In previous articles we discussed various liquidity alternatives and how to prepare for a liquidity event.
This article focuses on one particular liquidity alternative, the sale of a business, and discusses factors that are critical to making the process effective, ensuring optimal outcomes are achieved.
An effective divestiture process needs to accomplish the following:
Create Competitive Tension
The divestiture process can be structured as a targeted approach directed at one potential buyer, a broad auction – or anything in between.
A highly structured broad auction process maximizes competitive tension by signaling that many prospective purchasers are at the table and offers must be competitive.
However, in selecting and executing the appropriate process, one must weigh the benefit of a higher valuation against the downsides of a broad auction which include confidentiality and timing issues.
A broad auction exposes confidential information about the company to a larger number of potential buyers. This is particularly challenging to manage in circumstances where the most likely buyers are also the company’s most direct competitors.
A broad auction process typically takes upwards of six months and may take upwards of a year to complete. Targeted processes can typically be completed in a much shorter time frame.
Ensure the Most Relevant Potential Buyers are Identified
A broad auction process involves ensuring “no stone is left unturned” and all relevant acquirers are identified. Potential acquirers are vetted for strategic fit and financial capacity.
In a more limited auction process, acquirers are vetted and ranked (based on financial capacity and synergistic interest) to determine which should be included in the short-list that will form the limited auction process.
Ensure the Most Relevant Information is Presented to Potential Acquirers
The sale process involves providing potential acquirers with adequate information to articulate an expression of interest, while maintaining confidentiality around key critical competitive elements of the business.
Information should be released sequentially, with the more sensitive information being released in later stages, subsequent to potential acquirers demonstrating their commitment to the process and acceptable transaction terms.
The information should “put the company’s best foot forward” and guide potential purchasers to understand the vendor’s value expectations including presenting a normalized earnings analysis that illustrates the recurring level of recent historical earnings, and a forecast that illustrates the growth potential of the business.
In addition to running an efficient process, other important issues that need to be dealt with / negotiated during the divestiture process include:
- Deal structure and taxation
The form of transaction, whether it will be an asset or share deal, can have a significant impact on the after-tax proceeds in the hands of shareholders.
Despite an owner’s desire to divest of 100% of their holdings and walk away, investors often demand owners “roll-in” 10%-40% of their ownership as confirmation of the existing owner’s continued bullish outlook for the company and confidence in the strategic merits of the transaction, a means of ensuring alignment of interest between the parties and lowing their up-front cash investment.
Vendor take-back and earn-out arrangements are common with private company sales. These may impact the cash amount received by the vendor upon closing and be subject to differing tax treatment.
- Representations, warranties and indemnities
While many representation, warranties and indemnity clauses are fairly “standard, vendors should be focused on limiting their exposure and pushing back to have the risks identified and quantified during the acquirer’s due diligence process.
In summary, the divestiture process needs to be designed, managed and executed carefully to ensure optimal results are achieved. The existence of many important process and agreement related issues make having experienced M&A. legal and tax advisors by your side during the process critically important.