Imagine you are negotiating to buy a house and the current owner, the seller, wants to know all your personal plans for anticipated remodeling and also expects to be privy to how much profit you expect to make when you eventually resell the house. Residential real estate practice would consider this an absurd request, instantly denied.
Typical residential real estate buyers may show a financing commitment or similar proof of financial means, but no one is looking over the buyer’s shoulder questioning assumptions about improvements or expense reductions to operate the house. Beyond this basic qualification of ability to complete the purchase, the seller has no reason to pry into the buyer’s affairs because the premise of residential real estate is that the seller will be out of the picture immediately upon the buyer paying the agreed-upon price in full at closing. The seller will no longer be a stakeholder in the house, thereby limiting the nature and scope of questions that are appropriate to ask. Sure, cooperative buildings require greater financial due diligence, but that’s because the prospective buyer is essentially a partner in the building itself.
Why do Seller’s Expect Buyer’s Financial Information?
But in the world of strategic M&A among privately-owned print, mail and graphics communications companies, seller due diligence into the buyer is hardly an exception. In fact, recent client matters here at GAA have involved various levels of buyer disclosure with the sellers asking:
1) What is the buyer’s succession plan, given the age of the partners?
2) Does the buyer’s bank agree with projections for consolidation savings which under-pin the required debt service?
3) How much working capital will the buyer inject into the entity to support the revenue growth resulting from the “tuck in” of the seller’s book of business?
All good questions. Faced with these probing questions and others of similar intrusion, why would a buyer need or want to open the window on themselves when all they want to do is consummate strategic growth by acquisition? The answer primarily lies in the buyer’s choice of currency.
Payments in the form of earn-outs, such as royalties, commissions or contingent notes, all shift future business performance risk from the buyer to the seller and effectively make the seller a stakeholder in the buyer’s enterprise. Additional grounds for the seller to conduct due diligence and assess the buyer’s viability arise when the seller owns the building which will be leased to the buyer or if the seller will be employed by the buyer post-closing.
It is the choice of the buyer’s “currency” in the form of an earn-out, therefore, that causes the seller to ask for verification, assurance, and comfort that the buyer is a viable entity. It’s reasonable that the seller, in accepting the earn-out provisions, wants to know that the M&A plan is feasible and that the risk inherent with the deal structure is tolerable from their point of view.
An example occurred this week when a GAA client, a strategic acquirer, upon receiving the seller’s information request sent me an email asking “Huh, aren’t WE the buyer?” Of course, the buyer’s advisor can push back on the seller’s excessive request, which I did, however some disclosure was warranted. The buyer that is reticent to disclose financial information can express willingness to use more cash, which reduces the seller’s push for disclosure (“why do you care, our client is just going to write a check and be done with it?”)
How about All-Cash Deals?
Conversely, if the seller and buyer agree on a price that will be paid 100% in cash at closing, and there are no other post-closing obligations, then arguably there’s no cause for disclosure except to give the seller assurance that the deal will close. The seller is not asked to become a stakeholder in the buyer’s future success.
The strategic acquirers among my clients know that it’s never so simple. Rarely does the seller have a realistic firm price expressed in black and white dollars. More often than not, the buyer (and advisors) have to work through layers of Q&A and issues to get to the point where there’s clarity on “price” and “structure.” And in today’s market for printing and related companies, “structure” usually involves some form of risk-based consideration such as royalties, earn-outs, contingent notes, etc.
Planning for Buyer Financial Disclosure Increases the Likelihood of Success
In serving as M&A advisor to a wide range of qualified buyers over the past 25 years, I frequently recommend sharing financial statements early in the courtship process to gain the seller’s trust and demonstrate that the buyer is a solid entity and would be a good M&A partner. Financial statements showing financial viability are ideally supported by a good credit rating and positive reputation among trade suppliers, particularly paper houses and finishing companies.
I also encourage buyer-clients to speak with their bank well in advance of actual financing requests to alert the bank that M&A is a real possibility and to ascertain the bank’s general receptiveness to funding an acquisition. A buyer that follows these recommendations will have its house in order, be confident in their negotiations and demonstrate commitment to the seller.
On the seller-side of the table, one tactic to manage buyer inquiries about financial and business details is to ask for mutuality: “If you ask to see mine, expect me to see yours.” Most credible buyers will respect this request for mutual disclosure, to a point.
The main take away for graphic industry M&A participants is to be sure to expect at least some level of two-way financial disclosure. The days of the distressed seller showing up at the buyer’s door with a book of business and no expectation for anything (no cash, no financial commitment, no stakeholder status) are in most cases behind us. M&A opportunities are more likely to be consummated by buyers who are serious and maintain timely and accurate financial and business information that can be shared with potential sellers at the right time.
– John Hyde