When deciding the method by which to sell a business, auctioning is an infrequent option among Canadian business owners. Yet, this seller-oriented process is designed to secure the best price and terms possible business owners. By creating competitive tension, the auction process compels bidders to put forward the highest price they would be willing to pay in order to succeed.
Some argue that bidders in an auction tend to overpay for a target: while this may be due, in part, to a bidder merely wanting to “win” the bid, there’s also an issue of information disclosure at play. Unlike private negotiations where information and disclosures about a target company may flow readily, there is a risk of information asymmetry during an auction, whereby a bidder has less information upon which to base a bid, possibly resulting in overvaluing a target. The auction process, it is then argued, may result in gains favouring a seller which are otherwise unlikely to be achieved through other transactional processes.
Notwithstanding that, at first glance, it may seem as though the auction process is one-sided and merely facilitates the transfer of wealth from the pocket of the bidder to that of the seller, the auction process is more than a zero-sum game. In this article, we explore the various advantages to the bidders in an auction process.
- Dissemination of information. As a necessary part of the auction process, more market exposure is required for the seller. This may result in more information about the target company, including confidential information, being disseminated into the public domain. Consequently, the unfavourable impact of information asymmetry on the bidder is lessened and the risk of misjudging the value of the target company is mitigated. Moreover, if the bidder operates in the same market as the seller, the additional knowledge of other market players confers significant competitive advantages to the bidder.
- Validation of opportunity. The dynamic of an auction process allows the seller to survey the market thoroughly to identify all the potential bidders. Once the auction starts, the bidders will be able to recognize the existence of other bidders for the target company. The benefit from this information is three-fold. It not only serves as a confirmation of the value of the company to bidders but also validates this opportunity for bidders. At the same time, the auction provides an opportunity for the bidder to uncover all the participants in the area where it conducts business, which enhances its knowledge of the market environment.
- Speed of execution. In comparison with private negotiations, a well-organized auction typically results in transactions closing earlier. Without continuous back-and-forth with the seller, the management team of the bidder can spend less time and effort on the takeover bid. The bidder benefits from the reduced distraction to its management team, who can concentrate on more important managing issues and creating more value.
The author would like to thank Jiarui Zhao, summer student, for her assistance in preparing this legal update.