Plan Well Ahead for an M&A Deal
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Most company owners will agree that planning is essential in running a thriving business. Likewise, planning is an important component when buying or selling a business. If you’re selling a company, you must have certain things in order for the sale to be completed successfully. If you’re buying a company, you have to make sure you’ve conducted your own thorough analysis of the business you’re about to own, or you could face costly surprises later.
Planning far ahead of a sale or purchase will allow you to maximize your results. For example, if you have sufficient time, you may be able to negotiate better terms, more creatively structure the deal, or resolve other differences that could hold up the sale.
As with any complex transaction, it’s prudent to work with experienced professionals who can help assure a smooth transition, regardless of whether you’re on the buying or selling side of the equation. Qualified M&A advisers can assist you with all aspects of a purchase or sale. They also generally keep tabs on the market and can provide valuable insight into the optimum times to go ahead with the deal. Don’t hesitate to get in touch with these experts.
Q: How does a merger or acquisition affect a noncompete agreement between the purchased or merged entity and its employees?
A: Generally, a merger or acquisition will result in a new entity obtaining the right to enforce the terms of an acquired or merged entity’s agreements, but the new or acquiring entity might not acquire the right to enforce the acquired or merged entity’s noncompetes with its employees.
A new or acquiring entity should analyze the terms of any noncompete it acquires. Where a question exists as to the enforceability of acquired noncompetes, the new or acquiring entity should, at the very least, request that the employee consent to the assignment of the noncompete or employment agreement to avoid enforcement issues.
Paul C. Mallon, Jr.
One Woodward Ave., Ste. 1550
Detroit, MI 48226
Q: What factors make this a good time to sell my business?
A: Current market conditions provide business owners and management teams with what could be a golden opportunity to sell their business over the next 12 to 18 months. A convergence of favorable business tax changes, ready access to debt, and plenty of dry powder in the pockets of potential private equity partners are driving a strong valuation environment, making this an ideal market for owners who are ready to sell some or all of their business.
The recent passage of the Tax Cuts and Jobs Act (TCJA) provides businesses and investors with several benefits. And when you layer on the rise in demand from financial buyers, such as private equity firms, or strategic buyers looking to accelerate growth in the continuing healthy economy, companies in the market now could sell for more than they would have three or four years ago.
500 Griswold, Ste. 2700
Detroit, MI 48226
Q: I’m thinking about selling my company. How can I make sure my transaction goes smoothly?
A: Do your due diligence.
First, make sure that your books and records are in good shape, you understand your business, and you have a plan to address any issues or problems. This builds confidence when the buyer does their due diligence, and minimizes the chance they’ll find a problem. It’s always best to address issues up front.
Second, check out the buyer. Do they have a reputation for successful transactions executed with a minimum of controversy? Do they act professionally and cordially? Do parties in prior transactions feel they respected the spirit, as well as the language, of the letter of intent? Do they have a history of postclosing contentious litigation? Doing business with quality people is key.
Finally, make sure you engage counsel who’s experienced and well-respected. That way, you can focus on the real issues and not spend time, money, and emotional energy on issues that aren’t material.
Richard M. Bolton
Q: How and when do I prepare for an M&A transaction?
A: Selling your company or acquiring a new entity may seem like very different transactions, but the preparation for either event is very similar. Planning is an essential element, and bringing together your key advisers 24 to 36 months before the target date will maximize your net return on a sale or your buying power for an acquisition.
Your CPA, attorney and banker will work together to help you prepare the balance sheet and EBITDA to create your best negotiating position. There may be new costs to consider, possible changes in tax obligations, and even some restructuring required, along with the usual due diligence. While the event will be at least two years away, you still need to operate business as usual to meet all of your current and future contractual and financial obligations. In fact, sometimes the sale or acquisition doesn’t occur.
Your advisory team will not only be able to assist you during the planning stage, but will keep you updated on changes in the market as you approach the launch date of your project. Keep in mind that structure and terms are often more important than the price. Deferred compensation/earn-out options can be very successful negotiating terms to maximize the overall economics of the transaction, and your advisers can assist with defining those options.
Senior Vice President, Middle Market Group Manager
2301 W. Big Beaver Rd.
Troy, MI 48084
Q: How do the parties to a business acquisition typically adjust the purchase price to account for the changes in financial condition during the period between establishing the purchase price and closing?
A: A working capital adjustment is a typical approach to adjust the purchase price to address any changes in financial condition between the date the purchase price is established and the closing. Working capital adjustments usually occur after closing and involve an adjustment of the purchase price based on the amount by which the actual working capital at closing exceeds, or is less than, an established working capital target.
The basis for the adjustment is that the purchase price assumes a certain level of working capital is necessary to run the business. If the seller delivers working capital in excess of the target working capital, then the seller is entitled to the excess. If the seller delivers working capital less than the target working capital, then the buyer is entitled to a refund of a portion of the purchase price.
It’s important for the parties to establish the methodology to determine the final working capital, including whether a physical inventory will be conducted as part of the process, to avoid post-closing disputes.
Q: I’m in the process of selling my business. How can I minimize my potential post-closing indemnification obligations to the purchaser for breaches of the representations and warranties?
A: When representing the seller of a business, it’s a good idea to minimize the seller’s potential post-closing indemnification obligations to the buyer by shortening the survival periods for the representations and warranties, and insisting on a deductible or basket and payment cap. The shorter the survival period, the less amount of time the buyer has to asset an indemnification claim. By including a deductible or basket, the buyer is precluded from seeking indemnification from the seller until the aggregate amount of all of the buyer’s damages resulting from a breach of a representation or warranty exceeds a specific dollar amount (usually a percentage of the purchase price).
A mini-deductible can also be used to prevent the buyer from bringing an indemnification claim for a de minimis amount (e.g., less than $10,000). Finally, by including a payment cap (also usually a percentage of the purchase price), the seller’s maximum potential liability to the buyer is limited. For certain deals, requiring the buyer to purchase buyer-side representation and warranty insurance should also be considered.
Kenneth R. Lombardo
Business and Corporate Law, Securities Law, Taxation
Q: I’m preparing to sell my company, and I’m wondering if a non-binding letter of intent is a step that can be skipped?
A: Yes, it can be skipped. However, there are real benefits to an LOI, especially in a competitive bidding process. Consider:
- LOIs help funnel the negotiation by acknowledging the main deal points.
- LOIs often provide a buyer with the “confirmation” they need to begin due diligence or initiate the financing process.
- In the competitive bidding process, the LOI is the key tool used to leverage one bid against another.
- Non-binding LOIs can contain binding provisions including no shop, stand still, or break fee provisions.
John W. Crowe, Esq.
380 North Old Woodward Ave.
Birmingham, MI 48009
Q: What can I do to prevent surprises from arising and derailing my transaction?
A: Conduct due diligence on your own company before starting a deal. Almost any issue can be dealt with if it’s identified and addressed proactively; sometimes an issue can be fixed entirely. Even if it can’t be fully remedied, if you address it early in a process, you’ll be in the best position to avoid the issue costing you dollars — or, worse, killing your deal.
If a buyer identifies an issue you aren’t aware of (or are trying to hide), the buyer will have maximum leverage to extort concessions on price and other terms, and may even get “spooked” and abandon the transaction.
Peter G. Roth
Q: I own a minority equity position in my company and want to purchase the retiring majority owner’s equity, but I don’t have sufficient resources. How can I accomplish my goal?
A: This is a common question, as many executives aspire to someday acquire their employer. Prior to the development of the private equity industry, there was little opportunity to accomplish this dream, as adequate financing wasn’t available — but today, the purchase of equity in a privately- held business is much more viable.
Most often these are two-step transactions. Step one is buying out the majority equity holder with the help of a private equity partner. How much equity you already own will dictate how much private equity funding you’ll need and how much you can initially increase your ownership, with the private equity investor requiring some portion of the purchased equity position for their return. Step two is buying out the private equity investor at some future date, when the company has retired a significant portion of the first transaction’s debt. As the amount of equity to be purchased is less, the funding requirement is likely less, and is often achievable with conventional bank debt.
Peninsula Capital Partners, LLC
500 Woodward Ave., Ste. 2800
Detroit, MI 48226
Q: When should my business conduct a quality of earnings assessment, and why?
A: Whether you’re buying or selling a business, relying on an audit of past financial statements isn’t enough. Conducting a quality of earnings assessment early in the M&A process is paramount. You’ll need a flexible and adaptive transactional advisory team to analyze the integrity of a company’s reported earnings before interest, taxes, depreciation, and amortization, as well as its cash flow and profitability. These critical evaluations help support projected future results and provide confidence in a purchase price and terms.
Rehmann’s executive team conducts the financial due diligence to understand the facts behind the numbers. They utilize a multidisciplinary approach to coordinate with attorneys and other necessary advisers to guide clients through every stage of a transaction, beginning before the letter of intent is signed and continuing through the post-closing phase.
Donald Burke, CPA, CGMA
Q: I’m buying (or investing in) a company, but I haven’t done the Intellectual Property (IP) due diligence. What should I do?
A: Getting the IP due diligence right in an M&A transaction is a challenge, but doing so will help with the valuation, lock in the intangible assets, and reduce risk. Consider these tips:
- Conduct an IP Audit. Investigate what you think you’re buying and confirm that you want it. Patents, trademarks, copyrights, and trade secrets are what most people consider. Don’t stop there. Dig deeper to identify other intangibles (computer code, formulations, design concepts, testing data, invention disclosures). This IP audit results in a robust IP Asset List.
- Confirm that the seller owns the IP. Investigate the title to the intangibles on your IP Asset List. Patent, trademark, and copyright laws treat ownership differently, so while the seller may claim they own everything, you’d be surprised to learn the opposite. Once you identify any problem areas, you can negotiate with the owner to resolve them.
- Confirm that the items driving revenue don’t infringe. The last thing you want to do is buy a lawsuit. Analyze the balance sheet and investigate the items driving revenue to determine whether they infringe on third-party IP. Your investors will be upset if a competitor sues, gets an injunction, and then stops the sales of those things driving revenue.
Douglas P. LaLone
Fishman Stewart, Partner
39533 Woodward Ave., Ste. 140
Bloomfield Hills, MI 48304
There’s IP in Everything We Do!
Q: Does an earn-out make sense in the sale of my business?
A: It depends on the circumstances.
There are numerous ways to structure the sale. Few transactions are all cash. Many times there can be a gap between the value the seller is willing to accept and what the buyer is willing to pay. A well-drafted earn-out can be used to bridge that gap while satisfying the concerns of both parties.
An earn-out is a contractual provision in a purchase agreement that provides for the seller to obtain additional further compensation contingent on future financial performance of the business post-closing. Amounts paid pursuant to an earn-out are in addition to the amounts paid at closing.
With tremendous upside for a seller in an earn-out, it’s imperative a seller consider the following in such a transaction:
- Be realistic about the future growth of the company being sold.
- Acknowledge that he will, in all likelihood, be working as hard or harder after the sale, in an effort to maximize the amount of the earn-out.
- The person or persons you’re selling your business to.
- Try to retain as much control as possible while allowing the buyer the flexibility to grow (both sales and earnings) during the earn-out term.
In considering an earn-out, get professionals involved as early as possible. Their experience can be invaluable.
38505 Woodward Ave., Ste. 100
Bloomfield Hills, MI 48304
Q: What is rollover equity and why is it an important deal term?
A: As private equity funds are structured to invest in businesses, rather than manage businesses, a target company with a strong management team is a highly desirable prospect. Thus, it’s common for a buyer to insist that the company’s owners (or at least those owners who are actively involved in management) remain involved after closing. This promotes a smooth transition.
To incentivize owners to remain active, buyers generally require them to exchange (roll over) existing equity for equity in the new company. As a result, the existing owners would hold a minority equity interest in the new company. The amount of rolled equity varies, with the target’s owner(s) generally retaining a 5 percent to 40 percent interest. With such a potentially large investment, the existing owners must carefully consider and negotiate the proposed rollover package.
The most important point is to start negotiating these terms up front, not after getting deep into the sales process. By doing so, existing owners can often minimize tax liability, gain favorable positions to control future sales, and minimize requirements to make additional capital contributions.
Howard & Howard Attorneys, PLLC
Joseph P. Michniacki Mergers & Acquisitions,
Business & Corporate Law
450 W. Fourth St.
Royal Oak, MI 48067