Selling Your Company (Part 2): Getting the Deal Over the Finish Line
In this 4-part blog series, guest blogger and CommonAngels partner Scott Murray shares his insights with entrepreneurs on selling your company – from preparation to completing the deal to next steps and, finally, how to exist within your acquiring company. Below is the 2nd post of this series; be sure to check back next week for the next installment.
CEOs should play a key role in the transaction process. You need to be close to the deal, but don’t be the only one. Sometimes, I suggest not to even be there in the room, as you may be a reason why a decision cannot be made immediately, and you and the investors then have time to mull it over. I call this being the “Empty Chair in the Room”. It gives your negotiators an out to ponder the options and potential responses or counter offers. Plus, by not being there, you can be seen as the go-to person to get the final decision made. There are also times that you are going to need to step in to negotiate business issues that the lawyers and bankers get stuck on. Some other quick-items that got me through the psychology of negotiations:
- Pick your battles carefully. You won’t get everything you want. I also suggest making some asks that you are prepared to give up, so that you can give in on them and then fight harder for the ones you really care about
- Keep an eye on the lawyers. I have found that they sometimes argue about some mundane legal point just to see who is the smartest lawyer in the room, or to see who can win. Step in to stop this waste of time and money, and just agree on simple business wordings
- Don’t just rely on the bankers and the lawyers to tell you what is going on in the documentation process of the merger agreement. In the end, you are going to have to live with what is in the merger agreement and will be held accountable to that, while they all go on to the next deal.
Below is a list of key areas I liked to focus on as the CEO of the company being sold.
(a) Major business points from the term sheet. Some deals have a term sheet. The risk here is that you can spend more time on the term sheet then the deal documents but the benefit is that you can negotiate the major terms of the deal such as price, consideration, earn-out, reps, working capital targets, indemnifications, escrow agreements, employment terms etc. that provides a nice map for the lawyers. I would recommend doing this and then have the legal team show you where the business terms are included in the legal merger agreement.
(b) Representations and Warranties – how long do they last and how extensive are they. If you can get them to fall off on the deal closing that is the best for you. At most a representation time frame of one year following closing and including at least one full audit is a reasonable time frame for termination of the representation and warranties. Fewer representations are better then more of course. Another option is to include “Knowledge” in here so that if you don’t know about something you are not accountable. Fewer of your executives to have to make the representations are better. You the CEO, the CFO and General Counsel are reasonable to include in the knowledge representations. The seller will try to expand this list to sales, technology and operations people but you should push back on this request. I would recommend a cap dollar amount for the indemnification for breaches on representations and warranties. At most you should cap it at the deal value. Remember that if there is a material breach in the representations between signing and closing the buyer can try to terminate the deal or litigate.
(c) Break up fees. There will also be a break up fee in some deals. I have seen these be around 2% to 3% of the deal value but should only be due under specific circumstances such as a higher bid coming in. You will find that in a private deal there will be little outs as the buyer will require the majority of shareholders to agree in advance to the deal to de-risk the outcome.
(d) Escrow. This is the amount held back to cover for any breaches in representations and warranties in the contract. Usually this is a set amount of say 10% to 20% of the deal value and held for a period of say one year but is sometimes longer. Lower percentage and shorter time again is better and having the maximum payout for any breach of the representations and warranties that are limited to the escrow amount is optimal.
(e) Earn-out. Many times the buyer and seller just cannot agree on the sale price. One way to resolve this is to put in an earn-out that increases the purchase price or proceeds based on achievement of certain events. This has multiple benefits for the buyer such as retaining key executives, higher probability of achieve the goals in the first year, making the integration smoother etc. I have seen many of these earn-outs end up in dispute because the buyer would make changes to the business, integrate resources or change personnel in your company that impact your ability to achieve the earn-out. My advice would be to make the earn-out targets simple and easily measureable. These can include such things as a product rollout, revenue target or gross margin target. Don’t make them too complicated or everyone will just argue or worse litigate once the time to measure success comes about. Make sure that whatever the earn-out measurement targets are that you and your team have control over them. If the buyer changes the conditions and environment then there should be a clause that you have earned the earn-out amounts. Another consideration to discuss with your original investors and board is to have a higher proportion of the earn-out go to the management team as you and your team are the ones that are going to make it happen. If a member of your team leaves then they should not participate in the earn-out payments. This is a good way to keep your team together during the initial phase of the integration while everyone is getting over the nervousness that logically comes post-closing of the sale.
(f) Disclosure Schedules. These are usually the last and most complicated to prepare and relate to the representations and warrantees that you have made in the merger agreements about details of your business or exceptions to the representation and warrantees. They include general business matters that are referenced in the merger agreement such as contracts, employees, employment contracts, outstanding litigation, customers, vendors, leases, tax audits, intellectual property and trademarks etc. As the CEO you have the fullest viewpoint to make sure that these matters are fully disclosed. If you leave out material items then you run the risk of misrepresentation of the representations and warranties. If you are unsure about something you are better to include it as it will protect you from buyer claims later on after closing. You should read these carefully for accuracy and completeness.
(g) Employees. Most importantly make sure that you make provisions to take care of your employees. This can range from vesting of stock options, employment contracts that include severance provisions, earning of bonuses and future roles in the combined company. Remember these are the people that helped you get to where you are and you could not have done it without them. Your future reputation will depend on how you take care of your people in the deal and whether they might work with you again down the road.
OK now, let’s talk PRESS:
Once you come to the deal terms and sign the agreements, you will need to be ready to field a fair number of calls from customers, vendors, employees, investors and the press. Make sure that you have a select number of dedicated employees that are allowed to speak on behalf of the company, and a tight script of content that can be spoken about. You can also expect the buyer to want to control or be involved in the communication of the deal.