Selling your business – part 2
In our last blog we explored two steps of selling your business, namely establishing the value of the business and finding a buyer.
In this blog, we will look at negotiating the selling price, structuring the deal, and closing the deal.
Negotiating the selling price
What gets overlooked when negotiating the selling price
When negotiating the selling price, the following points are often overlooked:
- Due diligence should be done on the buyer. This provides a clearer understanding of the buyer’s motives for purchase and shifts the seller to an offensive rather than defensive posture.
- Substantial companies can reject bids. The bid process should be subject to a company’s ability to reject all bids if the price is too low.
- Marketing and promoting your company to potential buyers is just as important as marketing and promoting your product or service to potential consumers.
- Time on the market does not reduce the selling price. Sellers often make the mistake of thinking they have to reduce the price of their business because it has been for sale for a long period of time.
- Hire professionals skilled in negotiating. Parties representing the legal interests for companies often do not specialize in specific phases of the selling process.
- Do not lock in a price with the Letter of Intent. Often when due diligence is performed, buyers return to the table asking for price adjustments as part of their negotiating tactics.
The seller must do due diligence on the buyer. This places the seller on more equal footing with the buyer during the negotiations and often helps the seller get a clearer understanding of the buyer’s motives for the purchase. In addition, requesting the buyer’s business plan and financials shifts the seller to an offensive posture rather than the defensive position they are often in, especially when the current owner is anxious to move forward with the sale. It also implies that the seller is negotiating with alternative buyers and is looking for the best price and terms.
Large companies need to exercise caution when a bid system is part of the selling process. When sealed bids are used, the seller does not always have to settle based on the first round of bidding. The process should be subject to the company’s ability to reject all bids if the price is too low.
Another pitfall to avoid during the selling-price negotiation is recognizing the importance of promoting and marketing the company to potential buyers. This critical step strengthens the seller’s position in the negotiations to maximize the selling price.
Sellers may diminish the value of a business because it has been on the market for a long period of time. This factor does not necessarily reduce its value.
To maximize the potential for the highest selling price, the seller must have a qualified professional representing their interests during this important phase of the sale.
Once the selling price is agreed to by both parties, too often the deal is considered fundamentally complete and the selling price is settled by the signing of the Letter of Intent. A seller should not lock in a price with the Letter of Intent unless there is certainty that the due diligence period is very short and that the deal will close quickly and smoothly. Often when due diligence is performed, buyers return to the table asking for price adjustments as part of their negotiating tactics. Other interested buyers may have moved on, placing the seller at an extreme disadvantage.
Structuring the deal
Advice for structuring the deal
When structuring the deal, remember: Price and terms are interrelated. The final price agreed upon by both parties often will determine the structure of the deal, or vice versa. Market conditions mandate security on payment unless all cash is available. As a result, the selling price may be reduced in exchange for more security to the seller. When shares of stock are part of the transaction, the value of the stock should be hedged so if the stock value is reduced in the future, the sale price is made whole. If notes or bonds are issued as part of the selling price, they must contain provisions that limit the buyer’s ability to further leverage. One of the key sources of security overlooked is the encumbrance of assets of both parties to guarantee payment. The income stream can also be encumbered, providing another means to secure payment.
Sellers should keep in mind that the fourth key area is directly related to the third since the final price agreed upon by both parties often will determine the structure of the deal, or vice versa. Price and terms are interrelated. The seller is advised to consider that point while finalizing the price and terms so that when the deal is structured, the price resulting from the sale will be maximized. Current economic conditions mandate security on payment unless all cash is available. As a result, the selling price may be reduced in exchange for more security to the seller.
The seller should pay close attention to the following areas:
- Receipt of Stock. When shares of stock are part of the transaction, the value of the stock should be hedged by adding a clause in the contract that if the stock value is reduced in the future, the seller is entitled to receive additional shares to make whole the sale price. This can be critical depending on who the buyers are. Buyers often have the capability of moving a stock’s price higher to artificially inflate the value. This will result in the seller receiving stock that will drop in value and reduce the future payout.
Keep in mind not all stock is liquid in a volatile market, and that liquidity may require selling the stock at a reduced price. If stock is obtained, whether it is preferred or common, some form of limitation must be placed on additional shares being issued in the future to avoid diluting the value of the seller’s share by adding more shares to the marketplace.
- Notes-Secured or Unsecured. If a note or bond is issued as part of the selling price, the note or bond indenture must contain provisions that limit the buyer’s ability, prior to paying off the note, to further leverage without approval from the seller, or to place the seller’s notes or bonds in a secondary position for payment.
Since bonds and notes also fluctuate based on risk in the marketplace, a provision should be negotiated that these bonds and notes maintain their value at par.
- Security of Assets by Liens. Have notes secured by assets or some form of collateral even if all parties are substantial, to minimize any impact that would result from future defaults. One of the key sources of security overlooked is the encumbrance of assets of both parties to guarantee payment. The income stream can also be encumbered, providing another means to secure payment.
- Tax Ramifications. Remember to consider tax ramifications in your deal structure. Under the current tax code, paying the tax can often be less risky than a “like-kind” exchange that is subject to market conditions.
Closing the deal
Often the importance of selecting the right professional to finalize the deal is minimized. In many cases, the parties representing the legal interests for companies on a day-to-day basis do not specialize in closing the sale of a business.
Many sellers make the mistake of postponing the compiling of legal documentation required to close the deal. All legal documentation related to the assets, ownership, liabilities, stockholder equity, and any significant contracts that are required for the sale of the company should be assembled by the seller prior to beginning negotiations for the sale. A systematic list detailing all documentation required at the closing should be prepared and made available to the bankers, lawyers, and accountants representing seller and buyer. All parties must be given time to carefully review the list and make changes or additions. When done early, this critical step will help eliminate last-minute roadblocks that can slow or even halt the final phase of the selling process.
Avoiding hazards is critical
A seller can find a buyer and obtain a reasonable price for a business although the pitfalls may be numerous and the volatility of today’s marketplace daunting. However, current market conditions make it critical for a seller to fully understand and avoid the many hazards that will emerge during the selling process. This will enable the seller to negotiate a price agreeable to them at the time the deal is signed and, more important, to receive the full amount agreed to in the future no matter how future changes affect the marketplace.