Sunday, 12 August 2012

More Thoughts on Price Expectations

I noted recently that it is very difficult to predict exactly what a business’s selling price might be as a result of a well managed auction between two or more highly motivated strategic acquirers.  Outside of a competitive environment, a buyer will pay based on historical performance and not the incremental value they believe they can create.  Competitive tension is the situation M&A advisors seek to achieve and, personally, I have seen many competitive situations result in very good prices for sellers of mid-market private companies.
Because it is hard to predict what price might result, a discussion about price expectations should start with the notional value (the price a proper valuation will assign a business independent of what a particular strategic buyer might benefit from; see: What Will a Strategic Buyer Pay?) and then estimate the potential price increase based on the selling company’s attributes (i.e. complementary customers, products, brands, patents, etc.) and market attributes (no. of possible buyers, their financial strength, growth rate of the sector, etc.).  This typically results in an indicative range.
Discussing price expectations is a delicate dance between being realistic and optimistic, between the likely and the possible.  Some sellers want to hear a high number even if it is not likely achievable.  Others will worry that if you don’t pitch a higher sale price than the next advisor, you won’t fight for the best price on their behalf.  Sellers are often guided by publicly announced data points. Headlines where one market leader buys another for a tremendous amount (i.e. Facebook buys Instagram for $1 billion or HP buys 3PAR for 11 times revenues).  Such metrics don’t typically translate to smaller competitors yet, if you don’t account for the leading transactions in a business development presentation, you can be perceived as either not being in touch or not being the aggressive marketer the seller is looking for.  While I see the point, and I have lost mandates where other advisors led selling companies to believe they would achieve a higher sale price with them, I prefer to establish a reasonable expectation and over-deliver rather than over-promise and under-deliver.  The point I want to underscore here is that, regardless of whether one advisor promises to deliver a higher price than the other, if they both follow a thorough process and manage the auction as per the seller’s guidelines then both should end up pretty much at the same price.  Note, I say “as per the seller’s guidelines” because often the seller will guide the M&A advisor in the direction of a preferred buyer (and away from a potentially stronger but more hostile bid) for various reasons.  The point is, look to the material differentiators between advisors such as integrity, sector experience and international reach rather than promises of high prices.
I have talked before about aligning seller and advisor interest through compensation based on a successful transaction.  One mechanism that really awards over achievement is setting a base compensation rate up to an agreed level and then providing a substantially higher commission above that number.  For example, 3% up to $20M and 10% above that.  If the company sells for $24 million the seller would have generated $4M more than expected and the advisor would secure a healthy fee.  I am happy to subscribe to such models but the issue I have with them is that it is implicit in the arrangement that the advisor would not push for $24M otherwise.  The ideal situation is one where the seller has confidence in the advisor to do everything he can and the advisor in fact does everything he can.  If you are more cynical than that or need the additional assurance, then the extra incentive structure is something that can work for you.
Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap CorporateFinance in Toronto.

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