Over the last few years we have seen an increase in the use of auction sales when disposing of a business. So what is it that makes an auction an attractive process? And are there any disadvantages?
Going up – the advantages
- A competitive auction process can help the seller achieve the highest possible price for a business as buyers bid against each other to secure the right to negotiate and, ultimately, acquire the target. The seller may also be able to reach more potential buyers via the auction process marketing exercise.
- An auction process puts the seller in control. In a typical transaction, it is usually the buyer who dictates the timetable as it conducts its due diligence investigation into the target and then prepares first drafts of the transaction documents. With an auction, the seller sets the timetable and the process for the disposal.
- As well as the timetable, the seller also controls the flow of information to the buyer on an auction sale. Typically, potential buyers will be provided with an information memorandum containing details of the target and its business against which they submit indicative bids. Bidders selected to proceed to the next stage are then given access to a data room containing more detailed, and often sensitive, information. The seller is able to control carefully exactly who has access to what information and when.
- The seller may also achieve better overall terms on an auction sale. As noted above, it is usually the buyer that prepares the first drafts, including the sale and purchase agreement. On an auction sale, however, that agreement is generally prepared by the seller. This gives the seller the opportunity to specify its own preferred terms from the start. In addition, prospective bidders will be asked to comment on the agreement as part of the bidding process and, because this is a competitive process, buyers may be prepared to accept more “seller friendly” provisions as they try to make their offer attractive to the seller with a view to achieving preferred bidder status.
Going down – the disadvantages
- Whilst the seller may be able to control the flow of information to potential buyers, there is one piece of information that it is hard to keep secret on an auction: the simple fact that the target is for sale. As the target is actively marketed, more people will know about the potential sale. This could disrupt the target’s business as staff, customers and suppliers become unsettled by the accompanying uncertainty. In addition, it may be difficult to prevent the target’s competitors from using the auction process as a fishing exercise where they have no real intention to bid.
- The costs associated with a sale are usually higher for the seller where an auction process is used. Typically, the seller’s corporate finance adviser will actively manage and control the process, preparing an information memorandum and marketing the target to potential buyers. The seller’s advisers will also have to set up a data room of due diligence information and prepare the first drafts of the transaction documents. They will also have to negotiate and deal with several potential buyers, until a preferred bidder is selected, all of which will add to the costs.
- As well as increased costs, the seller will face increased demands on its directors’ time as they are required to respond to enquiries from, consider bids from and negotiate with multiple potential buyers.
- Not all businesses are suitable for sale by auction. The target may operate in a particularly restricted market, or one which is heavily regulated, meaning there are few potential bidders (or at least significant barriers to bidding). If the target has a complex business model that is difficult to encapsulate in an information memorandum it may be difficult to persuade potential buyers to bid.
- And what if the auction process is not a success? The seller could find that the target is viewed in the market as “soiled goods”, leading to an overall decline in its business.
Despite these potentially negative factors, auctions are becoming increasingly popular. They are particularly favoured by private equity sellers, who are keen to maximise the sale price, and are also more common on higher value transactions, where the consideration justifies the increased costs and complexity for the seller.