Responding to an Interested Buyer

I recently wrote an article about “whether you should entertain that offer,” and the short answer is “yes.”

It’s a really good idea for you to lead the early conversations, and it’s a really good idea for you to bring in a professional, too, at a certain point later in the process. So since you’re going to be leading the early discussions, you want to be armed with the right questions to ask, as well as some idea of the answers that you’re looking for. We’re going to focus mainly on the first part of that equation: what questions should you, on your own, ask a potential buyer of your firm.

Questions to Ask

Why are you undertaking this? This would obviously be the most basic of all the basic questions in the world, but you’ve got to pin the answer to the top of your private journal. After you know the primary reason, you can assess how effectively you’ll solve this problem they are trying to solve, whether it’s the right problem, other ways in which you might relieve the pressure they are feeling, and so on. You also need to know this so that you can use it as leverage during the negotiations. If their answer is “because we want a larger geographic footprint and really want to turn up our recruiting efforts on the east coast, then it’s going to sound a little hollow when they keep hammering you for your 11% EBITDA: you’re still in NYC and purchasing your firm will solve what they claimed as a primary motivation for doing it in the first place.

Why are you approaching us, specifically? Here you’re looking to surface any unfair advantage you might have, later. The first question is about what they are trying to accomplish, but this question is about why you might be the right firm—unique among all the others they might have chosen—to solve that particular challenge. If their answer to this question  means that you’re going to be largely interchangeable with a dozen other firms they might approach, I’m not sure why you’d proceed unless you’re just so sick and tired of running your firm that you need an exit, and quick. The previous question is why you want to get married. This question is about why this person is the right choice. It’s all about understanding your leverage, as well as understanding how sophisticated they are in this pursuit. You might be tempted to watch an unsophisticated buyer that you can take advantage with your superior negotiating skills, but remember that you’ll be working for this fool, later, and it’ll backfire. No, you want a sophisticated buyer who knows what they are doing and is looking for a genuine partnership where neither party takes unfair advantage of the other. You’re likely going to have to live with this new relationship long enough to get all your money.

Who else are you talking to about an acquisition? Now don’t fool yourself and think that they’ll ever tell you. That’s not why you’re asking the question. In fact, you might add an immediate clarification: I’m not expecting you to tell me, specifically, but I’m wondering what other kinds of firms you are approaching? The answer to this will tell you whether it’s a helter skelter broadcast, wasting a lot of people’s time, or whether they have a specific strategy. Here’s an example of how that might play out. Say you’re an 18-person dev shop firm in Houston that has historically focused on franchise operators. In addition to your firm, you discover that the buyer is also looking at a 40-person firm in St. Louis that historically focuses on SAAS startups. So unless the buyer can explain how their strategy unifies these different approaches, they just want to grow by amassing eager sellers in a firm that’s not going to experience much synergy or even organizational coherence. What you want to discover, when the buyer answers this question, is that they have a very specific target in mind, and that you fit solidly into that consideration set.

Can you tell me about your previous experience in the acquisition market? Previous experience, successful or not, is not a prerequisite in qualifying a buyer, but you absolutely do want to know what experience they are bringing to the table. If it’s little or none, be prepared to waste more time answering requests for needless information and getting the order of things all wrong. If their acquisition experience is substantial, be prepared to have your own act together so that you don’t get steamrolled by savvy negotiators who’ve used all the tricks in the book. But there’s another reason to ask this question, too, and that’s to surface the people you might want to talk to, openly or behind the scenes, about their experience with this potential buyer. If it was a successful purchase, the buyer should have no problem arranging a conversation with the seller who is now in the midst of an earnout, where they have experienced how far the buyer has been, whether the promises about the culture were true, and so on. If the acquisition wasn’t consummated, you’ll want to find out why, even if that means that you verify the information with the firm that didn’t walk all the way to the altar.

What You Should Sign

Those are some of the questions, but you’ll often be asked to sign two other things. One of them you should and one of them you shouldn’t, and note that they might both be in the same document.

It’s expected and reasonable to sign an NDA. That should protect you and it will obviously protect them. You’ll seldom need to ask for any modifications, because these are typically boilerplate documents and, personally, I’m not sure I’d even involve an attorney this early in the process, though that’s obviously up to you.

It won’t always happen, but there are times when a potential buyer will ask you to sign a no-shop clause, too, which simply prevents you from pursuing another buyer while you are evaluating this opportunity, and it further request that you disclose any approaches that other buyers might make while you are pursuing this. They are always bound by a certain timeframe, and usually that’s three months, though, they can be shorter.

The buyer wants to be sure that they aren’t wasting their time (and thus money), but unless there’s a breakup fee associated with the agreement, you aren’t going to have any incentive to sign it, at least now. The only time you want to sign a no shop clause is when you, too, don’t want to waste time, and you want to send a signal to the buyer that you are very serious about this and they should be too. But now is not the time to enter such an agreement, when the dating is just getting started. The time for that is later, right before everybody is going to take this potential opportunity so seriously that they’ll focus on it until it either happens or it doesn’t, and there’s a lot of time and money that shouldn’t be squandered.

Most of the acquisitions in this space will not have a breakup fee, and thus there’s very little incentive to enter a no-shop period as a seller unless either or both of those things in the previous paragraph are true. You aren’t going to get rich if this wedding doesn’t happen—you’ll just be very sad or very happy.

What Materials to Share

In addition to the early questions you might ask and the things you might decide to share, the potential buyer will also ask for some basic materials from you. Some of these requests are reasonable and expected, and some are premature.

These are the materials that you should feel comfortable sharing if you don’t see any red flags in the pursuit so far:

• Ownership structure. Who owns what percentage. You’d want to exclude any small percentages, especially if it’s not yet time to distract that person by bringing them into the early discussions. They’ll likely have a drag-along clause, anyway, and their opinion won’t matter in a legal sense, though it will obviously matter later if their approval is central to whether the deal happens. You wouldn’t even need to disclose actual percentages, yet, but you should be comfortable sharing who the major partners are.
• In terms of financial performance, it’s fine to share the topline revenue, the passthrough expenses if those are central to any financial analysis of your performance, and the rough profit. It wouldn’t be necessary to share any EBITDA number that you’ve already calculated on your own, yet, as how and when you reveal that might be an essential part of a later negotiation strategy. Besides, they’ll have their own interpretation of that and what you think might not matter as much as you hope.
• Employee count.
• Nature of the work that you do.
• The clients that you do it for. Typically this will be limited to the clients that you have identified on your website and others where there is no downside to including them (in other words, it’s impressive), but never share identifying information about departments or the specific names on the buyer side.

In sum, you’re giving them enough information to keep the conversation going. They’re going to need a lot more information if you’re expecting an LOI that’s specific enough to warrant your careful consideration, but that’s later. Here, we’re just dating and seeing if it’s worth pursuing.

Checking the Social Boxes

Think of your journey at this point as full speed ahead until you see a stop sign. Or rather, 40 mph in a comfortable cruise where the talk flows, there’s very little tension, and you’re just enjoying the casual ride on a Saturday afternoon. Eventually the top is going to go up on the BMW M5, you’ll put on a helmet, and you’ll be looking to maximize each corner apex, but we aren’t there yet.

In that spirit, you want to do some social exploration, and this is best conducted on your own, without any advisors in the way. You can’t absorb this stuff vicariously—it must be experienced on your own.

Do it any way you want, but I’m going to give you a specific three-part suggestion to start with:

1. Go to dinner at a neutral restaurant. Make it a very nice restaurant, and preferably have a separate back room where you can hear each other but other people in the restaurant can’t hear you. Make it a multi-course meal and take your time. Liquor is good (for them, anyway). Look for how much they pay attention versus allow distractions from their devices. Look at who they listen to and include in the conversation versus who they don’t pay attention to. Look at whether they let you answer a question or butt in with an interruption. Just get them talking and you’ll learn a lot.
2. Invite them to dinner at your home. Better yet, accept an invitation to dinner at their home. This is where you learn about their significant others, their approach to family, what their neighbors might think of them, what their choice of pictures hanging on the wall might say about their values, and so on.
3. Go to the other person’s house for the same thing.

This takes time, but it’s a statement about the personal investment you’ll be making in each other. It’s also laying a foundation for when things might get tougher, in the negotiations or even after the deals closes. You’ll understand each other better and empathy won’t be as elusive.

The Important Next Step

What I’ve just described are the important first steps that you should take on your own. Maybe you have an advisor in the wings, but they should not be leading this. Yes, partly it’s to save you money, but mainly it’s because you need to experience this first stage without any third-party advisor who’s interpreting things for you.

But moving forward, it’s just as important to have an advisor—and the right one—as it is to not have an advisor leading things before that boundary.

Everything you’ve learned up to this point screams “yes, this is a good enough opportunity with the right people, wanting me for the right reasons, that we should play it out and see where it goes.” But the road has a lot of twists and turns from here forward, and you need someone who knows what they are doing.

This is quite possibly the biggest financial transaction of your entire life, and you’ve never done it before and will likely never do it again, and you really want to walk with an experienced guide.

There are four simple but very good reasons to hire an advisor at this stage. You don’t need a lot of legal or tax advice right now, and taking that angle will actually mess things up, but you do need an M/A advisor, and here’s why:

1. Hiring one is a good sign to the buyer because you are taking it seriously and actually investing in the opportunity. Don’t think like this is similar to clamming up in a police interrogation setting and insisting that they let you hire an attorney before doing any more talking. No, this is about taking it seriously in a way that the potential acquirer will respect. (If they don’t, “there’s your sign,” as they say.)
2. This advisor will speak the language of acquisitions. They’ll know what the terms mean, what cadence to expect, what to say when, etc.
3. An advisor can shield you from the more emotional exchanges. If you get a question that pisses you off, it’ll cloud your mind for the rest of the day. But if the advisor gets that question, he can explain that that’s a reasonable request and shouldn’t be taken personally.
4. An advisor can shield you from the distractions that you don’t need, allowing you to avoid that very serious danger of investing so much in a potential sale that your firm flounders if it doesn’t materialize.

One last note. Please push back on stupid requests for information. Unsophisticated buyers, especially, will copy some materials request they find on Google and throw it at you as if you have all the time in the world and have that information at hand. If you get information requests like that, it’s a sign of sloppiness or disrespect. Push back, or at least ask if they need it, before you spend hours or delegate the request so that someone else spends hours on it. Often it’s just a reflexive request by someone lower on the food chain who wants to reinforce how important they are in the negotiations. Don’t fall for it. I’ve seen them so ridiculous that they’ve copied a materials list from an entirely different category. E.g., the list might ask you to detail your “franchise marketing fee” when you aren’t at all a franchise.

In some cases, you can even say something like, “Hey, how about we swap information? Send us a list of what you need and then give us the same, in turn.” Even though they’ll laugh and refuse, there’s actually some justification for it. Eventually you, too, will need to know who is on their cap table, how financially sound they are, etc. But it’s a great way to lighten the conversation and joke about it.

There you go. Yes, do entertain an offer from time to time, and this explains how to do it.