1. Be Careful with Private Equity Buyers. Private equity firms are in the business of buying and selling companies. Accordingly, they are extremely sophisticated and savvy and are often represented by large, aggressive law firms. Deals with private equity buyers are generally more complex than those done with strategic buyers due to, among other things, the level(s) of debt added to the target and/or financial engineering. Moreover, unlike most strategic buyers, private equity buyers usually require the selling entrepreneur (i) to rollover part of his/her equity into the acquirer (i.e., to maintain 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 closure.
2. Hire an Experienced M&A Lawyer Before You Hire an Investment Banker. An experienced M&A lawyer will not only help protect the selling entrepreneur in the actual sale process, but also will help retain a strong investment banker and negotiate the banker’s engagement letter. Indeed, investment bankers can (and should) be played off of each other to lower their respective fees -- just like effective bankers play prospective buyers off of each other to get a higher sales price and better terms for the seller. This approach can lead to substantial savings for the entrepreneur.
3. Get Your Papers in Order. An easy way to instill confidence in prospective buyers is for the selling entrepreneur to deliver (or make available) a complete, well-organized set of diligence documents. Accordingly, prior to initiating the sales process, the entrepreneur should ensure that the corporate books are cleaned-up, agreements are memorialized and/or updated to the extent necessary, public records do not reflect previously-released liens, etc. Moreover, financial statements should be recast 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 negotiating leverage, different risks, different timing -- and it is thus imperative that the selling entrepreneur sit down with the transaction team and strategize to develop a game plan in connection with the sale. The entrepreneur must communicate to the team, among other things, his or her deal-breakers, wish-list, problems and, of course, budget. An experienced M&A lawyer will quarterback the transaction and ensure that the game plan is being 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 solid investment banker and/or M&A lawyer will create a competitive environment (or the perception of same), and prospective buyers will be required to compete on price and terms. One buyer, for example, may offer a higher purchase price, but require a “cap” (as discussed below) equal to such price; another buyer may offer less, but only require a 10% cap. Accordingly, prior to choosing a buyer, the selling entrepreneur should negotiate and weigh all of the material terms of the offer, and the LOI should reflect such terms.
6. Sell Stock (Equity) Not Assets. As a general rule, the entrepreneur should sell equity -- not assets -- for three significant reasons: (i) potential tax savings if the target is a “C” corporation; (ii) to pass the target’s liabilities (disclosed and undisclosed) onto the buyer; and (iii) because it generally requires less documentation and less time to closure (which means less legal fees). Obviously, every deal must be structured with the assistance of competent counsel, including tax counsel; however, selling entrepreneurs should always be thinking about selling equity, not assets.
7. Insert a “Basket” in the Acquisition Agreement. The buyer should not be permitted to “nickel and dime” the selling entrepreneur for immaterial breaches of the representations and warranties. Accordingly, the seller should insert a basket (i.e., a deductible) into the indemnification section of the acquisition agreement -- usually in an amount equal to .5% to 1% of the purchase price. The buyer thus would only be permitted to recover for its aggregate amount of damages in excess of the amount of the basket (though buyers will often insist that if its damages exceed the basket, the seller should be responsible for the first dollar). Sellers should also push to include a mini-basket for individual claims -- e.g., unless the buyer’s damages exceed $10,000 with respect to a particular claim, it does not get counted toward the basket.
8. Cap Your Potential Liability. The entrepreneur wants to sleep well after his or her business has been sold and enjoy the fruits of years of labor. Accordingly, it is critical that certain key provisions be inserted into the acquisition agreement to protect the entrepreneur post-closing. One such provision is a cap on liability, which, as noted above, should ideally be negotiated in the LOI. Sellers should strive for a cap of 10% of the purchase price (or even less, with strong leverage) and should also try to minimize any buyer carve-outs. The seller’s message to the buyer is reasonable: inherent in any business are certain ongoing risks, and thus once the business is sold, you (buyer) should only be able to recover a limited amount of the sale proceeds (absent fraud).
9. Insert a Non-Reliance Provision in the Acquisition Agreement. Another important seller protection that should be inserted into the acquisition agreement is a so-called “non-reliance” provision, which requires the buyer, in effect, to acknowledge that it is buying the business based solely on the seller’s representations and warranties in the acquisition agreement and its due diligence investigation. Indeed, such a provision is intended to prevent the buyer from suing the seller based on any oral statements, writings, projections, etc. outside the four corners of the acquisition agreement.
10. Get the Buyer to Pay a Termination Fee. The selling entrepreneur should require the buyer to pay a fee if the acquisition agreement is terminated through no fault of the seller (e.g., if the buyer is unable to satisfy a financing condition); this is sometimes referred to as a “reverse break-up” fee, which can be as high as 10% of the purchase price (e.g., in the sale of Neiman-Marcus) or as low as the amount of seller’s transaction expenses. This is an issue that is often not addressed by middle-market sellers -- but should be.
Scott Edward Walker is a former big-firm New York corporate lawyer, with 14+ years of sophisticated M&A and securities experience. Mr. Walker is currently Of Counsel to Strategic Law Partners, LLP, a boutique corporate law firm in downtown Los Angeles specializing in mergers and acquisitions and venture capital financing; he can be reached at firstname.lastname@example.org. Please note that the foregoing article has been provided by Mr. Walker solely for informational purposes and does not constitute (and should not be construed as) legal advice in any respect. Mr. Walker expressly disclaims all liability in respect of any actions taken or not taken based on any contents of the article.