Fall 2015 Issue of Horizons

PRIVATE EQUITY

In transactions, surprises are almost always never good. Sellers should be open and honest about the exposures of the business. If a buyer finds out about these exposures on their own, trust erodes rapidly, risking the entire deal. Retrading Lately, as a result of the competitive M&A market, buyers have been stretching their initial valuations in order to reach exclusivity with target companies, only to retrade key financial aspects of the deal during negotiations. Retrading is a strategy employed by both strategic and financial buyers that involves bidding high in an auction to win with the intent to retrade the deal, from a valuation perspective, during buy-side due diligence. The ability to retrade is contingent upon finding evidence during due diligence to support renegotiation of a purchase price that is lower than the initial bid. This strategy can irritate sellers and jeopardize the closing of a deal. Sellers can potentially lose leverage once an exclusive buyer is found, and, if they reject a retraded offer, they face the threat of restarting the sale process despite the sunk costs from lawyers and bankers and, perhaps most importantly, their time. The primary ingredient in retrading is exposure to due-diligence adjustments to EBITDA revealed during the buyer’s due diligence process. The conspicuous disclosure of pertinent information on the front end of negotiations can add transaction value for both buyers and sellers in addition to providing protection from retrading at the end of the sale process. One practice to help mitigate the risk of a deal being retraded is sell-side due diligence.

Negotiation agreements will also often contain a target net working capital amount, or peg (determined during due diligence), which is compared to calculated net working capital delivered at the transaction close date. Variances between the calculated net working capital amount and the target net working capital requirement factor into the eventual selling price of the company. If delivered net working capital is higher than the target net working capital amount, the buyer pays more on a dollar-for-dollar basis. The opposite is also true if delivered net working capital is less than target net working capital.

As a seller, being able to articulate and support what the company’s normalized level of net working capital is can be significant in terms of building trust with the buyer. All buyers prefer sellers that have a complete understanding of their business. Contingent Liabilities The discovery of a pending lawsuit, major customer bankruptcy or vendor dispute (to name a few) during due diligence can bring a deal to a screeching halt. Legally, some contingent liabilities must be disclosed during the initial phases of a transaction. However, many contingent liabilities may be undetectable without the inside knowledge of owners and management. Due diligence procedures are performed to identify any such contingent liabilities, but open communication often brings to light more detail on contingencies than those uncovered by a due diligence team.

page 24 | horizons Fall 2015