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.
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 tired, 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.
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