Today’s mergers and acquisitions market, although less robust than several months ago, remains viable for both buyers and sellers. Mergerstat, a provider of global mergers and acquisitions data, reports 4,293 announced transactions in the first six months of 2001 — a drop of 18% from the first half of 2000. Mergerstat also reports a 51% drop in announced deal value compared to the first half of 2000. The situation is not as grim as it might appear. Most of the decrease in deal value stemmed from a slowdown in the number of deals with price tags of $1 billion or more. There are still deals to be made, but buyers and sellers must work harder to make them work. As a seller, it is critical to employ the right strategy.
1. Organize the Right Team
The first step is to organize the right team of professional advisors. Take a close look at your financial and legal advisors to determine their capability to obtain the highest value for your business. It might be the right time to engage an independent accounting firm with a specialty in assisting its clients in mergers and acquisitions. Likewise, longtime legal counsel that handles routine corporate and litigation matters for the business may not be suited to handle the transaction. It may be time to hire a law firm expert in mergers and acquisitions transactions that can bring together the staff and special expertise in intellectual property, employment, tax, environmental and employee benefits law often required to effectively lead, advocate and structure the transaction.
You should work with your accountant and attorney to identify an investment banker or business broker appropriate for the size of the transaction, your geographic location and your industry. A good investment banker brings to the table knowledge of the industry, potential buyers and transaction structures, and should be able to properly assess the true worth of the business.
Finally, identify a core group of insiders to help you to organize and assemble company data and records. These individuals should be trustworthy and loyal, as indications that an owner is considering selling the business can create instability and a loss of productivity.
2. Evaluate Target Buyers
With your team in place, evaluate your target buyers. There are generally two types, a strategic buyer and a financial buyer. A strategic buyer will purchase the business for some competitive advantage, to achieve economies of scale or the like. A financial buyer buys the business because it is a “good deal.” In some cases, the strategic buyer will pay more for the business than the financial buyer because of the perceived synergies and economies of scale.
In today’s challenging marketplace, the sale of the company to an employee stock ownership plan (“ESOP”) might be worth considering. An ESOP is an employee benefit plan that purchases the stock of the employer company from its owners for the benefit of its employees. The ESOP typically funds the purchase through pretax dollars contributed by the company and employees and by borrowing from lending institutions that specialize in funding ESOP transactions. An ESOP permits the owner to create a ready market for its stock by selling it to the plan trust. This method creates the liquidity for the selling shareholder and usually defers capital gains. At the same time, it preserves management and allows the employees to become owners of the business.
3. Get your House in Order
When a potential buyer comes to look at the business, the buyer will engage in what is commonly referred to as “due diligence.” However, before the formal due diligence period begins, the owner should organize and update company records. It is better for the owner to identify and solve any problems than to have a buyer identify them for the first time. In conducting due diligence, the buyer will examine the company’s charter documents, minute and stock books, material agreements, intellectual property, and other records. Sellers should require the buyer to sign a confidentiality agreement prior to reviewing any company documents. In some instances, such as a sale to a competitor, it may be advisable to reserve certain confidential and proprietary information, such as pricing and customer information, until later in the deal.
4. Develop a Negotiating Strategy
Identify your objectives early. Ask yourself why you want to sell. Is it time to move on to other ventures; time to retire; or time to create liquidity and cash out? Are you willing to, or do you want to, continue to work in the business after the closing of the sale? For example, if you want to retire, it may be easy to agree upon a covenant prohibiting you from competing in the same line of business. However, if your objective is to create liquidity and continue in a complementary line of business, the same covenant not to compete may be problematic. Further, if you are willing to work for the purchaser following the closing, an agreement which bases some or all of the consideration on the success of the business, commonly termed an “earn-out,” may be appropriate. Typically, a seller will have the potential to receive more consideration from the purchaser when an “earn-out” is involved. The seller may also want to consider financing a portion of the purchase price. Although seller financing carries more risk than cash, it can make a transaction more attractive in a difficult market.
With your objectives in mind, think through your negotiation strategy. Figure out what you can easily give up and what you must have consistent with your objectives. You may want to identify areas of agreement early to obtain the buyer’s commitment to the transaction before focusing on areas of disagreement. On the other hand, you may decide that you would like to flush out the buyer early on and put on the table those things that you believe are non-negotiable to see if the buyer will accept them.
5. Take the Letter of Intent Seriously
Critical to your negotiations and your transaction is the letter of intent. The letter of intent precedes the definitive agreement, but usually outlines the basic terms of the transaction, such as consideration and the mix of consideration paid (i.e. cash versus stock), “earn-outs,” and covenants not to compete. Sellers often take the letter of intent less seriously than the definitive documents because it is usually non-binding. Parties sometimes negotiate their letter of intent without involving their attorneys and other advisors. This is a mistake. Negotiating away from the letter of intent in the later stages of negotiations can be extremely difficult. Further, the letter of intent may be the basis for legal action if a party decides not to “agree” to a provision in the letter of intent. On the other hand, a well thought-out and negotiated letter of intent can save time, money and effort.
Opportunities remain in the current mergers and acquisitions marketplace. With the right team, planning and strategy, sellers can overcome the obstacles present in the marketplace and successfully sell their businesses.
Scott E. Adamson, Esq. and Anthony J. Marks, Esq.
Scott E. Adamson
Anthony J. Marks
Mr. Adamson and Mr. Marks are members of the Corporate and Securities practice group of the Los Angeles office of Jenkens & Gilchrist, LLP. Jenkens & Gilchrist is a national law firm with over 600 attorneys practicing in New York, Los Angeles, Chicago, Dallas, Washington, D.C., Austin, Houston, and San Antonio. Mr. Adamson can be reached at firstname.lastname@example.org and Mr. Marks at email@example.com.