This article addresses issues that a business owner and his or her team of advisors face in the process of negotiating with prospective buyers. It was written for the Topline Business Owners Workshop, an event hosted by Topline Valuation Group in conjunction with Kaulkin Ginsberg Company and Santos, Postal & Company, P.C., on Tuesday, May 12, 2015.
This is part one in a four-part series.
I. Selecting a Team
The first step to prepare the company for an M&A transaction is to hire a team of professionals that at a minimum includes:
- An investment banker
- A certified public accountant (CPA)
- Legal counsel that is experienced M&A deal lawyers
These professionals will help you understand what you want as a seller, and tailor those wishes and desires to the reality of the company that will be sold in the context of a market.
A. Investment Banker
An investment banker advises the seller on issues relating to market dynamic, trends, potential targets, valuation, pricing, and deal structure. He or she is also responsible for assisting the company in drafting the confidential information memorandum, which is the main marketing document used by the investment banker to sell the company. Further, he or she assists the seller in understanding the market, identifying and contacting prospective buyers, and negotiating evaluating offers. Finally, in many cases, multiple offers may have divergent structures and economic consequences for the seller, so evaluation of each offer is conducted by the investment banker.
B. Certified Public Accounts (CPAs)
The account (a certified public accountant) assists the seller in preparing the financial statements and related reports that the buyer inevitably requests, which also serve as a valuation tool for the buyer and for the seller to know what to expect in terms of an offer.
C. Legal Counsel
The legal counsel, who should be experienced in M&A deals, is responsible for assisting the seller in a wide variety of duties, including (without limitation):
- Assisting the seller in setting up the company for sale by cleaning up corporate records, responding to buyer due diligence requests, developing strategies for dealing with dissident shareholders, arranging necessary consents from third parties or governmental entities in relation to the deal.
- Working with the investment banker in helping evaluation competing offers, and also focusing on those aspects of the offers that are not necessarily expressed in hard numbers but affect the attractiveness of the deal, such as indemnification-related provisions in the letter of intent.
- Assisting in the negotiation and drafting of the letter of intent and nondisclosure agreements, which should be signed by all potential buyers who are provided with the investment-banker-prepared confidential information or who otherwise have access to the seller’s book and records.
- Negotiating and drafting definitive purchase agreements with buyers’ attorneys.
- Assisting the seller with post-closing matters, such as working capital adjustments, problems with the payment of a buyer’s promissory note, and other matters.
D. Step Back for a Minute
A seller should understand from the outset that the team of professionals that will assist him or her, especially the investment banker and legal counsel, have different goals in the context of a deal and are sometimes at odds with each other. We are not suggesting that the process of selling entails mastering a potential conflict of responsibilities or even interests between different factors of so-called professionals, but a seller is definitely better off understanding them. This isn’t because the seller will want to play those factors against each other – quite the contrary – but to understand what each one deems to be in your best interest as seller.
The overarching goal that unites the team of professionals is to sell the company, as each was hired in the context of the transaction for that purpose. The investment banker wants to accomplish that goal and also maximize sales price – another goal that is highly related to the goal of selling the company. Sometimes this means that once the investment banker feels that the sell price has been agreed to – usually through a letter of intent from the buyer – ideally he or she would like to see a smooth negotiation process on the remaining points so as to minimize potential conflict and maximize the chances of sealing the deal. Ultimately, the investment banker only gets a positive return on his or her investment in the seller (opportunity costs) if the transaction closes because usually the investment banker gets paid a commission on the transaction. While the investment banker is also desirous of getting you the best deal possible, he or she will be less willing to take hard positions on certain issues, especially when it comes to taking risks even in the process of the negotiation of the letter of intent.
This sort of behavior sometimes may act against the best interests of the seller, and may seem at times that an investment banker may be negotiating against the interest of the seller, as one client told us recently. In a buyer’s market – and in a seller’s market as well, but to a lesser extent – the seller’s peak in negotiating leverage is usually at the stage of the negotiation of the letter of intent. If the investment banker is not keen on negotiating a certain point that may be important in the context of a transaction in the letter of intent, odds are that the seller has given up his or her chance to get the best deal on that certain point. In this instance, the seller can use the advice of legal counsel to weigh the risks and consider whether the point should be negotiated now or later.
Legal counsel who are experienced M&A lawyers also share in the overarching goal of selling the company at the best price possible, but in the context of creating the least risk possible for the seller. There is no point in receiving the maximum valuation possible for the company if eight months later the seller may be exposed to an indemnity obligation of 35 percent of the sales price. In order to achieve the least risk possible, the legal counsel in most cases will have to negotiate with the attorneys for the buyer. Although attorneys differ in terms of negotiating tactics (and those tactics matter), an attorney will sometimes touch upon points during a negotiation that may cause some considerable tension among buyer and seller. Companies that are for sale come in many varieties, and what may be important for one may not be for another.
For instance, there is not much to be gained for a seller to heavily negotiate the off-balance sheet arrangements representation and warranty when the company for sale does not have any. Yet, many attorneys negotiate points that are counterproductive to the goal of selling the company since those negotiations may only serve to irritate a buyer and create doubts in the back of the buyer’s mind about what he or she is proposing to buy without creating any value or benefit to the seller. In this instance, the seller can use the advice of the investment banker and the accountant to determine the importance of an issue in the context of the company, and assure legal counsel that there is not much to be gained from negotiating a certain point.
In relation to the investment banker and legal counsel, the seller should use them as resources that complement each other, but also as a source of competing ideas that should be thoroughly considered in order to reach the best solution. Circumstances among sellers can vary widely. An idea or suggested solution may work for one seller, but not for another. The shrewdest of sellers will put both the investment banker and the legal counsel on the same page to achieve the best deal possible given the circumstances.
E. Investment Banker and Legal Counsel: Who to Hire First?
If we were sellers, we would hire legal counsel that is composed of experienced M&A deal lawyers first. Legal counsel is usually paid on an hourly basis, and their engagement letters are fairly straightforward. Experienced M&A deal lawyers are an essential ingredient to the deal team – sort of like electricity to a plant. The more the seller uses experienced M&A deal lawyers, the more expensive they become, but usually the seller is much better off by their active participation.
One of the instances a seller can enormously benefit from an experienced M&A deal lawyer’s advice is in the negotiation of the engagement letter with the investment banker. Investment banker engagement letters pose a number of issues that the average seller, especially a seller who has never sold a company previous to the transaction in question, may not know about, and, as a consequence, may fail to pick up. For instance, the average investment banker letter has a seller paying a commission on the closing for a part of the purchase price that the seller may receive years after the closing, and – in the worst case scenario – may never receive. There are other issues in which assistance from experienced M&A deal lawyers may be helpful, if not essential.
About the Author
Andrew J. Sherman is a partner in the Washington, D.C., office of Jones Day, with more than 2,600 attorneys worldwide. Mr. Sherman is a recognized international authority on the legal and strategic issues affecting small and growing companies. Mr. Sherman is an Adjunct Professor in the Masters of Business Administration (MBA) program at the University of Maryland and Georgetown University, where he has taught courses on business growth, capital formation, and entrepreneurship for more than 20 years. Mr. Sherm is the author of 23 books on the legal and strategic aspects of business growth and capital formation. Mr. Sherman can be reached at (202) 879-3686 or email firstname.lastname@example.org.