Sales skills should be carefully crafted for any business since it is an important tool to generate revenue. A strong sales strategy is vital for successful business growth. Become a great salesperson and generate more revenue for your business.
For any business it is important to know the best structure in terms of your sale. Please understand, structuring the sale of your business can be really complicated and has many different considerations you need to weigh. So, make sure you get good legal advice for making decisions and gaining profits in your business.
Valuation: Obviously, the first thing the parties need to agree on is the valuation of the business. As you remember, we discussed How to Value your Start-ups back in Lesson #32. So, I won’t go into too much more detail that that, as the valuation principles are largely the same, whether you are doing a venture financing or selling the business outright. So, please re-read that old lesson for details here. The only thing worth mentioning is strategic buyers will place different valuations on your business than a financial buyer will, depending on how important your business is to them (e.g. taking out a key competitor, or simply adding a minor product line), and whether you are filling a near team hole for them or bringing them a long term revenue pipeline and growth vehicle. So, you can only negotiate as hard, as you think you are important to their business.
Equity or Asset Deal:
An equity deal is when the buyer takes over 100% of your cawal stock, and all the related assets and liabilities of the business. An asset deal is when the buyer only acquires the key assets of the business (and whatever specific liabilities they are willing to take on, like current accounts payable). For the most part, buyers of start-ups are looking to do asset deals. It helps lower their downside risk of not knowing what skeletons are in your closet to creep up and bite them on the butt. So, that means, asset deals will be the most likely requested scenario from your prospective buyer, which is fine. Provided you understand you will need to resolve all open liabilities not taken by the buyer with any proceeds you get from the sale, which are hopefully enough to cover them.
Cash Now or Seller Note:
Of course, getting 100% of your cash upfront is your most desirable outcome. That said, you as the seller may want to get additional performance-based upside, in the form of an earn-out, which we will discuss below. And, certain buyers feel more comfortable when the seller still has a little “skin” in the game, not taking all your chips off the table day one. And, in other scenarios, the buyer may not have 100% of the cash to fund the business day one, and may ask to pay 50% now, and 50% over the next year or two in the form of an interest-bearing Seller Note to you. This is particularly true for smaller businesses with limited capital. So, like negotiating valuation, you need to negotiate the timing of the payments, based on what works best for both parties and the circumstances at hand.
Earn-outs are mechanisms to get the seller additional cash payments over time, based on hitting some present performance metrics. These are great for sellers that feel “the best is yet to come”, but still need to sell for other liquidity-driven reasons. The timing of earnout can be whatever you want: my iExplore sale was 18 months (very typical) and my Media Recall deal was seven years (very a typical). Buyers typically don’t like earn outs that last too long, since they want to fully control the business operations, and won’t want to tinker with the business, and risk a lawsuit from the seller, in the middle of the earn-out period. And, although sellers like the upside opportunities from earn-outs, earnouts are very difficult to contract in a way that doesn’t leave the buyer with loopholes to manipulate the pay-out calculation.
As an example, a seller will want revenue-driven earn-outs (to keep it clean and simple), but the buyer won’t like that, since you can load up expenses/losses to drive revenues. And, on the flip side, the buyer will want profit-driven earnouts (which you won’t want, as buyer can push down corporate overhead expenses to manipulate your profits to levels the earn-out would not be paid). In addition, it is preferable to having any revenues coming from promotional support by the buyer, help to credit your earnings and earn-out as the seller (which the buyers may or may not be willing to do, since they are the ones helping to increase your earnings-and hence their cash pay-outs to you for the business). So, it is a very delicate dance to negotiate a happy middle ground that works for both parties and still has a lot of “teeth” both ways.
Net Working Capital at Closing:
Net working capital is your current assets less your current liabilities. The buyer will typically ask for the seller to deliver the business with a historically average level of working capital at closing. So, as an example, if your average net working capital is $50K, they will want the business delivered with $50K of net working capital. Any more than that, and the sellers keep the overage as additional sale proceeds. Any less than that, and the seller needs to fund it to the buyer, to catch them up. This item by itself is a big negotiating point, especially since the balance sheet used for such calculations (and related auditing of the sub-accounts that comprise it), are usually prepared and calculated within the first 30 days after closing the sale, allowing opportunities for the buyer to manipulate the numbers in between the closing date and the calculation date. So, be careful in constructing language that is fair and protects you here, so you are not going out of pocket to make up for any shortfalls.
Representations & Warranties: Representations and warranties are basically the seller’s guarantee to the buyer that what they have communicated to the seller in terms of the assets and revenues of the business is accurate, and the fact the seller is willing to back it up in writing. So, in the event the buyer ever uncovers anything as inaccurate (and, in essence, had them buy the business under false pretences), the buyer can come after the selling shareholders for a refund of such amount. Now, typically there is a minimum basket set aside to cover minor things (e.g., no refunds for first $100K of issues). But, after that, they can get any monies paid to seller refunded to them, in a like amount (e.g., $500K unknown issue, means $400K refund to the buyer after the $100K basket is used up). These warranties typically have a 12-18 month life before they expire.
So, a couple of important things here. First, shoot to have any indemnifications provided by the selling shareholders as “limited to your own personal stake” in the business, not to be jointly and severally liable, having to cover the liabilities of your other selling shareholders, if they do not have the funds to refund their portion of the monies. Buyers will firmly try to negotiate otherwise, to maximize their protection. Secondly, because of this issue (the risk of refunding monies), I would suggest holding 100% of all monies paid for the business, in an interest-bearing escrow fund, not to be distributed to individual shareholders until the warranty period expires, and there is no risk of refunds. That ensures every shareholder’s cash will be there, when and if you need to refund it. That said, it will be a pain to you, if liquidity was the primary reason for selling the business. So, weigh your pros and cons here, before distributing any cash. Sometimes you can purchase indemnification insurance to cover items like this, allowing distribution of cash. But, insurance companies hate it, and it is very expensive and often not worth it compared to the escrow option. Once again, this was intended to be a very high level tutorial on a very complex topic that only a seasoned M&A lawyer should help you with. But, hopefully, it presented some key issues to consider, so you are smarter in negotiating your sale, when that time comes.