Selling your company can be difficult and time-consuming. Mergers and Acquisitions (M&A) require advanced preparation, sophisticated advisors, a dedicated management team, and an understanding of key business and legal issues. The following are several key lessons concerning the sale of a private company from the perspective of the selling company.
Time Matters
When selling a business, time is a critical factor. The longer the process takes, the higher the likelihood that the offered price and terms will become less favorable. There’s also the added risk of the entire deal falling through. Delays might lead to unforeseen issues cropping up, potentially reducing the sale price. To successfully navigate the M&A journey, sellers need to project a clear sense of urgency by dialing up the Fear of Missing Out (FoMO) while dialing down the Fear of Messing Up (FoMU) and a well-defined timeline for reaching the deal’s conclusion. Having a committed advocate on the buyer’s side can also play a pivotal role in ensuring a smooth and timely deal progression.
Multiple Buyers
A crucial step in achieving a successful M&A exit is generating interest from multiple potential buyers. The saying “One buyer is no buyer” underscores the importance of a competitive process. This approach increases the likelihood of securing the best price and terms and empowers a company to push back against unreasonable requests from a single bidder. Achieving this involves a proactive marketing effort to showcase your business to as many potential buyers as possible.
Business-For-Sale Flyer
We crafted a concise one-page business-for-sale flyer we could use for wide circulation. It highlighted the key aspects such as industry, revenue, and years in business. We took pains to omit any details that could reveal the business’s identity. In the flyer, we then provided a generic Gmail account for prospective buyers to express their interest and learn more about the offering.
Confidentiality Agreement
Having a confidentiality agreement with potential buyers is crucial for a selling company. These agreements should outline the receiving party’s obligations and establish protocols for handling information if the buyer loses interest. To assist with this process, we suggest you download a Sample Confidentiality Agreement available in the Free Downloads section of SteveBizBlog.
Confidential Business Review
Sellers should develop a confidential business review document to provide to potential buyers or investors. This document is an extensive report that is akin to a turbocharged business plan, offering in-depth insights into the business. It covers crucial aspects such as financial performance, operations, market position, growth potential, and other pertinent details. The primary goal of the confidential business review is to give interested parties a comprehensive understanding of the business and its potential value. For those interested, a free outline of the Confidential Business Review we utilized is available for download. To gain access to the Confidential Business Review document, you will need to ask the prospective buyer to complete a Confidentiality Agreement.
We assigned a unique copy number to each printed copy of our confidential business review document and kept a log so that we had contact information for each document we gave out to a prospective buyer, so that we could track each copy and get it back if the prospect failed to move forward with the acquisition.
Due Diligence Preparation
Sellers must be ready for a thorough due diligence investigation, and preparation is key. Buyers typically require detailed financial statements, copies of essential contracts, information on key intellectual property, employee details, benefit arrangements, and more. To streamline this process, sellers often organize all this information in an online data room, which can be time-consuming. While sophisticated bidders stress the importance of a well-organized data room, sellers may underestimate the complexity involved.
Before selling my businesses, I meticulously compiled copies of every conceivable due diligence document, from employee details to business contracts, placing them in a cardboard box for the acquirer to review. In today’s digital era, the process is more efficient – documents are scanned and securely stored in an online folder for easy access.
Addressing Documentation Gaps
In the M&A process, sellers frequently encounter challenges related to incomplete Board and Stockholder Minutes, option agreements, and contracts with outstanding amendments. Conducting an early internal review to identify and rectify such issues is crucial, as these deficiencies can potentially hinder the progress of a deal.
Addressing these documentation gaps in advance helps ensure a smoother transaction. Sellers should prioritize completing and correcting materials related to Board and Stockholder Minutes, option agreements, and contracts to present a comprehensive and accurate representation of the company’s affairs. By proactively managing these aspects, sellers can contribute to the efficiency and success of the M&A process.
Business Brokers and Advisors
When selling a business, having a business broker or an advisor well-versed in the M&A process is crucial. This individual serves as the lead negotiator, representing the seller’s interests throughout the deal. It’s essential to address key compensation terms in an engagement letter, covering aspects such as upfront fees, success fees, indemnification obligations, and conflict of interest provisions. Typically, the broker or advisor will draft the engagement letter, but it’s important to note that the initial draft tends to favor the broker/advisor and requires negotiation to align with the seller’s interests.
Decision-Making/Negotiations
In negotiations, having the decision-making authority to discern importance and the ability to make swift decisions is paramount. Seeking guidance from experienced financial and legal advisors is essential for sound decision-making. Winning a point in negotiations often hinges on leverage or perceived leverage. It’s crucial to grasp when and where to exert leverage strategically and to skillfully trade less significant points to secure victories on matters of greater importance. In the complex landscape of M&A, a strategic approach to decision-making can make all the difference in achieving a favorable outcome.
In the realm of M&A, buyers often have experience in numerous deals and seek exclusivity in negotiations early on to avoid competition. However, sellers, who typically sell a business only once, view this request as an opportunity to enhance deal terms and agree too quickly. Sellers should aim to delay granting exclusivity to optimize terms and engage with multiple potential buyers. Sellers should reluctantly accept exclusivity when there’s no choice or only after receiving a satisfactory detailed letter of intent.
Sellers prefer a brief exclusivity period (15 to 21 days), while buyers typically prefer a longer duration (45 to 60 days). From the seller’s standpoint, the goal is to terminate exclusivity early if the buyer suggests a lower price or unfavorable terms than those outlined in the letter of intent. Sellers should also insist that any extension of exclusivity requires the buyer to confirm the price and terms and to complete due diligence, maintaining a balance of power in the negotiation process.
Letter of Intent
Reaching an agreement on a detailed letter of intent with favorable terms for the seller early in the process is crucial. Once exclusivity is granted to a potential buyer, negotiating leverage tends to shift in favor of the buyer. To maintain control, it’s essential to negotiate all key terms in the letter of intent, covering aspects such as price, payment terms, representation and warranties, insurance terms, escrow/holdback, indemnification obligations, key employee considerations, pre-closing and post-closing obligations, closing conditions, and dispute resolution methods like mandatory confidential arbitration. To assist in this process, a Sample Letter of Intent, tailored for a stock purchase, is available for download in the Free Downloads section of SteveBizBlog.
Price and Terms
Addressing the question of price and terms early on in the M&A process is not just about agreeing on the headline price. Here are some crucial considerations:
Will the purchase price be paid in full in cash at closing?
If a public company, will the stock of the buyer represent all or part of the consideration, the terms of the stock (common or preferred), liquidation preferences, dividend rights, redemption rights, voting and Board rights, restrictions on transferability (if any), and registration rights.
If a promissory note is involved, consider the interest and principal payments, security, third-party guarantees, events of default, and the seller’s right to accelerate payment in the event of a breach by the buyer.
Determine if the price will be calculated on a “debt-free and cash-free” basis (company value) or if the buyer will assume the seller’s indebtedness and cash (equity value).
Decide if there will be a working capital-based adjustment to the purchase price and specify how working capital will be calculated.
If there’s a contingent earnout, outline how it will work, milestones to be met (such as revenues or EBITDA and over what time frame), payment conditions, seller protections, information and inspection rights, and dispute resolution processes. Precision in drafting is crucial, as earnouts often lead to post-closing disputes and litigation.
Careful consideration and negotiation of these details early in the process help mitigate potential conflicts and ensure a smoother M&A transaction.
Legal Counsel
When entering into an M&A event, relying solely on the seller’s regular business lawyer, no matter how competent might be insufficient. Despite pressure to retain familiar counsel based on past performance, a dedicated and specialized M&A lawyer is essential. While the existing counsel may continue to play a supporting role, having a full-time M&A lawyer ensures expertise in navigating the complexities of M&A transactions.
The M&A lawyer needs to be competent, dedicated, and mindful of the urgency required in completing tasks. Simultaneously, they must maintain a cooperative and approachable demeanor to facilitate smooth interactions with the buyer and their team. Striking a balance between competence and collaboration is key to a successful M&A process.
Approaching Strategic Partners
Engaging with strategic partners as potential acquirers can offer significant advantages. However, it’s crucial to articulate and persuade them on how the acquisition aligns with their current and future business plans. Some strategic investors may hold rights of first refusal or first negotiation, often established as part of early-stage financings or commercial agreements. While such grants might make sense at the time, they should be approached with caution and resisted, if possible, to secure the best deal for stakeholders.
Moreover, when the potential acquirer is a direct competitor, due diligence becomes a more delicate process, carrying inherent risks. Navigating these situations requires careful consideration to protect the interests of stockholders or members and to ensure the best possible outcome for the selling entity.
Shareholder or Member Considerations
Addressing shareholder or member issues early in the M&A process is imperative. Key questions to be tackled include:
Necessary Approvals: Identify which shareholders’ or members’ approvals are required for the deal.
Approval Timelines: Assess how quickly these approvals can be obtained to align with the transaction timeline.
Dissenters’ or Appraisal Rights: Evaluate the potential for dissenters’ or appraisal rights issues among shareholders or members.
Unhappy Stakeholders/Members: Determine if the deal requires approval from dissatisfied shareholders, members, or groups unhappy with the company’s management or return on investment.
Proactively managing these considerations from the outset can streamline the approval process, mitigate potential dissent, and contribute to a more efficient and successful M&A transaction.
M&A Committees
Establishing an M&A Committee is a common practice, and its effectiveness hinges on its ability to act swiftly and decisively. The primary advantage of such a committee is expediting the negotiation process while alleviating the burden on shareholders or members. The committee serves as a dedicated entity focused on key decision-making, contributing to the overall efficiency of the M&A process. By ensuring agility and responsiveness, an M&A Committee enhances the likelihood of a successful and streamlined transaction.
Employee Considerations
Employee retention and incentive issues in an M&A transaction carry substantial cost and closing condition implications. The seller aims to ensure fair treatment and incentives for its management team and employees under the buyer, but issues may arise if the buyer attempts to shift these costs to the seller.
The buyer should invest ample time engaging with the existing management and employees to address these concerns. This allows buyers to gauge the employee’s willingness to transition, assess motivation levels, and determine cultural compatibility.
Additionally, key management individuals receiving accelerated or deal-related payments must be vigilant about potential adverse tax consequences stemming from the transaction. Effectively managing employee considerations is crucial for a smooth transition and successful integration post-closure. In my two exits, I shared a portion of the sale proceeds with my key managers as an incentive to make the deal happen under favorable terms.
Financial Projections
During an M&A transaction, the buyer invests significant effort in scrutinizing the seller’s financial projections. This entails a thorough examination of assumptions and key metrics. Equally important, the selling company must possess a deep understanding of every facet of these projections. It is imperative for the selling entity to not only be comfortable but also knowledgeable about each component, ready to justify their reasonableness to instill confidence in the buyer’s evaluation process. This mutual understanding and transparency play a vital role in fostering trust and facilitating a smoother M&A transaction.
Intellectual Property
Intellectual property (IP) due diligence is a critical aspect of the M&A process and can be highly intensive. The seller bears the responsibility of managing and presenting patent filings, trademarks, copyrights, and domain names. Additionally, the seller must be well-prepared to address the extensive representations and warranties regarding intellectual property the buyer is likely to challenge. Buyers may seek to categorize these representations and warranties as “fundamental,” leading to longer survival periods and increased liability exposure.
Buyers are increasingly concerned about data privacy and cybersecurity issues in today’s landscape. Sellers must proactively address these concerns and demonstrate a strategy for managing and protecting sensitive information. A thorough understanding and management of intellectual property considerations contribute significantly to a successful and secure M&A transaction.
Contract Consents
As part of the M&A process, sellers must thoroughly review and comprehend the consent required from the other parties involved in their contracts. Sellers must identify and assess any consent requirements that could potentially impede or jeopardize the deal. Sellers should aim to limit or eliminate these consent conditions, especially those that might result in delays or allow third parties, such as landlords or vendors, to demand increased payments in exchange for their consent.
Proactively managing and streamlining consent requirements is essential to maintaining the momentum of the acquisition and avoiding potential obstacles that could adversely impact the deal’s success.
Managing Information Disclosure
In the M&A process, sellers face a delicate balancing act concerning information disclosure. On the one hand, there’s a desire to provide the potential buyer with a comprehensive understanding of the business early on, minimizing misunderstandings later in the process. On the other hand, there is a need to limit the disclosure of critical secrets or confidential information until the deal is close to completion.
Sellers must navigate this balance cautiously, especially when dealing with potential buyers who may be competitors. Concerns arise about the possibility of a buyer walking away armed with vital knowledge that could be used to compete with the seller’s business. Striking the right balance in disclosing information is essential to protect the seller’s interests and maintain a competitive edge in the market.
Purchase Agreement
The purchase agreement is a pivotal document for both the seller and the buyer in the M&A process. To address the many issues involved, sophisticated M&A counsel, encompassing both legal and financial expertise, is essential for the seller. Key issues in the purchase agreement negotiation include:
Escrow or Holdback: Determining whether there will be an escrow or holdback of the purchase price and the role of representations and warranties insurance.
Representations and Warranties: Defining the scope of the seller’s representations and warranties, including qualifications related to “knowledge” and “materiality.”
Covenants: Outlining the covenants of the seller and any shareholders before and after closing.
Conditions to Closing: Identifying the key conditions that must be satisfied for the deal to close.
Risk Allocation: Allocating various risks such as litigation, intellectual property issues, and unknown liabilities.
Treatment of Employees: Specifying how employees will be treated as part of the deal.
Indemnification Obligations: Defining the indemnification obligations of the parties.
Termination Provisions: Outlining how the purchase agreement can be terminated before closing and the associated financial consequences.
Regulatory Requirements: Addressing regulatory requirements like antitrust approvals and the associated issues.
Dispute Resolution: Establishing mechanisms for resolving disputes, such as through arbitration.
A Sample Purchase Agreement Outline is available for download in the Free Downloads section of SteveBizBlog for a more detailed list of issues to address in a purchase agreement. This resource can assist sellers in navigating the complexities of the purchase agreement negotiation process.
CEO Involvement
The CEO plays a pivotal and multifaceted role during the M&A process. They are tasked with not only selling the business vision but also clearly articulating why the company is an attractive and growing business with sophisticated and differentiated technology, products, or services. Beyond selling the vision, the CEO must also possess an understanding of the fundamental legal and business issues that will arise and make crucial judgment calls on these matters.
Keeping various stakeholders informed at each stage of the process is paramount. CEOs often find themselves in a challenging position, negotiating tough terms while knowing they are negotiating with a potential future employer. This challenge is heightened if the buyer offers the CEO and management post-closing equity.
To navigate this delicate balance, it may be beneficial for a broker, advisor, or the M&A Committee to take the lead in negotiating the deal terms and acquisition agreement. This approach allows the CEO to serve as a facilitator, fostering collaboration and ensuring a smoother path to getting the deal done.
Maintaining Financial Stability
Given the extended duration of an acquisition process, managing the variability of the business’s financial performance throughout the M&A deal can be a major challenge. Suppose the seller falls short of projected financial numbers during this period. In that case, the buyer can perceive it as a red flag, potentially leading to a reduced purchase price or termination of negotiations. Therefore, it is crucial for the management team to remain focused on running the business efficiently, even amid the distractions of the M&A process. This is one reason to engage and pay for the expertise of a business broker or advisor who will focus on the M&A process while the business can focus on hitting or exceeding its financial projects.
To mitigate risks, the projections presented to the buyer during the anticipated diligence and negotiating period must be easily obtainable. When forecasting my sales during our due diligence period, I would sandbag my sales projections so that my business could easily exceed my projections during the due diligence period. This proactive approach facilitates a smoother due diligence process and instills confidence in the buyer regarding the stability and reliability of the business’s financial performance. By maintaining financial stability and ensuring transparency in projections, sellers enhance their chances of a successful and favorable M&A outcome.
Conclusion
In conclusion, embarking on an M&A journey demands meticulous planning and strategic execution, with a keen awareness of the multifaceted considerations involved. Sellers must adopt a proactive approach, addressing key aspects such as employee retention, intellectual property, and contractual consents to ensure a seamless process. Forming a dedicated M&A Committee and engaging specialized legal and financial counsel emerge as pivotal strategies. Striking the right balance in information disclosure, navigating through the complexities of the purchase agreement, and managing the CEO’s crucial role requires a delicate touch. Also, sellers must maintain financial stability amid the extended M&A timeline. Ultimately, success hinges on a holistic understanding of intricate negotiations, diligent preparation, and a commitment to transparent and collaborative dealings, positioning both sellers and buyers for a prosperous and mutually beneficial outcome in the dynamic landscape of M&A.
