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Agency Financial Management Avoiding negotiation disasters Focus on specifics and expectations to ensure deal closure By Paul J. Di Stefano, CPA, CPCU
Recently, we have had conversations with a number of new clients with one thing in common: They had been left at the altar when trying to close a deal. While the casual reaction might be “so what,” the termination of discussions can be quite disappointing for the seller. The fact of the matter is that the seller, in many cases, may have invested a great deal of time and effort in discussions and meetings negotiating a deal, while at the same time preparing and analyzing voluminous amounts of data. The seller may have also postponed decisions important to the future of the agency. As Yogi Bera probably said: “It ain’t over till it’s over.” Most agency principals initially have little idea of what the deal-making process entails in terms of time, effort and experience. We have all heard of the proverbial deal written on the back of a napkin. The reality is that in those cases, the napkin had better be pretty big. All kidding aside, the deals written on the backs of napkins at lunch are usually done by the executives of very large corporations, who then turn those broad brush napkin strokes over to their financial team who in turn will scurry around working out the details. The problem with taking that approach is that, unlike their corporate counterparts, agency principals rarely have a staff to sort out the details of an agreement. Unfortunately, what typically happens is that the buyer loosely conveys the concept of the deal to his attorneys and asks them draft an agreement, leaving it to counsel to sort out the details. In that case what is usually produced bears little or no resemblance to the discussions between the principals. Transaction details One of the ways to flesh out the details of a transaction being discussed is the preparation of a letter of intent or term sheet by either the buyer or the seller. The exercise of preparing one of these documents tends to force both parties to think through the specific terms of the deal. Usually this can be done only after both sides have spent sufficient time together to understand one another’s operations. Without having focused on deal specifics early on, both sides may have completely different ideas of what terms are being envisioned. We at Harbor Capital believe that from a process standpoint both sides should invest the time to engage in discussions focusing on both buyer and seller expectations. We believe that this courtship phase is an important part of the process and therefore should be handled in an orderly and professional manner. We recommend that a formal agenda be established to ensure that all discussions and meetings are kept as productive as possible. It’s not enough that all sides keep restating the fact that they are excited about the deal and that it makes a lot of sense. Those statements may be quite true but until there is a meeting of the minds on the conditions and structure of the deal, little is being accomplished in terms of moving to a closing. In many cases the buyer will request information even prior to any detailed understanding of how the deal will be structured. Although this is not an unreasonable approach, the seller should ask for some broad terms before sharing detailed information. Some of the questions that should be asked are the following: What are the buyer’s valuation criteria? Is he willing to pay a multiple of cash flow? How will profit-sharing commissions be valued? Does the buyer have the financial capability to close the deal? Will he require the seller to take notes? How will those notes be guaranteed? Will the buyer be purchasing stock of assets? Will the transaction qualify for capital gains treatment? Another key issue is that of employment contracts. The reality is that employment contracts deal with many issues in addition to compensation for the key employees going forward. They also deal with the terms of non-competition and non-raid agreements for the sellers as well as the term of employment and causes for termination, all quite important details. Importance of an intermediary The deal process can easily get out of hand when agency principals start to grapple with all of these issues, particularly when there is no financial intermediary assisting in the process. In some cases, the deal discussions take on a life of their own with both sides wondering when the deal started going off the tracks. Harbor Capital is routinely contacted by agency principals who are understandably quite upset after a deal falls apart. The reality is that in most cases agency owners have spent months in discussions, gathering and sharing confidential information on their agencies. Unfortunately, in some cases the principals have already mentally begun to spend the deal’s proceeds, only to realize that the deal was in reality always far from being completed. Even in cases where the deal does not fall apart, some sellers who find themselves under pressure to exit are left in the untenable position of having to make compromise after compromise to get a deal completed. The reality is that an experienced intermediary would never leave such a client in the position of having no alternative but to cave in to demands that were less than equitable. Part of the intermediary’s function is to bring to the table other interested players who are both willing and motivated to complete a fair transaction. The tangible and intangible costs associated with a failed transaction are in many cases comparable to what it would have cost to be represented by a qualified intermediary such as Harbor Capital Advisors. The current reality is that the deal process has become even more complex. An example of this is the recent questions that have been raised regarding contingent commissions paid to agencies. This issue has complicated the closing of many deals. The question raised by some buyers is whether contingent commissions will continue to be paid in the future. Although the answer seems to be “yes,” many of the more conservative acquirers are attempting to take that controversy into account in structuring their proposals. To be effective in negotiations, sellers must be aware of how deals are currently being structured in the marketplace to counter any unreasonable positions taken by acquirers. In summary, the merger and acquisition process is much more complicated than it seems on the surface. Sellers that have tried to go it alone and failed can attest to that fact. Agency principals who decide to represent themselves should be armed with sufficient knowledge to anticipate all the issues that will be put on the table. Sellers should also think seriously about whether they are willing to take any chances when divesting themselves of what could be one of their largest assets. * The author |
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