Selling your business can be one of the most rewarding yet stressful life events. The decision to sell may have been made after thoughtful consideration over several years or can come out of the blue from an unsolicited offer that might appear too good to pass up. In either event, businesses throughout the manufacturing supply chain face unique considerations and market pressures to be addressed in the context of a sale.
This article addresses three key concepts to consider when contemplating a sale:
- 2024 is shaping up as another year of uncertainty as persistent inflation and higher interest rates add up to a cloudy M&A outlook – earnouts can often help bridge valuation gaps.
- Timing of deal execution is taking longer – soup to nuts, completing a sale of business can take several months.
- Transaction structuring – the more planning on the front end to structure transactions efficiently the better outcome achieved.
Deal Making in an Uncertain Market – Earnouts Help Bridge Valuation Gaps
2024 is shaping up as a nervy economic year. On May 1, Federal Reserve Chairman Jerome Powell indicated that "Inflation is still too high and the path forward is uncertain...in terms of the peak rate...the data will have to answer that question for us." While M&A volume has been slower than in recent years, strategic and private equity acquirers have plenty of capital available for acquisitions for attractive businesses. Valuation is one of the most common issues that occurs in deal making during an uncertain market. Increased labor costs, supply costs and supply shortages are impacting the bottom line of industrial and manufacturing businesses making determining valuation of a business tricky.
One of the ways to solve for purchase price valuation gaps is for the parties to agree to an earnout. An earnout is a purchase price payment paid after the closing occurs whereby the performance of the business post-closing determines the payment. Common performance related metrics include revenue, adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), or production-related achievements. Earnouts are fraught with issues – the natural tension is for the seller to want the buyer to take any and all actions needed to maximize the earnout payment. These actions may not be compatible to the buyer's desired operation of the business post-closing. Therefore earnout provisions are frequently heavily negotiated to determine what level of control a seller may have with respect to the business post-closing in order to obtain the highest earnout payment possible.
Timing of Deal Execution – Deal Fatigue is Real
How long will this process take? This is a common question for sellers beginning the process of a transaction. Often times, the answer is "well, it depends." In certain instances, the first step is hiring an investment banker and an M&A attorney who can help you solicit offers from strategic and private equity acquirers.
Investment bankers will launch work on gathering information about your business and packaging that information out to prospective acquirers. Generally, this process can take anywhere from one to three months. Once serious prospective acquirers have been solicited, then prospective bids will hopefully be made within another month or so. The investment bankers and M&A attorneys will then review the bids negotiating financial and high level legal issues.
After negotiating the final offers, typically a prospective acquirer is selected – then we are done right? Nope. Normally, the prospective acquirer wants "exclusivity" – i.e., you can only negotiate with this prospective acquirer for a certain period of time – anywhere from 45 to 90 days. During this exclusivity period, the prospective acquirer will conduct a deep dive of all aspects of your business (financial, legal, tax and accounting) – an intrusive, time consuming and distracting process that can take you away from the day to day of running your business. During this time, the lawyers are negotiating the definitive transaction documents – hundreds of pages of documents. Certain deals are structured such that the transaction closes on the same day as the definitive transaction documents are executed. Others, due to variety of factors, are closed at a date in the future which can be 30, 60 or 90 days later (or longer).
Transaction Structuring
Is your business an S-corporation, C-corporation, limited partnership, limited liability company, ESOP or something else? Many local, state and federal tax issues need to be considered so as to structure the transaction in a manner that is most tax efficient. Careful planning with your tax adviser and M&A counsel can help mitigate any potential tax surprises after the transaction closes. Transaction structures come in a variety of formats – asset purchases, stock purchases, majority buyouts with rollover equity, etc. All of these transaction structures can impact your after-tax proceeds.
Special consideration should also be given to estate planning. The sale of your business can create multigenerational wealth – planning for such an event prior to closing can help future generations enjoy the liquidity event. Careful planning should also focus on "thank you" bonuses for the employees of the business who helped make the company a successful operation.
Conclusion
Selling your business can be enticing, and having an understanding of the process is important first step to get the most out of the sale – especially in uncertain market conditions. That includes anticipating issues with valuation and planning to address those, knowing what to expect and what advisors to consult throughout the process, and how to best structure the deal to meet personal and organizational objectives. Indeed, front-end planning is among the most valuable steps to optimize back-end success.
Originally published by Industry Today.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.