Choosing a Buyer for Your Business (Comparing Multiple M&A LOIs)
There is a lot more that goes into analyzing an offer from a buyer of our business than just looking for the highest price offered. Sometimes the highest purchase price offered can turn out to be the worst deal on the table. After reading this brief article, you will have a strong foundation for analyzing and comparing M&A offers to help you choose to best buyer for your business. If you’re fortunate enough to have multiple offers, this information is essential.
The Purchase Price for the Business You’re Selling
When you receive a letter of intent for the sale of your business, the big bold price offered is the headline price. We know, from working as M&A advisors Austin, Texas, with all sorts of sellers of businesses, that you will hone in on the headline price.
The headline price is almost always the most you can make for selling your business. It includes deferred and contingent compensation (we’ll get to what those mean in just a moment). However, there are a number of things that could delay, or worse, prevent you from actually collecting the entire headline price. And, we don’t have to tell you that this is all about collecting the money, not just signing the LOI that looks best on the surface.
Guaranteed vs. Contingent Purchase Price Compensation
If the purchase price for your M&A sale is guaranteed, it means that if the deal closes, you are guaranteed to receive the agreed upon price in full.
If the purchase price (or some of it, at least) for the sale of your company is contingent, you will only receive the contingent compensation if you meet certain goals, or metrics – typically, revenue or EBITDA for the business you just sold in the year or two after the closing.
A typical earnout gives the seller additional post-closing compensation in if the business hits certain metrics in a specific time frame. This is a way of sharing risk or incentivizing the seller to contribute to an effective transition of the business after the M&A closing. As M&A brokers, one of our areas of focus and expertise is service businesses, especially professional services businesses, like law firms and real estate brokerages. These are the types of businesses where the assets proverbially “walk out the door every night.” Earnouts are especially valuable to a buyer of those types of businesses.
Getting Paid Now vs. Later (Deferred M&A Purchase Price Compensation)
If the purchase price for your business is paid upfront, you will receive cash at closing. That’s great, of course!
If the purchase price (or any part of it) is deferred, it will be paid over time. Deferred compensation most often shows up in the form of a seller carry back – selling financing. A seller carry back is where you agree to finance a portion of the purchase price for the buyer. For a $3MM business a buyer could pay $2MM upfront and finance the remainder $1MM in a seller-held promissory note for an agreed upon time frame and at an agreed upon interest rate.
We understand that money now is preferable. And, if you need the money for what you’re going to do after you sell your business, then you may need to get all the cash at closing. But, if you’re willing to consider giving the buyer some financing, you may receive more in the end. Your expectation should be a higher, even if only slightly, purchase price when you’re willing to carry some of the financing for a buyer of your business. And, if you get a nice interest rate on your loan to the M&A buyer, there’s nothing wrong with that.
Also, there may be some tax benefits if you’re able to qualify for the installment method of reporting your gains – that way you don’t pay tax on the entire purchase price at closing. You pay it as you collect out the loan.
Consulting and Employment Income
Although not explicitly part of the purchase price, sellers will often consider consulting or employment income in the same bucket as the purchase price – compensation for your business is compensation. However, the compensation earned by consulting or employment will usually be taxed differently in comparison to a stock or asset sale. It’s typically in the buyer’s best interest to shift the cost of the business acquisition to consulting and it’s in the seller’s best interest to shift it to the sale of stock or assets- consulting and employment income will usually be taxed at ordinary income rates. But, if you’re able to get enough of consulting or employment income, it may be worth the less favorable tax structure.
Types of Merger & Acquisition (M&A) Buyers
Beyond the purchase price, an important consideration when weighing multiple offers is the buyer – specifically, the type of buyer who submitted each offer for your business.
There are all types of buyers in the market, although a few that you’re likely to run into are private equity funds, industry competitors, and first-time individual buyers. Each category of buyer carries different attributes that can affect the deal from all angles.
Analyzing the different buyers for your company is something your business broker or investment bankers will do with you. This is where a seasoned M&A broker adds a lot of value. You may not have the experience and context to consider these “softer” deal issues, but an experienced M&A broker understands more about the motivations, styles, and approaches of various types of buyers. They’ll help you choose the best buyer among the ones right in front of you.
Private Equity Buyers in the M&A Arena
Private equity buyers are private equity (PE for short) firms. A private equity firm is an investment firm that typically has a large pool of other people’s money. They put that money to work buying and selling businesses. Private equity buyers are experienced and sophisticated. They tend to spend a lot more time and money on due diligence and have more lawyers and accountants working on their deals. This will make the closing process more rigorous and sometimes stressful. On the other hand, private equity buyers aren’t likely to get cold feet – this is what they do for a living. And, in our experience as business brokers and M&A advisors in the Texas business acquisition arena, private equity buyers tend to pay well. As financial buyers, they don’t overpay, but they generally don’t lose deals over a few dollars here or there.
Selling Your Business to a Competitor
Selling your business to an industry competitor can be a great deal. They understand the industry and, because there are often synergies (e.g., economies of scale or cost savings) that come along with adding another business to any existing business, they may be willing to pay the highest price. That said, they can often be the most critical.
And, if your deal falls apart, the prospective buyer will have valuable information about your company. Yes, if you have M&A advisors (business brokers, M&A brokers, or corporate M&A lawyers), they will be certain all prospective buyers sign confidentiality agreements. Still, you can’t force your competitor to forget what they learned in the process of trying to acquire your company. They may not be able to overtly act on that information, but it may still help them compete against you.
First-time Individual M&A Purchasers
First-time individual buyers show up in the main street part of the M&A market (business sales of less than $2 million). They’re typically buying themselves a job – a business they can work in as an owner-operator.
Individual buyers are the toughest to understand. Your M&A advisors will vet all buyers to confirm they are qualified to buy your business, although it’s tougher to figure that out for individuals because there will likely be no information about them available publicly. Some first-time individual M&A buyers can pay cash, others have no money and won’t ever get a loan, they just think they’ll pull something off and that’s worth it for them to go through the process.
Selling your business can be painstaking. Having the right professionals on your side of the deal can make it a lot easier. Call us at 512.910.2700 or click here to learn more.
Individual M&A purchasers are the most likely to get cold feet before closing. This is hard to vet upfront, it’s just a risk of the individual buyer vs., for example, a PE firm.
Does the buyer need financing? As business brokers and mergers and acquisitions advisors in Austin, we see deal structures like this all the time. The buyer will offer a portion of the deal in cash, and the remainder is financed. An advisor should have spent time investigating how qualified a buyer is, to see if they have the ability to close the deal.
Miscellaneous Deal Considerations
The considerations above are an aerial view of a deal. There is more that goes into weighing a than just looking at the purchase price (the amount and structure) and different types of buyers. The considerations below don’t fit into the categories above, although you should still consider them.
- A non-compete is an agreement that excludes a business seller from being in the same or similar business for a certain amount of time and for a certain location. For example, a non-compete could exclude an Austin brewer from being in the brewing business within a 30-mile radius five years after the closing. Non-competes vary by time, geography, and scope. If you think you might want to get back into the industry you’re exiting, the terms of the non-compete will be critical.
- An escrow holdback is when a buyer holds some of the purchase price for a certain amount of time, and if no post-closing issue arise for which the seller is responsible to reimburse the buyer, then it will be given to you at the end of the escrow period. Holding some of the purchase price in escrow is a form of post-closing risk exposure and is only claimed by the buyer if the seller violates the representations and warranties or something else arises post-closing that is your responsibility as the business seller.
- An indemnification cap is a limit on total claims for agreed upon issues that come up post-closing. Caps are common in private M&A deals. They vary by industry, geography, and by deal size. And, there are often carveouts to caps for things like fraud or intentional misconduct. So-called “fundamental representations” are also sometimes handled outside the indemnity cap. These are representations that the seller has no reason to mis-state. For example, title to assets or shares of stock is often considered a fundamental representation. As the seller of a business, you should know with 100% certainty that you own what you’re selling. Indemnity caps and escrow holdbacks aren’t always included as part of the key terms in an M&A letter of intent, although they often are. If they show up in your LOIs, don’t breeze by them. They may seem like legal mumbo jumbo, but they can important economic consequences to you.
Selecting a Buyer for Your Business
Hopefully you’re fortunate enough to have multiple offers for your business. This happens when you have a great business and great M&A brokers.
If there are multiple bids, maintain positive relationships with all bidders. If the buyer and deal you choose fall through for whatever reason, you may need to circle back to one of the other bidders.
Maintaining a good relationship with all bidders doesn’t mean you can’t leverage your multiple offers. You can and you should. This is about getting the best deal for you and your business. You deserve that. But, be honest and shoot straight with all bidders.
Once you choose a buyer, the real work starts! Best success with closing your deal. If you need some help, reach out to us at 512.910.2700. Braaten Woods is an M&A broker based in Austin, Texas. We focus on selling service businesses and technology companies in the $1 million - $20 million range.