When selling closely held companies, bigger is better. That well-supported premise will be evident over the next 10-15 years, as many businesses will be offered for sale. It’s partly a boomer-generation phenomenon and partly due to the fact that many owners in earlier demographic cohorts will also be selling.
As a result, it’s going to be a crowded marketplace. Early movers will be rewarded, as the pool of buyers will likely shrink over time. The above premise comes into play because sophisticated buyers look first (or exclusively) at larger companies. Such buyers’ thresholds are $5 million to $10 million of EBITDA and up. In other words, many closely held companies won’t attract such buyers unless they grow, either internally or by acquisition or merger. Unfortunately, internal growth may take too much time for many needing to sell.
Of course, acquisitions require cash or other currency, such as your company’s stock. That’s the first order of business. In the current environment, creative corporate finance techniques may be required. If company stock will be used, your company will likely need to obtain a valuation study, performed by a qualified, independent valuation professional. A number of professional firms provide such services.
Like so many things, processes and best practices exist for acquisitions and mergers. Once you decide on the first company to approach (“the seller”), the following steps are customary for M&A transactions between closely held companies.
As with most major projects, a team of specialists is recommended, all of whom should have M&A experience, in at least the following disciplines: accounting and tax; corporate finance; and legal (in addition to deal experience, niche legal needs associated with M&A deals). As noted above, a valuation specialist may be needed as well.
Closely held business acquisitions generally occur through the purchase of the seller’s assets or the purchase of all or part of the outstanding stock of the seller. For tax and other reasons, buyers generally prefer asset purchases; sellers generally prefer stock purchases. In addition to asset and stock transactions, several “acquisitive merger” and other techniques enable companies to combine their businesses. Some provide for the tax-free transfer/combination of companies. Such methods should be explored, particularly in a difficult financing environment.
To start the communications, buyers generally approach sellers. Of course, sellers can start the process, such as an owner nearing retirement age and implementing his or her exit plan through a sale. Generally, early in the process, the parties sign a confidentiality agreement, to protect proprietary information exchanged during the exploration process. If a gap of time will pass between the initial deal phase and the closing, buyer and seller generally sign a letter of intent or “term sheet.” Usually, they are partially binding and partially non-binding. If a gap is not anticipated, the parties can commence negotiation of the asset or stock purchase agreement and various companion documents.
In basic terms, two broad concerns require a thorough “due diligence” review of the seller: (a) its operational and financial performance and prospects — the “business due diligence” component of the review, and (b) legal considerations — the “legal due diligence” part of the review. The two parts occur either sequentially or simultaneously, depending on the parties’ motivations and resources. In any event, a thorough, careful due diligence review is a critical aspect of every transaction. They are time-consuming, but can reveal circumstances which impact price, justify other adjustments, or permit withdrawal from the deal — saving the buyer from consequences associated with the seller’s problems.
Deals vary, but buyers and sellers must consider carefully when and what to communicate about the possible transaction with the larger employee group. It’s a sensitive part of most deals, for many different reasons. Moreover, unless the acquired company will operate as a free-standing, “siloed” subsidiary, post-closing assimilation of the seller’s employees into the buyer’s company can determine whether the combination of companies ultimately succeeds. Indeed, many combinations have failed over the years because the two “company cultures” were never integrated successfully. Another challenge can be communicating the possible transaction to other “constituents,” including major customers, major suppliers, ongoing lenders and others. Again, care is advised with all such communications.
If the results of the due diligence review are satisfactory, including adjustments in terms, the buyer and seller teams will continue to negotiate the terms and will move to close the transaction as quickly as possible. In addition to earlier financial modeling, at this juncture various corporate finance options can be examined, which may enhance the financial returns to various parties. If the deal is attractive, but the buyer, the seller and the financing sources are having trouble getting to final terms on finance, consideration of an employee stock ownership plan (aka ESOP) as a part of the corporate finance structure may be in order. In any event, the ultimate goal is the closing.
It is hoped that this overview will help business owners understand how they might grow their companies by acquisition and position themselves for sale to an attractive buyer. It can be a challenging path but a rewarding one.
John Cramer is a partner on the Business Law Service Team at Wyatt, Tarrant & Combs, LLP in Lexington, and co-chair of its ESOP Practice Group. He can be reached at jcramer@wyattfirm.com or (859)288-7480.