As you get into your later years, there are times that you’d prefer peace of mind over money. The same could be said when exiting and selling a business—the highest price isn’t always the best deal you can get. That’s when you need to look at what’s beyond the sale price. Partner and Business Attorney at SFGH, Jeremy Waitzman explains the finer details of business deals that are often overlooked. With an extensive experience in M&A, he discusses how you can get the best deal there is for you as a seller or buyer. He further talks about the importance of knowing what you really want after the sale, prior to actually making the sale. On a technical note, Jeremy then shares his knowledge as a business attorney to explain the different legalities and documentation you’ll be needing to keep an eye out for to ensure a smooth transaction.
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Jeremy Waitzman: Beyond The Price Of A Sale
Small business is big business. The sponsor of this episode is Busey Bank. They understand that small businesses are the lifeblood of our economy. For more than 150 years, Busey has remained a dedicated partner to those businesses and entrepreneurs who bring vibrancy to the local community through sound advice and simplified solutions. Busey supports small businesses. For an array of business solutions tailored to your specific needs, visit Busey.com. If you’re seeking a business acquisition loan, be sure to reach out to the head of their SBA group, Steve Lasiewicz. He’s somebody I’ve known for years. He’s one of the best SBA bankers out there, bar none, and you can reach Steve at [email protected].
I’m pleased to have Jeremy Waitzman with us. He’s a seasoned corporate attorney with the law firm of Sugar Felsenthal Grais & Helsinger. I’ve known Jeremy for many years. We’ve had the opportunity to work on M&A transactions together. Jeremy was trained as a corporate M&A deal attorney and his experience is expansive having been involved in over 150 transactions. Jeremy, that’s a lot of transactions.
It keeps us busy.
He’s a frequent speaker, panelist and moderator on the issues related to mergers and acquisitions. He’s also one hell of a nice guy and well-respected by his clients and colleagues. Jeremy, welcome to the M&A Unplugged podcast.
Thanks, Dom. I appreciate you having me.
Give the M&A Unplugged community a little background or on yourself, on your firm and some of the things that you specialize in.
I’m a corporate guy. Everything from, “I want to form a company. I’m going to raise money,” is clearly M&A succession planning and issues related to the like. Sugar Felsenthal Grais & Helsinger has been around for over many years. Clearly, I was not with them when they started but it started as a tax and estate planning firm. As the client’s matured and needs arose, they grew and now we’re at 30 attorneys headquartered here in Chicago. We also have an office in New York City, but it’s the general corporate business law firm, everything from the corporate stuff that we do to the litigation, estate planning and real estate. We like to say that we can handle 95% of what a business or business owner would need either on the business side or personal side.
What have you seen in the marketplace in regard to transactions? In all my years of doing this, I’ve never seen a market that’s hotter than the one it is now. What are you seeing?
We’re seeing the same thing. It’s steady and people want to do deals. They’re between the private equity or family office money that’s out there and available and folks that are perhaps looking at an exit event. It’s still healthy out there.
It doesn’t seem to be slowing down. We brought a deal to the marketplace. They were HVAC, Heating, Ventilation, Air Conditioning, and we’ve got over 60 buyers that have expressed early interest in taking a look at the deal. It’s unbelievable. I thought we could spend some time talking about the things in a deal that goes beyond price. Oftentimes I say this and I hear people like you. I know you’ve said it and other people say that owners will many times not pick the offer with the highest price because there are many other terms and conditions that need to be considered.Outside of price, selling is about your employees, reputation, and exit. Click To Tweet
It’s interesting when people first get the offers and they look at the price. They’re like, “This firm, peg or strategic looks like they want the deal.” When you start to dig in and you read through the rest of the terms and conditions, there are lots of loopholes, shackles and all other things that can concern people. I know you’ve experienced this so why don’t we talk about that a little bit at a high level. Maybe we could drill into what are some of the specific things that owners need to worry about in an offer that goes well beyond price?
From a high level, if somebody is ready to move on or sell their business, there are factors behind that. It’s not only, “I need this cash windfall.” They’re tired. They’re ready to spend time with their grandchildren. There’s something else they want to do. Oftentimes, business owners have been doing this and only this for many years. Maybe they started it in their twenties and now they’re in their 50s or 60s and they’re done. It’s a mental mindset there that they want to perhaps explore or move on to the next thing. In the context of the legal terms, oftentimes it’s not only about price. It’s about wanting to take care of my employees. I want to make sure that when I’m out, I’m out. Things along those lines. When you’re talking about the 30,000-foot level, it’s what are you trying to accomplish and how do you get there?
It could also be when I’m out, I want to still keep a foot in. I want to take some chips off the table, but I’d like to stay involved. It’s all flavors of what can happen and the conditions of those matters. Why don’t we dive into some of the areas that you see that consistently come up that go beyond price that owners need to care about?
Let’s talk first about the business terms. Oftentimes, lawyers stay out of that fold. You come up with the business terms and tell me what they are and I’ll get it in the document. Let’s talk about something like payment structure. It certainly could be all cash, which is often the preferred method for sellers. What if there was a situation that maybe you get a little bit less at closing but could get future upside that could take the form of some earn-out structure? If certain benchmarks are hit, whether it be sales or otherwise, that you as the seller can get additional cash. It could be that you get what’s called rollover equity, meaning you take some stake on an equity basis in the continuing entity. You get a cash-out where you sell 100% of your company, but you’re retaining 1%, 2%, 5% or 10% of the resulting entity so you’re a shareholder. Instead of being the boots on the ground there every day, it’s a passive income stream. Sometimes people get to what’s called a double-dip. There were other things on the business side that may come into play.
Let’s talk about those two things for a little bit. We’ll keep it at a high level, but enough to give the M&A Unplugged audience an understanding of earn-outs. Not all earn-outs were created equal. They can be fraught with challenges. You want to make sure you do them in a way so you don’t wind up with litigation later on. Earn-outs can easily lead to that. That is one of the downsides to earn-out and why a lot of people don’t want to go there. They are a viable additional term in a deal. What are some of the high level things when you’re advising your client to be negotiating and looking for when it comes to an earn-out?
Clarity, plain and simple. It’s one of the most litigated areas of M&A, whether or not somebody is entitled to payment pursuant to an earn-out. Where you get into trouble, that is where you use ambiguous type terminology. It’s much better to say, “The sale of X units.” If you sell 5,000 widgets, you’re entitled to an additional payment of $100,000 as opposed to, “We’ll pay you 5% of the profit,” without clearly defining what that is. Even if you define what that is, you get two accountants in a room and they may not agree on what it is. Can you go do an objective measure on that? Are you smarter than a fifth-grader logic absolutely applies in this instance.
That’s great advice and profit too. The new owner can manipulate the profit and I’m not suggesting that they would but how one owner determines profit could be completely different when somebody else takes over. They may add different categories to the ultimate profit line. It’s good advice there. We see earn-outs used a lot when there’s a value gap. The owner was hoping to get X value. The buyers are willing to pay Y and earn-outs are used oftentimes to bridge that gap.
In situations where the business has been maybe in decline or there’s a new product or service that the owner had invested heavily in bringing to market but hasn’t seen any of the fruits of all of that labor, they know there’s going to be a big upside in the earn-out converge gaps in those scenarios. Let’s go to rollover equity. This can be a tricky one because is it rollover equity in the sense that somebody is buying the stock the owner’s retaining a portion of the company or is it an asset transaction and the owners are expected to buy into the newco? Those are two different rollover equity scenarios.
I would be remiss if I claim to know all the tax benefits, which definitely behooves working with the accountants, CPAs and tax attorneys on these transactions. The concept of rollover equity can take a couple of different shapes. You can sell 95% of your stock, in which case you continue to own 5% or you can sell assets and maybe instead of getting $10 million, you’re taking $9 million. With that bogey of the other $1 million, you use that to buy stock and perhaps a holding company that was established to purchase the assets. There are a few different structures that can take, but the bottom line is you’re either paying out of pocket for equity in the resulting entity or you’re retaining a piece of your prior company.
Your advice there about needing a seasoned and experienced tax person to be involved in those discussions so you understand and can weigh the differences in the rollover equity.
On the corporate side, it’s easy. You’re having a piece of the resulting entity. It’s the tax that’s the driver of structural type issues.
Moving on beyond business terms, what other areas pop up in a deal that requires some real consideration and thought?
You can take the structure of the transaction. Everybody says, “I’m closing my deal.” There are two parts to that process. There’s agreeing on the document and there’s the writing the check. Oftentimes they happen at the same time, meaning you sign the document and the check is handed off and the assets or the stock is transferred. Sometimes, depending on the occasion, either a buyer wants to lock-in the seller and isn’t quite ready to take the incidence where they’re getting financing. Alternatively, there could be regulatory concerns. We’re going to sign up for the deal. If it’s a larger transaction, it’s getting the antitrust approval. Perhaps there’s a government agency that needs to sign off on the transfer.
It’s like the selling of a cannabis business in Illinois. There’s a department in Illinois that needs to sign off on the transfer and that can take months. It’s along those lines. In an instance where there’s a third party that needs to step in or the buyer’s not quite ready to do it, most oftentimes because of financing, it can be what’s called a sign and later close. Meaning the purchase agreement itself is signed and baked but the deal closes that at some point in the future.
In those situations, what are the conditions under which the owner continues to operate the business? Are there specific conditions that the owner needs to be compliant with under the agreement that’s been signed?
It depends. I’ve had transactions where my seller says, “Until you send me the wire, you’re not telling me anything.” There are conditions in that agreement that allow one of the parties or the other to get out. You’d probably echo this, usually in that case, it’s almost like you have a boss. You’re the owner-operator, but you’re not the final decision-maker. Let’s say during that process some piece of equipment breaks and it’s going to cost $50,000 capital commitment, “New boss and buyer, this main piece of equipment broke. Should we spend the $50,000? What do you want to do there?” I like to think there’s a boss that that becomes a place that you didn’t have before.
Exactly, it’s important here. That goes back to picking the right buyer. If you don’t pick the right partners, that could start to be a problem and issues can start to arise when you’re in that waiting period. It’s important that you’re picking the right people to do this with. Why don’t we move over to representations and warranties? That’s a big meaty topic. Lots of people don’t quite understand what that is and what it means. Maybe you can give us a high-level definition and we can start to dive into the vagaries of reps and warranties.
Reps and warranties guarantee that may be a little bit too strong, but that’s the right way to think about them. They’re the guarantees that you’re providing to the buyer of the business with respect to certain elements of your business. It could be financial statements. It could be about employees. Anything and everything can be covered in reps and warranties. The bottom line is you’re making affirmative statements about your business to the buyer that in the event they’re untrue, there is some pathway for recovery for that buyer. That’s the bottom line on reps and warranties.
Maybe we could be illustrative here with the M&A Unplugged audience. What are some of the reps and warranties that pop up that in particular cause concerns for you as an attorney and for the seller of a business?
Part of that is what’s the most concerning depending on what type of business it is. I’m handling a transaction where my client is in the limo business and it is acquiring a competitor. The value is in the customer list. Part of what my client is paying for is access to these customers. If this customer list that has been provided is true and correct in all material respects, it turns out that 3/4 of the customers haven’t done business with that company for ten years. That’s part of what helped establish value. There’s clearly a breach there and my client, the buyer, is not going to be happy.In figuring out the best offer beyond the price, it’s important to know what you want after. Click To Tweet
Let’s dive into that a little bit. Where does the responsibility start and end? I would assume your client also has to do due diligence. Where do you cross the line between did they do the proper diligence or not in regard to whatever the seller is repping and warranting here?
There’s a concept called sandbagging, which is probably beyond the scope of this particular discussion, but it’s an interesting point. As a seller, you’re oftentimes given due diligence request list, which becomes your second job for a period of time. That buyer should theoretically know everything and anything. When you’re representing a buyer, as the attorney, you still want to put all the burdens or as many burdens as you can on the seller. Notwithstanding the fact that it’s been an open book or should be an open book as to what you’re discovering or not.
Sellers would like to take the position that, “You gave me a 40-page due diligence request list and I gave you thousands of pages of material. If something doesn’t look right, that’s on you.” It’s part of the negotiation as to ultimate responsibility under the purchase agreement. If I’m representing a buyer, I want that buyer to know as much as they possibly can when they’re going into the deal. If all you’re buying is a lawsuit, that’s a bad idea.
It brings up a secondary point here, which is diligence. When you’re an owner of a business and you’re in diligence, it’s important to disclose everything and to catalog everything that you’ve delivered to the buyer. In case there’s an issue later on, you can prove, “We turned over all of this information in discovery, whether or not the buyer chose to look at it is on them.” This is where you work with an M&A advisor and attorney and work inside of something called a data room. All of the information goes into the data room and is made available to the buyer and all of their advisors if they give them access. It’s critically important because if something pops up later, you have given yourself an insurance policy.
Further to that, you are required to prepare what’s called a disclosure schedule as part of the transaction. What that means is, let’s say there was a rep that said, “I’m licensed to do business in all States wherever I’ve conduct business.” It turns out that you were doing $100,000 a year business in Texas, but you never registered to transact business there. That would be a breach of the rapid warranty because the warranty said, “I’m registered to do business wherever I’ve done business.” In the context of disclosure and if that was the case, you might think, “What do I do here?” It’s past. There’s nothing you can do to fix it. The response is you do the disclosure schedule that says, “The rep said I’m licensed there, but I never got myself registered in Texas.” What comes out of that is either the buyer says, “I acknowledge that I’m willing to assume that risk.” Alternatively, you may have something that’s called a specific indemnity to address any liability that could come out of failure to register.
That’s a great segue. You have reps and warranties, but they could lead into specific indemnities. Why don’t we talk a little bit about that?
An indemnity, in a nutshell, is the obligation to essentially make the other party whole for a breach of some sort. Indemnities are one-two with reps and warranties. Meaning part of it is if there’s a breach of a rep and warranty, that leads to an indemnity. It’s either a cash recovery or perhaps it’s an offset against future payments. If you have an earn-out type structure, hold back or escrow. You can essentially be made whole by taking funds out of those different sources. Indemnities can take a few different forms. One is directly tied to a breach of a rep and warranty. Oftentimes, you’ll get blanket indemnities, something that says, “I as the seller will remain responsible for anything that happened while I was running the business.”
It’s interesting when you get unsophisticated buyers or perhaps buyers that don’t pick the right counsel. They will look at the term of the indemnity related to reps and warranties and try and get some caps on it either by time limitations or dollar figures. They forget that there’s a separate indemnity that’s tied generally to the operation of the business. While reps and warranties are important, indemnities are even more important because that’s what leads to where the liability and recovery can come from.
To drill down a little bit further on this, you’re pointing out between indemnities that survive maybe forever. If you committed fraud, you can’t put a time limit on fraud. Fraud is fraud. When somebody finds it, they can come back after you regardless if it’s three days after or three years after. Whereas some other categories might have a specific time limit and a cap on the amount that can be recovered.
In most instances, it’s called standard reps and warranties. I see those typically survive for 12 to 24 months. There are occasions that you’d go shorter than that and longer. Some of this goes to what we kicked this discussion off with, which is what other things other than price are important? I had an occasion where I was representing the seller of a bus company. He ran a school bus operation. He didn’t care all that much about price and all these things that typically sellers would care about. All he cared about was after a short period of time, he wouldn’t have to look over his shoulder.
There were all these things that typically sellers would care about and all he cared about was after a short period of time, he wouldn’t have to look over his shoulder. In that transaction, we negotiated that reps and warranties would survive for three months. For three months, my client was on the hook if something arose that was a breach of a rep and warranty, but in three months and one day, he was done. He wanted to go sit on a beach and not worry about it. He knew that the money in his pocket was going to stay in his pocket.
In reality, that’s a short period of time. When you look at most deals, I don’t see reps and warranties that go that shorter period of time often.
It was something that was the most important element to him. In exchange, he probably recovered less cash in a deal that he otherwise would have.
He traded off something else to negotiate that period down to three months. In your experience, I know there’s no set time frame, but the range is typically what, in your opinion, when it comes to recovery for indemnities?
The standard from what I see is 12 to 24 months. There are other things that sometimes people will create fundamental reps and warranties that will survive longer or statute of limitation type reps and warranties. You see that with respect to taxes or environmental type issues.
If an owner had specific issues in the business, those indemnities might last longer. If they’ve done some things with their books and records or tax, you might wind up having those last longer than other things truncated down the 12 to 24 months.
You’ll leave it within the reps and warranties but have a specific indemnity that is not limited by time.
What other big items outside of price do you see, Jeremy, that might come up?
It’s around liability exposure, things that could be important. If there’s a litigation matter, I’m going to stay local. Outside of price, take care of my employees. What are you going to do to my reputation? How are you going to roll things up if that is your plan? It’s unique to every particular situation. Sometimes it’s, “How quickly can this transaction happen? Get me out in 60 days.” Dom, as you can attest, it can be a long process and 6 to 9 months is what I see typical from somebody who decides to do it when there’s a closing. It’s unique to a particular situation.
Do you see non-compete and non-solicitation clauses causing issues in deals?Most of the time, the best price wins, but the question is, 'At what cost?' Click To Tweet
Absolutely. Depending on the situation, it’s either a huge deal or it’s not a big deal at all. Going back to my client that got the three-month survival period on reps and warranties. He said, “If they don’t want me to work all the way to the moon, I’m good with that.” Other times, clients have particular circumstances that they want to be under. “I will agree not to compete in this one city block radius, but other than that, I’m not agreeing to it and you can absolutely go to war over this issue.” It depends on how important it is to the buyer and the seller.
From a buyer’s perspective, the last thing they want to do is compete with the guy who built the business or ran the business for 20 to 30 years. It’s a binary. They rightfully get concerned when there’s so much pushback on a non-compete.
It matters whether it’s the type of business that the former owner was dub business. Meaning, the former owner was the head sales guy and operational guy, knew the product in and out and it’s a replaceable business. Take something like legal practice, not that it’s the typical buying and selling of a company, but the legal practice is all relationship-driven. Maybe you’ve bought Sugar Felsenthal, but if I go to another firm, most of my clients are coming with me. It doesn’t matter that third-party bought Sugar Felsenthal. In that business, non-competes mean everything. If it’s an industrial facility that takes millions of dollars to buy the equipment, build the product, send it out, and there’s no necessarily identify with that former owner, it might be less of an issue. There are startup costs and barriers.
I see this issue pop up a lot with owners who have lots of patents. They’re inventors and they’re constantly developing new products. They haven’t developed all of those insides of the company, but they still have this passion to go do a lot of that stuff and maybe bring something to the market. They’re always wanting to carve out inventions and things that they’ve created, so they have the freedom to go do that. The question always becomes, “Is that going to be directly competitive with the business you’re selling?”
I see the best way to deal with this is when it’s ambiguous, whether the next act is going to compete with the current act. You get it out on the front end. “I’m going to sell you my home repair business, but I still want to be able to work in putting up garage doors,” or something silly. If you talk about that as part of the business terms, term sheet, LOI stage, then it’s usually less of a fight than you’re at 11:59 on the day before closing and you say, “I want to be able to do garage doors still.”
You spent a lot of money to maybe have a deal fall apart. We had a client who I’d put in the category of the inventor, constantly coming up with new ideas and tinkering with ways to make his products better. From day one, he was honest. He said, “I’m going to carve these things that are not on the market out of the sale and I expect to be able to bring these out at a later date.” I was upfront with all the buyers along the way. Interestingly enough, we brought a buyer to the table that was able to strike a deal with the owner where they collaborate. The owner was able to continue to go tinker, but it was going to get the advantages of this new company being able to mass market whatever he developed. It worked out to be a great deal for everybody.
It’s something similar to this. I was representing an autobody shop where it was a husband-wife team. The husband was in his mid-70s and the wife was in her late 50s. As part of the transaction, she said, “I’m not ready to go golfing every day. I still want to be in this business.” All she knew how to do was the autobody world. The non-compete carved out her ability to consult in the space. She couldn’t go out and start another autobody shop, but it allowed her to meet her goals, “I want to keep working and I’m an expert in this area.”
If you were to take a 50,000-foot level and take a step back for the M&A Unplugged audience, what advice would you offer to owners of businesses who are looking to sell?
The first that is not directly related to terms is realize that selling a business is a second job. In the context of negotiating, drafting, figuring out what you’re going to do on terms, replying to due diligence and along those lines, I often hear, “How am I supposed to do all this? I still need to operate the business.” Dom, I’m sure you tell your clients and everybody tells their clients, “One of the most important things during this process is to make sure that the business is still functioning on all levels. Until that check’s received, there’s no guarantee that the deal is done.” That’s one logistical type of thing to realize.
In terms of how do you figure out what’s the best offer beyond the price, it’s important for that seller to think about what things are important to them in the sale. Is it not having to look over your shoulder? Is it making sure that your employees are going to have employment for the foreseeable future? Is it making sure that your legacy continues to live on either in terms of quality of product, reputation, market or things along those lines? It’s important before somebody even gets into the entertaining the offers to think, “What do I want here?” This is America and it’s a capitalist society. Most of the time, the best price wins. The question is, at what cost? If you want to make sure that your employees are taken care of, maybe that’s not the highest bidder. Maybe that means you go with the strategic buyer, not the financial buyer or vice versa, depending on who those people may be. It’s an art and a science, so to speak.
It’s been a pleasure having you on. If people in the M&A Unplugged community wanted to get in touch with you, how could they reach you?
My direct line is (312) 704-2199 or feel free to shoot me an email at [email protected].
Jeremy, thanks. It’s a pleasure having you and you shared some awesome information.
Thanks, Dom. I appreciate it.
M&A Unplugged community, let me recap a few things that Jeremy brought up that all points back to getting yourself the right M&A advisors when you get ready to do a transaction. You want people who specialize in this, who do deals day in and day out because many of the things that Jeremy brought up are technical and there are many nuances to them. If your attorney is not dealing with that day in and day out, you could have something that comes back to bite you. We talked about business terms being as important as the price. Two of the things that Jeremy brought up were, “Are you going to contemplate an earn-out?” If you are, have absolute clarity so that you can keep yourself out of litigation down the road.
If you’re considering rollover equity, what form is that going to come in? Are you going to retain a portion of the existing business you’re going to buy into a new code that is formed after the sale? Understand the tax ramifications of that. Understand what the structure of the deal is going to be. Are you going to do a simultaneous sign and close? Are you going to sign? Are there some things that have to happen from signing to closing? If so, what happens in that gap? Who’s going to operate the business? How is it going to be operated? Are there any constraints on the business? There are all sorts of things to consider.
We talked about reps and warranties, which are important. You have to understand that essentially, you’re going to guarantee to the buyer certain things about the business. In that guarantee, that’s going to lead to you indemnifying the buyer saying, “I guarantee these things and if something goes wrong, I further will indemnify you and that might come with some recovery or damages. Those have periods that they run or maybe some of them are evergreen.” Understanding all of those nuances is critical. You might have a great sale, but what good is that if two years later, the buyer is coming after you for something that you could have been protected for?
Those are great information shared by Jeremy. I enjoyed my conversation with them. If you would like to learn more about the process of acquiring or selling a business, please visit our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to being with you again in the next episode of the show. Until then, please remember that scaling, acquiring or selling a business takes time, preparation and the proper knowledge.
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- Sugar Felsenthal Grais & Helsinger
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