than science. In fact, I call it alchemy because valuation is often subjectivity masquerading as science and logic.

Valuation is really the intersection of cash flow and time. In other words, how long will the Buyer take to recoup the cost of the investment? And how many years' worth of profits is the Seller willing to take today in exchange for giving up an infinite flow of profits from that business?

If you want extra credit for this valuation section, keep in mind that cash flow and time aren't the only contributors. You also need to factor in the following:

Future prospects of the business:
Is the business growing rapidly? Is growth stagnant and flat? This growth (or lack thereof) may affect how much Buyers are willing to spend.

The risk associated with the specific business:
For example, are the company's products high quality, or has quality slipped? Is the company able to recruit, train, and retain good employees, or does it have a problem with excessive employee turnover?

Systemic risk:
Systemic risk
is risk affecting everything in the economy. The recent economic meltdown is a perfect example (unfortunately) of how the economy can affect everyone and every company. Plenty of well-run companies offering good products and services suffered due to a widespread downturn. Buyers feel a lot less generous in the valuation process when systemic risk is high.

Cost of capital:
Cost of capital
is another name for “what else Buyer can do with that money.” If Buyer has other options, he deploys that capital in those deals that offer higher returns and less cost.

And, on top of all that, valuation depends on negotiating prowess. In other words, are you a good poker player, or do you fold and collapse when someone puts a little pressure on you? (Chapter 11 offers you helpful negotiation strategies.)

You can craft all kinds of fancy algorithms and complex mathematical formulas, read every trendy business book and the writings of the ancients, and spend copious amounts of time searching for
comps
(comparable transactions) to see how other M&A deal-makers determined valuation. In my view, though, that's all overkill.

Most often, valuation boils down to a small, simple valuation range: four times to six times EBITDA (or 4X to 6X in M&A code). The magic number in the M&A deal-making world is smack-dab in the middle: 5X. These numbers are known as
multiples
, so when you hear someone say “a 5X multiple of EBITDA,” that person means a company with EBITDA of $3 million would have a $15 million valuation.

Five times EBITDA is an industry standard, a convention of deal-making. Nobody knows where 5X came from, but all you need to know is that it's a de facto standard. In good or bad times, that multiple may be a bit higher or lower, which is why I give you the 4X to 6X range.

As Seller, you can get a valuation higher than 6X, but you need to have a strong negotiating position. The best negotiating position is to have a highly profitable company in a rapidly growing industry. For example, venture capital deals usually garner far higher multiples for Sellers than lower middle market and middle market deals do. In a venture deal, Buyer is willing to pay a higher price because he's expecting the company to grow rapidly; he's betting on the future prospects of the business. See the nearby sidebar “Other valuation techniques” for more on types of valuation.