Inside M&A Banking

How do you protect a CEO from paying too much?

September 1 2006 by Robert Lawrence Kuhn


The relationship between CEOs and investment bankers is like that of medieval popes with Knights Templar, the famous order of warrior monks who raised their own revenue and were a power that the Church as much feared for its independence as relied upon for protection. M&A bankers present their profession as High Art, charging large fees for what seems quite modest work. When clients thought my M&A firm’s hourly charge outrageously high, I would smile sagely and tell the following story.

A rich man brings a rough diamond to an old jeweler. The old jeweler studies the stone, positions his chisel, and, with a single sharp blow of his hammer, splits the stone with perfect cleavage, yielding four perfect gems. A week later, the rich man receives a bill for $100,000. Enraged, he calls the old jeweler: “Are you nuts? $100,000? You didn’t work an hour!” “I’m sorry,” responds the old jeweler, “I should have itemized my bill: For cutting the diamond, $10; for knowing where to cut the diamond, $99,990.”

For investment bankers, relationships are key. The inside term is “coverage,” which means that bankers are assigned, usually by industry, to particular corporate clients and tasked to “cover” them. Translation? To smother or metaphorically kidnap them if necessary, with the twin goals of eliciting some new fee-generating deal and preventing competing bankers from getting or staying too close.

The fact is that despite all the front-page glory M&A transactions receive, most prove less lucrative than corporate buyers initially expect. This does not mean, of course, that successful acquisitions are not done. They occur all the time: Astute buyers pay high prices, turn their acquisitions into star performers and generate even higher returns. These rare-but not random-occurrences happen when perceptive buyers discern deep, untapped, even unrecognized opportunities, often involving operational leverage.

In the first article of this two-part series (“What M&A Bankers Would Rather I Not Write,” July/August), I revealed the kinds of manipulations that investment bankers use to make CEOs pay too much for acquisitions. In this article, I explain the 10 principles by which CEOs can defend themselves against overpaying.

Never Believe M&A Bankers. M&A bankers are not your friends. Not even those on your side, much less those on the other. This does not mean that what they tell you is knowingly false; indeed much of what they say is probably true. Most bankers, most of the time, tell the truth. The problem is twofold. First, what is true may not be the whole truth. Second, you don’t know when they’re not telling the truth-and sometimes neither do they.

This does not mean that you, as a buyer, should not listen to bankers representing a seller. Listen hard, because the one thing you know for sure is that whatever they tell you is crafted to get you to pay more. You’d be surprised how much you learn when you listen through this filter. For example, if bankers are stressing one thing, say, increasing net profits, why are they neglecting another, say, decreasing gross margins?

Run Your Own Numbers.Never rely on numbers generated by the other side’s bankers. You shouldn’t even use their models. There is great benefit working de novo: Build your own models; start from first principles.

Speak Directly With the Seller.Try to get time alone with the sellers, without bankers present-yours or theirs. Bankers will not like this. They fear that if buyers and sellers meet privately, this may diminish their perceived value, an unhealthy psychology when it comes time for M&A fees agreed to in principle to actually be paid.

At my firm, we told our bankers never to allow our clients, the sellers, to be alone with the buyers. It was as if our clients were underage juveniles and potential buyers were sexual predators. If such an encounter occurred, we chastised our banker for dereliction of duty. When meeting with bankers, watch when they become nervous, switch subjects or interrupt their clients, the sellers. Each is a lead to follow.

Negotiate With Another Company. Never negotiate with only one target. Try to find another candidate you can explore acquiring as an alternative. Even if this other company is a stretch, there is psychological benefit in diversifying your acquisition explorations. M&A bankers representing sellers seek as many buyers as reasonably possible; it’s part of their DNA. In my past life, we indoctrinated our seller clients and prospective clients with the mantra, “One Buyer is No Buyer.” Buyers should balance negotiating power by having acquisition options.

Plan a Worst Case Scenario.The best case will take care of itself; the worst case is what CEOs should study. What are all the things that could go wrong with an intended acquisition? Think not only about usual issues, such as integration and operations, but also about unusual shocks, such as product liability and macroeconomic dislocations.

Never assume that the future will mimic the past. There are two reasons for simulating depressing scenarios: It will make your company better able to respond if such circumstances occur; and it will dampen the euphoria that drives up prices-and investment-banking fees.

Seek Anti-Synergies. Most corporate acquisitions are driven by searching for synergies, trying to materialize greater value by integrating the acquired company with the acquiring company for a combined post-acquisition value larger than the sum of the separate preacquisition values. Clever buyers do the opposite. They seek synergies that are imagined but do not really exist, those that appear to be real but when attempted following the acquisition turn out to be illusory. I call these Anti-Synergies; they are the most insidious because you keep trying to make them work.

One way to find these hidden corporate viruses in your pre-acquisition analysis is to assume that each synergy for which you are doing the deal will be defeated. Try to imagine ways in which these apparent synergies disappear and calculate the consequences of each disaster. The exercise will be revelatory.

Scrutinize Any Recasting. Watch for hidden traps when assessing “recasting,” or the normalization of revenues and expenses. Here are two: If the recasting substantially reduces owner compensation to supposed market rates, can you really get a first-rate CEO for that lower salary? And check whether all those “one-time” expenses, such as extraordinary legal expenses, that get normalized (i.e., eliminated in the recast) are actually expenditures that regularly occur.

Don’t Bid Against Yourself. M&A bankers love this technique. Here’s the situation: 1. You are the only viable buyer; 2. the seller is anxious to unload his company; and 3. you keep sweetening the deal. That, we would say, is the fingerprint of a good banker. The antidote? Don’t be quick to raise your bid.

Watch Those Who Get Rich. Never assume that any seller who gets rich on your money will stay around post close, or that if they stay that they will work hard, or that if they work hard they will continue to do so. Former owners may have every good intention, but reality sets in quickly. Newly rich people become fickle. Be especially careful when an entrepreneur is selling.

Discern the Difference Between Owners and Managers. There are two kinds of companies that sell: those that are sold by owners who are active managers and those that are sold by managers representing passive owners. This difference colors every aspect of the deal. (There is also a difference between entrepreneurs, the founders of the business and subsequent generations of family owners.)

Entrepreneur owners will do things that professional managers will not. They will react more emotionally, particularly regarding their employees (or certain employees). And you know what? They have earned the right to act that way. They created their company and struggled through hardships. If they now want to do something unusual, work with them.

Finally, good investment bankers do bring a wealth of experience to deals. What’s more, because they expect to make a great amount of money and because they are profoundly concerned about their reputations, they will work intensely and creatively to make deals successful. The bottom line? There is nothing wrong with paying high investment banking fees as long as the product you get is a perfect gem.


Dr. Robert Lawrence Kuhn, an international investment banker and corporate strategist, is senior adviser to Citigroup Investment Banking. For 10 years he was president and co-owner of a middle market M&A firm that completed more than 1,200 M&A transactions. An intellectual with a doctorate in anatomy/brain research, he is also a television producer and the author of numerous books on strategy, creativity, science, business and finance.

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