When buying or selling a business a lot of time and effort is focused on price. But there is much more to business transactions than negotiating a good price or a good multiple. Terms play an equal, if not greater role in getting a good deal done.
There is an old saying in the deal business: “You set the price but I’ll name the terms.”
Business transactions are often discussed in terms of multiples. Buyers and sellers rely on multiples because multiples act as a yardstick. For a seller, there can be a certain satisfaction knowing that you negotiated a healthy multiple. For a buyer, a multiple serves as a reality check to ensure that the price paid for a business is similar to other comparable transactions. Multiples serve as goal posts – a frame of reference for both parties.
But there are many other important factors to consider when negotiating a business purchase or sale in addition to price. These are four of the more common ones we see when helping clients manage transactions in the collision repair industry.
How will you get paid (or pay) when the transaction is complete? Recently, the majority of transactions in the industry have been all cash, or nearly all cash deals where most of the purchase price is paid at the closing, with a small portion held back in an escrow account for a year or two. But this is a recent phenomenon, and likely not to last forever. Most deals use multiple forms of consideration, the common ones including cash, stock, seller notes and earnouts. But each of these forms of consideration is not equal.
Each form of consideration – cash, stock, seller note, and earnout – carries a different level of risk, and thus has a different real value. There is a fundamental valuation method in finance called CAPM (Capital Asset Pricing Model). CAPM effectively states that the greater the uncertainty, the lower the price of an asset (it gets more complex that that – subscribers email me if you want to geek out). In other words, $1 million in the form of earnouts over a year has a real value worth less than $1 million in cash (an earnout is less certain than cash). And the real value of these different types of consideration varies from company to company. Beware – assessing risk and determining what you are actually receiving in a business sale can become very complex very quickly.
Purchase Price Adjustments
It is common in transactions to agree to certain post-closing, purchase price adjustments, otherwise referred to as a “true-up”. The most common purchase price adjustments in collision deals are adjustments to working capital. The basic definition of working capital is Current Assets – Current Liabilities. But working capital has many accounts, including Accounts Receivable (AR), Accounts Payable (AP), Work in Process (WIP), Inventory and minimum required cash.
Purchase price adjustments are one of the most common sources of post-close disagreements. Agreeing upon the appropriate level of working capital a seller is to deliver to the buyer at close may seem like minutia. But depending on the language of the purchase agreement it can become quite contentious. Beware, a default to generic definitions and a lack of industry insight can leave you exposed and at the mercy of a more experienced dealmaker.
Indemnification is a form of protection against certain risks in the transaction. It is the act of promising to pay for the cost of possible future damage, loss, or injury. It is also one of the most complex and heavily negotiate aspects of a transaction.
Negotiating indemnification clauses may also appear to be distracting minutia. But indemnification clauses cover a wide range of subjects: breach of contract, breach of reps and warranties, excluded liabilities, tax, and environmental issues. Within the collision repair industry there are some unique considerations and subtle nuances. While this may appear boiler plate, different buyers have very different risk tolerances to these different issues. This is another area where industry specific deal insight creates a lot of value.
Escrow, Holdbacks, and Earnouts
It is common in “all cash” deals for a certain percentage of the purchase price to be held back in an escrow account for a period of time. Escrow and holdbacks are often used to secure future obligations, especially around purchase price adjustments. In the collision industry, a buyer will often insist on an escrow account to ensure a seller delivers the agreed upon working capital.
Holdbacks are different from earnouts. An earnout is an agreement in which the buyer increase the purchase price if the acquired business achieves a predetermined milestone, such as revenues, referrals, etc. Earnouts are often used when there is a valuation gap between buyer and seller.
You may find the negotiations of the earnout or escrow language painful or borderline ridiculous. Be careful and be prudent – take the time to think through all of the possible outcomes before signing off on your documents as these provisions can shift a lot of risk to you. Experienced advisors add a lot of value in this area.
Maximize Your Price AND Terms
Let’s work together. Business transactions get complex quickly. That is why we advocate putting your team together early. In addition to retaining M&A transaction advisors with industry experience, it is important to get both tax and legal counsel involved. A good M&A advisor will effectively manage other advisors, streamlining the transaction process and allowing you to focus on running your business.
Price is only one half of the transaction. Maximizing your terms while minimizing your risk is equally important. Competent M&A advisors bring industry specific knowledge and insight – benefits that exceed the costs, literally many times over.
If you are interested in discovering additional ways to maximize your terms in a business transaction I can help. (Subscribers email me direct, or use my contact page). If you are considering a sale, now is a good time to discuss how to maximize both your price and terms. But if you are not ready to exit now, there are numerous opportunities to grow. Use my contact page and we can brainstorm some ideas together, confidentially of course.
Until next week.