The Secret of Effective Negotiations in Mergers & Acquisitions
By: Marsha Lewis
Tags: Mergers And Acquisitions, Negotiation, Business Strategy

Negotiation is a sometimes overlooked area of the M&A process. Every time we see a public company which has been acquired at a price which implies a premium well over its market price, it’s worth stopping for a moment and considering that the premium was part of a negotiated price between both sides — and probably fiercely negotiated, by two teams of experienced M&A practitioners. Prices (and by extension, premiums) don’t happen by chance.

For this reason, whatever side of the transaction you’re on, negotiation skills could be worth anywhere between a few hundred thousand dollars in the lower middle market and literally billions of dollars at the upper end of the market. At DealRoom, we’ve found that much of the negotiations center around the details shared at the due diligence phase, which allow the buyer to see “ what’s under the hood “ of what they’re buying.

In this article, we touch on some of the issues that surround negotiations and give some examples of M&A negotiations. The article begins by looking at the LOI, a critical juncture in the M&A negotiation process. Thereafter, we look at some of the other issues that pertain to negotiation and how both the buy-side and the sell-side can gain from better negotiations, moulding the terms of a final deal to better suit their requirements. The reader should come away with a better appreciation for the importance of good M&A negotiation capabilities.

The Letter of Intent (LOI): A Critical Juncture

Although rarely legally binding, the LOI is a critical juncture for both the buy-side and the sell-side, but especially the sell-side. This is because it’s very difficult for the sell-side to renegotiate a price upwards after the LOI has been signed. It’s possible of course, but is more often taken as a sign of badwill on the buy-side. So, the sell-side has to be happy with the terms outlined in the LOI. On the other hand, the buy-side can use due diligence as leverage to improve the terms for them (usually meaning a lower acquisition price).

The price agreed is just the headline in the LOI. There are issues around whether the cash is to be paid all upfront or in installments, whether the price includes earn-outs (a good tool for both sides of negotiations), whether the selling firm should receive some stock (common or preferred) in the newly created entity, and whether there should be some cash held in escrow for a period to protect against unforeseen breaches of the seller’s representations.

At each of these stages, the buyer and seller are largely working in opposite directions, the former looking to reduce the price of the business, the latter looking to increase it. For this reason, whichever side of the table a company is on, they should know the limits of the terms they’re willing to pay or accept before entering negotiations.

‍ Preparation is a key element of negotiation — you don’t want to negotiate with a team of experienced investment bankers, who’ve probably conducted dozens of deals, without knowing what you want from the process.

Post-Due Diligence: Representations, Warranties and Indemnities

Representations, warranties and indemnities, typically inserted into the deal terms to serve the buy-side. Representations and warranties are usually used by the buy-side to confirm that everything that was discovered during due diligence was accurate and reflects the true position of the company. Indemnities are the clauses inserted by the buyer which protect them from the due diligence findings being misleading or inaccurate — for example, providing them with the option to pull out of the deal at a later stage.

At an absolute minimum, the buyer should seek to ensure that they have representations and warranties around details of the seller’s financials (i.e. that the financial statements have been prepared in accordance with GAAP and present fairly in all material aspects the financial position of the selling firm) and legal standing (i.e. that there are no litigations pending). Other representations and warranties can surround IP, existing commercial contracts and more.

The sell-side may also have some opportunity to insert their own representations, warranties and indemnities, particularly if they’ve agreed to acquire stock in the new entity created by the merger. These can include everything from director compensation to issues surrounding dividend payments. Taking all of these issues together, it’s not difficult to see how there could be a lot of negotiations for even a relatively minor transaction.

The Human Side

The best negotiators leverage a combination of IQ and EQ. That is to say, they use their brain and their heart. Like any deal, it helps if you can relate to the other side and show empathy. In The Partnership: The Making of Goldman Sachs by Charles D. Ellis, Ellis tells the story of two investment bankers that go to the house of the owner of a large US company for whom they wanted to offer their services. Other bankers had been. But the Goldman Sachs bankers insisted on cleaning the dishes after dinner. This little show of humanity won them the deal.

Most deals between buyers and sellers won’t offer the opportunity to wash dishes, but the lesson is clear: Humility and empathy go a long way. If terms are unacceptable, there’s a way to say that they’re acceptable in a way that the other side can respond to. Likewise, if your terms are rebuffed, it shouldn’t be taken personally, even if they’re rebuffed in a less-than-polite fashion. Negotiations are a time for cool heads and rationality, preferably with some amicability.

Conclusion

As one can imagine, the scale of issues that could be covered when talking about negotiations in M&A is vast. Much like any other relationship, the outcome is unlikely to be damaged if everybody is honest and empathetic from the outset. Ensure that you’re fully prepared for what may come and don’t be surprised by the unforeseen as deals can throw up all kinds of issues — even showing you things you didn’t know about your own company.