What M&A Banker Would Rather I Not Write
August 15 2006 by Robert Lawrence Kuhn
If you are a CEO, you were my target. For more than 10 years, I ran a firm whose business was to sell small- and medium- sized companies, and to sell them for the very highest possible prices. During that time, we closed over 1,200 M&A transactions, and when we sought prime candidates to pay the most money, corporate buyers were almost always at the top of our hit lists.
One business owner complained to me that we had not valued his company for “more than it was really worth.” He wasn’t being funny: My company had a reputation-among corporate buyers not always a good one-of asking and often getting high prices for its sell-side clients.
How did our M&A dealmakers cajole or coerce tough-minded, market-hardened CEOs to shell out top dollar, sometimes paying more for the business than it was “really worth”? What were our techniques? Our tricks?
Though I may face disfellowship from the High Church of M&A Bankers, I’m going to reveal the M&A secrets of the inner sanctum: how top dealmakers manipulate CEOs to get them to pay too much. Here’s what M&A bankers do to you.
Discern the Decision Maker
If you are the CEO of a corporate buyer, dealmakers want to find your V (vulnerable) spot. Many CEOs are motivated more by power than by money; they are more concerned about the reputation they build than about the returns they earn. At the risk of channeling Gordon Gekko (a fictional character in the movie Wall Street who became a symbol of corporate greed), I’d always like to have CEOs, the prospective purchasers on the other side of the table, who were more motivated by ego than by greed.
Make Hockey Stick Projections
When M&A bankers represent sellside clients, they are under no obligation, unlike district attorneys, to present their cases based on all the evidence. A banker’s job is to get the highest price possible; smart, aggressive advocacy is essential for a freemarket economy. Whatever M&A bankers present should be the truth, but not necessarily the whole truth. When they make forecasts, they do not even pretend to be unbiased.
Sure, they try to be credible, but I can’t tell you how many of our financial projections looked like “hockey sticks”-three years of historical profits sliding steadily downward followed by five years of forecasted profits rising steadily upward. When M&A bankers provide projections, image them as criminal defense lawyers (or as masked goalies).
Conjure Up Strategic Fit
“Synergies” and “strategic fit” are the Holy Grail when bankers search for buyers willing to pay an outlier price. If you come to believe that you can eliminate most of the overhead of an acquisition, folding the purchased business into your own business, then the target’s gross margin can magically become its net margin. As a result, the price you are now willing to pay, assuming a similar multiple, escalates.
The reason corporate buyers pay, on average, more than do private equity groups is that CEOs imagine synergies that may not exist. Worse, such ephemeral synergies may become stealthy anti-synergies, the kinds that appear to be real but transmogrify on full-scale implementation and become toxic to the entire company.
One textile company bought a similar company assuming that the seller’s products could be manufactured in the acquirer’s underutilized plants. But since the product quality of the seller was higher than that of the acquirer, the products produced were inferior, customers fled, and the acquired business disintegrated.
Recast Aggressively and Without Doubt
This is a common technique, especially when selling private companies. In making projections, the idea is to eliminate expenses that the private business owner, who is motivated to reduce taxes, runs through the company. These include “excess compensation” that the owner may pay to herself or to her family members. Some such recasting is legitimate when this compensation, to be charitable, is “above market,” but can the company really attract a quality CEO for the assumed lower compensation?
M&A bankers may use the term “normalize,” which means to recast the financials by eliminating “onetime expenses” like unusual legal fees. Sure, companies do have “one-time expenses,” but they may have them all the time-each specific expense may indeed be “one time,” but the perennial existence of a neverending series of “one-time expenses” may be a “normal” part of the business!
Make Presentations Elegant
The more elegant the package, the more believable its contents. This sounds so contrived (or simpleminded) that no sophisticated CEO would fall for this. Wrong. Subtle psychological factors are at work and M&A bankers exploit them. After all, how could big, beautiful books from large, distinguished investment banks contain little, manipulating fibs?
Seduce the CEO
Nirvana for sell-side M&A bankers is when the acquiring CEO gets emotionally involved with the deal. “Has [X] fallen in love?” was a question we’d ask. We couldn’t make you, Mr. CEO, begin to court our client, but once you asked for the first date, we knew how to puff your ego and make you feel great.
Never Appear Anxious
M&A bankers try to convince CEOs that their clients are not all that anxious to do the deal, that you the buyer want to buy more than the seller, the banker’s client, wants to sell-a state of affairs that is often not the case. Anxiousness, which we often felt, was always masked.
Speed the Process
“Time Kills Deals” is one of our adages. For sellers, especially when small companies sell to large companies, a quick close is almost always best. You never know what can happen, what disruption lies in store. Change and surprise do not normally bode well for sellers. New financials are more likely liability than asset. If actuals do not meet forecasts, the buyer puts downward pressure on price and negotiates final contract terms more stringently. Alternatively, if actuals beat forecasts-a happenstance that occurs, nonrandomly, well less than 50 percent of the time-it is usually more difficult for the seller to raise the price.
Induce CEOs to Bid Against Themselves
This technique is a favorite that M&A bankers try to use regularly. Here’s how it works: 1) You are the only viable buyer. 2) The seller is anxious to unload. 3) You keep sweetening the deal. The banker opens this lock with two keys: first, the buyer has to love the deal; and second, the banker has to convince the buyer that a hot auction is going on. Turning both keys leaves the fingerprint of a good banker.
Swamp Due Diligence
Due diligence is when the buyer checks the seller to make sure that what seems to be true really is true. It’s nail-biting time for bankers who have calculated their fees and are waiting for the most opportune moment to submit their fee letter to their client. The deal has been negotiated; price and terms are set. Neither will get better during due diligence; they can only get worse.
Every company has warts and it is the job of the M&A banker, representing the seller, to make them blur with the background. Not difficult to find, but difficult to see. Difficult to find? That would be improper and could be illegal. But difficult to see? That’s good representation. The idea is to so overwhelm the due diligence team of the acquiring company with paper-not boxes full of paper but rooms full of paper (especially on legal matters and assorted trivia). As a result, fundamental matters of business, like who will run the company after you make the current owners very rich, are not addressed.
Good bankers don’t hide anything (knowingly), certainly not anything asked directly. It’s not right and it’s not practical: Any evasion appears as a giant neon sign arrow pointing to a serious problem. The best M&A bankers are always forthcoming, always answering every question and often doing so exhaustively with massive amounts of material.
It is a statistical fact that most M&A transactions erode the value of the acquirer. M&A bankers do not like you to know this. They talk synergy and strategy, and get you feeling grand. But now you know what you’re up against. In the next issue, I’ll present the Principles that Protect CEOs from Paying Too Much. Don’t close your deal before then.
Dr. Robert Lawrence Kuhn was president and co-owner of The Geneva Companies, the largest M&A firm representing privately owned, middle market companies (in terms of number of transactions closed); in 2001, he sold Geneva to Citigroup, where he is now senior adviser to the Investment Bank (