Auction Process

What is an auction process?

Auction process refers to a structured sale process in which the seller side approaches several prospective buyers at the same time and collects offers under fixed rules. Also in use are the terms structured bidding process and controlled auction; the German term is Bieterverfahren. The prospective buyers bid according to a fixed timetable, usually in two rounds (two-stage auction process). The competition among the bidders is meant to improve the price and contract terms and to increase the certainty that the sale is actually completed in the end, that is, that the shares and the purchase price really change hands.

In principle, the process resembles the sale of a house, where the owner lets several interested parties view the property and sets a common deadline for bids. Such auction processes for real estate are permissible in Germany. A bid binds no one there; only the notarised purchase agreement is binding (Section 311b(1) of the German Civil Code, Bürgerliches Gesetzbuch, BGB). In a company sale, written ground rules, a detailed examination by the bidders and a fully negotiated contract are added.

Auction processes are common in company sales. They serve sales to strategic buyers (companies in the same or an adjacent industry) as well as to financial investors (investment companies that aim for value growth and later resale) or as part of a succession. The process is usually organised by an M&A adviser on the seller side. M&A stands for mergers and acquisitions, that is, company purchases and combinations. The sellers' law firm drafts the purchase agreement. There are no statutory procedural rules as in public procurement law; the ground rules are set by the seller side in the process letter.

Phases of an auction process

Preparation

Before the first approach, the documents on which the process rests are created. These include the equity story (the coherent explanation of why the company can continue to grow and gain in value), a reliable plan with a financial model and an anonymous short profile (teaser). Added to these are an information memorandum that describes the business model, market, key figures and plan in detail, and a complete data room with all the documents that bidders will later examine.

Sellers can additionally commission a vendor due diligence, that is, an examination commissioned by the seller side and carried out by auditors or law firms, so that bidders bid on an audited basis. In parallel, a broad list of possible buyers (long list) is narrowed to a shortlist of the addressees who are actually approached.

First round: approach and indicative offers

The prospective buyers first receive the teaser. Those who wish to continue sign a confidentiality agreement and receive the information memorandum with the process letter. By a fixed date, the bidders submit an indicative offer. Indicative means that the bidder states its preliminary price expectation on the basis of the information known so far, without being bound. The offer contains a price or a price range, the valuation basis, the sources of financing, the key assumptions, the desired scope of examination, required approvals and the intentions for management and employees.

Second round: due diligence and binding offers

On the basis of the indicative offers, the seller side selects a small group, often three to six bidders. They receive access to the data room, a management presentation, expert discussions with those responsible and, where appropriate, site visits. Questions run through an orderly question-and-answer procedure. With the data room, the bidders receive the sellers' draft purchase agreement. The binding offer then contains the price, the marked-up draft contract, proof of financing and the remaining conditions, such as the still outstanding approval of the bidder's supervisory board or investment committee.

"Binding" in this context does not mean that the bidder is already contractually bound. It means an offer without reservation of further examination, with documented financing and a concrete contract text. Both sides are legally bound only upon signing of the purchase agreement, and in the purchase of shares in a GmbH (German limited liability company) only upon its notarisation.

Final negotiation, signing and closing

The contract is negotiated to completion with one or two preferred bidders. As long as two bidders negotiate in parallel, competition is maintained. Only after that does one bidder receive exclusivity, that is, the right to negotiate alone for a limited time. What is prohibited during this time is governed by a no-shop clause. The signing of the purchase agreement follows. As soon as the closing conditions have been met, such as clearance by the competition authority, the contract is completed: the shares pass and the purchase price is paid.

The process letter as a set of rules

The process letter determines how the process runs. It states deadlines, the required content of the offers, the contact persons and the rules for the data room and questions. A ban on contacting the company's employees, customers or suppliers without consent is usual.

At the same time, the seller side secures its freedom of action. It reserves the right to change or end the process at any time, to exclude bidders and to accept no offer. Each bidder bears its own costs. Legally binding in this phase is above all the confidentiality agreement.

Variants of the auction process

• Broad (open) process: Several dozen prospective buyers are approached. Market coverage is high, as are the effort and the risk that the intention to sell becomes known.
• Limited process: A carefully selected group, in practice often ten to 30 addressees, is approached. In the German Mittelstand (mid-sized companies), this is a common form.
• Exclusive one-to-one negotiation: Negotiations are held with only one prospective buyer. The process is discreet and fast, but a market comparison is missing.
• Dual track: The sale process runs in parallel with the preparation of an IPO or a funding round, so that the shareholders can compare the alternatives.

A broad or limited process is worthwhile when several serious groups of buyers come into consideration. If there is an obvious buyer who knows the company and can pay, or if confidentiality is particularly important, a guided one-to-one negotiation may be preferable.

Comparing offers in an auction process

The stated purchase price is only one part of the offer. Offers become comparable only when all components have been brought to the same basis:

• purchase price mechanism, that is, a fixed price based on a past reference date (locked box) or an adjustment after closing on the basis of a closing-date statement (completion accounts),
• share of payments that flow later or only conditionally, for example through an earn-out (a part of the purchase price that depends on later targets), a retention, a vendor loan or a reinvestment by the sellers in the acquirer,
• scope of warranties, liability limits and the question of whether warranty and indemnity insurance (W&I insurance) replaces the sellers' liability for breaches of warranty,
• closing conditions, clearance risks and the certainty of financing,
• timetable, reservations of approval by committees and plans for employees and sites.

Competitors as bidders

Strategic buyers from the same industry often pay the highest prices because of expected synergies, but they also gain insight into sensitive data during the process. The seller side therefore discloses in stages: customer-related prices, margins and salaries are made accessible only late, to only a few bidders and, where appropriate, only to a shielded circle of external advisers (clean team). This protects trade secrets and complies with German and European competition law, which limits the exchange of competitively sensitive information between competitors.

Practical example: auction process for a software company

The shareholders of a software company with EUR 8 million in annual recurring revenue run a limited auction process. 24 addressees are approached, 15 of them strategic buyers. 13 prospective buyers sign a confidentiality agreement, seven submit an indicative offer, four are admitted to the second round, and two submit a binding offer for 100% of the shares:

• Bidder A, a strategic buyer: EUR 40 million at closing, fixed price under a locked box, warranty liability largely replaced by warranty insurance
• Bidder B, a financial investor: EUR 44 million total price, of which EUR 36 million at closing, of which EUR 4 million is retained in an escrow account for 24 months, and up to EUR 8 million as an earn-out after two years if a revenue target is reached
• Available at closing: Bidder A EUR 40 million, Bidder B EUR 36 million minus EUR 4 million = EUR 32 million
• Earn-out: the sellers estimate the probability of reaching the target at 50%, expected value 0.5 × 8 = EUR 4 million
• Expected total proceeds from Bidder B if the retention is released in full: 32 + 4 + 4 = EUR 40 million

Before discounting and taxes, both offers are therefore equal in expected value, although Bidder B names EUR 4 million more. However, Bidder A pays EUR 8 million more at closing and leaves the sellers with less risk. The sellers continue to negotiate with both bidders. Bidder A raises its offer to EUR 41.5 million and then receives exclusivity for the final contract negotiations. The improvement of EUR 1.5 million arises because a second bidder remained in the process until the end. The decision is made only after comparing all components, not according to the highest stated figure.

Distinction: auction process, trade sale and takeover offer

• Trade sale: refers to the sale to a strategic buyer, that is, the type of acquirer. A trade sale can come about in an auction process or in a one-to-one negotiation.
• Public takeover offer: For listed companies, the bidder addresses the shareholders directly under the rules of the German Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz, WpÜG). An auction process, by contrast, is steered by the seller side itself.

Common mistakes

• Starting with unfinished documents. A data room that is still being filled during the second round delays all bidders at the same time and costs credibility.
• Deadlines without enforcement. Anyone who regularly grants extensions to individual bidders loses the pacing on which the competition rests.
• Exclusivity too early. If it is granted before a fully negotiated, financially backed offer, negotiating power shifts to the bidder.
• Comparing on price alone. Conditional and later payments, liability and closing risks often change the value of an offer more than the stated figure.
• Deviations from plan during the process. If the company misses its own plan during the process, bidders use this for price reductions. A cautious, achievable plan protects against this.

Frequently asked questions

How long does an auction process take?

From preparation to closing, six to twelve months often pass. The preparation of the documents, the bidders' due diligence and the waiting time for regulatory clearances determine the duration most strongly.

Must the seller accept the highest offer?

No. The process letter reserves the right of the seller side to reject any offer and to end the process. No bidder has a claim to be awarded the deal.

What is the difference between an open and a closed auction process?

What matters is whether the bidders know the bids of the others. For real estate, an open auction process means a bidding round in which the prospective buyers learn the highest bid at any time and can outbid it. In a closed process, everyone submits their bid in sealed form by a deadline. Company sales generally follow the closed pattern; "open" there usually means a broad process with many approached prospective buyers.

Do employees and customers learn of an auction process?

The risk rises with the number of approached prospective buyers. Anonymous teasers, confidentiality agreements and a contact ban in the process letter limit it but do not rule it out. Companies therefore decide in advance when and how they will inform employees and important customers.

The Roemer Capital view

A sale mandate with us begins with preparation, not with the approach. Before the first teaser of at most five slides is sent, the information memorandum is ready. In addition, there is a financial model covering at least three plan years with a base case, a cautious case and an optimistic case, as well as a data room that can be made available within 24 hours. We agree the bidder list with the shareholders, including the question of which competitors receive which information.

We prepare binding offers in a uniform overview that places payment timing, conditional components, liability and closing risks side by side. This makes visible which offer is actually worth the most after deducting the risks.