Sell-side Due Diligence Part Two: Know Thy Bidder-A Chat with Paris Aden, Valitas Capital
By Andrew Seale
No one brings their business to market without expecting some deep digging due diligence by potential bidders. It’s an essential part of the buying process. But sellers need to recognize due diligence isn’t only a tool for buyers, it’s a crucial aspect of the seller’s strategy too.
In the first part of our two-part series, Paris Aden, partner and co-founder of Valitas Capital Partners, a boutique advisory firm, discussed the benefits of hiring an advisory team to do sell-side due diligence before going to market. In this second part, Paris sits down with The DealRoom to offer some insights on how the seller should approach their own due diligence on bidders once they’ve gone to market.
Part Two – Know Thy Bidder Amidst the growth of search funds providing aspiring entrepreneurs with capital to acquire businesses, and investment banks becoming more aggressive with how they source clients for deals, business owners are seeing a growth in “inbound” acquisition interest.
“I think most of them think they can easily sell their business,” says Aden. “They get letters and emails from people, often multiple times per week, saying, ‘I’ve got a client that wants to buy your business’ or ‘we’re a PE fund, we think you’ve got an amazing business, and we’d love to come and talk to you about buying your business.’”
But it’s important to remember an inquiry is not an offer, says Aden.
“Someone can write a number on a napkin and slide it across the table at you and say, ‘I want to buy you for this amount,’” Aden says, “but, as you can imagine, there’s a whole lot more you need to understand as a seller to be sure you can actually get a deal across the finish line at the value the bidder wrote on that napkin.”
A serious buyer is always going to undertake due diligence before buying your business, but the Valitas Capital Partners co-founder argues that more business owners need to tackle their own due diligence on bidders to understand who they’re dealing with and what they’re walking into.
Qualify Their Offer The first step, says Aden, is to qualify the bidder’s interest.
“There’s all of this unqualified interest often misconstrued as real offers,” he says. Search firms, for instance, are a relatively new phenomenon where a young professional type with entrepreneurial aspirations and none of their own capital is tapped by a group of investors to seek out a business to buy and run, generating a return for these investors. “They're very proactive in canvassing the market,” says Aden, adding that he knows of some that approach thousands of businesses over a few months. Even still, they need their investment committee’s approval before they’ll get the capital to fund the transaction. Some investment banks have also become more surreptitious with their practices for sourcing clients, approaching business owners and telling them they have a buyer interested in them. Once the business owner agrees to sell, unbeknownst to them, the investment bank goes out to find a buyer.
“It’s called the Double Bluff,” explains Aden. “It’s a dishonest practice but, unfortunately, it happens more often than you would like.”
The key, he explains, is to qualify the bidder.
“If a potential buyer comes in and says, ‘We like to pay six times EBITDA for companies and we’ll pay 6 times for yours if everything checks out’ – is that an offer?” says Aden. “The answer is no. They don’t even know what your EBITDA is. They haven’t done any due diligence on it.”
Essentially, you need a Definitive Agreement in place and the road ahead is long. There are many terms that need to be negotiated to arrive at what usually amounts to a 40-page to a 100-page agreement. “And only once all those conditions are met do you have an agreement to sell,” he says.
What’s Their Track Record? Start by checking the bidder’s references and researching the deals they’ve tackled and closed in the past. Do they have a track record of following through on offers? How many acquisitions have they completed over the last five years?
“Try getting access to the people they’ve closed transactions with to get a sense of how they’ve actually behaved in those transactions,” Aden says. “The number one question you really want to answer is: does this buyer deliver and follow through on the things they commit to doing?”
Understanding a potential buyer’s history and investigating past conduct of a bidder is where an experienced M&A advisor is indispensable.
How do they plan to finance the deal? With regards to large-cap publicly-traded companies and PE funds that have committed capital, there shouldn’t be any challenges with financing, says Aden. In any event, it’s astute to ask a potential buyer to describe the financing commitments they have in place and how quickly they can fund the transaction.
“If it’s early in the process, the question you want to ask is, ‘Tell us about how you intend to finance this transaction and assure us that you think this is going to be easy and attainable for you,’” says Aden. Further along, you’ll be looking for a more specific description of the commitment. “Typically, we require, for example, that they provide a commitment letter from their lenders confirming that the financing is available.”
And then, of course, ask them to confirm how they’re going to source the equity component of the transaction consideration. Plus, how will you be paid? “Is it cash, shares, US dollars, Canadian dollars, Euros… are they proposing to purchase the shares? Are they proposing to purchase the assets?” adds Aden.
You also want to know what the assumptions are behind the number being offered. How did they get there? “If you don’t know what the assumptions are, you cede your power to negotiate,” he says. “It is really important to have an investment banker who has prior experience with these things and can investigate.”
What are the hoops to jump through on their end? It’s good to understand who you’re talking to in the due diligence process and whether the bidder actually has the authority to close the deal.
“Usually the answer is no. If it’s a corporation they often require board approval. PE funds always require investment committee approval,” says Aden. Are there other approvals required? “You want to know: how far along are they in this process? Is their board (or committee) even aware they put this proposal out?”
Due diligence often requires other players such as accountants, and lawyers to provide legal advice, etc.… Will they need to interview customers and suppliers or talk to the key management team?
What are their plans for your company? Knowing why a buyer approached you, and what success looks like to them, can give you insight into what’s going to happen to the business after the transaction closes. Strategic buyers may, for instance, be looking for cost-side or distribution synergies. Financial buyers, on the other hand, are apt to be looking at the stand-alone potential of the business to essentially “sell it for three times the equity cheque they paid for it five years later.” Other questions to consider: Will the business keep its name or will it be changed? How do your products fit within their plans? And what about your key employees?
“You want to focus on where they see the synergies and what their plans are for the integration,” says Aden. “Are they going to micromanage the team or are they just going to give them targets and let them run with it?”
Knowing the plan for management and employees can influence which bid you accept. He points out that while price is always a crucial factor when selling a business, it is rarely the sole factor. The founder’s legacy has a value that is hard to quantify. These people are often pillars of their communities, so the reputational stakes can be high.
“You’ve got to ask yourself why you’re doing this deal,” says Aden. It’s often the most important question for the seller to ask when it comes to selling their business. “I can’t think of a single situation where a founder said, ‘Just get me the highest value possible, even if they’re going to treat my employees terribly, and not honour my legacy,’” he says. “You have to trust their intentions.”