They think it’s all over…..
When business owners shake hands on a deal with a buyer they often assume that all the hard work is done. But significant value can be gained or lost between the handshake and when the legal agreements are signed, so it is crucial to have the right financial advice through this important phase of the deal.
A game of two halves
We are often called upon to advise shareholders who may have negotiated a deal themselves to sell their business or used the services of a business broker. This stage frequently represents the high point of the deal (before it actually completes) with the headline price seeming attractive and the buyer making lots of positive noises about a set of “light touch” documents and a quick and easy sprint to completion.
However, experienced buyers know that much of the ground they may have given to the seller in the price negotiations can be clawed back through the due diligence and legal stages. It is not unusual for a seller to lose 10% or more of the headline sale price through lack of preparation, badly drafted documents, overlooking the detailed financial points of a deal, and poor advice from business brokers or inexperienced accountants.
It’s a six pointer
There are six deal traps for the unwary seller:
- Offer letters and heads of agreement
- Earn-out structures and deferred payments
- Cash and debt
- Working capital
- Warranties and indemnities
- Completion accounts or locked-box
Ambiguity (accidental or deliberate) can help a buyer but undermine the position of a seller. It should never be assumed that terms included in an offer letter or a heads of agreement document (which sets out the agreed position between buyer and seller) mean the same thing to both sides. For example, sellers may often assume that an offer price excludes any cash balances in the company on the basis that this is “their money” while a buyer may have based their valuation on such assets being included. The negotiating strength of the seller is at the maximum before heads of agreement are signed so that is the best time to nail down any difficult commercial or financial points.
Earn-outs, where an additional payment is made to the seller if the business achieves certain targets after sale, can be useful in bridging valuation differences. For a seller, the key objectives are to ensure the targets are achievable, that future performance cannot be artificially manipulated by the buyer, and that the deferred payment structure does not create onerous tax liabilities.
It’s all to play for
Private company valuations are often expressed on a “debt and cash free basis” that is, cash is added to the base valuation for the business or debt is deducted from the price. This all sounds straightforward until we start considering matters such as Corporation Tax liabilities or potential liabilities under foreign exchange contracts and fixed rate loans which may need to be quantified and dealt with in the agreements.
The flip side to the “debt and cash free” provision is the requirement to have a normal level of working capital in the business. Buyers do not want to find they need to put funds into a business after buying it because the seller manipulated the working capital down to unsustainable levels in order to boost cash balances. Buyers will, therefore, usually adopt a conservative approach and so being properly prepared and having evidence to support your case for a low level of target working capital is vital for the seller.
While many of the warranties and indemnities in the legal agreements will be covered by a lawyer, the accounting, and in particular, the tax ones require expert advice. Most generalist accountants will have little or no experience of tax deeds and indemnities, yet getting this wrong can be expensive as every pound gained by the buyer is a pound lost by the seller. A good M&A accountant will know how the tax indemnities fit into the overall deal and be able to identify and advise on the right protections for the seller.
At the end of the day
Most private company deals include a mechanism to ensure the buyer gets the assets they are expecting. Traditionally, this is done by agreeing completion accounts sometime after the deal closes. However, the alternative “locked box” mechanism enables the parties to agree the final price and any adjustments before completion and so gives certainty on the deal price. This is very favourable to the seller, but if it is to be adopted it is important to get the seller to agree this early on – preferably before you sign heads of agreement.
Our corporate finance practice has extensive experience in advising selling shareholders on the sale process through to completion. If you are thinking about selling your business, or even if you are in the middle of a deal and need help and support on any of the issues covered in this article, please get in touch with us.
For further information contact:
Simon Chapman
M: 07831 255302
D: 01926 468705
E: simon.chapman@burgisbullock.com