The most ruthless tactic in private mergers and acquisitions
Buying and selling a private Internet service company can be a smooth process which evolves into a win win for both the business buyer and the business seller … OR it can turn out to be a disaster where either the shady seller misrepresented the company or the shady buyer went into the deal fully intending to bait and switch the seller.
One thing which makes me angrier than anything else in this profession is when a business buyer takes advantage of a business seller. Buyers can do this in a number of ways but the specific way I am referring to is called a “bait and switch”… a silly name yet ruthless tactic.
This is how it plays out …
After a buyer and seller have agreed to the terms of a deal and signed a Letter of Intent, they start working on due diligence and the purchase agreement. One to two weeks before closing the unscrupulous buyer says the following to the seller.
“I am so sorry to tell you this but our board of directors has grown cold on this deal because (insert lies) and no longer wants to pursue it. We discussed this dilemma for days and decided that we would still be willing to close this deal next week if you would agree to a price reduction of 15%. We realize how disappointing this news must be and if you decide not to accept this price reduction and walk away from the deal, we will totally understand.”
It is true that some buyers discover things during financial, operational, legal, and technical due diligence which were either not revealed or were misrepresented by the seller, so a proposed reduction in price is absolutely warranted. In these situations not only is the seller lucky the buyer is still willing to close the deal, but the seller probably expected this price reduction was coming.
However, some buyers fully intend to do this to sellers before they ever sign the Letter of Intent.
Why? … because they know that some sellers, after grumbling, complaining, cursing and debating … will say “ok”.
Why? … for two reasons … first, because the seller is days away from no longer having to manage employees, vendors, and customers. Second, because the seller has already spent the money in their mind … paying off debt, paying off the house, paying for college for all the kids, taking care of relatives and finally pursuing the hobby they have been dreaming about for years. The fact that all of these dreams could disappear in the next 24 hours if they themselves don’t simply say “ok”, is predictably insurmountable for many sellers. And buyers know this.
One of the many great things about the Internet is, it’s now a small world and word travels fast in professional communities. Buyers simply cannot do this to sellers over and over without becoming known for this type of tactic. I actually have a list of people known to pursue this tactic as a strategy. For many years I have swapped names of these shady characters with other M&A professionals in the US, Canada, UK and Australia.
There are a few ways to reduce the chance of this happening and to lessen the adverse affect if it does happen.
1) Avoid buyers who have a reputation for doing this.
Sellers should network around their industry and ask previous sellers how their deal went. Chances are that if a buyer did this to them they will be more than happy to reveal the details of their divestiture experience.
2) Before a LOI is signed, try to reveal as much as possible to the buyer so there is the least amount of additional education required post LOI.
Of course many times the customer list, software code and certain agreements are just too proprietary to reveal to buyers pre-LOI.
3) When an LOI is signed, the seller should make the expiration a short window so if the buyer doesn’t close the deal the seller can go back to the #2,3,4 buyers, sooner rather than later.
4) Right before a LOI is signed, the seller should make a follow up information package and send it to the #2,3,4 buyers, so when the seller signs the LOI with buyer #1 and can no longer communicate with the #2,3,4 buyers … they are as educated as possible, so if the deal with the #1 buyer doesn’t close, the other buyers are that much closer to closing the deal.
Side note about sellers getting deposits as a form of protection:
I guarantee that in most seller’s initial Company Information Package provided to the buyers, which includes trailing three years financials, legal, operational and technical details, there is at least one error in them. All the buyer has to do is say … “If there is a misrepresentation in the information I was given prior to the signing of the Letter of Intent, I can walk from the deal and get my deposit back.” So it makes the deposit a waste of time. Negotiating the terms and conditions of a deposit can be extremely time consuming, taking focus off the actual deal. In addition a tiny deposit doesn’t work either because in a $5mm deal a $10k deposit will not have any bearing on either party’s decision. So the bait and switch mentioned above still works with a $10k deposit.
In closing I feel I must add a few positive comments defending the typical business buyer.
Many business buyers (maybe not “most”) are very honest and just don’t want to get ripped off by a seller misrepresenting the company. During due diligence buyers discover things about the company that the seller initially was either hiding or not presenting in the clearest of light in fear that the buyer wouldn’t want the company. This happens all the time. So what do buyers do, they either walk from the deal or suggest a lower price … rightfully so. In anticipation of this, many buyers price some due diligence disappointments into the LOI valuation, then if during due diligence none arise, they got a better deal than they thought. However, if they do find a skeleton or two, they can still close the deal with the original LOI pricing and deal structure.
In addition to discovering misrepresentations during due diligence, the business environment can change in 2-4 months and/or the buyer’s strategy can change as well. So it is reasonable for a buyer to change their mind about a deal within the 2-4 months a deal is being worked on. It happens.
But we all know it doesn’t happen over and over with the same buyers.
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