Deal Asymmetry – How Sellers Can Level the Playing Field by Investing in Strategy Over Resources
It always starts out innocently enough. An unsolicited phone call from a private equity group, search fund, or family office looking to find a company to buy and operate. If you own a company with $2M+ in EBITDA, such inbound calls are familiar. If you own a company with $2M+ in EBITDA wherein the primary revenue stream is recurring - especially SaaS - the inbound phone calls are a two-to-three times a week occurrence.
Their pitch is powerful. They’re interested in you. They’re interested in your company. From the enthusiastic, congenial tone of their voices, to the never-ending blandishments, they’re simultaneously making you feel special and worthy of their praise, and selling you on what a good fit and good team you both will make in the future. The notion of merging the companies gains purchase as a foregone conclusion in the collective consciousness of all parties.
There’s nothing necessarily wrong with this process. It’s simply how it works.
The value imputed to you as a potential seller is designed to engender trust and mutual respect, and mutual respect has an interesting psychological dimension to it. Respect, however mutual, suggests that there exists an additional relational dynamic between buyer and seller - one of equality. And in the instance of putting a deal together, this perception of seller is wrong.
Once the business terms of a deal are agreed upon by both parties and memorialized in a written letter of intent (LOI), the respective interests on the parties diverge, as both sides position themselves to ensure that the deal consummates on favorable terms. From the seller’s perspective, favorable terms mean the deal trades at the price and structure detailed in the LOI. Favorable terms to the buyer, however, mean that the deal doesn’t trade for a penny more than it ought to, as the product of an exhaustive due diligence process.
And herein lies the asymmetry of the deal. Buyer, usually bigger, has much greater access to, and amounts of resources: time, money, and armies of talented human capital. Seller may have a lawyer, accountant, and tax specialist on the ready, but buyer has law firms, accounting firms, and tax specialists on retainer. Additionally, depending on the nature of the asset being sold, buyer will also have battalions of consultants for technology audits, KYC assessments, market analyses – basically, everything imaginable.
The resources that buyer has at its disposal dwarf those of seller, not only in terms of the number of people, but the amount of money buyer can allocate for their services. And these people – attorneys, advisors, consultants, CPAs, etc. - don’t come cheap. For seller, transaction costs for micro-market deals ($10M -$100M in transaction size) typically run between $100k and $200k. For buyer, transaction costs for the same deal size typically run $300k - $600k. With such hefty fees being paid by buyer, buyer’s contractors need to justify their value. Thus, it’s not unusual for these advisors to aggressively search for any element of the business being acquired that can justify a reduction in purchase price, or change the structure to de-risk the transaction: more monies held-back tied to future performance, additional escrow monies to protect against potential liabilities, etc. In both events, changes to the deal that accrue to buyer’s benefit. All of buyer’s “hired guns” want to be heroes. They want to show buyer that they’re worth the money. They want to get their client a better deal. And a better deal for buyer means a sub-optimal outcome for seller. (It’s important to note here that the negotiations between buyers and sellers described herein are not to be characterized as distributive bargaining. As a point of fact, M&A deals are not zero-sum games)
So, what can a seller do to offset this asymmetry in buyer resources? Unfortunately, not much in terms of numbers of personnel and dollars available to spend. But neither one of these aspects is an objective advantage to buyer without taking into account the quality of the resources, and negotiating strategy employed.
I’d take experience, wisdom, and negotiating prowess over armies of advisors and monetary advantages any day. And I often do. When seller is properly represented by an experienced M&A pro, it levels the playing field considerably.
Adam T. Hark is Managing Director of Preston Todd Advisors. With 15+ years of consulting in payments technology, SaaS, and fintech, Adam advises clients on growth, exits, and market positioning strategies. Adam can be reached at firstname.lastname@example.org