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John Warrillow

A buyer approaches: Three mistakes to avoid Add to ...

When you run your own business, you learn a lot by trial and error. In the early days, nobody else is going to collect that late receivable, so you figure it out. There’s nobody to delegate the design of your marketing materials to, so you decide on a logo and a slogan all by yourself.

This self-taught experience means business owners tend to be street-wise and pragmatic, with one glaring exception: Many entrepreneurs – even the uber-successful – are glaringly ignorant about the process of selling a business.

Recently I was reminded of just how naive I had been before going through the process myself when I received this e-mail from a reader who was running a very successful business:

John:

Your book inspired us to get off our asses and find a potential buyer for our company. Well, we may have found one. The suitor is sitting on a ton of cash and their CEO has started the process by asking us to sign an NDA [non-disclosure agreement]and a six-month “no shop” clause. I am sure they will want to close with us. We are debt free with 50%+ net profit and consistent growth, and we are in the exact same space as they are but we offer something they don't. We are absolutely the perfect addition to their company. Can you refer me to an M&A [lawyer]

My first reaction when reading this e-mail was disbelief, followed by a pinch of frustration. Here’s a guy who is incredibly successful and who has built a business with enviable profit margins yet, in the most important transaction of his life, he’s about to blow it.

In my opinion, he‘s making three big mistakes:

Mistake No. 1: Hubris

Most big companies are constantly trolling for acquisitions. Just because this reader has been approached does not mean he’s going to close a deal.

Take, for example, The Riverside Group, a very large company that acquires smaller businesses, manages them for a while, and then tries to sell them for a profit down the road.

According to a recent presentation it gave to the financial community, it approached 4,228 companies in 2009, offered a letter of intent to 63 of them, and only closed on 15 deals.

So if the buyer who has approached the reader follows the same pattern, there is a less than 2-per-cent chance that an advance from the CEO would lead to a formal offer, and only a one-in-four chance that an offer would actually lead to a deal closing.

Now, admittedly, Riverside is a private equity company and this person has been approached by a strategic acquirer so the proportions would be somewhat different.

The point is that big companies initiate acquisition conversations with a lot of small businesses; but that doesn’t mean they’re going to get bought.

In this case, the big company is apparently sitting on piles of cash so, presumably, it could build exactly what this reader has created on his own. The acquirer will only buy his company if it calculates that the cost (time and money) to build what he has created will be less than building it from the ground up.

Just like every business is for sale, every business can also be replicated with enough money and a motivated competitor.

The right thing to do:

If you get approached by someone who wants to buy your business, play it cool. Take the CEO out to lunch and have a casual chat. Imply that this is not the first of these kinds of lunches you’ve had. Talk about the synergies between your two businesses and let the CEO know that you always consider acquisition offers carefully.

Mistake No. 2: A six-month “no-shop” clause

A “no shop clause” is a legal agreement whereby the seller agrees not to pursue active negotiations with another company for a period of time. It’s very likely that a letter of intent would have a no-shop clause but, in the reader’s case, there are two potential problems.

First, in my opinion, a no-shop clause should only be signed at the very end of a negotiation process, when both parties have agreed in principle to complete a transaction with specific terms (for instance, closing price, working capital, earn-out, etc.).

In this case, the two parties have just started discussions and nobody else has had a chance to participate in the bidding. If the reader were to sign a no-shop clause now, he would lose negotiating leverage, giving the buyer half a year to drag out discussions.

Second, a six-month no-shop clause, in my opinion, runs too long. Most no-shop clauses are either 60 days or 90 days. By agreeing to six months before a set of deal terms, I feel the reader would be indicating to the buyer that he is a naive, first-time seller, which the purchaser could use to his or her advantage throughout the negotiation.

The right thing to do:

Agree to a 60-day no shop clause after your negotiations are complete and you have signed a letter of intent, which includes key deal terms, like closing price, working capital calculation, diligence check list, and employment agreements for the owner(s).

Mistake No. 3: Confusing an M&A lawyer with an M&A banker

My reader thinks he needs a lawyer but, in my experience, what he really needs is a professional company seller.

A broker’s job is to sell your company just like a real estate agent sells a house. A broker will start by soliciting a number of prospective companies to try to find a few interested parties. The broker will organize some meetings for the potential buyers to meet the seller, then try to muster a few competing offers to increase the competitive tension for your company. This gives Leverage to get a better price and better deal terms before signing a no-shop clause. A business lawyer would then vet the Letter of Intent and be very involved in the drafting of a purchase agreement.

The right thing to do:

Hire a good M&A professional to run the process for you. You will be charged 4 per cent or 5 per cent (the fee goes down with the size of the transaction) of the overall transaction, but the broker should make that back, and more, by allowing you to focus on operating your business while the negotiations take place, and by creating some competition for your business.

Special to The Globe and Mail

John Warrillow is a writer, speaker and angel investor in a number of start-up companies. You can download a free chapter of his new book, Built to Sell: Creating a Business That Can Thrive Without You.

Join The Globe’s Small Business LinkedIn group to network with other entrepreneurs and to discuss topical issues: http://linkd.in/jWWdzT

 

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