You’ve started, grown, and now are looking to sell. When the exciting moment comes in your entrepreneurial journey to take steps toward offering your business for sale (or responding to a spontaneous offer), it’s important to be prepared. Understanding the process and the players can be the difference between a successful exit and a lost opportunity. As early as possible, educate yourself and set the foundation for a successful sale. Prevent the death of your deal with the right preparation.
LAY THE FOUNDATION
Before you begin entertaining prospective buyers, there are steps to take as a business owner that will position you to obtain the maximum return with the least disruption. Here are a few examples:
Contract with Sale in Mind
Whether with landlords, employees, contractors, vendors or customers, keep in mind your goals and intent to sell and set the contracts up accordingly. For example, does your lease allow you to assign it to a buyer of substantially all of your company’s assets? Is the non-compete signed by your star salesman assignable? Will your customers with long-term contracts have an out upon sale because you need their consent to assign the contracts?
Keep your Financial House in Order
Simply put, sloppy financial records make buyers nervous and that devalues your company and will lead the Buyer to demand more protections in the form of hold-backs of the sale proceeds and indemnification obligations that can last for years. Make sure you have proper P&L, balance sheets and tax returns for the last 3 years. Are you in compliance with GAAP? How about detailed budgets? Do you know your COGS (cost of goods sold), CACS (customer acquisition costs), EBITDA, and profit margins? It’s highly advantageous to have a financial team on your side from the beginning to keep the books clean and organized with your goal to sell in mind.
Understand How Your Company is Valued
If you listed your business for sale today, do you know what price you would ask for it? More importantly, do you understand the valuation method that led to that price, and whether it is the most common method for your goods or services? An experienced valuation expert and an M&A advisor can help you understand how your business is valued – and who will pay the most for it. As an example, a strategic buyer who can leverage your business as a footprint in a new geographic market and apply its economies of scale to your operations will typically pay more than a buyer who is new to the industry. Once you know your valuation metrics and your optimal buyer characteristics you can continue to grow and later package your business in the most desirable manner.
Pay attention to maximizing both the GROSS and the NET capture from your sale
“Working with a qualified deal team such as your legal team and investment banking team can help tremendously in capturing the highest GROSS valuation for your company,” commented Danyell Munassi – Associate Vice President of Wealth Management at Raymond James Financial. “They can assist you with valuation enhancement by ensuring that you have the right strategic buyer, and the optimal deal structure. However, many often underestimate the impact on achieving the highest NET asset capture from a transaction through advanced pre-sale planning and strategic tax mitigation strategies such as recapitalization, so having a strong CPA partner and advanced planning team can be critical to achieving optimal outcomes.”
BUILD YOUR TRANSACTION TEAM
It’s important to include all key players in the acquisition process early and often. Choose a team that has experience with entrepreneurs and has completed acquisitions in the past. Your team should include:
Investment Banker, M&A Advisor, or Business Broker
While all of these transaction professionals have the ability to prepare and market a business for sale, there is a difference. You should find a professional that has industry expertise and who works with sellers comparable in value and complexity. If you’re selling a $50M tech company your broker is not the same person selling a $2M restaurant franchise.
M&A/Business Transactions Attorney
As with brokers, you need to find an attorney with substantial M&A experience, adept at handling comparable transactions, from due diligence to contract negotiations to closing deals. Your go-to business attorney has a role to play but if he or she has little to no experience handling M&A transactions, you need to expand your legal team.
Accounting/Finance Team
Obtaining sound tax and financial advice (before the deal is inked!) and having a CPA who is capable of effectively responding to due diligence inquiries is critical. Your current bookkeeper/CPA may not be the one to navigate you through the sale of your business. There are considerable tax strategies that can be deployed in a sale which can save hundreds of thousands – if not millions – of dollars.
Advanced Wealth Planning/Advisory Team
Upon a sale, you will be receiving money – hopefully a lot of it. The time to plan how you will invest that money for the right balance of liquidity to pay taxes and diversification to mitigate risk is not when it is already in your account. You will also need guidance for advanced estate planning and asset protection, prior to the closing of your transaction. Many strategies which are critical to tax mitigation at the time of the transaction, and estate tax mitigation in the future should be worked on 12-24 months in advance of the sale. “Pre-planning work can yield tremendous tax savings at the time of transaction and protect your family from costly estate taxes down the line,” said Cam Ahari – Financial Advisor at Raymond James.
Advisor/Business Coach
If you have a business advisor or coach, this is when you will need them the most. Selling your “baby” can be an emotional rollercoaster and many tough decisions must be made along the way. For many business owners, their attorney or CPA has been their confidant, but your company’s legal counsel and CPA represent the company, not you, the owner. Especially when there are several co-owners who may have different positions on deal terms or strategic decisions, getting your own legal counsel, CPA and advisor/coach is critical.
Key Executives
You will need to decide early on who to inform of your intentions to sell and who will be involved in the process. Rarely can an owner navigate the sale without their CFO being in the know, but as you expand from the C-suite, who do you tell? If employees discover that you are selling, they may get fearful and look for new employment. This would hurt the deal, and potentially devastate your business if the deal falls through. You also must consider that the more people who know, the greater the risk that confidential information will be leaked, including to customers and suppliers. There is a lot of strategy around these choices.
Once you have your team, put together a communication plan and pre-schedule meetings out for three months. M&A transactions are a huge time commitment, so you must create bandwidth for yourself and your team as you would with any other large-scale project. And remember to educate your team on your core values and what matters to you most: Is it the bottom-line financial outcome of the sale? Preserving the legacy of what you built? Protecting employees? Being offered ongoing employment by the buyer? Cutting all ties at closing with an all-cash deal?
NAVIGATE THE ACQUISITION PROCESS
With the foundation set and team in place, the acquisition process has six main components with much to consider and plan out with your team. It’s important to set expectations of your involvement and intent early, avoid any litigation, and be ready to walk away if the deal isn’t what you were expecting. These activities are not linear, with most overlapping and interacting throughout the transaction.
Know Your Buyer
Whether you receive an unexpected call from a private equity firm, or a buyer responds to your investment banker’s proactive outreach, once a buyer is interested, don’t jump into anything until you know your buyer. Is it a competitor? Does it appear to be a good fit, and able to do the transaction? How is its reputation? You need to do due diligence on your buyer too, especially if you’re likely to be employed by the buyer, subject to an earn-out after closing, or receiving rollover equity. “Evaluating the Buyer is critical where there is rollover equity in the buyer-entity, which can be 20% or more of the purchase price, putting the Seller owners in the position of investor,” explains business transactions attorney and Trenam Law shareholder, Brian Tunis. This spawns a new and significant second transaction, with reverse due diligence and document review and negotiations.”
Negotiate the Letter of Intent (aka Term Sheet)
The buyer will submit to the seller a LOI/Term Sheet, which presents the initial offer. While you can likely spot the deal breaker terms, you may not recognize the risks and unintended consequences associated with terms you do not fully understand, or you may too quickly reject terms that are common in M&A transactions, such as a lengthy post-sale noncompete period. It’s important to get an attorney involved before the LOI/Term Sheet is signed to ensure it sets forth a clearly articulated offer that is closely evaluated and includes deal points that are essential to you. While the LOI/Term Sheet is typically non-binding, changing material terms after this stage (aka “re-trading”) can lead to ill-will and blow a deal.
Structure the Purchase
Most buyers prefer to purchase a company’s assets, not its stock. This is primarily to limit liability from past acts, but also for tax reasons. However, there are circumstances that call for an equity purchase. “Sometimes a client comes to us with the assumption of an asset sale structure, but we discover that an equity sale is far less disruptive. For example, if their business operates utilizing a significant number of contracts with anti-assignment language which would be triggered in an asset sale but not an equity sale, we may advise them to pursue a sale of their equity instead,” explains Macgregor Hudson, business transaction attorney at Trenam Law. Whether an asset or an equity purchase, the purchase agreement will outline the terms of the purchase. For example, it will identify what assets are being purchased, which liabilities are being assumed, the purchase price, the payment schedule, the parties’ representations and warranties, and details such as holdbacks, earn-outs, indemnification obligations, and restrictive covenants (non-competition/non-solicitation).
Due Diligence
The process of due diligence is inevitably a time-consuming burden on an operating business, and if not done well by the seller, can result in devaluing of the business and less favorable deal terms. To make it efficient and effective, start as early as possible to organize information in digital folders labeled with typical due diligence categories. Categories of important information include but are not limited to:
- Financial Statements and Tax Returns
- Customer Contracts
- Employment and Independent Contractor Agreements
- Supplier/Vendor Contracts
- Equipment/Inventory
- Intellectual Property Assets
- Leases/Real Estate
- Litigation/claims
- Insurance/risk management
- Permits/Licensing/Compliance
Make sure you are in control of who accesses these folders and that confidential information the buyer should not yet see is redacted (examples are customer names and social security numbers of employees). This is the time to review your records. For example, you don’t want to have your prospective buyer point out that some of your contracts are unexecuted or expired.
Financing
Unless the buyer has the ability (or desire) to pay all cash at closing, there will be a contingency for the buyer to obtain financing, whether from a bank, private equity engagement or some other source. The lender will also be conducting their own due diligence, of buyer and seller, and may be the cause of a failed deal.
Closing
Assuming due diligence does not uncover any major issues that result in termination of the purchase contract, the final contract is executed along with numerous ancillary documents. Before this day arrives, your transaction team will model the “flow of funds” so that debts encumbering assets are paid off, transaction costs are paid from proceeds, escrowed funds are sent to the escrow agent, and the seller-owners receive their cash at closing, and equity grants, if applicable.
Post-Closing
As the deal closes, management teams and their professional advisors continue their work together to execute on the post-closing transition, including transfer of employees and employee benefits, customers and vendor relationships, physical and intangible assets, and more. There are also many accounting and tax matters to attend to post-closing, including working capital adjustments. Further, and most important for sellers, is the handling of purchase price funds held in escrow for indemnification for breaches of representations and warranties or other contingent payments associated with the deal.
MANAGE RISK
With so much at stake, it’s important to work with your acquisition team to reduce risk in the acquisition process.
Protect Confidential Information
- Assess the risk: Is the buyer an existing competitor? Prospective competitor? What risks are you taking by engaging in due diligence and how can it be mitigated?
- Share strategically: while entering into a confidentiality agreement is imperative, these documents do not have the power to delete knowledge from the brain so be strategic about what information to disclose, and when.
- Respect mutual confidentiality obligations: make sure each member of your team is fully apprised of obligations to protect buyer’s confidential information, and the mere existence of the intended transaction.
- Who, what and when: Who should know about the potential sale, how much do you share, and when? If you reveal the deal to employees, have them sign a joinder to the applicable Nondisclosure Agreement.
QUESTIONS TO CONSIDER
- In the letter of intent, will you give the buyer an exclusivity period during which you will not solicit or entertain other offers? Is so, for how long?
- Are all the owners of the seller on the same page? If not, can the majority owners “drag along” the minority?
- What is the minimum you can accept as a sale price? You must consider debts, employee bonuses, transaction costs, taxes and other expenses that will reduce your net proceeds before you can know this number.
- Will you agree to have some of the purchase price be in the form of an earn out, such as payments being dependent on maintaining a minimum amount of revenue from major contracts?
- Will you accept seller financing? If so, what percentage of the purchase price and under what terms (duration, interest rate, principal/interest payment schedule)?
- Will you stay on as an employee, or contractor? If so, for how long and for what compensation?
- Will you accept a portion of the purchase price in the form of rollover equity in the buyer entity, or in an entity that serves as a holding company for management equity? If yes, how much can you accept in illiquid stock and still pay taxes and net what you want in your bank account at closing?
- Will you agree to restrictive covenants that may mean you can no longer work in your industry? Noncompete covenants associated with the sale of a business are commonly five years post-closing so you must pay close attention to the geographical scope and how a competitor of the buyer is defined.
- What are the values that drive your decisions in this process?
- maximizing net proceeds to owners?
- relieving you from the stress of debt?
- protecting employees?
- protecting customers?
- protecting the brand (legacy)?
- getting a second bite at the apple with rollover equity in buyer?
- being free at last (v. ongoing employment)?
ARE YOU READY TO BE READY?
If you are looking for guidance on the sale of your business – or if you are looking to buy a business, contact the mergers and acquisitions team at Trenam Law by emailing Sheryl Hunter at shunter@trenam.com. We can assess your readiness, help you prepare, bring together an experienced team and guide you every step of the way.
