This year, mergers and acquisitions have made headlines, as large corporations and private equity firms use record amounts of cash to gobble up targeted firms. And companies of all kinds, private, public or institutionally held, are looking for ways to quickly enter new markets or acquire key positions in strategic areas.
Companies considering an exit strategy which involves being acquired should ensure they are properly prepared, so that they can capitalize on an offer when the time comes. Planning the exit properly can help smooth the transition process and may increase the value of your business remarkably.
When considering the future of your business and a possible exit through acquisition, besides taking a hard look at valuation, owners should take stock of certain fundamental questions, including:
• When would be the best time to sell my business?
• How much is my business worth today?
• Have I completed all preparatory steps to make my company an attractive acquisition candidate?
• Do I want a continuing role after the sale?
Once the decision to sell has been made, you would do well to conduct an in-depth examination of key corporate operations or “sell-side due diligence.” Most effective when it’s undertaken well in advance of the sale, the exercise often identifies areas that may need corrective action. The following items include some of the key matters to address when an exit is on the horizon or when you are planning a financing round.
In acquisition discussions, first impressions are important. Nothing will taint your credibility more with a potential buyer than the appearance that you don’t have your act together. It’s important to have your key legal documents in order, up-to-date and, these days, posted or ready to be posted in an electronic due diligence room.
Review your key contracts for possible breaches. Contracts are often inadvertently breached due to minor lapses like missing notices or late deliveries. Make sure that your stock options are properly documented and authorized and that the strike price of each option relates back to a contemporaneous valuation. Review prior share issuances with your attorney to confirm they track back to a valid exemption under applicable securities laws.
In many businesses, the company’s most valuable assets are its intellectual property. Therefore, it is crucial to ensure your intellectual property rights are all properly protected, registered and duly transferred from employees and consultants to the company.
That means every person who touched the code or other technology. For portions of your technology that you get from third parties, each item must track back to a license in good standing. Owners should work with counsel to ensure this documentation up to date well in advance of any acquisition discussions.
You should also have policies in place to cover the protection of trade secrets and confidential information. If you have patents, review their status with patent counsel to ensure everything is up to date. Uncertainty around any intellectual property ownership can derail transactions entirely or result in dramatically diminished valuations. Rectifying deficiencies after news of a potential acquisition has gotten out can be difficult.
Good, accurate financial statements maximize your company’s marketability. Ideally you will have a professional set of financial statements covering at least two full fiscal periods and the applicable stub period. The financials should be prepared in accordance with GAAP, consistently applied.
For larger companies, having audited financial statements prepared in advance is always recommended. Audited financials give buyers a higher level of comfort that your financial statements are reliable. They can also help uncover problems of which the owner may not even have been aware.
It’s prudent for the business to have an up-to-date business plan. A key element of creating potential high valuation is the ability to articulate the company’s future growth, strategy and prospects. Where current business is a key factor in the valuation, buyers will certainly ask about the strength and current status of customer relationships, as well as which third-party relationships would be at risk in the event of a sale. Knowing your company’s current contractual relationships in advance will prepare you to respond to these concerns in a way to maximize valuation and minimize buyer concerns about revenue loss.
Typical M&A transactions require consents from various parties. For example, if you are a manufacturing company, governmental consents may be required to transfer key operating permits. If you are a technology company, consents may be required from key vendors, customers or technology collaborators. Such parties may object to working with the buyer for competitive or other reasons. Before embarking on your M&A adventure, you should have a high level comfort that you can manage your key relationships to achieve a successful conclusion.
The one thing buyers hate most is uncertainty. Disputes arise all the time in the ordinary course of business. But buyers are often very hesitant to buy a company with active problems, and may reject the entire transaction because of even a relatively minor dispute.
Whenever possible, resolve litigation, contract disputes, employee lawsuits and fights with former partners before approaching potential acquirers. Remember, it’s not personal, it is just business. The buyer will not care if you hate your former partner, but the buyer is never going to do a deal if there is an open dispute about who owns the company.
Every seller has skeletons in its closet. Buyers know that. In general, it’s best to be up front about issues you cannot solve. Sophisticated buyers will always uncover difficult issues during the due-diligence process. And when they do, if you have not been up front about the issue, your credibility with the buyer will be shot.
Get in front of the issue. Spin the story in your favor if possible. Don’t let the buyer control the agenda. For example, we were recently involved in a transaction in which one of the seller’s initial technology licenses was about to become non-exclusive.
We took the initiative to disclose the expiring license to the buyer. But the seller was able to convince the buyer that the license was no longer critical because the company had since changed the licensed design to a proprietary design. After that, the expiring license became a non-factor in the negotiations.
Sometime during the course of the initial preparations, it will become necessary to discuss the process with employees and existing investors in the company. The nature and timing of these communications should be well thought out to assure they are not premature.
Typically, in an M&A deal, the buyer and seller will enter into a term sheet or letter of intent describing the general deal terms in advance of negotiating the definitive sale or merger agreement. The term sheet is generally not binding, but very often contains an exclusivity clause, which prohibits the company from talking to other potential suitors during the negotiation of the definitive agreement.
The seller’s leverage drops dramatically as soon as you sign the lock-up agreement. You can’t talk to other buyers any more. In addition, while terms are non-binding, the parties often rely substantially on the terms in the term sheet as evidence of agreement.
For these reasons, it’s best that you negotiate all key deal terms before you sign the term sheet. While purchase price is important, there are many other critical issues for the seller to consider, including personal liability for breaches of representations and warranties, escrow holdbacks, indemnities, employment terms and non-competition covenants. The seller can and should negotiate those items from a position of strength, at the time of the term sheet.
Overall, planning the exit properly may increase the entire value of your business. Design your exit well ahead. The sale of privately held businesses often represents the end of one chapter and the beginning of another. The quality of the new chapter can depend significantly upon whether thoughtful preparation was undertaken well before the sale process began.
David Goldenberg and Conrad Everhard are partners with VLP Law Group.