Common perception is that in an acquisition the acquirer has all of the power. After all, they are the one that’s writing the check and they can walk away at any time. But companies considering an eventual acquisition exit need not give up hope because there are several things that can be done to maintain a balance of power, if not an upper hand, during critical parts of the acquisition process. I’m going to attempt to describe some basic M&A do’s and dont’s through the lens of two stories and the associated lessons learned. Part one in this series (see related article here) had a sad ending for the selling company. But Part 2 has a very favorable outcome. Both stories draw from actual acquisitions I have been involved in, either on the buyer or seller side of the table. But since I have been involved in 10 such deals to date and many dozens of exploratory acquisition approaches, I have incorporated elements from multiple engagements to better help demonstrate the lessons learned.
Now for the story.
For this story, Elephant Inc. will be the acquirer and Shockwave Innovations (aka – Shockwave) will be the target for acquisition (the seller).
Shockwave had a very impressive track record of growth and recent years of profitability on their way to $30M in revenue. The company was extremely well run with established processes, disciplined bookkeeping and file archiving, and a strong company culture. They had partnerships with a few of the giants in their industry, including a couple of relationships that could legitimately be considered strategic by both sides. Investment bankers regularly visited Shockwave on their trips through town, hoping the company would someday be approached for acquisition or continue their growth for another couple of years and pursue an IPO. After all, representing a company in an acquisition or IPO is a primary way investment bankers make their money.
One day, out of the blue, Shockwave got an inquiry by Elephant Inc., who were one of the giants in the industry but not one Shockwave had a partnership with. Elephant had a gap in their product portfolio where Shockwave had a specialty and was considered the market leader. But Elephant also had a reputation of being a “cheap” acquirer. Even though Shockwave hadn’t decided to sell the company, they decided to see what Elephant wanted to talk about. Sure enough, after a couple of discussions with representatives from Elephant’s relevant product business unit, their Corporate Development team got involved. Shortly thereafter, Elephant let it be known that they were interested in acquiring the company.
The Offer
Shockwave made it clear from the start that they were focused on growing a great company that could IPO someday (see related article titled “Answering the ‘Exit Strategy’ Question“) and hadn’t discussed the possibility of selling the company with their Board. They made it clear that any offer needed to be substantial enough to cause them to deviate from that course. They also asked not to see any offers in writing because they didn’t want an unacceptable offer to suddenly set the valuation for the company. Instead, they asked to keep things verbal to start.
Side note: Setting the formal valuation for a US-based company is done via a process referred to as a 409A business valuation (IRS nomenclature). Such a valuation is done by a certified professional and takes many financial and risk-oriented data points into consideration. One significantly influencing data point is a formal offer to acquire your company. The adage “your company is only worth what someone is willing to pay for it” is true and a written offer can cause the valuation of your company to skyrocket overnight, thereby causing your Common share stock price to skyrocket even if you don’t accept the offer. Goodbye stock options at $0.60, hello stock options at $1.75. I’m not suggesting you shouldn’t get formal 409A valuations on a regular basis to properly price your shares. Rather, I’m merely pointing out the potential implications of a written offer that isn’t accepted.
Elephant requested some information about Shockwave’s business and financials in order to help them determine their offer (see related article titled “Revealing Company Info Before Getting an Acquisition LOI“). Shockwave pushed back on several of the requests but eventually Elephant got the minimal amount of info needed to work up an offer.
As expected, Elephant’s first offer was insulting – something like $80M (2.7x multiple of Shockwave’s trailing twelve month revenues). Knowing an offer was coming, the Shockwave founders discussed what offer would cause them to at least step back and consider it while also being viable enough to notify their Board. The number was $120M or a 4x multiple of revenues. While this is certainly a respectable multiple, Shockwave probably would have set their minimum bar even higher if it hadn’t been for a weakening economy that brought uncertainty to the next couple of years. The reply back to Elephant was quick and clear – “NO”.
Elephant increased their offer to $100M, which was met with a reply of “NO, we’re building a great company and you are distracting us from that with offers that way undervalue our company”. Finally, with a slight wince of pain in their voice Elephant offered $120M and Shockwave had no choice but to strongly consider it and discuss it with the Board. The offer was accepted and Elephant then put it in writing via a Letter of Intent (LOI).
LOI Negotiation
Knowing that an LOI would include what’s called a “no shop” clause that would prevent Shockwave from talking to other potential acquirers and entertaining other offers, they decided to reach out to their big strategic partners to see if any would have interest in making an offer. But because the economy was getting progressively weaker and the outlook not good, these companies had put acquisitions on hold for a little while and each regretfully declined participation. So there went the possibility of a competitive bidding situation, which is commonly used to drive up the acquisition price. Shockwave’s leverage came from the fact that they didn’t need to sell the company and could walk away at any point.
Side Note: This type of action to try and create a competitive bidding process is very delicate and often best handled by investment bankers. If an acquisition doesn’t end up happening, these other potential acquirers know an attempted acquisition approach failed. That could “leave a little stink” on the selling company as you might remember was the case in Part 1 of this series.
There are differing theories as to how many details and terms to put into the LOI. It’s a non-binding agreement but it also serves as the basis for negotiating the final merger agreement. Knowing that Elephant had to stretch to get to an acceptable price tag, Shockwave was a little nervous they would later try to offset that with favorable terms to Elephant, but deal killers for Shockwave. I read somewhere that a notable angel investor once said “tell me your price and I’ll tell you my terms”. With this dynamic in mind, Shockwave decided to spend a little extra time and effort making sure certain things were in the LOI. After a week or two, it was signed.
Due Diligence
The Shockwave executive team reminded themselves of two key things every week: “We’re not selling our company, Elephant is buying it. We must keep running our business as before because the moment Elephant starts playing games with the terms of the deal, we’re walking away”. (see related article titled “Are You Selling Your Company or is Someone Buying It? “) For some reason, Elephant approached the acquisition as they did every other one, which almost always involved a company that desperately wanted or needed to be acquired.
Because Shockwave was so well run, they could produce requested information very easily and quickly. This allowed due diligence to go very smoothly and it left a very positive impression on the Elephant due diligence team. (see related article titled “Setting the Stage for a Future Acquistion Exit“).
After a couple of weeks of due diligence, the two parties started negotiating the merger agreement in parallel. After getting Elephant’s first draft, Shockwave immediately noticed four showstopper issues and brought them to Elephant’s attention. For some reason, Elephant didn’t want to spend time negotiating these issues but rather focused on other items. Shockwave pushed to address the showstoppers and made it clear they were truly deal killers. Still, Elephant refused to address them. At that moment, the Shockwave team knew the balance of power had shifted in their favor. Elephant still had the mindset of other acquisitions in which the selling company was truly a Seller that needed to get a deal closed. Shockwave, on the other hand, continued to remind themselves that they were building a great company that didn’t need to sell. And they knew that if Elephant really wanted the deal to close, they would need to concede on all of the showstopper issues.
The Last Stand
Shockwave learned that Elephant already had a big acquisition announcement planned to coincide with an Investor Day presentation, so they could make a big deal out of it. With 24 hours to go to the desired announcement date, Elephant still had not addressed the showstopper terms. But they had already made travel plans for several company executives to be in the city where Shockwave was headquartered and they had confidentially briefed two industry analysts so they could publish reports on the day of the announcement. At that moment, the balance of negotiating power was completely with Shockwave, who ended up getting everything they wanted and more in the final few hours before the announcement was made.
Lessons to be Learned
- Are you selling the company or is someone buying it? If you don’t need to sell your company, you can be prepared to walk away at any time. Remind yourself of this throughout the process.
- Keep running your company as if the acquisition is going to bust – Anything can happen and the last thing you want to do is lose your momentum if the deal busts.
- Having a very well run company is a difference maker – Acquirers see lots of companies with great technology but terrible processes, discipline, culture, bookkeeping, etc. You can set yourself apart from the norm and use it to gain leverage during negotiations.
- Acquisitions by large companies are usually co-sponsored by a product business unit / division and the corporate development function – It’s almost impossible to get a deal done without sponsorship and activity by both functions. If you don’t see both involved, the supposed acquirer might just be fishing for information. The missing function might later engage but until they do, you’re not getting a real offer. So be careful how much info you share early in the “dance”.
- Your business valuation, and therefore your stock price, can increase just from getting an offer in writing – This can happen even if you don’t accept the offer.