Let’s say you have committed to selling your company. You have worked the landscape of potential partners thoroughly. You have finally arrived at the point where someone sees enough value in what you and your team have created that they are prepared to put in an offer. You have formal and informal advisors who have educated you on the relevant value metrics for your market and your business. Even the buyer of your company has shared with you how they think about valuation and the sort of internal models and methodologies that drive their valuation thinking.
The offer comes in. NOW WHAT? Well, the answer is, “it depends.” And what it depends upon is shockingly simple to understand, but nearly impossible to follow in practice. This dynamic explains why the number of deals that you read about is dwarfed by the number of deals that never reach the finish line.
The Art of the Counter depends upon your “hole cards.”
Excuse me, come again?
No fooling, your negotiation strategy is remarkably similar to what the book says to do in Texas Hold’em. In short, you play and bet Pocket 7’s differently than you play and bet Pocket Aces.
Ok, I think I see where you are going. But, uh, can you tell me what a “hole card” is in a company sale process?
Of course, but first let’s talk about what happens in the real world. Every year Wall Street firms spend enormous sums, MBA schools dedicate curriculum and authors publish books on Asset Pricing Models. The notion is that pricing can somehow be perfected in almost any environment. As a 15 year investment banker I submit to you that this notion is all poppycock in the company sale process. The RULE in this process is…Sellers Want More and Buyers Want to Pay Less.
To provide some simple context, we analyzed 10 different and random M&A projects that our firm was working on over the course of this year where we represented both buyers and sellers. Over the 10 projects, the average counter was 33% higher than the initial offer – we refer to this as the “bid-ask spread.” The highest counter was 50%. In general, if a valuation gap greater than 50% exists, formal counters are usually not submitted under the theory that the gap is simply too large to bridge.
What you seem to be telling me is that in deals where companies are aligned and genuinely seem to want to transact, the statistical average counter is 33% greater than the initial offer. Come to think of it, that seems pretty formulaic to me.
BINGO! The goal of the buyer in an initial offer is put forth an attractive offer that is just above the line of being insulting. The goal of the seller in countering is to come back with a counter offer that does not leave money on the table, but does not drive the buyer to walk away. So, back to statistics, if the initial offer is $100 million, a buyer should expect the counter to be 33% greater or $133 million.
So what happens next? Almost without fail, buyers go off and justify their initial offers and why they are “fair” and sellers go off and create synergies explaining why the 33% increased counter offer is “fair.” Both parties spend significant time preparing their analyses, which results in each party becoming emotionally committed to their position. Making matters more intractable, more of the respective company’s management and Board members become involved in the process, which only serves to reinforce the belief that each side’s point of view is right. The rationale usually follows the infallible logic of: if all these people believe in it, how could it possibly be wrong?
Why don’t sellers and buyers just meet in the middle and split the difference?
Well, because they don’t. Talk inside sellers board rooms centers on how “cheap” the buyer is and on the other side the buyers typically say “wow, I wish I could have some of what they are smoking over there.” The sides slowly but surely grow apart and walk away believing it was the right thing to do because those “other people” are not reasonable and frankly never would be.
Wait, I thought you said this blog was about Texas Hold’em?
Ah, yes, The Art of the Counter is, in fact, all about Hold’em. In Hold’em, your “hole cards” are two cards you know you have that the other side doesn’t. Focus on the phrase know you have. If you know you have something it gives you conviction, and with conviction you have unlocked the key to countering.
In technology markets there are many hole cards. Among the most important would be execution against key performance indicators (KPIs), strength of new product introduction, revenue growth rate, ability to finance revenue growth, profitability, ability to grow profitability while investing in new technology, strength of management, strength and cohesiveness of ownership, and ability to execute within an ever changing competitive landscape.
The vast majority of buyers and sellers have remarkably strong instincts regarding the hole cards they possess. Whether you are holding strong hole cards or weak hole cards should determine 100% of your countering strategy and tactics… whether buying or selling, every time! In this “Hold’em” scenario, buyers reading their hands appropriately would be happy to “pay up” when the hand so dictates and sellers would be willing to “settle for less” when the hand so dictates. As stated at the outset, the “Hold’em” approach is so simple to understand, yet nearly impossible to practice. Alas, in practice, we end up with the 33% bid-ask spread.
So how exactly do you know if you are sitting on Pocket 7s versus Pocket Aces in a company sale process? That is a different blog for a different day. Counter well, my friends.