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6 Bargaining Tools

Business Transaction

Acquisition negotiations are confrontational by their nature. In the most fundamental sense, negotiations are a test of wills and a battle for control between two parties with completely opposing interests.

If you are an owner or a CEO of a middle-market company, defined as a company with a transaction price between $2 million and $250 million, you must accept the extremely confrontational nature of the negotiating process. You must feel comfortable in this type of environment.

Here are six negotiating strategies and techniques that, if followed, should make a negotiator successful in acquisitions.

1. Assert Your Dominance
You want to convey to the acquirers that your objectives and will are going to prevail on the substantive issues during the acquisition process. This dominance should be established early in the process, as it is far easier to establish dominance at the outset than it is to retake it from a dominant acquirer.

My philosophy is that one side is basically “the boss” in all negotiations. This means that on substantive issues, you want the acquirers to feel that they must concede to you or risk losing the deal.

Obviously this is not easy for a middle-market seller, as the acquirers likely will be much larger than the seller. Furthermore, the acquirers are accustomed to prevailing in these matters. Correspondingly, you need an experienced, aggressive, determined negotiator to force the acquirers to “play your game.” This type of negotiator will convince the acquirers that these negotiations will be different from those with which they are familiar.

2. Limit the “Reps” Although this subject is too complex and covers too many legal and investment banking considerations to cover in detail here, there are a number of points of which you should be aware. Fundamentally, acquirers are used to a rep, warranty, and covenant package (the “reps”) that basically encompasses a “my-watch, your-watch” concept. This approach says that anything that happened while the seller owned the company is the seller’s responsibility, regardless of when the issue manifests itself, and any issue that occurs while the acquirers own the company is their problem.

The fundamental flaw with this concept is that one of the major reasons owners sell their companies is to escape the risk inherent in the equity ownership position. Under the “my-watch, your-watch” concept, a selling owner still is potentially responsible for all of the company’s pre-closing actions during the post-closing indemnification period, even if the issue had not matured or was not known to the seller at the time of the closing.

Conversely, when the seller’s advisor developed a value for the company, it was based on factors known at the time. If issues positively affecting value had occurred, but were not yet known, they would not have been factored into the expected transaction price. So even though these positive factors matured under the “watch” of the seller, the seller will not get a post-closing price adjustment for their impact on the company’s true value.

Since the seller doesn’t get the benefit of any unknown positive factors, the seller shouldn’t get the downside risk of any unknown negative factors.

Unfortunately, the “my-watch, your-watch” concept is the norm. Most advisors and attorneys accept it as the way a deal should be structured. I don’t. I think that the majority of the seller’s reps should be limited to some form of “knowledge,” except for a few reps where absolute guarantees can and should be given an acquirer.

Basically, the knowledge qualifier will limit a seller’s exposure to those things of which he/she is aware. That is what should be expected, and that is what’s fair. Although this position is not customary, it can be sustained if you have considerable negotiating skill on your side.

Your indemnification exposure for violation of the reps will be on the personal level and, therefore, not limited by the protection of the corporate veil. It is conceivable that violations of the reps could cause a seller a loss that exceeds the sale price. This exposure usually is limited by placing a ceiling on the seller’s indemnifications.

The ceiling will vary depending on the deal environment at that time and the unique characteristics of each company. However, the ceiling for the seller’s exposure should not exceed 15%-35% of the total deal price.

3. Evaluate the Exclusivity Period
All acquirers should be brought together simultaneously to leverage one buyer against the other to achieve the maximum selling price and deal terms before the execution of the Letter of Intent (LOI). At this stage of the process, most investment bankers select the company with whom to negotiate a Definitive Purchase Agreement (DPA). Their decision usually is based on only the level of the acquirer’s price and the composition of the deal consideration. However, there are other factors that should also be evaluated in making this decision.

Prior to selecting the acquirer to enter into an LOI, all the prospective acquirers’ philosophies and general positions regarding the reps and indemnifications should be discussed, as the seller’s exposure in these areas can be more important than the deal price itself, in certain cases. Therefore, the reps and indemnifications should be a significant factor in selecting the company with which to negotiate.

The LOI provides for an exclusivity period to negotiate a deal with the selected acquirer for a specified time period, usually 45-90 days. During this exclusivity period, the seller can neither solicit nor have conversations with any other prospective acquirer.

Although most investment bankers don’t require this, a skilled negotiator requires the client’s exclusivity period be terminable at its sole discretion if the selected acquirer asks for a price reduction or a change in the composition of the transaction consideration. This is essential to protect a seller’s legitimate interests.

4. Know Your Adversary
A successful negotiator will know the personal and team goals of all members of the acquirer’s negotiating team. This includes the principals, investment bankers, and legal counsel. Not only must you know the team goals, you must determine if any of the members’ personal goals are in conflict with the team goals. They often are. You also must become familiar with the style and determine the negotiating strategy of the acquirer. Armed with this knowledge, a negotiator should be able to establish and/or revise, if necessary, the negotiating battle plan. An experienced negotiator will know the adversary so thoroughly that the adversary’s reactions and every move can be anticipated such that the negotiator will have already determined a countermove to combat the acquirer’s reaction to the negotiator’s intial move. This ability to stay one or two steps ahead on all negotiating issues will help assure eventual success.

5. Obtain Drafting Rights to DPA
The drafting rights to the DPA are extremely important. A seller’s ability to obtain control of these rights is critical to eventual success. If the seller doesn’t get this control, it assures getting the acquirer’s canned acquisition documents, which are likely to be structured unreasonably in the acquirer’s favor. This means the seller will have to expend considerable negotiating capital to get back just to a fair starting point to negotiate a reasonable DPA.

After a seller obtains the drafting rights, it is in the seller’s best interests to prepare a reasonably fair first draft of the agreement. A seller never wants to make excessive demands that will unlikely be obtained. A much more favorable deal will be realized by developing a negotiating pattern of sustaining the seller’s major positions. Correspondingly, the seller’s starting position should not permit significant concessions in order to obtain an acceptable deal.

This negotiating approach will allow the acquirer to know that you are reasonable but have minimum flexibility after you define your position. You want to get the acquirer used to conceding the major points that you demand.

6. Focus on “Winning the War, Not the Battle”
This requires you to have a clear definition of what victory is in this negotiating war. Therefore, before the negotiating process starts, it is essential that the seller clearly defines pricing objectives, desired deal structure, the composition of the transaction consideration, and the acceptable level of exposure in the reps and related indemnifications.

If the seller remains completely focused on these goals, he/she can make any concessions that the acquirer requests, assuming they do not prevent sustaining the basic positions needed to “win the war.”

However, my negotiating philosophy dictates that an acquirer not be given any substantive concessions, unless a comparable concession is received in return. Correspondingly, a seller should be willing to concede nonessential issues in return for concessions that facilitate the achievement of his/her overall acquisition goals.

Negotiations are an art, not a science. They are the most critical part of the acquisition process. In fact, they are the very essence of acquisitions. Negotiations will determine if a sale is a success or failure.

The way to assure your success in the negotiating process is to follow the strategies and techniques discussed in this article and to make sure your lead negotiator is an experienced, knowledgeable, and aggressive veteran of the negotiating wars.

George Spilka & Assoc. | georgespilka.com | PFFC-ASAP 318

George M. Spilka is president of George Spilka & Assoc., Allison Park, GA, an acquisition consulting firm based near Pittsburgh that specializes in middle-market, closely held corporations. He has advised clients on the sale of their firms for 25+ years. His client base includes converters, manufacturers, and distributors. Contact Spilka at 412/486-8189; This email address is being protected from spambots. You need JavaScript enabled to view it.; georgespilka.com.

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