Why Price Isn't Everything When Selling Your Company in a Merger or Acquisition
Although it is tempting to sell your company for the highest purchase price, price isn't everything when selling your company in a merger or acquisition. True, a $25 million offer looks sweeter than a $20 million offer. However, here are three important issues other than price to consider when selling your company.
1. Type of consideration
Is the buyer paying you in stock, "boot" (e.g., cash), or some combination? An all cash purchase provides a clean exit for you and your shareholders and shifts all of the post-closing risk to the acquirer. An all stock purchase ties you to the future performance of the acquirer, and the post-closing risk is shared by you and the buyer. Stock purchases send a signal to the market that the acquirer believes its stock is undervalued. However, the acquirer's stock usually decreases in value upon the announcement of the deal in all stock transactions.
2. Earnout
An earnout is a portion of the purchase price that is carved out for the seller to earn over time post-closing. Earnouts are used in about 25% of mergers and acquisitions and often used to bridge differences in valuation between the seller and the buyer. The earnout is tied to financial or operational metrics that you must meet in order to receive some portion of the purchase price. Common earnout metrics are EBIDTA, sales, and revenue goals.
The amount of the earnout is how much of the purchase price is at risk for the seller. For example, in a $25 million transaction, an earnout of $5 million means that the consideration that changes hands at closing is $20 million. You may or may not ever receive the remaining $5 million. The deciding factor is performance after the deal is consummated. Earnouts typically last 24 to 36 months, sometimes longer. The longer the earnout period, the higher the risk that you will not see the entire earnout amount.
The key to successful earnouts is to negotiate metrics that you have a high deegree control over achieving. As the seller, factors like achieving cost or revenue synergies in the combined entity are difficult to influence and should be strenuously avoided as earnout criteria. In order to maximize your chances of reaching earnout goals, you want to maintain control and continuity over your operations. To minimize conflict, make sure that the conditions governing the payment of an earnout are clearly defined.
3. Escrow
Escrow is an amount set aside from the purchase price to deal with liabilities that may arise after the deal has closed. Usually 10% to 15% of the purchase price is placed in escrow for 12 to 36 months to mitigate the buyer's risk of:
- Post-closing changes to net working capital and the balance sheet, and
- Liabilities arising from breach of the representations and warranties in the purchase agreement. Such breach could include claims against the seller for intellectual property infringement; litigation or fines arising from violations of securities law, employment law, or environmental law; breach of contract; and delinquent taxes.
You must carefully negotiate the terms of escrow because post-closing disputes over escrow arise in about 40% of all mergers and acquisitions. Terms such as the amount of escrow, the duration, deductibles, and how claims are paid deserve close attention. The relationship between escrow and indemnifications should also be considered.
Conclusion
Your board of directors has a fiduciary duty to take reasonable steps to obtain the highest possible purchase price for the shareholders to consider. However, that does not mean that you have to accept the highest price. Get advice from an experienced investment banker or mergers and acquisitions advisor, and your M&A attorney working on the deal, to help you negotiate these terms.
There are definitely more than three factors that demonstrate why price isn't everything when selling your company. What other factors would you cite?
Twitter: @DougYPark
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