M&A: the blend of negotiation and due diligence

The negotiation and due diligence processes provide acquirers with one of the first times they can really get to know a company — both across the boardroom table and via its financials. How should they ensure they make the most of this opportunity?


Digging deeper

Meeting a potential target for the first time offers acquirers their first real glimpse into the heart of the company. On top of that, taking the first steps down the due diligence road provides the chance to see what a potential acquisition is really made of. Preparing for these steps is crucial.

Marshall McKissack, head of M&A at investment bank Stephens Inc., points out that both negotiation and due diligence are intertwined. “I really think [a negotiation] starts with the due diligence process and determining where companies see risk”, he says. “After you figure out where clients see issues, you can negotiate to protect their interests in the various transaction documents. Secondly, the market constantly evolves around terms and other conditions — having a sense of where the market is can be very beneficial in order to move a deal forward.”

Prepping a deal

Away from this, preparation for a deal can consist of several things, including forward planning, prioritizing, thinking from the other side and calmness.

For Brian Moriarty, former vice president at Hewlett- Packard, thinking about what the businesses would be like combined is necessary even at this early stage, given that reaching a negotiation implies an interest on both sides.

“You need to create a business integration plan, even at this stage, that is approved and supported,” he says. “There is no point negotiating unless you know you want to buy the target. This all comes before you even talk about price.”

On top of this, buyers also need to center negotiation efforts around what interested them enough to get around the negotiating table in the first place. “You need to crystallize what the key drivers of the transaction are,” says Matthew Gemello, partner at Baker & McKenzie. “The majority of your negotiating efforts and resources should focus strategically on getting to an optimal result on those particular drivers.”

One often overlooked point is putting yourself in the shoes of the target, and indeed the other stakeholders in the deal. “In our last deal we learned about the behavior of the bankers, as well as the seller’s behavior in prior deals,” says Jeff Drazan, managing partner at Bertram Capital. “You also need to make sure that you’re asking a lot of questions.”

“You also need to bear in mind the target’s mind frame,” adds Moriarty. “If they are private, for instance, why are they selling? What are their price expectations? This can help to structure an offer that you make.”

Finally, adds Karim Motani, corporate development and strategy director for 1800flowers.com, it is important to be measured in your reactions. “Our last deal was an auction, and as a strategic, we’re not involved in as many auction processes as private equity firms, so we hired a banker to negotiate on our behalf,” he says. “Using an intermediary created space between ourselves and the target; it gave us time to be considered in our responses. I believe this helped us to secure the deal at the right price.”

Smooth things over

Yet even with the best preparation in the world, acquiring negotiators need to accept that there will be some issues that both parties will wrangle over. “There are always sticking points,” says McKissack. “That’s why they call it a negotiation.”

Indeed, just because an opposing party isn’t keen on some parts of an acquisition does not mean they don’t want to complete the transaction. It is more important to understand their concerns about the proposal. “If you’re open to more creative solutions, the best thing to ask is why they are taking that position,” says Moriarty. “Often times, it’s not that they are dead against the deal, it is just that they have concerns about certain aspects. If there is a problem, you have to be able to identify a creative solution around it, and asking is the first step to that.”

Creativity is something that is particularly acute the technology industry, and is much more noticeable since the sector’s rise in recent years. “The thorny negotiating points are not really surprising, given there’s such a narrow playing field of issues that come up. What has changed, however – particularly evident in Silicon Valley and with technology-based plays — is a greater desire to be flexible to solve problems,” says Gemello. “With M&A players in the more traditional industries, there is a greater tendency to have two sides entrenched on their issues and wedded to their ‘standard’ way of dealing.”

For Drazan, it’s also important that acquirers reiterate a solid business case for the deal. “You have to hit them straight with the facts,” he says. “Your behavior should be consistent as well. And your case must have a really solid rationale.”

On top of this, acquiring negotiators shouldn’t forget that identifying potential trade-offs could help to bring the two sides closer together. “We first try to weigh up both sides’ sticking points and then look at the deal terms,” says Motani. “From that, we can look at possible trade-offs. In a recent deal, one of the sticking points we had surrounded break-up fees, escrow accounts and warranties. And if you’re pushed, you have to be willing to make concessions.”

Credit where it’s due

Away from the boardroom, the due diligence process has become another avenue for companies, as well as thoroughly investigating their counterparts, to become more trusting of each other.

“These days, sellers often have conventions in place in order to expedite the due diligence process. Bigger companies, for instance, will put forth a quality of earnings report,” says Motani. “It helps to get the parties more comfortable with each other while speeding up the process as well.”

In terms of the process, due diligence has already been sped up exponentially over the last few decades. “It’s certainly moved — on a detail basis — almost exclusively online,” says McKissack. “A lot of it is done in online data rooms in conjunction with lots of phone calls, compared with 10 to 15 years ago when a lot of it was done with paper on site, which was quite laborious.”

It isn’t just the process that has changed, however. For Moriarty, due diligence has become a much more forward-thinking exercise. “When I started, due diligence was about identifying liabilities you did not know about. This, of course, still happens,” he says. Now, however, the process is much more focused on the future, on things such as integration plans, business plans and confirming assumptions.”

Gemello agrees, adding that companies are becoming increasingly practical, especially in the midst of a crossborder M&A boom. “One big shift has been having buyers who are increasingly comfortable enough with their risk management profile, and aren’t afraid to do business as the locals do – not across the board, but there is a big commercial willingness to do that,” he says. “It is that it’s a very interesting overlay of commercial and strategic practicality.”

Diligent value

While what consists of due diligence may have changed, what takes precedence in the process hasn’t. “It’s biased to whatever drives value,” says Moriarty. “It’s also biased towards finding liabilities as well, of course, and both are critical. However, unless you do diligence and understand the former, there’s no need for the latter.”

McKissack agrees. “Financial due diligence, accounting due diligence and quality of earnings — these are the basis of the foundation of value. Legal, risk and contract reviews are also important. But they all drive value at the end of the day, whether it’s in dollars and cents or by protecting yourself from unnecessary risk.”

From other perspectives, however, certain issues are more important than others at the moment. “The hottest button in the world right now is compliance,” Gemello says. “Unknowingly buying your way into a compliance problem can destroy the underlying value of the acquisition, putting aside the commercial and reputational impact on a buyer and its own business. We are spending more time with clients at earlier stages of their deals, as they strive to better understand the local regulatory climate(s) in which their targets are operating. It’s been far and away the primary focus.”

For Drazan, focusing on the product and the seller’s customers takes precedent. “Customer references are the single most important component of our diligence,” he says. “What choices did the customer have before buying, did the product or service live up to the expectation, and how has the company behaved in the aftermath of the sale? Getting the answers to those questions is crucial. Management references come next after that hurdle.”

Motani adds that, as well as ensuring that the lawful side of things are taken care of, due diligence is also vital to understanding the competitive landscape. “The legal and contract side takes precedent. We don’t want to have any legal liabilities postpurchase,” he says. “We also want to adjust our competitive positioning. This means looking at the competitive nature of the market, as well as other macro-level issues we’re up against.”

Download the full interviews here.


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