CEO Advisor Newsletter March 2023
Critical Issues in M&A Transactions
These issues should be discussed with the buyer's or seller's team of advisors, which should consist of an M&A advisor, corporate/transaction attorney and tax advisor. This team of advisors will benefit any party in a transaction by hundreds of thousands to millions of dollars depending on the size and complexity of the transaction.
5 Critical Merger and Acquisition Transaction Issues
1. Cash vs. Earn Out vs. Seller Financing vs. Equity
The method of payment for a transaction, whether in cash or non-cash methods, may be a determining factor for both parties in consummating a transaction. The following are key factors to determine:
Cash. Cash is the most desired, most liquid and least risky method from the seller's side of the transaction. Cash tends to be the buyer's strongest position and should pre-empt rival bids better than equity or other methods. A strong seller can expect 60% - 80% cash in most cases, but don't count on 100% cash at closing in a great majority of sales. Taxes are the key issue with cash at closing, as the purchase price is secondary to the amount of cash you keep after taxes.
Earn Out. Since a company is a living, ever changing entity, most acquiring companies want to both incentivize and gain some assurance that the seller has a strong on-going concern and that the seller should be able to achieve its Forecast in the future. An Earn Out involves quarterly or annual cash payments to the seller for achieving Revenue and/or Net Profit goals, as well as, other goals in some cases for a one to five year period. There are typically stipulations to achieving the Earn Out payments such as the founder(s) staying employed with the acquirer, meeting a future Forecast or other criteria.
Seller Financing. For most sellers, seller financing is far more favorable than an Earn Out (since Earn Outs are not guaranteed), but most transactions do not include seller financing. In some circumstances, seller financing for a minor portion of the transaction can be more beneficial to the seller than the risk of an Earn Out, will delay taxes for sellers, and may suit both the seller and acquirer.
Equity. Equity involves payment by the acquiring company's stock, issued to the stockholders of the seller, at a value relative to the seller's value. There are transaction costs and risk, as well as, tax implications to receiving stock as part of a transaction so both your M&A advisor and tax advisor should be consulted early in the process of the negotiations. The issuance of equity will generally provide more flexible deal structures and can be very lucrative to the seller in an up market in the future.
2. Deal Structure
There are basically three methods for structuring a transaction:
An Asset sale is most desirable to an acquirer, because a "step up" in tax basis of the assets occurs for the acquirer equal to the purchase price, which is typically the fair market value. This enables the acquirer to significantly depreciate the assets and improve profitability post-closing. Proceeds of an Asset sale will typically be ordinary income to a seller.With a Stock sale the selling shareholders pay long-term capital gains provided they have owned the stock for at least a year. Additionally, the acquirer would have a cost basis in the stock purchased and not the assets, which would remain unchanged and cause an unfavorable result provided the fair market value is higher. There are variations of deal structures, such as Stock sales with Asset sale tax treatment so it is critical that you have a seasoned team of an M&A advisor, transaction attorney and tax attorney.With a Merger there is an opportunity to defer some (or possibly all with a merger of equals) of the tax liability whereby the value remains tax free until its eventual future sale. There are several types of mergers so consult your advisors before structuring a deal as a merger.
3. Working Capital Adjustments
M&A transactions typically include a Working Capital Adjustment as a component of the purchase price. The buyer wants to insure that it acquires a target company with adequate working capital to meet the cash requirements of the business post-closing, including obligations to customers and creditors, as well as, salaries and other expenses.
The seller wants to receive consideration for its assets that enabled the business to operate and generate profits. In terms of measuring the working capital, the agreement will include a formulaic method that compares the actual working capital at the closing against a target level established in the non-binding Letter of Intent.
4. Representations and Warranties
Both parties will be required to make certain representations and warranties about the business and the process of fulfilling the transaction. These representations and warranties should be taken seriously as any missteps in the post-closing period will result in the other party referring back to these provisions of the agreement with real (legal and financial) consequences. Be transparent and only promise what you can live up to. Gaining guidance from your M&A advisor and attorney will be extremely helpful and avoid any issues post-closing.
5. Closing Conditions
The transaction agreement will include a list of closing conditions which must be met in order for the parties to close the transaction. These are often negotiated at the time of the definitive legal agreement (although sometimes a detailed list will be included in the Letter of Intent).
These conditions may include, Board approval, the absence of any material adverse change in the seller's business or financial conditions, the absence of litigation, the completion of a Quality of Earnings report, the delivery of a legal opinion from seller's attorney and shareholder approval. Additional provisions that are key to a transaction for an acquirer are non-competes and non-solicitation of employees and customers.
Well in advance of commencing the sale process, assemble your team of a seasoned M&A advisor, corporate/transaction attorney and tax advisor to strategize and discuss the above critical issues.
CEO Advisor, Inc., is an M&A advisory firm with over 70 years of M&A experience. Contact Mark Hartsell, MBA, President of CEO Advisor, Inc. at (949) 629-2520, by mobile phone at (714) 697-3370 by email at MHartsell@CEOAdvisor.com or visit us at www.CEOAdvisor.com for more information.
Ten Reasons to Explore Growth Capital
- All businesses need capital to operate. Growth capital enables the CEO or business owner to grow sales, profits and value in the business for an optimal exit in the future. Below are 10 reasons why CEOs should explore growth capital.
- Growth capital, different from seed or venture capital, is typically in the form of an equity investment from a Private Equity firm. The best time to start seeking growth capital is when your business is at $7 million to $10 million or higher in revenue, and the business is profitable with growth (10-15%+). CEO Advisor, Inc. has hundreds of Private Equity firm relationships in many industries with a focus on software, technology and media, as well as, healthcare.
- If your company does not meet the above criteria for Private Equity funding, call CEO Advisor, Inc. so we can assist you in properly preparing for funding and to accelerate your growth.
- Here are 10 reasons why CEOs desire growth capital:
- 1. Growth capital enables a CEO or business owner to plan, grow and invest in their business vs. worrying about using his/her "personal money" or continually being constrained by cash flow issues.
- 2. Growth capital from a Private Equity firm can provide flexibility and enable you to personally take some money off the table at closing to secure your financial situation today, while pushing for a much larger exit in the future.
- 3. Growth capital takes you out of the rut of growing 5% - 10% per year and working 70 - 80 hours per week in a company that is not sellable to becoming a high growth, highly valued business with the funding you need to be positioned for a large future exit.
- 4. Growth capital enables you to hire the management team and employees you need to realize your true potential as a company.
- 5. Growth capital enables you to invest in product development, a larger sales team, marketing and new equipment.
- 6. Growth capital provides both short-term and long-term growth and expansion for your business.
- 7. Growth capital enables you to properly capitalize your business, while providing the peace of mind in case of a temporary downturn in the business or a downturn in the economy.
- 8. Growth capital by a Private Equity firm includes business and finance savvy investors who can be integral and helpful in growing your business with you.
- 9. Growth capital enables you to sell a portion of your company at today's high valuations, while holding onto a minority or majority ownership in your company for a substantially larger exit in the future.
- 10. Growth capital positions you and your company for a large exit in 4 - 5 years enabling you to realize your life's dream of an optimal sale of your business and a secure retirement.
- CEO Advisor, Inc. has more than tripled our clients' sales, substantially increased their profits, raised millions of dollars for growth capital and turned unsellable companies into sought out, extremely valuable companies worth many tens of millions of dollars.
- Call for a growth capital consultation with the President of CEO Advisor, Inc. Contact Mark Hartsell, MBA, President of CEO Advisor, Inc. at (949) 629-2520, by mobile phone at (714) 697-3370 by email at MHartsell@CEOAdvisor.com or visit us at www.CEOAdvisor.com for more information.