«    2008    »

Integra brochure
(pdf - 1.6 mb)

March 28, 2008

M&A negotiations go on untit the very last moment

Integra Group, a leading oil service provider and manufacturer of oil recovery and gas extraction equipment, has acquired in excess of 16 strategic assets within a few years.

Vladimir Kozhokar, general manager in charge of Kazakhstan, vice president in charge of Central Asia, Integra Group, who occupied the position of vice president in charge of business development in the course of aggressive M&As, talked to us about the nuances of negotiations conducted in the course of mergers and acquisitions.

- Lately, Integra has acquired over a dozen oil services providers and machine building companies.  How are these negotiations conducted?

The process of M&A negotiations is initiated long before any personal negotiations are set up.  A lot depends on the history of the target company’s incorporation, which has an effect on any negotiations.  Initially, information is obtained from public sources.  Besides, no matter how big our sector, the number of specialists employed in it is limited, and we can always get information about companies and find out the state of affairs and the ownership structure, etc.

When the information package is complete, it is clear to us whether the undertaking is worth the effort.  Primarily, we try to find contacts with the owners, people who could introduce us, provide references and suggest negotiation strategies. 

- Who acts as an intermediary?

- It differs.  Everything depends on the origin of the target company.  If it was found by an investment bank, and it has a business relationship with its owners, bank representatives often act as intermediaries.  Otherwise, business owners look for the purchaser and approach investment banks; in this event business owners initiate our negotiations.  They offer a brief overview of the company and assist in arranging further negotiations with the business owners concerning a potential transaction.  Frequently, the owners take the initiative.

Besides, any specialist employed in this sector for about ten years, maintains professional relationships.  So we can always find someone’s acquaintance who can introduce us to the business owners.

Negotiations begin after a preliminary phone call from an intermediary, or when a personal meeting is arranged or references are made.

- Who is in charge of preliminary negotiations?  The owner or the corporate purchaser?

- Life is so varied that no ready made pattern exists.  There is no need for the sole owner to initiate the process.  Everything depends on the succession of links.  Sometimes, the project manager expresses this idea.  He may propose a potential target, and because he has personal contacts there, he may provide a reference.

In our company, top managers initiate negotiations.  Integra is open to the public, it has multiple stockholders, and they are not personally involved in this process.  Negotiations are initiated and conducted by the managers.

- How is the offer made?  You can’t just come in and say: “We want to buy your company...”

- Of course not.  Every conversation is based on logical principles.  Whenever you visit yours friends at home, you follow a certain behavior pattern:  you greet your friends, ask them if there is anything new, tell them about yourself.  Business negotiations are also based on a pattern.  Of course, everything depends on the company and its owners.  If they have made up their mind to sell the company, and if they had approached the intermediaries for this purpose, it is easier for us to initiate the conversation: having spent a couple of minutes chatting, we can start negotiations without any preparations.

It happens that owners have no intention to sell their business, or they pretend not to have it.  The seller needs to pretend that he is not at all interested in the sale.  “We may sell if a good price is offered, or maybe not...” It often happens this way if a potential transaction is “pre-tested” by phone.  At that point, the most important objective is not to lose the customer, but to continue your negotiations.

There is no need to do much talking at the first meeting.  We need to make it clear that the meeting is a milestone on the way to this transaction.  However, there is no need to force the issue. What is of major importance is to take the contact with the person a step further.  Whenever the contact is in place, specific issues can be discussed.  Due diligence or deal structuring should not be discussed even at the second meeting, let alone the first one.

The point is that every business owner needs time to get used to the idea of selling his company, for a number of reasons.  One owner has spent ten years of his life in this business, and he treats it like his baby.  Another owner thinks that he is prosperous, and he has no idea what he can do when he sells it.  We want to make a transaction, and his business logic suggests the same idea. However he cannot think about his life after the closure: he thinks about his life as an affluent retired person. He can buy some land and plant grapes there.  He is not ready for that!

That’s why at this stage we need to understand what options can be offered and what benefits the transaction will bring.  One owner wants to keep managing the company to make his contribution to its development.  Other owners have grown-up children who are ready to start their own businesses, and they need cash.  Business is a reflection of our lives: we generate new contacts, we try to look our best, although we need to find out the needs of this person and to understand him.  The same processes are typical for the initial stage of business acquisition --  people study each other.

- How often does the owner want to stay on as manager or a minority shareholder after the acquisition?

- Almost never as  a minority shareholder.  Often as a top manager.

- What is the share of your declines at the initial stage?

- Not big.  We screen companies before selecting a target, and never make an offer to someone who is not likely to accept it.  About three out of ten initial projects are not successful.
- Is the price specified at this stage?

I prefer to identify methods of company assessment.  Although I can do it having obtained some business information and its potential  value.  The final figures are generated through a due diligence and after many hours of negotiations.  I can specify the amount at the first meeting, but I will not do it, not to lose the seller to a lower price and not to arouse his ungrounded expectations.  Initial assessments may be overestimated, and later we may find out that this business is worth a lot less because the owner provided wrong figures in the beginning, or some risks need further consideration.  There is no need to hurry and put the price on the table.

- Are the results of initial negotiations specified in formal documents?

Everything depends whether the owner is ready to sell his business.  We may sign a confidentiality agreement that would briefly outline our intention to make this transaction.  More often, this agreement merely prevents disclosure of any sensitive information.  Sometimes, we sign a letter of intent that may specify general business assessment methods, has an exclusivity clause, etc.

- What about the next stage?

- After the confidentiality agreement has been signed, we ask the counterparty to provide documents and information, and authorize a technical, legal and financial due diligence.  We usually set deadlines, although, they are never met  for objective reasons: we may ask for certain financial data, but then comes the end of the quarter, the accounting department runs out of time, and the financial department has no information for us.

This stage usually takes about two months, although it may take either more or less time, depending on the size of the business, the complexity of its structure, and whether the owner is ready to sell it quickly.  Sometimes, we come down to terms, and another player enters the scene, despite the exclusivity clause.  “Why are you talking to them?  They won’t pay you as much as we can.” And the seller begins to think about it .  “Why not?” he thinks.  In this situation we want the owner to be as sincere as possible. We are not afraid of any competition.

- Do departments within target companies often  resist its sale?

- Yes. Every second transaction means overcoming internal obstacles.  No matter how we hide our due diligence, no matter that we say that it is a pre-investment research, an alliance is the point, the information gets out anyway.  Speaking of technical due diligence, there is no need to imitate business research by banks and investment companies.  The number of specialists is limited, and they all know each other.  If Mr. Smith working for Company A comes to visit his competitor, Company B, no one can say that some bank is doing research.

In the best case scenario the top management is aware of what is going on and they are ready for the coming changes.  Ideally, owners must provide a clear explanation to their managers and key experts: “I am selling this company for such and such reasons, for example, because I am tired, and I want to get rid of the responsibilities, or the company cannot develop without a strong partner and supplementary capital investments, and I can find no other solution, etc.  But you have nothing to worry about, you are excellent specialists, and I have talked to a potential purchaser, you will retain your positions.”  At this stage, it is also important  for the owner to introduce us to his top managers for us to get in contact and to tell them that not only machines and contracts matter, that the staff is the top asset as they develop  businesses  and manufacture products.  We need to know the attitude of managers and specialists as soon as possible to find the best approach.

Another in-house problem is the failure of co-owners to come to agreement.  We may negotiate with a majority shareholder, and he assures us that he is in control and that he will obtain the approval of minority shareholders and consolidate the 100% package.  Sometimes he succeeds, though sometimes he fails, and then we have to talk to them.  We do prefer a consolidated stake.  Sometimes we are ready to buy a controlling stake, and later we talk to minority co-owners.

- What happens in the event of a conflict between co-owners?

- It depends whether the company is attractive enough.  If the conflict is in place, but the company is still attractive, we will talk to each party that can produce his impact on the transaction.

- When do advisors step in?

It depends on the type of the business  purchased.  Availability of cash in our company also matters.  We perform technical due diligence ourselves, although if the company has a complex structure, we may get some experts involved if the company is engaged in any business besides oil recovery.  Our security service performs a complete check as well.

As far as financial and legal advisors are concerned, we first address our in-house professionals to find out whether they have the time for this effort.  If the company has many legal entities, and we know that this business will be restructured before the transaction is effected, we either buy the company as it is or  get rid of anything that we do not need.  In this event we bring advisors who are supervised by our in-house specialists.

- How often does the deal fail to close at this stage?

- Not often. The point is that we have our idea of the target business.  At the stage of search and selection, we do our best to find out what this company looks like, whether it has any skeletons in the closet. Out of ten companies that undergo initial negotiations three drop out after due diligence.  This is unfavorable as due diligence drives our resources, staff, and advisor’s fees; therefore, we do our best to collect as much information at the initial stage as possible.
- What about your negotiations with owners at the stage of due diligence?

- At this stage the owner and his key managers answer our questions and clarify some issues that are still vague.  In the course of our interaction we get an idea of the company’s value, and later we enter into business value discussions with the owner.  They may go on until the very last minute. New information can emerge at any time.  Besides, if our due diligence takes several months, things can change in its course.

For example, we initiate our discussions in the middle of the year, and closer to the year’s end contracts are renewed, which may raise the owner’s expectations.  He says: “When we first discussed the issue with you, we thought that the revenues would reach $10 million.  Now we may get $11 million, and next year we can expect $15 million, so the price has to go up.”  We may say yes, although we may split our payment into two installments, and the second one will be tied to the next year business plan implementation.  The owner may say yes, or no, he may ask for the position of the top manager, to personally ensure implementation of the business plan.  Terms are discussed until the very last moment, and the same is true of research.  Of course, the owner wants to show the best, or to hide something or to draw attention away from some factor that is important in terms of business value identification.  If we organize thorough company research, we know how to identify their skeletons.  Legal risks may emerge at the last moment, and we have to explain it to our sellers that they have to give us a discount even though the price has already been set.

- Which transaction stages are the easiest and the toughest ones?

- The party afterwards is the easiest part.  That’s a joke.  The toughest one... After 6 to 12 months we verify the degree of integration of this new business into our company.  It involves the same M&A procedures.  We reconsider our assessments, implications to understand the degree of their correctness now.  It is hard to see our mistakes.  No other task is as tough as realizing that we had been deceived or that we had deceived ourselves.

- How frequently do you come across voluntary deceptions, or particular misstatements?

- It happens.  The company may hide the information that could reduce the company’s value.  For example,  the true value of services is hard to identify.  Business owners can mess with expenses and distort the true value of their businesses.

- What will happen if this information is discovered?

- If it is discovered at the stage of due diligence, we are happy.  We just need to be ready.  It is different if risks are discovered after the transaction.  To avoid this, our agreement has the seller’s guarantees and representations, and compensations payable to the purchaser if the above guarantees or representations are violated.

- Do any third parties get involved in negotiations? Several years ago governors used to influence the outcome of transactions.

- Never in my experience.  A few times local authorities expressed their willingness to have companies sold.  They were just willing to settle a conflict or to bring in an efficient owner in order to get more jobs.  No “kickbacks” were requested or influence exerted.

- How long does the whole process take, from initial negotiations to the closure?

- It differs.  Some companies are bought within 6 weeks, but that is rare.  The minimal term is two months, if the transaction is simple: one payment is made, co-owners are willing to sell their business, etc.

One of our transactions took 3,5 years.  We obtained approvals from shareholders several times, we obtained permissions from the anti-monopoly authorities, although at the very last moment some minor detail killed the transaction.

We bought this company at the fourth attempt.  This was the longest deal in the history of our company.