The Auction Process

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Overview of the Auction Process

A company’s owners may elect to sell their business through an auction process. This may result in a higher price for their business, though the eventual price must be netted against the commission of any brokers used to assist in the sale. An auction also provides evidence that the seller’s board of directors did its best to obtain the best possible price, thereby possibly averting any shareholder lawsuits claiming the reverse.

To initiate an auction, the seller’s owners typically hire a broker to conduct the auction for them. Under this approach, the broker creates an offering book (also known as a sales prospectus) describing the company, but without revealing its name. The book usually contains the following information, which is designed to reveal the seller’s investment potential:

Investment summary. A brief overview of how the seller would be an excellent investment opportunity.
Company overview. A short list and extrapolation of the key reasons why the seller is worth acquiring.
Market analysis. Describes the market in which the seller operates, and the seller’s niche within that market.
Products and services. Describes the key products and services offered by the seller, as well as their margins. This can also include a discussion of major customers and distribution channels.
Management. Notes the qualifications of those managers expected to transfer to the buyer.
Historical and forecasted financial statements. Includes audited financial statements (without footnotes) for at least the past two years, and preferably more. Should also include an estimate of future financial performance for at least the current and following year.
Capitalization table. Summarizes investor ownership by class of stock.
Asking price. States the target price. If comparable sales have occurred recently, then note them in this section as justification for the asking price.
Concluding remarks. Brings together all preceding sections into a one-page summary of the investment proposition.

The broker sends an auction notice to a broad array of possible buyers, and obtains an NDA from anyone who expresses interest. Despite the NDA, there is a strong likelihood that the seller’s financial and operational information will soon find its way throughout the industry, and into the hands of competitors. Thus, anyone choosing to sell through an auction process should be ready to deal with broad distribution of potentially damaging information.

Confidentiality is a particular problem if the seller retains a broker that indiscriminately sprays the auction notice throughout an industry. The broker may gain a few more bidders, and certainly gives its own name better brand recognition in the industry – but the seller’s confidentiality has vanished. It is better to conduct a low-key auction with a small group of pre-qualified bidders, so that noise about the auction is minimized. However, if an activist shareholder insists on a sale by auction, then it may be necessary to publicize the auction, so that the shareholder can be assured that a broad-based auction is indeed taking place.

Once the NDA is signed, the broker issues the offering book. The broker also sends additional information to those expressing interest in exchange for a letter of intent, with the intent of quickly whittling down the list of potential bidders to a group with the interest and wherewithal to make a valid bid for the seller. The broker then issues a purchase agreement (note that this varies from the normal acquisition approach, where the buyer controls the purchase agreement). Bidders mark up the document with their changes, leading to further dickering with the broker. The broker will attempt to keep several bidders lined up, in case the bidder offering the best price backs out of the negotiations. However, if secondary bidders are shifted into the lead position, they now know that the broker has experienced some difficulty with their predecessor, which gives them greater bargaining power.

Issues With the Auction Process

Negotiations may break down with multiple bidders, so that the broker finds itself dealing with the last possible bidder. If so, the broker will not reveal that other bidders have dropped out, since this gives the bidder more negotiating power. Conversely, the bidder should always suspect that there are no other bidders, and be willing to walk away if the broker will not accept the bidder’s best offer.

Many experienced buyers are unwilling to engage in an auction process, because they know the price at which the seller will eventually be sold is more likely to be at the high end of the price range. Instead, they may withdraw from the process, and wait to see if the auction falls through. If so, they can re-enter the bidding, and negotiate on a one-on-one basis, usually resulting in a lower price.

The auction process tends to use somewhat more time than a normal acquisition. It requires about one month for the broker to create an offering book and derive a list of potential buyers, another month to screen those buyers, one more month to receive bids and conduct due diligence, and a final six weeks to close the deal. Thus, given the number of parties involved and extra auction steps, the seller must be prepared to wait longer than a normal acquisition transaction to complete a sale.

In summary, the auction process is time-consuming and expensive for the seller, but can also result in a higher sale price. Given the chance of obtaining an unusually high price, it is more common to see larger firms tread the auction path; not only are they better able to afford it, but brokers are more willing to represent them, in the expectation of considerable fees.