In this "Jnet" series, we introduce current topics in the field of corporate M&A, revitalization and restructuring that are relevant to Japanese companies operating in the United States. In this issue, we feature a recent survey conducted by KPMG LLP and "The Deal" on selling a business in turbulent times.
The last two years have been challenging for both buyers and sellers. M&A activity continued to decline in 2009, and according to a recent survey conducted by KPMG LLP and "The Deal" (the KPMG survey), 32 percent of those surveyed aborted between one or two deals last year. Nearly $228 billion worth of deals were pulled in 2009. These failed deals have significant costs to all parties, but may be particularly costly for sellers. During a sales process, the company’s management team typically shifts its focus from running the business to dealing with due diligence requests. At the same time, employees at all levels may become distracted by the rumor of a sale or the need to produce documents. That loss of productivity can severely impact a company, and may be particularly frustrating if the deal falls through. In addition, companies that are not ultimately sold may risk exposing proprietary information during the due diligence process.
According to the KPMG survey, a significant portion of companies will be selling businesses in 2010. In the coming year, 27 percent said that they planned between one to two divestitures, and 7 percent said they planned between three to four divestitures. When asked for their top two reasons for conducting a divestiture, 47 percent said it was because of a change in their strategic focus, 32 percent said the divestiture was opportunistic, and 23 percent said they were motivated by a desire to raise cash or improve liquidity. Other sellers were interested in deleveraging their balance sheets (18 percent), downsizing their businesses to meet current demand (10 percent) or in response to regulatory requirement (7 percent).1
From our experience, there is, however, a distinct contrast in results between (a) sellers who attempt to run the traditional structured auction processes without considering the changed and more demanding requirements of bidders in today’s market and (b) sellers who take a creative approach tailored to the few bidders who are actually able to finance the deal and are genuinely interested in the target.
Although the traditional structured auctions are the seller’s most efficient method of maximizing competitive tension for the target, from the bidder’s perspective, they have always carried disadvantages that were only ever tolerated because there was no alternative. These include:
- Limited access to management – This is the most valuable single aspect of buy-side due diligence. In structured auctions prior to exclusivity being granted, bidders typically had to accept a highly rehearsed management presentation and some very limited follow-up Q&A sessions.
- Limited access to information – Bidders have had access to limited and, worse, unreconciled information, making it difficult to understand and to complete due diligence on the target.
Our more successful sell-side clients have learned to adapt their sale processes to bidders who demand significantly more access to management and information before making a final offer. Certain leading practices can greatly improve sellers' results.
Despite some relative optimism that deals will rebound in 2010, there are still numerous obstacles that are hindering a robust deal environment. When asked which single factor will make its hardest for deals to be completed this year, respondents in the KPMG survey said the availability of debt financing was the number one obstacle (37 percent). Dealmakers also believe that the deal environment is being negatively affected by unpredictable revenue projections (20 percent), disputes concerning valuations (17 percent), and generally negative market conditions (16 percent). Savvy sellers are treating expressions of interest with much more skepticism and, in certain circumstances, are excluding bidders who cannot demonstrate credible funding. It is necessary, therefore, to undertake much more rigorous due diligence on interested parties to ensure they can finance the transaction; assess the synergy opportunities available to them; and test bidder stakeholder dynamics—will they really make a bid?
One technique that sellers can utilize is to require bidders to attend a “gating event” following expressions of interest based on a very short information memorandum (IM) (supported by selected financial information). This event is typically offered to four to six bidders and is designed to facilitate a decision as to which bidders to let into the process. It is attended by both the seller and the management team. The latter make a presentation of the business, which is followed by an interactive dialogue including Q&A during which the potential bidder can seek clarification of key points. In return, the bidder must explain the extent of and reasons for its interest, its perspective on the key value attributes of the target, and its ambitions and plans for the business. Following the session, first-round bids are submitted, which are evaluated based on the credibility of the bidders as well as the value of the bids.
In many processes, this rigorous scrutiny of bidder credibility has meant the number of parties taken into the full due diligence phase being as low as two rather than the more traditional four to six. Given the smaller number of bidders, it is feasible to provide them with more management access than typical auctions. It also means that the information provided can be tailored to focus on the key interests and concerns of each bidder—this extends to further management interactions being tailored as to content and attendees.
The early opportunity to discuss the potential of the business with management also typically results in significantly higher quality first-round bids than those generated by IMs in conventional auctions.
A key part of a successful sale has always been about designing a process that ensures management articulates the value proposition in a robust and credible manner. Key lessons relevant to today’s market are:
- Ensure management is properly incentivized. This does not need to be only about money—their future role and the fate of their employees are the most obvious of many nonfinancial issues that may be important to them. Also ensure emotional attachment through involvement and consultation in the process—this is overlooked incredibly frequently.
- Be empathetic to buyers. Provide information on the target that reconciles to the perimeter of the business being sold. It is possible to include detailed data books covering financials and tax, market and commercial analysis, upside opportunities, detailed and grounded separation plans, employee relations and benefits, and a synergy analysis.
- In addition to providing bidders with the information they need to conduct due diligence, these materials provide the seller with prior notice of key value issues in time to allow them to be addressed.
- Use the deal team and advisors to coach and rehearse the management team. In many deals, not enough time is spent on this.
- Ensure that the management team is challenged on the upside opportunities and downside mitigation strategies relevant to the business. It is essential that they are persuaded of the merits of the arguments that only they can communicate convincingly.
- Ensure that management time is only diverted to the sale process to the extent necessary. Get others to do the “heavy lifting” in terms of preparing and verifying data. In the current market environment, it is more important than ever to have management focused on driving its business forward.
In conclusion, sellers need to be much more flexible in how they run their sale processes, even to the extent of considering options such as splitting and selling businesses previously operated under one management team. Second, sellers need to be more vigilant about assessing and dealing with potential bidders than they might have been before. Finally, sellers need to consider how best to make information available using a combination of more or less detailed IMs, data books, and, wherever possible, increased access to management for bidders.
This text was reprinted, with permission, from "M&A Spotlight: Selling a Business in Turbulent Times (PDF)".
For more information regarding this article or KPMG’s services in the area of mergers and acquisitions, please contact a member of your KPMG engagement team or Yoshinori Suganuma at firstname.lastname@example.org or 212-872-7821.
KPMG Corporate Finance LLC Disclaimer: Corporate finance services, including Financing, Debt Advisory, and Valuation Services, are not performed by all KPMG member firms and are not offered by member firms in certain jurisdictions due to legal or regulatory constraints.
1. Since multiple responses were allowed, numbers add up to more than 100 percent.