As noted in the first article, which focused on the pur-chase price mechanisms used to bridge a valuation gap, the corporate investment market remains challenging into 2014. In a deal context, a buyer’s nervousness can translate into an extended due diligence process, demands for additional contractual protections and a reconsideration of pricing. Once a buyer has begun to question the risk profile of the investment, it is extremely difficult to provide reas-surance without making concessions.
In this article we turn our focus to sale preparation, and in particular how good due diligence planning can deny a buyer a sought-after excuse to dictate sale terms or chip price.
Appointing advisers
Unless the corporate venturer has received an unsolicited offer that represents an attractive market price, obtaining strategic advice from a reputable corporate finance house is an important step in planning a successful exit. This advice need not carry an intimidating price tag – corporate finance advisers may offer a menu of services, from high-level advice on likely categories of buyer to identifying and approaching specific potential purchasers, advising on the best marketing messages and running a sale process.
A well-connected corporate venturer is no doubt aware of the most obvious purchasers, but a couple of key questions will recur if the venturer embarks on a sale process without professional advice. Would another party, such as a wild-card strategic or investor known to a corporate finance adviser, have been willing to pay more, move faster or buy on better terms? Similarly, will the proposed method of exit appeal to those investors most likely to pay a good price for the asset? (see below)
Due diligence
Once initial exit planning is under way, another quandary arises – at what point should a selling corporate venturer appoint its other advisers, and when should it start its due diligence process? Why not defer the preparation of a data room, appointment of advisers and accompanying costs until the sale process is more advanced? Why not wait until the first expressions of interest, or perhaps first offers? Once initial offers have been received, why dedicate critical management time to matters of detail when the buyer will conduct due diligence anyway?
The answer is that this approach is a gamble on pricing. The need for speedy execution is often cited as a reason for undertaking only light sale preparations, but requiring a buyer to conduct due diligence at speed while being drip-fed key information prompts a predictable response from a buyer – if we, as buyer, identify any risks that the seller cannot explain or solve quickly, better to assume the worst, ascribe a conservative value to the potential liabilities and revise our price downwards, rather than risk momentum by pausing to examine the issue in detail.
Far better for a corporate venturer to have anticipated these issues and questions by engaging professional advisers in advance, and commissioning focused and commercially-minded due diligence reports.
A full suite of detailed vendor due diligence reports may be par for the course on large-ticket merger and acquisition transactions, but an astute corporate venturer can gain the same advantages by focusing on strategically or financially significant aspects of its business (see below).
Data room preparation
Dull as it may seem, ensuring a prompt, orderly and comprehensive flow of information to buyers is critical, and the administrative task of compiling a data room often slips down the priority list. Delayed or poorly-organised due diligence materials can slow a sale process, prompt a wave of document requests and bol-ster a buyer’s argument that is it only fair to
require extensive contractual protections.
Presentations
Any savvy buyer will expect one or more presentations from the management team of the target corporate venture. The selling corporate venturer and its management team should plan and rehearse these, checking that critical information, statistics and tone are consistent, both with each other and with information in vendor due diligence reports and any data room.
All key members of the management team should be visible, particularly if they are to remain involved in the venture after the sale.
Finally, they should try to anticipate, and prepare answers for, any awkward questions. A corporate finance adviser should be able to draw on experience to warn of a buyer’s most common concerns.
Sale negotiations
Like it or loathe it, a degree of horse-trading is inevitable in negotiations, but an unreasonable starting position is likely to be met with an unreasonable counter-proposal, delaying agreement and eroding goodwill.
Rehearse the terms and level of contractual protections you are prepared to give, allow for some push-back but be clear and consistent, both internally and in your communications with the buyer, where the red lines really are.
In the final article of the series we will examine some of the issues that arise on separation of a corporate venture from its founding group.
Have a back-up plan
In an unpredictable market, corporate venturers may want to consider structuring their exit preparations to enable a swift flip between exit routes – a dual-track process. We set out below the most common exit routes, and alternative liquidity events, should the principal exit route hit difficulties.
Primary exit route Alternative liquidity plan
IPO Private sale; syndication; Asset sale Hive off valuable assets, for additional private investment
Sale (of controlling stake up to 100%) Refinancing/reorganisation; further investment or bolt-on to enhance value; retention pending improved market
Asset Sale Hive off valuable assets, for example intellectual property or books of business;
split group by business division; licensing deal
Who to appoint, how and why
Why?
Pre-sale vendor due diligence typically assists a sale by:
- Increasing speed of deal execution once a sale process is under way.
- Reducing advisory costs in the long term.
- Reducing the burden on management to respond to due diligence questions during critical stages of a sale.
- Reducing the risk of the discovery of unexpected issues that cause, or are used as an excuse for, a late price chip.
How?
When deciding which advisers to engage for vendor due diligence, and the breadth of issues they should examine, a corporate venturer should ask itself:
- Which technical and operational aspects of the business are core to its success?
- Would the provision of third-party professional reports on those areas enhance a buyer’s perception of the asset’s value?
- How long would it take a buyer to conduct adequate due diligence from a standing start – assuming no vendor due diligence?
Who?
Areas to consider for the commissioning of due diligence advice/reports and typical scope items include:
- Commercial – market share, key competitors, planned and poten-tial growth areas.
- Financial – overview of historical trading, performance since last audit, projections, financing arrangements.
- Tax – overview of tax structuring and group tax policy, compliance history, potential efficiencies and future threats.
- Legal and regulatory – impact of sale on key contracts, compliance with regulatory regimes.
- Intellectual property, IT, environmental and insurance, depending on business sector.
Top tips for engagement terms
When engaging vendor due diligence professionals, the following points are critical.
- Scope: Check that the scope of work in the adviser’s engagement letter accurately reflects what you want done.
- Fees: Check fee levels, and when they are payable.
- Exclusions: Check the adviser’s engagement letter does not exclude responsibility for, or make the corporate venture responsible for, the adviser’s own negligence.
- Caps: The adviser may also cap the extent of its exposure, either as a flat amount or a multiple of fees. Consider whether this is set at a rea-sonable level, and in particular, whether a buyer would accept the cap.
- Reliance: Check that the adviser will, at no extra cost, allow the buyer to rely on its report.
- Q&A: The engagement letter should acknowledge that the adviser will both make itself available for Q&A sessions with the final pre-ferred buyer, and assist the seller course of the sale process.