SELLING YOUR COMPANY? 3 TIPS FOR ENTREPRENEURSby Scott Edward Walker on May 22nd, 2015
Last week, my client closed the sale of his company for approximately $65 million. Like most M&A transactions, it was a difficult and tricky ordeal. Indeed, we started the sales process nearly two years ago — so when the wire hit, he was a happy man. He even sent me a very gracious email:
“There is no way this could have worked out so well without your hard work, experience, and persistent attention to detail. I appreciate immensely who you are and all you do.”
Below are three significant tips for entrepreneurs who are thinking about selling their company based on my 19+ years of doing M&A transactions (including nearly eight years at two major law firms in New York City).
Tip #1 – Create a Competitive Environment
A lot of entrepreneurs who decide to sell their company end-up talking to just one potential buyer. This is a huge mistake. There is nothing that will give an entrepreneur more leverage in connection with the sale of his business than a competitive bidding process (or the perception of one). Potential buyers can be played-off of each other and, as a result, the seller will be able to strike the best possible deal.
Most importantly, the time do this is prior to the execution of the letter of intent (LOI) – which is when an entrepreneur has the strongest leverage as a seller. Once the LOI is executed, all of the entrepreneur’s leverage is gone because he generally won’t be able to shop his company around (or even talk) to other potential buyers for a period of 60-90 days due to the “no-shop” provision. Accordingly, prior to the execution of an LOI is when the seller wants to create a competitive environment and have prospective buyers compete on price and terms.
In the deal that just closed, my client had several interested buyers and thus was able to negotiate not only a great price but also very pro-seller terms (such as the cap on liability, as discussed below). Indeed, we negotiated a very detailed LOI, covering all of the major terms of the sale, to prevent the buyer from trying to jam my client once the LOI was executed and the no-shop kicked in.
Tip #2 – Cap the Seller’s Potential Liability
After an entrepreneur sells his company, he obviously wants to sleep well and enjoy the fruits of his years of labor. It is thus critical that certain key provisions be inserted into the acquisition agreement to protect the seller post-closing. One such provision is a cap on liability, which (as noted above) should ideally be negotiated in the LOI. A cap on liability basically means that if something goes wrong post-closing and it turns out, for example, that the seller has breached a representation and warranty in the acquisition agreement, the buyer can only recover up to a certain amount (i.e., the cap).
Sellers should strive for a cap of 10-20% of the purchase price, with as few buyer carve-outs (exceptions) as possible; and if part of the purchase price will be put in escrow to cover any post-closing indemnification claims by the buyer, the seller should push hard to make the escrow the exclusive remedy. The message to the buyer is clear: inherent in any business are certain ongoing risks — thus, once the business is sold, the buyer should only be able to recover a limited amount of the sale proceeds (absent fraud).
In the deal that just closed, because of the competitive environment that was created (and the fact the buyer was anxious to do the deal), we were able to negotiate a very low cap and minimal carve-outs.
Tip #3 – Include a “Non-Reliance” Provision in the Acquisition Agreement
Another important seller protection that should be inserted into the acquisition agreement is a so-called “non-reliance” provision, which requires the buyer to acknowledge that it is buying the business based solely on (i) its due diligence investigation, review and analysis and (ii) the seller’s representations and warranties in the acquisition agreement. This is a significant, but often overlooked, technical provision — which typically arises in the context of a fraud claim.
Once the deal closes, the relationship between the seller and the buyer changes dramatically. The seller now has the purchase price proceeds (subject to any escrow), and buyer now owns the business, together with its rights under the acquisition agreement if something goes wrong post-closing. The non-reliance provision is intended to prevent the buyer from suing the seller based on any statements, writings, projections, etc. outside the four corners of the acquisition agreement. Absent a non-reliance provision, the buyer would have a huge potential hook for its litigators to sue for fraud based on, for example, oral statements made by the seller and/or his representatives.
In the deal that just closed, this provision was heavily negotiated, and we had to push very hard to get it inserted into the acquisition agreement. Indeed, sophisticated buyers are loathe to deplete their post-closing litigation arsenal.
I love helping founders sell their company. There is so much emotion and uncertainty during the process that it’s where I think I can add the most value as a corporate lawyer. Indeed, as noted above, I spent nearly eight years at two major law firms in New York City handling M&A transactions from $20 million to $2 billion – and no matter what the sales price, selling a company is a painful process, with lots of twists and turns. I hope the foregoing three tips are helpful — and if you have any questions, please email me at email@example.com. Cheers, Scott