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As instruments of strategic company management they have become an indispensable element of business life: "Mergers and acquisitions", meaning combinations and takeovers of enterprises or parts of enterprises. How can such transactions be negotiated in an effective and focused manner? There are extensive theoretical negotiation models – but how can these be implemented specifically? This book wants to make a contribution to transferring such theories to day-to-day M&A negotiation practice. It conveys practical knowledge in order to make negotiations for the purchase and sale of an enterprise more successful. The focus is on the area which in Germany accounts for the majority of enterprises: medium-sized companies. It is addressed to entrepreneurs, attorneys, auditors and tax advisors as well as all corporate finance professionals who are involved in negotiation situations. With numerous case studies from consulting practice, Arnd Allert accomplishes the transfer of theoretical knowledge to day-to-day practice. In this book, Arnd Allert has compiled his knowledge from more than one hundred M&A transactions and gives an insight into the world of M&A consulting which in this comprehensive form so far was almost impossible to find.
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Arnd Allert has been working in the corporate finance industry for more than 20 years. He started his professional career at Deutsche Bank AG. In 2003, he founded the M&A consulting firm Allert & Co. GmbH, which today is among the leading consulting firms for mergers and acquisitions in Germany. In addition to his consulting activities, he is lecturing at universities on the subjects of „Mergers and Acquisitions“ as well as „Negotiation“ and, in addition, is a member of several supervisory and administrative boards.
As instruments of strategic company management they have become an indispensable element of business life: „Mergers and acquisitions“, meaning combinations and takeovers of enterprises or parts of enterprises. How can such transactions be negotiated in an effective and focused manner? There are extensive theoretical negotiation models – but how can these be implemented specifically? This book wants to make a contribution to transferring such theories to day-to-day M&A negotiation practice. It conveys practical knowledge in order to make negotiations for the purchase and sale of an enterprise more successful. The focus is on the area which in Germany accounts for the majority of enterprises: medium-sized companies. It is addressed to entrepreneurs, attorneys, auditors and tax advisors as well as all corporate finance professionals who are involved in negotiation situations. With numerous case studies from consulting practice, Arnd Allert accomplishes the transfer of theoretical knowledge to day-to-day practice. In this book, Arnd Allert has compiled his knowledge from more than one hundred M&A transactions and gives an insight into the world of M&A consulting which in this comprehensive form so far was almost impossible to find.
Holger Knoblauch is a German lawyer and the founder, co-owner and managing director of his translation firm, HK Translation Services. After studying law in Bonn, Würzburg, Dublin and Tokyo, he worked as an associate with international law firm Shearman & Sterling LLP for five years. After relocating to Hong Kong, he set up his translation firm there in 2005. Today, HK Translations operates from company headquarters in Ludwigshafen am Rhein, Germany, and is one of the country’s leading language service providers specializing in the areas of law, business & finance. Its clients include top national and international law firms as well as global corporate players and renowned financial institutions (www.hktranslations.com).
in small and mid-sizedM&A-Transactions
English first edition
© 2015 by Arnd Allert, Mannheim
Cover design: Daniela Hertel, Grafissimo!
Book design: Caroline Franz
using images from
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using electronic systems in any manner whatsoever without
written permission from Kuebler Verlag.
Structure of this Book
1. Negotiating in M&A Transactions
1.1 Definition of the Concept of “Negotiation” and Basic Models of Negotiations
1.2 The M&A Process as a Series of Negotiation Stages
1.3 Principal-Agent-Problem in M&A Consulting Practice
1.4 Theoretical Analysis – Instruments of Negotiation
1.4.1 BATNA – Best Alternative To a Negotiated Agreement
1.4.2 Reservation Price
1.4.3 ZOPA – Zone of Possible Agreement
1.5 Significance of the Basic Principles of Human Communication and Information Processing for the M&A Process
1.5.1 Paul Watzlawick's systems-theoretical communication model
1.5.2 Thomas Harris' transactional analysis
1.5.3 Friedemann Schulz von Thun's “message window”
1.6 Preliminary Considerations in Dealing with Stress Reactions During Negotiations
2. Theoretical Negotiation Models and their Transfer into M&A Practice
2.1 From Distributive, Competitive (Intuitive) Negotiation to Cooperative (Rational) Negotiation
2.2 Obstacles for the Transition from Distributive to Cooperative Negotiation
2.3 The Harvard Concept as a Possible Route from Distributive to Cooperative Negotiation
2.3.1 Basic Game Theory Principles
2.3.2 Basic Principles of the Psychology of Perception
2.4 Dealing with Risk
2.4.1 Trust your “Gut Feeling”?
2.4.2 Representing Uncertainty Using Mathematics
2.4.3 Uncertainty in Financial Planning Calculations
2.5 Summary of Different Theoretical Negotiation Concepts
3. General Aspects of International Negotiations
4. Negotiation Issues in the M&A Process
4.1 Structuring and Preparatory Measures
4.1.1 Analysis of Motives
18.104.22.168 Analysis of Sell-Side Motives
22.214.171.124 Analysis of Buy-Side Motives
4.1.2 Preparation of the Longlist
4.1.3 Preparation of the Information Memorandum and Other Documents Relevant to the Transaction
126.96.36.199 Information Memorandum
188.8.131.52 Financial Factbook
184.108.40.206 Vendor Due Diligence
220.127.116.11 Valuation Guideline
18.104.22.168.1 Definition and Distinction from Conventional Company Valuation
22.214.171.124.2 Negotiation Parameters in Enterprise Valuations – Issues for Argumentation and Offensive
126.96.36.199.3 Brief Description of the Most Common Methods
188.8.131.52.3.1 Income Approach to Valuation
184.108.40.206.3.2 Market Approach to Valuation
220.127.116.11.3.3 Asset Approach to Valuation
18.104.22.168.4 Issues for Argumentation and Offensive
22.214.171.124.4.1 Value is Not the Same as Price
126.96.36.199.4.2 Negotiation Parameters of the Income Approach Valuation Methods
188.8.131.52.4.3 Negotiation Parameters of the Market Approach Valuation Method
4.1.4 Strategic Selection of the M&A Sales Process
184.108.40.206 Sequential, Bilateral Negotiations
220.127.116.11 Structured Process
18.104.22.168 Auction Process
22.214.171.124 Comparison of the Different Processes and Their Applicability to M&A Practice
4.2.1 Sounding and Approach
4.2.2 Exchange of the First Transaction Documents
126.96.36.199 General Remarks
188.8.131.52 Preparation of the Management Presentation
4.2.4 Obtaining Non-Binding Offers
4.2.5 Non-Binding Offers from the Buy-Side Perspective
4.2.6 Due Diligence
4.2.7 Obtaining Binding Offers
4.2.8 Negotiation of the Sale and Purchase Agreement
184.108.40.206 Composition of the Negotiation Team
220.127.116.11 Preparations for Negotiations
18.104.22.168.1 General Preparatory Measures
22.214.171.124.2 Dealing with the Perception of the Power Situation
126.96.36.199.3 Selecting the Right Strategy and Tactics
188.8.131.52 Negotiation Stages
184.108.40.206.1 Opening Stage
220.127.116.11.2 Argumentation Stage – Genuine Negotiation
18.104.22.168.2.1 How to Make Concessions
22.214.171.124.2.2 Dealing with Difficult Negotiation Partners
126.96.36.199.2.2.1 Irrational Conduct
188.8.131.52.2.2.2 Arrogance and Antipathy
184.108.40.206.2.2.3 Aggression and Personal Attacks
220.127.116.11.3 Completion/Agreement Stage or Break-Off Stage
18.104.22.168.3.1 Testing the ZOPA – Leading the Transaction Into a Dead End
22.214.171.124.3.2 Building Bridges
4.3 Pre-Closing Phase
4.3.1 Signing and the Conduct between Signing and Closing
4.3.2 Closing and Post-Closing Conduct
5. Ethics in Negotiations
List of References
Figure 1 The M&A process flow, using the example of the sale of an enterprise
Figure 2 Selection of possible areas of conflict
Figure 3 The classic Lehman Formula
Figure 4 Different compensation combinations for M&A consulting services
Figure 5 Example of the economic development of a company
Figure 6 Model calculation for the continuation scenario (contribution to a foundation)
Figure 7 Model calculation for the liquidation scenario
Figure 8 Model calculation for the IPO scenario
Figure 9 Comparable companies – overview
Figure 10 Range of values in the IPO scenario
Figure 11 Sample comparison of alternatives for action
Figure 12 Schematic diagram of the creation of a ZOPA
Figure 13 Summary of theoretical negotiation principles
Figure 14 Selection of key factors influencing a negotiator in M&A transactions
Figure 15 Message - Sender - Receiver model
Figure 16 Domination, equality and subordination in transactional analysis
Figure 17 The 4 sides of a message
Figure 18 Occasion-related stressors in M&A transactions
Figure 19 The human brain
Figure 20 Hormones produced in the human brain
Figure 21 Ways of coping with stress in M&A transactions
Figure 22 Sphere of responsibility and sphere of influence
Figure 24 Redefinition of the sphere of responsibility and the sphere of influence by involving an M&A advisor
Figure 23 Maslow's pyramid of needs
Figure 25 The basic principles of the Harvard Concept
Figure 26 Potential liability risks I
Figure 27 Potential liability risks II
Figure 28 Potential liability risks III
Figure 29 Pay-off diagram of the prisoners' dilemma
Figure 30 Pay-off diagram of the negotiator’s dilemma
Figure 31 Problem areas of the application of cooperative negotiating
Figure 32 Example of a complex decision-tree
Figure 33 Example of a pay-off matrix
Figure 34 Terrified woman
Figure 35 Bids for drilling licenses
Figure 36 Results of an experiment conducted by the author with 1,000 rolls of the die
Figure 37 Results of an experiment conducted by the author regarding the aggregate number of pips in 1,000 rolls of the dice
Figure 38 Example of the economic development of a company
Figure 39 Definition of the expected value of the value drivers
Figure 40 Value drivers and likelihoods of occurrence
Figure 41 Risk simulation of a value driver with right-skewed distribution
Figure 42 Monte Carlo simulation of the terminal value with equal distribution
Figure 43 Income statement after conducting a Monte Carlo simulation
Figure 44 Determination of the enterprise value using Monte Carlo simulation
Figure 45 Division of the determined enterprise value in intervals
Figure 46 Analysis of the risk of a total loss
Figure 47 Value drivers and modified likelihoods of occurrence
Figure 48 Determination of the enterprise value using a Monte Carlo simulation with modified likelihoods of occurrence
Figure 49 Intuitive, competitive negotiation vs. rational, cooperative negotiation
Figure 50 Relevant factors in international negotiations
Figure 51 Influence of a country's culture on the negotiation style
Figure 52 Analysis of the motives in the course of the M&A process
Figure 53 Forms of conflicts of interest of seller and management
Figure 54 Incentives in the case of conflicts of interest between seller and management in M&A transactions
Figure 55 Interests of different groups of investors
Figure 56 Preparation of the longlist as next step in the M&A process
Figure 57 Identification of suitable target companies as part of the preparation of a longlist
Figure 58 Preparation of the information memorandum and other documents in the M&A process
Figure 59 Sample outline of an information memorandum
Figure 60 Sample outline of a financial factbook
Figure 61 Sample outline of a teaser – page 1
Figure 62 Sample outline of a teaser – page 2
Figure 63 Dependency of the valuation method on the quality of information
Figure 64 Stand-alone valuation, opportunities for increasing value and purchase price potential (without consideration of tax effects)
Figure 65 Complexity of determining value price
Figure 66 Merger model
Figure 67 Distinction between traditional enterprise valuation and valuation guideline
Figure 68 Present value concept vs. IRR concept
Figure 69 IDW's concept of functions
Figure 70 Overview of the most common valuation methods
Figure 71 Simplified reconciliation from enterprise value to equity value
Figure 72 Results of cashflow modeling and its effects on the value contribution of the terminal value
Figure 73 Arguments for enterprise values
Figure 74 Sensitivity analysis of the effects of different WACC and beta factors
Figure 75 Selection of a peer group
Figure 76 Rough calculation for the determination of the implied beta factor of a multiple
Figure 77 Various multiples and the corresponding length of distribution
Figure 78 Sample DCF analysis with implied multiples and sensitivity analyses
Figure 79 Selection of the sales process in the overall M&A process
Figure 80 Vickrey auction
Figure 81 First-price sealed-bid auction
Figure 82 English auction
Figure 83 Dutch auction
Figure 84 Summary of standard auction rules
Figure 85 Overview of the features of the different sales processes
Figure 86 Seller objectives in the selection of the M&A sales process
Figure 87 The perfect number of bidders
Figure 88 "Magic triangle" in the transaction process
Figure 90 “Handelsblatt Online”
Figure 89 Newspaper article in the Financial Times Germany of 9 July 2012
Figure 91 “Reuters Deutschland”
Figure 92 Comparison of negotiation and auction
Figure 93 Three elements of a negotiauction
Figure 94 Overview of offers – phase 1
Figure 95 Overview of offers – phase 2
Figure 96 Sounding & Approach in the overall M&A process
Figure 97 Risks and opportunities profiles of the basic merger strategy types
Figure 98 Exchange of first transaction documents in the M&A process
Figure 99 Management presentation in the transaction process
Figure 100 Stages of a management presentation
Figure 101 Example of an abbreviated investor profile
Figure 102 Success factors of a management presentation 1
Figure 103 Success factors of a management presentation 2
Figure 104 General motives of top decision-makers and matching features of the enterprise to be sold (example)
Figure 105 Feature-advantage-benefit table
Figure 106 Obtaining non-binding offers in the M&A process
Figure 107 Alternative courses of negotiation processes
Figure 108 Decision-tree for submitting a first, non-binding offer as a basis for further negotiations
Figure 109 Selection of strategic considerations, tactics and methods for distributive negotiation
Figure 110 Due diligence phase in the M&A process
Figure 111 Physical vs. virtual data room
Figure 112 Submission of binding offers in the M&A process
Figure 113 Negotiation of the purchase agreement in the M&A process
Figure 114 Parameters of a share deal vs. an asset deal
Figure 115 Illustration of the tax aspects and their effect on marginal price in choosing an asset deal or share deal structure
Figure 116 Varying international views regarding the evel of specificity of contractual agreements
Figure 117 Varying international perspective on the matter of contract drafting
Figure 118 Negotiation teams in M&A practice according to the FBI model
Figure 119 Varying international organization of negotiation teams
Figure 120 Varying international communication styles
Figure 121 The four greatest challenges in negotiations abroad
Figure 122 Possible sources of information regarding the people at the negotiating table
Figure 123 List of possible negotiation issues for a sale and purchase agreement
Figure 124 Varying international sensitivity for time
Figure 125 Basic negotiation strategies
Figure 126 Hardball negotiation tactics
Figure 127 Overview of results when the different negotiation strategies clash
Figure 128 Network of relationships in M&A transactions in crisis and insolvency proceedings
Figure 129 Varying international interest in the relationship and the result of the negotiations
Figure 130 Varying international attitudes towards the general types of negotiation strategies
Figure 131 Psychological effect of the seating of the participants in negotiations
Figure 132 Argumentation by comparison
Figure 133 Evaluation
Figure 134 Chain of proof
Figure 135 Compromise
Figure 136 Handling of objections
Figure 137 Handling of objections, using the example of an automotive supplier
Figure 138 Various patterns of concessions
Figure 139 Perception of a large concession by negotiators from different cultures
Figure 140 Varying international degrees of emotionality in negotiation situations
Figure 141 Technique for replying to personal attacks
Figure 142 Distance zones – internationally and in Germany
Figure 143 Varying international body languages
Figure 144 Interdependency of the relationship between the negotiation partners and the demands raised and its effect on negotiation tactics and style
Figure 145 Signing in the M&A process
Figure 146 Closing in the M&A process
This book mainly seeks to convey two messages: On the one hand, it describes the reality of negotiating M&A transactions involving medium-sized enterprises – today generally referred to as mergers & acquisitions (in brief: M&A) – below the perception threshold of standard mass media and professional publications. It thus addresses an issue which from an empirical perspective represents, in particular, the German economy like no other, but often appears too insignificant for mass media. It concentrates and operationalizes the treasure trove of experience of M&A advisors who for years have dealt exclusively and very successfully with sales of non-listed German medium-sized enterprises. That does not mean that the book is of no interest, for example, for students of business administration or even for M&A advisors with a capital markets focus. It certainly is. However, this applies with the proviso which at the same time is the second core message of this book:
Anyone dealing with medium-sized enterprises who only sees the transaction and disregards the people behind it or even considers enterprises to be merely ‘commodities’ will never get through to the owners of medium-sized enterprises, their language and way of thinking. For this reason, contemplating transactions involving medium-sized enterprises does not commence with the present and neither the past, but with the future of the people who are at the foundations of an enterprise. The objective is not only to ‘get the deal done’ with an acceptable or a very good price – but to ask oneself: How does the transaction have to be designed or structured and what kind of negotiations are required in order for the transaction to be successfully concluded and, thus, the enterprise as well as the people involved in it to have a secure and better future? This conclusion is forward-looking not ‘only’ from an ethical perspective. An ethically sound course of action is no luxury or amenity which one chooses to afford, but in the experience of the author it is also, especially in the context of medium-sized enterprises, simply more successful in the long term than any other approach.
Since M&A transactions no longer take place only behind closed doors, but have also become an issue for the public and for scientific debate, there have been a lot of research and publications on this topic. However, most articles and books one can read on the subject focus either on strategic, statistical, financial, procedural or, in particular, legal aspects. Mostly, the issue of dealing with people and their future before, during and after the negotiations is – if at all – only addressed briefly and divided into the different steps of the negotiation processes (non-binding offer, letter of intent, binding offer after due diligence, SPA negotiations, etc.) from a procedural perspective.
However, it is by no means the intention of this book to disqualify the existing publications on the issue of M&A, but rather to complement them. The aim is to close a gap of experience and perception that is evidently existing in this context. In order to be able to do this, it systematically examines all the elements which usually remain hidden ‘in the black box of the experienced dealmaker’. Eventually, the issue here will always be the clear and unambiguous focus on negotiation techniques, which means dealing with, on the one hand, the complexity of a transaction and the ‘hard facts’ and, on the other hand, the sensitivities, hopes and sometimes also fears of the people involved, which one has to be able to handle in M&A deals.
This concept is also the methodical core of this book: The successful negotiation of M&A transactions (involving medium-sized enterprises) has a lot more facets and objectives than merely the conclusion of a purchase agreement. For that reason, this book transfers known negotiation concepts and techniques from other areas to the area of M&A involving medium-sized enterprises and combines theories with actual and real-life practice.
The importance of this is also shown by statistics: Many studies show that M&A transactions were not successful in retrospect. However, the best collection and analysis of statistical data are only available for transactions of listed companies – i.e. for sales of enterprises, the success of which is measured either in terms of an increase of the stock price or based on published profitability indicators. This seemingly complete transparency and fungibility of the wealth of figures does not always help in understanding the matter. It has to be borne in mind that the development of stock prices, in particular, are known to be influenced by many more internal and external factors than only the subject matter of our examination, the economic success, for example, of the merger of two enterprises. No one may know in which manner the figures of a company would have developed if the transaction had not occurred.
In any event, in the case of unsuccessful mergers, acquisitions of enterprises or disposals of companies, the assumption suggests itself that something might have been overlooked: the clear and unambiguous focus on value-driven negotiation techniques for M&A-Transactions, which form the basis in order to actually achieve the objectives pursued with the transaction to be reflected in the transaction structure.
And this is the hypothesis and the promise of this book: Success can be achieved if negotiations are conducted the right way and aimed at creating value. This is because organizing and conducting negotiations in an ethical manner means significantly more than mere bargaining at a bazaar, where you haggle for a while to then agree – starting from maximum positions – on a certain price. Rather, it is a manner of thinking and acting which deals with the complexity of the ‘product’ as well as with the organizational and human sustainability, both from the buyer's perspective and beyond. In most cases, this also includes taking into account a number of parameters which, unfortunately, are not always disclosed in the negotiations.
How helpful the inclusion not only of the hard, but also of the soft facts can be, may best be understood by looking at the example of safeguarding an enterprise in the context of legal succession. If communication and thinking disregard the fact that in this case the transaction is not only about an ‘object of sale’, but also about appreciating the lifetime achievement of a person, the buyer will fail, either during or after the sales process.
Even though, in the end, M&A transactions involving medium-sized enterprises are also about figures, they are not exclusively about figures. Anyone who keeps this mind will simply negotiate more successfully.
One last thought: Howard Raiffa, one of the great scientists in the field of negotiations, chose as a title for his standard work on this issue: “The Art and Science of Negotiation”. Art can certainly not be learned, but one may and has to learn the craft as a basis in order to then also express art. The philosopher Adorno is said to have coined the term of art as the “knowledge of the standard, plus deviation”; this book aims to convey the standard and point out, at some instances, the possibility of deviation from this standard. When describing the term ‘rhetoric’, it is often said that a good author is born, but a good speaker is made; this also applies here in a similar manner: a negotiator is not born, but made. I hope you will find this book entertaining and be successful!
Since a comprehensive description and explanation of the negotiation element in M&A transactions comprises a multitude of topics, I gave a lot of thought to the structure of the book. It is intended, on the one hand, to provide the conceptual foundations in order to describe the generally accepted assumptions in the theory and practice of negotiation and, at the same time, to show whether these assumptions can also be applied in M&A consulting practice. On the other hand, is it important for the competent reader to advance relatively quickly from abstract to specific information with a practical benefit. Hence, I decided to divide the book into two major parts.
Part A comprises definitions of certain terms and theoretical explanations of important concepts in the context of negotiations. I consider this necessary, since a common understanding of the reader and the author of certain terms and words ‘creates a common basis’. This is the only way to eventually weave together the many threads which have to be combined for a thorough understanding of the negotiation element in M&A transactions, in a manner which is comprehensible for the reader.
Part B describes the practical application of the concepts in M&A consulting practice. In order to be able to use a conceptual guideline in this part as well, I reflected the general process of an M&A transaction already described in Part A and described the individual elements of the negotiations in detail with a view to this process. Many of the presented concepts, methods and tools are, of course, also applicable at other stages of the negotiations; however, it seemed to be most plausible to describe them sequentially and along the process chain of an M&A transaction.
The publisher has dedicated a website to this book. Please use this website in order to be able to download the checklists for the preparation and follow-up of negotiations referred to at various instances in the book.1 These checklists are meant as a first suggestion. Since the powers of comprehension of each person are different – and this is even more restricted in stress situations, such as the final SPA negotiations in an M&A transaction – it is advisable to compile one's own checklists and tools, in order to be well prepared for difficult negotiation situations.
No one writes a book all on his own. Accordingly, gratitude is due to the people who have contributed to the creation of this book with their advice and support. First an foremost, my business partner, Matthias Popp, whose negotiation skills I had the privilege to observe in many transactions and from whom I have learned a lot. My thanks go to Dr Johannes W. Feuling for the support in many respects of now more than a decade and his suggestions regarding this book. Since the first part does not only address the psychological basis of conducting negotiations, but also the physiological effects of stress situations, I am grateful, in particular, to Dr med. Heinz Uhl for the thorough explanation of the relevant medical facts and symptoms.
Allert & Co. would not exist in its current form if Professor Dr Carl-Heinrich Esser had not offered me his advice and support from Day One of the formation of the company. How to drive a hard bargain and still preserve decency and form as an individual at all times – this I was taught by my “First Instructor and Mentor” during my employment with Deutsche Bank AG, Mr Peter Rohr. I am also grateful to all attorneys, insolvency administrators and other business partners with whom I had the pleasure to negotiate over the years – either side-by-side or across the table. My grandfather taught me that one ‘had to steal with the eyes’; accordingly, I have ‘stolen’ tips and tricks from all the negotiation partners mentioned above and have tailored them to my needs. I hope they will forgive me.
I am also greatly indebted to my publisher, Mr Bernd Kübler, for his continued trust in me in different areas for meanwhile almost 20 years, and also to his wife Alena for attending to the extensive editorial tasks.
Last but not least, I thank my wife Anita for her incredible patience and indulgence with my moods during the writing of this book and my entire family for their sacrifice of family time. I experience defeats in negotiations all the time in discussions with my daughters; although still young, they employ a multitude of the techniques listed in this book intuitively and successfully, and they show me again and again how bad a negotiator one is, if one is truly emotionally involved. However, I like these defeats in negotiations best. Without you, all this would not be possible.
In addition, I thank all clients of Allert & Co. for the trust put in me in the last ten years and the opportunity to jointly achieve successes in numerous exciting (and exhausting) negotiations. I would like to conclude these acknowledgments with the words of Henry Kissinger in one of his works: “It goes without saying that the shortcomings of this book are my own responsibility.”
What, then, does the term ‘negotiation’ mean? In order to establish a joint basis for the ideas presented in this book, it seems useful to define the term at the outset: In everyday language use, this word is used very often. Be it in a discussion with a child about when to do the homework or in multilateral negotiations of international conflicts (unfortunately, sometimes also involving war) – from a structural perspective, it is always the same process, for which there is a good definition:
“Negotiation is a process whereby two or more parties seek an agreement to establish what each shall give or take, or perform or receive in a transaction between them.”2
Important points – with a view to the M&A process – of this definition are:
- two or more parties (e.g. buyer, seller, but possibly also staff, creditors, key customers)
convergent and divergent interests (for instance, the completion of the transaction as a convergent interest and e.g. the amount of the purchase price as a divergent interest)
voluntary decision to negotiate (e.g. in the case of M&A transactions that are not dictated by a crisis situation)
- agreement (on the object of the negotiations and the procedure)
sequential process requiring time (e.g. as defined by the process letter of the M&A advisor)
at first, mostly incomplete information (e.g. information asymmetry between seller and buyer at the beginning of a transaction)
alteration of positions as a result of new circumstances (e.g. purchase price adjustment after new interim figures or changes in the amount of working capital)
- Who is supposed to do what?
(agreement on the allocation of tasks, e.g. exchange of risks, opportunities and warranties)
The general idea is as follows: A negotiation is intended to create a value between the parties by way of a suitable agreement which puts the parties into a better position than without this result of the negotiation.
However, in this respect the following is also true: Any negotiation may be conducted by means of dispute or amicably. While in earlier times many disputed negotiations were settled by means of fight (or even war), today this is rare in the economic context. In this respect, the starting point of negotiations is always the pursuit of certain objectives. Remarkably, Carl von Clausewitz in his book “Vom Kriege” (About War) defines war “as the mere continuation of politics with other means”. In this sense, von Clausewitz wrote, war was “an act of violence, intended to force the opponent to fulfill our will”.3
The process flow described in Figure 1 shows the individual steps in the course of a company transaction, using the example of the sale of an enterprise. This Figure serves as basis for the explanation below of the individual negotiation issues.
Figure 1The M&A process flow, using the example of the sale of an enterprise
Even though in company mergers and acquisitions the ultimate objective is the legally binding completion, the closing of the transaction, there are still a number of negotiation situations on the way to this destination, all of which are very important as necessary intermediate steps for achieving the eventual completion.
For example, obviously the negotiation partners seek to improve their respective positions in the course of the discussions.
Accordingly, the terminology of negotiating in M&A transactions often used in practice is not restricted to the negotiation of the wording of a purchase agreement, but comprises all negotiation issues in the M&A process.
Nonetheless, in many publications the term ‘selling’ is still used synonymously with the term ‘negotiating’.
Are these two terms actually only two words for the same thing?
‘Selling’ means: to point out to the potential customer
the product features
the mode of operation
By reasoning in this order – after dealing with any objections – an agreement is reached in the form of the sale.
In contrast, ‘negotiating’ means: on the one hand, the ability to use the instruments of active selling specified above, but on the other hand also to identify and take into account
of the other party. It should already be said at this early stage: The ability to successfully structure and negotiate an M&A deal in most cases requires more of the fine art of careful listening than of persuasion. If you look at the requirements asked of an M&A advisor, at the beginning of the M&A process the focus is certainly more on the selling capabilities, whereas at the end of the sales process negotiation know-how and skills as stated in the above definition and a large portion of experience are decisive for a successful transaction.
For decades, M&A advisors both on the sell-side and buy-side have been remunerated primarily on a success fee basis. This market standard, on the one hand, makes this segment highly attractive for investment banks and consultancy firms, but this also entails a number of risks and, in particular, areas of conflict for negotiation situations, which cannot be disregarded when looking into the subject. This applies to the M&A advisor, for one thing, but also to other parties involved in a transaction.
Figure 2Selection of possible areas of conflict
Figure 2 above shows a selection of possible areas of conflict, all of which may be summarized in the principal-agent problem known from business administration theory.
The principal-agent problem or agency dilemma (sometimes also referred to as principal-agent model) is a concept from New Institutional Economics originating from economic science. This theory was first discussed in an article by Michael Jensen and William Meckling in 1976. Its main features are based on the theory of incomplete contracts which was established, amongst others, by Ronald Coase. In this respect, the party retaining a contractor is referred to as principal and the commissioned party as the agent. The latter usually has an information advantage (asymmetry of information), which may be used in different ways either for the benefit or the detriment of the principal. The theory thus offers a model for explaining the conduct of individuals and institutions within a hierarchy. Besides, it offers general statements on the structuring of contractual agreements. The principal-agent theory is based on the assumption of economic subjects who are restricted in their decision-making, for example because of an asymmetric allocation of information. They only have incomplete information when they have to assess the conduct of other parties. Furthermore, it is assumed that the parties involved are opportunistic. Using a wide definition, there is a principal-agent relationship as soon as the economic well-being of one party (principal) is dependent on the acts of another party (agent). According to a more narrow definition, there is a principal who commissions an agent with a task by way of mutual agreement against consideration. Since both of them pursue different objectives, conflicts may arise. In addition, risk attitudes are being considered: Generally, there can be risk neutrality, risk aversion or risk appetite on both sides. This depends on the character traits and the respective situation of the protagonists. The principal commissions the agent hoping that he will complete his task for the benefit of the principal. However, he only has a restricted perception of the commitment and/or the qualities of his agent and sees – if at all – only the result of the latter's efforts. In contrast, the agent has an information advantage, since he has a better knowledge of his own qualities and is in a position to determine his own conduct himself and, accordingly, to assess it accurately. He is likely to exploit this information asymmetry to the detriment of the principal, if this serves his own purposes.
In order to eliminate this conflict and to establish an alignment of interests, in the past a success-based compensation was deemed an appropriate instrument in order to neutralize this potential conflict by means of the joint focus on the objective of the completion of the transaction. The market standard for this success-based compensation was found in the classic Lehman Formula4 and its modifications. Originally, the Lehman Formula was designed as a compensation model for banks who had raised capital from an investor or were conducting a major share transaction for customers. The formula was applied to the aggregate amount of the transaction and originally structured a success fee as follows:
5% for the first million of the transaction volume
4% of the second million
3% of the third million
2% of the fourth million
1% of the amount exceeding 4 million.
For example, the fee of a bank in a capital increase of €10 million thus amounted to
Figure 3The classic Lehman Formula
This formula was also used in the M&A area, in particular in the period between 1970 and 1990, but as a result of various aspects, including inflation and especially changed expectations regarding returns of the parties involved, it was used with different threshold values (e.g. 5% for the first EURO 10mn, plus 4% on the next EURO 10mn etc.). Meanwhile, all kinds of variations can be found in the market. In particular in the case of sale transactions, the Lehman Formula is often used in an inverted manner and the percentage rates increase with an increasing transaction volume. This is intended to act as an incentive for the advisors to realize as high a sale price as possible.
In M&A transactions outside the capital markets, there are at least the purchase price for the shares and the extent of the representations and warranties granted as relevant economic parameters. Both parameters are crucial for the economic success of a transaction. However, the Lehman Formula and its variations grant a reward exclusively for the purchase price achieved.
Assuming a transaction could be completed for the seller at a very attractive, high sale price, but the seller would have to grant unreasonably high warranties, then from a purely economic perspective the interest of the advisor of the seller is exclusively the conclusion of the contract. In contrast, if the remuneration of the advisor were to include also the extent of the representations and warranties, then his advice might be different. The difficulties in this situation arise from the fact that at the time of the commissioning of the advisor the extent and the structure of the representations and warranties are not yet determined and that, as a consequence, no hard and unambiguous definition of this objective can be stipulated in the engagement letter or project agreement between the principal and the advisor.
This problem can be solved by granting the advisor – instead of a purely success-based compensation – a basic fee which not only covers part of the costs, but also provides an incentive to pursue and support the transaction taking into account all aspects, even if this includes the non-completion of the transaction.
Another commonly used means for the alignment of the interests of advisor (agent) and principal is the agreement of a so-called break fee or break-up fee, i.e. a one-time payment in case the transaction is cancelled, which provides the advisor with an income exceeding the mere reimbursement of costs and expenses. However, the drafting of such contracts is often difficult, since many clients are reluctant to pay a break-up fee if the reasons for the breaking-up do not arise from the sphere of the client, e.g. in the case of unreasonable warranty demands, but in a dramatically changing capital markets and financing environment, e.g. in the months after the outbreak of the banking crisis in November 2008.
Besides, unfortunately there are many advisors in the market who are ‘selling’ their consulting services and the certainty of the completion of a transaction by becoming engaged exclusively on a success fee basis. The potential client is told that he has no risk from the commissioning of the advisor, and often these ‘advisors’ actually succeed in obtaining an engagement from the client with this reasoning. This, in turn, creates market standards that make it difficult for the sincere advisor to enter into a project agreement regarding the consulting in view of the sale which is well-balanced and in alignment with the objectives of the principal.
It can also still be observed in the market that there are ‘advisors’ who accept compensation in fees from both the buy- and the sell-side. The conflicts in this case are evident. From a theoretical perspective, such conduct might possibly be justified in the case of a mere brokerage service, but on the whole the brokerage function is of rather small significance in the context of a complex project such as the sale of an enterprise and also in an age of market transparency created by the Internet and the global means of communication and information.
The following table gives an overview of the different compensation parameters in the collaboration of a seller with an M&A advisor as well as the respective advantages and disadvantages:
Figure 4Different compensation combinations for M&A consulting services
In addition to these principal-agent conflicts concerning compensation, there are also other potential conflicts which may arise from a possible information asymmetry between the principal and the advisor.
Every negotiation involves tension between the promoting or creating of value, on the one hand, and the claiming of value, on the other hand. Any advisor who as a negotiator – in the absence of his constituent – makes more concessions at the negotiating table in a situation where for him this is adequate with a view to creating value runs the risk of doing this at the expense of his constituent. As the negotiations are progressing it becomes increasingly difficult for him to convince his constituent that these provisions are for the benefit of the constituent or were even necessary and were not imprudently conceded for his own benefit or the benefit of the other side. This puts the original relationship of trust between principal and advisor to a serious test.
The more vehemently a negotiator represents the motives of his constituents, the more likely it is that in the course of his successful operating in the negotiation process he will be able to secure these intermediate successes (position improvements) and will also have to make corresponding concessions in other instances. However, these steps may result in the constituent denying the negotiator's authority for these intermediate steps, arguing: “You were not entitled to make this concession – you should have consulted me first”. The negotiation partners, however, will increasingly assume that the negotiator has been conferred extensive competences. It will be difficult to explain to them if the negotiator is suddenly ‘hiding’ behind the decision of his constituent with regard to certain issues the importance of which may not be the same for the other party as that of the concessions made earlier when obtaining the position improvements.
The better a negotiator knows the motives of his constituents, the harder he can fight for these motives. However, too much know-how entails the risk of a limitation regarding the search for creative solutions. The original advantage of the negotiator, who is able to operate from a more remote perspective and with emotional distance, gives way to the disadvantages of the fully informed and, thus, also fully involved negotiator.
Unfortunately, the conflicts listed above only represent a selection of possible conflicts between the principal and the advisor in M&A transactions. For the elimination of these conflicts, it is crucial to create as much of an alignment of interests as possible between principal and advisor.
This has to be achieved, on the one hand, with a respective remuneration regime (adequate retainer, adequate success fee (possibly combined with a minimum and maximum fee and a break-up fee) and, on the other hand, by continuous communication between advisor and principal, which makes it possible to identify, to explain and, thus, to professionally deal with the system-inherent conflict potentials described above – and in the ideal case to even avoid them entirely. Naturally, this requires a high degree of mutual trust – not only regarding the professional skills of the advisor, but also regarding his personal integrity.
Accordingly, it is important for the principal to select an advisor who has a positive track record of these qualities and who, as a consequence, does not depend on completing the transaction at any price, with any warranties and with any contractual partner.
In order to make sure that in the further course of this book we will be using the same language and terminology, in the following the most important terms are defined which we can utilize in order to analyse negotiation situations.
The term BATNA was coined by the authors of the Harvard concept, who consider thinking in alternatives as the basis of rational, cooperative negotiations. In this context, the acronym BATNA refers to the “Best Alternative To a Negotiated Agreement”. It describes – in addition to the many alternatives which exist in the course of negotiations and the agreement with the negotiation partner – the best alternative in the event that an agreement is actually not reached. For example, the BATNA of an entrepreneur with regard to the failure to reach an agreement for the sale of his company may be
the continuation of the company with the existing management and the withdrawal of the entrepreneur to the shareholder level,
an IPO of the company,
the liquidation of the company or
the contribution of the company into a foundation.
Before important negotiations it is crucial to consider what is most likely to occur if no agreement is reached – and which options are available in case of a failure? In this respect, it is particularly important to correctly assess the probabilities and – if possible – to put a price tag on the various alternatives5.
In addition to assessing one's own BATNA, anticipating the BATNA of the negotiation partner is also an important element in the preparation of negotiations. It should be noted that in this process it is of paramount importance to assess the situation of the negotiation partner on the basis of facts and to accept in the analysis that some factual circumstances cannot be evaluated with certainty. Assumptions and allegations such as: “Potential buyer A has no alternative!” are extremely dangerous, as they lead to misconceptions which may also have a counterproductive effect on one's own attitude towards the objective of the negotiations and misdirect the negotiation position one is assuming. In this respect, the motto has to be: ‘Stop guessing!’
The case study presented in the next chapter describes the search for alternatives (BATNA) in the course of a sale assignment resulting from an unsolved succession in the enterprise.
We need to keep in mind: The specific knowledge of the best alternative translates into independence in the negotiations. The BATNA analysis is a must-do in any proper preparation of negotiations (see the checklist).
Therefore, let us summarize BATNA once again:
BATNA is intended to clarify in advance what other options generally exist in the event of a possible failure of negotiations and which alternative approaches may be selected.
BATNA is a synonym for the search for possible alternatives and the identification of the best alternative as an important aspect in the preparation of negotiations.
BATNA is the point of reference to decide whether leaving the table is to be considered more favorable than concluding the negotiations with an agreement.
BATNA is more likely to lead to a success than the setting of a fixed limit (“I want to achieve this maximum goal or receive at least this minimum amount; otherwise, the negotiations have failed”), because the more important question of the existing alternatives in the event of a failure of the negotiations is clarified.
BATNA is a material factor for successful negotiations: The specific knowledge of alternatives generally strengthens one's own negotiation position.
The so-called reservation price refers to the marginal price of the respective transaction partner and is thus the highest price which a buyer is prepared to pay or, respectively, the lowest price which a seller is still prepared to accept. In negotiations the reservation price is the point at which a negotiator is prepared to leave the negotiating table (‘walk-away point’), because as a result of reaching his ‘pain threshold’ he does not – or does not want to – see any more point in continuing the negotiations.
When looking at the reservation price, not only one's own idea of pricing, but also the costs have to be taken into account which may arise, for example, as a result of another buyer – maybe a competitor – completing the transaction at the ‘walk-away point’, with future effects to be expected on one's own enterprise (e.g. generating of economies of scale by the other buyer, who is thus able to bring down the market price for certain products and thereby triggers a deterioration of margins; over time, this will also have effects on the earnings situation of one's own company).
In his book “Dealmaking”, Guhan Subrahmanian, professor at Harvard Law School, writes on the issue of reservation value (= reservation price):
“Your reservation value should reflect your BATNA … The reservation value has nothing to do with what you hope to pay, what you ‘should’ pay, or what is a ‘fair’ price … It simply reflects the point at which you are creating value in the deal versus away from the table in your best alternative to a deal. It's an important number to keep in mind as you enter the room.”6
Henry Meyer is 60 years old and has been the managing shareholder of HMT Tool Manufacturing GmbH8 for 22 years. The company's development over the last ten years was characterized by a steady increase in sales. A further extension of the business volume is also expected for the future. The company has locations in six countries and is the owner of several patents that are well-recognized in the industry. HMT is considered a ‘brand’ in the relevant industry.
Mr Meyer has decided that in the near future he wants to withdraw from business life and receive an adequate consideration for his lifetime achievement. Already at an early stage, he addressed the issue of succession in the company – which cannot be solved within the family – and has commissioned an M&A advisor with the discreet sale of the company. He lets the advisor know that he sees the enterprise value at an EV/EBITDA multiple of 6.4. This means that in the sale he seeks to achieve as a total enterprise value the 6.4-fold of the earnings before interest, taxes, depreciations and amortizations.
The following table shows the economic development of the company.
Figure 5Example of the economic development of a company
On this basis the advisor offers the company to a limited number of possible buyers. Since at this point in time the market is rather difficult, so far the efforts made by the two of them have not brought about the ideal result which obviously would be desirable: The demand was not large enough in order to kindle a price-driving competition among the parties interested in an acquisition. Nonetheless, there is an interested party, MARA AG, who has offered a purchase price on the basis of an enterprise value (cash and debt free) in an amount of 5.3 x EBITDA. The purchase agreement has been negotiated. There are no more obstacles to a completion of the transaction. The enterprise value amounts to EURO 42.1 million.
In spite of the opportunity presented by the sale of the company to receive both a consideration for his entrepreneurial lifetime achievement and to solve the succession problem, Mr Meyer is not satisfied with the result. After all, he had previously envisaged a purchase price in the range of 6.4 x EBITDA. He sees himself in a dilemma, since, on the one hand, it is his firm intention to once more negotiate the purchase price, while on the other hand he feels that – due to a lack of competition among the interested parties – he is at the mercy of bidder MARA. It is because of this feeling that he fears he might be going too far with a higher price demand and even jeopardize the transaction.
Together with the M&A advisor, Mr Meyer now conducts an analysis exactly in accordance with the BATNA concept: a focused preparation for the purchase price negotiations, by considering and evaluating the possible alternatives to a sale:
1. Contribution into a foundation, hiring of a manager and continuation of the company and distribution of the profits to shareholders
Figure 6Model calculation for the continuation scenario (contribution to a foundation)
In this scenario, the calculatory result is as follows: Since the company is solely financed with equity, the total distributable cashflow, i.e. the distributable liquidity, over the next five years amounts to approx. EURO 20.3 million.
2. Liquidation of the company
The table below shows an approximate liquidation calculation:
Figure 7Model calculation for the liquidation scenario
From this, Mr Meyer learns that the result of a liquidation of his company – as an alternative in case no agreement is reached – would generate a one-time amount of approx. EURO 16.2 million.
3. IPO of the company
Figure 8Model calculation for the IPO scenario
The calculation of this scenario produces the following result: The EBITDA is reduced by the costs of the IPO and also by the costs of investor relations activities incurred in the future.
The comparable listed enterprises which can be used as a starting point for an IPO evaluation show the following evaluation ranges:
Figure 9Comparable companies – overview
The investment bank contacted by Mr Meyer with regard to a possible public offering demonstrates to him that an IPO would result in the following value range:
Figure 10Range of values in the IPO scenario
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