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Parental Guidance

Being in business with a partner presents its own unique set of challenges; when that partner is family, however, the dynamics and complexities increase considerably.  My father was in business with his older brother for more than 30 years.… Continue reading →

These were thrilling times for my family! My father was about to consummate the purchase of a business and my mom was looking forward to a quality of life change; to say they had high hopes for their future would… Continue reading →

A business owner can expect to sell their company once, possibly twice, in their lives. As with most things done infrequently, it is hard to be successful and upwards of 75 percent of business owners who sell have ‘seller’s remorse.’ The remorse comes from not understanding all the options, misjudging the value of their business (almost 60 percent of owners), as well as not being prepared for the process (70 percent of owners). Factoring in the emotional and mental aspects of transitioning from what is often times one’s life’s work and it isn’t hard to understand the challenges.

 

Advance planning and handling the sale as a process, not an event, is the key to a successful exit. A good exit requires two to five years of advance planning. During that period, owners should learn their options, ensure the company value satisfies their retirement needs, complete company value enhancements, understand and time the markets, engage in tax planning and prepare emotionally. If all that is done, owners will exit on their terms and maximize control of the sales process.

 

Challenging as that may be, the formal sales process is not that difficult to understand and getting a good grip on it will help any owner exit under the best possible circumstances. Essentially there are four steps in the sales process, Letter of Intent, Due Diligence, Definitive Purchase Agreement and Closing. A lot of work goes into each step, but it is all very logical.

 

Letter of Intent (LOI) is very simple; it is written documentation that a buyer would like to purchase a business for a certain price and terms and carries the implication that the seller is agreeable. The key element of an LOI is the “I” or “intent.” Intention to buy is not a commitment to buy so both the buyer and seller can step away from the sale at any point. Given the rather non-committal nature of an LOI, it is understandable to wonder ‘why bother.’ The point of the LOI is to document the price, major terms and conditions the seller is willing to proceed if accepted by the buyer and it also includes a ‘no shop clause’ which prevents the seller from asking other would be buyers to make alternative bids. The no shop clause may sound constricting to the seller, but it presumes that the seller has vetted the marketplace prior to the LOI and feels that is the best deal. Finally most buyers are often unwilling to invest in due diligence without knowing the seller is committed and the LOI helps satisfies that condition.

 

A potential sticking point during the LOI period is deciding on an asset vs. a stock sale. The majority of transactions in the middle market are done as an asset deal, where the buyer purchases the assets of a firm, but not the firm itself. The challenges with a stock deal is that the buyer inherits any known or unknown liability the company incurred prior to the buyer’s ownership because the company life continues and generally the liabilities the company incurred follow the company. The representations, warranties and indemnifications provisions in the definitive agreement are created to mitigate this risk by pushing liability back to the seller. Still, a stock sale remains a large risk because the seller could become insolvent post deal as well as the legal costs to enforce as well as the time spent doing so. Further, any goodwill paid for the business by the buyer generally cannot be written up and depreciated for a tax deduction and thus the ROI is lower for a buyer or the price is reduced so the buyer can achieve their expected return.

 

Once both parties sign the LOI, due diligence begins. This is the period where the buyer and his or her advisors (accountants, attorneys, etc.) examine the books, records, property and other items that are connected with the seller’s business. Sellers should spend ample time prior to due diligence vetting the buyer to verify the buyer isn’t on a ‘fishing expedition.’ If this is a concern there are ways sellers can withhold that information until the Definitive Purchase Agreement is completed. Clearly some negotiation on these issues is likely given buyers tend to want more information and sellers less but they are very rarely insurmountable. It is also the time where the seller does further due diligence to ensure the buyer is financially prepared for the sale, is the right type of business person, or any other issues that the seller might be interested in with respect to the buyer. Both sides should be thorough in this process, poorly done or incomplete due diligence can have serious consequences.

 

After the LOI, and usually during the due diligence process, a Definitive Purchase Agreement is prepared. That agreement is binding and would determine such issues as asset versus stock sale as well as resolve any due diligence concerns in a manner acceptable to buyer and seller. The Definitive Agreement will conclusively spell out representations and warranties that the seller makes about the business, and what indemnification liability it may have. The Definitive Agreement will also contend with side agreements, such as employment agreements with the seller or other key employees as well as any leases which need to be negotiated. For instance, if the seller or the seller’s family owns the property on which the business is located, then a lease must be negotiated. Finally, covenants not to compete on the part of the seller will almost always be a feature of the Definitive Agreement.

 

The last step in the process is the closing. The closing is the event which the title to the shares in a stock sale, or the title of the assets in an asset sale, passes to the buyer, and the seller receives some or the entire purchase price. One of the most important things for a seller is managing the process so that employees, customers and the public are informed of the sale in a coordinated manner that makes sense. In many cases, a seller will involve a few trusted employees into the inner circle and let them know about the deal during due diligence. Informing the broader company usually follows the conclusion of legal work and financial transfer. Many companies call the employees into a joint meeting and the seller will explain and introduce the buyer or a senior executive representing the buyer. Sellers frequently will call major customers and explain the sale, introducing the buyer, then distribute a press release announcing the sale leveraging Social Media as appropriate.

 

By Scott Yoder, CEPA, CM&AA, CPA (inactive)

As previously seen on divestopedia.com