Negotiation is a critical skill in both our professional and personal life. Whether we are negotiating the purchase of a home, a salary raise or the sale of a business, negotiation skills play a pivotal role in the ultimate outcome. But like all skills, mastering negotiation involves understanding its fundamental building blocks and diligent practice supported by timely feedback.
When it comes to M&A transactions, the stakes could not be any higher. On the sales side, we might be negotiating the sale of an asset that represents a large portion the owners’ net worth and that has taken many years to build and develop. On the buy-side, we might be negotiating an acquisition whose potential reward may be high, but so is the likelihood that unforeseen events will unfold post-transaction during the integration, operation and/or growth of the acquired company, so there is not much room for error.
Moreover, as M&A advisors we will encounter negotiation opportunities all throughout the full lifecycle of a transaction from getting engaged by the client, to negotiating with potential buyers/sellers, to closing the deal.
It is therefore of vital importance to familiarize ourselves as much as possible with the nuances in the negotiation process and recognize that it is a skill that can be mastered with practice. The effort will be highly rewarded in satisfied clients, durable agreements and a reputation for fairness and high professional standards.
What follows is a brief overview of some of the most important elements in negotiating an M&A transaction including fundamental building blocks and how to recognize and overcome common transaction roadblocks and negotiation errors. It is not intended to be an in-depth review of negotiation, as it doesn’t address specific strategies, tactics and counter-tactics. But it can certainly provide you a head start by focusing your attention on the handful of factors driving successful negotiation outcomes.
Building Blocks of a Successful Negotiation. The very first step in mastering negotiation is to adopt a definition that best encompasses both its purpose and scope. Thus, it is helpful to think of negotiation as a process of needs discovery whose objective is to reach an agreement that best addresses those needs. Note that there are a couple of points worth noting in this definition. First, it emphasizes that negotiation is a process of convergence, not imposition. Second, it highlights the nature of a process centered on conversation and discovery, not confrontation.
From this definition, it also becomes evident that being able to identify needs (most of them unspoken) is critical. And to accomplish this objective, it is vitally important to understand the difference between interests and positions. In a nutshell, an interest is someone’s standing on an issue (e.g. “Our asking price for the business is $30 million”). An interest, on the other hand, is the motive behind the stated position (e.g. “Each of the three company owners is seeking at least $10M to be able to retire.”) Without a clear understanding of the needs involved in the negotiation – both yours and theirs – it will be virtually impossible to craft a viable solution.
Another important element in negotiation is to understand the different stages involved in the process. When mastering any skill, it helpful to rely on a simplified framework that enables us to absorb, analyze, plan and apply best practices. With that in mind, the following six-step negotiation model can be highly effective in planning and conducting high-stakes negotiations such as M&A transactions:
Preparation – this is by far the most important step since it has great influence on the ultimate outcome. At this stage, it is critical to define the so-called “negotiation cornerstones,” namely: needs that the negotiation will fulfill, the best alternative to not reaching an agreement, the options available to craft a satisfactory agreement, what benchmarks will be used to justify the offer, the negotiation milestones from start to finish and what are the important messages that need to be conveyed to the other party during the negotiation.
Discovery – the main objective in this step is to validate our assumption about the other side’s interests and options. This is accomplished by asking carefully worded questions and listening for subtle needs-related hints hidden in the answers provided. At the same time, this step provides an opportunity to disclose information to the other side, particularly in terms of our interests and options.
Brainstorming – this the step where options are generated, revised and evaluated based on the information gathered during the discovery step. The best option will be the one that addresses both sides’ interests that also conforms to fair external standards.
Decision – in this step the draft agreement is created and revised until a final agreement is reached. Issues to consider include assessing how well the agreement satisfies everyone’s core interests and how realistic are the commitments from both sides.
Post-mortem – once the negotiation is completed, it is important to gather the negotiating team and evaluate what worked, what didn’t work and identify any potential improvements.
Learning capture – the final step involves memorializing the lessons learned on checklists that can be used in future negotiations.
Please note that seldom negotiations evolve through distinct and well-defined stages. Once the process gets started, all kinds of unforeseen events such as delays, due diligence surprises and changes to previously agreed terms are likely to happen and therefore should be anticipated as much as possible. There are, however, two actions that you can take to minimize the impact of surprises. First, is to realize that preparation – the most critical step in the negotiation process – is completely under your control. Second, to the extent that you can take the lead in the process you will be able to shape the agenda and maintain a realistic pace and timetable.
Overcoming Roadblocks. The reality of most middle-market M&A transactions is that at some point they will reach a roadblock. No matter how carefully one has prepared for the negotiation, researched the target’s capabilities and financial strength and successfully carried out the negotiation agenda, a variety of obstacles still are likely to prevent the deal from closing. Finding a way around these common obstacles requires foresight, preparation and a good deal of objectivity.
So, what are some of the most common roadblocks that are likely to stand in the way of a successful M&A transaction and what are the best ways to navigate them?
Unrealistic valuation – It is common for intermediaries to walk into situations where the seller has a target value for the transaction based on (a) a personal goal completely unrelated to the realities of the business; (b) previous transactions in the industry involving much larger (and sometime much more successful) companies; or (c) a full valuation report prepared by an valuation expert for tax purposes. In these situations, one must recognize that the seller needs to be educated about current market transactions involving similar businesses and open the door to the possibility of negotiating a conditional offer in a letter of intent that takes into account the target’s prospective performance as well as recent comparable transactions.
Adverse business performance during due diligence – This type of surprises is common in middle-market businesses and their occurrence is likely to impact the offering price. Assuming that the changes can be explained logically, the full and timely disclosure of the issues goes a long way toward building confidence between the parties. Then, the solution could involve negotiating an “if and when” amendment to the terms of the agreement that would enable the seller to receive the originally agreed upon price if the negative trend is reversed.
Assuming a fixed pie – Most M&A transactions are not just about price. In fact, there are three major factors to consider when evaluating an offer: price, terms and conditions. The likelihood of negotiating a mutually satisfying transaction can be increased significantly once it is realized that there are many levers beside the price that can be used to craft a winning agreement. These additional levers include: what’s included, deal-related deadlines, tax treatment, risk allocation, standards of performance and royalty/licensing agreements among others. Knowing what needs are the most important to both sides can help prioritize these options and craft a viable solution.
End-runs – There are situations during a transaction’s lifecycle where the seller/buyer may be tempted to bypass the professional deal team and negotiate directly with their counterpart, not realizing that they do so at their own peril and great expense. As explained in the previous section, negotiation is a process that requires experience, objectivity and careful planning. And negotiation tends to be an emotionally charged interaction for those who are too close to the deal. Hence, it is important to explain to clients in advance the realities of this process and warn them of the potential adverse consequences of taking matters into their own hands and going off-plan.
Common Negotiation Errors. One of the fastest ways to increase our negotiation ability is to be aware of and eliminate the most common errors. But, although this practice may seem simple, is not always straightforward. Negotiating an M&A transaction has many moving parts and for the inexperienced, the process tends to be emotionally charged which increases the potential for error. So, with that in mind, where should one begin? There are many negotiation missteps that can be overcome with practice, but in terms of impact, the three common errors listed below are an excellent starting point.
Negotiating without a plan – The main reason to negotiate an agreement, or any offer in an M&A transaction, is to arrive at a conclusion that is better than what could be achieved without the negotiation. Thus, it is important to take the time – prior to begin negotiating with the other side – to clearly define the negotiation cornerstones previously described in the preparation step. The clarity provided by planning these few elements certainly will give you an edge toward negotiating a productive and fair agreement.
Not understanding the other side’s perspective – A common mistake in negotiation is to assume that the other side has a similar frame of reference as we do, commonly known as projection bias. Skilled negotiators are aware of this cognitive trap and rather than assuming that their point of view is correct, they will make an effort to learn how the other party is looking at the facts involved. Keep in mind that behind every offer there is a story, and we will never understand the offer until we understand their story.
Getting hung up on a single item such as price – Focusing on a single negotiated item is really not negotiation, it is haggling. And in most cases, the best result one could hope for in haggling is a mutual compromise which almost always is a sub-optimal outcome. Skilled negotiators have identified ahead of time the relative importance of their needs and have prepared a plan to trade elements of lesser importance for those that are most important to them. They see the pie not as fixed, which leads to a zero-sum game, but one that can be expanded by giving each side what is most important to them.
A Highly Rewarding Skill. Putting in the time to study and practice negotiation can be highly rewarding. As mentioned at the beginning of this article, negotiation is a fact of life. And the good news is that it is a skill that can be mastered by anyone.
Becoming a better negotiator means that we must master the process and its basic elements, be adept at identifying needs, developing options to satisfy those needs and follow an agenda that leads to a successful outcome. It also means realizing that although it may seem at first that the objectives of the negotiating parties are mutually exclusive, the reality is that a successful negotiation involves many levers in addition to price, so the size of the pie is never fixed.
Reaching an outcome that meets the goals and aspirations of the parties involved is a tall order indeed, one that requires a great deal of preparation and skillful execution. However, negotiation is a process that can be mastered through diligent daily practice. And, as our proficiency level and confidence increase, so will be the stakes involved in the negotiations we undertake. That is the path that leads to a being a skilled negotiator and a successful career as an M&A advisor.
About the Autor
Enrique C. Brito, MBA, CFA, CVA, CM&AA is a managing director of Kaizen Consulting Group, an M&A advisory firm headquartered in Richmond, VA providing merger and acquisition, capital formation and business strategy services. He has over 25 years of corporate finance and investment banking experience and lectures nationally on the subjects of M&A, business valuation and negotiation.
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