14 Misconceptions & Mistakes with Company Divestitures
The divestiture of a business is obviously THE most important transaction of the entire life of the business … and should be treated as such. Over the years I have seen many of the same mistakes being made, as well as selling CEOs and business owners holding onto the same misconceptions with regards to the company divestiture process. I will touch on the following topics.
(1) 3 or 300 buyers
(2) valuation variances
(3) the #1 deal killer
(4) proactive first month
(5) overpriced or distressed
(6) too much credit
(7) CEO reply %
(8) the geography equation
(10) deal exposure
(11) divestiture strategy pivot
(12) the trickiest company of all
(13) outsider longshots
(14) billion dollar buyers and million dollar sellers
Before I start, I need to reveal that my scope of experience comes from my 20+ years executing M&A transactions in the Internet service sector.
1. Speaking to 3 versus 300 potential buyers
A mistake many CEOs make is to communicate a possible divestiture with the easiest 2-3 buyers they can think of, then force a deal. It sounds foolish, but people do this all the time. The reasons that some CEOs do this are;
(1) They don’t want word to get out into the market that the company is for sale. While I do understand this, there are ways to reduce the probability of too many people finding out about the sale. Of course, there is still a chance someone finds out about the sale and unethically shares this information, but the trade off is the difference in total deal value is far greater from auctioning the company to 50-300 buyers than the total deal value attained from forcing a deal to one of just three buyers.
(2) They don’t have the spare hours in the day to allocate to marketing the company to 50-300 prospective buyers.
Another problem with just marketing the company to the easiest three buyers is that experienced buyers will know there is not a professionally run process in place, hence they assume the buyer pool must be very small … and they will adjust their initial offer and proposed deal structure accordingly.
Imagine a CEO who needs to search for a new Chief Technical Officer or Chief Financial Officer. They shouldn’t quickly select someone from a pool of just three candidates they already know, rather they should retain experts in the executive search field and instruct them to (1) identify a pool of prospects (2) communicate the opportunity to them (3) screen the pool for the best and most willing, then (4) try to make a deal. In many cases, anything short of this process is simply careless. So why would the divestiture process, which is the single most important transaction in the history of any company, be handled with any less procedural discipline?
Side Note: There are certain companies where there are only 1-4 capable and logical buyers in the entire world. This is due to government regulations/restrictions, technical commitments and in some cases the massive size and/or location of the company. In these situations, the vast buyer pool to reach out to simply doesn’t exist.
2. Valuation variances
Different buyer’s valuation opinions on the same business can vary greatly because of each buyer’s post-closing strategy. For example, a buyer might have the ability to immediately cross sell the seller’s customer base with theirs and/or have the ability to reduce 25% of the seller’s operating expenses within 3-12 months post-closing … while other buyers will only be able to reduce the seller’s expenses by 5%. This enables one buyer to legitimately value the seller’s company notably higher than other buyers. So it is a mistake to only think of the selling company when quantifying valuation, rather think of the logical buyer’s post closing strategies as well.
3. The #1 deal killer of all
As we know there are plenty of events and discoveries which can kill a divestiture. There is one discovery which stands out among the rest as being the #1 killer of all … and that is when a seller lies about anything. If a seller lies about something irrelevant, and some do, certainly their incentive would be much higher to lie about something significant. Newly discovered seller dishonesty casts a vail of doubt on every piece of due diligence information the seller has provided. What used to surprise me is, this dishonesty would become apparent in cases where the seller’s company was in great shape, growing and profitable. There was no reason to lie other than to get just a bit more money from a deal … instead they end up paying a bit in the form of a reduced offer from the buyer (yet the seller sometimes doesn’t realize it). On the other hand, I have seen distressed companies where at least the seller was honest about the miserable situation the company was in.
The mistake I have seen buyers make is to isolate the seller’s dishonesty, as to think that the integrity pollution was contained to a single piece of due diligence information.
And the mistake I have seen sellers make is underestimating how smart and paranoid buyers are (… as they should be).
4. The importance of being extremely proactive in the first month of the divestiture process
The first mistake that some CEOs and business owners make is underestimating how proactive the divestiture process needs to be in the first month in order to maximize the final sale price. Think of almost any large fixed asset auction … the more buyers at the auction … the higher the final sale price. This is no different than selling a business. The buyer pool must be identified, contacted and educated in a short period of time. One of the reasons is, smart buyers will respond early with offers and the only way the CEO can know if that offer is the highest is to have identified, contacted, and educated the entire buyer pool.
Of course an offer deadline can be set where offers for the company are due 120 days from the start of the process, however this is really more logical and effective with public companies and much larger private deals >$50mm where the educational process is more on-site and involves the buyer’s due diligence teams travelling back and forth from the target’s many offices and engineering sites.
(1) A weakness with bid deadlines is many buyers will wait until the final week, so for the prior weeks and months, the seller receives no real valuation feedback from buyers.
(2) Some buyers might have already been looking at another target acquisition for a few months prior to knowing about this seller’s company being for sale, and are not willing or able wait 120 more days for a deadline.
(3) It should be noted that while I prefer not to have a bid deadline set, there is certainly a minimum time period after starting the process before early offers should be considered.
5. Acquisition targets are either growing fast and overpriced, or they are distressed
There is a misconception that most companies which are for sale are either growing fast and overpriced, or are in a distressed situation … either way there are not many good deals out there. This is far from being the truth. I have had many sellside clients who are experiencing partnership disputes, divorces, health issues, the need for capital for another venture, retirement and other life scenarios where they are wanting to sell the company … yet the company is not in trouble, it’s doing just fine and is priced fairly.
6. Selling CEOs give too much credit to buyers needing to get funding
It is unfortunate how difficult it is to raise capital for acquisitions in the Internet service sector. Whether it is from a bank, an angel investor, a family office or a group of investors, the probability of a buyer raising capital for an acquisition in the Internet service sector is generally low. The problem is, too many buyers who have never raised capital for a company acquisition … think they can … and too many sellers believe these buyers.
In some cases, a buyer has borrowed capital in the past for a data center acquisition, yet later on is having trouble raising capital for another company acquisition because the value of the acquisition is far greater than the total value of the fixed assets being acquired … as is the case with almost all SaaS providers, some cloud service providers, MSPs, & VARs.
When selling CEOs are comparing the best offers from buyers, it is a mistake to give too much credit to buyers who are going to need to raise the capital to fund the acquisition. It certainly doesn’t help that some buyers know they are in the weak position, hence offer more favorable terms than other buyers to boost their position and secure the deal … only to predictably renegotiate the deal downward at a future date.
What ends up happening is …
(1) The buyer’s potential investors insist that the buyer go back to the seller and negotiate a better deal OR they will not provide the capital for the acquisition. This renegotiation many times turns out to be worse than the #2 buyer’s offer which was backed with “capital on hand” for the deal.
(2) The buyer cannot raise the capital.
(3) After #1 or #2 occurs … The other buyers that had the capital on hand for the deal have found another deal to acquire, or when re-approached by the selling CEO to pursue the deal for a second time, the buyer lowers their offer price and terms in fear that there must be something wrong with the seller’s company.
Having said all of that, if there are no other options, give the buyer who needs to raise capital a chance … some buyers actually pull it off.
7. Hearing back from buying CEOs or their M&A decision makers
Getting right to the point … if I reach out to 100 CEO’s (or their M&A decision makers) presenting each of them with a sellside client of mine, a far greater percent of these CEOs will return my message … than if my sellside clients contact the same 100 CEOs themselves.
The reason is simple. Many of these CEOs would like to have an open line of communication with M&A professionals in the industry they are in … and they would prefer not to hear a recurring sales pitch from the CEO of a company they are not interested in acquiring.
8. The Geography Equation
I catch myself on a regular basis with the misconception that a buyer for a certain company must be in a certain geographic location around the world.
Geography is especially complicated because with each deal, the following components of geography must be analyzed.
Which is more important for a specific deal?
A) Which countries do the buying company’s owners/investors live in?
B) Which countries do the selling company’s owners/investors live in? (absolutely important)
C) Which countries are the selling and buying company’s management and employees in?
D) Which countries are the selling and buying company’s customers in?
E) Which countries are the selling and buying company’s infrastructure in? Should there be overlap or would the value of the deal be much higher if there wasn’t geographic overlap?
There is a misconception with some selling CEOs that a proper divestiture strategy can be executed with someone in-house.
Managing a company divestiture is a full time job. Yes, in some cases there is someone in-house who is capable of the job and has the time to devote themselves to the process, however; in most cases there isn’t. Many times a mistake would be to force the CFO into this role. I don’t know many CFO’s with an extra 6-8 hours a day for the next 3-4 months.
The job includes assisting with the development of the divestiture strategy, the identification of the buyer pool (an ongoing process), the communication and education of each of the 50-300 prospective buyers (extremely time consuming), conference calls, document creation, negotiation, pre and post-closing strategy.
Regarding the communication and education of each of the buying prospects … each time a prospective buyer is contacted the communication needs to be documented. This includes the original communication of the blind teaser, the response to that message, the NDA, the initial deck (Company Overview & Financials), follow up documents (FAQ, engineering docs, vendor, customer and employee agreements), conference calls, managing offers … on and on.
10. Deal exposure
While there are many well constructed business brokerage web sites, one of the problems is not enough strategic buyers look at them … and many sellers don’t want their deal added to these sites. What I have found is a far greater % of financial type buyers than strategic buyers look at these business brokerage sites in the IT space. While financial type buyers are always on the hunt for an investment, strategic buyers tend to be focused on running their companies when they first learn about an acquisition opportunity. I don’t want to take anything away from the value of these sites, because they are valuable tools for both the divestiture process and for finding a business, it’s just a mistake to rely solely on these sites.
For every qualified buyer who responds to a sellside listing I place on one of the business brokerage web sites, I find at least 20-25 interested and qualified buyers by proactively identifying then contacting logical strategic buyers myself.
11. Divestiture strategy pivot
As the weeks pass, both the business owner (CEO), and the M&A professional learn from the feedback they receive from buyers. All feedback is important both the good and the bad especially if the same issue is continually brought to the forefront. Sometimes there is the ability to correct the negative issue during this process, and other times there isn’t, rather just the opportunity to explain it in more detail. The issues which come up can be regulatory, legal, certain asset valuations, the seller’s deal structure requirements not being met, on and on.
A divestiture strategy pivot could be in many forms so it is important to slow down and not get caught up in the momentum to get a deal done.
It is a misconception that a divestiture strategy pivot is a negative thing or diminishes value in some way. In most cases it does not, rather the seller was simply asking buyers to value a certain asset too much and that made the entire deal overvalued. In this case, the strategy pivot would be for the seller to keep ownership of the asset and if need be, lease the asset to the buyer post closing.
… or the seller insisted on a certain deal structure which no buyer would agree upon. In this case, the seller needs to adjust the deal structure requirement and re-educate the buyer pool.
Whatever the divestiture strategy pivot is, make sure to think if you should take a step back and re-identify the prospective buyer pool which might be interested in the new divestiture strategy.
12. The trickiest type of Internet service company to market for sale
There is no doubt the trickiest Internet service company to market is one of the 1,001 flavors of a SaaS provider. This is primarily due to two reasons.
First, the buyer could be anywhere in the world. Second, the buyer could be from multiple industries depending upon which business function and vertical the SaaS is focused in. The misconception I have seen many sellers possess is to restrict their scope of the buyer pool, insisting that the buyer must be in a single industry (or location).
When identifying the buyer pool during the initial phases of the divestiture process, as opposed to casting a wide net to include the world … there are logical pockets of focus around the world depending upon the SaaS industry … for example gaming in northern Europe and eastern Asia could never be ignored, and financial services in NYC, London and Frankfurt.
I find myself coming to the conclusion over and over that regardless which industry my sellside client is in … I make sure to include a buyer search in the major hubs of Internet innovation and finance … San Francisco, NYC, Seattle, Boston, LA, Chicago, Austin, London, Toronto, Sydney … and of course there are plenty of 2nd tier markets.
13. Outsiders can be longshots
This topic is taken from one of my previously written articles, but fits nicely into this “misconceptions/mistakes” article. From my experience “outsiders”, who are buyers not presently in the same industry as the target company they are looking at, close far less deals as a percent of the deals they look at than industry “insiders”. Here are the two main reasons
1) This buyer is probably going to do two very smart things … be paranoid and take their time. In analyzing this deal this buyer has a lot to do over the next few weeks & months. They have to learn about the industry, learn where my sellside client’s company ranks within the industry, quantify the pros and cons of each of the value drivers of my client’s company, then come up with a valuation and proposed deal structure. Not only are they going to take way too much of everyone’s time to come to a valuation and offer conclusion but much of that time is likely to be spent obsessing about the wrong things. The problem with their own diligence is they are competing against buyers who are already in this industry, buyers who understand the inner workings of all of the value drivers … hence “insiders” move through the analysis process to the valuation and offer stage much faster.
2) The outsider cannot realize cost savings and other synergies which make a higher company valuation logical, so the outsider will almost never be the highest bidder … and if they happen to be, the completion risk (from LOI to closing) is uncomfortably high.
So, the mistake here would be for a selling CEO to assume that when comparing offers from two buyers, one being an insider and the other being an outsider … that they are both equally likely to close the deal.
14. Billion dollar buyers and million dollar sellers
It is a misconception by many business sellers that billion dollar companies don’t acquire tiny million dollar companies. This is far from the truth. I have sold several sub $5mm private companies to multi-billion dollar publicaly traded companies. Here are the reasons and logic why they do it on a regular basis.
Billion dollar public companies don’t make tiny million dollar acquisitions then put out a news release expecting a positive reaction from the stock market. The truth is, knowledge of these tiny acquisitions is rarely made public because the actual company acquisition wasn’t the strategy, only a part of it.
One way to look at the logic of a small private company acquisition is … every billion dollar corporation has sales people right? … and every time a sales person makes an individual sale that sale doesn’t “move the needle”, yet it makes perfect sense for each sales person to pursue individual customer sales. So, in many cases it’s quite logical for a small team of managers to pursue strategic acquisitions and acquire 30,000 SMB customers with each deal … even if each acquisition accounts for less than 1% of total revenue for the buying corporation.
There are many other reasons small private company acquisitions make sense yet “don’t move the needle” such as:
- Faster entry into a new geographic market
- To acquire a new product or service offering as opposed to developing it in-house
- To test cross selling different products into the acquired customer base, or sell the acquired company’s products/services back into the corporation’s customer base
- Acquire a company’s IP (Intellectual Property)
- Remove a competitor from a specific market
- Vertically integrate
- To do an “Acqui-Hire”. For example, to acquire a small cohesive development/engineering team as opposed to attempting to hire them one by one.
- To continually train and give experience to the company’s merger and acquisition team members: including managers from the legal, accounting, operational, sales/marketing and technical departments
- Maybe to practice a certain M&A strategy on a tiny deal in preparation for an upcoming much larger company acquisition where the cost of mistakes would be far greater
- To acquire a government issued permit or wireless license which a target company owns and it is cheaper and faster to acquire this company as opposed to going through the approval process. Or, there is an exclusive allocation issue where the target company acquisition is the only way to acquire the permit or license
These are the 14 misconceptions and mistakes I could think of now.
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