The fourth and final installment of The Credit Junction's M&A blog series. In this piece, learn about negotiating the final details associated with the sale of your business.
Prior to selling your company you probably daydreamed about your life post-transaction – golf every day, travelling the world, starting a car collection and maybe even purchasing a vacation home. Not so fast, though. Before you start that life, you may still have obligations to the company you just sold as an employee, board member or consultant. Be sure you have a view of your ideal role post-closing and clearly communicate that to your advisory team.
A former client of mine owned a service company that he started from a single truck. Over the course of approximately 20 years, he grew the business into one of the largest industry players in the Northeastern United States. His customers, who were Fortune 500 companies, wanted him to serve them nationally, however he was not willing to take on debt and risk his company to execute the business strategy necessary to successfully grow the business.
The strategic options that we discussed included doing nothing, acquiring a competitor, selling to a competitor, and selling a majority of the business to private equity firm. Once he had some perspective on the value of his company, he decided to partner with a private equity firm and sell a majority of his company. By doing this he could realize 80% of the value of his business immediately and position himself for the proverbial “second bite at the apple” when the private equity firm decided to ultimately exit the investment.
We helped him negotiate the majority recapitalization with the private equity firm. As part of the transaction he became Chairman and relinquished operational control to an incoming President hired by the private equity firm. This decision was not taken lightly. However, he was able generate enough capital from the sale that he and his children would not have to worry about the future. Going forward, he realized that he was not interested in spending 100% of his time executing the business plan to receive only 20% of the benefit. He negotiated a role that was one of an advisor with an occasional business development appearance. It quickly became evident that the new President and the private equity group had a different understanding. The private equity owners expected him to travel for client management meetings and for new customer calls on a weekly basis, something he was not interested in doing.
Despite having a two-year performance-based earn-out, my client decided to resign as Chairman and become a part-time consultant. He no longer had the drive to put in long days in the office or spend a significant amount of time on the road away from his family. The private equity firm understood and agreed to renegotiate his involvement. They had the luxury of having a high-caliber President and Chief Executive Officer who was a proven industry leader and could manage the firm without depending on my client’s full attention.
In hindsight, it should have been clear that our client was looking to throttle back and enjoy life a bit; he purchased his dream car about two weeks prior to the close. The take away from this story is to be honest with yourself and transparent with the buyer as to expectations for your role post-closing. Clear communication from the start will only contribute to the success of the partnership going forward.
Below are a few items to consider as you negotiate the purchase and sale agreement and the employment/consulting agreement.
Transaction terms with post-closing impact
Every term in every transaction agreement has a post-closing impact. However, certain terms specifically deal with future payments and the timing of such payments.
- Earn-out/performance-based payments: Earn-outs and performance-based payments are typical terms found in deal structures. In most cases, owners forecast a rosy scenario to support their high valuation expectations. Buyers will discount the projections to justify their lower valuation. An easy way (in the documentation) to bridge the gap is to set a floor for the purchase price and provide potential performance payouts if certain benchmarks are achieved. In theory, this is a structure that makes sense for both parties. However, there can be a significant amount left to interpretation based on the drafting of earn-out clause in the agreement. Many buyers will say that earn-outs keep the parties on opposite sides of the table until the earn-out is earned or expires.
- Deferred payments/installment sale: Deferred payments or an installment sale consist of contractual non-contingent payments that are scheduled to be made regardless of the company’s financial performance. While not labeled seller financing, these payments represent the right to be paid and rely on the existence of the company and the excess cashflow for the payments to be made.
- Seller financing: In order to achieve a certain valuation, buyers may ask sellers to take on some risk related to a portion of the purchase price that they were unable to finance. The result is seller financing in the form of subordinated notes. These notes typically have below market interest rates, long terms and significant restrictions relating to the payment of interest or principal.
Post-closing transaction roles
Private equity firms typically develop a strategic plan for the 100 days following an acquisition. This plan will cover every aspect of the business including sales, manufacturing, operations, finance and administration. The plan will be driven by the financial projections that were disclosed during the due diligence process. Be prepared to create the strategy and execute the tactics around that plan. Here are some of the roles you could hold post-transaction:
- Employee: The first thing to remember is that you are not in charge anymore. As much as you want to make unilateral decisions, it will be important to consult with the private equity group on significant operational changes. The last thing you should do is surprise your new partners with a major decision. Most employment agreements have 1 to 3 year terms. Most agreements tend to be shorter rather than longer and have termination clauses for both parties.
- Advisor/Consultant: If you are functioning as an advisor or consultant, it is probably evident that you have a significantly diminished role and that you are no longer in charge. It is likely that you are being consulted on an as-needed basis and are not active in the day-to-day operations of the business. This is an ideal role if you are looking to transition out of the business. It allows the current management to utilize your knowledge base while also diminishing your influence within the employee ranks.
- Board member: Serving on the board of directors is an easy way to remain active in the company but have a clear split from operations. You will be involved in the overall strategic direction of the company but not be responsible for the execution. This is a good long-term solution to company insight and involvement if you retain a significant ownership position.
For many business owners, the sale of your company represents the culmination of countless sleepless nights over the years. Each of these years was filled with milestones: your first sale, your first hire, revenues multiplying, etc. The final milestone to hit is successfully executing a sale and creating generational wealth. It’s a marathon, not a sprint, but if you are diligent and patient throughout the process, it will pay off.