Evaluating an Unsolicited Offer

In today’s active M&A environment, business owners may receive an offer to buy their company, even when they have not expressed an intention to sell. Especially for successful and/or fast-growing companies, and businesses in growth sectors, such unsolicited offers are quite common. How should you respond? In this article, we’ll look at how to evaluate an unsolicited offer. In the next one, we’ll examine the pros and cons of a single offer and discuss what to do next.

We recommend evaluating an offer in two stages: first understand the context of the offer; then assess the details of the offer itself.

Context of the Offer

Answering four questions will help a business owner to establish the context:

  • Who is offering?
  • What are their intentions?
  • Where am I in terms of my hopes and plans for this business?
  • Is this a hostile bid?

Who is offering?

Understanding who the buyer is offers a rich array of insights into the likely seriousness and value of the offer, the probability of completing the transaction, and what might be in store for your business post-sale.

A buyer may be “strategic”, i.e., already a player in or adjacent to your industry. From this vantage point, the strategic buyer likely knows your company, and has specific market-, capacity-, or competition-related reasons for expressing an interest. Alternatively, the buyer could be “financial” – like a holding company or private equity fund. Typically relying on publicly available information about your company, the financial buyer may have done exhaustive research, or might simply be scattering low-ball offers around to see who bites. Strategic and financial buyers may have very different plans for how they will generate value through your business, as we will discuss in the next section.

Is the buyer serious, or is this offer of the opportunistic or tire-kicking variety? One clue lies in his or her answer to, “what are you looking for, and why would my company be a good fit with your criteria?” The response will tell you how much research they have done, how well they understand your business, and whether they have a coherent investment strategy. Industry conditions provide another clue. An opportunistic buyer may use cyclical weakness to try and acquire businesses at a depressed price.

Beyond the general buyer categories of strategic vs. financial and serious vs. opportunist or tire-kicker, you will want to learn as much as possible about the specific company making the offer. What is the buyer’s business, reputation in its industry, acquisition track record, and financial health? This latter point is key because a well-capitalized potential buyer has a greater capacity than an unprofitable or over-leveraged one to complete the purchase. Finally, does the potential buyer have any history of fraud or questionable business practices that would make further dealings untenable?

What are their intentions?

Any buyer wants to generate value from an acquired business.  But their approaches to doing so can differ dramatically. The following table contrasts the intentions of typical strategic and financial buyers.

Strategic Buyer

Financial Buyer

Expects to generate financial return through combining acquired and existing businesses to strengthen competitive position, market reach, product line, profitability, etc., creating cost and revenue synergies

Expects to generate financial return through some combination of incremental improvements to the business’s efficiency and profitability, and financial engineering

Does not buy with the intention to sell – focused on long-term value creation

Buys with a specific investment window, often 3-7 years, with the intention of selling at the end

Note that either type of buyer may make significant operational changes, including reorganizations, staff layoffs, facility closures or sales, and product rationalization, in pursuit of their financial goals.

Consider also the buyer’s strategy. Would the acquisition drive consolidation in an industry sector?  Is it the first deal or one in a discernable series?  Would it represent the buyer’s entry into a new market, acquisition of an important new technology, or elimination of a competitor? Understanding the strategy will provide insights into what the buyer might be willing to pay, as well as what it is likely to do with your company.

Where am I in terms of my hopes and plans for this business?

Where are you on the continuum from “actively looking to sell” through “eventually, but I hadn’t been planning to yet” to “never, no way”? What plans are currently in place to grow your business and create value? Is this the best time to sell, or would you get a better return in the future? What would you do if you sold the business, both professionally and personally? How would you use the proceeds? Who else will be affected by the decision?

Is this a hostile bid?

A hostile bid is defined as “a specific type of takeover bid that bidders present directly to the target firm’s shareholders because the management is not in favor of the deal. Bidders generally present their hostile bids through a tender offer. In this scenario, the acquiring company offers to purchase the common shares of the target at a substantial premium.” (Investopedia) It is primarily a risk for publicly held companies; while conducting a hostile takeover of a private company may be theoretically possible, a number of factors make it highly unlikely. The considerations triggered by a hostile bid are quite different from those involved in other unsolicited offers and will not be covered here.

The Offer Itself

Assessing the offer itself involves answering the following questions:

  • Is the offered price fair and reasonable?
  • How does the transaction structure affect what I will receive?

Is the offered price fair and reasonable?

Does the price fairly reflect the value of your business? We have written extensively about how to value a business and encourage you to familiarize yourself further with this important topic <link to valuation e-book>.

The enterprise or total value of a business is comprised of:

  • Interest-bearing debt and equivalent liabilities
  • The value of all outstanding shares, or the owners’ equity, often referred to as the “intrinsic value” of the business. This in turn is comprised of:
    • Adjusted net book value, i.e., tangible operating assets less liabilities
    • Intangible value, including identifiable intangible assets (e.g., brand names, patents, copyrights etc.) and non-identifiable intangible assets, or goodwill
  • Any incremental value above the intrinsic value, as perceived by a buyer, resulting from expected synergies or other economic benefits that are not available to the business on a standalone basis. Intrinsic value plus expected synergies is known as “strategic value”.

Because of their ability to reflect the future economic benefits of an ongoing business, cash flow methodologies are commonly used in business valuation. There are various ways to estimate value based on cash flow – each with its unique benefits and limitations – including applying a multiple to an income number like EBITDA, capitalizing cash flows, and discounting cash flows.

Valuation refers to a set of methodologies used to estimate the worth of a business. The resulting range is the starting point for determining how much a buyer should pay for the target company. An offer price may differ markedly from a valuation, however, because it reflects what the deal is worth to that specific buyer.

In most cases, an unsolicited offer will be as low as possible, with respect to both price and deal terms. Absent a competitive situation, the buyer has no incentive to begin with a richer offer. That’s why, even if the number looks attractive, it’s important to respond with caution.

To understand whether an offer is reasonable, you will also want to know what comparable businesses are selling for. Rapidly growing companies and those in attractive industries can often command higher prices than the average.

How does the transaction structure affect what I will receive?

An attractive purchase price doesn’t necessarily translate into an attractive offer. The form of payment, structure of the purchase, and allocation of the purchase price can all affect a deal’s accounting and tax treatment, timing of proceeds, relative risks borne by buyer and seller over time.

  • Form of payment – A deal may involve many forms of payment, both at closing and into the future. These include: cash; debt and other notes payable to the seller; stock in the buyer’s firm or the newly formed company; collateral and security; future payments of principle, interest, revenues; a future balloon payment.
  • Structure – The three basic acquisition structures are: (1) asset purchase, (2) stock purchase, and (3) statutory merger or reorganization.
  • Allocation – The purchase price of a deal is allocated among different assets, e.g., stock and tangible assets, patents, goodwill, royalty agreements, and customer lists. This allocation will determine the tax treatments for both the seller and buyer.

If the offer has a large stock component, do you want to hold equity in the buyer, or in the new company, over time? To what extent are you comfortable with proceeds being contingent on future performance when you no longer control the business?

Properly evaluating an unsolicited offer is only the first step. In the next article we will examine how best to respond.