TSL TRENDING STORY
Getting Past Breaking Points
Keys to Successful Deal Making
By Tom Goldblatt
Here’s a familiar scenario: A transaction is moving along at a nice clip with all parties actively engaged, civil and seemingly happy. And then it happens. The breaking point. The deal hits a snag, bump, a roadblock, or even a crater. The bad news is that breaking points – big or small -- are inevitable. The good news is that breaking points – even those that look like they may deep-six the deal – can be resolved.
As you will learn in this article, the skills that are necessary to manage through breaking points are about both financial prowess and emotional intelligence – understanding the mutual interest in the deal and each side’s motivation for completion. To be a successful deal maker, it is imperative to recognize when a breaking point is occurring and then know how to do everything in your power to bring the parties back into a new alignment. After all, this is when we earn our money.
Why Breaking Points Occur
Breaking points are part and parcel to deal-making because of the time span from when a deal starts and when it closes. During that duration, anything can disrupt the transaction: macroeconomic events can change the business environment, a major customer may be lost or gained, a potential liability may be discovered or a key executive may depart. A breaking point may also erupt due to the change in the leverage or power of one of the parties involved. After the buyer signs a letter of intent and gains exclusivity to a transaction, the seller loses the ability to easily switch to alternative buyers which may create tensions and mistrust if a problem should arise. With any of these events, a misalignment in the transaction may occur, spurring one of the parties to seek a renegotiation of terms.
Staying Ahead of the Curve: How to Anticipate and Prevent Breaking Points
The most important way to avoid breaking points lies with the initial structure of the deal. Some techniques that will help keep the deal aligned while also allowing room for overcoming breaking points, include:
Clearly state proposed deal terms. Put as many deal terms as possible into writing in clear, unambiguous language; then use examples to prevent potential confusion. No matter how clearly you may think an agreed-upon term has been stated, it can become a point of contention during a dispute. Even clear contract terms may not be adequate. Identify those terms which you think could become challenged at a later date and create a paper trail that shows intent.
Use objective, not subjective criteria. As a deal progresses, leverage may change and memories will be short. By limiting the amount of wiggle room in the interpretation of terms, you will be reducing opportunities for disagreement. For example, if you are trying to create a term that will decrease or increase the purchase price based on the performance of a company at a later date, try using an objective third party measurement instead of relying on a figure within one party’s control.
Full disclosure upfront. A deal is usually struck based on the buyer’s expected incremental cash flow from an acquisition. Although the value of a deal is based on the future, diligence often focuses on past performance or trailing twelve months cash flow. The biggest cause of breaking points occurs after a buyer has secured exclusive rights to close with the seller, but then -- during final due diligence -- discovers an adjustment to past EBITDA. To minimize the potential for this disruption, it is imperative for a seller to disclose to the buyer all potential negatives prior to striking the initial deal. Without this transparency, those adjustments will come back to haunt you. Our approach is pre-emptive. We have buyers contract with a third-party accounting firm for a Sell Side Due Diligence and Quality of Earnings before the sale process begins.
Develop a complete understanding of each side’s objectives, concerns and mindset for the deal. The better you understand what each side is trying to achieve and avoid, the better you can help craft the structure of the initial deal to meet these objectives and monitor its progress.
Preserve Your Leverage. The seller maintains leverage up to the point of giving the buyer an exclusive. One of our chief tactics is to avoid lengthy exclusives. We shorten the exclusive period by addressing those items that often lengthen a deal -- such as schedules for an Asset Purchase Agreement, UCC releases and consents -- as early as possible, and also by fully populating the data room with diligence materials. We also keep alternative buyers active and in the wings by establishing the transaction as an auction where multiple parties have the opportunity to bid on the deal until the close.
Move Swiftly but Carefully. Try to move everything along as quickly as possible without harming the buyer’s ability to complete their study of the company. In getting a deal done, time is rarely on your side. The longer a deal lingers the more opportunity for an unforeseen breaking point. For example, how many deals were delayed or scotched by the unpredicted Lehman Brothers bankruptcy or 9/11?
Stay Close to Key People on the Transaction. If a breaking point is percolating you will want to know about it as early as possible when it will be easier to remedy. Make allies with key players from both sides of the transaction who can keep you tuned in to the progress of the deal and alert you to a potential problem. All transactions involve multiple parties beyond the seller and the buyer. Early in the process, (optimally even before the deal starts) get to know these potential influencers and witnesses. You never know when you will need a favor.
Don’t Create a Breaking Point Yourself. Don’t drive a deal so tight that you force a future breaking point. The deals that break the most are those that try to squeeze every last dollar and term in favor of one party. If you push too hard for a bargain and force a buyer out of their comfort zone, then even the slightest hiccup can lead to a deal’s demise. If, on the other hand, the buyer thinks they have a good deal and they are being treated fairly, they are more likely to adapt to any negative events or changes.
Overcoming Breaking Points
Even though you did everything right in structuring the deal to avoid breaking points, they will still occur. This is when a deal maker moves into action to resolve the problem, get the deal back on track and move to completion. Here are tools for overcoming breaking points:
- As soon as it appears that a deal is moving towards collapse, jump into action. Remember, time is your enemy; the deal won’t get better on its own.
- Before reacting, gather the facts and gain a full picture of the events that led to the breaking point; this is when you can call on your new allies for information and insights.
- Once you have fully assessed the situation, reflect back on the parties’ mutual interest in the deal. Separate out the emotional component and just look at the facts. This may be the most important step of all. If you can recall and understand each party’s mindset– and appreciate their mutual interest in seeing the deal completed -- then you will have a better chance of success.
- It’s also important to remember that while all parties may want the transaction completed, they have different motivations. We have found this to be especially true in the middle market where Ravinia Capital often works with family-held businesses that are focused on something other than the bottom line. In these cases the owners may have an emotional connection to an enterprise that has been in the family over multiple generations, or they may be concerned about non-financial matters, such as continuity for employees. However, the private equity firm just wants large returns to it is limited partner. Meanwhile, the commercial bank is motivated by the desire not to lose money or damage its reputation. Your job is to understand and remain mindful of the convictions of all the decision makers, get into the deal as deeply as possible, and stay connected. Deals can change quickly.
- Don’t point fingers, assess blame or take a moral position. Use facts to try to resolve the conflict, and get the deal back on track.
If all else fails, try to bring the parties together into a room, lock the door, and don’t let anyone leave until an agreement is struck. A good six-hour, face-to-face negotiation can save weeks, if not months, towards completing the objective.
- There will be times, however, when the breaking point will break the deal. One side may be pushing too hard for reductions – even though they still claim an interest in doing a deal – and you will just have to say “Pencils Down.” Or, along a similar vein, you may need to signal that you and your client are willing to walk if a fair compromise cannot be struck.
Putting Words into Action
I want to conclude with Ravinia Capital’s experience with a recent transaction. We entered a letter of intent in May to sell a family-owned business at an excellent price. The transaction was set to close in September. July results came in significantly off budget; we knew we were looking at a breaking point. To salvage the deal, the seller ran a detailed investigation to understand the genesis of the loss so we could prove to the buyer that it was an aberration and would not affect future cash flows. Importantly, we were able to accomplish this within 24 hours. We proactively contacted the buyer and provided them with our analysis. We gave them full access to the people at the company involved. And, in return for not trading down the price we offered a few concessions on the asset purchase agreement that we had been holding back just in case we needed some currency for last minute negotiation. Even though some minor snags surfaced along the way, we resolved them all and successfully closed the deal. By then, the breaking point was a distant memory.
Great deal makers know how to survive breaking points. They develop the skills that enable them to anticipate and identify possible trouble in a deal. Then they know how to either prevent the problem from becoming disruptive or mitigate its effect. And finally a great deal maker will have the know-how to turn a breaking point from a problem into part of the solution to help drive the transaction to completion. Remember, every deal is going to have a breaking point. It’s what you do with it, how you handle it, and how you get past it that will set you apart from your peers.
Tom Goldblatt is president and managing director of Ravinia Capital, which he founded in 1998. He has more than 20 years of operating experience working in roles ranging from salesman to CEO. In 2016 he won ‘Distressed Dealmaker of the Year’ by the 8th Annual M&A Advisor Turnaround Awards. Tom is a frequent speaker on alternative capital raises in challenging situations, distressed investing, and business development and networking. He received a BA in Accounting from the University of Illinois at Urbana-Champaign, a JD from the University of Chicago and MBA from the Kellogg School of Business at Northwestern University.