checklist

twelve tips for negotiating mergers

four businesspeople, left handshakeplus: guarding against deal fatigue.

by marc rosenberg
cpa firm mergers: your complete guide

after you’ve identified a merger partner.

after you’ve convened a get-to-know-you meeting.

after you’ve exchanged financial and production data.

after you’ve received letters of intent,

more: mergers: one stage or two? | what your merger letter of intent needs | 61 things buyers should explore with sellers | thirteen ways to woo potential firm buyers | one times fees isn’t the only way | four reasons to fear a merger
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… now you’re ready to get down to business! it’s time to begin arguably the most critical of the dozen or so major steps in the merger process: negotiating the deal.
the success of a merger is in direct proportion to the effort made by both firms to address all possible terms, policies and issues before the merger takes place. i’m often asked, “do mergers work?” my answer is always the same: “yes. if you do them right!” doing it right means being thorough, asking the right questions and giving it time.

most firms seek lois from multiple firms, often two or three. this makes a lot of sense for sellers because it puts them in the enviable position of selecting the most attractive of several offers. in many cases, the multiple offers give sellers bargaining power when they tell one buyer candidate that another offered better terms. this often results in buyers modifying and reissuing their loi.

here’s a common scenario. based on prior meetings and conversations, the seller prefers one buyer over the others because there is a better personality and culture fit.

but lo and behold, the lois come in, and their favorite firm offers somewhat less attractive deal terms than the front runner. this positions the seller to try to get its preferred merger partner to match the most attractive terms.

once the seller decides which loi is most attractive, common practice is to negotiate in earnest with just one buyer. most buyers are not willing to invest the substantial amount of time it takes to negotiate merger terms if they know the seller is simultaneously negotiating with other firms and playing one against the others.

after both firms sign off on the loi, they are ready to negotiate the deal. this step is not only key in terms of its significance but also more time-consuming than any other step.

merger negotiations are the time when both parties drill down into the details and agree on terms, policies and next steps.

every merger i’ve ever worked on featured several meetings.

  1. there are too many issues to address in one meeting. it’s almost always better to convene several short meetings – say, two to three hours each – than to meet for an entire day, which is always tiring and tries everyone’s patience and energy.
  2. each meeting builds on the previous session. doing a merger is a really big deal for both firms. anxiety levels are high. the firms don’t always think of everything they should ask and address at each meeting. the time between meetings gives each firm a chance to think about what was discussed at the previous meeting and form further questions to clarify terms and address nuances.

what to address at merger negotiations

every meeting should have an agenda. it shouldn’t be airtight and rigid, but to make the best use of everyone’s time, it’s best to list what needs to be accomplished at each meeting. it’s always best to distribute the agenda for each session well in advance, giving each firm an opportunity to prepare for the items to be addressed.

the common thread to all that follows is this: a key to successful merger implementation is avoiding surprises after the merger is consummated. it’s much easier to address merger issues during the negotiation stage than after the deal is done.

  1. obviously, the terms in the loi are a good starting point. everything in the loi needs to be discussed in detail. in most mergers, everything in the loi is subject to negotiation. this is especially true where the buyer is smaller than $20 million. in cases where a large regional firm is acquiring a much smaller firm, the extent that loi terms can be negotiated is greatly limited. the buyer may not say this outright, but it’s essentially “this is the deal … our standard terms to all sellers … take it or leave it.”
  2. though the most negotiating time is usually devoted to the deal terms (price, payout term, down payment, compensation, etc.), many other areas generally not included in the loi need to be addressed:
    • how the two firms will be integrated, mainly clients and staff. the firms must agree on employment of the seller’s staff as well as their titles, compensation and benefits.
    • policies such as billing and collection practices, workpaper requirements, quality control and personnel policies.
    • what each of the seller’s partners’ roles will be. how much will they work? what kind of work they will do? which clients will they work on? client transition requirements.
    • if the seller’s partners come in to the buyer as equity partners, what systems and plans will be used to allocate partner income, pay partner buyouts, plan for succession, and manage and govern the firm?
    • software used and timetable for software conversion.
  1. both firms should make every effort to get to know each other as well as possible because the key to a successful merger is culture and personality fit. this is far less critical when the seller is small and intends to retire soon after the merger.
  2. if the seller’s partners become equity partners in the buyer, the seller must be comfortable with key provisions of the buyer’s partner agreement. examples: voting, duties of a partner, prohibited acts and grounds for expulsion.
  3. merger implementation issues should be agreed upon:
    • effective date of the merger
    • how and when clients will be told of the merger
    • how and when staff will be told of the merger
    • formal written announcements
    • selection and use of attorneys, including who pays their fees
    • arrangements for the next merger step, due diligence
  1. related to these points, early on in the negotiations, both the buyer and the seller should define their main concerns and try to get them addressed. it’s natural for a firm to have concerns it is reluctant to express to the other for fear of offending them. this is where a good merger consultant can play a vital role, engaging in shuttle diplomacy to get the issues addressed and resolved.

deal fatigue

adapted from a blog post by peter fontaine, managing partner of newgate law.  

it is safe to say that every merger or acquisition suffers from some degree of deal fatigue. this is a serious condition caused by several factors. perhaps the most common are simply the many months it takes to go through all the steps in the merger process and the patience it takes to persevere. symptoms of deal fatigue include frustration, anger, irritation, indifference and exhaustion.

the initial excitement of joining forces starts to dissipate; people simply become tired of working on the merger. they have other priorities (managing client work) and pressures (hiring staff in a tough labor market) that mount during the seemingly endless process of doing a deal.

the longer it takes to negotiate the merger, the more issues surface. this is especially true toward the end of the process when one party tries to reopen previously closed deal points.

consequences of deal fatigue

  • trust may begin to erode.
  • the parties gradually lose their willingness to compromise.
  • as the deal drags on, one or both parties declare that they “just want the deal done.” this can lead to poor judgment: agreeing on terms that are later regretted, cutting due diligence short and rushing to complete critical steps in the process.
  • one or both parties call off the merger because they feel getting the deal done isn’t worth even greater investment of their time and patience.

preventing deal fatigue

  1. at the onset, invest the time to really get to know the other firm’s key personnel. the better you know them, the easier it becomes to compromise and resolve differences because they are not merely foes on the other side of the negotiation table.
  2. at the same time, avoid falling in love with the people and the deal. love can make us blind to the realities of the situation. strongly resist doing just any deal because of the pressure to do something.
  3. make sure that the letter of intent is robust and comprehensive. this minimizes the risk that key issues omitted in the loi will arise later when both parties’ patience wears thin.
  4. negotiate the most important or difficult issues first, when the parties are still fresh and fatigue has yet to set in.
  5. establish timeframes for accomplishing each step in the merger process, especially those routinely done by others, such as due diligence and attorneys’ preparation of merger documents.
  6. rely on merger consultants to keep the process on track and resolve differences through shuttle diplomacy.

prognosis

deal fatigue can sound the death knell for a cpa firm merger, but it doesn’t have to. deal fatigue can be contained with precautionary measures. each party should adopt a realistic approach to balancing their time between working on the merger and their normal client and firm management duties. as benjamin franklin advised, “an ounce of prevention is worth a pound of cure.”

tips for negotiating mergers

  1. always negotiate in good faith. be as honest as possible. if you can’t negotiate with honor, it’s likely the merger won’t work. if you think your merger partner is negotiating in bad faith, break off the discussions immediately. if the firm is dishonorable during negotiations, it will get worse after the merger.
  2. one way to negotiate in good faith is to try to see your merger partner’s point of view. put yourself in their shoes. stephen covey said it best in his landmark book “seven habits of highly effective people.” habit #5 is: “seek first to understand, then to be understood.” covey advises, “use empathetic listening to genuinely understand a person, which compels them to reciprocate the listening and take an open mind. this creates an atmosphere of caring and positive problem-solving.”
  3. in any meeting with an agenda, including merger negotiations, there will be many items to address, some big, some small. address the big agenda items first, while both firms have time and energy. after deal fatigue sets in and you are physically and mentally exhausted, avoid negotiating important merger terms.
  4. enter the negotiations with as few must-haves as possible. this doesn’t mean you should accept terms and policies you find unacceptable for the sake of compromise.

one of the best examples of excessive must-haves is when sellers are insensitive to buyers’ cash-flow burden. the worst of all worlds goes something like this: the seller wants (a) a high purchase price, (b) to continue working at the buyer for an unspecified number of years while earning the same or higher compensation than before the merger and (c) a large down payment. this will likely result in a severe negative cash flow to the buyer. this scenario is most common when the buyers are local firms with under $20 million in revenue. large buyers, especially regional firms, tend to look at a downward merger as a long-term investment and are more willing to incur a cash-flow deficit in the beginning years.

  1. the best way to negotiate is to bargain as if you are prepared to walk away. don’t be a jerk about it or be inappropriately rigid. but if a term or policy is truly critical to you, it’s important to have an assertive attitude.
  2. every merger negotiation reaches stumbling blocks. one firm wants a certain term and the other seems adamantly opposed. when this happens, don’t belabor the disagreement. instead, move on. table discussion on the issue and put it on a list to be reopened at the end of negotiations. more often than not, the two firms will find it easier to compromise at a later date.
  3. no one likes surprises at the end of a transaction. that’s a big reason to uncover and ideally work through the big items first, including those that are the most sensitive and those issues on which one firm feels the other will be difficult to deal with.
  4. don’t let your attorney screw things up. i’ve seen many a deal threatened when, after months of stressful, thorough negotiations, the two firms reached a handshake agreement on merger terms and turned things over to the attorney, who proceeded to dredge up several difficult issues that one of the firms found offensive or disagreeable.

this is not to suggest that the attorneys aren’t competent, aren’t trying to do their job or are wasting time on picayune issues. the point here is to keep updating your attorney throughout the merger process. the attorneys should provide a list of items the merger partners should address on their own that the lawyers will bring up if the buyer or seller doesn’t.

  1. never assume anything. examples that i have seen cause problems because one party assumed something and failed to do their due diligence:
    • two firms had known each other for many years, and each had a high regard for the other’s technical quality and professionalism. so the two firms dispensed with one of the most basic forms of due diligence: reviewing client workpaper files to make sure the quality of the other firm’s work met minimum standards. after the merger, the buyer’s audit partner was furious at the low quality of the seller’s audits.
    • a buyer’s partners averaged 1,100 billable hours per year, while the seller’s average was 1,800. they didn’t discuss how this disparity would be handled. naturally, after the merger it become clear that the buyer expected the seller to delegate more and the seller’s partners expected to continue doing a large amount of staff-level work, as they had for many years.
  1. both firms should do their best to move things along. never be in a rush, but don’t drag things out either. in most mergers, the partners doing the negotiating have large client responsibilities, which infringes on their time to actively address the steps in the merger process. the delays are usually more the fault of the seller than the buyer. sellers should be aware that if they repeatedly fail to meet deadlines, buyers may lose patience and call off the deal.
  2. sellers should beware of buyers who say, “don’t worry; when you merge in with us, nothing will change for you.” any buyer who says this is lying or delusional. i guarantee you, some things will change. and if the seller is unwilling to adapt to those changes, the merger may not be successful.
  3. always negotiate in good faith. i know, i know. this was tip #1. but it bears repeating!