Trying to Quantify the Impact of Competition in a Sale Process

March 2, 2023

Spencer P. Cavalier, CFA, ASA, Co-Head, Cedric C. Fortemps, CFA, Co-Head, Nathan B. Wah, CPA, Associate
Downstream Energy & Convenience Retail Investment Banking Group

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It is a perplexing phenomenon observed by many mergers and acquisitions (M&A) practitioners: some companies elect to sell themselves without formally structuring and executing a sale process to achieve broader market discovery of value (i.e. purchase price and terms). While most shareholders desire to maximize value and terms upon exiting a business, this lack of fuller discovery is a head-scratcher for M&A transaction advisors, lawyers, and accountants. Admittedly, there are situations where the best buyer for a company may seem obvious and terms such as “preferred buyer” and “culture” are often cited by owners and management teams. However, it would seem any selling shareholder looking to maximize value would naturally want broader market discovery, even if a process involved marketing to a limited number of potential buyers, which is often the case in situations where confidentiality and/or certain buyer criteria are of extreme importance. Whether a process is broad or limited, the simple presence of competition in a sale process most always motivates buyers to submit much stronger offers.

In thinking through how to achieve full value discovery for a potential client who is hesitant to run a broader process, we became curious to find out what research studies may be available that would provide evidence of competitive sale processes driving increased value for sellers. We were interested in what the publicly available research would show compared to our anecdotal experience with these situations. Based on our knowledge of go-shop processes and our experience, we thought researching the results of those processes would likely show, that in most cases, higher and better offers resulted from the go-shop period.

Go-shop processes were originally created in the mid-2000s to address concerns by fiduciary boards of directors that management teams had marketed and negotiated the sale of a company only to a single buyer. Go-shops are mainly seen in the public M&A arena, especially private equity take-privates of public companies, and have been an effective tool to employ in situations where a client desires to negotiate and sign a purchase agreement solely with one buyer and then subsequently market test the negotiated deal with one or more potential bidders. Often, fiduciary boards reference the Delaware Supreme Court’s decision in Revlon v. MacAndrews [1] of its duty to maximize the value shareholders receive.

Our research focused on (1) does the existence of a go-shop provision serve to increase the initial bid and/or improve shareholder value, and (2) if a seller truly seeks pure, untainted shareholder value discovery, is the go-shop tool as equally effective as a traditional, competitive sale process that requires pre-signing market discovery.

In its basic form, the go-shop process allows a seller to exclusively negotiate and sign a contract with a single buyer and then initiate a post-signing “go-shop” process to see if superior offers exist from additional potential buyers. Although there are many variations, go-shop solicitation periods often range from 20-50 days, provide the original bidder with a termination fee of typically 1% – 3% (depending on when the original deal is terminated), and often give the original bidder matching rights to a superior bid found during the go-shop period. These provisions are rarely seen in private company M&A transactions.

There have been multiple studies conducted on the effectiveness of go-shop processes, and arguably the most notable research was performed by Harvard Law and Business School Professor Guhan Subramanian [2]. Professor Subramanian’s original study reviewed and assessed private equity buyouts between January 2006 and August 2007. Out of the 141-deal sample, 48 transactions included go-shop provisions and produced a higher bidder 12.5% of the time. We would have expected a higher percentage, but it should be noted that Subramanian’s study found that sellers were able to achieve higher value from the original bidder in exchange for pre-signing exclusivity. We did not study the magnitude of the higher value offers in cases when a higher bidder surfaced, so it’s possible that the amount of the premium may have been significant when that occurred.

Subramanian’s original study results were surprising to us because our anecdotal evidence of competition driving value is very different. The table below illustrates actual transaction premiums from relevant transactions where Matrix clients had received an offer prior to deciding to engage Matrix to advise and execute on a structured sale process with multiple potential buyers. As you can see from the results, our clients were able to improve the value received for the business by 50% on average by executing on a competitive process as opposed to accepting the negotiated offer in a non-competitive situation. In two of the four transactions, the final buyer was the same one that had initially made the offer, but they increased their offer dramatically due to the competitive process.

We believe one reason the results from go-shop processes are very different from our experience is the way the go-shop purchase agreements are structured, which typically include a right of first refusal (ROFR) or something similar (i.e. matching right). We believe the relatively low incidence of initial go-shop buyers being topped is partially because a ROFR, and depending on the situation, can significantly chill the competitive bidding for a business. A potential buyer is much less likely to devote significant time and resources to submit an offer on a business if they feel like another buyer is the preferred buyer or has a legal matching or topping right for the business. With major oil fuel suppliers, and recently a dealer group in Prince William County, Virginia, pushing for ROFRs in wholesale marketer agreements or in state law in the latter situation, the harm that a ROFR can have on the value of a business should not be dismissed.

There are also other reasons while go-shop processes have not been as effective in generating higher offers than the initial offer. With many innovative legal and financial clauses in purchase agreements, go-shop provisions have changed significantly since their introduction, and studies show that go-shops have become less effective today. A subsequent study of go-shop effectiveness, titled “Go-Shops Revisited,” was published in 2019 by Guhan Subramanian and Annie Zhao [3]. The study examined 108 transactions with go-shop provisions during 2010-2018, and during that time the success of the go-shop provisions for these transactions dropped to 5.6% (6 out of 108 transactions secured higher shareholder value). When the authors examined a shorter time period of 2015-2018, the success rate declined even further to 2.5%. The drop in the success rate was attributable to go-shops being less effective in encouraging jump bids.

As also discussed in “Go-Shops Revisited,” there is no single reason why go-shop provisions evolved to become less effective over the study periods. Reasons would certainly vary by transaction and be revealed if a close examination of often opaque issues was thoroughly conducted. However, on the surface, based on review of available terms and the reality of market dynamics, go-shops are potentially much less effective today due to the following reasons:

• Go-shop time periods are often negotiated by the initial bidder to be shorter in duration;
• The introduction of matching rights, as discussed previously, that serve to deter prospective go-shop bidders;
• Conflicts of interest that limit the effectiveness of the go-shop process, such as CEOs’ incentives to suppress a deal price and discourage third party bids;
• Conflicts of interest among deal professionals who may lack independence due to financial incentives (such as providing financing to the initial bidder or providing other capital markets services) to promote the initial bidder and deter third-party bidding; and,
• The increased complexity and requirements of a go-shop agreement. Third-party bidders must often meet a higher standard than the original bidder by submitting a comprehensive acquisition proposal during a compressed go-shop period to qualify as a superior proposal.

Ultimately it is apparent that any sale process that introduces the potential for “asymmetry” can lead to manipulation and a suboptimal result for shareholders. The topic of go-shops and auction theory are the subject of a paper authored by J. Russel Denton, “Stacked Deck: Go-Shops and Auction Theory [4].” The paper examines different styles of auction processes and the effectiveness of go-shop provisions. Further, it analyzes the differences in valuation theory between financial and strategic buyers, the latter of which can often be more aggressive by applying their knowledge of potential synergies, which a financial buyer may not enjoy. Denton stresses the importance of marketing a company to multiple buyers, from the beginning of a sale process, as the competition from multiple bidders (or the potential entry of additional bidders) will encourage more aggressive bidding and a better result. Further, it is important to provide consistent information to all buyers to reduce the feeling of a “winner’s curse.” As Denton suggests, bidders who do not feel they have been provided with solid and consistent evaluation information are often concerned they have been chosen as the winning bidder due to overvaluing the target, resulting in “winner’s curse” syndrome. Denton’s paper concludes by recommending boards of directors conduct a true “auction” with a pre-signing market test rather than negotiating a deal with a preferred buyer and subsequently employing a go-shop process, as go-shops are often structured in such a way to discourage other bidders.

In conclusion, the creation of the go-shop provision was intended to help shareholders and executive management teams better negotiate a transaction with their preferred acquirer, while also providing fiduciary boards of directors’ protection that the deal would subsequently be market tested to satisfy their fiduciary duty to maximize value for all shareholders and provide protection from potential shareholder lawsuits. Unfortunately, it can be very difficult, if not impossible, to structure a go-shop process that is void of any form of asymmetry, which essentially gives the original bidder an advantage. Except for very rare situations which do occur, from our experience, there is no substitute for selling a company through a structured, professionally managed competitive process, using experienced and independent advisors who unequivocally advocate for the shareholders and seek broader, pre-signing market discovery.

This holds true for private companies as well. Even if a private company does not have a fiduciary board or other stakeholders who have a responsibility to maximize value, thorough discovery of value allows selling shareholders to make a fully informed decision and not be left to wonder if any value has been “left on the table.” Further, fuller discovery does not preclude the option of selling a company to a preferred buyer, even if the preferred buyer’s value is inferior, as there may be other (tangible or intangible) reasons to transact with that party. In summary, we encourage all potential sellers to carefully structure a sale process that enhances the prospects of fuller market discovery to maximize value.

About Matrix Capital Markets Group, Inc.
Founded in 1988, Matrix Capital Markets Group, Inc. is an independent, advisory focused, privately-held investment bank headquartered in Richmond, VA, with additional offices in Baltimore, MD and New York, NY. Matrix provides merger & acquisition and financial advisory services for privately-held, private-equity owned, not-for-profit and publicly traded companies. Matrix’s advisory services include company sales, recapitalizations, capital raises of debt & equity, corporate carve outs, special situations, management buyouts, corporate valuations, and fairness opinions. Matrix serves clients in a wide range of industries, including automotive aftermarket, building products, car washes, consumer products, convenience retail, downstream energy, healthcare and industrial products. For additional information or to contact our team members, please visit www.matrixcmg.com.

Disclaimer
The contents of this publication are presented for informational purposes only by Matrix Capital Markets Group, Inc. and MCMG Capital Advisors, Inc. (“Matrix”), and nothing contained herein is an offer to sell or a solicitation to purchase any of the securities discussed. While Matrix believes the information presented in this publication is accurate, this publication is provided “AS IS” and without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranty of merchantability, fitness for a particular purpose, or non‐infringement. Matrix assumes no responsibility for errors or omissions in this presentation or other documents which may be contained in, referenced, or linked to this publication. Any recipient of this publication is expressly responsible to seek out its own professional advice with respect to the information contained herein.

[1] Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. 506 A.2d 173 (Del. 1986)

[2] Subramanian, Guhan. “Go-Shops vs. No-Shops in Private Equity Deals: Evidence and Implications.” Business Lawyer 63, no. 3 (May 2008): 729-760

[3] Subramanian, Guhan and Zhao, Annie, “Go-Shops Revisited” (January 30, 2019)

[4] Denton, J. Russel, “Stacked Deck: Go-Shops and Auction Theory.” Stanford Law Review 60, no. 5 (April 2010): 1529-1554