Business Brokers: Advising Our Clients Part 2

Last week’s post – Part 1 of our discussion about business brokers advising our clients – dealt with financing issues, tax issues and knowing what – the business’ assets or the equity in the business – is being sold. In this Part 2, we look at a couple of issues that we have to be ready to discuss with our clients and to advise them on. This discussion assumes that “our client” is the seller. Yes, we occasionally represent the buyer and that’s a situation that would require a completely different discussion. But because in the vast majority of cases we represent the seller, that’s the point of view I take in this post. So let’s look at a couple of these additional considerations, none of which are ever likely to have been considered by our clients until we bring them up – or until a letter of intent or purchase contract – that we have to respond to – is on the table staring us in the face.

How Does Our Client Get Paid?

Most “mom and pop” businesses – those with transaction values of up to $1 million or so – are acquired by “mom and pop” financial buyers; buyers that are looking to replace a job either immediately or “eventually”. These types of transactions are generally pretty clean and uncomplicated with the buyer usually able to pay cash from savings or savings and a third party loan. At most, these transactions may involve some owner financing. But once the deal size moves in the Middle Market, deal structures can get more complex; indeed, some might say “creative”. If we believe that our client’s business is likely to be acquired by a strategic buyer – which in the vast majority of cases means another company – we advise our client early on to be prepared for the possibility of an offer that includes some very creative, buyer-friendly methods of paying for it. One example of this is deferred payments. Though the terminology is a bit high falutin’, for all intents and purposes, “deferred payments” essentially means that the seller will finance part of the acquisition price. The space between the definitions of “deferred payments” and seller financing is pretty thin but a deferred payments agreement generally doesn’t subject the deferred amount to interest charges – at least in the offer from the buyer.

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In addition, deferred payments might be tied to the performance of the combined firms – or of the acquired business if the buyer intends to keep it operating separately as, for instance, a subsidiary. But a deferred payments deal is conceptually little different from the definition of seller financing and, as I mentioned last week, the seller should be compensated. But it’s our responsibility to make sure the seller is nor blind-sided by an offer with such a condition. If we discuss this possibility early on, it’ll be easier to discuss how to handle it when it arrives. Another interesting acquisition strategy is for the buyer to offer our client equity in the acquiring company. Such a scheme adds to the complexity of the deal from our point of view. First, if our client would consider such a condition, some serious due diligence would have to be performed on the acquiring company. Depending on the business and industry, audits for compliance and environmental issues might need to be done. What are the long term plans of the acquirers? In such a situation, our client needs to understand the value of the shares – or options for shares. Can the acquiring company’s future prospects be surmised with any degree of confidence? Second, there is value to the risk our client would be taking by accepting equity in the acquiring company as payment. What happens to the value of our client’s equity if the value of the acquiring company declines? What are the restrictions on our client in disposing of that equity? And these are risks that need to be compensated for; an understanding by the parties that such risks warrant a premium to the otherwise agreed-to acquisition value. Remember, anything other than a cash offer has value to the buyer and the buyer should pay for that value. Of course, whether the buyer agrees to pay for that value is a separate question. But it’s our job to explain this to our clients and discuss how the offer might be considered in that light. Most importantly, we should explain the potential for some unconventional payment methods soon after taking the engagement.

What’s the Impact on the Employees?

Has your client thought about how the current employees will be treated by a new owner? Does your client assume that all employees will still have jobs once the acquisition closes? Such an assumption would be ludicrous – and we need to advise them about this. If there are some employees that the seller wants to protect, plans for how to do that must be considered before the business comes to market. The best way to do this, of course, is with an employment contract. Our client could give favored employees equity in the business but that doesn’t guarantee that their job is secure. It only guarantees that their equity might be worth something. But equity can be diluted. And if a buyer wants to acquire 100% of the business, having to deal with multiple owners is a pain in the posterior and will likely diminish the pool of buyers as well as the eventual transaction value. Our clients must know that any plans that, to any degree, tie the hands of a buyer post closing are likely to dissuade some buyers and negatively impact the value a buyer will place on the business, thus reducing the proceeds likely received by the seller.

What Are The Terms of the Transition Period?

In almost all cases – even with small “mom and pop” transactions – the buyer will want the seller to stay on for some period of time in the hope of making the transition as smooth as possible. If the buyer of a business we’re selling is doing a strategic acquisition, it is likely that the buyer will want the existing management team – including the seller – to stay on for an extended period of time. This team, after all, has grown the business to its current desirable state and the buyer can be expected to want to see such growth continue. If we believe the business is likely to be a strategic target, we need to explain to the seller that there’s a good chance a buyer will want them to stay on for a lengthy period of time to continue to grow the business. This is particularly true if the buyer is a private equity fund whose timeline is to get in and out in five years. If our client tells us he or she is limiting their involvement in the transition to 60 days or some other relatively short window, we have to tell them how that stipulation will probably impact the types and numbers of buyers we should expect and that such impact will likely have negative repercussions on the eventual selling price as well as the time it will take to find a buyer.

The Bottom Line

All this advice could – and, in our business brokering course, does – fall under the general category of managing our client’s expectations. Bringing these issues up only when they’ve been put on the table by the buyer handicaps our client, the seller, because they are totally unprepared for something they’ve never even considered. By allowing that to happen, we do a disservice to the people that have shown great faith in us by hiring us in the first place. It’s incumbent on us, as professional business brokers, to prepare and guide our clients through the entire selling process. That’s what we get paid for. If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast. I’ll be back with you agin next Monday. In the meantime, I hope you have a safe and profitable week.