You Don’t Know What You Don’t Know
Let’s review what a business seller may not know about the sale process, along with some things that buyers don’t want you to know.
Experienced buyers are master negotiators. They know all the tricks. Without an equally skilled negotiator at your side, you will be at a disadvantage.
Business value and price are stated in terms of a multiple of EBITDA (earnings plus interest and taxes paid plus depreciation plus or minus nonrecurring adjustments to revenue and expenses). You should focus on both variables. Buyers often have a higher view of your EBITDA than they reveal, as they know the true synergies, such as revenue synergies (ways to expand revenue) or cost synergies (costs they can reduce), that can be realized post-acquisition to increase your reported EBITDA.
Buyers keep this information from sellers and hire accountants to perform a “Quality of Earnings” analysis whose goal is to offer reasons why your EBITDA should be lower than reported. Prepare for this by stress testing your EBITDA calculation. On the multiple front, a fair EBITDA multiple varies widely by industry, and even within industries. Factors like company size, gross margin, growth rate and customer concentration can drastically affect the multiple offered.
Private equity buyers may present a strong initial offer, then push for a protracted exclusivity period during which they will use a Quality of Earnings report to hammer away at your EBTIDA or even say the bank does not accept your reported EBTIDA. Eventually, they retrade price. Don’t succumb to this strategy. Avoid it by having deal exclusivity lapse if deal terms change.
While price is important, so are terms. Savvy buyers will propose a good price, but pair it with unfavorable payment terms, such as making the price subject to an earnout, which requires the seller to meet certain sales and/or EBITDA benchmarks post-closing. Earnouts are unreliable. Another deal term is a rollover requirement, where part of the purchase price is used to purchase an ownership interest in the buyer rather than paid at closing.
While this can produce a second payday when the buyer is sold at a higher multiple, it can be risky. The most important question to ask about a rollover is “What is the exchange value? If you are rolling 2 million of sales price into the buyer at a price of 10x EBTIDA, while you are selling at 6x, this means that if the buyer sells for less than 10x EBTIDA, you won’t get the return you are anticipating. A high exchange value is dangerous. Other deal terms that can reduce the purchase price include an aggressive net working capital peg (if you don’t meet it, price is reduced) and a high indemnity escrow or hold back (8-10%, not 15%).
Don’t pass the pen! Buyers always want to draft the documents. This is a distinct advantage that can be avoided with a detailed Letter of Intent prepared by an exemplary deal lawyer.
