Armando (0:00 – 0:54)
Hi, I’m Armando Roman, host of the Founders Guidepost. Welcome to a community of business exit experts who have come together to share their expertise with you, the founder, who will someday have that once-in-a-lifetime event, the exit of your business. What will you learn?
You will understand the high points of what’s required for a successful business exit, the key professionals involved, their roles and responsibilities, when to engage them, and in general, what you should expect and what you should not expect. You’re a long way from that startup business that you were many years ago, but when you’ve never sold a business before, you don’t know what you don’t know. You will come away with an understanding of a successful business exit done right, from pre-planning to finish.
Enjoy.
Armando (0:54 – 1:48)
Mike, thank you so much for this time that we’re having here together to have a conversation about that business owner who has a company, maybe had a 20, 25 years. And now he or she realizes that it’s getting close for time for them to sell. And they’ve spent their lifetime getting their expertise, building the value of this company.
Now it’s worth millions of dollars, but they’ve never sold the company before. And they don’t know what they don’t know, but they do know is they really have this one opportunity and they wanna make the most of this opportunity. So that’s where you come in.
So if you could introduce yourself, talk about what you do for a bit, and then we’ll just have a conversation that this business owner might wanna listen to so that he or she can learn from the conversation we’re having.
Mike (1:50 – 2:00)
Excellent. Nice to meet you. Thank you Armando for this excellent opportunity.
I really appreciate it. I’m Mike Patterson, part of Spencer Payne Law Firm. We’re 400 plus attorneys in 22 cities and I’m in Phoenix, Arizona.
We’re about 20 of us in Phoenix. I do a lot of international, but my main focus of my work is precisely this M&A. We call it merger and acquisition in the industry or selling your business or being on the buyer’s side.
We do that too. We know both sides of this coin very well and would love to help your clients think through, boy, what a great thing for someone who only has one shot to sell their baby as it were. Their business is their baby and most of them have created this value and hate to say it, but most of, a lot of people I see who are in this situation, almost all of their value is in their business.
They may have other assets, but most of it’s right here. Right, right.
Armando (2:00 – 2:19)
So when a business owner is thinking about selling and again, not ever done this before, Mike is the attorney that helps people go through this. What are some of the things that you’d say, we’ve got to talk about X, Y, and Z. What are some of those things that are just imperative?
Mike (2:21 – 5:27)
Well, part of it is I’m gonna walk through some of the decisions you’ll have to make, people that you may want to bring in alongside of you to make it better, increase the value, et cetera. One, a couple of things I would say just right up front is I’m glad that it’s a wealth planner like Armando who’s asking this question because in the end it’s how much you keep. It’s not how much we sell it for.
Or, and we really do need to know your goals right up front. Is highest price your only goal or do you wanna really be able to walk away from it or you don’t mind working for a couple of years? That may make a difference in how it’s negotiated.
Who do I wanna leave my business to? Now I’m assuming based upon the way you framed this Armando that we don’t have an adult child who’s gonna take over the business. We’re selling, we’re talking about selling it, okay?
And then best other terms. I mean, a lot of people are, it’s not just the cash price. It’s how much of that is up front and how much of that is paid out in an earn out at which I’ll explain in a minute.
A shorter non-compete. Are you gonna go do another business after this or are you gonna, are you planning to golf and travel the world? And do you want, I mean, most people the answer is yes.
I want a lot less risk on the backside. I want you to negotiate for me so that there’s very little indemnity there, reps and warranties, keep it, protect my backside so I can really walk away from this. And then it’s really important for me to know are you gonna do a next business after this?
How close is that business to this expertise? And that’ll play into things like a non-compete, et cetera. But then there’s various topics I’d like to cover Armando like who else you ought to be talking to?
Are you the 100% owner? Are there other people in the decision-making? What’s the difference between the types of sales like an asset purchase versus an equity purchase?
And then how can we structure it to maximize value? Should I use a broker and investment banker? What could I be doing right now to prep?
Let’s say it was a year from now you’re gonna do this. What can I be doing right now to prep for this to make it easier when the time comes? Is my company as clean as it could be?
What should I be thinking about to clean up this and that so that a buyer would be more attracted? And then I’d like to walk you through kind of the anatomy of a deal, what the documents are, from a letter of intent, memorandum of understanding down to the definitive, to closing date. So you get a feel for, oh, this isn’t as mystery as it…
When the time comes, you’ll have heard these things terms before. It’s not…
Armando (5:28 – 5:50)
It all sounds very, very relevant and very important. The pre-planning, I imagine you’ve probably had phone calls where you get a phone call where the business owner has already signed the letter of intent or has already entered some kind of a deal. And preferably they do that after they speak with you.
Right, Mike?
Mike (5:51 – 11:08)
Right, I’d actually like to be in on it from the letter of intent stage, even though some of those are not binding. I tell clients over the years that the apple doesn’t fall very far from that tree and basically you’re not gonna get a lot different deal than what you negotiated and signed in that letter of intent even if it’s non-binding. We’re not gonna be very far off from that.
And some of the leverage may have been given up to allow you to be able to walk away from things. So you wanna keep the leverage so that if this deal isn’t… If they’re not moving along toward the deal you want that you say, hey, you know what?
I’m gonna cut and walk and find a new buyer who wants to do it my way. You know what I mean? So I would actually along the lines of what I was telling you also earlier about, I really do think that they do need to talk to a wealth manager.
Most people have their whole patrimony, all their assets in one, most of it in this one big business. What they really do need to do is diversify particularly as they’re getting older. But that’s your advice, not mine normally but I’m smart enough.
I’m getting older myself and I know I need to diversify too. And so, but I mean, that’s really important. And when all your eggs are in this one basket it is really important.
And we’ll talk a little bit in a minute here if they pay you all in cash, that’s great. If they pay you all in stock of a public company, if it’s a public company that acquires, still it’s diverse and we need to figure out how to diversify all that stock in that one company or diversify that cash. That’s the whole, that’s one point of, one real benefit of doing this.
I’ll tell you too, estate planning is really important. If someone has not done estate planning with, that’s a different kind of attorney from me, we have them. But I remember I had three partners one time in a business and they were, they did a sophisticated estate plan with us, with one of my partners, cross insurance, islets, they call them.
But basically they were insured so that if any of them died there was insurance to pay off the other partners and buy them out. Well, most people think, ah, that’s just wishful thinking. Some people think it’s wasted money, but in right in the middle of everything as we were marching down towards selling the business, one of the partners, unfortunately got a massive brain tumor and died in two months.
Well, it was, even though it was really sad, the spouse, the widow in that situation, they had an adult child who had an invalidity and she couldn’t work and had to take care of that child. But I will tell you that insurance meant the whole world and the buyout and the ability to go forward with that business sale. And she got some more as well out of that.
I mean, but that planning really made a difference. Then also I would say insurance broker too. If, do you need some independent insurance products given that you may sell your business?
And if the business is the source of all your insurance right now, you might need independent health insurance or something else. But then a next thing I would tell people is just as a preliminary question, is this really all your decision? Most people say, yeah, it’s my business.
Okay, but is there a minority partner who’s got 20% and maybe we need to go read the documents and see if he’s got a first right of refusal or G. And some people come and say, hey, yeah, I’m 100% owner of this. Yeah, and are you married?
Yeah, I’m married. And things aren’t going so well and we might be divorcing soon. Well, that’s pretty important, right?
Because do the documents allow you to make all the decisions during a divorce situation or are we now down where Judge Smith is also involved in our business sale because and an ex spouse, et cetera, in that whole thing. Are there buy-sell agreements? Is there a stock reach purchase plan of some sort going on?
There’s also another way where people have a lot of little shareholders where they’ve given out options and other things over the years. And yeah, I’m the 95% shareholder, but I gave 100 options to 15 of my cousins and uncles and aunts because they were good to me in the beginning. Well, there may come a time, you may really need to consider, do we need to consolidate some of that?
And so that really is just you dealing with a buyer. Buyer’s really not gonna be too pleased with what we call a cap table, the listing of all the shareholders. That’s got too many names on it and those people don’t have a real reason for being there.
Armando (11:08 – 12:06)
Yeah, and so Mike, all those, you’re touching on a lot of areas and that doesn’t all take place in one day. It may have taken that couple or that person 20, 25 years to build this company up to what it is today. So it sounds like what you’re saying is they really have to kind of go through the whole thing and look at all those things and where are they today?
Did they give out the little pieces of stock along the way? Do you have to do something with titling or something so that you can have a clean sale on the back end? But it sounds like what is referred to often as due diligence, that that’s going to bring a lot of that out, meaning that when that prospective buyer is looking at that company, they will ask these questions and they will want to have clear answers so they know exactly what they’re getting and what they’re not getting and they wanna limit their liability.
Can you speak about that for just a few minutes?
Mike (12:07 – 17:06)
Absolutely, I’ll talk about your due diligence and also just put on your list there too. I’m betting that if you’re the sole owner of this business and you’ve created all this value, somewhere along the way, you signed a few personal guarantees where you’re personally liable for this or that if the business can’t pay and you probably want out of those in this transaction. So we need that inventory, things like that.
And then also let’s talk about what you wanna have lists of and due diligence. One thing you need to know is what makes my business valuable and is it my intellectual property? And we need to list that.
We need to look at your intellectual property and we need to say, is it all protected? Do I have one key patent? Do I need to occupy the space around that patent with several other patents so that it’s even stronger and of greater value when a buyer comes looking?
Do we need, are the contracts that you have, and this is really key, are they assignable? Many, many business sales are driven by you have 20, 25 big contracts with big companies or maybe you have that one huge contract with the Air Force or Honeywell or Intel or something. And then you need to look down in clause 67A or wherever that is and see how the assignment works.
Is it that you don’t have, anybody can just assign, it’s silent, that would be wonderful. Probably not the case though. Many times they say these contracts are not assignable unless the parties consent.
And if that’s the case, then a consent at the time of a sale might mean that the big party on the other side of your company, your big, big contract, maybe you’ve got a sweetheart deal at 4% with them. But if you have to go get consent and they know a deal is pending, maybe they renegotiate that to six or 7% before you’re done so that the value of that could change. But now if you know that, then we can work on the strategy on how you do the deal.
Or it’s not uncommon though for there to be contracts that need to be assigned at closing. Another area that people wanna look at is, do you need to get rid of, do you need to clean it up a little bit and get rid of non-profitable side businesses and products that are basically your main shtick that you do every day, not your core business. Should you streamline non-productive staff and workers?
I mean, do you have some people that, we’ve kept Sally around for 60 years and we’ve always been good to her. Maybe now it’s the time to think about giving Sally retirement. What about getting revenue up as high as you can and getting what we call earnings before income EBITDA, get that up as high as it can because that will be part of the negotiation.
Should we document loans and transactions with you that were undocumented along the years? Maybe you gave the business 100,000 or 300,000 and that’s on the books but there’s no promissory note to go with that. What’s the interest rate on that loan?
There ought to be a promissory note for that. Let’s make one real quick. So even if those are- How do you clean all that up now?
Let’s clean up the board of directors and get that person who’s kind of the stick in the mud, is it time for them to move on? So that when it comes time to negotiate the deal with the buyer, that there’s not somebody, a naysayer around, maybe that’s important. I’ve actually seen deals lost because of a really negative, problematic person that really it was time for them to have gone a couple of years ago.
So litigation that you need to push to get it resolved. I mean, you may say, well, I want another $10,000 out of that litigation. Well, let’s get that one settled and done, okay?
And then your accounts receivable, are you all 90 or less or 100 and maybe a few at 120 or do you have some accounts that are a couple of years old on there and big ones? And is it time to write those off or call them up and cut a real smoking deal and just get that off? Are there problem clients that are slow paid that it’s just time to wish them well and send them to someone else?
Armando (17:07 – 18:14)
Yes, you used the words cleanup. You’ve used the word cleanup a couple of times. And when you said cleanup, I was thinking of balance sheet and financials, but you’re making the point that it really just isn’t that.
Yeah, that’s probably part of it with receivables and that, but you said maybe with some of the board members, cleanup with maybe some of the employees, meaning it sounds like what you’re saying is going through each of the parts of the business and taking a fresh look at it, even the sales and products and the revenue, are there certain profit centers that really are dragging the rest of the company down and just get rid of them? So as you do this, Mike, with different clients in that and help them navigate all these, the pitfalls so they can get to the finish line and actually have that sale on the best terms for them, what are some of the common things that pop up that maybe they just didn’t see?
They just didn’t look far enough down the road to see them and it derailed that sale before it came to closure.
Mike (18:15 – 22:18)
Right, well, and of course, I forgot to say you were right on the, you do wanna clean up your asset, you have asset lists and IP lists and your financials in order and schedules that will eventually be attached to a deal. Anyway, you can start preparing those now. In fact, I even have had one client over the years that when he filed his articles of organization, he was a serial entrepreneur and when he filed them the first day to start the business, he created his data room, started creating his data room for the day he was gonna sell the business.
And he had been through this several times and so he just started tucking all the key documents in there. I’ve only had one client that was that way. But you’re asking, what are things that pop up?
Let me just tell you. One thing is, have you tied down your key people? Are the people the value to your business too?
And I recently had a deal where a person said, oh, nobody’s gonna want our people, they just want the book of business, my book of business. And so really it’s not EBITDA that includes the cost structure too, but it’s just my top line revenue. That’s all anybody’s gonna care about.
They’re gonna want the top line revenue from these contracts and then they’re not gonna want any of my people. Well, tell you what, I talked to a couple of brokers in the industry to talk about how we were gonna find a buyer and they said, oh no, in this pandemic atmosphere that we’re in, people very much care about you. They may wanna take your people because they can’t find good people.
And so not too fast. And then I wonder if you have tied down your best people. So it is often a common mistake that where one person has owned and run the business for 40, 50 years and they’ve got one guy or manager or plant person or sales, the lady that heads is the VP of sales.
Those people are critical to those client relationships going on with the business or to the plant being able to operate after he’s gone. And yes, you may be asked to stay on in an employment agreement for one or two years in an earn out, we’ll talk about in a second so that you get this part of the purchase price upfront and then you get the rest of this after if things keep going well for a year or two after you’re there. But what I was gonna say is I helped sell a veterinary clinic a while back and there were two doctors that were part of this veterinary clinic that there were no employment agreements with them and there were no non-competes with them and to keep them from going somewhere else and practicing and taking all their clients with them out the door.
And why it made a big deal in terms of value was there are kind of two prices in that industry that you can sell for, selling to other docs or the docs that are in your practice and then selling to the big national roll-ups that wanna buy up all the veterinary clinics and are paying a premium for those clinics but they would never touch a clinic that had doctors who could walk out the door and take all their clients with them. So the failure over the years to tie up, just to have ordinary agreements and tie up the key people to make sure that they’re gonna stay around or motivate them with an option or something like that, that’s a key area is making sure if your team is important to your value, then you want to take a good look at what do I need to do to make sure they stay around after this?
Armando (22:20 – 22:35)
Did I answer that question? Okay. Yeah, I was gonna ask you more specifically, how do you keep the employees around?
Is it through incentives or what is it to keep the people there?
Mike (22:35 – 25:09)
I actually have seen once something called a stay put agreement that actually there was a guy who was so key to the business that they signed an agreement with him where he said he would stay put for a year. And in exchange for that gave him, he couldn’t have an option in the company because a new buyer would wanna buy it and own the whole business, but he would be incentivized out of the purchase price by the seller of the business in exchange for staying put. And there were also provisions there too that what happens if I fall over today from a heart attack or get hit by a truck and then my wife’s gonna wanna sell the business.
But Fred, the day after I got hit by the truck said, well, this place isn’t worth hanging around for. I’m going across town to something else. I gotta protect my family too.
Well, then the value of the business just went, because Fred’s gone and he’s key to everything. And so an agreement like that, options, giving him an option or what we might call the phantom option or some right of participation in the value, maybe not stock so that he doesn’t get to vote yes or no, on this buyer or that buyer, but you control all that. But out of the proceeds, he maybe gets, he or she maybe gets a little kicker or some sort of a bonus that’s tied to hanging around and seeing it through.
Could you, believe me, during the due diligence period where someone is coming and asking and you’re having to pull together lists and it’s all hands on deck, you certainly want your two or three key people on your team to be, have all the oars in the water. I mean, that makes sense. So that’s important.
I don’t know if I’ve answered that question. There are multiple ways to give them and people who have been taking care of those people along the way with bonuses and otherwise, there’s generally a higher level of trust. But these days we’ve seen so many people jump ship and go elsewhere.
This is a key issue to a business that may be selling.
Armando (25:10 – 25:28)
Yeah, that makes a lot of sense. There’s so much in the media now about the scarcity of employees and people who have left their jobs that I can see why you’re saying that it’s more timely now more than ever possibly to keep the employees intact during this transition process.
Mike (25:31 – 28:13)
And Armando, there may be a way to look at your business right now and say, should I change my structure a little bit in the business? Let’s say I own the building or the warehouse where the manufacturing takes place. You might, many people put their building into a separate entity, a separate LLC, and then they put the operations of the business in a separate entity.
There may be a buyer who comes along that wants your building and maybe one of your NSEGs going forward is you sold them the business, but you held onto the real estate and you have a long-term lease with them. And that’s another kicker and the thing continues to appreciate. In real estate value, and then someday you sell it, you know, and have another exit someday.
That may be another way. Your IP, sometimes people put their IP into a different entity as well. There’s another reason to do that that is not related to buying or selling the business.
And that is if your business ever got sued and somebody got a big judgment against your company, if your IP is really a critical part of your business, if it’s all under one entity, then they could actually take control of your IP and sell your IP. If it’s in a separate entity and you can license it to other parties and you maintain control of that, they may only have a judgment against this one. But the ability to separately lease your building and separately license your technology.
Like for example, I may have four patents or three patents and I’m currently only using them to manufacture this widget. But technically these patents could be used in automotive industry, but I’ve never gone there yet. And maybe they could also be used, the same technology could be licensed in aerospace, you know, and maybe I give, when I sell the business, I give an exclusive license to this buyer of my patents for this application.
And so no one can ever compete with them on that. They have the exclusive for that. But then I have the freedom to license my patents in other industries that the buyer doesn’t care about.
That could be, that’s a possibility. So restructuring for potential maximum value and probably talking to the buyer about that could, and then if they insist, no, I’ve got to have the patents that then you have some price leverage.
Armando (28:14 – 28:41)
Right, and part of what you’re touching on is, you know, the asset protection where you’re putting different assets in entirely different entities from an asset protection standpoint, just protecting the overall net worth. That makes sense. But I liked your example about the patents where if you are able to retain the patent yourself and grant a license for that specific purpose, then you can retain that asset and maybe license it to others as well.
Mike (28:42 – 31:15)
Yes, and I’ve done sales of businesses on the real estate, as I mentioned, in a couple of situations where they didn’t want the real estate, but they did take a lease. They didn’t want to buy it. And then some circumstances where they want to buy the building along with it.
And then there’s also some options. There are two for them, for financing with banks on financing the real estate. And that’s one thing too, due diligence on the buyer.
I want to know, are they really solvent? How are they planning to purchase my business? Are they going to go out and finance it and use other people’s money to do a little capital raise to buy my business?
Is that additional piece of risk? Are they a national firm that has lots of cash and they can just write the check and do it? Are they planning to use their stock to buy my business and just give me half cash and half stock?
Are they in an extreme example of which we would negotiate against for the seller? I don’t want a very limited amount of cash being paid to me upfront and the rest of it being paid to me over several years and they’re basically using the ongoing cashflow from my business to buy my business from me. And they’re requiring me to stay around and run the thing to make, so that I can help them buy my business.
You know what I mean? In an extreme example, I’m trying to put it down on, so it makes sense, but no, we want as much cash upfront as possible. And then moving to the term of earn out.
Earn out means, is that portion of the purchase that is paid later deferred, but it’s subject to generally some contingencies that the business in year one and year two, still revenues are still at this level. And then of course, and nothing bad has popped up in the meantime. Well, we try to negotiate for our sellers when we’re on this side, as much upfront as we can, limitations on what the contingencies are for the earn out.
And then some other things which I’ll talk about in a minute about that are in the documents to lower your risk.
Armando (31:16 – 31:46)
Yeah, so definitely a lot there, Mike. You’ve touched on so many things in just the few minutes we’ve been on this conversation that it seems like easily very overwhelming for that seller, especially when he or she is still trying to run that business and keep it profitable, keep sales going forward, keep all the employees on board. So when they go through the sales process and you’re helping them in this, it just sounds like it can be really overwhelming.
Mike (31:49 – 33:32)
I understand that. I think if you use some good professionals and we’re gonna come in a second to talk about whether you should use a broker. And these people are not just about finding you a name and getting a percentage, but really good ones help you walk the deal through on the negotiation side in the end.
And I’ll talk about the value there. But also, we don’t want you to have a heart attack in the middle of the deal. And we’re definitely there to help it go smoothly for you.
And it really can. I think if you plan well and you use good professionals around you, we’re gonna try to get you maximum price and maximum the best terms for you to lower stress. And for example, there’s even one thing called a rep and warranty insurance.
I’m representing and warranting to the buyer that there’s none of this and there’s none of that. And there’s no environmental liabilities in my plant and all the rest of that. And there is actually insurance out there, but a whole new industry that has grown up where there’s a cost to it and you evaluate whether it’s cost versus whether it’s worth it.
But if your deal’s big enough, it’s probably worth looking at after we’ve negotiated your reps and warranties as far as we can. You wanna get a little policy so that you can go sleep at night while you’re traveling Europe. You don’t have to worry about it.
One of those things turned out to be a problem, that rep and warranty insurance is gonna kick in and pay for that. So there’s things like that.
[Speaker 3] (33:34 – 33:34)
Yeah.
Mike (33:35 – 43:29)
I would say, let’s talk for just a second about what it just picture so that you know kind of the terms of art in a deal like this and the sale. Asset purchase versus an entity equity purchase. I think most buyers, the default would be, I just wanna buy the assets of your business.
I don’t want any of your litigation or some lurking sexual harassment lawsuit that someone hasn’t made the complaint yet, but it happened on your watch. All those kinds of potential liabilities that are out there. Potential contract dispute where someone is about to, we don’t know, but someone may sue you for infringement or something like that.
And you rep and warranty your document to seller’s knowledge. And we try to get those knowledge qualifiers in there. There are no claims and we’re gonna add in to seller’s knowledge.
And on some they’ll allow that, some they won’t. And then limit that down to one person’s knowledge if we can. But what I’m trying to say is, why would someone buy the equity of your business, lock, stock and barrel with all of your liabilities?
Why would they do that when they could just buy the assets and not buy your liabilities? Well, there may be a tax reason, but there also may be some key licenses that are owned by the business that are non-transferable. I sold a hospice one time and the key license for that hospice ad, you had to buy the business, the equity.
Because if you just bought the assets, the license would not transfer with it. I helped a client, it was their business, they’re selling. But in the nuclear power industry and they had control panels for nuclear power plants.
And they had a key license with the nuclear regulatory agency. And everybody wanted that license. They really, I mean, yes, they wanted all the engineers that went with the business too, but they really wanted that license.
So they bought the equity of the business for that. There might be a contract with a key government agency or something like that. So those are the reasons.
And then another thing going through Terms of Art that I wanted to talk about is in the documents themselves, that kind of the anatomy of a deal is the first document you do is a letter of intent, LOI as you described, or sometimes called Memorandum of Understanding between the buyer and the seller. First, you got to find a buyer. And we’ll talk in just a second about whether you should use broker.
But you get this LOI signed, it typically may be non-binding as to the terms, so that neither party is obligated to go through and sell the business or buy the business. But there will be some terms in that document that are binding. And one thing I’d like to see in the document, if I’m representing seller, is that there’s a short, very short period for due diligence.
We’re gonna let the, before the buyer has to go hard, if you will, and commit to this deal. And they may have some further due diligence that they could do in the definitive documents that we talked about. But at that point, they’re on the hook.
Maybe they even have to put some money down that will go hard as well on the deal as well. But we want that buyer to go hard and to be committed within a very short period of time. And after having looked at this limited due diligence, and we will even spell that out what that is, what really could be horrible is to see a seller locked into a letter of intent that really doesn’t allow them to ever really terminate.
And the buyer just drags it on forever and ever, even months. And then they keep sending in their teams to do due diligence and then they use the information that they got out of that due diligence to negotiate you down on the price. So, well, we were gonna pay you X million, but we came in and looked at it and we found this, this, and this.
And now we’d like to adjust our purchase price to this. Well, if you can’t get out of that LOI, what I’d like to see is you have the leverage so that you could say, hey, look, the deal has now changed. I’m walking, I’m gonna find a new buyer.
You now no longer have the exclusive with me. Normally these documents say that we’re not gonna talk to anyone else while this letter of intent is in force. Well, I want you to have some back doors to get out of that if this deal isn’t moving forward because you’re tying up your business and now you can’t go to talk to other buyers.
And then once the letter of intent is done, there should be timing in there for something we call definitive documents. Those are the real documents that take us to closing. Who drafts those?
Well, that’s always a question. Who drafts those? Do you want your attorney to draft them or the buyer’s attorney to draft them?
I would actually suggest to you, you’ll actually save some money in my view if you spend the money and you do the first draft because they have to red line in the stuff that’s buyer favorable. And it’s hard if they bleed all over your document, then we would seemingly have more leverage to say, hey man, you’re asking for a lot here. And so if they send you documents that are just heavily favorable to the seller, and now we have to back those out and make them reasonable for a buyer, I’d prefer not to have to do that.
On to the next thing, what’s being bought, what’s not being bought. Regardless of whether it’s an asset purchase or a entity purchase, we wanna make sure we have lists in there that include what’s part of the business, what’s not part of the business. Earn out very clear about what the terms are when you get the rest of the money.
And one comment I would make to people is, if a significant part of your purchase price is paid over one, two, three years, I would like to see you have some control over the business where you’re gonna be there and have some control over how sales are made and that kind of thing. Because if you’ve lost complete control, business may not hit those numbers. And the way they’re accounted for in the accounting department may not be accounted the same way.
And all of a sudden you didn’t get your full earn out because you were no longer in control of the business. So I’d like to see you in control for as long as you’re waiting for the rest of your earn out. Or at least some control.
They’re gonna wanna control the business. The reps and warranties, we wanna limit those and then ensure if you can. Indemnities, there’s these things called caps and baskets.
And I’m not trying to make you gloss over here, but a cap would be the total cap that you might ever have to pay them back if something really bad happens. Litigation about something that, we’re gonna try to negotiate a cap for you so that you can go away and sleep at night on what your total liability would be. And then I’m also gonna wanna try to do a basket.
And what a basket is, is they can’t bring an indemnity claim for you to pay them for the first $5,000 claim that comes along. They have to get a basket together of 25,000, 50,000, whatever. And maybe they have to get three claims together before they can actually come to you and ask for an indemnity.
And maybe they never get there. So you don’t wanna be nickel and dimed while you’re vacationing in Europe, you know? And then we’ve talked about your employment issues.
Do your employees terminate the day of the closing, and then are rehired by the new business that same day on a new employment contract with them? That’s most of the time what happens. Are there benefit plans that you had with them that need to be cashed out or terminated as of the date of closing?
And then they start from there with their own benefit plans. Very rare that they’re gonna roll over things into the new one, but you probably want an employment lawyer looking at some of that with you. I know I got a little bit into the weeds there on what a definitive document would look like.
I think it’s helpful as you look forward that it’s not all mystery. That’s not too bad. You know, with a little bit of help, we can see that through.
And this is what I do for a living. I draft those things. But I just want you to know what that’s about.
The other two things, only other two things that I would talk about with you probably would be, it is how do we determine what the value is of the business? And then do I use a broker? It goes along with that.
Did you have another question, Armando, before we move on?
Armando (43:29 – 43:58)
No, I like where you’re going. That is a big question. Do you use a broker?
Do you use an investment banker? Do you use an intermediary? Who’s really gonna help you?
And what are the different roles? Because again, the business owner who’s selling for the first time, and it’s this one once-in-a-lifetime transaction worth millions of dollars, they wanna make sure they do it right, of course. And faced with those choices, if you could just speak to what each of those does and how they can be helpful to the seller, that would be good.
Mike (43:59 – 51:02)
And I would say, when I say use of brokers or investment bankers on the sell side, so business brokers, you’ve probably heard that term used. That is often for businesses in a practical matter. If a business is a million dollars, it’s probably gonna be a business broker, a few hundred thousand for a business.
That’s gonna be probably a business broker. And the commissions may be a little bit lower than an investment banker. From like 5 million and above, you’re probably using an investment banker that’s FINRA licensed.
And by the way, FINRA is the Financial Industry Regulatory Authority. You could only do asset sales with a non-FINRA licensed person. Someone who’s actually selling the stock into your business or there are stock or equity pieces in there, that person needs to be licensed with FINRA or they’re not allowed to handle those types of transactions.
They’re gonna charge you a percentage of the deal. There is a commission and there is an engagement letter with both the business broker or an investment banker. And I’d like to review that document too, because they’re gonna have their Rolodex.
That document is gonna talk about how long they’re exclusive to you. And there are times when I’ve seen most of the brokers that people work with are great folks and very good at what they do and do get them to the finish line. Occasionally someone comes in, charges a retainer and then monthly retainers, they pay to that broker.
And then for just a few months, and then nothing happens and they never really got a buy. Now that would be a worst case scenario. Most of the time, they are bringing lots of people to the table.
But I would like to see some terms in that contract with the broker that allow you, if you’re not getting results a way out after a while, because you wanna move on and sell your business. Your timing is really important too. And so I guess one thing I think that makes a broker valuable is they do a process where they bring various potential buyers to the table and that gives you leverage both on price and on terms of the deal.
So you can ask for a better cap on potential indemnity and you can negotiate if your business is a hot item and there are three people bidding or five, you can ask for more cash upfront or all cash upfront. And you’re gonna see amongst those. I had a client who was selling a healthcare related business and was looking for $20 million was their target.
And I kept telling them, you need to use a really good healthcare experience of investment banker in this process. They resisted that because they didn’t wanna pay a commission, but they finally got one and a nationally known one. And the person went out and did a process and brought them four 30 million plus offers to the table.
And they chose amongst those. And by the way, they did not choose the highest bid. They chose one that was a lower bid that had more cash upfront and better terms.
And, but you can be choosy at that point if you’ve got multiple offers. So I think a really good broker really brings you value. And I actually went to the dinner at the end of that where the broker bought us all dinner and the client just said, I just wanna kiss you to the broker.
I can’t believe, did we even, and they even said, I’m not sure we even paid you enough. You know what I mean? On that, I thought, oh, don’t say that.
But I mean, a really good investment banker, broker brings value to this deal and matches you up and brings. And I wanna say a word about strategics too. Most people who have been working in their industry their whole life, they know the big fish that are just above them that, and they have made up in their mind, the person who would really wanna buy us is Widget, you know, Widget.com, you know, and they’re a big company and I know they would pay top dollar. Well, you wouldn’t be surprised any profitable business that is making revenue. There are a lot of family offices out there. There are a lot of investment companies out there.
There’s a lot of money on the sidelines in this market and don’t just settle for, I know the one person that would buy my business and I’m gonna give them a call myself. You know, you should think that approach through before you do that. And the other thing is value.
I think an investment banker can really help you or a broker. I’m not just totally prejudiced this way. I’m actually doing, I’ve done a deal recently where I called the four potential buyers that the client identified for me.
They did not wanna use a broker and I’m not a broker and I don’t claim to be one. And, but I did make the approach to match up for a client and they’re doing pretty well on their own but that’s the way they wanted to handle it. And, you know, but I would say that in most cases there’s even another reason, another circumstance where you may want to use a broker and that is anonymity.
It may be devastating in your business if word got out that your business was for sale. In fact, you might lose employees, you might lose clients, your competitors, the sharks in the water would come in and say, you know, Armando’s selling his business, you should jump to our firm right now, you know, kind of thing. And business brokers and a third party like that, that’s part of the value is they handle it on an anonymous basis, get NDAs in place.
In the first approach that they make, they say, you know, Mike’s, we have a business that is in this industry. It’s in the Southwest United States. Top line revenues are X, are you interested?
You know what I mean? And then they get the deal documents and then they get strict, strict NDAs in place. And then now we’ll talk and give you a little more information.
[Speaker 3] (51:07 – 51:07)
Yeah.
Mike (51:07 – 55:41)
Well, Mike- I haven’t talked about value, valuing the business. There’s three ways to value a business, Armando. Replacement value, open market value and then heavily used as cashflow sales.
There are other value evaluation triggers in the market that valuators use, but I’m just talking in general terms. You know, there’s a lot of ways to look at a business. And then there are other things I would say that are kickers that maybe will give you a premium.
And that is, do you have IP that is so unusual that you may not even have revenues, but you’ve got this IP that’s gonna change the world? Okay. If you’ve protected it and you’ve occupied the space and you can give cease and desist to other people to keep them from using it, well, then maybe some big fish is gonna want that IP, period.
You know what I mean? Key contracts and clients that nobody else in your industry has, that may give you the plus. Do you have some talent in your workforce that is really unusual and unique?
Or it’s not abnormal, but everybody in the industry has 13 employees and you’ve got 70. That makes you much more attractive. Is there a timing issue in your positioning in the market?
Right now, things are happening and the whole world, the Apple card is upset and there are winners and losers. And right now, if you’re in the supply chain business and you had 30 ships that could bring stuff from all over the globe to, you know, and get it unloaded quickly in North Carolina instead of Long Beach, I mean, I think you’re better positioned and there’s a timing issue, of course, right now. Or if you have inventory in the United States that other people don’t have, there’s timing and positioning.
And then did you finance your growth at the right moment already so you don’t have to go out and do that? Should you get a valuation? Just know it may have to be disclosed.
And another question I ask businesses that come to me is, did you recently, let’s say in the last year, go to your bank and tell them that my business is worth X in order to get a line of credit or something like that? Just keep in mind that those things pop out sometimes. Did you just recently do a private offering to bring in a couple of preferred shareholders?
And did you tell them that your business was worth X in the process of doing that? Did you make disclosures? You just need to think about, what have I told other people?
And I’m about to tell, and has something significant happened between then and now so that I can tell the new buyer, well, it’s worth twice that now because we then got two new patents and we then landed Apple as our major client, big, huge contract with Apple. So, I mean, we know what your story is, your value as well. But then if you need help with that, there’s always these experts outside that can put a value on it or the investment banker themselves have internal processes.
They’re motivated to have that sales price be as high as possible. And so they’re gonna talk to you, work through your story and get that price as high as they can because they get a higher commission too. And they wanna help you have a high price.
Is that all overwhelming? I need to go back to the encouragement and say, you can do this. And I think if you’re the one that’s gonna start today and start collecting a few things, cleaning up a few things, thinking about where the value is to your business, what makes us special?
Why are we unique in the market? And how do we focus on that core and so that we’re attractive when someone comes calling, we’re lean and mean and focused on our mission. And then I think you will have a story to tell and you’ll get highest value.
Armando (55:43 – 56:28)
Yeah, that makes a lot of sense, Mike. Thank you for that information, a lot of information. And part of the things I would say that I came away with just hearing you talk is it’s really looking at all parts of the business and not just right now today, but also looking at the history of the business and being able to document the different things along the way that maybe that happens two years ago, three years ago, and you kind of forgot all about it, but that there’s appropriate documentation there that as you said, tells the story of what happened, but also tells the story that now that’s a closure and it’s resolved, it’s not gonna crop up later to scare the buyer or become a cost for the seller or anything like that.
Mike (56:31 – 57:51)
I think, great point. And Armando, I’ve done some public reporting for public companies over the years. And one of the things we tell people to put in that management discussion in those public reports is what is the thing that keeps the CFO and the CEO up at night?
We can talk about all the things that the securities laws require you to disclose, but what are those things when you’re laying in bed at night that you actually worry about, there’s a little problem, you know what I mean? And I would say, that’s for public companies, but I would say applying it to your company, a private company that you’re gonna sell. If you know those things in the back of your mind that have been a recurring issue and that you wish you could just take your eraser and wipe those off the whiteboard, well, getting ready to sell your business, it’s now time to, let’s go aggressive and fix a few of those.
And if you need to talk to me as an attorney or Armando or some other advisors on, let’s get some ideas for how we fix that so that you’re a lot more confident going into the race that you don’t have those things to deal with.
Armando (57:51 – 58:26)
Yeah, and every business owner knows what those are. That’s right, they’re different for everyone. Right, right, so they might not be written down, but they’re certainly out there.
And you make a good point, Mike, that as you go through that sale process, if they’re bothering the owner, the seller of that business, probably gonna bother the buyer as well. So why not address it before you get too deep into the process so that it just minimizes that timeframe and helps get to that finish line faster?
Mike (58:27 – 58:55)
And we avoid too the risk of non-disclosure of something really important. Of course, we would need to disclose all the things that really are a problem. But I would say, since you teed this up today of I’m gonna sell my business soon, the exit is on the horizon, maybe let’s say a year.
Well, so let’s get busy. Let’s clean up all those things that are bothering you.
Armando (58:56 – 59:25)
Yeah, and so Mike, if someone is thinking they’ll sell, say in the next year or 12 to 18 months, I’m thinking of how far back should that business owner be looking in their own business to do that cleanup? You mentioned maybe the owner lent money to the company, but there was no promissory notes. How far back should those types of things be addressed and documented?
Mike (59:26 – 1:03:51)
Well, and I mean, you raised a good point along the way, is you thought when I said cleanup, that we’re talking about financials. If there’s something, is there something accrued on your financial statements that has no document attached to it or particularly personal items that are related party, as we call it, to the principal himself or herself? Are there those related party transactions?
Those are the ones that get a lot of scrutiny. So if they’re on your books now, or if you feel that you’re owed money from the company, or there is some arrangement between you, maybe you have a related business and it’s the exclusive supplier of a component to your business, or it’s your brother-in-law who’s supplying that. Is there a written agreement between you and that other, between your business and that other business?
How would we disclose that arrangement? Is there someone in your company who provides a specific service or good or something like that to the company or who is entitled to something, to some right, that he or she gets 1% of every time, there’s some special arrangement. You need all those to be written down.
And if you think that one of those may not be saleable to a third party buyer when they come along, maybe it’s time to dig deep and pay some money and buy that right out and be done with that so that you’re clean. Now, not everything has to be bought out. There’s a lot of money out there that wants to come buy your business just today, just the way it is, because there’s people just wanting to buy up businesses right and left right now.
So timing is everything too. I had a business that, I mean, their business was going like this and their industry, and they shot to be the number two in the world in a particular service that they provided. And they were a small company, right here in the metropolitan Phoenix.
They went from two people to 130 in five years. Fantastic. And young too.
I mean, young couple maybe. And I, but I looked at them and said, have you ever thought about an exit? And they said, oh no, this is such a cash cow and it’s going like that.
Why would we consider selling it? It’s making lots of money, hands over fist right now. I said, well, but look at your industry.
Is there something you could dream of that could change worldwide? Some factor that could, you’re really dependent upon, and there’s a regulatory agency being in the United States and that the registration of these rights never shifts off shore to China or somewhere else. What if that changed next year?
But well, yeah, but that would be huge, but that really changed the value of our business. And I said, well, I just think about that, Mike told you, sell while it’s hot. You don’t wanna be one day too late.
And I did have a relationship here in town where people had thousands and thousands, the largest fleet of taxis in Arizona and in another state, but they woke up one day and there’s these guys named Uber who all of a sudden were, everybody now works for them, Uber and Lyft, right? And so if you wanna get, and they did such a great job. And I think you don’t wanna wait until your product or service is, there’s some disruptive event that changes your entire industry and now your business is not worth as much.
You wanna go for the timing on, don’t wanna sell one day too late and have it be not worth as much.
Armando (1:03:52 – 1:04:45)
Well, right, right. And that kind of gets back to, we talked about earlier about asset protection too, that keep entities in separate or keep assets of different entities. But then also maybe that couple that you talked about, maybe they could have taken some chips off the table.
Maybe they could have sold part of the company or done something to at least put something in a safer place so that if the industry changed, then they weren’t left with an empty bag. Instead, they had some value that was real for their family going forward. But Mike, thank you so much because you’ve gone through so many things in just a short amount of time based on your experience that really can be helpful to that owner who hasn’t gone through this before.
And so if that person is listening, saying, well, I really need to talk with Mike. Mike, how would they get in touch with you? Is there a phone or email?
How should they reach out to you?
Mike (1:04:46 – 1:05:26)
Sure, my cell phone where I give it out freely and people call me on it, 602-471-5170. 602-471-5170 or Armando knows how to reach me. So my email at Spencer Payne, mpatterson at spencerpayne.com.
And I have a team of four other M&A attorneys. We’re a team and I lead it and we’re working on these kinds of deals all the time. We’d love to talk to you.
I’d be happy to do initial intake at no charge just to make the acquaintance.
Armando (1:05:27 – 1:05:33)
Yeah, excellent. And Mike, is there anything that you wanna add maybe that we didn’t touch on in this conversation?
Mike (1:05:34 – 1:06:37)
Well, you made a good point right there at the end and that is you may not wanna sell the whole business. So, I mean, you might decide to sell 51% of your business control, but you may wanna keep a little bit because you wanna stay along for the ride or you may wanna take some off the table. You may wanna do a private offering in your company and raise some investment.
That takes some off. Part of the purpose of that may be to take some of your interests off the table, but you may wanna stay involved. So, you made a good point right there at the end, Armando, that people may wanna keep part of their business and still go vacationing in Europe and play golf and put someone else in charge or staff.
Maybe one of the purposes and use proceeds of that raise will be to pay you off, but also to hire in some professional management who can run it so you can go enjoy whatever your next dream is.
Armando (1:06:37 – 1:06:45)
Right, right. And hopefully the regulations won’t change around the industry that could threaten your business, but that kind of stuff happens.
Mike (1:06:47 – 1:07:26)
Yes. I think right now we’re, I’m not a tax expert, but I think one of the M&A crazes right now is that at least we’re in a window where buying and selling businesses is attractive from a tax perspective and you always need to get good tax advice, but that’s another window where we should, anybody that’s got a great business should think about, should I sell it? Or should I hang on to it?
Or should I acquire three more and roll it up into a bigger thing that then I’ll sell it in three years for 10 times the value or 20 times the value?
Armando (1:07:26 – 1:07:51)
Right, right. Well, Mike, again, thank you so much. Your expertise comes across loud and clear.
This is the space that you’re in. You definitely have your arms around what needs to be addressed and that. So thanks so much for this time and thanks for the phone number.
If people have any questions or thoughts, they can reach out to you and ask you those directly. So Mike, again, thanks for the conversation. Really enjoyed this time with you.
Mike (1:07:51 – 1:08:02)
Thank you, Armando. You have a very broad view and I know that the very fact that you do these things means that you’re looking at the big picture for your clients and good for you.
Armando (1:08:02 – 1:08:04)
We’re always trying to help.
Leave a Reply