The term "highest and best deal" has been well-known in the bankruptcy field for many years.

In a bankruptcy auction of a business or real property, the judges, trustees and creditors recognize that the better deal is not always the one that offers the highest price. It is not uncommon to approve and accept a deal with a lower price in that arena if that offer includes more favorable terms and comes from a buyer that is more qualified or more likely to perform.

It is surprising and oftentimes disappointing how this basic concept is missed or ignored in the context of automotive dealership transactions. I have seen too many failed attempts to sell a dealership or a large block of stores and to see these deals fall prey to the lure of the higher bid.

In many instances, the seller proceeded with a suspect buyer or accepted unfavorable terms. In the end, the buyer simply scuttled the deal and left the seller to pick up the pieces.

Needless to say, the consequences of this mistake can be enormous in a declining market. It reared its head in a recent example of a substantial deal negotiated almost a year ago — at the height of the post-COVID-19 market.

The seller, an automotive dealer, decided to proceed with the buyer that offered the highest price. Unfortunately, the seller accepted one-sided terms, including broad and protracted contingencies.

In the end, and after many months of processing the contingencies, including due diligence and factory approvals, the buyer simply elected to walk away from the deal and because of the onerous terms imposed on the seller, did so with complete impunity.

As a result, the seller was back to the beginning with nothing to show for its efforts, wasted time and disruption except substantial professional fees. Worse, the seller now needs to restart its marketing effort in a market that has receded to less attractive blue sky values or multiples, and that more favors the buyers.

Currently, this looks like a price reduction of at least 20%. To place this in perspective, the second-highest buyer in the original deal was within 5% of the original buyer's price. Proceeding with the buyer offering the slightly lower price and better terms may have been the wiser choice.

Unfortunately, this is not an isolated situation. Indeed, it is clear that the mergers and acquisitions market continues to decline.

While there were some indicators that the decline was slowing at the end of the second quarter of this year, the third quarter reflects more negative results, including a significant drop in relation to the first half of the year.

This concerns both a reduction in deals as well as a reduction in multiples[1]. As for the latter, it has been my experience in automotive deals since the first quarter that blue sky prices have dropped by at least 20%.

Interestingly, the multiples in the automotive M&A arena have remained steady. This is based upon the input of several valuation experts in this sector.[2]

This trend is not helped by recent world events. These obviously include two wars as well as the rise in COVID-19 infections.

Needless to say, the sharp rise in interest rates is another significant factor. This problem is multifaceted.

First, capital for acquisitions has become substantially more expensive. Second, floor plan, working capital, loans and mortgage rates are higher. As a result, earning are suppressed. None of this is motivating acquisitions.

We have seen several periods when dealers and other businesses could barely survive. Many filed for Chapter 11 protection or simply closed their businesses. The current climate does not come close to this situation. What we are dealing with now appears to be just a softening of historically high profits and values.

The dealers are still experiencing respectable numbers, although there is a true sense that the bloom is off the rose. It is too early to tell if this is a prelude of tough times ahead. Most view this as more a return to normalized operations.

Nevertheless, it is wise to assume that a deal negotiated now should yield a better result that one negotiated later this year, or the early part of next year. As such, the prudent seller must do all that is necessary to craft a deal that has the highest level of success.

How can this be achieved? How does one negotiate the acquisition in a fashion that maximizes the likelihood of a successful transaction and precludes the buyer from simply waltzing away in the end? Of course, no deal is guaranteed.

As we know from experience, circumstances can develop — some completely unexpected — that can jeopardize a deal.

However, with effective negotiations and proper drafting of a strong buy-sell agreement, it is possible to significantly reduce these risks and substantially increase the probability of a successful transaction.

Here are some ways to accomplish this goal.

The Right Buyer

Never forget the old adage: You can't do a good deal with a bad person.

Understanding your buyer is as crucial as the buyer understanding your business. A wise seller is likely to do as much due diligence on its buyer as the latter conducts on the seller.

Here are some of the salient considerations:

What is the buyer's reputation?

What is the buyer's track record? Do they close their deals or abort? Are they notorious "tire-kickers," or do they have a strong record of closing deals?

Do they move quickly or string out the seller? One of the worst experiences for a seller is a buyer inflicted with "paralysis by analysis."

Does the buyer tend to renegotiate after the deal is inked?

What is the buyer's track record with the manufacturers? Has the buyer been turned down by the same franchiser or is it highly regarded?

Does the buyer have immediately available funds for the deal, or require lender or investor approval?

The Right Terms

There is nothing more dreadful for a seller than receiving a termination notice after months of processing a deal.

By this time, the manufacturer and lender are notified of the deal and the rumors are rampant.

An aborted deal places enormous pressure on the seller to "restore the business and its relationships to PNC-Sale Condition." Needless to say, it is no easy task.

What can the seller to do avoid this unfortunate result in an acquisition?

Virtually every termination notice issued by a buyer is based upon the purported failure of one of the contingencies contained in the buy-sell agreement. This is where the game is won or lost. How the contingencies are handled in the deal will be a strong factor in controlling the destiny and viability of a transaction.

The most volatile of the contingencies is financial due diligence. This is the one contingency that a seller can't control.

In this regard, the language of this contingency typically gives the right to the buyer to terminate if the buyer is not satisfied with the results of its financial evaluation or, worse, the right to terminate for any reason or no reason.

For this reason, I caution a seller against the execution of a formal acquisition agreement and the processing of a deal with such a contingency outstanding. The better approach is to require that the buyer complete its financial due diligence prior to the execution of the formal agreement.

For example, this can be accomplished when the parties have executed a nonbinding letter of intent. Alternatively, the financial due diligence can be conducted after the execution of the formal agreement in the first stage of the transaction. Under this approach, the manufacturers and other third parties — e.g., the lender — are not notified of the deal unless and until the due diligence is deemed satisfied.

It should be noted that the latter is the less desirable approach since a staged buy-sell can be quite protracted. The seller is well-advised to avoid buyers who resist or reject either of these approaches.

The concern, however, extends beyond the financial due diligence contingency. Careful attention should be given to the other contingencies in the deal. These principally include franchise approval, financing approval — if applicable — environmental investigation and physical inspection.

Each one of these should be crafted in a manner in which the seller can control the result or, at minimum, to give the seller the highest likelihood that the contingency will be satisfied.

For example, a franchise approval contingency should not be based upon what the buyer considers to be satisfactory terms and conditions. Rather, the contingency should only require standard or reasonable terms and conditions.

As another example, an environmental investigation contingency should provide the seller the option — but not the obligation — to cure any legitimate environmental concerns.

Vigilance

Another way to enhance the success of a buy-sell transaction from the seller's perspective is constant vigilance over both the buyer's performance and the performance of the necessary third parties, such as the manufacturers.

Upon execution of a formal agreement, the seller should carefully docket each of the requisite contingencies and stair-steps in the deal and closely monitor the progress of each, constantly inquiring with both the buyer and the third parties.

In this way, the chances of proper and efficient performance by the buyer and the third parties will be greatly enhanced.

Conclusion

Of course, all sellers want the maximum price for their dealerships and one should never lose sight of that goal. However, placing a deal at risk for the optimum price can be regretted.

In the end, the seller should balance the optimum price against the optimum terms in pursuit of the best deal.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] PITCHBOOK, Global M&A Report (Q3 2023).

[2] These experts have pointed out that multiples continue unabated.  However, they are also quick to point out that while prices have declined, this is more a function of reduced earnings and the manner in which buyers calculate earnings, including discounting of the post-covid surge in profits.  Most agree that the latter is not a reliable prediction of formal, normalized earnings.

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