Considerations in Preparing for the Sale of a Privately Held Business
Carl D. Roston, M&A and Private Equity Practice Co-Chair, Akerman LLP talks us through the best means to structure a business for sale.
In our experience as a law firm nationally recognized for middle market M&A, the principal goals of most sellers of privately held businesses are to maximize the likelihood that the transaction will close while maintaining confidentiality and minimizing disruption, and to maximize the proceeds (after taxes and potential indemnity claims). Yet a surprising number of entrepreneurs who have spent all or a considerable portion of their professional careers devoted to increasing the value of their businesses fail to implement a planning and sale process designed to maximize the likelihood of achieving these dual objectives. For the successful and sophisticated entrepreneur who is relatively inexperienced in planning for a sale process, an unwillingness to devote sufficient focus, energy, time, and resources to an unfamiliar, stressful, and time-consuming sale process often destroys significant value that the entrepreneur worked so hard to create. Whether the enterprise value of the business is $50mn or $1bn, our clients tell us they find great value in a handful of pragmatic initiatives.
The purchase price rarely increases once negotiations and diligence are in advanced stages, so value is added by engaging experienced professionals well in advance of the sale process (up to two years before being ready to sell) to implement best practices designed to optimize the value of the business from a buyer's perspective and identify and remediate issues that could give a buyer ammunition to terminate negotiations, reduce the price, or demand less favorable terms. Calls to ascertain whether a prospective accounting firm, law firm, and/or investment bank have successfully and recently executed sale transactions for businesses of a similar size and sector is highly correlated with a successful sale process. The right traits include pragmatism, an ability to find creative solutions to getting deals done confidentially and on optimal terms, and an aptitude for prioritizing and balancing factors that maximize value and manage risk. The cost of audits for at least a couple of years prior to sale as well as a quality of earnings analysis is often dwarfed by the consequences of failing to do so: a failed transaction process often taints the business in the view of other putative buyers and damages the business significantly if word of the potential sale is leaked to customers, suppliers, and employees; a substantial decrease in purchase price as a result of discovery of financial statement deficiencies late in the sale process is commonplace; and potentially catastrophic post-closing purchase price adjustments and claims by the buyer may also result when financial statement deficiencies are uncovered post-closing. A seasoned investment bank can recommend business strategies in the years prior to the sale process designed to make the business most attractive to buyers. The right M&A law firm should quarterback the process in furtherance of accomplishing these goals, and also effectuating advance tax planning designed to mitigate estate, gift, and income taxes. It is also constructive to develop relationships prior to beginning the sale process with insurance brokers, wealth managers, and family counselors, as all of them can support accomplishing these dual goals.
Managing Risk and Maximizing Value
Addressing skeletons in the closet and material contingencies (e.g., environmental and other regulatory issues and litigation) that may jeopardize the transaction or cause a putative buyer to reduce the price it is willing to pay should be undertaken well prior to the sale process, as waiting until the sale process may be too late to remediate issues. Likewise, implementing a number of best practices can preserve value. It is advisable to lock up key executives with non-competes and ensure that intellectual property is owned by the company (and not its employees or others). Many companies also seek to align interests with key members of management whose views may significantly impact the success of the transaction by offering transaction success bonuses, severance, and other incentives. Optimizing contractual relationships (e.g., avoiding change of control and non-competes that burden the business, diversifying key customer and vendor concentration, and entering into key agreements for reasonable duration) also adds value. Likewise, maintaining an organized digital inventory of all key agreements, permits, litigation, and other material due diligence data facilitates an organized process that mitigates surprises that can jeopardize transactions and create liability.
Process, Process, Process
The sale process is a marathon that often takes a year or more, so advance planning enables management to be less distracted by the process and able to focus on running the business. A number of best practices in the process should be implemented. The members of management who are aware of the process should meet regularly both to keep their eyes on the sale prize and remain vigilant about keeping the process confidential. Disclosing the most sensitive confidential information and bringing incremental members of management under the tent about the sale process should occur only when necessary as the process advances. Careful consideration should be given to whether the investment bank should reach out to all potential buyers in order to maximize price or run a narrower process designed to maintain confidentiality. It is typical in a sale process that after a number of buyers complete preliminary due diligence, one will enter into a letter of intent with the target and be granted a period of exclusivity to negotiate and close the transaction; as the leverage shifts to the buyer once exclusivity is granted, it is essential that the target investigate the reputation of the putative buyer for actually closing without re-trading price and make available all relevant due diligence, so as to mitigate the risk that a putative buyer will be surprised (or feign surprise) and terminate negotiations or seek to reduce the purchase price. Likewise, a target should avoid agreeing to exclusivity for as long as possible, and, ideally, until the putative buyer has either provided comments to a purchase agreement and other material documents or provided a detailed issues list, in each case containing tentative understandings as to key terms including conditions to closing, price, tax, structure, non-competes, employment agreements, purchase price adjustments, remedies, and indemnity. So as also to minimize surprises (or feigned surprises) by the putative buyer, it is recommended that when the seller's counsel delivers the first draft of the purchase agreement to the buyer, the disclosure schedules (which describe potentially problematic exceptions to the representations and warranties of the seller) be attached. A seller should also consider including with the draft purchase agreement preliminary bids from insurance companies on representation and warranty insurance (which is typically purchased by the buyer). This increasingly common insurance effectively eliminates exposure of the seller for most post-closing breaches of representations and warranties, reduces the risk of sellers for post-closing claims, and streamlines negotiations (thus reducing the risk that the parties will be unable to agree on terms and terminate negotiations).
Failing to begin advance planning a couple of years prior to a sale process can destroy the value that the entrepreneur has worked so diligently to create; and these pragmatic steps increase the likelihood of accomplishing the dual goals of closing the transaction on a confidential basis while mitigating disruption to the business and maximizing the proceeds.