For the last few years, you have been preparing your business for sale and now you have decided to sell your business. A challenging process will follow. Negotiation is an important part of this process.
However, it is not horse-trading. Usually, discussions are substantive with analysis and arguments. But what are the most common negotiation points? And how can you best prepare for these? In this article, we will give you insight into the five most common negotiation points:
1. Price
You can prepare for the price discussion by having a valuation performed. This will establish a range of the value of your business based on the most common valuation methods (usually by discounting future cash flows). This will give you a good indication of what to expect and will also give you arguments you can use during negotiations.
It is not common to share detailed valuation reports with potential buyers. When you do, you can get bogged down in impossible discussions about the assumptions used. The discussions are usually held at a more abstract level, such as EBITDA multiples (Earning Before Interest Taxes Deprecation and Amortization) and payback period, for example. If you expect a higher EBITDA multiple than is common in your market, the valuation report gives you the necessary arguments for this.
It is also always a question of who names the price first. Is it you as the seller or do you leave that to the buyer? There is no simple answer to this question. Our starting point is, when we conduct a broad sales process, the buyers are the first to state their price in an indicative offer. In a one-on-one process, it depends, among other things, on the extent to which you are able to assess synergy benefits of the buyer. If you can properly quantify these synergy benefits, it is often advisable to put down an asking price.
Price is obviously one of the most important negotiating points. However, it is certainly not THE decisive factor in negotiations. For example, a lower price - combined with fewer guarantees (see later in this article) - may be more interesting to the seller than a high price accompanied by many guarantees, with which you will have the sword of Damocles hanging over your head for many years.
2. Standards
It is common to "normalize" one-time and/or non-market costs or revenues in your income statement to show your "normal" results. Common normalizations include reducing management fees to market levels or omitting one-time large consulting fees and/or transition fees.
However, don't be too creative with normalizations. The buyer, along with his financial advisers, will study the normalizations very carefully. You really need to be able to substantiate the normalization numerically. For example, if paying transition fees occurs annually, this is a less likely normalization and the "missed revenue" is often difficult to quantify as well. If you normalize too much in your favor, you come across as less credible and bids will often fail.
3. Working capital and net debt
Another part that always gets a lot of discussion is the level of working capital the buyer obtains. The buyer will be mindful that he should not have to make overdue creditor payments or purchase additional inventory immediately after the purchase. To avoid this discussion as much as possible, it is often agreed in the letter of intent that the purchase price will be adjusted depending on any deviation from the "normative" working capital level.
But what is normative? There are many discussions about this, but often the average working capital level over the past 12 months is considered. So, if on the transaction date the level of working capital is lower than the normative level of working capital, this will ultimately lead to a lower transaction price and vice versa.
As a seller, you would do well to have monthly figures ready, showing the level of working capital. You would also do well to optimize your working capital well in advance of a deal (> 2 years). You also need to understand when an item belongs to working capital and when to a net debt item. For example, a seller will consider advance billed revenue as working capital and the buyer will consider it a debt item.
4. Funding
The buyer of your business has access to several sources of financing. In addition to the buyer's own financial resources, banks are often willing to finance part of the purchase price, and an investor is often used. Sometimes the seller also co-finances part of the purchase price, for example by providing a subordinated loan(vendor loan) or in the form of an earn-out (in the case of an earn-out, payment of part of the purchase price is postponed and is only paid after certain milestones have been achieved).
Of course, if you as the seller are financing a portion, this is also an integral part of the negotiations. After all, you remain at risk. Make sure this is factored into the other parts of the transaction, that the term is not too long and that you continue to have some degree of influence over the business.
5. Warranties & indemnities
You've negotiated all the financial details of the deal and recorded them in a letter of intent. There is now often a feeling that the transaction is almost complete. Unfortunately, this is not yet the case. The buyer will still want to conduct a due diligence and the purchase agreement will still need to be negotiated.
Important parts of the purchase agreement are warranties and indemnities. Warranties and indemnities are provided by the seller to the buyer and protect the buyer from risks that originated prior to the transaction. For example, it is common for the seller to guarantee that all past taxes have been properly paid and that there are no major pending lawsuits.
A guarantee is limited in scope and time (1-3 years). An indemnity is often not: there is no maximum scope and the term is often long (5-10 years). This part of the purchase agreement can easily be 10-20 pages long. Guarantee only what you can really guarantee and share information about any risks so that there can be no claims about them later. Also make sure you are assisted by a specialized merger and acquisition lawyer.
Closing
Of course, the topics discussed are not exhaustive, but they give an idea of the most important negotiation points. Make sure you are well prepared before negotiations begin and that a good "negotiating climate" has been created.
Also, avoid surprises for the buyer during the process. You do this by preparing a sales process early and sharing the right information in a timely manner. In addition, it is important that you always have a good alternative and can leave the negotiations without too much damage in case you do not reach a deal.
