Tuesday, August 2, 2022

Mergers and acquisitions are a significant focus of Williams, Bax & Saltzman, our full-service law practice. Many of our M&A clients approach us with hurried, last-minute requests to get their business ready for sale. The good news is that the stress and missteps we see in the M&A process are mostly, if not completely, avoidable.
Operating as a practice for over 35 years, we've seen it all when it comes to errors we see our clients make or about to make and help them avoid leading up to an M&A transaction. Capturing this experience, we’ve compiled a list of the top 10 Errors to Avoid for Sellers during a Mergers and Acquisition Transaction.
1. Unrealistic Pricing Expectations
This occurs when the selling price an entrepreneur is seeking has not been validated by valuation experts. An Entrepreneur planning an exit is often thinking of retirement and seeks to ensure they have enough resources to live comfortably and maintain, or enhance, their standard of living. As a result, owners often conflate business valuations with what they feel they need to retire. However, what a business is worth and what an entrepreneur requires to retire are entirely unrelated. The best practice for assessing the value of a business is to seek a qualified business valuation expert who can consult on a neutral, unbiased basis. This neutral data that a third-party valuation expert can provide adds objectivity to the negotiation process and fosters reasonable expectations for the seller.
2. Lax Operational Oversight
Owners frequently play operational catch up when they decide it's time to sell. A lack of sound systems and operational controls not only costs the business during the years the seller operates it, but also extracts a high exit cost in the form of a lower purchase price when the seller goes to exit. We regularly see clients scrambling to get their financials and books in order in accordance with GAAP, which can take weeks or months to accomplish. Legacy accounting, tech debt, and poor data access also increase personnel and management costs. Getting one's financial management house in order five years before a potential exit is not too soon to address these issues that to which owner should constantly be attentive.
3. Old Inventory
Out-of-date, worthless inventories, equipment, or receivables on the books are liabilities a buyer will not wish to assume and will not value (and may even be considered a liability) in reaching a price they are comfortable paying. Purchasers see this, and it tells them a story of how well or poorly a business was managed any issues, perceived or actual, will usually cause a lower purchase price.
4. Bad Timing
Sale of a business will be impaired by underestimating the length of time to get the business ready for sale, marketing the sale to a buyer and then running through due diligence. As can be seen from the above three items, addressing any issues getting the business ready for sale can easily take months. Once the business is being marketed, it often takes 6-12 months to find a buyer. However, Sellers cannot feel relieved at that point, as buyers have long due diligence lists, and gathering, producing and reviewing the information a purchaser will request takes a lot of time and resources. Additionally, often the seller wants to keep most of its personnel in the dark until an opportune time arises so current employees do not flee for other opportunities. However, this places further burdens on the resources of the owner as only a select few key employees are in the know and able to assist with the somewhat daunting task pulling together the information requested by a potential suitor. We hear owners undergoing this process saying, “I have two jobs now my regular one, and now a new one responding to information requests from the potential buyers!” Workload during this process can easily double. Preparing for a sale long before you have a prospect, assembling data by category in a document vault so it is easily made accessible, and that accessibility is monitored can be accomplished before there is an interested buyer requesting information. Doing so enables a potential seller efficiently conduct its own due diligence on its own systems, contractual relationships, and internal data to examine them the way a potential buyer would look at them. Such an exercise is invaluable, as it will highlight any issues that will likely be the subject of purchase covenants, such as contractual and other third-party consent issues in advance while there is still time to remedy (or at the least identify) them so they are not a surprise shortly before a sale occurs.
5. Key Employees
Ignoring the interests of key personnel whom a prospective Seller has identified as having the most value to the business. Addressing the needs of these key constituents is necessary to ensure they are on board and have “skin in the game.” It is imperative that the potential seller align its key employee’s interests with the seller. Failure to do so can result in the loss of such stakeholders or worse still, their migration to a competitor as a free agent who can try to take their skill set and contacts elsewhere. Owners often fail to realize it is quite common to pay incentives to key personnel to stay on prior to and following the closing to help ensure continuity of operations, and that any applicable earnouts are achieved (and the purchaser may insist on those key employees to be part of the deal in any event). Where one or two salespeople represent 80% of the revenue of a company, they are, in essence, the company, at least from the buyer’s perspective. An owner needs to take care of such personnel and view them for what they are valuable company assets. Too many business owners look at financials and hard assets alone and forget to value their people. This can often ruin a business’s sale value more quickly than any other factor.
6. Contractual Constraints
Not knowing if third party consents will be required can impair completing a transaction on a timely basis. Whether it is licensing (governmental or software), a landlord’s lease, or even basic office equipment, contracts with key vendors that require consent to assignment (as well as customer agreements that require consent in order to be assigned, which could directly and negatively impact revenue stream) represent an issue that should be resolved long before a closing. An owner should know well in advance what third-party consents will be required, and the timing and processes involved for obtaining each one, because the buyer will surely know, and require such consents be obtained.
7. Ignoring Key Team Member
Legal counsel and accountants should be engaged to review and comment on a sale term sheet or letter of intent before rather than after a “non-binding” letter of intent is signed. Non-binding letters of intent may actually be binding on the parties in some aspects, and even if not “binding,” they do freeze the basic deal parameters (such as pricing and structure) and may not permit much flexibility for certain key deal structure factors after execution. The time to know the tax consequences of the structure of a transaction is long before any letter of intent is signed. After all, it is not about what the gross sales price looks like but what you, the seller, keeps post-sale. Structures resulting in capital gains versus ordinary income treatment usually deliver far more dollars to the seller’s pocket. Understanding up front the interplay of depreciation, recapture, and asset characterization is key. Assessing how much a buyer is likely to require for working capital to be left in the business, and whether a target number is fair or reasonable, or necessary, should be examined before a buyer comes along. We as your counsel work on these issues in advance of the execution of a letter of intent so the letter cannot be used as a weapon against you in the negotiation of the ultimate sale agreement.
8. Failing to Learn About the Buyer and Their Resources
It is important for a seller to find out early whether the Buyer has sufficient resources on hand to consummate the sale. Does the buyer require financing? If so, how much? Does a committee of investors have to approve access to capital and a purchase? What is the timing and who is involved? What is the buyer’s level of sophistication and experience in such acquisitions or the particular business? Knowing whether a buyer is a Private Equity group, a strategic investor or a competitor will tell a seller a great deal about the offer price they can expect and what confidential information can be shared and when. Having answers to these questions informs how much money should be left in escrow, subject to earnouts or whether a seller can finance a prospective buyer.
9. Being Penny Wise and Pound Foolish
It is illusory to “save” money by failing to bring in the requisite expertise in advance and assembling a team of advisors with different disciplines to guide the owner. The owner knows their business, but not how to sell one. Having a good business valuation expert, accountant, lawyer who has M&A experience, investment banker or business broker and insurance person are a minimum-sized team. Having data experts and personnel culture experts added to the aforementioned professionals can be some of the best money an owner can spend. Such a deep dive review in advance avoids pitfalls, strengthens the business and its revenues, and can enhance its attractiveness, and therefore the offer the owner will receive from a third-party buyer. Failing to do so works the opposite way.
10. Unrealistic Expectations
It is all too common for owners selling their businesses to expecting too high a price, or too little time or effort, or that all conditions will remain equal in the business environment. Recent events serve as a perfect cautionary tale: No one expected a pandemic, or the extreme worldwide economic impact it would have. Events outside the control of owners affect business values and can greatly increase risk. The sale of a business should, when conducted successfully, take risk off the table, or at least sufficiently mitigate risk to make it manageable. 
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While the above list is not exhaustive it stands as a list of fairly constant issues we come upon in our practice when representing Sellers. In our next article we will develop and detail similar issues from the purchasing client’s perspective.
Please feel free to contact our corporate law attorneys—Joel Goldblatt (goldblatt@wbs-law.com) 
and Andrew Arons (arons@wbs-law.com) —with any questions or comments on this subject.
Information contained in this publication is intended for information purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.