The “re-trade” in an M&A transaction is the bane of every seller’s and sell-side advisor’s existence. The seller and the seller’s advisor have a nice transaction structured with a solid buyer, the buyer is going through its diligence, the lawyers are drafting the definitive purchase and sale agreement, and…BAM! The buyer notifies you that items were discovered in diligence, often in a quality of earnings (“QOE”) report, that “force” the buyer to concede to a reduced price (or other material change in terms) to close the transaction.
As a sell-side advisor, you are frustrated, embarrassed, and disappointed. The buyer has effectively tilted the leverage it its favor. They are saying, “Don’t go with us on this, and you’ll lose out on months of process and weaken and perhaps even taint yourself in the market.”
Once a buyer has triggered an attempt at a re-trade, your options are limited. See the last three pieces of advice in the list below. So, let’s go back in time and examine some solid tactics for avoiding the attempted re-trade in the first place. And then let’s review your options once an attempt to re-trade is made:
- Diligence. Be thorough in your own due diligence prior to going to market so the chances of a buyer discovering something that arguably reduces the value of your client’s company are minimized. Put yourself in the shoes of a buyer and try to anticipate every issue that the buyer may find with your client and the company.
- Early QOE Report. Consider a QOE prior to going to market. These can generally run between $25K and $75K, but a high-quality one should uncover most if not all significant issues that could affect the value of the company. The risk in ordering these ahead of going to market is that the buyer may not accept your report and demand the buyer pay for another QOE by a firm hand-picked by the buyer. But the investment of $25K to $75K could save millions down the line.
- Diligence the Favored Buyers. Include as part of your diligence some reference checks on the competing bidders. Try to find out who has a track record of re-trading. Then, of course, try to avoid them altogether or manage down the tolerance for a re-trade.
- Fully Inform Bidders Prior to the LOI. Make sure that – prior to signing the letter of intent (“LOI”) – the potential buyers have been expressly informed of any negative information that could affect the value of the company. It never works to hide the ball.
- Avoid Formulaic Pricing. Formulaic pricing (e.g., buyer will pay 10X past year’s EBITDA) is an invitation to the buyer to dispute the validity of the EBITDA that was assumed at the outset and begin a re-trading debacle. Try to agree on a fixed price, and then stick to it.
- Heavily Negotiate the LOI. Years ago, and still too often today, the LOI was lightly negotiated. Parties would agree on price and a few other major terms and plan to hammer out many other items – for instance, reps and warranties, indemnifications, holdbacks, employment contracts – in the definitive documentation phase. As you can imagine, this creates an ideal environment for a re-trade. Try to get as granular as you can in the letter of intent. And market conditions favor this today, with demand for quality companies far outstripping supply.
- Avoid a Long Period of Exclusivity in the LOI. The longer you allow a buyer to diligence, the higher the odds it will attempt to re-trade. Try to keep the contingent period of the transaction – the period before a buyer needs to waive conditions to closing – as brief as possible.
- Include a Loss of Exclusivity Clause in the LOI. In the event that the buyer attempts to re-trade on price or any other specified term. This is a critical one.
- Keep Other Bidders Warm until Contingencies Are Waived. Sure, it can be awkward, but remind a couple of other strong bidders that there are always significant risks that can derail a transaction prior to signing the definitive agreement and inquire whether they would be interested in an outreach if the successful bidder were to leave the process. In this market, you will be surprised how many will have that interest. By the way, you may need to work around the “no shop” provision of most LOIs, but this is usually quite workable.
- Be Prepared to Be Reasonable. Everything we’ve discussed thus far with a re-trade assumes that the buyer is being unreasonable in its request. But it’s important to be open to the possibility that an element or elements of the request are reasonable. An example of this includes a shift in the external environment, such as a material change in asset values or in the business cycle.
- Be Prepared to Walk. At least with respect to the elements of the attempted re-trade that are unreasonable, this is your ultimate leverage. It’s very difficult to do, with all the time and effort you and your client have invested, but sometimes your only alternative to losing millions of dollars is to walk. Getting comfortable with this option – your BATNA (best alternative to a negotiated agreement) – is empowering. (Not sure if credit is due here to Roger Fisher and William Ury, of Getting to Yes, but I would always err on the side of generosity to these two gods in the field of negotiation.)
