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How to Approach M&A Negotiations

"When you're going through a negotiation, focus on what you need. It's not about trying to out-negotiate the other party. It's about trying to find a middle ground that works for both sides" - Larry Forman

In this episode, Larry Forman, Senior Manager at Deloitte, talks about approaching M&A negotiations.

Larry talks about the mindset that you need to have approaching negotiations, his advice to sellers, and things to look out for if you are the buyer.

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Larry Forman

Larry Forman, Senior Manager of Deloitte, has been building company value through global corporate development for over 20 years in the software, data analytics, EDI/E-Commerce, document management, and information and media industries, most recently leading global deal teams at LexisNexis and Teradata. With a background in sales, C-level management, and venture capital, and a passion for innovative deal-making and strategy, he has helped small privately-held firms and large public, multi-national companies accelerate their growth, enter new markets, and create sustainable value. He has completed over a $1 Billion in domestic and international acquisitions and divestitures, often managing global deal teams.

Episode Transcript

Text Version of the Interview

Pillars of negotiation

Negotiation can mean a lot of things to a lot of people. Some people want to try to get the very best out of the deal and probably push things too far in the process. So the first pillar is to try to be fair.

Try to find a middle ground simply because with most negotiations, particularly in M&A, it's not one and done, whether you are the seller or the buyer. 

If you're selling a business, you still may have a long-term relationship with the buyer simply because there's are adjustments that need to be made, and there could be many reasons why you still have to collaborate with the seller or the buyer. So you want to have a cordial relationship to get their cooperation when you need it. 

So I try to do deals that are fair to both sides. If I'm the buyer, I want to get my best deal. Or, if I'm the seller, I want to get the most out of the transaction. But all of that has to be within something reasonable and defensible. 

The second pillar is to be open and clear as to what you're trying to do and why you're trying to do it. In that process, you will build something extremely valuable in negotiation: trust. 

If there's no trust between the two parties in the negotiation, it leads to rather extensive negotiations and sometimes deals breakdown. It's better off setting the tone of being open and honest and admitting when there's an issue, especially if you're on the selling side when you put together the memorandum, disclose everything.  

Setting the trust early allows you to deal with the unexpected in a way that doesn't blow up the deal. 

The third pillar is, if you're going to ask for something in a negotiation, give a reason for it. Don't just ask for something and expect the other side to understand it because they will be reluctant to consider it. 

Whereas if there's a reason for it, they might understand why you need that and consider your request. They may not concede ultimately, but they may come up with an alternative that works just as well.

So help them problem-solve with you. And the best way to do that is to set the context early on in the deal. So if you're selling a business, why are you selling the business? Explain it. If you are buying a business explain your strategic rationale. 

I wouldn't say things that will cause the deal's price to go up, but I would explain that; here's our hypothesis on buying the business. Here's what we expect to do with it once we buy it. 

And therefore, if there are things that show up in the due diligence process that are counter to those hypotheses, the other side can understand why it's an issue for you and why that would be an adjustment in the deal value or in the operating model or something else that goes along.

Key M&A phases with negotiation

Every phase of the deal process involves some form of negotiation. I'll highlight a couple of phases in particular. 

One is right at the beginning when you're putting together a letter of intent, memorandum of understanding, or an indication of interest; they all mean the same thing. It is where you're setting out the business terms for doing the transaction, including financial terms, legal terms, and other things that matter to you when you're offering up the indication of interest.

The things negotiated in this phase are sometimes the price range if it's not broad enough. If the price range is broad enough, the two sides are usually comfortable starting. 

What I do is give a range and explain it. If it's absolute perfection and exactly what I expect or better than I hope, then the top of the range is likely. If there are detractors of the deal, then the price will go lower, and if there are a lot of things they don't expect that can't be resolved, then the deal may just fall apart.

Other things could be, how long do we have a period to do the deal? The time frame matters a lot to the seller. So you want to talk about your process and why it takes this long to get to the final closing. 

You could have a fair amount of due diligence that you do upfront, but there may be secondary due diligence that takes place later, simply because there are some things the seller doesn't want to expose until they know there's a deal.

A simple example is when a seller doesn't want you to see their software code until they're pretty close to knowing that the transaction is likely to happen at a price they like. They also may not want you to talk to customers, even though I think customer due diligence is pretty valuable for the buyer. The seller doesn't want to spook a customer or two because somebody is talking about a transaction. 

And the other part of it is that nobody really knows how long the deal will take. We don't know how long it will take for the contracts to be negotiated, for example. 

We can set a specific period of time for the due diligence, but contract negotiations can be short and sweet or they can be prolonged depending upon the issues that come up in due diligence. And also the posturing of the legal teams. 

I try to keep the lawyers from doing anything but the legal terms and get the business people to focus on the business terms and have the business people manage their lawyers, but that doesn't always work that way.

So if I get a lawyer on the other side that's trying to change the business terms, I'll usually turn to the business leader on the other side and say, "I'm confused. Am I negotiating with you? Or am I negotiating with your lawyer?" And I've done that a few times, and it's rude, but it gets the job done.

After Due Diligence

When you get through the due diligence, if you're the buyer, you might find some things about the company that is not what you expected. And then the question is, how does that impact your evaluation of the business? 

So you need to be honest about it and tell the seller everything you find problematic. These are value detractors that they need to fix before we close. But if there are things that can't be fixed in a timely fashion, then I want to concession on the valuation because it's not what I thought I was buying. 

That's a hard conversation to have, but if you can explain why it's a value detractor and why you think the value adjustment you're asking for is reasonable, you can usually find a middle ground on that.

Terms negotiated in LOI

How long do you have an exclusive period with the seller? They may say, you have to get the deal done in 90 days, and you might say, that's not going to work for our process, but here's what I'll get done in 90 days.

So, it could be how long the negotiations are going to go on, or the due diligence and the whole buying process is going to go on, which includes the contract development and contract negotiation. 

It could also involve the people who will come with the business. Am I buying the whole business? Am I buying part of the business? Am I getting the engineering team I need or not? You lay those things out. 

All those things could be all the major elements of it can be negotiated in the LOI. I don't usually see that much negotiation going on there other than over price and timing, and a major element in the deal. 

For instance, if I'm buying this business because I want the people, then one key issue is I have to get at least 80% of the people to sign on before we'll do the deal. If that's a deal stopper at the beginning, we need to talk about it. 

Generally, that's more of an issue towards the end of the process, but it may be something you put in the indication of interest upfront.

Negotiation around Sensitive Information

Often, when it's a technology purchase or technology sale, there's certain sensitivity about exposing the technology or key trade secrets to the other side. 

You can break the due diligence into two pieces. The first is the initial tech review at the architectural level to understand how your product is constructed without exposing the code.

And then do secondary due diligence when there's high certainty that the deal will occur. Usually, the seller's more willing to expose more sensitive aspects of the company.

The alternative to that on the technology side is pretty straightforward. There are third parties that will do technology reviews and only provide you, the buyer, back a report on what they've seen, but you're not exposed to the code. 

You're getting answers like:

  • Is the code well constructed? 
  • What kind of technologies are involved? 
  • How many open sources are in there? 
  • Are the open-source licenses appropriately handled or referenced? 

All of those things could be done by a third party without exposing the code to you, the buyer. Especially if it's a situation where they're selling to someone they feel might be a competitor, and if the deal breaks down, it will be damaging to them. So that's the two ways I would think about that. 

It really gets down to certainty of close on the customer side before exposing the customers to you as the potential buyer because they don't want to lose customers.

You can request a fair amount of customer information and get back mass answers. So, for example, if I'm doing due diligence, I could ask the seller to provide me a list of the top 10 customers, perhaps give me the industry, but don't give me the customer's name.

I want to see the revenues for the last three to five years. So I can look at revenue trends with that particular customer. Are the revenues growing in those top 10? Are they declining? Or is the top 10 wildly different every year. So I get some sense of the continuity of the business without ever having to talk to the customers.

So if I see high customer churn, that will tell me something without even talking to the customers themselves. If I see customers that have, that are sticky, that stayed there year in, and year out, that's usually a good sign of stability for the business. 

So one could assume that those customers aren't going away. And as you can imagine, recurring revenue is far more valuable quality-wise than one-off revenues. So a customer with a long-term relationship is better than a brand new customer in some ways. 

Initial Price Negotiations

The most common approach is if I'm looking at a business, hopefully, they have some confidential information memorandum, or they have some basic information they're willing to provide on the business's financials and their financial forecast.

I'm going to use their information and create my models, and I'm going to evaluate what they said regarding the company. If it turns out during diligence that their information is inaccurate, the price will go down. I would explain to them why. 

It's more of running discounted cash flow models based on the numbers.

If the buyer priced the company too high, it's important to understand how they value the business because it's not the same as my analysis and I'm using pretty standard approaches to doing the evaluation. And sometimes it comes down to things that I didn't even know was there. 

For example, they might have this rather large contract pending that's not in the projections yet, but the seller thinks it could be worth X, so they added that to the valuation. 

In that case, I might bifurcate the deal and tell them their business is worth X, but if they get this other contract and it's worth what they say it's worth, I might consider an earnout. Many things can affect the valuation and the results, but you want to understand what the variance is.

We did this one deal, and the seller is asking for all kinds of indemnities related to a particular bill that was going to congress that hasn't passed yet and wasn't fully understood. 

And we can give him that based on the fact that we don't know what the bill looks. I held my ground and told him that if they insist on this, we're just going to have to back out from the deal. They caved in and closed the deal. 

When you're negotiating, focus on what you need. It's not to try to one-up somebody; it's not trying to out-negotiate them. It's trying to find the middle ground that works for both sides. 

I was doing that, but he was so focused on the contract.

Also, don't try to negotiate everything on the spot. Often, the best thing to do is say, let me think about it and then get back to them with a rational response because if you try to negotiate when everybody's heated, something dumb will happen, so don't do it.

Due Diligence Surprises

If you're a seller and you're putting together your confidential information memorandum to present to the prospective buyers, diligence the business yourself as if you were a prospective buyer. 

Discover everything you can about the business so that you can fairly represent it to prospective buyers. You're not caught flat-footed with a bunch of surprises that the buyer finds in due diligence. 

Even though I thought I did a fairly good job of doing diligence on our business, I had that happen to me. One of our contracts prevented them from getting much revenue from a large customer. 

So I had to concede something on the price for that piece, but if I had seen that earlier, I would have tried to mitigate the agreement or negotiated the agreement before we went out for sale. 

So, whenever there's an issue that can be mitigated, either mitigate it before closing or at least show a process to get it mitigated. So you don't end up with the big value subtraction due to that. 

And the other times are closing requirements. A simple example that is commonly negotiated is automatic assignment clauses. If there aren't any, the buyer will always look for the certainty that the customers will move over to them post-close. 

So between signing and closing, you go in and let the customers know that the transaction will happen, and you want them to agree to transfer the assignment from the seller to the buyer. 

And you might have to argue about what percentage of those buyers have to come over or what dollar value of those contracts have to come over before you close. So that's something that gets negotiated towards the end of the deal, depending upon what the buyer imposes pre-closing conditions.

Sometimes there are non-economic issues too. If there are key individuals that the buyer has identified that are must-haves for the business, then between signing and closing, you to secure that they sign on for the new business. 

So there's a two-part set of golden handcuffs. The first one is to get them to help you close this deal, and they'll get a bonus for doing so. And the second is there'll be stay bonuses. If they remain at the business for six months, 12 months, 18 months, whatever the number is. 

And those things can be negotiated together with which people fall into that category and who pays for it.

Deal Breakers

Sometimes it has to do with limitations of liability. For instance, you're saying you're going to be able to sell them the business, and you have the right to do that, but you dont own your IP. In that case, you should be giving a high indemnification to the buyer because they're buying something they think you have the right to. Those things should be an unlimited liability.

In other cases, the liability might be limited to an amount negotiated between the two parties. No matter what happens, the ultimate limit of liability is a million dollars. And then the question is, okay. How much of that limitation of liability might be in a holdback. 

In other words, I'm going to buy the business for $25 million, but I'm going to put $2 million of it into escrow. And I'm going to wait until the first year goes by to make sure that there's nothing that shows up that wasn't disclosed in the schedules of the transaction document.

Disclosure schedules

If I were to caution anybody in terms of working on a sales contract or acquisition agreement, I would say pay very close attention to the disclosure schedules because it will tell you what you're getting and what you're not getting.

And don't leave those at the last minute because if you do, chances are they'll get messed up. And you won't get what you thought you were getting, or you might have sold something you didn't think you sold.    

They're also tedious, so you have to make sure you have the time to get them and review them and not just put them into the agreement at the last minute.

The business owner should be the one reviewing this. The business sponsor for the deal has to understand what he's getting and all of the things he asked for because there could be situations where some things are left out by design, and you expected it to be included in the deal. 

So the financial people should be looking at it, and the business people should be looking at it. If you just leave it up to the lawyers, unless the lawyers know your business extremely well, you're probably only going to get a legal point of view and not a business point of view.

Does Getting Customer Assignments Violate the NDA?

To avoid violating the NDA, we would have the seller go to the client and tell them about the deal, and they should talk to us. If the customer decides to talk to us, that's a way to get permission to give their name out. If the customer doesn't give their consent, then the seller will probably not give us the name.

I'm happy if I can call the client myself, but it's a three-way call a lot of times. The seller is there shepherding the client, and I'm asking the client a scripted set of questions because the seller doesn't want me to ask too many questions that are different than what he expects me to ask. 

Things Hotly Negotiated

Non-compete clauses. It can be the duration of the non-compete, meaning you cannot compete with the eventual buyer of your business for a specific period of time. Usually, it's 2 to 3 years; sometimes, it's five years. Any more than that is too much. 

And sometimes, It could also be the definition of the business you're selling. There was this one deal where we were trying to sell one of our business sectors to a rather large company, and they came back with a non-compete clause that defined the business so broadly that our parent company would not be able to operate. 

So I told them that I would agree to the deal if they would increase the price to a billion dollars because they're practically buying our entire company. And when he realized that he made a mistake in his definition, he reiterated it, and we closed the deal. 

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