This is the third blog in a series of 5 that our Partner and Head of Corporate Finance, Paul Mason, has written, based on his experience of negotiating deals successfully over many years.
Don’t sweep it under the carpet (Part 3)
A lengthy, onerous and – bluntly – painful part of a transaction, after agreeing ‘Heads’, will be some form of ‘due diligence’. This is where the prospective buyer seeks to remedy the massive “knowledge gap” between themselves and the seller. The seller is always going to know more about the business which they have built up and lived with than a prospective buyer. Due diligence is the process by which questions are asked, answers are provided and clarified, and the prospective buyer reaches a point whereby they can make an informed decision on whether to purchase, and on what terms.
The working assumption for any seller has to be that bad news will come out during due diligence. Whether this is financial or operational underperformance, litigation risk, or something murky in the company’s history, any assumption that it can (or should) be hidden is a foolish one.
Bad news has one of three consequences:
1. It can cause a deal to collapse;
2. It can erode the buyer’s price (or weaken the structure) versus the previous agreed deal; or
3. It can be accepted without material impact.
When advising sellers, we always want to find a way to push any bad news into that third category, which requires careful management of timing and delivery. Hiding it amongst good news might work occasionally for politicians, but it rarely works in M&A, especially if the buyer is suitably advised and experienced.
Reflecting on the last blog post about negotiating the Heads, it is often (but not always) best for sellers to bring out the headlines of any bad news story into the open before Heads. Whilst this can risk reducing the headline price or deal structure, at least the sellers are agreeing to enter into the next stage knowing a more realistic and deliverable deal is on the table. There isn’t the false comfort of an inflated price, which is invariably going to suffer significant erosion when the bad news emerges. Secondly, establishing trust requires honesty and integrity: having bad news teased out can damage this important principle.
There can be a fear that tabling bad news early will turn off a potential buyer to the point where they walk away. Conversely, waiting until they are emotionally “in” and heavily invested in a process will surely make them less likely to back out? Unfortunately, emotion is rarely something we want to encourage in M&A if we want to get the right deal. The tactic of leaving bad news until the 11th hour is a gamble that I very rarely condone.
In the penultimate, fourth part of this blog series I will look at how to act during a deal and advice for managing difficult and tense negotiations.
If you are looking to purchase or sell a business, contact Paul today on 0131 558 5800 or email email@example.com.