Major Steps In The Sale Of Your Company
Major Steps In The Sale Of Your Company:
How To Get Liquid Without Melting Down
Co-author: Steve Morton
The following steps are not intended to be a technical review of the sale process, but a list of some of the most important, and frequently missed or mis-sequenced, steps in selling a business. They are in chronological order, although the order will vary among transactions.
Make up your mind already!
The decision whether or not to sell sometimes should not be made until the final point is negotiated in the acquisition agreement. However, this is rare.
Normally, even the sale price should not determine whether the company will be sold. It will, however, determine the timing and the identity of the buyer. The major exception is when the seller has no idea what the business is worth and does not find out until the sale has been in progress for some time and realizes that there is not a buyer on the horizon at a fair price. Thus, credible input as to the range of company value should be obtained early.
Get professional assistance at the outset
Your professional advisors should help you determine the range of value of the business and economic terms of sale. For non-price terms, here are a few examples of matters to consider:
Your financial objectives: Can you wait an extended period to get paid? Does your personal tax situation facilitate taking income now or require that you attempt to defer it?
Your family objectives: Do you need to pass some of the wealth down now? (The sooner this is done, the better the chance of not having the gift valued at less than the sale price.)
Your company objectives: Do you feel committed to the employees to provide certain comforts as to their futures?
The company’s liabilities: Are there certain liabilities that must be absorbed/can only be satisfied by the company? (E.g., insured losses, warranty claims more easily resolved in the company?)
The company’s tax status: Does the company have a low basis in its assets, so that an asset sale could be extremely expensive? Are there any net operating loss carryforwards or current losses to absorb gains on an asset sale?
The Seller’s Preparations
Clean up of the financial statements, the minute book and the stock book are good places to start in making a good impression on potential buyers.
Resolution of disputes and litigation is preferable unless it inflicts unreasonable expense: The buyer will take out “insurance” in the form of withheld purchase price payments until material contingencies are resolved.
Usually, organization of what a buyer typically will want will facilitate getting a full offer at the outset. The best way is to get a form of buyer’s “due diligence” document request from seller’s own counsel and start assembling the documents that a buyer normally would want.
In the process of organizing for the buyer’s review, develop a method for disclosing negative information as accurately and routinely as possible.
Obtain a form of nondisclosure agreement for potential buyers to sign before getting any nonpublic information about the company.
Based upon the results of these preparations other economic elements can also be structured. For example, is the business one likely to have substantial contingent/undisclosed liabilities? If not, the seller can seek a much smaller or no holdback of the purchase price. It is not uncommon to see 20% to 50% of the purchase price take the form of deferred payments that can be offset to satisfy breaches of the seller’s representations or warranties or undisclosed liabilities.
Do we sell assets or stock?
This decision will be a byproduct of the efforts described under “Get Professional Assistance at the Outset,” and “The Seller’s Preparations” above, plus buyer's reasonable expectations (which may be affected by industry practice and manner of sale).
The sooner the structure is resolved, the less likely there will be expensive and potentially embarrassing corrective action later. For example, if a purchaser demands to purchase assets and the agreements are drawn, only to learn that certain assets, such as contracts and licenses of the seller, are not assignable. The deal then has to be reworked as a stock sale.
The Asset Sale
Involves the owner of the business selling its assets, with no transfer of the legal entity that ran the business. Typically, only those liabilities that are either specifically listed, or are incurred in the ordinary course in normal and customary amounts, are assumed by the buyer.
Most often preferred by buyers because they can (i) better avoid undisclosed liabilities and (ii) book up tangible assets (i.e., allocate the purchase price among tangible assets) however they see fit, within legal limitations, for accounting and tax purposes.
Frequently is stymied by contracts that say they are not assignable or by non-assignable, important government licenses or permits that are not readily obtainable.
There can be adverse tax consequences for the Sellers. If the selling entity generally has a low basis in its assets, there is the potential for substantial double taxation of the sale proceeds (once for corporate gain, once on distribution to the owners of seller) (unless the seller files its tax returns under Subchapter S of the Internal Revenue Code).
The Stock Sale
Owners sell their stock or other interests representing ownership of the entity that owns the business; as a result, all assets, liabilities, contracts, licenses and other rights of the business are not transferred, but beneficial ownership passes by virtue of transfer of ownership of the owner.
Sellers like it because (i) everything is moved to the buyer en masse upon the transfer of stock or other ownership interests (with a few exceptions, consents to transfer are not required as in an asset sale) and (ii) for the most part, the sellers won’t have to arrange for payment of unknown or disputed liabilities left behind in the selling entity except pursuant to indemnification obligations in the sale agreement (which can be limited by negotiation).
Double taxation on the gain on the sale of assets is eliminated.
The Tax-Free Reorg
With limited exceptions, tax-free reorganizations can be done only in transactions that are the equivalent of stock sales. They involve the sellers receiving, at a minimum, 40 to 50 percent of the purchase price in the form of the buyer’s stock.
As to the portion of the consideration received as stock, the reorganization defers taxation of the gain until the buyer’s stock is disposed of by the seller (or the seller’s shareholders).
Estate Planning
The sellers must not forget that the process they are launching may establish a substantially higher value for the company than previously was considered realistically. Therefore, measures to transfer wealth (if the seller’s owners, after consultation with their advisors, conclude such action is appropriate) should be taken while an appraiser can establish a value for the stock of seller commensurate with prior perceptions of value. Once a letter of intent or definitive agreement is signed at a higher valuation, the estate and gift tax valuation will have to move up to the letter of intent valuation (but without limiting the ability to use the minority discount concept used in family limited partnerships).
Assess the playing field of potential buyers based on “fit” and pick a solicitation strategy.
You will want to invite offers from only those who provide the best fit, assuming you can get these facts before soliciting indications of interest. Again, you may need professional assistance. Several factors are:
Availability of the consideration desired (i.e., the buyer’s financial soundness [comfort letter sometimes required] and ability to get cash; ability to deliver stock if a tax-deferred transaction is desired);
Operational strategy of the acquirer and its compatibility with your operation (for example does your product or service complement theirs?);
Reputation and track record of the potential buyer (e.g., do they tend to downsize, relocate, centralize?)
Compatible long-term objectives (revenue growth, earnings, customer base).
Once the likely list of candidates is developed (and this can be a substantial list, particularly if the company has broad markets), the seller must decide whether to take an auction approach or approach each of the potential buyers individually; (if the latter, they usually are ranked, with the most attractive being approached first). A major advantage of openly conducting an auction (with no obligation to accept an offer the seller deems insufficient), is that the seller can draft a preferred form of purchase agreement and ask the bidders to comment on the terms of the acquisition agreement at the same time they make their bids. In that manner, the seller should get a better agreement.)
Let the Discussions Begin!
As noted, potential buyers must be approached thoughtfully. Some discussions will be extremely delicate and will require the use of intermediaries. For example, in some instances, the most likely buyer will be a direct competitor. The nondisclosure agreement must be signed before any information is exchanged. Execution of a nondisclosure agreement can be complex in businesses with substantial amounts of proprietary market or research data.
Selection of the Winner and Letter of Intent
The “winner” must be identified after either successive approaches or an auction. If the seller is held by owners with common objectives (such as a family) the process of selecting the winner is easy. The process is more complex where there are varying objectives, such as when one shareholder has relatives employed by the seller who may lose their jobs, depending on which buyer is selected. Other potentially competing objectives are cash needs versus tax deferral and willingness to accept buyer’s stock or notes.
Once a winner is selected, a letter of intent should be prepared; from a seller’s perspective, the more detail in the letter, the better, because you have a better opportunity to avoid unreasonable demands in the definitive purchase agreement if you have addressed the point previously.
Some of the points frequently addressed are:
- Structure
- Asset sale, stock sale, merger
- Tax planning
- Liability planning
- Accounting
- Pricing
- Earnout/Holdback/Escrow/Kickers
- “No shop”
- Confidentiality
- Basket or cap
- Breakup fee
- Conditions to closing
- Non-binding
- Expense sharing
Your attorney and/or other M&A advisors must review this document before you sign it or you run a significant risk of having your head handed to you on a platter when the final documents are drafted.
Negotiation of the Definitive Purchase Agreement
Counsel will advise the seller on how to negotiate the final, or definitive, agreements. Most definitive agreements are prepared by the buyer’s counsel and will require substantial negotiation to assure the seller does not retain excessive exposure to claims from the buyer after the closing.
As noted earlier, in some auction scenarios the seller can specify the form of purchase agreement and required bidders to provide all requested changes along with their bids.
Occasionally, a transaction will die at this stage as the purchaser learns that the seller is unable or unwilling to make certain representations. That is the principal reason why the seller should include the bad news along with the good during buyer’s diligence process.
In addition to representations, the parties agree to their respective conditions to their obligations to close the transaction. For example, some transactions will require that certain consents be obtained prior to the closing, or that the buyer’s diligence be completed without uncovering any breaches of the seller’s representations. Occasionally, the transaction will be structured to sign and close simultaneously.
Announcement to Employees
When employees hear that their company is being sold, insecurity normally sets in immediately. Thus, as a general rule, whenever any employee is told about the sale, it is best to describe the employee’s go-forward role as best it can be done under the circumstances.
As a general rule, a sale should not be announced to the seller’s employees until at least the letter of intent is signed. Sometimes, the announcement is not made until the definitive acquisition agreement is signed or the transaction is closed. These delays are often necessary to minimize distraction to the work force and maximum opportunity for the buyer and seller to reach an understanding about the future of the company’s employees. Under federal laws, at least 60 days’ prior notice of employee termination must be given if a substantial reduction in force is involved.
In all transactions, at least some key employees must be made aware of the transaction so that the buyer can get its diligence completed. These employees, plus outsiders, must be carefully instructed as to how to communicate confidentially with the seller. Faxes frequently are a problem.
Frequently, when the long-term status of employees cannot be assured, an interim retention program is implemented, such as “stay bonuses” for key personnel who can stay through the transition period.
Announcement to Customers
This normally is done when the general announcement of the transaction is made to employees. It obviously will need to be in the tone desired by the buyer, which in most cases will be extremely positive. Planning to allay concerns of customers must start when the deal is conceived, because if they can’t be made comfortable, the seller has nothing to sell.
Frequently, at least some customers will have to be approached before the deal is completed, either to obtain legal consents or to give the buyer comfort as to the extent of the customer’s commitment to the company as a vendor.
Closing
When the conditions set forth in the definitive purchase agreement are satisfied, the parties will actually transfer the purchased assets or stock in exchange for delivery by the buyer of the closing date consideration. If a transaction has been properly prepared for closing, this process often is more logistical in nature.
The closing can be tense when there are substantial time pressures and/or it is unclear that one or both parties are capable of satisfying the conditions to the other party’s obligation to close the transaction.