When selling privately owned businesses owners want to maximize the value they receive. Using the right selling method can increase the value and improve the terms of a sale.
The modified auction process is usually the most effective way to sell a privately owned business and the one we often recommend. The process is just what it sounds like -- an auction among potential buyers who bid against each other to win the deal. The modification is to leave out the buyers who would have no interest and concentrate the process among the most interested and capable buyers.*
The modified auction is designed for the seller’s advantage -- it is a way to give them some power and control in the process that leads up to and culminates in a transaction.
Buyers come into the process thinking specifically about their needs and interests. As is expected, they look for any advantage to get a better deal. By hiring a professional intermediary, the seller signals to the market that they are demanding a fair price for their business and will invest time and money to give themselves the best chance of getting full value in a transaction. The modified auction process, with its timetable and stepwise progression from beginning to end, lets the buyer know that they need to follow the rules of the process as laid out by the intermediary or lose out. They also know that they will be competing with other interested buyers to win the auction.
There are number of basic steps to the modified auction process which we have outlined below. In addition to providing leverage to the seller, the process is designed to increase the interest of the buyers. At each step in the process the potential buyers are given new information that reinforces the value of the company being sold. Throughout the process, the buyer is encouraged to bid aggressively in order to continue to the next stage the process and be competitive with the other bidders. The further they go in the process the deeper they commit to winning the deal. Since no information about the bids are provided to the potential buyers, they rely on guidance from the intermediary to adjust or modify their bids at various points in the process.
A Note on Confidentiality
Before going further on the discussion of the process it is important to address this critical issue. Only the successful bidders whose offers are accepted will know who the seller is until a completed transaction is made public. We make every effort to maintain confidentiality throughout the process.
· The seller will tell us who in their organization knows about a potential sale. We work only with those people.
· We only use the information we receive from the seller for the purpose of selling the company.
· To participate in the selling process owners and the selling team will have to collect information from within and will be observed spending a lot of time doing things they didn’t previously do. There are ways to deal with this, and the right solution depends on the situation.
· Buyers are required to sign a confidentiality agreement that prohibits them from disclosing to anyone outside of their company that the company is for sale and forbids them from contacting anyone in the selling company or its customers or suppliers.
· It is likely that despite everyone’s best efforts the secret will get out eventually. By being vigilant the seller can delay that from happening – and in many cases confidentiality is never breached.
Step One: Writing the Descriptive Memorandum - Sometimes called “the black book” or CIM (Confidential Information Memorandum), this is a 30-to-100-page document describing the company, the people, the history, the business model, and the opportunity. It also includes three to five years of historical financials and the results for the latest quarter that has been completed. A clear and compelling DM is what will give prospective buyers the information needed to make the decision to pursue an acquisition. The preparation of the DM requires extensive back-and-forth between the client and LSA to make sure the information is comprehensive and accurate, and usually is ready for final approval by the seller within 30-60 days.
Step Two: Writing and Mailing the Teaser – The Teaser is an email sent to a wide range of likely buyers. It is designed to generate interest (tease) as a first step. The text of the teaser contains just enough information to “whet their appetite” but does not reveal the name of the company and refers to it anonymously. The teaser balances the need to provide good information to spark interest while not giving away so much that the buyers know who the company is.
The subject line of the teaser needs to say in a few words why the recipient should open it. We experiment with different subject lines and re-send teasers to get the maximum exposure.
The universe of teaser recipients is composed of selections from LSA's proprietary database of both strategic and financial buyer prospects, names of prospects provided by the seller and additional names that surface from our focused research. This research enables us to add non-obvious potential buyers that have recently emerged or are in flanking market sectors where the company for sale would provide incremental sales and profits to a buyer. We strive to cast as wide a net as possible because you never know where the teaser might turn on a light in a potential buyer’s mind.
Creation of the teaser list starts at the beginning of the engagement and is done concurrently with the development of the descriptive memorandum. From the initial teaser mailing(s) the process may take two weeks to two months, depending on what is learned from the responses. Teasers are modified both in content and subject lines and resent to those who either do not open or do not respond.
Buyers who respond to the teaser and ask for the DM must sign a confidentiality agreement (also called a Non-Disclosure Agreement). Confidentiality agreements often need to be negotiated with the buyer prospect and sometimes involve attorney approvals and re-writes, which can add time to the process.
Step Three: Distribution of the Descriptive Memorandum - Ideally the completion of the DM and the execution of the confidentiality agreements from a significant number of interested buyers who have responded to the teaser coincide so that we can gauge the level of interest in the company early on and establish the timetable for the rest of the process.
We will email the DM as a .pdf to the potential buyers along with the Sales Process Letter which tells them what we expect from them and when we expect it. We usually give them two to four weeks during which they should review the DM and then send us a non-binding indication of the value they would pay to own the business: an Indication of Interest (IOI). They are told that we will be selecting who goes to the next round based on the price and terms they quote in their IOI.
· The Sale Process Letter - This letter provides any needed guidance to the buyer on what the seller expects. For instance, it may include specific points such as “the seller will give preference to all cash offers”, or state that the owner “will only be available for a brief transition period after the sale.” This letter also includes a timetable for the remaining steps in the process up to the closing of a transaction.
Step Four: Initial Discussions - Once the Descriptive Memorandums and the Sale Process Letter are distributed there is a lot of back-and-forth between LSA and the buyer prospects. They have questions, make requests for additional information, and call to chat about what they have seen in the DM to get a sense of how well the auction is going, etc. This is just the beginning of the always ongoing interactions between LSA and prospective buyers. We try to limit how much new information we provide at this stage. However, this is a judgment call. If a buyer makes a case for new information that is pertinent and relevant, we may accommodate them, or we may let them know that that information will be made available later. That decision is made in concert with our client.
To avoid “leaving money on the table” we never tell buyers what the price of the business is. Letting the buyers set the price with their offers can generate a price well above what the seller might have quoted and often does.
Step Five: IOI Submissions – IOIs can vary greatly in form and substance. Some buyers will put forth a brief note with a price range. Others will submit detailed letters with the full offer they would make written out in a legally drafted Letter of Intent (LOI) that includes all the major terms that the buyer will want to see in a final agreement. If the company is attractive to potential buyers, several of them will submit IOIs with high enough prices to get them into the next round.
Step Six: Management Presentations – The purpose of this step is to give both sides a chance to look each other in the eyes, ask questions and begin to form a bond with each other (or not). The DM has provided the buyer team with a lot of information. They come to the management presentation looking to confirm what they have read, to get a chance to evaluate the seller and hopefully to fall deeper in love with the idea of owning the company. At the same time, the seller has the opportunity to increase a buyer’s interest with a presentation tailored specifically to them. The presentation includes an update on the financials since the DM was written and shows the buyer greater detail on the factors that make the company an attractive buy. Management presentations used to be done in person but are now more frequently done via remote meeting tools, like Zoom or Google Meets.
The meetings can last as long as three hours. The seller may have one or two of the company’s leaders present who may also present to the buyer. The buyer may also make a presentation designed to sell the seller on the idea of them as the best buyer. Plenty of time is usually left open for a question-and-answer period during which the comfort level of the buyer can be raised to a higher level. At the end of a successful management presentation the buyer signs off with their conviction that they want to own the company advanced and strengthened.
Step Seven: Opening the Data Room – The potential buyers on leaving the Management Presentation will be given access to the Data Room. No longer a physical location, the data room is an online secure site where the seller has filed information the buyer will need to do its due diligence. In essence they want to look at everything they can to get comfortable with buying the company and give themselves the comfort that they know what they are getting.
Step Eight: Letters of Intent – The most important document in the whole process is the final Purchase and Sale Agreement that comes at the very end. The second most important document is the Letter of Intent. After the Management Presentation the potential buyers are given two to three weeks to do their confirmatory due diligence in the data room and submit a “firm” Letter of Intent (LOI). The LOIs are all due on a specific date. When they are received, they are opened and compared. What is compared are the price and the terms that the buyer will require to close. The seller can choose one of the offers or, as is often the case, respond with a set of changes they would like to see from two or three of the buyers. This final stage allows the seller one last “bite of the apple” and is expected by the buyer. Once the final topping up is done by the successful buyer, a final LOI is written and submitted. While an LOI is not binding on the buyer, it will be written so that when it is accepted (and signed) by the seller it creates a legal duty for the seller that can have serious consequences if the seller does not honor its terms. Accepting an LOI is a very serious step for the sellers’ and they should only do it after obtaining the advice and counsel of their lawyer.
Step Nine: Purchase and Sale Agreement – The final accepted LOI is used as the template for the lawyers (usually those representing the buyer) to write the first draft of the Purchase and Sale Agreement (PSA). We counsel our clients not to OK the starting of the drafting of the PSA until all of the business points are agreed to and the only wrangling the lawyers will have to do is over legal points. At the same time as the drafting begins, the buyer will begin doing their final due diligence, which will be voluminous and painstaking. Another difficult final step is the creation of the charts and exhibits that will go into the PSA. The seller will be very busy during this period making sure that all the information that goes into the agreement is accurate.
The PSA will describe the whole transaction. Some of the critical issues that arise are whether the buyer is acquiring the stock of the company or they are acquiring selected assets and assuming specific liabilities. Additional agreements such as employment contracts for people who are continuing with the business under the new owner are executed and added as appendices to the PSA. The PSA is also a road map for what happens after the closing. The buyer will likely require that some amount of the consideration (sometimes as much as 10%) that goes to the buyer be held in escrow for six months to a year. This is designed to protect the buyer from any misrepresentations or defective warranties the seller might have made in the PSA. It is rare that the full amount of the escrow is not paid out to the seller. Any adjustments to the working capital that the buyer required to be available to them on the first day of their ownership will be specified in the PSA and result in a “true up” as needed, e.g., if there is not enough working capital the seller pays the buyer and vice versa.
Step Ten: The Closing – Closings are now done remotely with the lawyers trading final drafts and signature pages via email. The seller and the buyer sign the final agreements. Payment is made by the buyer via wire transfer and the deal is done. It usually takes six to 12 months to get to this point.
We hope this description of the auction process has been helpful to you. We have been through this process ourselves many times as sellers and buyers and as intermediaries. Our goal at LSA is always to do the right things to make sure that the seller gets full value and does not wake up the morning after the deal is done and begin second guessing themselves. Seller’s remorse is a real thing, but as we have learned over the years, the only antidote is to have run a full process intended to maximize the chances that the seller will have gotten the full price that was available in the market at the time they sold.
*In some instances, a modified auction may not be the best technique, so some form of a negotiated sale is appropriate. This entails approaching likely buyers one at a time in a series giving each one the chance to make an offer before going to the next one. If the first buyer makes no offer or their offer is unacceptable, the seller moves on to the next potential buyer and repeats the process until an acceptable offer is made.