What to Ask, Sign, and Share With a Potential Buyer

Following up on the recent episode on whether you should be considering that offer to sell your firm, David provides four questions to get answered, two documents to sign, and a short list of materials that can help you take the lead in early conversations with a buyer.

Links

”Should You Entertain That Acquisition Offer?”

Transcript

Blair Enns: David, today we're talking about what to ask, share, and sign when a buyer expresses interest. I haven't counted, but this is three or four or five in a series on selling your firm. You've got selling your firm on your mind.

David C. Baker: Yes, I wonder why I'm talking about that. It's such a mystery.

Blair: Maybe you've written a book about it. Maybe you're in that business.

David: Maybe we closed a $10.2 million deal Friday, and that's on my mind-

Blair: Oh, wow.

David: -for a client.

Blair: That explains one of the drinks I had this weekend. It was in your honor.

[laughter]

Blair: Celebrating with you.

David: When to ask, share, and sign when a buyer expresses interest, or if your college kid wants to listen to this, then it's like when somebody expresses interest in you. Didn't somebody tell us the other day that we needed to support his kid's school fundraising thing? He wrote to us, remember? He said, "You need to send me money for my school soccer team because my dad makes me listen to your podcast episodes on drives to our soccer game."

Blair: I remember. We won't say the full name, but shout out to Paul.

David: Yes. Oh, that was great. Of course, I sent money to the kid.

Blair: Paul's kid. One of our clients, your client, my client, their kid starts hitting us up for donations. For the listener, neither of us gave him any money. Don't try this at home. Wink, wink.

David: Thank you for that disclaimer.

Blair: We previously talked about whether or not you should be open to possible acquisitions. We'll post the link in the show notes, or you could just scroll down your feed to two episodes before, it's in there somewhere. My takeaway from that episode was this message that even if you don't think you're selling, part of your brain, a very small part of it should be tuned to the cues, should be partially listening for the cues or the clues that somebody is subtly suggesting that maybe you might want to sell your business to them.

David: Yes, because it might actually happen, but even if it doesn't, the main point of that exercise is you'll learn some things in that process that, as long as you don't let yourself get distracted, you can't learn in any other way. It's a good idea to do it. I feel like, "Well, if I'm going to tell you to do it, maybe I should tell you what kinds of questions to expect, what questions you're going to need to ask, and what should you sign and when, and what should you share?" I don't want to throw you to the wolves. This is part two of that whole series, really.

Blair: Let's start with the questions that you should ask. You've listed four of them. The first one is, "Why are you looking to buy a firm at all?" Is it, "Why us?" or is it, "Why are you undertaking this at all?"

David: "Just why this process? What leads you to think that an acquisition makes sense, because there's lots of other ways to do it? You could merge, you could grow. What's driving this?" There's some obvious reasons why you would ask this question, which I don't even need to repeat. There's a hidden one in here, and that's that you want to understand what the reason is, because you may need to use that later if this actually does go somewhere. If somebody says, "Hey, well, yes, great question. There's a bunch of reasons, but the main reason is we really want a presence in Austin. We're a dev shop. We want a presence in Austin. It'll make it easier to recruit and so on."

Then, six weeks later, while you're being grilled right before you sign the LOI, they keep hammering you with your low EBITDA. Then you say, "Hey, folks, remember why you wanted us? We're still in Austin."

[laughter]

David: That's the first question, "Why are you undertaking this?" Just because you need to understand all the reasons. It gets them talking, and that's the key here. They'll often share more than they should, but really, you want to file this away.

Blair: Under future leverage, when they come back to you and say, "Hey, well, oh, we thought you're performing at this level on this metric, et cetera," and you point out, "Well, we're still in Austin."

David: They also don't know a lot about you at this point. You may decide whether or not you even want to pursue this, because if what they identify as their primary reason for buying you isn't a good match for you, say maybe it is 20%, "We want to add to our EBITDA, we're looking for a firm," and like, "Well, we've had eight for the last two years in a row," then you can just save your time. There's lots of reasons. That's the first question., "Why are you undertaking this?" Undertaking, that sounds formal. What's a better way? "Why are you doing this?" I'll just restate that.

Blair: "Why are you looking to buy a firm at all?" They give you the reason. "Well, we want to expand our presence or have a presence in Austin." Then the follow-up question is, "Well, why us? There are lots of firms in Austin. Why are you approaching us specifically?"

David: Yes. "What struck you about us?" Again, this may not match reality, because they probably just asked around, they've looked at your website, obviously, they may know something about you because they met or something. This is an expansion of that first question. You filed it away because it might be something in your pocket that you can use later in negotiating. The other thing you're trying to surface here is to figure out how sophisticated they are. If they list all kinds of reasons that are not all that strategic, then you know, "Oh, should I keep pursuing this or not?"

"Why an acquisition and why us specifically?" You're looking for a pattern. Do they have a strategy? Is there a specific reason for this acquisition as a whole? Then why are they filling that hole, that gap, with a firm like ours? Why us specifically? They're going to answer this question because it's pretty easy to answer. The third one is a little bit harder. This is where you make them a little bit nervous.

Blair: Yes. So far, these four questions that you ask somebody, these are reminding me of the context questions that we might ask in a qualifying conversation. Qualifying conversation, you get an inbound inquiry, "Hey, can we have a chat about us working together?" You get on a Zoom call with them, and your questions basically mirror this, "So why are you doing this, number one?" They state the reason. "Why us specifically?" Then your third question, "Who else are you talking to about an acquisition?" The same question you would ask under the decision-maker quadrant in the qualifying conversation.

You want to find out, "Is this a competitive sale? Are you talking to somebody else? If so, who else are you talking to?" You make the point here in your notes that they're not necessarily going to answer that question, but you should ask it anyway.

David: Yes. There's no way they'll answer that question. It gives you too much leverage. Plus, if they're serious, they're under an NDA and can't do that anyway. It's a mutual NDA. I've always wondered, in a sales context, would they answer that question? The answer is yes. Sometimes they do. Sometimes they'll come right out and tell you who they're talking to. I love those scenarios.

Blair: It's amazing the questions that will get answered if you ask with authority, "Who else are you talking to?"

David: Yes, long pause. You got to be willing to pause, too. They're not going to tell you who it is, but here's what you're looking for. You might even jump in and say, "I know you can't tell me. I know you can't be specific. Really, what I'm asking is, describe the other firms for me. How big are they? Not where they are necessarily, but how big are they? What kind of work do they do? What's their mix of service offerings and so on?" All you want to know is if there is some pattern in the request, because if they're talking to an SEO firm somewhere of six people, and they're talking to a 60-person SEM firm, then those are very two different things.

You just want to know if these people are sufficiently sophisticated to have a specific goal in mind about size, type of firm, service offering design, maybe where they are, and so on. "Who else are you talking to? Hey, I know you can't really tell me, but just describe the other firms that you're pursuing."

Blair: Your fourth question is another good qualifying question, too, in some cases, which is like, "Have you ever done this before?" The way you framed it is, "Can you tell me about your previous experience in the acquisition market? Have you bought firms before? Have you tried to buy firms and failed?"

David: Right. They're going to proudly tell you the ones that they attempted, and you're going to want permission to talk to them. If you don't get permission to talk to them, you're going to want to do it anyway, because these people are in the earn-out. Whoever they've had as a purchase target before, they're already in the earn-out. The honeymoon's over. This is where you are having the most difficulty about even thinking about an acquisition. It's like, "Do I want to work for somebody else?" "Well, here's some other people that are working for somebody else. Talk to them."

Then if you can find out the people where it didn't work out, that's a little bit harder, but you can still pursue the information, even if you don't talk to those people and say, "Can you tell me about the ones-- Just so we don't show up on this list, if you pursued other things that didn't work out, what killed it? What were the things so that we can have an honest discussion about that?" These are four questions. They need to be asked in order, but I just love them because they just make you sound so smart and in control and not afraid of the answers. "Yes, we're going to have to like each other for this to work, but let's just get right to it, too." I really like these four.

Blair: I have a question about the second part of the fourth question, "Can you tell me about your previous experience in the acquisition market?" The second part is acquisitions that weren't consummated. You said you probably have a hard time finding them. Now, you're my Mr. Deep Dark Web. When I want to know private information about a human being, another human being, I call you. I don't know what resources you use and I don't want to know because they're probably not legal.

David: I can't tell you.

Blair: You can find anything on anybody. If you were the advisor to somebody, are you able to get information? If you're representing the seller, are you able to get some of that information on the potential acquirer of failed acquisitions?

David: More than likely, yes. More than 50% chance. In this case, it would simply be, I would have already heard about it through other people, or I would just call up-- There's about a dozen of us that do really good work in this space, and I know all of them. I would just call them up and ask, and they would tell me. There's a way to find out.

Blair: There are lots of ways, and you know what they are. I feel like I'm revealing a side of you that very few people know. I'll tread lightly. Those are the four questions you should ask. Why are you doing this? Why us specifically? Who else are you talking to? What's your previous experience in the acquisition market? Now you've got what you should sign, one of two things. What's the second one? I'm only looking at the first year.

David: An NDA or a no-shop clause.

Blair: Oh, sorry. Yes. A no-shop clause.

David: This is important because it's going to come up immediately. If they don't bring it up, then you need to bring it up. They're going to ask for materials, that'll be the next step, and you would never share materials without a signed mutual NDA. That's going to come up very quickly. Those things, they're all very, very stock and standard. You barely even need to read them. You're not going to probably get your attorney involved and ask for some changes. It's just not worth it. Just sign it. That happens right away.

Now, some of these have what's called a no-shop clause in them. Sophisticated buyers would never ask you to sign one of these at the outset, but unsophisticated buyers would. The letter of intent is the high-water mark. After that, things are pretty well decided. We're just looking for something we missed, and we close, and we're done. Everything before that is a negotiation. That's the way a sophisticated acquisition works.

In an unsophisticated acquisition, the LOI is much earlier, before the buyer has discovered much about the seller at all. They just throw a bunch of LOIs out there like gifts. Then they decide, "Okay, now let's look at these firms." Meanwhile, they're leaving three, four, five, six firms hanging. None of them know that there are multiple LOIs out there because that's usually not a part of the disclosure.

You don't want a no-shop clause because you basically said at that point, "I'm not really open to any other offers. I'm treating this so seriously." That's a weakening of your position this early. It's a strengthening of your position later, but not right now, and so you would never sign that. You should sign an NDA right away, but it should not have a no-shop clause in it.

Blair: I really like that. I don't like being in that weak, vulnerable position where the acquirer has all this leverage. What do you mean by it's a position of strength for you later?

David: Because that sends a signal after you've learned about them, you understand that both parties are being fair, you trust them, you have a rough outline of what the agreement is going to look like. At that point, it sends the right signal to the buyer that you, as a seller, are really serious, and it hands them the goodwill that they have earned, but there's not much disclosure remaining. You already know what you're going to get. If the LOI comes at the right moment, all the negotiation has already happened. When you sign that no-shop clause, then that's a great signal to them, and you don't need any more power because you've got the leverage.

Blair: Got you. Is that a reciprocal agreement? What I mean by that is, is the acquirer attesting to the same thing that they're no longer negotiating with somebody else?

David: No. The way that is handled, and it's not very common in our industry, would be to have a breakup fee and the breakup fee would be so onerous that it wouldn't make sense for them to be negotiating with two parties at the same time because they are going to pay a breakup fee to one of them. That's not usually a part of the deals in this space, except for the very largest ones.

Blair: We've covered what to ask, the four questions to ask. We've covered the two things that you might sign. Now, under the banner of what materials to share, you've got a little bit of a list here, starting with ownership structure.

David: It is a list, but it's a lot shorter than what you normally might get asked to send. That's another signal, honestly, of how sophisticated the buyer is. A sophisticated buyer is not going to give you busy work. They're not going to ask for stuff they don't need, at least not right now. They might ask for it later. The things that you're going to get asked to share, that list could be way longer than this list. These are the things that you should share comfortably right away. The first is ownership structure, or the cap table. Who owns what percentage of what? You should always share that right away. There shouldn't be any surprises there.

You could say there's four people who are on the executive team. Between them, they own 6%. You could say that kind of thing without getting specific, but all the 100% of that ownership should be accounted for. That's the point of that one. Then financial performance. By that, I mean your financial statements. They have to be accrual. You shouldn't be in this game if you don't realize that. They have to be accrual. They do not have to be approved by anybody else at this point. It's balance sheet income statement the last three years. Might be tax returns.

Blair: You made the point about it has to be accrual as opposed to cash basis, and then you glossed over it. I would just imagine there's some people listening to this who are interested in the topic, but maybe low financial literacy. Do you want to just explain that?

David: Yes, actually, it would be hard to explain how somebody with low financial literacy is deeply interested--

Blair: In this topic, and has something to sell.

[laughter]

David: I'm just going to let that go.

[laughter]

Blair: Some of these people are creative people who just happen to build these businesses that are-- Honestly, right?

David: That's true. You're right. You're absolutely right. That's the first group. The second group are people that have an 80-year-old male accountant that still wears suits to work in New York City. Those are the only other people on the cash account.

Blair: I want to defend my accountant friends who do wear suits to work, who maybe aren't 80 years old.

David: Let's do that in another episode. Don't use my time.

Blair: We're talking about what materials to share. Ownership structure at a pretty high level. Financial performance at a pretty high level. Employee count is also on here. The nature of the work that you do.

David: Yes. Service offering design. What's the typical engagement look like? What are the big categories? If you're a dev shop, do you also do UX research? Do you manage hosting, too? Those kinds of questions that would be pretty basic, and they could probably just learn from your website, too.

Blair: Now, this last one on the list of what material to share, clients. How detailed do you get on that?

David: You share the company name, for sure. You would never share the person, the contact name. You might share the department. Probably not. All you need at this point is just the client name. Then you probably are going to share the total dollar volume you're doing with them, or you could just break it up roughly and say, "This is within this range," but I think you ought to tend more towards the trusting side in these kinds of conversations. Sellers sometimes worry about how this is used against them. Frankly, I almost said I hardly ever see it. The truth is, I've never seen it. It's just like I wouldn't worry too much about that. You don't want to give them the names of your client contacts, for sure.

Blair: Pretty high-level overview across a few different categories. I'm really interested in this. You call it extra credit for some social stuff or checking the social boxes.

David: That's because you love dinner.

Blair: Yes, I love dinner. My wife says, and she's not the only one to say this, you can't be friends with somebody until you break bread with them. You suggest that you should have dinner together with the acquirer.

David: Yes. I try to be really super specific. I don't want to be pedantic, but I want you to know this is a serious thing. Meet at a neutral restaurant. I have three suggestions. Meet at a neutral restaurant. That just makes sense. You always want spouses or partners, significant others, with the people that are actually involved in the business. You want them to bring their partners, too. That's really good, because these are the people they're going to talk to after work every day who are going to help form their opinion of you and so on.

Dinner at a neutral place first, then invite them over to your house. I really think it ought to be at your house. Ideally, the buyer is going to invite you over to their house first, but you can just set the stage, the expectation is like, "Well, if you invite them over to your house, they're going to expect that that's what you want next." Either way, it happens. Three meetings over meals together. I know this takes time. I know it requires travel sometimes, but this is a very big decision, and this may be the most important part about it. The only thing that you personally can gauge. Your advisor might have an opinion on this, but that opinion doesn't matter all that much unless it's bad. Anyway, extra credit.

Blair: Extra credit. Now, the critical next step, maybe the final step, or close to the final step. You want to talk about four reasons to hire an advisor at this stage. What are they?

David: Yes, it's a good sign to the buyer. This isn't like NYPD Blue, where you clam up and say, "I want to talk to my lawyer." That's exactly the bad signal. "Oh, this guy's guilty." No, it's a good signal to the buyers, like, "Oh, so you're so serious about this that you're going to spend your own money to get professional advice about it. That's great." If the buyer at this point looks dejected because you're going to work with a professional advisor, then run like hell. It's a good sign.

Blair: Also, the advisor speaks the language of acquisitions.

David: Yes. They're not going to be embarrassed when they hear a term.

Blair: I would imagine a good acquirer who's acquired more than one firm really wants to work with a professional.

David: Yes.

Blair: Is that true?

David: For sure. If it's the right professional, yes. It's not like they want to bypass the professional and get right to the person that the professional is representing. It's not that. Sometimes they'd rather work with another professional. They don't want somebody that's old-fashioned or pedantic or really slow or nitpicky. You recognize good professionals right away, and there's a lot of good ones out there.

Blair: Yes. You don't have to explain cash versus accrual to--

David: To my podcast co-host.

Blair: [laughs] Then you've got a couple of other really good points here. An advisor can shield you from the more emotional exchanges, and they can also shield you from the distractions. I can see the value in both of those things.

David: Yes, exactly. The distractions is obvious. The emotional stuff is you're going to take this far more personally than you should because you see your evaluation the first time, and you say to yourself-- You don't make an objective response. You say, "You mean I worked 17 years for that?" Professional advisor knows you really well, too, and knows how you process information and knows whether you want to hear about this tonight or tomorrow or whatever. It's both those things together. They help shield you from the ups and downs that bad emotional exchanges result in, and they can help shield you from distractions, which is the big danger that you're trying to avoid.

Blair: I was going to ask you if part of your role when you are the advisor is being a therapist because I'm thinking I couldn't imagine worse therapists in the world than somebody who's a high consumer of therapists himself, not to take your personal inventory or anything. Then I realized, "Oh, it's Jonathan who manages the M&A practice. He would be very good at this. He would be a very good therapist."

David: Yes. We're okay. It's very true that this person plays that role. In fact, there are times when your advisor will talk you out of a deal, even though it means they're not going to get a commission on it because their reputation is more important to them and you are desperately eager for the wrong reasons and the advisor is pretty comfortable that a better offer could be found. There is a lot of really candid-- By the end of a deal, whether it goes through or not, you're pretty good friends.

Blair: Yes, that's great. That's a great thing to end on. What to ask, share, and sign when a buyer expresses interest. I'm not going to recap it all. There's a lot here. This has been a great conversation. Once again, David, I learned a lot. Maybe I'll have to sell my business at some point because I know so much about M&A.

David: I hope not.

Blair: Thanks, David.

David: Thanks, Blair.