Corum is the world’s most successful advisor to the sellers of privately held software and IT companies. We have advised on over 300 transactions and created over $7B in wealth – and that is all we do.
Most of us only get one chance to sell our company and the way the deal happens and the deal value can determine the fate of the shareholders and their families for life and sometimes generations. So getting the sale right is really important.
Sellers are normally doing this transaction for the first time, but buyers do this for a living. Without help, it can feel you’ve brought a knife to a gun fight.
In other blogs, we have discussed how deal structure and tax considerations can be almost as important as deal value. We also talk about how creating an auction process with multiple interested buyers can create the “fear of missing out” circumstance that can drive up value.
In this blog post, we will talk about how sellers can get the buyer to pay more than they might initially be inclined, once the preferred buyer and the basic deal structure have been agreed upon.
Earnout is often the most common way to bridge the gap, and it can be a fantastic way to do so. This is where the buyer and seller agree on a base price but the buyer agrees to pay more if the seller accomplishes specific things after the closing of the deal.
When it comes to structuring the earnout, the period must be short. Going over 2 years can cause some serious dysfunction in the company as people and markets change.
You must also ensure that the goals and objectives set for the earnout can be clearly defined. Whatever goals are picked must be aligned with the company. If they are not aligned, then this may make the company again dysfunctional or create animosity between the acquirer and the acquired.
If you are considering this, make sure that the buyer is open to the idea early and be careful to set expectations early. If you are projecting a “hockey stick” growth post-acquisition, be aware that those numbers could become your target so be realistic.
Post-acquisition the seller normally has less control over their company, so the buyer can often (and sometimes unwittingly) create barriers to the seller meeting their targets. This is where a good advisor can come in handy and created specific wording in the Definitive Agreement to cover this consideration. Failure of the buyer to manage their end of the deal can trigger the balance of the earnout.
Some advisors write their comp strategy so that they only get paid when the client gets the earnout. I like that alignment as it keeps the advisor in your corner post-acquisition.
While an earnout can be incredibly valuable, it can also be a little bit risky. As a seller, you will want to try and get as much cash as you can upfront and then see what the earnout can possibly be for your company.
A less risky form of bridging the gap is deferred payment. This is usually seen in very large deals or in smaller deals with a buyer who is buying the business from his cash flow.
This is another conversation to have very early on in the negotiating process. This conversation should include ensuring that a buyer actually has the means to pay you. Deferred payment is still not as good as cash at the close, but it can be a good way to get a little extra value out of the deal.
When creating an agreement of this kind of payment, there need to be provisions in the case that the buyer fails to pay. This can be the return of the business to the original owner or taking a share in the integrated company or many other things. What makes the best sense will depend on the companies and the individuals involved. A good advisor can make a difference by helping point you in a direction that makes the most sense.
Patents, trademarks, trade secrets, copyrights, and other intangible assets are becoming more valuable to some buyers. Finding and valuing these assets can be a good way to work up the price.
This will be something you will want to talk about during the negotiation process and can be a tool leveraged after an initial offer is made by a buyer. Some intellectual property will be more valuable than others and the value will depend on the company that you are looking at as a potential acquirer. Knowing how to leverage this information can be difficult if you are starting an M&A process for the first time so look for advisors that have expertise in this area.
Keeping Your Deal
One little-discussed consideration is keeping the deal you thought you had.
The sale process is long and can be a distraction for the seller. In many cases, the selling CEO is the “Chief Sales Office” and months of negotiation and Due Diligence can be a big distraction. When the buyer made you an offer based on your sales projections, then 6 months into the transaction closing those predictions are not being realized because senior people are distracted by the process, you might hear, “We still really like your company, but given the poor results we can’t pay what we originally said.”
There are a couple of lessons that can be learned from this experience. Sometimes the attempt to not pay what was due is a way for a buyer to try and negotiate down the price. They don’t want to lose the company, but they want to see if they can lower the price. You need to stay focused on the business during this time – let you advisors carry their share of the load.
Working Capital Definitions
Another way that you might be able to find extra cash in the deal is by looking at how you’re defining excess cash. Excess cash can be taken out of the company by the seller before the close, but there are so many definitions out there as to what that means. As you’re working on the agreement, you may be able to create a definition that allows you to still pull some cash out of the company before it closes and therefore improve the amount of cash at closing.
Receiving all cash at the close is the best way to go always, but if there is an expectation gap, don’t be afraid to be creative to close that gap. If you don’t know exactly how to be creative with this part, then turn to a trusted advisor. They will have seen every trick in the book and know every way to negotiate a deal to get the Optimal Outcome. So pick your advisor well and make sure that you are leaning on them.