In 1987, a representative of Michael Jackson approached the modest Sycamore Valley ranch house and knocked on the door. The owner of the ranch was shocked by the visitor’s message. He told the homeowner that he represented someone who wanted to purchase the ranch at a substantial premium over its current fair market value. He also indicated that the offer was non-negotiable and the home owner had to respond either “Yes” or “No” in a matter of hours.
Although this is a somewhat unusual real estate transaction, it reflects a surprisingly common scenario in the world of mergers and acquisitions, with one important distinction.
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My House Is Not For Sale
When someone knocks on your door and tells you they want to buy your house, it is not appropriate for them to then ask, “So how much do you want for it?” Even the eccentric King of Pop communicated the price he was willing to pay.
However, in many cases, acquiring companies behave in a less rational manner than Mr. Jackson. When we sold Expertcity to Citrix, we experienced this awkward, yet common situation. Citrix politely approached us, told us they had an interest in acquiring our company and then asked us, “How much?”
Our response was that there was no “price” as our company was not for sale. We were not rude nor indignant. We simply stated the truth. As we were not engaged in selling our company, a “price” was nonexistent. At the same time, we made it clear that we were flattered by their interest and that we were happy to continue our discussions and further explore if a reasonable deal could be crafted. We then turned Citrix’s question around by saying, “You knocked on our door with an intent to buy so you obviously have some idea of the price you are willing to pay. What is that price?”
I then had several discussions with my Board and fellow Senior Executives. We all agreed that we needed to fully explore all the viable alternatives available to us, in order to ensure that we maximized our liquidity event.
We realized that we had to define our Best Alternative to a Negotiated Agreement (BATNA). Fortunately, we had several alternatives available to us, including:
- Access the public capital markets via an initial public offering (IPO)
- Open up a “sales process” and solicit bids from multiple companies
- Do nothing – continue to run our business “as is”
To bolster our negotiating position, we engaged an investment banking firm to explore the IPO market. Although this option was not attractive to the management team, it was a viable alternative circa 2005 and it would have allowed our institutional investors to liquidate their investments. However, due to the SEC’s onerous regulations, management’s liquidity would have been severely constrained. At public entities, insiders are effectively limited to selling their shares during the middle month of each calendar quarter (i.e., February, May, August and November). Most importantly, our ability to run the business in an autonomous manner would have been significantly compromised, as we would have been relegated to answering to Wall Street on a quarterly basis.
Establishing a sales process was the least attractive option, even though this approach might have resulted in a bidding war that could have driven up the purchase price. Senior management was more concerned with ensuring a cultural fit with our acquirer, rather than squeezing the last dollar out of the deal. Citrix promised to operate Expertcity as a separate division and maintain its offices in Santa Barbara and it was unclear if other potential acquirers would have been willing to make, and keep, similar commitments.
There is a well-worn adage in the M&A world that, “companies are not sold, they are bought.” In other words, the most attractive companies generate unsolicited buyers which can often lead to premium purchase prices. Companies that seek buyers are often viewed as “damaged goods” which cannot otherwise succeed as self-sustaining entities. Such companies, if they are able to complete a transaction, often sell at a discount. We avoided the risk of the deal becoming shopworn by not initiating a bidding process.
Doing nothing was the most realistic and potent competition faced by Citrix. Both parties knew that due to the rate of our revenue growth, Expertcity would become too expensive for Citrix, if an acquisition did not occur in the relative near-term. Doing nothing became our BATNA.
We eventually sold Expertcity to Citrix for $230M. I am proud to say that Citrix lived up to all of its commitments and Expertcity, renamed Citrix Online, went on to become one of the largest employers in Santa Barbara county.
Get Out Of The Zone
As shown above, every negotiation entails a buyer and seller comfort zone. In order for a deal to be consummated, an intersection of these zones must exist. In this example, agreement is achievable between $145M and $185M. In general, an agreement cannot occur outside of this range, unless new data, coupled with a persuasive argument, are introduced in order to drive the buyer or seller outside of their initial comfort zone.
Brian Epstein Had No Clue, Let Alone A BATNA
The Beatles’ Manager, Brian Epstein, was a 30-yr old, former furniture salesman when Beatlemania hit America in 1964. When he was approached by savvy New York businessmen to license the Beatles’ name and likeness for various novelty products and toys, he firmly stated that he would not accept a penny less than 10%. The businessmen had a difficult time hiding their surprise, as the expected range for such licenses was between 20% to 40% of the product’s price, as shown below.
Speaking from ignorance, Mr. Epstein effectively moved the negotiations outside of the expected shared comfort zone, costing the Beatles tens of millions of dollars in the process.
If you attempt to assess the value of your company within that of a larger organization, you too will be speaking from a position of ignorance. While ignorance may be bliss, it is a bloody awful foundation upon which to negotiate. When in doubt, keep your mouth shut and allow the other party to establish one of the boundaries of the shared comfort zone. If you are unsure of the fairness of their initial proposal, you can then seek additional information to determine where it falls within the expected range.
If a seller names a price at the outset of a negotiation, they effectively establish the upper bound of the negotiations. Once a sale price is communicated, the buyer is then incentivized to negotiate your initial proposal downward.
If you name an outrageously high price, you may scare away the would-be buyer, as they may feel that you do not have a realistic opinion of your adVenture’s value. If you set an initial price that is too low, you effectively shift the comfort zone in an unfavorable manner.
When I assisted the CEO of RedMojo in the sale of his company to Novell, our BATNA was to accept funding from venture capitalists.
This alternative would have precluded an acquisition for several years, as most institutional investors are not interested in a small, short-term returns in lieu of a larger, longer-term exits. At the same time, RedMojo’s management was not inclined to accept venture funding, as it would have required the team to work several additional years to generate a return sufficient to warrant the dilution caused by an institutional investment.
Fortunately, there were multiple companies interested in acquiring the company, which negated the need to establish a sales process and risk the deal becoming shopworn. The combination of multiple bidders and the legitimate BATNA of venture funding allowed us to maximize the price we obtained for the company’s assets.
It is impossible for you to fully understand the potential strategic value of your adventure once it is part of an acquiring company’s organization. A fair response to the question, “How much do you want for your company?” is, “What would our assets be worth as part of your organization?”
Once the potential buyer states the expected value of your assets within their organization, you can then focus your arguments on the combined value the two organizations can jointly create, rather than allowing the acquirer to drive down the standalone value of your company via comparisons with other companies or by assigning a multiple to either your revenue or net income. Attempting to determine the combined value of the entities is a worthwhile exercise because it forces both parties to think through the acquisition and contemplate how the combined company would work together.
When someone knocks on your door and asks how much you want for your house, your response should be, “Thank you, I am very flattered that you like my house. I like it too. However, as there is no For Sale sign in my yard, I have no price in mind. I know what it is worth to me, but the important question is ‘What is it worth to you?’” If they want your house as much as Michael Jackson wanted the Sycamore Valley ranch, they may be willing to pay you a very, pretty penny indeed. But the only way to find out is to get them to make you an offer and define the low-end of their purchase price comfort zone.
After Michael Jackson’s financial and personal demise, Neverland Ranch was “sold” not “bought”. After it had languished on the market for years, it was finally acquired, at a below market price.
John Greathouse has held a number of senior executive positions with successful startups during the past fifteen years, spearheading transactions which generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.
John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.
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