“If you think that you can sell your company yourself, you are possibly right. If you think that you will sell it for what you deserve, think again.” – Dave Johnson – CEO, Netropole
Very often, I am contacted by a seller who received an unsolicited offer from a buyer that they know and like and want to move forward with in a transaction. Many realize immediately that they are out of their element and then move toward engaging an M&A advisor. Others are not so sure, because they feel like the hard part has already been done (finding the offer), so they are of the mindset they can take on the rest themselves*. When I get a call from a prospective seller with an offer or Letter of Intent (LOI) already signed, here is how I explain what happens afterwards to help them determine if they need an advisor or not.
Let’s Start With the LOI
I have seen situations where an LOI is less than I would expect for the company’s revenue and net income. I can make this determination based on the adjusted EBITDA, which most likely was not shared with the prospective buyer and, therefore, money was left on the table. The first thing I do, even after an LOI is signed, is calculate this very important number. While most owners are decent at adding back the personal expenses, there is much more that makes up this number. If my calculation is substantially different, I will ask for a new LOI based on the more accurate set of numbers. Most buyers will agree to another look and prepare a new LOI if the numbers are significantly higher. After all, a good buyer never wants a seller to feel like they have been taken advantage of. If they are not willing to do this, then maybe you didn’t make a great choice in picking the buyer.
Deal Terms That Aren’t in the Seller’s Favor
If you have an all-cash offer, then there isn’t much to complain about. That is, unless you are selling to someone who is backed by a PE firm; in that case you might want to ask if you can roll some equity, as that will very likely return a higher yield than if you just invest it with your financial advisor. In the case of an earn-out, most people don’t think through all the scenarios of how that might work. For instance, say you negotiate another $3M in earn-out after an increase of $5M in revenue in the first year after the sale. Well, what happens if you only get to $4.999M? Do you lose the entire $3M earn-out? Unless you negotiate a “down-stroke,” or a buffer, you will. Most sellers never think about that and can therefore leave a good chunk of cash behind if the earn-out is not achieved. An advisor can see these opportunities and make changes accordingly. Remember, it’s not your attorney’s job to negotiate your terms, so don’t assume they will take on that role.
Due Diligence: What to Give When
Most sellers just readily hand over all requests made by the buyers. I, however, don’t. Except in rare cases, certain items like customer names and employee names should not be shared until a first copy of the purchase agreement is available for review. Holding back this information serves multiple purposes, which I won’t get into here. But it will protect you if the transaction doesn’t ultimately happen.
Quality of Earnings Results
A seller should never agree with a buyer’s Quality of Earnings (QofE) results without questioning any differences or negative additions and how they were determined. After all, the goal of the buyer is to reduce the number, not increase it. Most sellers without representation don’t know that this is a give-and-take exercise, not a definitive audit result. A QofE is subjective and, therefore, not entirely objective, which means there is room for compromise. This exercise alone can lead to substantial loss of dollars for the seller if not managed.
Net Working Capital Adjustments
Similar to the QofE, this can be subjective as well in terms of the adjustments. Current assets (less cash) minus current liabilities is pretty easy to calculate, but then there are adjustments to those numbers called definitional adjustments and diligence adjustments. The diligence adjustments are those that need to be looked at in detail. The period the PEG is calculated should also be reviewed in detail to see if another period might be more advantageous to the seller.
Negotiation of Insurance Tails
Every buyer will want to make sure (specifically in a stock transaction) that there is sufficient tail insurance in place to allow for any lawsuits post-sale that are a result of something that happened prior to the close. There may be situations where a specific policy is requested that either the seller does or does not need. And then there is the decision of the period of time for those policies. Again, all negotiable and not likely defined in your LOI.
Determining Off-Balance Sheet Indebtedness
As part of any transaction that is cash-free/debt-free, sellers need to identify off-balance sheet indebtedness that needs to be extinguished, or money left behind for those items not paid off. When I mention this to even my most sophisticated sellers, they look at me and say, “we have none.” But, in actuality, most sellers do. And most sub-$10M companies don’t do the best job at accruing all of their expenses. Examples of this might be unaccrued PTO time, 401K matches done at year end, bonuses at close, etc. Debt like accounts payable or credit card expenses are already part of the working capital amount and thus don’t need to be considered. The indebtedness amounts need to be as exact as possible so that when your true-up period comes, which is usually 90 – 120 days later, you don’t have to write a check back to the buyer.
Customer Calls by the Buyer
Most every buyer wants to speak to your customers 5 – 10 days before the close. The number of customers and how this is done can vary by buyer as well. But, as the seller, you want as few people as possible to know that a transaction is about to happen, so it’s important to know and negotiate your options in terms of how these calls are carried out. Recently, I had a seller that would only allow his customers to be contacted by a third-party vendor who posed as a Customer Satisfaction Survey. It achieved what the buyer wanted and kept the transaction quiet.
Conclusion
Sure, getting the offer is a big step forward. But seeing its full potential can often only be done with an experienced M&A advisor by your side. What I mention above are just a few things an M&A advisor can help with, in addition to smoothing out conversations around deal terms not defined in the LOI. I tell my sellers that my fees will more than pay for themselves in terms of money not left on the table, the time involved to deal with all this, and the emotional energy that it will take to step through each of the above points. Now that you see what is involved AFTER the LOI, you might want to reconsider going it alone.
* There are times when I think it makes sense for an owner to sell without an advisor. For those situations, though, I do recommend owners educate themselves about the ins and outs of M&A transactions using tools like my Ready…Set…SELL (Your Company) online course, where 100% of alumni respondents said they felt more prepared to sell on their own if they chose to.
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