When you’re in the beginning stages of selling your business, the thing you’re most likely focused on is getting paid. The compensation you will receive at the end of the sale (the closing) can be a combination of cash, debt, stock, or other incentives (known, collectively, as the purchase price or the seller consideration). Whether it’s in the letter of intent, a memorandum of understanding, or whatever other offer document the purchaser has prepared (the offer document), your eyes will immediately search for the purchase price and assess its fairness. From a seller’s perspective, this is the moment when the purchase price should be negotiated most vigorously, and it is up to the seller to confirm that the purchase price is properly reflected in the final, signed offer document.
I have represented purchasers in countless mergers and acquisitions. Based on my experience, I can tell you with certainty that the purchase price stated in the final, signed offer document is typically the maximum amount that the seller can hope to receive after the closing. To put it differently, once the offer document is signed, the entire sales process going forward is purposefully structured to give the buyer one or more excuses to chip away at the purchase price. In this article, I will reveal the strategies that competent purchasers use to end up paying as little as possible for your business.
The sale of your business is a negotiation whereby you want to get paid as much as possible, while the buyer wants to pay as little as possible. That’s a given. But you should also keep in mind that different types of seller consideration carry different risks. From your perspective, you would rather have the purchaser send the entire purchase price to your bank account, in cash, the second that the sale closes. This puts your purchase price at the least risk because cash has the most liquidity, and having it in your bank account gives you possession and control. For these same reasons, the purchaser would prefer that the purchase price be made up of as little cash as possible and subject to certain conditions or uncertainty.
For example, the buyer may want a portion of your cash consideration to be put into an escrow in order to satisfy any potential indemnification claims (as further discussed below). For further discussion on escrows and their use, see Using an Escrow to Solve Your Business's Payment Dilemmas.
The buyer could also request that a portion of the purchase price be in the form of a promissory note; this allows the purchaser to delay paying you a certain amount until a later date. The buyer could also offer you a portion of the purchase price in the form of stock in either the buyer entity, the target company or another affiliate. This option can either be a blessing or a curse, because the value of that stock would be subject to fluctuations in the issuer’s future value and may also be subject to restrictions on the transfer or redemption of those shares.
Another popular buyer strategy is to offer you future cash payments, based on the business’ post-closing performance (called an earn-out). The buyer and the seller can negotiate a variety of terms and conditions for the earn-out payment, including the relevant financial targets (often based on EBITDA) and whether or not the seller should still receive a portion of the earn-out payment if the company fails achieve those targets. Earn-outs also typically require the seller’s continued employment with the company (for a minimum time period) so that the company can continue to benefit from the seller’s institutional knowledge, influence, and expertise.
Any conscientious, risk averse purchaser will want to conduct a thorough due diligence investigation of your company. In short, due diligence is a review of all of your company’s documents, instruments, financials, and other information so that the purchaser can identify any potential liabilities that it might be subject to following the sale. If the due diligence process reveals an existing or potential liability, it is likely that the purchaser will seek to either reduce the purchase price or deal with the matter in the indemnification provisions of the purchase agreement (the indemnities), which would also have an adverse effect on the purchase price. For further discussion on how the due diligence process works, see Selling Your Business: A Guide to the Due Diligence Process.
The representations and warranties in the purchase agreement (collectively, the reps) are declarative statements made by the seller about various aspects of the business. If the buyer finds out, whether through the due diligence process or otherwise, that any of the reps are incorrect, then it might seek compensation through the indemnities (see Representations, Warranties, and Indemnities in Your Sales Agreement).
Furthermore, if there is an intended lag time between the signing of the purchase agreement and the closing of the transaction, then the sale contract will typically include pre-closing covenants; these are promises by the seller to either take, or refrain from taking, certain actions between the signing and the closing. For example, these covenants could require that you continue to operate your business in the ordinary course, arrange for the buyer to make customer visits, maintain the confidentiality of the pending transaction, not incur any additional debt, and so forth. As with a breach of the reps, a breach of the pre-closing covenants can result in the buyer exercising its indemnity rights or terminating the transactional together.
Indemnification is how the purchaser gets repaid in the event it suffers some unexpected loss due to a liability that the seller had either overlooked, misrepresented, or failed to disclose. The indemnification provisions are purposefully structured to put your purchase price at risk. You and your legal counsel should carefully review all of the terms of the purchase agreement, particularly how the reps work hand-in-hand with the indemnities. Let me be completely clear — the indemnification provisions pose the greatest risk to your ability to enjoy 100% of your purchase price after the closing.
Business acquisitions rarely close on the target closing date. However, keep in mind that the purchaser can always try to argue that any delays are being caused by you and your team, either because of a sluggish due diligence process or the failure of your management to readily prepare and assemble the documents that will be exchanged at closing. Buyers sometimes use delays (regardless of fault) to invoke their escalating costs, usually in the form of attorney’s fees, and pressure you to accept some adjustment to the purchase price as a result.
To put it simply, any last minute surprises on the eve of closing are usually bad for the seller. You and your management should be open, efficient, and thorough during the due diligence process so that the company discloses all potential liabilities to the purchaser as early on in the process as possible. When closing is imminent, and all parties are at peak eagerness to finally conclude the arduous sale process, then an eleventh-hour revelation can give the purchaser optimal leverage to squeeze you into reducing the purchase price.