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Selling Your Company: Debunking 5 Deal Myths

Posted on by PLinden

You’ve worked hard, probably for years, to build your business. Sweat equity, tears, gut-wrenching decisions, and more missed family celebrations than you care to admit. Now you’re thinking about selling, and this is not the time to take shortcuts. A Harvard Business Review report finds that 70% to 90% of M&A transactions fail, usually because buyers and sellers take shortcuts during the evaluation process.

The average business owner may sell a company once in a lifetime, and the process can be confusing and uncomfortable. Understanding the truth about these five common myths will help you position yourself to get the best deal possible.

Debunking 5 Deal Myths for Selling Your Company:

Myth #1: The highest offer price is the right one.

Total purchase price is only one measure of an offer, so dig deeper to understand the quality of each offer. Often, buyers for your business – whether strategic or financial – have completed numerous M&A deals and are adept in the use of various financing options that comprise their total purchase price.

While all these options have their place and potentially add up to a higher purchase price, all increase your risk of receiving full payout of the purchase price. Consider a few examples:

  • Earnouts provide for a portion of the purchase price to be paid to you contingent upon the post-close company reaching certain financial or performance targets. Because the buyer will likely have operational, financial and accounting control post-closing, negotiating the criteria required to determine and achieve earnout metrics is crucial. 
  • Rollover equity, typically offered by a private equity buyer to owners and key management team members, involves receiving a percentage of your sale proceeds in the form of equity in the new business. The private equity firm needs your expertise and will refer to this as “skin in the game”, but you need to realize that your equity share may not turn into cash for a long time (if ever).
  • Promissory notes, another common component of a private equity offer, do sound promising – but there are innumerable ways to structure one and your payout will likely be unsecured and subordinate to third-party lenders if you don’t negotiate hard for yourself. 
  • Escrow accounts, held by a third party, retain a portion of the purchase price for a specified period (typically 12-36 months). Escrow accounts are frequently set up to protect the buyer against a breach of reps and warranties laid out in the definitive agreements and, more recently, to offset a negative purchase price adjustment. The escrow provides the buyer with a readily available method to cover its losses. 
  • Holdbacks. These are like escrows, but the buyer simply holds on to a portion of the price for a specified period. These are even less desirable than escrow accounts as at least with escrows there’s a third-party account holding the funds. With holdbacks, the buyer is effectively sitting on a portion of purchase price proceeds, requiring considerations of collateral or guarantees of the buyer’s obligation to pay the withheld funds. 

Each of these financing options can be structured in countless ways, unique to your situation, and you should work with your deal professionals to study any tax implications, voting rights and restrictions the buyer has placed on them.

It is generally safe to assume that the buyer could be motivated to delay or make payments to you contingent on performance. Comparing offers “apples to apples,” you may very well find that the best offer has a lower price but is less risky, due to the higher ratio of cash to speculative financing options. As we say in the deal business, “cash is king.”

Myth #2: It will be just like selling a house.

Sellers are frequently surprised by the typical timeline and process of selling a business. The average house sells in weeks, while the average time to sell a business is nine to 12 months. A successful sale of a business requires a great deal of planning and a year or more to control expenses, drive sales, document the operation and develop key staff. Potential buyers need to be pre-qualified and then, as they perform due diligence on your company, you need to perform due diligence on the buyers. Unlike a house sale, the sale of a business involves confidentiality and intricate “base case” and “upside” financial models. The nuances of the letter of intent and definitive purchase agreement demand extraordinary attention to detail and in-depth discussions, as numerous variables can impact the amount and timing of proceeds paid to you. Even after you close the deal, if part of your payment is in the form of delayed or speculative compensation (see Myth #1), you continue to be on the hook helping the new owner run the business successfully. The process of selling a company takes far longer and is infinitely more complex than selling, well, just about anything.

Myth #3: I already have all the trusted advisors I need.

Many business owners believe they don’t need the help of deal professionals to sell their business. You already have skilled accountants and attorneys who do fine work for you, but are they experienced in working on complex M&A deals?

You get one real shot at selling your company, and the outcome will impact the rest of your life. A seasoned deal-professional will provide value beyond merely executing a closing, and each type of professional serves a specific purpose.

An experienced deal-professional is driven to get you the best possible deal and has a deep understanding of the market, the multiples, the financing options and the documentation. And what about the all-important confidentiality? If word gets out that your company is for sale, you can damage your reputation with customers, vendors and employees – all of whom are critical to selling your company successfully.

A deal-professional will guide you through the difficult waters of the deal process and, although the financial outlay for this level of expertise may not be insignificant, the deal professional brings value to every aspect of the deal by finding more money in the deal, enhancing terms, and seeing subtleties that people who don’t do M&A every day will miss. It may be tiring, but it’s true: you wouldn’t hire a general practitioner to perform your heart surgery.

Myth #4: The LOI and definitive agreements are “standard.”

Expect, and demand, that your M&A attorney digs deep on the documentation. A thoughtfully negotiated and comprehensive Letter of Intent (LOI) establishes specific and critical deal terms prior to drafting the purchase or merger agreement, rather than engaging in the more arduous process of negotiating deal terms through extensive (and expensive) drafts of those definitive agreements.

An effective LOI establishes whether there really is a “meeting of the minds” between the parties that can survive the rigors of the transaction process.

Negotiating a comprehensive LOI at the beginning of an M&A deal substantially improves the likelihood of successfully closing the transaction, is more cost-effective for both parties and makes the drafting process more efficient and better coordinated. Although most of its provisions are non-binding, the LOI is often considered to be the good faith understanding of the parties and a roadmap for the definitive agreement.

Myth #5: Selling my business will be easy.

Said no successful seller, ever, because it’s simply untrue. Deals are hard, competitive, messy, exhausting, often contentious, and take a long time to complete. Buyer and seller are pitted against each other.

Statistics time and time again indicate that the best deals come out of a competitive auction process, where numerous buyers are approached, screened, and given a chance to put forward their best offer for your company; in other words, you may receive several offers to evaluate and have multiple potential buyers to meet.

Are you prepared to rework financial statements, objectively value your company, populate and monitor a data room, screen buyers, conduct tours, negotiate a deal, and handle frequent bouts of pre-deal jitters …. all the while continuing to run your business profitably? Selling your company will be an exhausting and emotional experience.

We Can Be Your M&A Deal Partners.

Putting the same level of effort into your sales strategy that you’ve put into every other strategy you used to build the business over the years can put you on the path to maximum results. At Linden Law Partners, we specialize in quarterbacking all aspects of M&A deals, and we have represented buyers and sellers in hundreds of M&A transactions.

While there are many common threads among the most successful transactions, we recognize the uniqueness and personal attention required for each deal. Contact us to discuss how we can help.

New Attorney Announcement

Posted on by PLinden

New Attorney Miles Williams

We are thrilled to announce that lawyer Miles Williams has joined our business and transactional practice group. An entrepreneur himself, Miles knows exactly what it takes to run a business and how to relate to clients. Click here to learn more about Miles and his experience. 

‘Acqui-Hire’ Transactions: Their Place in the M&A Universe

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What Is An Acqui-Hire?

The purpose of a typical merger or acquisition is to acquire the customer base and other assets of the target company. However, in certain cases — and in certain industries in particular — companies are acquired exclusively for their labor talent. This type of transaction has come to be known as an “acqui-hire,” and technology companies in Silicon Valley have been utilizing this quasi-hiring process for years. The practice is now also becoming more prevalent in non-tech industries throughout the U.S. 

When Are Acqui-Hires Used?

Hiring a qualified and proven team can be highly competitive. The demand for top talent in the technology sector in particular often dwarfs the supply. As a result, major players like Google, Facebook, Apple, and Amazon have become creative when recruiting and hiring the most highly skilled employees.

In an acqui-hire, companies onboard an already-cohesive team of employees who have experience working in the acquirer’s industry and who have a specialized skillset. An acqui-hired team is often tasked with a particular project or goal within the acquiring company and given extensive autonomy, which can reduce the time and costs of post-acquisition integration. 

How Are Acqui-Hires Structured? 

The target companies of an acqui-hire are often startups that were successful in raising initial funds in an early round of financing but were unable to secure additional funds in later rounds, and therefore are low on cash. These companies may sometimes position the startup for an acqui-hire instead of simply closing their doors.

As a result, and because of the nature of the purchase price structure (discussed below), current investors of the target company will typically receive some return on their investment but do not usually get back more than their original investment. Many acqui-hires: 

  • Are priced on a “per-head” basis. In other words, the majority of the purchase price is allocated to paying for each team member hired in the form of an upfront cash payment, future equity incentives that vest over a period of time (e.g., 3-5 years), or future payments under an employment agreement. The amount allocated per employee can range from a few hundred thousand dollars to $1 million or more. 
  • Result in the winding-down of operations for the target company. Sometimes, the legal structure of the target company remains intact for liability reasons, or sometimes the entire entity may be acquired so that it doesn’t have to manage a separate winding-down process. 

Benefits and Inherent Challenges in Acqui-Hires? 

Acqui-hires can give buyers quick access to top-notch, proven teams through a quicker and more simplified deal structure as compared to a typical M&A transaction. As mentioned above, because of the autonomous nature of the team being acquired, buyers may be able to limit the costs of a complex post-closing integration associated with traditional M&A deals.

From the seller’s perspective, an acqui-hire can often be structured to give their investors some return on investment versus a complete write-off and their employees a better landing than they would have had were the company to have simply shut down. 

On the flip side, acquiring companies in most M&A deals face an uphill climb when it comes to keeping top talent from the acquired company. Despite the financial incentives intended to keep employees with the buyer for a set period of time, many employees nevertheless choose to find other opportunities.

Moreover, after installing the new team, buyers often still have to contend with lingering morale issues and general integration speedbumps. For some employees, the culture change associated with an acqui-hire is too much to overcome, and they will leave the acquiror as soon as they are able.

Finally, there are numerous pre- and post-closing liability considerations for sellers to undertake (and for buyers to diligence with each particular deal) before entering into an acqui-hire, including ensuring that the board undertakes a fair process in approving the deal, ensuring that the company’s creditors will be paid, and identifying and addressing potential tax issues.

Considering An Acqui-Hire? 

Acqui-hire transactions make sense for small companies that have top talent, but perhaps are short on capital. Some companies looking for an innovative edge and an expedited hiring process might find aligned interests with those small companies. The benefits of acquiring a team of proficient employees are many for certain large acquirers, but the prospect of an acqui-hire presents unique considerations that should be addressed and handled by business transaction specialists.

Linden Law Partners has been lead counsel on numerous complex M&A deals. We have helped business owners across a wide variety of industries achieve economic outcomes from high-stakes transactions. Contact us to set up a consultation so we can discuss the options with you and your team. 

© 2021 Linden Law Partners, LLC. All rights reserved.

Colorado Super Lawyers Recognizes Pat Linden For Work in M&A

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Super Lawyers® has recognized Pat Linden in its 2021 edition for Colorado attorneys for his work in mergers and acquisitions (M&A). Only 11 Colorado attorneys made the 2021 list for M&A. Pat was also named to the M&A list in 2020.

Colorado Super Lawyers

Super Lawyers® is a rating service of outstanding lawyers who have attained a high degree of peer recognition and professional achievement in their field of practice. The annual selections are made using a rigorous process, including a statewide survey of lawyers, an independent research evaluation of candidates, and peer reviews by practice area. Only 5% of all practice lawyers in each state or region are named to the Super Lawyers® list.

Click here to learn more about Pat’s practice and background. In addition to the Colorado Super Lawyers® designation, Pat was recognized as Colorado’s best M&A attorney in 2018 and 2020 by Law Week Colorado in its annual Barrister’s Best publication, and was named Colorado’s best private equity attorney in its 2019 edition.

Post-Closing Considerations for M&A Sellers

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Rarely do private company owners sell their companies, pocket all the cash at closing, and ride off into the sunset to never worry about their business again. Selling owners and key employees of acquired private companies almost always both play a crucial post-closing role in the 2-to-5-year period after the initial sale. The buyer (particularly any private equity buyer) will lean heavily on selling owners and existing management to continue operating the business day-to-day post-closing.

This helps the buyer to learn and acclimate to the purchased business. The continued involvement of the selling owners and key management after the closing is usually a condition imposed by buyers to proceed with the transaction. Given this reality, there are some fundamental post-closing management considerations that are pivotal for selling owners to prepare for before the transaction closes. 

Post-Closing Considerations:

Second Bite at the Apple for Sellers 

Many buyers require sellers to “rollover” a percentage of their equity into the buyer’s post-closing entity to incentivize the selling owners to have a “stake in the game” going forward to align their interests toward a lucrative second sale of the business down the road. In private equity, for example, the typical “second bite at the apple” horizon is between 3-5 years.

(For more on private company rollover considerations, see our previous article here). If structured correctly, the rollover equity can provide sellers with additional and potentially significant financial upside on the buyer’s subsequent sale of the business.

Sellers should carefully vet and validate the buyer’s valuation model to ensure the value of their rollover equity is what the buyer says it is as part of negotiating the overall transaction purchase price. Caution should also be taken to ensure the valuation cannot be manipulated after closing or determined based on subjective factors solely at the discretion of the buyer.

In addition, because sellers will only hold a minority stake after the sale and will lack overall control of the business, it is critical to feel comfortable around key provisions in the post-closing governing agreements (like an operating agreement or shareholders’ agreement) that will impact the sellers’ retained equity.

Such items include ensuring the adequacy of anti-dilution rights, equal participation rights on sales or subsequent financings, and other rights that prevent the buyer from taking actions that disproportionately impact the rollover equity of the sellers relative to the buyer’s equity.

Employment Agreements for Sellers

It is common for selling owners to continue in management employee capacities post-closing, which means that employment terms (and often detailed employment agreements) will be expected and important for the buyer and sellers. The stakes in employment agreements can become particularly high if a separation from employment can impact the rollover equity of the seller (or if an employment separation can impact the obligations of the parties related to earnout payments if they are part of the deal).

(For more on earnouts, see our article here). Well-advised selling owners will negotiate for severance on terminations “without cause” or for “good reason” (terms which themselves can mean very different things depending on how negotiated) and look to avoid the ability for the buyer to repurchase their rollover equity.

Buyers, and particularly private equity buyers, will routinely endeavor to negotiate equity repurchase rights based on prices “determined in their subjective discretion” often payable over years with little or no collateral. 

Sellers should and will normally push back on these positions to ensure they will get the full benefit of the value of their rollover equity, whether or not they are employed at the time of the second bite at the apple sale.

Because the equity rights of sellers will be memorialized in an operating or shareholders agreement, there is a substantial interrelationship with the employment agreement that should be identified and properly drafted.

Sellers would be naïve to think buyers will automatically offer up favorable terms to sellers on these aspects of the deal. That is rarely the case and savvy sellers and their advisors should plan to negotiate these terms to obtain mutually fair and sensible outcomes.  

Equity Incentives for Key People

In addition to incentivizing sellers after the sale, most buyers and sellers collaborate on and implement a post-closing equity incentive plan for key employees (which can also include participation by selling owners) to help keep those key employees working for the acquired business. These financial incentives most typically take the form of stock options, LLC profits interests, or restricted stock grants.

Sometimes key employees who are optimistic about the prospects of the business and the opportunity to participate in the second bite sale will inquire about opportunities to invest some of their own cash in the post-closing entity for a class of ownership on par with that of the buyer and the sellers.

Buyers and sellers alike often wait too long in the process to begin to formalize and fully negotiate the post-closing equity incentive plan for key employees (as talented employees will pay attention to these items and will frequently negotiate on them). 

Conclusion 

Selling owners have a lot more to think about than just the price at closing as the general expectation is that they remain with the acquired business after the initial sale, usually with continued skin in the game via rollover equity. The strength and viability of that equity position are often highly dependent on a post-closing employment relationship. Equity incentive arrangements for key employees will also affect the landscape for both buyers and sellers beyond the initial sale.

Linden Law Partners has guided many sellers through these obstacles and opportunities as part of the M&A deal process, always looking for ways to maximize the post-closing success and financial outcomes for sellers.

Contact us today to discuss your options if you are evaluating the sale of your business.

© 2021 Linden Law Partners, LLC. All rights reserved.

Linden Law Partners Represents SKA Fabricating Inc. For Sale to Private Equity Firm

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Linden Law Partners Represents SKA Fabricating Inc.

Congratulations to our clients at Ska-Fabricating Inc. (Ska Fab), a company based in Durango, Colorado, which was recently acquired by Hanover Partners, a private equity firm based in San Francisco and Portland. Ska Fab manufactures and sells depalletizers, conveyors, and packaging line equipment to beverage and food producers across the world. Ska Fab opened for business in Durango from a 500-square-foot space. Today, it has more than 60 employees.  

Read more about the deal here: https://www.durangoherald.com/articles/ska-fab-purchased-by-private-equity-firm/.

Linden Law Partners represented Ska Fab and its shareholders on all aspects of the transaction. Co-Founder and CEO Matt Vincent had this to say about us:

“Linden Law Partners represented our company for a sale to a private equity buyer that closed on December 31, 2020. Given that 2020 was a difficult year, we managed to put together a deal that survived the pandemic and they worked quickly to get it across the finish line despite a fair number of obstacles along the way.

The deal was complex with a lot of moving parts. Their understanding of the deal process is outstanding, and they’re great at knowing what needs to be negotiated hard versus what doesn’t. They were integral to helping us get what we wanted, and the buyer was happy, too. I hope to have the opportunity to work with the team at Linden Law Partners again in the future.”

The Basics of Representations and Warranties Insurance for M&A

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Representations and Warranties (R&W) insurance, once reserved for public company and higher-market mergers and acquisitions, is becoming more prevalent in lower middle-market private company M&A transactions.

Recent trends show that Representations and Warranties Insurance, which provides liability coverage for breaches of representations and warranties made by a seller in an M&A deal, is now being used in an estimated 25% of private deals. In this article, we provide an overview of R&W insurance and the potential benefits and risks to both buyers and sellers.

What Does R&W Insurance Cover and What is Excluded?

R&W policies cover certain types of losses or damages incurred by the insured (usually the buyer) arising from a seller’s breach of representations and warranties in the definitive purchase agreement. The policies cover losses above a deductible amount (typically equal to 1.0% of the transaction value) up to the amount of the policy limit (typically equal to 10% of the transaction value).

However, R&W policies do not cover all losses or damages arising from breaches of representations and warranties Standard coverage exceptions include losses or damages arising from, among other things,

(1) known liabilities (such as a known lawsuit or known failure to pay taxes),

(2) purchase price adjustments,

(3) consequential, punitive or exemplary damages,

(4) agreements based on projections or forward-looking statements (i.e., failure to achieve some post-transaction sales or earnout metric), and

(5) breaches of certain “fundamental” representations and warranties (a select category of representations and warranties in every acquisition agreement that are considered so basic or “fundamental” to the deal that a buyer would not do the deal were it known that a fundamental representation and warranty was untrue).

Common examples of fundamental representations include the power of sellers to legally consummate the deal, good standing of the seller entity under the state law of its incorporation, seller’s good title to assets, tax matters, etc.). Other deal-specific issues identified during due diligence could result in additional exclusions from coverage under a R&W policy.

Although sellers will customarily remain responsible for losses not covered by an R&W policy based on the terms of the definitive purchase agreement, buyers may balk at R&W insurance if too many known or unknown material risks are excluded from coverage.

Benefits of R&W Policies to Buyers and Sellers

While the buyer is the policy holder in M&A transactions around 90% the time, both sides can benefit from a R&W insurance policy. Closing “holdback” or “escrow” arrangements can be reduced or eliminated altogether, which means buyers can make more attractive offers to sellers and sellers can receive more of the purchase price at closing (as opposed to sales proceeds otherwise being tied up in escrow or being treated as seller-carry financing for a lengthy post-closing period).

Sellers may also be more willing to make broader representations and warranties with fewer qualifiers (such as materiality and knowledge qualifiers), which could reduce the time spent negotiating and drafting the R&W terms and the related indemnification provisions in the purchase agreement.

Buyers may be able to realize greater coverage and a longer timeframe in which to make claims under an R&W policy than based on traditional seller indemnification obligations (which may be much more limited under the definitive purchase agreement than is afforded by the terms of the R&W policy).

Overall, buyers and sellers alike may be able reduce their legal exposure, allowing the parties to focus less on risk allocation (which is inevitably a time consuming and gritty component of any M&A deal where a R&W policy is not utilized), and to instead focus more on the nuts-and-bolts financial and accounting elements of the deal.

Costs of R&W Warranties Insurance

Premiums for R&W insurance run between 2 and 3% of the policy limit (i.e., the coverage amount). Providers also charge underwriting (due diligence) fees, which can be as high as $50,000.

To illustrate the costs and coverage of a standard R&W policy, consider an M&A deal with a $100 million sale. Assuming the retention (deductible) equals 1.0% of the purchase price and the coverage limit equals 10% of the purchase price, the buyer is covered for losses that exceed $1.0 million up to a cap of $10 million.

The premium would cost between $200,000 and $300,000. A common arrangement involves the seller paying the deductible and the buyer paying for the premium, although the parties can negotiate other ways to split the costs of the policy, such as splitting the premiums and fees and/or splitting the deductible (in any proportions that are agreeable to the parties).

Steps to Purchase an R&W Policy

Buyers usually approach insurance brokers to obtain a quote for R&W coverage. Several well-known major insurers and brokers, including AIG, Chubb, the Hartford, AON, Lockton and Marsh, currently offer R&W insurance policies. The underwriter will receive a fee for its due diligence process.

In this phase, the insurance provider will likely request detailed information regarding the buyer, the seller, and the transaction. Expect for the insurer and its underwriter to be involved in the due diligence process, and to also be involved in the review of the seller’s disclosure schedules to the definitive purchase agreement.

Let Us Guide You to a Favorable Outcome

Representations and warranties insurance can provide numerous benefits to the parties, but not every M&A deal is a good fit for an R&W policy. Bear in mind that R&W insurance does not solely benefit buyers in a high-stakes business acquisition; sellers should also pay attention to these policies and weigh the applicable advantages and impacts on ongoing liability following the sale.

Linden Law Partners has been lead counsel on countless M&A deals, yet we recognize how unique each one is. Reach out to discuss how we can provide value to your next transaction.

© 2021 Linden Law Partners, LLC. All rights reserved.

Mistakes Sellers Make During the M&A Deal Process

Posted on by PLinden

Successful M&A deals don’t just happen by accident. Each M&A transaction has its own complexities and numerous factors must converge to result in a mutually beneficial outcome for both the buyer and seller. Sellers who are willing to critically analyze a deal objectively and possess the gravitas to have tough conversations with buyers stand the best chance of obtaining an optimal outcome for themselves and avoiding some common seller “deal traps” outlined below.

5 Mistakes Sellers Make During the M&A Deal:

1. Mistakenly presuming they have a deal. Many sellers, after getting a high-level, non-binding commitment from a buyer at the right valuation or purchase price may think that the core deal has been settled and all that’s needed is a “standard” purchase agreement. But what many people (who don’t do M&A every day) don’t realize is the cardinal rule that while price matters, deal structure often matters even more.

Many sellers have limited understanding or appreciation of how structure ultimately can significantly affect the price they actually realize in a sale. In the final analysis, the Seller’s realization is all that really matters.

The starting point for an optimal M&A deal structure is a robust letter of intent (LOI) that does more than lay out the purchase price and boilerplate provisions. (Read more about LOIs here).

The more general or formulaic the LOI, the more sellers will have to negotiate when it’s time to document the deal (which is anything but standard) at a heightened cost over a prolonged period, and by then, a seller may be too far along to pull back from the deal or negotiate better terms.

As a general deal rule of thumb – buyers benefit from “less” up front and pulling sellers into the process (buyers almost always have more leverage than sellers after the LOI is signed); sellers most typically benefit from “more” up front and should negotiate hard at the LOI stage.

Saavy sellers also need to understand that the process for closing the sale of their business is fundamentally different than selling or buying the typical business product or service. Hard conversations are often part of the process – either you have them at the beginning, or you have them when you’re in the middle or even the end of the deal (at which point those conversations will only be harder and the stakes even higher).

Unlike with other various other deals, such as schmoozing a new customer, handshakes and cocktails (and an LOI) are just the very beginning, and not even close to the end, for M&A deals.

2. Failing to perform due diligence on the buyer. Too many sellers, particularly in smaller deals, assume potential buyers have the necessary funds and capability to make the purchase and close the transaction when they don’t. When this happens, sellers have sunk time and money into the process with nothing to show for it.

Accordingly, every seller needs to take appropriate steps early in the process to ensure the prospective buyer has the actual capital, resources and experience to close the deal. For many deals, the buyer will also need the acumen and resources to capably integrate the buyer’s and seller’s businesses post-closing. (Learn more on this topic here).

Buyers should be willing and able to provide financial statements, meaningful commitment letters from lenders, credit pre-approvals, references, and a track record of successful investments or purchases in the seller’s industry and market. If a buyer balks at this, continually delays providing this information, or provides sparse, vague, or otherwise inadequate information, it’s a big red flag.

3. Not mentally preparing for the process. There are a few things sellers need to accept before starting the M&A process:

  • The transaction will take longer than expected.
  • It’s common for sellers to experience deal fatigue.
  • There will be costs (tangible and intangible).
  • There will be sometimes be periods characterized by adversarial communications.

M&A deals are marathons, not sprints. This is true no matter how “straightforward” the deal is, or how quickly the buyer claims it and its lawyers can close. The psychological element of these transactions is too often neglected by both sellers and buyers, and in particular, sellers can become inundated in the deal process to the point of conceding on important terms just to get over the finish line.

Understanding the nature of the M&A deal process at the start is the best way for both sides to avoid being overtaken by its highs and lows, and can help sellers stay firm on the critical deal terms that matter most to them. A seller should be ready to be thrust out of its comfort zone if it wants the best deal it can get.

4. Not being willing to walk away from the deal. Every seller needs to have the willingness to walk away from the negotiating table. Demonstrating that you, as the seller, are not afraid to walk away conveys that you have leverage and can help motivate the buyer to move past negotiating roadblocks and close the deal.

In virtually every successful M&A transaction we’ve worked on, at some point during the deal the seller flexed some muscle to get something important and was willing to walk if it didn’t get it (and not unsurprisingly, in almost every instance by demonstrating that willingness to walk it got the deal over the hump to where the seller felt good enough to move forward and close).

Sellers shouldn’t be afraid to ask and legitimate buyers don’t just pick up their chips and go home based on reasonable seller asks or negotiations. It’s a typical part of the process and negotiations.

5. Commoditizing the advisors and legal counsel. A seasoned deal professional that you work with during your M&A deal will provide value beyond merely executing a closing, and each type of professional serves a specific purpose. The worth of having advisors, including attorneys, with proven experience in M&A can’t be overstated. Not hiring advisors that are M&A specialists is kind of like seeing a general practitioner to perform your heart surgery.

It’s not surprising that the financial outlay for this level of expertise may not be insignificant. Cost savings in the short term can seem attractive, and cost is important – to a degree. But in reality, what seem like big fees are often dwarfed by the value of finding more money in the deal, enhancing terms and seeing things that people who don’t do M&A every day won’t see and capture for you.

Put simply, a great M&A advisor is no commodity. The overall value you should realize from their services and counsel will outweigh any relatively immaterial cost-cutting measures in the end.

We Can Be Your M&A Deal Partners

At Linden Law Partners, we specialize in quarterbacking all aspects of M&A deals, and we have represented buyers and sellers in hundreds of M&A transactions. While there are many common threads among the most successful transactions, we recognize the uniqueness and personal attention required for each deal. Contact us to discuss how we can help.

© 2020 Linden Law Partners, LLC. All rights reserved.

NEW ATTORNEY ANNOUNCEMENT

Posted on by PLinden

New Attorney Jeff Thomas

We are excited to announce the arrival of Jeff Thomas, a securities and commercial litigation lawyer, who has joined our firm as special counsel. Jeff brings more than 20 years of federal government and big law experience to assist our business clients. Click here to learn more about Jeff and his experience.

Section 1202 and Qualified Small Business Stock

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Planning for the most favorable tax treatment on their investment is always a major consideration for investors. Because of a renewed interest in using C corporations as investment vehicles as a result of the reduction to the corporate tax rate to 21% under the Tax Cuts and Jobs Act of 2017, investors have shown a renewed interest in the potential tax benefits under Section 1202 of the Internal Revenue Code (IRC), making understanding its basics important for corporate founders and CEOs and prospective investors alike.

Section 1202 And Qualified Small Business Stock

Some background: in August of 1993, Section 1202 of the IRC was added to encourage investments in certain small businesses (referred to in the IRC as “qualified business” entities). Section 1202 allowed taxpayers to exclude 50 percent of gains from the sale of Qualified Small Business Stock (QSBS) issued before February 18, 2009.

This amount has changed over the years; now, investors holding QSBS purchased after Sept. 27, 2010 for five years or more may exclude 100 percent of the capital gains on the sale or exchange of the QSBS. The amount of gain excluded is capped at the greater of $10 million or 10 times the taxpayer’s aggregate adjusted basis in the stock.

What is Qualified Small Business Stock (QSBS)?

QSBS is stock of a “qualified small business” within the meaning of the IRC. Generally, a “qualified small business” is a C corporation whose aggregate gross assets do not exceed $50 million before and immediately after the QSBS’s issuance and whose aggregate gross assets have not exceeded the $50 million threshold at any time after August 10, 1999. Further, the stock must be of an active domestic C corporation in addition to the following requirements:

  • The stock must have been purchased on original issuance (and not on the secondary market).
  • The purchaser must have exchanged money, non-stock assets, or services for the QSBS.
  • At least 80 percent of the corporation’s assets must be used in active conduct of a “qualified trade or business”. This must be the case during substantially the entire period in which the investor holds the QSBS stock.
  • Certain trades and businesses, as well as most professional services business, are not qualified trades or businesses, including trades or businesses that operate in the financial, insurance, farming, mining, oil and gas, and hospitality industries, among others.

The QSBS investor is not permitted to be a corporation. The shareholder can be, however, a pass-through entity such as a partnership or LLC.

What’s the Benefit for QSBS Under Section 1202?

If the QSBS holder holds the stock for at least five years, 100 percent of the federal income tax gain from the sale or transfer of the stock can be excluded (as long as the QSBS was purchased after Sept. 27, 2010 and the other requirements touched upon above are met). For those companies that can satisfy the Section 1202 requirements, this extremely favorable tax treatment can be very attractive to investors.

However, because of the potential difficulties in meeting the numerous requirements under Section 1202, companies are advised to carefully review the types of representations and warranties investors may ask them to provide with regard to Section 1202 treatment of their stock.

Holders of QSBS can realize potential tax benefits even if they do not hold the stock for five years. If QSBS is held for more than six months, the holder may be eligible to roll over the capital gains from the sale or transfer of the stock to another qualifying corporation’s QSBS if purchased within 60 days of the sale of the QSBS. This is statutorily established in Section 1045 of the IRC.

Conclusion

The slashing of corporate tax rates due to the Tax Cuts and Jobs Act of 2017 has resulted in a quasi-revival of interest in QSBS tax planning. Section 1202 can be useful in spurring investment in certain startups and smaller companies. However, the numerous requirements and limitations must be carefully considered to determine the feasibility of obtaining, and making any promises on achieving, QSBS tax treatment.

The attorneys  at Linden Law Partners are well-equipped to negotiate and structure investments in a wide variety of startups. Contact us here to discuss your options and see how we can help navigate a win-win solution for your company.

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