The marketplace is buzzing with M&A activity.  Seems everyone is either a buyer or seller or both, depending on the day.  As I watch a number of these transactions, or attempted transactions take place, there are some common things that you need to think through so you are ready to negotiate well when that time comes.  This is part of an ongoing series I’ve been writing about exit.

One of the foundational items is to create a list of non-negotiables – things you are unwilling to move from as you progress through a deal.  I like to think of them as ‘core values’ for a buy or sell.  The purpose of core values is to provide the guardrails within which you will run your business and live your life.  We need the same around transactions.  The most important part of having this list is that it allows you to lessen the emotion that comes with the deal.  Anytime I see emotions run high in a transaction, it often does not end well.  You need to think through with clarity, before you make an offer or receive one, which items just aren’t negotiable and are off the table.  Then when one of those comes up you can calmly say no and see if the deal has enough momentum to be adjusted to carry on.

Price is always the number people want to focus on.  But price is never translated directly to dollars.  There are many factors that determine what that price turns into in terms of true funds.  Obviously tax implications are a huge consideration and can quickly reduce the number.  In many of the deals I’ve been close to, the common thing I hear is ‘the amount of money I ended up with was less than I had hoped for and expected’.  That happens because the price does not equal cash.  They are related, but certainly not the same thing.

Actually it is more important to focus on the means of payment.  Once a price is set, how will you receive payment?  That can impact the outcome significantly, both in terms of timing and dollars.  Here are a few payment types I see happening:

  1. Cash – nothing beats cash, but taxes will consume a good portion of it
  2. Deferred payment – Seller’s Note with interest – a possible approach if the seller has confidence in the buyer and business
  3. ESOP – bank or seller funded – a strategy to move ownership
  4. Earn out – based on the ability of the business to continue performing after the transition

The timeline used for payment can certainly impact the final outcome as well.  Confidence in the business and ownership determines whether a seller is willing to spread payment over time.  It is an area to explore with your tax accountant to determine the best option.

Asset allocation is also a critical area.  In the US, there are seven distinct asset types to be aware of:

  • Class I assets: cash and general deposit accounts
  • Class II assets: actively traded personal property
  • Class III assets: accounts receivable and debt instruments
  • Class IV assets: inventory and stock in trade
  • Class V assets: tangible/physical assets
  • Class VI assets: intangible assets not including goodwill
  • Class VII assets: goodwill and going concern value

Buyer and seller have to agree on the classifications and sign a Form 8594 IRS document which both sign to assure taxes are filed correctly for the transaction.  Since tax is handled differently for the classifications of assets, it is a requirement that both parties agree to the allocation and file their tax returns accordingly.

As part of most transactions, there are allocations made around items like:

  1. Non-compete
  2. Non-solicitation
  3. Customer lists

These are Class VI assets which are more favorable to the seller than the buyer because of the tax implications.  So in some cases, there is a desire by the buyer to shift dollars to salaries or other classes that can be taken as a business expense at time of payment.  This tug of war between the two sides of a deal can become a deal-breaker if not handled openly and with good communication.  It can have a significant impact on one or both sides of the transaction, so you need to be aware of the impact.

Many transactions today have some form of employment for the departing owner.  It is critical to be sure there is clarity around the role and expectations associated with that employment.  In many cases, it is more of a transition role and quickly moves to a sideline position rather than active participation.  If there is not clarity around that, it can become a struggle between the new owners and past leadership.

I’m often asked what is enough in terms of price.  There are many ways to calculate business value.  There is no right or wrong answer.  The key for a seller is to determine what number is adequate to meet their lifestyle needs.  That needs to include the impact of taxes and other costs.  If the deal will provide you the money needed to meet your requirements, you are in a good spot.  If it falls short, and you find you’ll not have enough funds to provide the future you have planned, it may be time to go back to the drawing board and determine what changes have to be made to increase business value.  This could require you to continue ownership and leadership of the company as you implement key changes, remaining at the helm until the business is worth the price that you need.  Running a company with a healthy balance sheet that you are prepared to sell when the right offer comes along will position you for M&A success.

Know your number, create your list of non-negotiables, and run your company like you might sell it tomorrow.  Those are three key preparations that make a successful sale!