1. Beware of private equity buyers. Private equity firms are in the business of buying and selling companies. Consequently, they are extremely sophisticated and intelligent and are often represented by large and aggressive law firms. Deals with private equity buyers are often more complex than deals with strategic buyers due to, among other things, the level(s) of debt added to the target and/or the financial engineering. Also, unlike most strategic buyers, private equity buyers generally require the selling entrepreneur to (i) reinvest some of their capital in the acquirer (i.e., to keep skin in the game) and (ii) to include a financing condition in the acquisition agreement, which, in today’s choppy debt markets, adds a level of uncertainty to the closing.
2. Hire an attorney with experience in mergers and acquisitions before hiring an investment banker. An experienced M&A attorney will not only help protect the selling entrepreneur in the actual sale process, but will also help retain a strong investment banker and negotiate the banker’s letter of engagement. In fact, investment bankers can (and should) compete with each other to lower their respective fees, just as effective bankers compete with potential buyers for a higher selling price and better terms for the seller. This approach can lead to substantial savings for the entrepreneur.
3. Put your papers in order. An easy way to instill confidence in potential buyers is for the selling entrepreneur to provide (or make available) a complete and well-organized set of due diligence documents. Consequently, before initiating the sale process, the entrepreneur must ensure that the corporate books are cleaned, agreements are entered into and/or updated as necessary, public records do not reflect previously released liens, etc. Also, the financial statements need to be restated by experienced accountants to paint a more accurate financial picture of the business.
4. Develop a game plan. Every deal is different – different players, different trading leverage, different risks, different timing – and therefore it is imperative that the selling trader sits down with the trading team and strategize to develop a game plan in relation to the sale. The entrepreneur must communicate to the team, among other things, their reasons for breaking up, wish list, problems and, of course, budget. An experienced M&A attorney will handle the transaction and ensure the game plan is executed.
5. Negotiate the Material Terms in the Letter of Intent. The entrepreneur’s strongest leverage as a seller is prior to the execution of the letter of intent (the “LOI”). This is the time when a strong investment banker and/or M&A lawyer will create a competitive environment (or the perception of it), and potential buyers will need to compete on price and terms. A buyer, for example, may offer a higher purchase price, but demand a “cap” (as explained below) equal to that price; another buyer can offer less, but only requires a limit of 10%. Consequently, before choosing a buyer, the selling entrepreneur must negotiate and weigh all the material terms of the offer, and the LOI must reflect those terms.
6. Sell shares (equity) not assets. As a general rule, the entrepreneur should sell stock, not assets, for three important reasons: (i) potential tax savings if the target is a “C” corporation; (ii) pass the liabilities of the target (disclosed and undisclosed) to the buyer; and (iii) because it generally requires less documentation and less time to close (meaning less legal fees). Obviously, each deal must be structured with the assistance of a competent attorney, including tax advisor; however, selling entrepreneurs should always think about selling stocks, not assets.
7. Insert a “Basket” in the Acquisition Agreement. The buyer should not be allowed to “take cents” from the selling entrepreneur for immaterial breaches of representations and warranties. Consequently, the seller must insert a basket (ie, a deductible) in the indemnity section of the acquisition agreement, usually in an amount equal to 0.5% to 1% of the purchase price. Therefore, the buyer would only be allowed to recover the full amount of damages in excess of the basket amount (although buyers often insist that if their damages exceed the basket, the seller should be responsible for the first dollar). Vendors should also push to include a mini basket for individual claims; for example, unless the buyer’s damages exceed $10,000 with respect to a particular claim, they are not counted toward the basket.
8. Limit your potential liability. The entrepreneur wants to sleep well after his business has been sold and enjoy the fruits of years of work. Consequently, it is critical that certain key provisions be inserted into the acquisition agreement to protect the entrepreneur after closing. One of those provisions is a liability limit which, as noted above, should ideally be negotiated in the LOI. Sellers should strive to cap at 10% of the purchase price (or even less, with heavy leverage) and should also try to minimize buyer exceptions. The seller’s message to the buyer is reasonable: inherent in any business there are certain ongoing risks and therefore once the business is sold, you (the buyer) should only be able to recover a limited amount of the sale proceeds ( absence of fraud).
9. Insert a No Reliance Provision in the Acquisition Agreement. Another important protection for the seller that must be included in the acquisition agreement is the so-called “no reliance” provision, which requires the buyer, in effect, to acknowledge that he or she is purchasing the business based solely on the seller’s representations and warranties in the acquisition agreement and its due diligence investigation. In fact, said provision is intended to prevent the buyer from suing the seller based on oral, written, projections, etc. statements. outside the four corners of the acquisition agreement.
10. Make Buyer Pay a Termination Fee. The selling entrepreneur must require the buyer to pay a fee if the acquisition agreement is terminated through no fault of the seller (for example, if the buyer is unable to satisfy a financing condition); this is sometimes called a “reverse breakout” fee, which can be as high as 10% of the purchase price (for example, in the Neiman-Marcus sale) or as low as the amount of the seller’s transaction fees . This is an issue that mid-market sellers often don’t address, but they should.