On the morning of November 29th, 2011, I arrived at the offices of the wealth management firm Greycourt & Co. in Pittsburgh to meet with David Lovejoy, the grandson of Ray Lovejoy, one of the founders of Western Exterminators (“Western”). At the time, David was the head of a voting block (one of three) that controlled about 40% of the equity of the business.
I was in Pittsburgh that morning on behalf of our client, Scotts LawnService (“Scotts” or “the Company”). The President of Scotts had recently engaged Potomac to advise Scotts on its formal entry into the pest control industry.
It was my job to formulate an entry strategy into the pest control industry, design a financial framework to measure returns, and tie an acquisition strategy to the Company’s overarching business strategy of being a national leader in both lawn and pest. At the onset, we had aspirations of growing Scotts into a $500 million in revenue player in a short period of time. My initial mandate was to determine an appropriate platform acquisition target and then convince the sellers to sell to us “without going to auction.”
By early November 2011, we had formulated our entry strategy and tied it to a formal acquisition plan. We weren’t interested in buying just any ol’ pest control company that moved. Our strategy required that we acquire the appropriate scale and managerial resources and capabilities — whether that be Terminix, Western, Massey, Orkin or Rentokil North America — size didn’t matter, capabilities did.
It was around that time that I received a call from an industry colleague who said that the Western shareholders were “beginning to explore a potential sale of the business and they would like to sit down with you to hear your ideas.”
Later that afternoon, I received a call from Lovejoy, who was in Zurich at the time, and we made arrangements to meet in Pittsburgh the following week. Timing was of the essence for him. He said: “We were approached a few months ago by an acquirer that I believe is a good partner for us. I want to meet with you sooner than later to discuss whether or not it makes sense for us to move forward. Time is of the essence and I am willing to travel to wherever to get in front of you and Scotts.”
The Meeting with Western
Over a cup of coffee that morning in Pittsburgh, we began to discuss the situation.
“Paul, as I mentioned to you, a few months ago, we were approached by a foreign pest control business that has shown continued interest in acquiring our business,” David said.
He continued, “the shareholders are now beginning to think through whether or not now is the right time to go to market. I would love your thoughts on overall market conditions as well as what Scotts LawnService might be able to bring to the table.”
Like you, Western had been approached on at least a quarterly basis by members of the Big 3. The big companies often want to “stay in front” of you in the event that the day comes when you finally want to sell. They want to have “the relationship” so that you won’t take the business out to a competitive sale process.
After a lunch, we retired to the conference room and spent the afternoon pouring over Western and Target Specialty’s financial statements. I had a lot of questions for David and he was prepared with a lot of answers.
He said that Western had recently engaged an investment bank to explore strategic alternatives (a fancy way of saying, they hired an investment bank to determine “what the business is worth?” and “who would pay what for it?”).
Lovejoy did an admirable job answering the questions that he believed to be appropriate and bobbing and weaving on the ones that he did not. He understood that the Western shareholders shouldn’t negotiate this transaction on their own behalf and they needed a proper advisor, which is why what happened next was all the more bizarre.
After my meeting, I headed out to Ohio to meet with the president of Scotts to discuss what I had learned. After short deliberations, we decided that Western wasn’t the right platform acquisition for Scotts but if we could get it at the right price, it might make sense to move on it. The president asked me to stay close to Western, but focus my attention on more promising platform opportunities that provided us the necessary capabilities.
Things Start to Get Strange…
A month or so after my meeting with Lovejoy I received a telephone call from the lead advisor from the Western team. He informed me that the shareholders were not interested in “running process.” Which simply means that they didn’t want to invite any other acquirers in to bid but rather wanted to negotiate solely with Rentokil because “they like Rentokil.”
This is one of the biggest rookie mistakes in the book and I am never surprised to see sellers pull this boneheaded move when they don’t have quality sell-side advice. But this firm went out and engaged an investment bank and the advisors should have put a smack-down on this nonsense right off the bat. But they didn’t.
I was so puzzled by the fact that they didn’t want to take the business out to competitive process that I even sent the following email to Western’s lead advisor:
“You should definitely get ServiceMaster and Rollins involved. I could see either of them buying both pest control and distribution at probably one of the richest multiples ever paid for a pest control company. We are starting to see an increase in multiples in the market and you should without question seek full price discovery amongst the strategics before tying it down.”
I went on to provide him all of the necessary contact information for the right people at Rollins and ServiceMaster. I didn’t need to do that, however, because Rollins and ServiceMaster called on their own. Nonetheless, from October 2011 through September 2012 — for reasons my feeble mind will never grasp — the shareholders of Western negotiated with only one acquirer — Rentokil.
Until this day, I will never understand why and how Western’s advisors allowed the shareholders to not go to market and run proper process. No other M&A insiders in the industry can understand why either. For example, on the 2013 PCT M&A seminar, I made a comment about how Western left money on the table and one President of a Big 3 called me afterward and said: “You just said what everyone else was thinking but afraid to say.”
There was not a senior deal guy in the industry who didn’t believe that Western left money on the table, probably millions of dollars. By allowing Rentokil to have the better part of a year to negotiate without the slightest hint of competition, the shareholders sold Western at a discount.
This violates the 1st Potomac Principle of selling your business: Never Fall in Love with a Buyer Before All the Cards are on the Table
James Freund, one of the greatest M&A negotiators of all time who literally wrote the book on M&A negotiation back in the 1970s (the book is called The Anatomy of a Merger) said, “From a seller’s perspective, a clear case of positive leverage occurs where two or more willing and able suitors are vying simultaneously for the prize, and the seller doesn’t care which one ends up as the winner… if the seller cares who wins, there’s a wholly different dynamic at work.”
When you, as the seller, begin to concern yourself with who the ultimate buyer will be, leverage begins to shift to the buyer that you favor. You lose the psychological edge and begin to take a softer line on terms and price in hopes of not killing the deal — thereby leaving cash on the table.
I have seen this play out over and over again. In fact, when acquirers come out to meet you prior to negotiating the deal, they are hoping to sell you on “the intangibles” of doing the deal with them. How they will take care of your people, your good name, etc. The more you like them and want to do the deal with them, the harder it will be for you to take a tough line in negotiations. Is that to say one acquirer won’t be better than another? Absolutely not, but you shouldn’t try to make that decision before all of the cards are on the table.
Never try to determine who the ultimate winner will be before going through full process. Sit back and let the formal sell-side auction process do its job for you and deliver to you the absolute best deals available in the current market. Then, once you have all of the birds in hand, begin to make your decision. You’re under no compulsion to sell to the highest bidder, but if you look at each acquirer the same throughout the process, you’ll be in much better shape when it’s time to sign the purchase agreement.
If you’re a buyer and in the market to make acquisitions, you should keep this in mind as well. It’s unlikely that you’ll be able to beat Orkin, Rentokil, Arrow, Massey and Terminix on terms and price — and if you are, that probably means that you’re paying too much. However, if you can get a seller to like you, it will have a non-conscious impact on his ability to negotiate with you. Negotiations start with the first meeting and if you can do what Rentokil was able to do with Western — keep other acquirers out of the process — you’ll end up getting a better price.
Violation of the 1st Potomac Principle Invariably Leads to Violation of the 2nd Potomac Principle: Never Do An Acquirer’s Job for Them
Professional poker player and author David Sklansky says in his book Theory of Poker, “one of the most important goals in poker is to induce the opponent to make mistakes.” So too in negotiating an M&A transaction, one of your primary goals — whether you are a buyer or a seller — is to induce the other side to make “mistakes.”
But what do we mean by mistakes?
Sklansky goes on to say:
“It is very important to understand that when we talk about making a mistake according to the Fundamental Theorem of Poker, we’re not necessarily talking about playing badly. We’re talking about a very strange kind of mistake — playing differently from the way you would if you could see all your opponents’ cards. If I have a royal flush and someone has a king-high straight flush, that player is making a mistake to call me. But a player surely cannot be accused of playing badly by calling or, as is much more likely, raising with a king-high straight flush. Since he doesn’t know what I have, he is making a mistake in a different sense of the word… In advanced poker you are constantly trying to make your opponent or opponents play in a way that would be incorrect if they knew what you had.”
Let’s talk about how this applies to M&A negotiation.
In order to get a deal done, a buyer has to eliminate its competition. It typically does this in one of two ways: either (1) pay more than other acquirers, or (2) cause the seller to make a serious mistake. Option one is clearly good for the seller whereas option two is clearly bad for the seller (and good for the buyer).
There are a handful of serious mistakes, or cardinal sins, if you will, that a seller can make. Today we are only discussing one of them — not running proper competitive process, or in other words, negotiating with only one buyer. As a buyer, you want to induce your opponent, the seller, to make the mistake of only dealing with you.
Sellers, irrespective of their levels of experience or sophistication, typically don’t understand that valuation is subjective. They tend to think that there are “going rates” or mechanical formulas for valuation and that every acquirer will come out with the same valuation. As a buyer, this is typically a good thing. You generally want the seller to think that price is “objective” — so be careful of educating them to the contrary.
Further, business owners invariably believe that they are great negotiators — and many of them are. But that doesn’t mean that they should be negotiating on their own behalf. I negotiate for a living and know that I can’t negotiate a material transaction for myself. Everyone’s heard the old maxim which states, “an attorney who represents himself has a fool for a client” and there is a very good reason for that. I think the United States Supreme Court said it best in its 1991 decision, Kay vs. Ehrler:
“Even a skilled lawyer who represents himself is at a disadvantage in contested litigation. …He is deprived of the judgment of an independent third party, in framing the theory of the case, evaluating alternative methods of presenting the evidence, cross-examining hostile witnesses, formulating closing arguments, and in making sure that reason, rather than emotion, dictates the proper tactical response to unforeseen developments in the courtroom.”
Large privately held businesses and publicly traded companies who have a small army of sophisticated negotiators, lawyers and finance professionals on staff almost always engage outside advisors when they are selling significant assets. In the pest control industry, the extreme majority of transactions over $4 million have an M&A advisor running process — for good reason.
However, in this case, Western had an advisor but for whatever reason decided to make a “mistake” that ultimately cost them. The shareholders of Rentokil negotiated directly and solely with Rentokil because “they like Rentokil.”
I like Rentokil as well.
That doesn’t mean I am going to do Rentokil’s job for them and eliminate all competition from the process without getting something of value in return.
Your number one source of bargaining leverage is competition among buyers. Rentokil’s number one pain in the ass when trying to buy your company is the prospect of Orkin, Terminix or another acquirer coming in and wanting your business more. Or coming in and making their own mistake and dramatically overpaying for it. You eliminate the competition and you leave money on the table.
Whenever a strategic acquirer, whether it be Orkin, Rentokil or Terminix prepares to make an initial offer, they make a variety of assumptions.
- What is the business worth to the current shareholders? (Fair Market Value).
- What is the business worth to us? (Investment Value / Strategic Value).
- How competitive is the process?
- Who is the next likely buyer? What are they likely to pay?
- Do they like us more than other acquirers or are we competing on price?
Whenever you are buying a business, your focus must be on the “next likely buyer.” If you’re Terminix, you’re less concerned about what the seller wants for the business and more worried about what Rollins or Rentokil might be willing to pay for the business. As a buyer, your success at the bargaining table can be summed up by “never pay more than you have to based on what the next likely buyer is wiling to do.”
One of my mentors and brilliant M&A advisor Dennis Roberts used to always say, “I have always considered the seller facing off against a lone prospective buyer to be almost as inconsequential in the process as a chicken flapping its wings, facing off against a great white shark. The buyer, just like the great white, is in heaven – and so, too, will the chicken be . . . shortly.”
This plays out in the pest control industry all the time. I find that just about every time that a pest control company doesn’t go through a formal process, it’s a bust. The shareholders end up leaving money on the table… and that’s a shame.
Don’t make the same mistake. Take control of your exit planning. Understand the value of your business and how you can ultimately exit at the top.
