Musings on business value, sale preparation, sale negotiations, sale structure.

Archive for October, 2010

Horse and cart due diligence

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Much of what is written in this newsletter may sound familiar to many small business owners: The need to reschedule or remove debt, selling assets, assumed deals and evaporated deals with the consequent confusion and feelings of rejection. Apart from the fact that the unfolding first story probably happens in a parallel universe to ours, and in a higher league than the second, it should not detract from the lessons to be learned.

People often say that motivation doesn’t last. Well, neither does bathing – that’s why we recommend it daily. – Zig Ziglar

Just over a year ago Old Mutual(SA) said that its capital position was 3.9 times that required by law. Then 2010 saw OM Plc selling up assets in the USA to reduce the group’s net debt. A recent proposed sale of its Nedbank shares to HSBC was “to further improve its capital position”. Doesn’t that sound like a position many small business owners have found themselves in of late, albeit to a slightly different extent? Anyway, bottom line is that OM clearly wants to sell, and Nedbank management made no bones about the joys of being taken over by a bank with a clear resolve in making big moves into other countries in Africa.

On 23 August 2010 HSBC, Europe’s biggest lender, announced that it had entered into exclusive discussions with Old Mutual about the possible acquisition of OM’s Nedbank shares. The press release read “HSBC has been granted a period of exclusivity by Old Mutual to conduct a due diligence exercise”.

Financial newsrooms were abuzz about this being a possible positive spin off of the soccer tournament, a vote of confidence in South Africa, and the reason for the strength in the Rand. The usual nonsense, in other words.

Earlier in October rumours emerged that HSBC was not going to make an offer for the shares after all. Then on Friday 15 October this was confirmed. Nedbank’s CEO was quoted as having no idea of the reasons for the break off, nor having been given any indication during the due dilligence that anything was amiss. I would imagine that the greater part of last week was spent trying to get answers out of the suitor as part of a post mortem while the South Africans nursed bruised egos and decried the HSBC cavalier behaviour and lack of decorum.

Clearly the shares owned by OM will be sold to somebody, but the conditions will now be different. HSBC has had a wonderful time ploughing through some very juicy information, Chinese walls notwithstanding; and some of that information may well stand them in good stead as they make other plans to wade into Africa without paying for the intellectual property that would have come with Nedbank. Those exposures are going to cheapen the deal with other buyers because they are now buying into less than virginal territory.

Reading the various press statements and articles, it appears that Nedbank and OM are less troubled by the ending of the deal, and apparently more upset by the manner in which the whole thing was terminated. The usual nonsense, in other words.

As I said in the opening paragraph, there are many similarities between this (non) deal and activities around many small businesses. I am thinking in particular about smallish successful businesses who’s owners are approached by a big brother investor or buyer. By “buyer” here I mean someone intending to buy out the business.

And for a much smaller business:

I had a shocker of a meeting last week. A business owner who approached me was staring down the barrel of a gun. Ted’s business had been on the market for two years. I suppose it had suddenly come to the market on the day that his big competitor called him, unsolicited, and asked if he was possibly for sale.

He had known for some time that he was starting to irritate the big cheese, and took a certain amount of satisfaction in the knowledge. So when the guy called him and asked for a price he went home as the triumphant warrior to his wife. “Honey we will retire soon. Rustibolox called today, and wants me to give him a price tomorrow.”

(You’ll appreciate that some of the names in this newsletter have been changed to protect…etc. To be clear, I do not know anybody by the name of Ted, looking to sell his business.)

The following day Rustibolox indicated that the price was reasonable, seemingly without giving it much thought. But, he was quick to say, they would need to do a due diligence. “How about lunch?” It all seemed very civilised, and Ted was impressed that the person he had always seen as a ruthless operator, appeared to be human after all. Similar to the early part of the Nedbank (non) deal there was much back slapping and self congratulations.

Early in the next week an accountant arrived and quietly got on with poring through files. Within a few hours he had become part of the furniture, occasionally asking for information, or another file. By the second day all guards had been dropped, and he was into the server. At the end of the week, the accountant announced that he would be away for a week, and that he would see them all the following week.

At the start of the following week Rustibolox asked Ted to come over and explain a few things. The meeting was cordial, but somewhat less enthusiastic than the first lunch, and this time there was only coffee on offer. Ted left with the very clear impression that he wasn’t going to be getting his price. But a few hours later the accountant reassured him saying that there were some more things to be investigated – a request from Rustibolox.

More meetings; now progressing to discussing price, terms and takeover dates and methods. And the price was slipping, although the way they explained it to him… Well, it just seemed strange. But Rustibolox seemed to know what he was talking about, and he was right about the way Ted had taken some short cuts.

Then the biggest shock of all. A signed offer arrived. It was time for Ted’s attorney to be consulted. He read through the agreement, then told Ted: “This is going to see you walk out of your business with just R4M.” And when Rustibolox’ attorney had finished talking to Ted’s attorney, it was clear that there was going to be no upwards movement. Sadly Ted went home to tell his wife that he had asked his attorney to turn down the offer.

But that’s not all…

In the weeks that followed Ted was approached by a business broker who claimed to have 200 different buyers for Ted’s business. “No really, they all want yours, and with so many interested buyers we will definitely you get a much higher price.

(As an aside, Suitegum has 800 registered buyers, but only a portion would be interested in any particular business. Even taking a particular business offshore, the response is never close to 200; and how would we deal with so many anyway?)

Needless to say, the 200 buyers never materialised. It turns out that the broker had never sold any businesses before, and was really a front for a group of buyers. He had a vested interest in a share of the business for himself. And then it emerged that all his jargon was fuelled by the rights to a “system” that supposedly works in North America and Europe, wherein they still insist that a business has to go to overseas markets to be sold at all.

When I met with Ted, it was clear to me from a cursory glance that this business had never been worth anything close to R10M. The original Rustibolox approach flattered to deceive as he delved into the intellectual capital of the business, plundered the customer list of its best customers, interrogated the discount structures, stole the methodology which made up Ted’s margins, and finally got into his supplier list. When a supplier called him one day to ask if it was true that he was about to sell the business, and asked him to shorten his payments in anticipation, the game was up.

Lessons from both

If a sale of a business is to be successful, it is important that a seller be in charge of the deal at all times. If he allows a single purchaser to take over, he has lost. The biggest influencing factor of price is having a choice of buyers without granting exclusivity. In this way the pressure stays on the buyers to remain honest, as they concern themselves with the state of play and the other buyers.

Recently a fairly large franchise group was acquired by a group that owns many similar chains, for what looked like a crazy price, and which when compared to the other bidders’ offers was more than 60% higher than the mean. Why would the buyer see things so differently to the other bidders? The reason they paid the higher price was because the acquisition fitted so well into the buyer’s supply chain, resulting in significant savings and extra profits, while at the same time absorbing a competitor. The acquirer was more interested in making a fair offer than screwing a smaller competitor because of the broker instigated pressure. There had been several buyers, all keeping one another honest.

It must fall within the scope of the list of buyers to whom the business is taken that they be financially able, and potentially interested in the acquisition. A competitive market place must be created. Dealing with only one buyer puts all the pressure on the seller. Dealing with lots of different buyers puts the pressure on them. Prices rise, terms improve and deals happen faster.

It is difficult for a business like Nedbank to dictate such terms to a suitor like HSBC, but the banking regulator may make life difficult for the next prospective buyer. All very similar to the world of small business, once a deal has flopped. Ted is going to approach the sale of his business very differently next time as well.

And why would one ever agree to the the due diligence being conducted prior to terms being agreed for the sale of a business?