In many cases, there will be a rush to get to a letter of intent (“LOI”) between parties with the assumption that a number of the items below can be addressed as part of the final purchase or merger negotiations. While that is certainly true, there are also elements that should and can be addressed early on. Rushing to an LOI isn’t helpful to either party if the ultimate outcome is that they will not be able to reach terms. It is a waste of time and energy for both parties – sometimes at the cost of other opportunities – to not have initial discussions on the elements outlined below.
What the market will pay
This is can be determined by a valuation. Company owners will want to be sure to obtain a valuation (with varying scenarios as necessary) that prepared for a merger or acquisition. Valuations prepared for other purposes, including estate or charitable contributions, may not accurately reflect the value in a financial or strategic acquisition.
This is NOT what you (as the business) owner need or want for your sweat equity, to start your next company, to pay off the debt or to retire. It is fantastic and fortunate when what the market (your buyer) will pay lines up with what you want or need. It happens often enough…but that doesn’t mean that it is a viable way to set the selling price.
How you want to get paid
How much you are willing to accept can be impacted by how the actual payment comes to you. You may be willing to accept less upfront cash in exchange for retaining partial ownership or a solid earn-out agreement. Common elements (which may be combined):
- Cash payment: The amount a seller receives at closing. While the buyer may be financing the acquisition, the payment to the seller is one of the uses of the loan proceeds and is received in cash.
- Seller financing (often referred to as “carry back”): Structured purely as payment terms of the total purchase price and are not contingent upon future company performance.
- Earn out: Deferred payment dependent upon certain future company performance milestones. In an earn-out scenario, the seller will need to carefully consider his or her ability to influence the future performance that will impact the payout totals. These are often common when current year growth and anticipated future growth are factored into the purchase price.
- Ongoing equity position: A seller may decide to sell a majority portion of his or her business and retain an element of ownership. This can be driven by the desire to stay engaged in the business and/or capitalize on future growth.
Your desired level of (ongoing) involvement
Your level of involvement can be dictated by the payment structures as noted above, but it can also be negotiated as ongoing employment, a consulting arrangement or some combination of these that changes over time. It is not uncommon to see transition consulting agreements from 3-12 months in many transactions where the seller has been actively involved in the business.
It is also not uncommon for you to sever ties a week after you hand the keys over. So much depends upon the nature of the business, the buyer and even the financing structure (banks and investors can require and restrict involvement).
Your non-negotiable terms
Sometimes referred to as non-starters or game changers, these are the elements that you want to address at the front of negotiations. If there is a lack of willingness to work through these by either party, a smooth transition and sale process is less likely.
What are the things you are not willing to do or accept? What are the elements that are must-haves? Common items include:
- How the purchase price is allocated. There are tax implications on how and when the purchase price is paid out. You will want to consult with an expert who understands these elements (hint: not all tax accountants do)
- Employment contracts with benefits for 2-3 years for self and key employees
- Retaining certain intellectual property rights or structuring them into a licensing agreement
- Consulting agreement for you with reduced workload
- If you stay on as an employee or consultant, having no travel requirement
- Board level participation (mostly common in an earn out scenario)
- Limited non-compete and/or non-solicitation so you easily move on to your next big thing
Your flexible terms
There will be other items that are less important to you. Some of them may be on the list above – especially if you have very limited ongoing involvement and no earn out. Other items that you may not be as concerned about include:
- Name change for the company. In an asset transaction, the acquiring company will not be the same as the seller – but can continue to do business under a “d/b/a” so that the change in ownership is transparent to customers.
- Change in business services, customers and/or vendors
- Change in non-key employees
- Change in physical location of the Company’s operations
What we want to emphasize the most is that as a business owner and seller, you need to think through all of these BEFORE you get an offer…and arguable before you even list your business for sale if that is the path you are choosing to go. A good intermediary will ask you these questions and understand who an ideal buyer will be as a result of these as well as your business performance.
Hey! You can get these points in an one-page downloadable visual here.