In prior chapters, we’ve discussed how to get ready before starting negotiations to buy or sell a business.
Now it’s time for the first meeting (or two).
The First Meeting
Both buyer and seller should think through very carefully, in advance, what they are willing to disclose to help establish mutual interest. For instance, the seller may be willing to disclose overall revenue numbers, but not profitability or who the company’s best accounts are.
Until mutual interest is established, a Confidentiality Agreement is generally not signed and confidential information is not exchanged. Hence the first meeting may not include an exchange of confidential information.
Although confidential information may not be exchanged at this point, the first meeting is very important.
At this meeting, a seller should be able to clearly explain to a potential buyer:
· Why the seller’s business is for sale?
· Why now?
· What is most important to the seller in the sale transaction?
· What the seller will do to help the buyer post-sale?
Likewise, the buyer should be able to clearly explain to the seller at that same meeting:
· Generally speaking, what is most important to the buyer in this potential acquisition?
· What makes the buyer a strong potential candidate to buy this specific business?
The first meeting is generally NOT the time to talk price. Instead, we recommend starting with only a general discussion of the items above.
Set the Basic Rules For the Negotiation
If the initial discussion goes well and a possible sale seems likely to be worth further discussion, then it’s helpful to set some basic “Rules” the parties intend to follow during the negotiations. Nothing can guarantee success, of course, but following these basic rules will greatly improve the odds:
Rule #1: Win/Win negotiating.
Both sides must believe the sale will be a mutual “win” for them. Never let negotiations become a contest to see which side “wins”. In almost every case, BOTH sides will lose as soon as EITHER side believes they have “lost”.
It is rare for a buyer to feel they simply must buy the seller’s specific business. Most of the time, a buyer can simply walk away if the proposed sale becomes a “lose” for the buyer.
Likewise, few sellers feel they have only one potential buyer. Even if only one potential buyer is currently at the table, the seller often has the option of simply not selling. Even in those situations when it seems the seller simply MUST sell to one specific buyer, your authors have encountered many prospective sellers who would rather shut the business down, than feel like a “loser” in the negotiations.
Even if circumstances are such that the “loser” decides not to withdraw from the negotiations altogether, there will almost certainly be multiple ways the “loser” can try to even the score. Everyone loses once this kind of thing starts, including the side that thought they “won”.
Rule #2: The sale must “work” for both sides.
Both buyer and seller should agree to cooperate to improve the overall aggregate tax effects of the transaction for both sides.
The seller should cooperate to structure the sale in ways that will “pencil-out” for the buyer. If the sale must be an “all-cash deal”, the seller should recognize the buyer must still justify the money spent based on the cash flow the buyer expects to be available.
Rule #3: Both sides will control their respective professional advisors.
The technicalities of the sale of a closely held business can be very complex. Both sides are likely to need their own attorneys and CPAs and perhaps others to be involved in the process.
The principals involved in the negotiations on both sides need to insist that all of their respective advisors respect rules #1 and #2 above. Your advisors know more about the technicalities than you do, or you would not need them. They will want you to get the “best” deal you can, and sometimes work a little too hard to “improve” on the results the buyer and seller have been negotiating. Although your advisors are virtually certain to find a few things to argue about, don’t let their discussions about the fine points of a deal turn a win/win into a win/lose.
Your advisors do not know as much about your specific business as you do, and they will not be the ones living with the results. This material will help you become an “issue spotter” even if you are not an attorney or CPA. And although you may not know all the technicalities, you are likely to know more than many professional advisors do about the practical side of buying or selling your specific business.
The cliché about “deal killer” attorneys or CPAs can easily become more than a cliché. It is the opinion of your authors that trying to get the last 2% out of a deal is absolutely not worth the damage that pushing for that last concession may cause. In particular, letting an advisor talk you into changing something that the principals have already agreed on with a handshake can be quite damaging to the overall negotiations.
Attorneys often prove to be in love with their documents, and they love to make revisions to the other side’s revisions – and so on and so forth, often costing many thousands of dollars in wasted legal fees hassling over style points that really don’t matter in the overall scheme of the deal. Without direction from you, they can easily end up “majoring in the minors”, with their precious documents taking on a life of their own. They are not businessmen, and often behave more like professional gladiators. Tell your counsel in advance that that’s not what you want to happen, and that you will terminate their services if you feel it’s going in that direction. In fact, it’s often advisable not to use the services of your usual attorney who helps with your estate planning or zoning issues or trial work; instead, ask around to find an experienced “transactional” attorney whose main focus is doing business deals, hopefully having done hundreds of these. After all, they specialize just like you do within your industry – so a general practice attorney can rarely match-up against specialized transactional counsel.
The same applies with CPAs. For example, most CPAs have no business doing valuations of businesses; but virtually all of them will tell you they can do it. Just like specialized legal counsel, you need a CPA or comparable valuation expert who has credentials and/or extensive experience not only in business valuations if that is part of what’s needed in the deal, but also with broad tax background in business purchases and sales who can advise you on the optimal structuring of your deal. There can easily be tens of thousands or even millions of dollars left on the table merely because of the way a business sale is structured.
The bottom line: Professional advisors are absolutely necessary in the purchase and sale of virtually any business; but you need to use them wisely and control them.
Still Too Soon to Talk Price
· Have a meeting of the minds regarding the way negotiations will be handled, and
· A substantial amount of confidential information has been exchanged, and
· The buyer has had a chance to assess the overall situation,
Talking “price” is premature.
Talking “price” too early in the negotiations can lead to expectations that are too high or money left on the table if things end up looking better than expected. Either one can kill what would otherwise have been a successful sale.
Therefore, once the buyer and seller have mutually decided that proceeding to the next step is justified and the basic “rules” for the negotiations have been agreed upon, the next step is for the buyer to sign a “Confidentiality Agreement”.
The buyer will need to see a lot of sensitive and confidential information before deciding if even making an offer is really justified, much less what that offer should look like. However, the seller should not let this very sensitive and confidential information be seen unless the buyer is willing to commit in a signed writing to keeping it strictly confidential.
This is a normal and reasonable part of all business sales. It is so basic that a buyer who will not sign a reasonable Confidentiality Agreement should not be considered a serious buyer. These agreements are generally considered simple and straight forward, but that is not always the case.
A well prepared buyer or seller may even bring to the first meeting a Confidentiality Agreement they consider acceptable. Because these are such a standard part of a closely held business sale, it is common for a buyer to sign this type of agreement on the spot if they have in mind to push hard to close a transaction. That is not always wise. It is perfectly reasonable for a buyer or seller to want the Confidentiality Agreement to be looked over by their attorney first.
A typical Confidentiality Agreement will bind the buyer and sometimes even the advisors the buyer chooses to share the information with. If the buyer is an individual, this is often all that is needed. If the buyer is a separate entity such as a corporation or an LLC, then this is not always broad enough. The key employees of the buying entity should also execute the Confidentiality Agreement personally if they are potential competitive threats to the seller, and the buyer entity should take responsibility if such an employee violates the agreement.
When a closely held business is sold, it is common for the buyer to be another closely held business. If that is the case, it may make sense for the mutual Confidentiality Agreement to also bind the owners of the buying business individually as well as corporately.
Note: Providing confidential information without insisting on an agreement to protect that confidentiality could jeopardize the legal status of the information. The seller could accidentally have turned confidential information into publicly available information that can no longer be legally protected at all.
Reciprocal Confidentiality Agreement
The seller is quite likely to be asked to offer seller financing for part of the purchase price. If so, the seller is perfectly justified in asking for information sufficient to justify extending credit to the buyer just as a commercial lender would do. Depending on the information requested, it may be perfectly appropriate for the buyer to insist on a Confidentiality Agreement covering that information before providing it.
Another very useful route if the prospective buyer is reticent to share personal financials, is to have the buyer provide all such information directly to the seller’s CPA instead of to the seller, with a written agreement that the CPA shall not share that material with anyone else, but will simply evaluate the buyer’s credit worthiness on this prospective transaction and then return all such confidential materials directly to the buyer and simply render an opinion to the seller as to credit worthiness. Your authors have rarely encountered a prospective buyer who refused such an arrangement.
Information Needed, and When
Once a Confidentiality Agreement has been signed, the seller can then begin collecting the information needed to assess the opportunity prior to making an offer. The information needed at this stage is not as extensive as will be needed to complete the buyer’s due diligence later in the process.
Since no two sales are exactly the same, it is not possible to create a practical checklist of what information to collect regarding the selling business. The typical minimum requirement at this stage includes five years of financial data, including both internal company statements and company tax returns, copies of any key employee non-competes, plus whatever extra information may be needed based on specific company details.
The representations and warranties ("rep's & warranties") in almost all Purchase & Sale Agreements require the seller to proactively disclose all material items. This is going to have to be done sometime during the process, and we recommend sellers voluntarily disclose every item the seller thinks may be material early in this process. The buyer can then decide what additional information will be needed prior to making an offer, and can incorporate the results into the offer.
Buyers will often walk away if they conclude that a seller has been trying to hide something material, and failure to disclose a material item which the buyer does not discover until after a sale is consummated can be cited later as grounds to rescind the entire transaction. Withholding key information about the company will almost always backfire on the seller, sometimes in devastating fashion.
This is also the time to bring up all items the seller considers essential to an offer. Leaving sensitive items until late in the negotiation process in hopes that momentum will carry the day when they do eventually come to light is a high risk strategy and basically a waste of everyone's time.
Much more information will be needed to complete the buyer’s due diligence if an acceptable offer is ultimately made. This will be discussed at length in a later chapter.
The Price is NOT the Price
At this point, an offer is not yet on the table; but both buyer and seller should be consulting their respective professional advisors. The way a sale is structured can have an enormous impact on the final results, and it is much easier to avoid pitfalls if your advisors are included early in the process rather than consulting them at the 11th hour and discovering that you’ve made some serious mistakes in how you’re approaching the transaction. It can be extremely awkward to have to back-up and correct these, can seriously disrupt the momentum of your deal, and sometimes even kill it completely.
Taxes. In the wrong circumstances with a poorly designed sale, the combined taxes on the buyer and seller can easily exceed 50% of the overall available cash flow from the business. It is quite common for your advisors to be able to restructure the sale in ways that greatly reduce the overall tax burden.
For example, some of the total “consideration” for the sale may be allocated to an agreement by the selling shareholders personally (as contrasted with their corporation) not to compete with the buyer after the sale. This is likely to have tax as well as legal effects, and can often result in lower overall taxation on the sale. Post-sale employment can also be a major tool to help improve the overall sale. It must be “real work for real pay”, and cannot be sham “employment” of the former owner.
In some cases the oddities in the tax code make it possible to LOWER the price and simultaneously improve after-tax cash flow for both sides. A lower price and better after-tax cash flow can be a win/win/lose (the loser being the IRS).
Risk. Risk can be even more important than price. Most sellers could reduce taxes by not being cashed-out, but are afraid they may not get paid if they don't get all their cash at the front end.
Most buyers would be willing to pay more if they were confident they would succeed. It is common to see a variable price formula-based “earn-out” that pays the seller more if future results of the purchase are good.
Terms. The payment terms are the key to reducing taxes and risk. Creative terms can easily end up more important than the supposed “price”.
Letter of Intent
The culmination of this phase of the negotiations is normally memorialized in what’s called a non-binding “letter of intent” or “terms sheet” outlining all of the key elements of the proposed deal. We will discuss these further in later chapters.