Last year was an historic year for consolidation and M&A and has many advisory firms wondering whether an exit this year or next might be in the offing. Decision makers planning for an exit should avoid five common mistakes in the process.
1. Forgetting to Due Diligence on Your Own Business.
How will your firm look to a potential buyer? Every sale or financing starts with due diligence and that means corporate books and records and significant contracts should be in good order. Now is the time to complete equity grants, estate planning transfers or other exit bonus structures long promised but not papered. In connection with equity awards, tax considerations are critical, including potentially, a so-called 409A valuation of the business, to establish “fair market value” for tax purposes. Also, consider necessary changes to important third party contracts, leases or client agreements, especially negative consent provisions. Better to consider, negotiate and implement those now, instead of during the compressed time frame of a contemplated sale.
2. No Competitive Process
Valuation and benchmarking tools and the Truelytic’s dashboard can offer critical insight and perspectives on value. Finding a specific buyer willing to pay a price that represents full value is a separate question. For that, most advisory firms might want a competitive process, most likely run by an experienced and practical investment banker with experience in similar deals. Many firms make the mistake of talking to only one potential partner or in reacting to an unsolicited term sheet from an interested party. Due diligence commences, negotiations quickly follow, and the team finds itself confronting the often difficult choice of status quo versus sale to one particular buyer. Remember: terms, conditions and equity valuations improve only in the context of a competitive process, with multiple suitors with terms sheets bidding against each other. The executive team should consider how to create such a process or meet with investment bankers who know how to make that happen.
3. No Plan B
Resist the temptation to put off a needed management shakeup or client pricing changes just to maintain the status quo. Projections for 2017-8 should include a go-it alone strategy, with realistic plans for personnel, marketing and cash flow, including any necessary equity or cash infusions to increase top line revenues for the longer term. Hope for a game-changing transaction is not a substitute for a real time operational and financing strategy. Chances are, finding and negotiating the right transaction will take months, especially if a competitive process is in play. Any team would want the leverage of continuing the business in the ordinary course while the auction/sale process is ongoing.
4. Avoiding the Hard Questions in the Letter of Intent
A letter of intent should set out expectations for both sides as well as the parameters for continuing negotiation. In many cases, the sellers should spend a lot more time on two basic questions: (i) what is the purchase price and (ii) under what circumstances will I have to give some it back. Is the purchase price at closing satisfactory or is much of it dependent on earnout payments, which provide for contingent purchase price payments over time, the details of which still require negotiation? What are the indemnity obligations for any breach or inaccuracy of the sellers’ representations and warranties and are they capped, limited or do they survive the closing for a very long time? What are the terms of any continuing employment, including non-competes and severance? Sellers will save a lot of time and money if they invest the time hammering out these issues for the letter of intent instead of waiting until the deal is at the documentation stage.
5. Structure Matters
The firm should be engaging its accountants and lawyers about tax and structure planning now. What are the tax implications of the proposed deal structure? This year's tax code proposals could bring big changes and thoughtful structural changes now could yield significant efficiencies this year or next. Also, if the team is not familiar with "installment sale" structures, which provide for deferred tax treatment of sale proceeds, they should consult their legal and tax advisors and get up to speed.
Financial pundits are suggesting an uptick in corporate finance activity in 2017. A proactive exit planning strategy---and avoiding typical mistakes---will best position your firm for what lies ahead.
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