Shared Risk Can Sweeten Business Sale
Selling a business isn't as simple as it was - the structure of the deal is often more important than the price.
Cash deals are rare. Seller financing, disposition of liabilities, shared risks and interests in the future successes of the business have become critical components of today's transaction. The good news is that, by decreasing the buyers' risk, you can increase the sale price of your company.
The Association of Merger and Acquisition Professionals, a national organization of leading merger and acquisition intermediaries, has recently completed its annual survey of member transactions.
The survey was based on information from 99 transactions completed by IMAP members in 1994 at a total value of $765 million. Average selling prices were generally 10 percent higher in 1994 than in 1993, and 20 percent higher than in 1992. A midyear polling of members indicates prices are somewhat higher again in 1995. Most of the selling companies were privately owned and had revenue of $1 million to $50 million. The structure of these deals, rather than the generosity of buyers, is responsible for these price increases.
A majority of sellers are still required to sign non-compete agreements even though tax law changes now require that these be written off over a 15 year period regardless of the actual length of the agreement. Ninety-six percent agreed to non-compete restrictions. Seventy-nine percent took back seller notes. Forty-two percent agreed to contingent earnouts.
Although the percentages may vary, the results of the survey reflect current experience in the construction industry. They clearly support the contention that deal making has embraced the win-win notion. Shared risk is an important element in achieving the goals of each party.
Business sales in the construction industry typically occur at lower prices, as a percentage of revenue, than many other industries. These businesses are only as strong as their flow of new contracts. There are three strategies to achieve a good price. Sell when the flow of new business is strong. Remain with the business to insure the continuity of existing customers and profit margins. Bring in new business for the buyer over a period of time.
The high percentage of asset transactions confirms buyer aversion to unnecessary risk. In the sale of smaller companies, asset transactions account for 95 percent of all sales. When stock is acquired, the buyer assumes all the liabilities of the seller, whether those liabilities are known or unknown. When assets are acquired, only selected liabilities, if any, are assumed by the buyer. The sale of assets, however, often places a higher tax burden on the seller. Further compensation may be required to complete the transaction.
The fact that so many asset deals are getting done indicates that many buyers are willing to pay a premium for a company's assets rather than assume additional risk. Most buyers are looking in familiar industries. Frequently, they are already active in the industry or related industries. They are not willing to assume the risk of a steep learning curve.
Seller financing became essential during the period of "tight money." Now that money is more available, sophisticated buyers still demand seller financing as an additional security for the deal. This financing is typically in the form of notes, consulting agreements, non-competition agreements, royalties and earnouts. Sellers can simple expect to take a smaller percentage of cash out of the transaction, even though the total price may be higher.
The IMAP survey indicates non-competition agreements are a part of 94 percent of these transactions. This is particularly true with closely-held companies, where one or two executives have a strong influence on the performance of the company.
The use of earnouts is a popular way to pay sellers a premium for the company, if profit forecasts are achieved. Usually the earnout is expressed as a percentage of the dollar increase in either gross profit or earnings before interest depreciation and taxes. Expressed in simple, clear terms, an earnout can overcome an impasse on price and motivate both parties to work diligently to insure the success of the transaction.
To the extent that a buyer can tie the seller's proceeds to the future success of the company, he can reduce his risk and justify paying more for the company.
For example, a buyer may be willing to offer $3 million in cash at closing for all the assets and declared liabilities of a company. Alternatively, if the cash flows of the company allow, he may be willing to offer $1.5 million in cash at closing, plus a note, non-compete and consulting agreements and a percentage of future profits which would total considerably more than the cash purchase price.
There are many financial components to this type of transaction. For the most part, they all involve a shared risk between buyer and seller. To the extent that buyer and seller are well matched and the transaction has properly recognized all risks to both parties, risks can be minimized. A properly structured transaction can serve the best interest of all involved.
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