In this post, we explore 10 crucial factors other than the purchase price and purchase multiple that entrepreneurs should consider when preparing to sell their business.
While there is something elegant about the simplicity of a purchase price multiple (i.e. “I sold my company for 8x LTM EBITDA.”), the problem is that purchase price multiples are never created equal. There are a lot of devils in the details of the terms of sale.
Below, we distill 10 key factors other than purchase price in a transaction:
- The Consideration: How will you be paid? In cash? In stock of the acquirer? Seller financing or some combination? If stock is a significant portion of the consideration, the value of the deal becomes linked to the future performance of the acquirer, which is probably out of your control. Also, the stock may not be freely tradeable or liquid. If there is a seller note, the terms (interest rate, repayment terms, etc.) are very important.
- Adjustments to Purchase Price: Will the purchase price be subject to adjustments based on performance between now and the closing date? Typically, adjustments are based on trailing revenue or EBITDA at close and/or changes in working capital or net assets. A key consideration is the limitations to the adjustments.
- Earn-Outs: An earn-out is a payment at a future date contingent on certain performance criteria. While relatively simple in theory and seemingly useful to bridge a valuation gap, they can create a contentious relationship due to the misalignment of goals and the wide range of interpretations. In fact, earn-outs are a frequent source of litigation after closing. It is important to consider the protections you have as a seller during the earn-out period. The best way to eliminate an earn-out scenario is by making your business’ revenue and profits more predictable.
- Taxes: Depending on the structure, the after-tax impact on the seller can vary dramatically. A good review of tax impact and structuring can be found here.
- Escrow: Escrow is the amount that will be held back at closing to fulfill some contingencies. Key considerations are how much of the total purchase price is being held and for how long.
- Indemnity Limits: Indemnification is a form of protection against certain risks in the transaction. They are some of the most complex and heavily negotiated provisions. The provision can cover a wide range of subjects: breach of contract terms, breach of representations and warranties, fraud, excluded liabilities, taxes and environmental issues. As a seller, you will want to limit the indemnification liability both in terms of dollar amount and duration. More on this in a subsequent post…
- Employment Issues: There may be non-compete agreements and/or employment agreements with the seller(s) and key employees. On the other hand, there may be employee terminations. A key consideration is who incurs the severance costs.
- Approvals: Are third-party approvals needed? Approvals can be required from Board of Directors, stockholders or lenders. It might also involve regulatory approvals from the DOJ/FTC, SEC or FCC.
- Fees: Who is responsible for the legal, accounting and due diligence costs? These can add up, and must be netted out. Especially in smaller transactions, these can have a big impact on net proceeds.
- Deal Protection Measures: Many times, the buyer will require deal-protection measures such as break-up fees, voting agreements, material adverse changes or no-shops. These protections are usually in favor of the buyer.