Selling a business is a transaction that for many (if not most) business owners will occur only once in their career. As such, it is important to know what types of advisers the business owner should consult with, and to have a basic understanding of the major "deal points" that will be negotiated between buyer and seller.
While it is possible for a business owner to negotiate and close the sale of a business without assistance from outside advisers, it isn't recommended. Remember, as a business owner, your skill sets evolve around the unique product or service you offer and general business knowledge. It is unlikely that you, or one of your partners, have the level and scope of expertise needed to successfully handle a transaction of this type.
In assembling your advisory team, there are any number of skill sets that should be considered. One important component of any deal is understanding how to value your business, and for that exercise a business valuation consultant, business broker or accountant is likely a good starting point. Many owners have a sense of the value of their business, but in some instances that value is arrived at solely from negotiations and discussions with a potential buyer and the buyer generally has an incentive to pay less, rather than more for the business. Part of what you get with an adviser is an advocate for your point of view in a transaction. You will also need legal assistance, as regardless of the form of transaction (sales of assets, sale of equity, merger or combination), there will definitely be a myriad of legal issues to sort through. Other participants in this process might include experts in the areas of insurance, banking and public relations.
Keep in mind that most (if not all) of these advisers have limited value-added the longer you wait to bring them into the process. For example, if you sign a letter of intent or term sheet without seeking outside advice, you may be locked into certain deal terms, or even the structure of the deal, that aren't optimal from your perspective as a seller. The ideal time to bring at least one adviser into the process is when you are either being asked to exchange information with a prospective buyer, or to sign any sort of agreement or contract.
The ideal business sale would involve the seller receiving all of the purchase price in a single payment of immediately available funds, with no risk or potential that some portion of the purchase price might be subject to being returned to the buyer at some point. Unfortunately, this kind of deal is not typically encountered by sellers. For example, the purchase price for your business might involve several forms of consideration, such as some cash and a promissory note from the buyer. When you accept a note, you are acting as a lender and like any lender you need to evaluate the risk of nonpayment and hopefully, have some form of collateral and/or assurance of payment (such as a personal guarantee of the buyer's principals, presuming the buyer is an entity rather than a natural person). If you are receiving stock from the buyer, that stock may be "restricted stock" which cannot be readily traded and thus represents an illiquid asset for some period of time; also, the stock's value can fluctuate over time, which represents another risk to the seller or recipient.
From the author's experience, one form of consideration you should try to avoid at all costs is an "earn-out" or other type of deferred or performance-based payment. There are at least three good reasons to be concerned about earn-outs. First, as a seller you need to understand that when a buyer starts talking earn-out to you, there is almost certainly a difference in opinion over valuation of the business. Second, because earn-outs are usually tied to some measure of financial performance, they are for argument and disagreement about whether the "target" has in fact been achieved. Finally, once you've sold the business, you may not have enough control to achieve the target as you will be likely reporting and answering to someone else.
The other concept the seller hopes will never come into play is a claim for indemnification by the buyer. Any sophisticated buyer will ask for representations and warranties about the business in the definitive transaction documents for the deal. The representations and warranties (typically about 25-30 in number) will cover virtually all aspects of the legal, accounting and operational aspects of your business. You will be asked to give these snapshots of the business, or in the case of a representation or warranty that you can't provide, the buyer will ask you for an explanation in the form of what is usually called a disclosure schedule.
If it turns out later that a representation and warranty was incorrect, and the buyer suffers damages as a result, the buyer will seek reimbursement of those damages by means of indemnification. So, in negotiating with the buyer, four very important considerations are: 1. How long do the representations and warranties stay in effect after the deal closes? (This is typically also the period in which indemnification claims can be asserted against the seller); 2. What is the maximum amount the buyer can recover from the seller? 3. Are claims for indemnifications subject to any kind of "deductible?" and 4. What is the indemnification mechanism? How does the buyer go about getting the money back if there is a valid claim?
The best mechanism for the buyer (and thus the worst from the seller's perspective) is an actual hold-back of some portion of the purchase price. For example, the purchase price is $10 million but at closing the seller only receives $7.5 million, with the remaining $2.5 million being "held-back" until the two-year indemnification period ends. From the seller's perspective, the ideal arrangement is to receive the entire $10 million at closing and then if there is an indemnity claim, the buyer has to try and get the money back from the seller (which isn't a mechanism buyers are too fond of). A middle ground that is often utilized in these situations is for a third-party escrow to be established so that neither seller or buyer is holding the $2.5 million.
These are just a few of the most important issues to consider in a transaction of this type, so a potential seller is well served to seek advice on these and other matters as early in the process as possible.
James Newman is a partner in the Reno office of Holland & Hart, LLP, where his areas of legal practice include mergers and acquisitions and corporate law. Contact him at 327-3014 or jnewman@hollandhart.com.
