The sale of any private company is a complex process that has the capacity to change lives. While the buyer and seller share a common goal (to close the sale), at the heart of the sale process is a conflict in interests and priorities. On the one hand are the current owner, management team and employees of the seller – the known – who have invested months, years or even their entire careers growing the company. On the other hand is the buyer – the unknown – who often comes with comparatively little knowledge of the company and its past performance but promises future success and (hopefully) a significant amount of money. Even with thorough planning and extensive due diligence review of the target, there are often unforeseeable difficulties to be addressed by both buyer and seller, and the differing perspectives of the parties often complicate resolution of these issues. Having financial and legal advisers to guide the parties through this process is often just as important as advising a seller during negotiation of the transaction documents to be executed at closing. As we enter what is shaping up to be a busy second half of 2012 in terms of private company M&A activity, we offer a few key considerations that should be top-of-mind for every seller.
The recent volatility of the economy, the rapid rate of change in most industries and the turmoil of an election year render the timing of the transaction (along with valuation) to be one of a seller’s most important considerations. Actually, timing and valuation are often related: the more patient you are, the more time you have to wait for the perfect offer. However, if you need to sell immediately, flexibility on price and other negotiated issues may be required. Despite what buyers – and even some advisers – may promise at the outset, a well-run, middle market M&A sale process frequently takes between three and six months. So the first step for any seller is to establish a conservative closing date or range of dates and plan the rest of the sale process accordingly.
Few things frustrate a buyer more and slow down a sale process faster than dealing with a seller who has incomplete or poorly organized records. While every seller should expect to be bombarded with due diligence requests, a well-organized, comprehensive and efficient due diligence program will reduce transaction risk and costs for all parties. A buyer noticing an apparent lack of organization will ask questions like, “Are you sure you don’t have any environmental reports, or did you just lose them?” or “Are your financial projections based upon reliable and accurate historical results and sound and supportable growth targets?” Questions like these can erode the most valuable commodity in any transaction – trust – and even plausible answers to these questions may be met with skepticism. Also, any increase in transaction risk will impact other aspects of the transaction; a skeptical buyer may require stricter representations and warranties, more security for post-closing obligations (including possible personal guaranties in closely held corporations), broader indemnities or, worse yet, a purchase price reduction. Given the importance of due diligence to the buyer and the effect a poor diligence process has on the sale process, having organized records should be a top priority in every sale transaction.
A seller usually goes to market in one of two ways: either the seller knows of potential buyers and contacts them directly, or the seller goes through an auction process (typically conducted by a financial adviser). Which road the seller takes often depends on its financial goals (Is the goal to maximize value by contacting as many buyers as possible? Or to only approach a select group of potential purchasers?), the nature of the industry and the seller’s desired timeline. If the seller wants an auction, it will take time for the seller and the financial advisers to prepare and conduct a well-run auction. This added complexity must be accounted for in the overall transaction timeline.
One of the first instances where a divergence in the interests of buyer and seller becomes apparent is on transaction structure. Buyers generally prefer to purchase assets, since the buyer can select the assets and liabilities it wants to purchase, and sellers prefer to sell equity, since the buyer assumes all the seller’s assets and liabilities. However, depending on the type of company being sold (for example, an LLC, corporation or partnership), there may also be tax distinctions between a stock or asset structure that can save or cost the sellers a significant amount of money and impact the price (for better or worse) that a buyer may be willing to pay for the business. Further, factors related to the seller’s operations, including number of employees, number and relative importance of contracts, regulatory approval or compliance concerns, can also affect potential transaction structures. The seller, with assistance from experienced accountants and lawyers, should decide upon a preferred transaction structure before approaching buyers, who ordinarily will have their own preferences. Depending upon the tax basis for the seller’s assets and its overall tax circumstances, the advantages of selecting a tax or asset sale may be so significant that the parties will seek to quantify the tax savings and negotiate an allocation of the savings between themselves.
That a company is up for sale starts as a closely guarded secret known only to owners and senior management, but word often spreads beyond those who “need to know.” Once it does, employees naturally become concerned over whether the potential sale of the company will lead to downsizing. This concern can lower morale and may cause some employees, often the most valuable ones, to begin updating their résumés at a time when the seller needs them the most. A seller should have a well-defined plan for informing employees of the pending transaction at an appropriate stage of the sale process. Those identified as key employees should be actively engaged to help ensure that they remain with the business through closing (but in a manner that does not tie the hands of the buyer). Strategies to consider include retention bonuses and covenants from the buyer that clearly outline obligations to employees post-closing.
In our experience, a realistic timeline, due diligence preparation, an appropriate go-to-market strategy, an efficient transaction structure and attention to employee concerns are each critical to maximizing value in a sale process. Attention to these key elements can help ensure that the closing of a complex, sometimes daunting transaction is one of the best (and hopefully most profitable) days of your life.