The Auction Process
Overview of the Auction Process
In many situations, the seller of a business will opt for a selective auction, which is conducted among a small number of prospective bidders who are most likely to have a strong interest in acquiring the company, and in offering a reasonable price. There is some chance that an outlier bidder will not be invited who might have offered more for the business. However, having a short list of bidders involves less work interruption by the seller’s management team, shortens the auction process somewhat, and may improve the level of confidentiality.
Following management presentations and plant tours, it is now time to solicit letters of intent (LOIs). It is better to solicit LOIs, rather than term sheets, since term sheets are less specific.
Expect bidders to submit their LOIs at the last possible moment, or even deliberately wait a day or two after the due date before making a submission. Bidders do this because they are always suspicious that their offers will be shopped to other participants. Consequently, it is not uncommon for a final submission date to come and go with only a few LOIs trickling in; better offers may still be on their way.
A brief review of the LOIs will not necessarily reveal a clear winner. Instead, it may be necessary to create a matrix in which the various factors offered by each bidder are enumerated. For example, one bidder may offer a higher price, but with half of the payment structured as a five-year note, while another bidder is willing to offer an all-cash deal but at a price 25% lower than the highest bid. The seller needs to sort through these offers and evaluate each one. If there is an investment banker involved, this person can offer valuable advice, especially based on any experience he or she may have had with these bidders in the past. Nonetheless, the final decision rests with the seller.
Based on this decision, one bidder is selected, and negotiations over the exact terms of the purchase agreement commence, using a purchase agreement template that is provided by the seller. This can be an arduous process that does not always end in a sale, so the other bidders should be politely put on hold.
All aspects of the purchase agreement are open to negotiation, so settling upon a mutually agreeable version can require a significant amount of work by the attorneys representing both sides. One item that is likely to be reduced through these negotiations is the price. For example, the seller may not want to escrow any part of the purchase price, which the bidder will only agree to in exchange for a reduction in the price. Or, the seller may want a certain legal structure for the deal that improves its tax liability situation, which the bidder will only accommodate in exchange for a price reduction. Another common scenario is that the bidder finds problems during its due diligence investigation, and demands a compensatory price reduction. Thus, the price stated in the LOI tends to be the maximum that the seller is ever likely to see, with a variety of issues forcing it down to a lower level.
It is of some importance to not allow too long a period to elapse before completing a transaction with the designated high bidder, since negotiations may fail, and the seller may need to turn to the next-highest bidder to conclude a deal. This can also be a negotiating tactic by the bidder, to delay matters so long that the seller no longer has any other interested parties. It will likely require 60 days to complete any remaining due diligence, negotiate the terms of the agreement, and close the deal. If the bidder extends this period past 90 days, the seller needs to start considering shifting to the second-best bidder. Of course, no discussions with other bidders can commence until the exclusivity period stated in the LOI has expired.
During the negotiation of the purchase agreement, the attorneys for the two parties take over and work their way through each draft of the document, summarizing issues found and sending them back to their principals for direction. There will also be some areas in which information is missing, requiring fast-tracked research to find, verify, and incorporate it into the document. Also, due diligence has typically not been completed by the time the purchase agreement is being drafted, so last-minute items found in due diligence will have to be incorporated into the purchase agreement. All of the iterations involved in this process result in spectacular legal bills once the acquisition has been completed, but that is part of the acquisition process.