Few matters are more complex and have greater importance to business owners than the purchase or sale of a business. Business owners buying businesses often do so strategically to either build revenue opportunities in their existing business lines, or to bolt on a new line of business that will have exciting synergies with their original business. As to business owners who are sellers, sometimes the sale is a “carve-out” or divestment of just one portion of their overall business, where the objective is to increase cash and reduce overall business exposures, and to increase focus on the core business operations of the company. But most frequently, the sale is of the entire business.

The aim of this article is to provide successful business owners with an overview of the process for selling their businesses in a transaction that results in a maximum monetary yield for the seller and the least possible amount of post-closing risk to pay any money back to the buyer. Principal merger & acquisition attorneys at Lerch Early & Brewer routinely represent buyers and sellers of business enterprises valued in millions, and tens of millions of dollars, and also in the hundreds of millions of dollars when transactions also involve substantial inventory or real estate assets. Business owners benefitting from transactions of these sizes require a sophisticated sell-side team consisting of an investment banker or broker to lead the marketing process, experienced counsel to mitigate process and transaction risks and maximize actual legal and financial outcomes, and accountants qualified in specific M&A tasks such as “normalizing ebitda”, determining the appropriate target working capital, and projecting after-tax transaction results.

ADDRESS LONG-LEAD NEEDS EARLY: Ideally the business owner has addressed long-lead considerations like succession-planning involving family members in the business, as well as estate tax planning. If they expect to face gift and estate taxation, business owners expecting a substantial business valuation boost associated with a future sale will often want to gift portions of their business equity to loved ones a few years before the process of marketing the business actually starts. Generally, this concerns first kicks in for businesses likely to sell for more substantially more than $10 million, taking into account state and federal gift and estate tax exemptions available for married couples.

Often the most significant long-lead consideration is trying to put in place long-term management of the company that will stay there after the sale. A BUSINESS OWNER WHO CAN DEMONSTRATE THAT THE BUSINESS HAS OTHER EXCELLENT MANAGEMENT IN-PLACE TO CONTINUE ITS SUCCESS AFTER THE CURRENT OWNERSHIP SELLS AND LEAVES THE COMPANY, WILL MAXIMIZE THE MARKETABILITY AND VALUE OF THE BUSINESS. Key managers might be incentivized both to stay with the company, and to build its earnings, with equity or equity-like incentives that will let them participate in some of the value that will occur at the time of a future sale. These key managers can then become tremendous assets to the sale process. When the owner knows the key managers have a stake in maximizing value, those managers can often be let in “under the tent” to deal directly with the investment banker or broker, and even with potential buyers.

Other long-lead steps include assuring that any minority shareholders (e.g., owners of less than, say, 20% of the business equity) will cooperate with the sale; that non-competes are in place with most company managers and executives and that these non-competes are written in a way that transfers incident to a sale of the company’s assets or stock; and that the company has a record of conscientious compliance with all applicable legal, tax and accounting requirements so that the buyer will be receiving a “clean company.” A company with all of the above features, coupled with a solid record of growth and profitability, will become an extremely attractive target for buyers.

FIND THE BEST PEOPLE TO MARKET YOUR BUSINESS: When the business owners are ready to sell, the next step is to identify the best possible investment banker or broker to lead the marketing process. For high-value companies, this typically will be an investment banker team with an excellent reputation and specialized knowledge in the particular industry sector of the business. Industry conferences, executive leadership forums, confidential calls to competitors who just sold their own company, or counsel or accountants, can be sources for finding bankers with strong credentials who work effectively. Interviews with potential bankers or brokers provides an opportunity to gain insight on the buyers’ market for the business, potential valuations, and how the broker would conduct the marketing process. When a choice is made, the terms and conditions of the formal engagement of the broker can have far reaching consequences, and fully negotiating arrangements with a broker or investment banker is an essential step. 

AFFIRMATIVELY OBLIGATE THE BROKER TO IDENTIFY POTENTIAL PURCHASERS AND ENERGETICALLY CONDUCT A FORMAL SALE PROCESS. The process that usually results in the highest value is one where there are (or seem to be) multiple parties vying to buy the business. The FORMAL PROCESS should include collaborating with the client to create a prospect list, creating and sending teaser information, controlling confidentiality through non-disclosure agreements [LINK], preparing the a confidential marketing memorandum giving detailed company information to approved prospects who have signed confidentiality agreements, coordinating due diligence requests, soliciting letters of interest or letters of intent within a defined time frame, and strategically negotiating with buyers as the prospects submit their letters of interest, letters of intent, and best and final offers.

AND ENGAGE THE BROKER ON THE RIGHT TERMS FOR YOUR BUSINESS: Compensation provisions, including any non-contingent monthly or milestone fees, minimum commission amount, and the commission rate structure itself should be analyzed carefully—such as by creating spreadsheet illustrations of fees at different values–and then negotiated. “Tail provisions” protect the broker from being terminated just before an earned commission becomes due by assuring payment of the commission for a period of time after termination. These provisions often are written for too long a period, in a way that effectively prevents the business owner from replacing the broker, which in turn lowers the accountability and motivation of the broker.

CPA’S KNOWLEDGEABLE IN MERGER AND ACQUISITION FINANCIAL AND TAX CONCEPTS ARE ALSO ESSENTIAL TO MAXIMIZING VALUE FOR BOTH SIDES. Especially at larger transaction values, buyers will engage accounting firms experienced at conducting quality of earnings studies on the target business, to determine the flow of earnings the buyer is likely assured of keeping after the sale closes. These “Q of E” studies involve rigorous testing of the seller’s business contracts, goodwill, expenses and financial systems. Buyers usually also want to assure that the sale is structured for tax purposes as an asset sale, so that they can amortize the full price they are paying for future tax advantages. Two common ways this can be accomplished, even when the transaction is actually a stock or equity sale, is a Section 338(h)(10) election, or reorganizing the business to be treated as a partnership for tax purposes. BUT THESE STEPS IMPOSE A TAX COST ON THE SELLER, AND AN EXPERIENCED ACCOUNTANT FOR THE SELLER SHOULD RUN PROJECTIONS OF THE ADDITIONAL TAX COST so that the seller’s team can try to recover some or all of it in the deal terms.

MERGER AND ACQUISITION ATTORNEYS SHOULD HELP QUARTERBACK THE TEAM AND ASSURE THE PROCESS RESULTS IN A SUCCESSFUL TRANSACTION. Counsel has a critical role to play before, during and after the sale process. Prior to the start of the marketing process, attorneys should help assure non-competes and change of control agreements are negotiated and in place in a way that will motivate key personnel to cooperate with the selling owners. Counsel should be aware of market norms and negotiate the investment banker agreement in a fair manner that assures the broker remains accountable and motivated. As the marketing process begins, counsel typically should review all changes proposed by buyers to the standard NDA for the deal, collaborate with the broker and CPAs to address any special deal challenges (like, a sudden customer issue or downturns in business or earnings), and monitor the process.

Once the broker has obtained price and deal term indications through letters of interest or letters of intent, counsel becomes ever more deeply involved in evaluating competing buyers and their offers, and in negotiating the letter of intent with the best buyer. Though “non-binding” in most respects, the letter of intent sets forth binding obligations concerning further due diligence by the buyer, and a period of exclusivity for the buyer to conduct diligence and reach the final formal agreement with the seller. IT ALSO SETS FORTH THE OVERALL FRAMEWORK OF THE INTENDED FINAL DEAL DOCUMENTS, so many key terms such as overall price, terms of any earnout or rollover, net working capital targets and adjustments, required pre-closing corporate restructuring or tax elections, and crucial limitations on indemnifications and potential liabilities of the seller after the sale, are—in practical effect—binding when the letter of intent is signed.

CLOSING A DEAL IS LIKE LANDING A PLANE. In the negotiation and finalization of the final transaction documents, counsel should assure that provisions are carefully drafted to match every benefit that the broker and the team negotiated, address every tax and accounting consideration identified by the accountant, and satisfy the expectations of the seller and continuing post-sale managers. Disclosure schedules must be prepared detailing exceptions and listings of information required by representations and warranties set forth in the purchase agreement. Counsel must assure that any pre-closing corporate restructuring is implemented in a careful and timely way, in compliance with state corporation authorities’ procedures so that the closing is not delayed or tax benefits lost. In the day or two before closing, the attorneys for the parties to the sale work to meet all closing requirements of the closing checklist, finalize and sign the purchase agreement, complete the final disclosure schedules and a host of other documents, prepare or fully vet the settlement statement, and tend to pre-closing determinations of closing day net working capital and distributions of excess cash. The day of closing is often one of excitement, anxiety and sometimes surprise—and it is the day that clients’ investment in a great overall deal team pays off.