3. The Negotiation Phase

During the negotiation phase, several activities take place concurrently:
 

  • Due Diligence: Comprehensive assessment of the target company's (and the buyer's) financial records and other information that is material to the transaction. The term due diligence means "reasonable care." The purpose of this process is to be able to execute the transaction with open eyes and to avoid bad surprises after the deal. Such bad surprises could be:

    • Hidden tax liabilities or social security obligations
    • Hidden legal liabilities (lawsuits, etc.)
    • Lack of ownership of key resources (e.g., technology)
    • Missing patents
    • Missing employment contracts with key personnel
    • Etc.
       
  • Refine Valuation: As the negotiations and the due diligence produce new information, the valuation of the target company should be refined. As the course bundle on Firm Valuation shows, the value of a company follows more or less "mechanically" from the key assumptions about the firm's value drivers. It is therefore important to be able to identify and understand these value drivers and to be particularly careful about them in the due diligence.
     
  • Negotiation: The negotiation is the process that brings the parties from the (individual) valuations to an agreement  on the actual transaction price and deal structure. A reasonable process could entail the following steps:
    • Compile a list of all the aspects of the deal.
    • For each item on the list, determine whether there is an agreement or a disagreement among the parties.
    • First settle the issues on which all the parties agree.
    • Only then turn to the (typically few) areas of disagreement
    • Identify deal breakers early on (e.g., keeping the company name, keeping a certain ownership stake) and try to make no concessions on them.
       
  • Deal Structure: One of the main results of the negotiation is the purchase price and the composition of that purchase price. We will discuss these issues in great detail in the following subsections. 

  • Financing Plan: Ultimately, the financing plan consists of a profound financial analysis and valuation of the combined firms and makes it clear to the lenders and shareholders that the transaction is a good and carefully contemplated investment. The document also summarizes the various sources of financing for the transaction, such as:
    • Bridge or interim financing
    • Mezzanine and permanent financing
    • Professional investors (venture capital, private equity)
    • Seller financing (vendor's loan, etc.)

  

These concurrent activities will lead to the ultimate go/no-go decision by the top managements of the acquiring and the target firm. All elements of the transactions are summarized in the takeover or merger agreement, which will be the governing document for the closing and integration if the transaction.