Overcoming M&A Challenges

Mindset to prepare for M&A

To improve chances of M&A success, there are two crucial things deal makers must do at the outset of a deal. One is to understand the lay of the land better than anyone else. And the other is to always act like an honest broker.

Because if people come to trust you and they realize you know the lay of the land, they're going to allow you to work your magic, find ways to find common ground, and cross off issues one by one. 

So, what do I mean by lay of the land? There are four components that go to the lay of the land. 

The first is to try to understand the relative negotiating leverage of the buyer versus the seller. And that's equally important, whether you're the buyer or the seller, representing the buyer or the seller.

So what goes to relative negotiating advantage? One important aspect is whether the seller has alternatives. Are there competing bidders? If it's a pre-IPO target, is an IPO an alternative to a sale? And maybe, if it's in a strong growth phase, the seller might decide to defer selling it if the time isn't right.

Another component that goes to leverage is: Does the buyer have synergies? And if they do, how do they compare to competing bidders' synergies? 

The third component of leverage is whether or not this acquisition is strategically important to the buyer because buyers behave very differently if it's strategically important to them to get the deal done. Otherwise, they're very price sensitive and they just want the lowest possible price for yet another deal that isn't strategic. 

Also, in learning the lay of the land, I try to identify impediments to closing. For example, the need for regulatory clearance, which is increasingly difficult today, and the need for financing, as opposed to a buyer that can just write a check without financing.

And then, how long is it going to take to get regulatory clearance, to raise financing, and so on. And ultimately, what is the likelihood of success or failure if the deal hangs in the balance on regulatory clearance or financing. 

Yet another part of the lay of the land is where the buyer is on the learning curve. Does the buyer already know going in just about everything worth knowing about the target? Or will they need to do a lot of due diligence to get comfortable and understand what they might be buying? 

And I suppose the last thing I mean by knowing the lay of the land is to do triage on the negotiating issues. Is it an issue on which the buyer and seller can likely agree? Can they at least find common ground if it's a little contentious? 

And the third triage category would be what I call zero-sum issues, where someone will win and someone will lose. 

After knowing the lay of the land, and after triaging on the issues, deal professionals can add a lot of value by turning those issues and finding common ground, so that the parties can put the issue behind them and get to closing.

That's the most scientific of my answers, but I thought it's important to get a framework.

On that last point of the triage, figuring out which issues are easy to resolve, which ones can be resolved with some effort if you find common ground, and the last category, obviously the most difficult, are the zero-sum issues where there'll be a winner and a loser and if it's going to be a successful deal.

On those zero-sum issues, the party with the most leverage is likely going to win them if there's to be a deal at all.

Strategic Negotiation Tactics

In many deals, leverage depends on whether getting the deal done is strategically important to the buyer because if it's a must-do deal, it changes the negotiating dynamics. Leverage is most important when the buyer wants it so bad it hurts, when it's strategically important to them.

I have an example. CF used to have a second business line that consumed cash rather than generated it for 10 years. I was tasked with selling it. How do you find someone willing to pay a meaningful amount for a business that consumed cash year in and year out, even in good times? 

I got the business sold and the deal closed because it was strategically important to the buyer to expand in its existing business line. So in negotiating, I decided focusing on financial metrics would be a losing approach. 

I used just one piece of paper comparing the relative size of the buyer to our cash-consuming subsidiary in the buyer's industry. I suggested scaling down the value analysts placed on the buyer's company to our smaller target. This approach worked. 

The traditional approach of presenting historical financials and suggesting potential cash generation would never have worked. It had to be reframed this way and couldn't have been if the buyer didn't view it as a strategically important deal, instead of one driven by the numbers.

But not in some sense, you've seen one deal, you've seen them all. However, every deal is different. They differ along these dimensions I described. So, if you master the lay of the land and come across as an honest broker, you can usually find a way to get any deal done as buyer or seller.

Having a foundation of trust and honesty

It's easiest to be accepted as an honest broker if you have a substantive, deep understanding of the lay of the land. If you're representing the seller, you know why the buyer wants to do this deal and vice versa. 

If you've given thought to the likely open issues and have come up with approaches issue by issue, you can find common ground and explain why that's where it lies in terms the counterparty understands. This turns it into a workmanlike instead of contentious process. 

To be an honest broker, you need to know the lay of the land better than anyone else. Once you know it that well, it's relatively easy to work constructively instead of contentiously.

There's usually a range from pro buyer to pro seller within which both parties could agree. Depending on whether you're the buyer or seller, you want to scope out the most favorable part of the common range, issue by issue, and try to get most, ideally all the issues to land in the common range at your end. I've closed probably over a hundred deals using this approach consistently.

I've thought of an example related to synergies. A financial buyer might not have synergies unless they have portfolio companies in the same industry. But strategic buyers almost always have synergies. The synergy is the fair market value plus the value created in the buyer's hands. 

In a competitive situation, the seller can often end up with most of the value created by adding this target to the buyer's empire. The common ground is the range between the fair value and the bigger number with the synergies. If you're the buyer, you try to save most of the synergies for yourself. If you're the seller, you try to extract most of it for yourself since the buyer will realize the synergies if they're real.

Assessing buyer transparency in deal negotiations

Transparency usually comes out automatically in a competitive auction, where the competition drives the deal price higher and higher until one by one, people with inferior synergy drop out. It becomes uneconomic for buyers, leaving, in theory at least, just the buyer with the greatest synergy of all the bidders.

It's the rare counterparty that will put its cards on the table about something as central to the deal as the price. But you can often estimate the synergies from outside looking in.

Negotiating that may be more of an art than a science in the endgame. I once worked on a divestiture of 40 percent of the public company parent. It was a competitive auction. I was with the seller. We opened all the bids and of the four or five bids, the highest one stood well higher than the other bids.

Our investment banker, without batting an eye, called the bidder that had put in the meaningfully higher bid than other bidders and said, "You're close, but if you add another 100 million, it's yours." Even though that bidder had already put in a far higher bid than the other bidders.

That bidder swallowed hard, added 100 million. And so that's the art of negotiating in an auction.

It's part science, just estimating what they could afford to pay and still come out ahead with the estimated value created by buying the target. Or you can play poker and just come up with some way to test your hunch that they have more in them.

And of course, few buyers lead with their final and best offer. It almost goes without saying they have more in them. The question is how much and how to extract it.

Mastering valuation and identifying synergies

I approach it maybe from the other direction. I spent roughly 10 years in private practice representing private equity buyers, and they usually didn't have any synergies. They were loath to participate in auctions, competitive bidding situations, where there would be other bidders, strategic buyers with synergies that they didn't have, value created that they couldn't create. 

PE buyers will often take a pass on competitive bidding opportunities with strategics bidding against them and fish in different waters, trying to get exclusive looks at something for sale. 

How do you get good at it? I think it's just working on enough deals until you get the hang of it, thinking about what's going on and why. Then, play some of your hunches and see what happens.

Well, you could do a lot worse than learn enough about the counterparty, and see the deal through their eyes. That helps you negotiate against them. It also helps you identify the common ground to put difficult issues behind you and get the deal done.

And, you know, if you are inherently fair and come across as fair and knowledgeable, it's happened a number of times in my career where both parties just look to me to find ways to resolve issues and trust me to do something fair for all concerned.

On the subject of earnings calls, AI is the newest on the scene. Traders on Wall Street are literally turning AI loose on earnings call transcripts, looking for clues, what's said, what's not said, words chosen.

But back to my example of trying to sell our cash-consuming business, I spent some time confirming my hunch that the eventual buyer would probably find this strategically important acquisition and might be willing to let a little thing like cash consumption rather than generation be secondary.

Identifying and overcoming obstacles in the M&A process

Problems don’t usually surface at the early stages because it's the honeymoon phase. Both the buyer and the seller would like to see the deal happen, so they work together to build momentum. And often that means postponing dealing with some of the more difficult and contentious issues. 

In most deals, the difficult issues surface when the lawyers and tax professionals first get involved.  It's then crucial to see if zero-sum issues can be transformed into common ground. If you're creative, you can often turn these challenging issues into opportunities for agreement.

But sometimes, additional difficult issues surface during due diligence. That really turns on whether the buyer already knows the target, the same industry, for example, like the back of its hand, or is going to be getting up to speed through due diligence. 

And occasionally, some amazing things surface during due diligence. Not often, certainly not always, but if you do 100 deals, you'll see some astonishing things come up during due diligence.

Uncovering surprises in due diligence

I'm going to give five examples. The first two came to light when lawyers and business people plowed through the data room. The third, fourth, and fifth issues were not the sort of things you would ever find in a data room. They were uncovered through the use of private investigators.

First, the two data room examples. In one case, the target company had grown through a roll-up strategy, buying companies in an industry from entrepreneurs. To keep the entrepreneurs engaged and get those roll-up acquisitions closed, they had handed out bespoke equity or equity incentive packages deal by deal. 

I was representing the buyer, and when we saw how pervasive and bespoke these arrangements were, our client, a financial buyer, threw up its hands because it was very difficult to model how much they would get as the PE buyer versus the entrepreneurs in terms of future value created. It was almost impossible to model. So that literally killed that acquisition.

Another one was where the target company was a manufacturer, and by license from a third party, it had the right to use a well-known trade name on its heavy machinery.

But during due diligence, the buyer learned that the extremely important license to use the trademark would evaporate on a change of ownership, especially because the buyer competed with the third party that had licensed the well-known brand. That one got solved, but it was critical to the value. A lot of the value of the target would evaporate if it lost its right to use the well-known on its heavy machinery.

The three learned through using very sophisticated private investigators in each case. One case, we discovered massive bribes of foreign government officials and extensive trading with enemies of the state on the OFAC list. Needless to say, that killed that deal. 

Another stranger one was where the target had sizable operations in a third-world country. We learned through a private investigator that the foreign government had silently appropriated the operations in that country, which were a sizable fraction of the global operations for the target.

They had repopulated the board so that the government had a majority and had silently appropriated the economics of the entire operation. Again, that's the sort of thing that kills deals.

The last example, in some ways stranger still, we learned, again representing the buyer entering a new industry in a new geography, that the entrepreneur of the target, someone they'd be completely dependent on, had a gambling problem. He had bet and lost huge sums at the horse races and was heavily indebted to the mob. So that killed that deal. 

So I realize due diligence feels like drudgery, but every so often you find something so important that it goes to whether or not the deal should go forward or not.

Utilizing a private investigator (PI) in a Deal

Well, all the well-known big law firms that specialize in major M&A transactions have relationships with private investigators. Some of them have private investigators on staff, employees of the law firm. 

Others have deep relationships with third parties who specialize in getting to the bottom of sophisticated private investigatory due diligence, nearly always outside the U.S. in the case of a U.S. buyer looking at something outside the U.S. This is a very specialized niche, but there are world-class experts who do it, generally through big law firms, for the big law firms' clients.

Navigating complex negotiation stages

I'll go back to my triage. By triage, I mean the issues that are easily resolved, the ones that are contentious but where you can find common ground, and the ones that remain zero-sum, win or lose, no matter how hard you try to identify common ground. 

The ones that are easily resolved are easily resolved. In situations where you think there's common ground, the trick is knowing the lay of the land well enough to identify that common ground, the range from pro buyer to pro seller. Being contentious, both sides are going to have to compromise somewhere in that area where they can find common ground. 

As a deal professional, if you're not the CEO or CFO, you need to make sure as the negotiator that you have the internal support you need to make the compromises. You must land, hopefully at your end of the common ground, but not where you'd like to land ideally if you had the CEO, CFO had their way. 

Then, having identified the range of common ground, the art is in negotiating as close to your end of that range as you can, issue by issue. That leaves the intractable zero-sum issues, where you've tried hard to identify a common ground, but there just doesn't appear to be a common ground there. 

Then it comes down to leverage, if the deal's going to happen at all. So if you're the party with the leverage, you want to be firm because someone's going to have to win. You have the leverage, it should be you rather than the counterparty with less leverage. Firm but reasonable. You're playing with fire. The viability of the deal is at stake. So, firm, yes, but also reasonable. 

Conversely, if you're dealing with these intractable, winner, loser, zero-sum issues, and you're the party with less leverage, then you have to avoid what I'll call collective deal fever, because if you're the buyer and it is strategically important to you and the CEO and CFO to get the deal done, you don't have as much leverage. 

But you have to guard against strategically important things turning into deal fever, like conceding the point or raising the offer price. So, I think those are the most difficult issues, and it maps to triage. And the question of whether it's strategically important or not to the buyer looms large.

I believe it can often backfire. If you threaten to walk away or issue any other threat and your bluff is called and you don't follow through, that proves the counterparty was right. You were bluffing. I'm not a big fan of threatening to walk away if we don't get our way.

It's a discussion the deal principle needs to have with the top executives. Take their temperature, if you will. Could they really countenance walking away over this issue or that issue? Or is it too strategically important shading into deal fever? But I think a starting point is being able to talk about the possibility of walking away.

Zero-Sum scenarios in M&A auctions

Well, price is probably the cleanest example of Zero-sum. How much is the buyer willing to pay for something strategically important if they have to? In order to guard against deal fever, buyers will often set, agree on the largest amount they could ever see themselves paying.

But inevitably, that will be put to the test. Did we really mean that was the most we would ever pay? Because it looks like we might have to pay a little more to stay in this competitive auction to get this strategically important deal closed. 

That's why it's so important for the negotiators on both sides to figure out whether it's strategically important, a must-have for yourself if you're the buyer, for the buyer if you're the seller. Because if it's not strategically important, then it's just going to be driven by the financial metrics and at some point it won't make sense for the buyer to pay even more.

If you're the buyer and you have synergies, it would unlock a lot of value if you were to buy it. But none of the competing bidders have anywhere near your synergies. Then you're sitting pretty because you just have to outbid the highest of the other bidders without your synergies and you pocket the synergies for yourself.

It goes without saying as often as not, you don’t hear the truth from the person conducting the auction. You may have put in, by far the highest bid and be told, well you’re close, but you’re not there.

Valuation and auction bidding strategies

Well, the most common approach is to take everything you hear from the person conducting the auction with a grain of salt. And just keep your eye on your own prize. What would be a good deal for you as the buyer? What wouldn't? Try to guard against deal fever, other emotional factors.

Another way to deal with it is to remember that valuation is more of an art than a science. You change one or two assumptions and you get a very different valuation. So, take what bankers conducting an auction tell you with a grain of salt. You also have to take what your internal valuations are telling you with a grain of salt. Because they're incredibly sensitive to arbitrary assumptions.

It's easier to get better if you do a lot of deals. And if you do post mortems on them, then you can calibrate your approach better. Saying, "Oh, four out of the last five deals we did, it looks like we overpaid with the benefit of hindsight." That tells you something.

At CF, we have a process where we routinely do one year, three year, and five year check-ins as a way to calibrate our thinking about valuation. So if you have that process, you capture the learning automatically and it gets discussed rather than just filed away.

Overcoming M&A challenges between signing and closing

The period between signing and closing can be challenging, especially if there's a significant delay for reasons like regulatory clearance or financing. Deteriorating market and capital market conditions can cause  buyers to reassess their willingness or ability to close the deal.

And adverse market developments aren't the only risks. There could be other material developments between signing and closing. In a deal that needs regulatory clearance, and everyone thought that would be easily obtained, more and more in the U.S. and many other countries around the world, it's getting harder to get deals cleared. And that often takes the form of unexpected, unpleasant surprises between signing and closing.

In deals involving public companies, stockholder activism could emerge. Believe it or not, it's not uncommon to find activists saying to the buyer, "Oh, you're paying way too much, you probably shouldn't even buy this company." And other activists going to the target company saying, "Oh, you never should have signed that deal, you're not getting paid nearly enough."

And roughly half of stockholder activism now is deal-focused, and as often as not on both the buyer and the seller side. So that's something to bear in mind if there's a long period between signing and closing.

Sometimes the synergy, the value for the buyer, is inherent in the tax regime, in the regulatory regime. It's not unheard of for those to shift, maybe even dramatically between signing and closing. There might be a major lawsuit or major regulatory investigation aimed at the target between signing and closing.

And as we sit in 2023, there are crises everywhere you look. A crisis might develop affecting the buyer or the target between signing and closing. 

So given all the things that could happen, these are some of the most heavily negotiated provisions in acquisition agreements, how to deal with them if they do come to pass between signing and closing, and why it's really important to have excellent lawyers on both sides there.

People who do deals for a living have developed what I'd call market approaches to allocating the risk between buyer and seller if one or more of these things happens. It typically isn't all that bespoke.

There's no reason to reinvent the wheel. The answer is to get top lawyers who know their way around deals to deal with it in the acquisition agreement and then hope for the best that all's quiet. 

Mitigating post-merger integration risks

The single biggest risk during post-merger is loss of talent or demotivation of talent at the target, particularly in sectors like tech and professional services. Because, as the old saying goes, the assets of such companies go home every evening. They're not tangible assets. It's crucial to ensure key talent remains motivated and committed, as they are the invaluable assets that help run the company. 

There are various ways to mitigate this risk. Strategies like deferring liquidity for key individuals can be effective, reducing the urge to leave after receiving a payout. While seller non-competes have been a classic approach, their current legal standing is questionable. 

And then the classic carrots, incentive retention packages, making it well worth people's while to remain and remain engaged at the new subsidiary. But I think there's ultimately no substitute for having a work environment that people want to join and that people are loath to leave. Handcuffs, incentive packages, and the like, seller non-competes if possible, only go so far. People have to genuinely want to stay and want to do their very best. 

People are naturally drawn to workplaces with an appealing culture, an exciting strategy, and a rewarding mission. At my company CF, for example, we have a wonderful, robust culture we call Do It Right.

It has four components: worker and public safety, because in the chemical industry, safety is of paramount importance; second, inclusion and diversity, because we want the very best people, making CF a very diverse and inclusive company.

This has led to the most talented, diverse candidates wanting to join CF when they have other options, creating a virtuous circle; third, legal compliance and business ethics, a very important part of doing it right.

And finally, environmental stewardship. Being a chemical company, we have a major impact on climate change for better or worse. Turning from culture to strategy, CF, three years ago, announced a new and exciting strategy called clean energy.

Our strategy involves making dramatic and rapid reductions in our carbon footprint to produce a carbon-free product, ammonia, that is a drop-in substitute for fossil fuels in certain applications.

Not only are we reducing our carbon footprint rapidly and dramatically, but we're also supplying our customers with a carbon-free substitute for fossil fuels, enabling them to reduce their carbon footprints in turn. It's a very exciting new strategy and one of the reasons we have great people who want to join the company and great people who wouldn't dream of leaving it.

I've become convinced it's a huge competitive advantage to have the right culture. And it helps more than a little with integration. Particularly if the key assets of the target are the people.

Biggest challenges in M&A

I have seen big challenges in M&A and in some sense, it's my second of two war stories. I told you about taking the money-losing company public at the same time as Google and outperforming Google for the next 10 years. That was my first war story.

During the financial crisis in 2009, early 2010, we found ourselves in a four-way cross-border takeover battle. We had made a hostile offer for a competitor in the U.S. A few weeks later, a bigger competitor in Canada made a hostile offer for us. So, we were simultaneously playing offense and defense for over a year.

Then a fourth company, a European competitor, by some measures the largest of all, entered the fray. It made a friendly offer to buy our U.S. target, and that deal was signed and announced. 

At that point, the large Canadian company coming after us said, "Well, we're still interested in acquiring CF." So, it looked very much like you could see the final outcome. The European company would buy our competitor in the U.S. and the Canadian company would buy us, and that would be that. 

But being a lawyer, I realized that at the other company in the U.S., once they announced a deal to be acquired by the Europeans, it turned it into an absolute auction. The board of the other company in the U.S. really had no choice, legally speaking, but to sell the company to the highest bidder.

So I recognized that and engaged in extensive consensus-building within the company up to and including our board. Our investment bankers, everyone, convinced them we should put in a topping offer. Outbid the Europeans for the U.S. company we wanted to buy. 

So we did that. It turned out the European company only had one bid in them. So at that point, we won the contest, if you will, to buy the other company in the U.S. We doubled in size with that acquisition, and that made the combined company now twice as large, too big for the Canadians to handle, so they dropped their pursuit of us. And so we doubled in size against all odds to everyone's astonishment. 

We were the underdog throughout, right up until the end when we made the winning move. And it was a great acquisition. The combined company outperformed its competitors markedly for the next several years. So if it wasn't for recognizing the winning move and convincing all my colleagues to make that move, we would have been taken over and that would have been that. 

You don't see hostile takeovers nearly as much today as you did for decades. Now it's all about stockholder activism.

Most hostile takeovers, but certainly not all, start out with preliminary friendly discussions between CEOs about putting the two companies together. Those rarely result in mutual agreement. “Yes, let's put the two companies together. I'll run it. You'll depart with a nice package.”

And so even the typical ones that start out with a friendly discussion eventually turn unfriendly in one way or another. Sometimes, the fact that it's turned hostile becomes public. Other times, the hostility is behind the scenes and only inferred by the public.

Advice for first-time acquirers

The best general advice is to do as many deals as you can and learn from the very best. Sooner or later, sometimes in the natural progressions, other times much earlier than you were anticipating, you're suddenly flying solo. 

You may have been thrown in the deep end of the pool before you were prepared to run your own deal. Other times, you've had good training and you're ready for it. But either way, odds are you've been given that responsibility for a reason. You wouldn't have been given that responsibility if the people who gave it to you didn't think you were up for it. 

So, embrace the opportunity to learn by doing. 

If you've been thrown in the deep end of the pool, instead of schooled for several years, you may make mistakes, but in any event, you always have the option of going back from time to time to the people who trusted in you, who gave you the responsibility and saying, "Oh, this is a tough challenge. I was not expecting this curveball."

But it's a combination of doing a lot of deals, learning from the most talented people you encounter in those early days, and then handling the transition from being part of a team to running the show.

I'm a big believer in learning by doing. I wanted to learn about futures and options. I took a course in it, but I didn't feel I really understood it as well as I should. So I took a small sum but a lot at the time, opened a retail account to trade futures and options, thinking that nothing would cement those lessons like playing with real money and all that leverage.

So, I'm not risk-averse when it comes to learning new things. I think you need enough risk that you pay attention. You bring out the best in yourself as you learn to master it.

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