Should you sell your business to a PE firm who makes a preemptive offer before a broad auction sale process?
Suppose a middle market company hires an investment banking firm to sell the business with a broad auction process. But before the broad auction process begins, a PE firm makes what seems to be a reasonably high take it or leave it offer. If you pass then that PE firm will refuse to participate in the auction process. Essentially the PE firm is trying to preempt the competitive auction process and get the deal before anyone else has a look.
Would going through to a broad auction process result in a higher price because it is more competitive? Or, is it better to just sell to a firm that is smart enough to make a preemptive offer like this?
This is a good question, because a number of PE firms try to develop some sort of proprietary sourcing strategy that attempts to cut out the middle man of an investment bank or broker (which are just poor man's investment banks and common in the middle market on down). I work in the lower-middle-market at a firm that (I think) has a pretty well-developed proprietary sourcing strategy and can provide my 2 cents. From the perspective of a seller, the advantages of dealing directly with a buyer (strategic or financial) are: * Reduction in fees. This is the most obvious one. Most banks or brokers in this space will be charging either a fee up front or a retainer (in addition to the closing fee). All in all, this will probably be upwards of $100,000 even in the lower middle market, which is obviously less attractive the smaller the company is, as the fee becomes a bigger piece of the sale. * Avoiding paying for a mediocre process. In the middle market, especially the lower you go, there are a lot of really shitty brokers and banks that really aren't worth what they charge. You're basically paying these guys for their email list which they'll blast with their teaser and hope for as many bites as possible. Some of the decks I've reviewed from these guys are absolutely horrendous, and in many cases I would prefer what a seller's CFO could put together to what these guys do. This is especially true if the seller is targeting strategic buyers. Chances are they will already know a lot of players in their industry so the value-add from a network perspective by a broker may be very small. * Controlling the process. This may or may not be obvious, but the more talking heads you involve in a process, be they owners or intermediaries, the longer a process usually takes (all else equal). For owners looking for a quick sale due to their circumstances or preferences, it can be attractive to be able to drive the process how you want to at your preferred pace. * The relationship piece. At one end of the spectrum, a seller may deal with a bank/broker who does all the interaction with a bunch of potential buyers, and as a seller you may only even talk to one after you're already past the initial bid stage. Even then, your interaction may be superficial until the LOIs come in. At the other end of the spectrum, you could be approached by (or approach) a buyer and develop a more of a working relationship before any precise bid is made. This can be especially important for a seller who is rolling over equity and/or going to continue to work in the business, since they want to work with a buyer they trust and know they can get along with. For many smaller companies, the legacy component is also big - sellers may be giving up control of a business that's been family-run for generations, and they often put a large premium on handing it off to a buyer they believe won't tear apart their baby. Being able to size up and work with a buyer more closely through a disintermediated process can help provide comfort in this regard.
All of the above points become increasingly MORE attractive the more finance-savvy the seller is and the better their network is. If they have a good idea (not just a pie-in-the-sky fantasy) of what their company is worth and the above points hold, finding a financial or strategic buyer that hits that number or close to it can be a lot better than using a banker/broker to find it. I can do a follow up post about the advantages of using a bank/broker, but I figured listing the main advantages of not using one was more relevant to this thread.
This is super interesting, I'd be curious to learn more.
On the flip side, from a seller's perspective, the advantages of a bank/broker are: * The financial savvy. This incorporates a few things. A good bank/broker will know how to shop a sale. They know what buyers care about and how to present it. Sure it may take time to put together a deck, but it may save a huge amount of time compared to sending a bunch of disjointed PDFs and spreadsheets to buyers who then have to figure out information themselves that could have been presented in a deck. Buyers love having work done for them. They'll obviously verify what is in a deck during diligence, but for the sake of doing an initial screening and getting to a first bid, having a good deck to lean can cut down the time to making a go/no-go decision on submitting an IOI. A good deck is also a good indicator of the quality of information that will be provided in diligence. I can't tell you how infuriating it is to work with a disorganized seller or bank during a real diligence process. * The process. Obviously investment banks and brokers do this for a living and probably know how to run an efficient and effective process much more than you as a seller. Understanding what needs to happen when is important, since dead deal costs for legal, accounting, etc. are a thing and it's a delicate balance to manage the process such that you are maximizing the chance of the deal proceeding to the next stage while minimizing costs at each stage (including time). * Managing expectations. Business owners in the middle market can be very "unsophisticated" when it comes to selling a business. They may have wild expectations with regards to value, and a good bank/broker will serve to temper these expectations, which can be valuable in avoiding the seller trying to run their own process expecting 15x EBITDA for their $5mm EBITDA business and wasting a ton of time and goodwill with potential buyers. This gets important when negotiating the legal as well - purchase agreements, employment agreements, etc. Another example of a frequent point of contention with unsophisticated sellers is the Working Capital Target. A good bank/broker will be able to sanity-check what the buyer is proposing and whether it's in line with the market. * The network. Especially on the financial buyer side (and strategic if the bank is industry-focused), you're going to be able to reach many more potential buyers by using a bank/broker. Not only the number matters though but the reputation. Banks/brokers usually have sponsors they know and can more easily tell who can actually get deals done than a seller will. This can save a ton of time, energy, and money in avoiding dead deals because a seller picked a shitty buyer. The network also obviously extends to the chance at achieving a higher price. This is probably obviously the number one allure of going through a bank/broker - the chance to achieve a higher price through auction, which probably needs no explanation.
Echoing what zanderman said above, your decision will pivot on what your goals are. Do you want to cash out and hit the golf course/beach/etc., or are you rolling equity and/or staying for the next phase of the company's growth?
If the former, then you need to have a serious conversation with your bankers and any other stakeholders in the business to determine if you realistically think the valuation that you would get - and the actual structure of the offers - from other bidders would be sufficiently higher to justify losing a hard bid and sure thing. This is more art than science as no one will know until the indications start to roll in, but - as zanderman mentioned - your universe of buyers and your bankers’ ability to maximize value on your behalf will be paramount in this situation. If you are uncomfortable with the opportunity cost, then you may want to give some serious consideration to the bid that you already have on the table.
If you are rolling a good chunk of equity and/or plan to remain with the business in your current – or at least some - capacity, and they provided you with an offer specifically to prevent you from engaging in a lengthy and (usually) exhaustive auction process, despite having already hired an investment bank, you can probably assume that (i) they've analyzed the market and provided you with what they believe is a premium valuation for the industry segment that you operate in, believing it to be a takeout offer; and (ii) are interested enough in the business to provide you with some leeway should you choose to engage with them - forgo the auction process - and negotiate. That being said, their willingness to be flexible will depend on numerous factors including: how long the offer has been outstanding, how the process has unfolded, the relationship you have developed with them through prior discussions, how badly they actually want to buy the company (though this is difficult to game out), etc. Another thing that you should consider is what the growth prospects are for the company now, as well as how rapidly and to what size you think the PE buyers can scale the business. If you are bullish on your company’s future prospects, then you need to consider whether the second bite of the apple could at minimum make up for – but ideally be larger – than the value you think you may have left on the table by choosing not to let the bankers market the company. This is especially important if your company is earlier stage, and you need the help/resources/insight in order to meet your objectives – in which case you should place emphasis on whether you think the buyer is the right group to partner with and will help you achieve your goals.
Keep in mind that you can always choose to engage with the sponsor that made you an offer and, should it end up not being a fit, break off the deal and take the business to market. Although this is not ideal, this path is not fixed and you can usually find a way out – though that involves breakup fees (generally), hitting the restart button on the process, a good amount of ill will, etc. If you shop the deal, the sponsor is probably pulling their offer because either they don’t want your bankers having – what they think is – a premium valuation to try to use as a baseline multiple when they shop the deal, and/or they are just annoyed/fatigued with how the process has played out generally and have decided to move on. Should your bankers shop the deal and the market doesn’t give you what you were hoping for – or even throws you lower valuations and/or more onerous bid structures – you can probably reengage with the sponsors that provided you with the initial bid.
Either way, determining whether or not to have bankers market a business in a competitive auction process is going to be dependent on the seller's goals and will evolve from there based on which scenario they think will provide the highest probability of meeting them.
zanderman these are great answers. I've been on both sides of the table and have tried to convince management teams of each option, depending on which one was to my benefit at the time.
Even though I'm on the buy-side now, in more situations than not, it is to the management team's benefit to go through a process, with the assumption that their representation is capable and has their best interests in mind. The reason a PE firm wants to pre-empt the process more than anything is to capture the value that a competitive process would squeeze out of the deal.
...good luck catching me saying that to a management team today, though.
Layne Staley thank you, and yes I agree, all things considered a reputable bank is probably the way to go. As with any negotiation, there is a zero-sum component to it, so on the buy side we will likely emphasize the negatives of doing so (but at least be transparent about some potential positives)
Every PE with half a brain wants to pre-empt. But understand that a LOI is non binding. All they are doing is trying to get a look before others, knowing that if they find something they don’t like (which could also bring down price in an auction), they can always walk away. And if it’s good, they are getting it without someone bidding it up. It’s basically a win win for them, while potentially holding the seller back from best price.
A targeted auction with best 10-15 buyers is the way to go if you have something attractive. Probably have to go broad if it’s a no name small asset. Only let someone pre-empt if they are the best buyer by a mile (eg strategic with clear synergies / need and ability to pay) and knows the company well / won’t get hung up in diligence.
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