Negotiations

Buyer/Seller Meetings, Management Meetings: All Good

April 17, 2014 By Ney

I really enjoy buyer/seller meetings, also called management meetings by M&A folks. Before the meeting there have been calls, questions answered, valuation dances, and a stream of documents delivered. But until the sellers and potential buyers meet face to face, you really have no idea how it will turn out.

Great potential buyers can turn into aggressive jerks and so-so buyers turn out to be princes. Private equity buyers can frustrate sellers by focusing on earnings, customers, inventory turn, etc. while strategic buyers can frustrate sellers by knowing “too much” about their industry.

I just spent a day and a half with a potential buyer that was so serious about the potential purchase, we decided to go ahead and spend that amount of time with him. Typically I’d allow a buyer about 4-6 hours max for a meeting, and say that we could spend more time after we had signed a letter of intent and entered into due diligence. In this case, the buyer was a real gentlemen and the meetings went well.

It was a gamble that paid off, as he turned out to have the highest offer and we did indeed sign an LOI with him.

Not only that, but this deal is in Washington state. I flew myself up for the meeting in my plane, and on the way back I took a detour over the mountains of Washington. Here is the video of that flight:

Deal Closed – Seller’s move away

August 17, 2013 By Ney

Typically for multi-million dollar deals there is a substantial (months or years) transition period for the seller to stay around to make sure employees and customers are comfortable and don’t leave. I typically spend some amount of time working with sellers and buyers to make sure expectations in this area are reasonable on both sides. But it typically ends up being months or years.

But not always. Last year I sold a company where the owner had a great “number two” person that could obviously bring continuity to the transaction, and the owner was able to immediately leave. And leave he did, taking an around-the-world trip with his family.

Then, interestingly enough, the very next deal involved a seller that had a health problem and he wanted to also leave immediately after the deal closed. And leave he did, moving a few states away to a drier climate.

A deal I’m working on right now is mixed. There are two owners and one wishes to leave immediately (and it looks like that will happen), while the other is somewhat younger and will stick around a number of years.

What to do with Cash and AR – Asset vs. Stock Sale

August 27, 2012 By Ney

I received the following question via email:

Ney,

How do you typically treat cash in a stock sale vs asset sale. A rule of thumb tells me that me on asset sales, the seller typically keeps his cash and receivables, but not always. How about on a sale of 100% of corporate stock, what happens to seller’s cash. The buyer is buying assets and liabilities, and does that meant, that seller’s cash on the books is transferred to buyer? Please let me have your opinion on this matter.

As always, thank you for your input.

Jack (I changed the name – a little)

Jack,

It depends on size of company, not really asset vs. stock (although small companies are often asset sales). Smaller deals are typically structured so that the seller keeps cash and AR.

Larger deals, especially ones that use EBITDA for the valuation metric (typically $500K in earnings and above), are typically sold with “gas in the car”. That is, they are sold with enough assets to produce the EBITDA that was advertised. This includes current assets like AR and enough inventory. It also includes payables, but not long term debt. Some buyers insist on some cash as part of current assets, others do not. In any case, it is usually not all the cash – just enough to operate the company.

Often a buyer (having already set a price) will calculate a Net Working Capital value that must be present at close. NWC is current assets minus current liabilities (pretty much cash, AR, inventory less payables). Usually this is calculated by taking the past 12 months of balance sheet snapshots and taking an average (and negotiating). This NWC number then “puts a stake in the sand”. The seller can’t then reduce inventory, aggressively collect AR or do anything that reduces the normal NWC before close. On the other hand, if sales go up and AR goes up before the close, he gets credit for that.

How does that work exactly? Well, another “true-up” NWC calculation is done based on the closing date, and is usually done within sixty days. If the NWC is above the target (AR went up, inventory went up, payables went down, etc.) then there is a purchase price adjustment upwards and the buyer would owe more money (or the seller takes home more cash). If the NWC true-up calculation shows that the NWC at close was below the target (AR was down, inventory down or payables up), then there would be purchase price adjustment downward. More cash would have to be left in the company, or money would be taken from a holdback escrow account.

This all makes sense too if you think about it. For example, if a seller accidently pays off ALL debt, including accounts payables, before close, the NWC calculation would show that the buyer would owe him for that, because that was part of the WC calculation. On the other hand, if the seller calls up a few large accounts to get them to pay their bill before close, the average AR would be down and he would be dinged on the purchase price.

Why would a buyer care so much about about AR and inventory? Because they expect to have paid a certain price for the company, and if inventory and AR are down then over the next 60 to 90 days the buyer will discover that he actually paid more as AR and inventory come back up to normal levels.

This can be a big deal, so it is usually wise to address NWC early so the seller knows what is expected at close.

So…to get back to the original questions. You have a price and you have a NWC target for close. Then, whether asset or stock sale, you make it happen. That is, you create the purchase price allocations for an asset sale, or a stock price calculations for a stock sale. But the basic purchase price and net working capital calculations are the same.

(Having said that, Asset vs. stock sales can profoundly change the tax impact of the buyer and the seller. So often the purchase price is indeed different, based on taxes)

Hope this helps, Ney

Earnout Series: How to Tell if an Earnout is in Your Future

March 21, 2011 By Ney

Some of my clients tell me they would never accept an earnout, but then go on to say how they believe the historical earnings don’t tell the whole story and that a buyer needs to believe the company will grow in the future. In other words, pay more. Unfortunately, many buyers will say, “I don’t quite believe you, prove it”. And that’s an earnout. Here is how to tell if an earnout makes sense when you sell your business.

When are Earnouts used?

An earnout is contingent future payments based on performance milestones. For example, in a simple earnout arrangement an extra payment of $100,000 to the seller may be “earned” by growing the company by an additional $1 million in revenue in the 12 month period after the close of the transaction. Earnouts are used when there is a difference of opinion on what the earnings will be in the future. The buyer says, essentially, “show me”. Earnouts are well known in the technology sector; however it really has more do with high growth scenarios than technology.

Business are Bought for Future Earnings

In looking at Earnouts, it is useful to remember that what a buyer really cares about are future earnings. Since we don’t know what future earnings will be, we generally use historical earnings for valuation. Earnout discussions naturally arise when there is a significant difference between historical earnings and future projections.

Let’s look at a few scenarios of historical vs. projected earnings.

Scenario One – Stable Earnings

This company has a stable history and a believable projection. It isn’t hard for anyone to believe that projection. In other words, the risk is fairly low, and the seller should not expect an earnout.

The purchase price in this case should be comprised of cash and possibly a note, but unless there are other risks, the note shouldn’t be contingent on revenue or earnings – and there should not be an earnout.

Scenario Two, Supported Growth

In this scenario it is also easy to see where earnings are heading – up. In other words the projection of future growth is clearly supported by historical trends. However there is often some discussion about who is going to benefit from the growth. A seller may say, “You can see what will happen, so I want to base the purchase price on a high multiple, or possible use next year’s earnings”.

A buyer, on the other hand, may say that if the company grows, it will be because of his effort after he buys the company, not the sellers. After all, he certainly isn’t buying it to give all the earnings to the previous owner.

A smart seller will counter this by explaining that much of the future growth is because of the foundation he has built. The website, reputation, product, service, etc. have all come to together to build momentum that would be difficult to stop. However, what he is also saying is, “Just trust me on this”. No one likes to bet hundreds of thousands or even millions trusting someone you recently met, so earnout discussions start.

In this type of scenario, an earnout could look like the following:

A “base price” of cash and notes is calculated using historical performance, and an earnout is structured based on the company hitting certain targets. The target may be a revenue or earnings milestone or just about anything that makes sense. The next blog post will cover typical earnout stuctures.

Scenario 3, Unsupported Growth

We often (too often) see a scenario where the company doesn’t really have an upward trend, yet the business owner believes there could be a lot of growth opportunities. For example, the owner may say, “I never got around to putting up a website but if you built a website and sold products online, sales would double.” In this case the buyer does have a pretty good case to say, “Well, if I spend the money and time to build the website, then I should enjoy the rewards”.

Sometimes we can negotiate an earnout in this type of scenario, but it really depends on the situation and why exactly the seller believes growth is inevitable.

Scenario 4, Recession Proofing a Transaction

Although earnout agreements are mostly seen in growth companies, we’ve also seen it a few times in protecting the buyer from further decline during the recession. Many companies have seen a retraction of sales and earnings from the time before the recession, and that is just fine with buyers – as long as the performance has stabilized. We’ve seen buyers, fearful of further decline, set a purchase price on a lower “base” number, then set up an earnout target of simply staying put. In other words, if the business does the same in revenue and earnings in the future, then additional payments are made to the seller. If the business slides some more, then the seller gets the “base” price that was somewhat lower.

In the next few blog posts, I’ll cover how frequently earnouts happen, and how they are typically structured.

Business Buyer Meet Business Seller

January 25, 2011 By Ney

We have packaged the company, marketed it, screened potential buyers, received a number of offers and conducted conference calls. Our M&A process is designed to allow the business owner / seller to able to continue running his business while we manage the flow of potential buyers. But we can only do so much. Now its time for the critical buyer / seller meetings.

We spent a week in a small town conducting management meetings with potential buyers. Usually it doesn’t take an entire week, but traveling to this small town wasn’t that easy, so we had to be flexible and allow potential buyers enough time to visit with the company. I think everyone is a little apprehensive before a visit. The seller certainly is, as this is something that typically happens once in a lifetime and every step in the process can produce some anxiety. I’m a little anxious because to this point I’ve been a match-maker representing the seller, so I hope I’ve done a good job and that the buyers and seller will get along. The potential buyers at this point have put in a lot of time and effort, so they are likely a little anxious that they can make a good enough impression so that they end up with the business.

By the end of the week we knew that the visits went well. Two of the buyers mysteriously seem to have switched personalities on the plane trip out, but not in a negative way – just in an interesting way.

So what goes on in a meeting? Well, it depends on the type of buyer (strategic or private equity PEGs) and what the immediate concern of the buyer is, but they typically go like this:

How’s the weather, the trip and your kids.
The buyer usually goes first, and provides an introduction of their firm. Sometimes strategics don’t understand the value of selling themselves, but PEGs do and will typically spend some time differentiating themselves from other PEGs. For my part, I listen and make sure that a few key points get brought up. With PEGs I’ll make sure they address their source of funds, investment timeline, type of companies they invest in, etc. By this time I already know the answer, but I’ll ask anyway so that they will discuss it in front of the seller. (I already know the answer because by this stage in the game I don’t want the buyer’s answer to be, “Well, I don’t have a dedicated fund or really any money at all. I’m hoping to get a term sheet signed and then I’ll shop that around to hopefully raise money. I’ll then be the CEO of the company because this is the only way I can get a job”.)
I like the seller at this point to do a presentation, one they may do for a potential customer. Prior to this a buyer may be focusing on financials or other hot-spots, but at this point buyers are trying to understand the full range of products, services and what makes the company special.
The visit usually then drops into what the buyer is concerned about. For a PEG it may be market size, growth opportunities or competition (In other words, can they really grow it and sell it?). For a strategic it may be manufacturability and how the two sales forces can work together (In other words, are those strategic synergies really there?).
There are usually some additional information requests that come out of the meetings, and we note these. Sometimes critical issues come up, like the accounting numbers don’t actually add up (it happens). Then we scramble to figure it out.

It is obvious during the entire visit that the two parties are sizing each other up. The buyers are asking questions I’ve heard them ask before. They don’t care so much about the answer, they just want to hear how the seller explains it. I can tell the seller is bouncing between the monetary aspects (will I get enough?) and questions they have about employees and how the acquisition may benefit the company’s ability to sustain itself and grow.

Come to think of it, I’ve never (knock on wood) had a buyer/seller meeting turn ugly.