The Psychology of DivestingBy M. Eric Furlow
November 28, 2006 — (WEB HOST INDUSTRY REVIEW) — I have heard the statement tossed around for years, “at least 50 percent of mergers and acquisitions have been shareholder value destroying events for the buying entity.”
Not many finance professionals would argue with this fact. Why not look at this statement from the other side of the transaction – from the seller’s standpoint. If just over 50 percent of transactions were shareholder-destroying events for the buying entity, were just over 50 percent of transactions shareholder value maximizing events for the selling entity?
Absolutely not, in my opinion. The real number is much more like 90 percent.
There are well-known arguments why mergers and acquisitions often destroy shareholder value for the buying entity. They include, among other reasons, overpaying and the poor execution of post-closing integration strategies.
Looking at transactions from the seller’s standpoint raises the question of how many divestitures occur at less than market value with less than reasonable terms. In other words, in how many transactions is money “left on the table?” Maybe a more important question is: how many proposed, well-valued transactions to sellers pass on, and at what future cost?
Addressing the question of how many divestitures occur at less than market value with less than reasonable terms – in the scenario where a seller is being represented by a professional, the answer is not many at all.
A professional representing a company is most often in tune with market values and typical deal structures, and is financially motivated to get the highest price. So if the seller takes a deal, it is either a well-valued deal, or it addresses the needs of the seller with regard to liquidity and tax implications.
Regarding the question of how many well-valued deals are passed on, the number is high, whether the seller is represented or not. Many sellers pass on the best deal only to later settle for an inferior deal. This has a lot more to do with psychology than people think. Whether a person gets a degree in finance or a degree in an IT field and heads off to work, inevitably everyone faces the same next dimension in business – the psychology of business participants.
A large amount of research has been done on the psychology of business managers and how they make decisions regarding purchasing, hiring and firing, financial and operation leverage, forecasting and so on. But there is comparatively little work addressing the psychology of sellers or selling decision makers. I have, however witnessed several common behavioral patterns during the 12 years I have been involved in mergers, acquisitions and divestitures.
One of the most common behaviors, I call a deer in headlights. When a seller decides to potentially divest a company and goes through the process, the experience is usually new for them, and as a seller becomes confused, overwhelmed or unsure, their reaction is often to pull the plug and not do the deal.
Another behavior is seller’s pride. Creating and building a business to the point at which another entity would want to acquire it is an impressive feat. Sellers commonly, and understandably, have pride in what they have created, and many would like to add a premium to the value of their businesses to address their perceived superiority. This is an area consultants have to approach carefully. In the reality of an arm’s length transaction, the market decides what a business is worth.
Sellers sometimes have the misconceptions that friends or non-industry advisors know when to sell a company, whom to sell it to and for how much. It is puzzling that a seller intelligent and disciplined enough to build a business, only hiring the best employees and managers who know the industry, would then seek the advice of others who have no idea about the inner workings of the business, let alone the industry, when it comes time to sell.
Industry valuation measures, whether they are revenue, EBITDA, net income multiplier or a dollar per subscriber measure, change all the time. In my experience, most telecom and Internet subscriber type industry valuations trend downward over time and rarely go back up.
While old industry valuations are irrelevant other than for forecasting future values, many sellers have old valuations in mind that can kill good deals. Some sellers lack an understanding of the liquidity of businesses in general. And selling a business in the top quartile of an industry’s valuation cycle is very difficult to do. Most sell their businesses either too early or too late.
The costs to the seller of passing on a reasonable deal are several. The best-suited buyers have already looked at the company and walked away for some of the reasons discussed, never to return. The seller will not be able to get the best buyer’s offer price out of his mind. Sellers who pass on good deals may also end up disenchanted by the process, considering time consuming and failing to generate any positive results.
I represent about the same number of buyers as I do sellers. I always recommend that my clients be more cautious when acquiring other entities and more aggressive when divesting.
M. Eric Furlow is president of Furlow Consulting (furlowconsulting.com), which helps individuals and corporations merge, acquire, divest and value telecommunication and Internet companies.
