|
Now that both the stand alone
(fair market value ) and synergistic (investment value)
have been determined, it is time to get to the real action
….. making a deal. Price can certainly be affected
by deal terms:
• Amount of Cash
• Stock Sale vs. Asset Purchase
• Covenant not to Compete
• Alternatives to Provide Seller Value
• Seller Financing / Collateral and Security
Agreement
Bridging
the Gap
What do you do when buyer and seller professionally and respectfully
disagree about the value? First, look to the deal structure
and the after tax net proceeds available to the seller. Under
different assumptions and allocations (capital gain vs. ordinary
income; single level tax vs. double taxation) consider different
structures that are tax efficient to buyer and seller to bridge
the gap. The after tax net proceeds amount is usually a smaller
gap to bridge than the actual purchase price itself. After
all, it is net realized amount that is the true measurement
of price to the seller.
When deal structure is not sufficient to make the deal, an
earnout might. Usually defined as a percentage of an important
measure of value to the buyer, the earnout is really the opportunity
for the seller to “prove it”.
•
% of Revenues in excess of base for unmatched expectations
• % of EBITDA when free cash flows is most important
(leverage)
• % of Buyer Net Income and % of
Seller Net Income (if competition for future capital and resources
is an issue)
Most important to any earnout agreement is the definition
of terms. What does the term profit mean? Before or after
taxes? Before or after year end bonuses? Should there be limits
on the amount of overhead that can be allocated? Is the calculation
pro-forma? If so, attach a detailed example. For that matter,
any earnout calculation should have an example in the
Exhibits to the Definitive Agreement.
Allocation of the Purchase
Price
If the transaction is an asset sale/purchase, one
of the very first things both buyer and seller should do is
prepare a Preliminary/Draft Purchase Price Allocation even
if the purchase price is not yet fully developed or determined.
The purpose of the draft allocation is to understand the concepts
and taxation of the planned transaction as both buyer and
seller see it. Form 8594 is required by the IRS and is an
excellent tool to start these discussions. From experience,
it is a wonder how many parties can get agreement on price,
terms, financing, etc and even talk to each other about the
concept of allocation without really dealing with the allocation
and related taxability in detail, up front. Not understanding
the purchase price allocation can be (and often has been)
the source of a failed transaction and hard feelings at the
end of deal negotiations. Be aware !!!
Employment Agreements
Used by buyers to assist in the transition of value from buyer
to seller and to allocate value to the seller (tax deductible
to buyer; ordinary income to seller), employment agreements
can either reflect true market value for services or pay “disguised”
purchase price proceeds on a tax advantageous deductible basis
to buyer. The theory centers around fair market value compensation
for services to be rendered.
For lots of other reasons, employment agreements are also
very important to sellers. Besides compensation and allowances
for employee benefits, participation in stock options, vacation,
etc., it is also the employment contract process that is used
to “guarantee” continued employment. It is customary
that employment agreements “protect” the seller
from unwarranted termination. Such contracts are usually for
a term certain, the seller cannot be terminated except for
moral reasons and provision is made for payment in full if
both parties agree to terminate the contract at an earlier
date.
Collars
and Packaging Adjustments
When a buyer purchases the shares of a company
it also purchases the “current position”. That
is, working capital (defined as current assets less current
liabilities) is part of the value of the company. However,
the current position is often added to the value and then
“guaranteed” by the seller of being within a range
(say 15%) of the agreed value at the closing date.
| |
Example: Company A has had an average
working capital balance of $1,500,000 for the last two
years. The value is added and considered as part of
the value exchange for a purchase of all of the outstanding
common shares of Company A. As part of the Definitive
Agreements, a “collar” is negotiated that
says if working capital is less than $1,350,000 a reduction
in the purchase price will result. Similarly, if working
capital is more than $1,650,000 additional consideration
will be paid.
|
|
Collars also extend to the price of buyer shares sometimes
used to purchase the outstanding shares of the target (seller).
That is, in a stock for stock purchase, a price will be set
for the shares of the buyer being exchanged for those of the
seller. If, at the date of close, the price of the shares
is “out of the money”, that is, lower than a previously
agreed price, then buyer or seller (probably both) can terminate
the transaction. The stock price collar goes both ways (a
price less than agreed and a price more than agreed) for fairness
reasons to both buyer and seller.
Not all transactions are stock purchases. There are also asset
purchase agreements. In an asset sale, the assets included
in the purchase generally include what is needed for the buyer
to assume and then continue operations. Generally, sellers
retain cash and receivables and pay off accounts payable,
interest bearing debt, etc. Debt assumed by the buyer is really
an increase in the purchase price and additional consideration.
Sellers should be mindful to add the “selected”
assets to the transaction value and carefully exclude those
assets not meant to be sold as an Exhibit to the Definitive
Agreement. Buyers should be aware of the short and intermediate
term financing needs (45-60 days) to start new operations.
Events
Subsequent to the Planned Transaction
As important as it is for sellers to focus
on the transaction at hand, it is a prudent seller who also
thinks about the future. What if the buyer is later acquired
or merged? Usually called change in control it is not unusual
for sellers to have their entire purchase price consideration
come due and/or even the original price increased if the buyer
has a change in control within a 24 to 36 month period. If
the subsequent transaction is done at values greater than
given in the original transaction, the difference can be measured
and added to the original deal.
Stock for Stock Transactions
If the seller is to receive shares (rather than cash) in the
sale, it is important that the seller understands the rights
that accompany the shares received. Are there bring along
rights (similar to change in control provisions) that allow
the seller to have the shares already received to be “brought
along” in a subsequent transaction…….to
the public capital markets or another business combination
of some type. Similarly, put rights are most valuable
and important to sellers who take stock in a transaction.
That is, can the seller require the buyer or capital markets
to buy the shares and, if so, in what amounts, at what price
and at what terms? Obviously, the marketability of the shares
(the put right) would increase the value to the seller (now
holder) of the securities.
Timeline/Sequence for a Transaction
| |
|
|
|
| |
Prepare
Company for Sale |
|
|
| |
Normalization Adjustments
Corporate Records
Contracts
Bank Financing
Security Agreements
|
|
|
| |
Prepare
Selling Memorandum |
|
|
| |
Executive Summary (Revenues, Gross Profits,
EBITDA, summarized)
Detailed
|
|
|
| |
Interview
/ Hire Transaction Assistance |
Series
B |
|
| |
Circulate
Selling Memorandum |
|
|
| |
Terms, Conditions, Timeline Confidentiality
Agreement
|
|
|
| |
Letter
of Intent |
Series
C |
|
| |
Strict
Outline
Due Diligence
|
|
|
| |
Definitive
Agreements |
Series
D |
|
| |
|
|
|
| |
Closing
the Deal |
Series
E |
|
| |
Sensitivity Analysis
Working Capital Effect
Sample Earnout
|
|
|
| |
Series
A |
| |
Normalization
Adjustments Analysis |
| |
Series
B |
| |
Transaction
Advisory Services
Engagement Letters |
| |
Series
C |
| |
Letters
of Intent |
| |
Series
D |
| |
Definitive
Agreements |
| |
Series
E |
| |
Closing
the Deal
and Sensitivity Analysis |
|
|
|
|
