Operations
Review the current year’s financial statements; e.g., interim, monthly, quarterly, compared to the budget. Focus on the incoming orders and analyze the backlog.

Industry structure
Compared to the industry, analyze the company’s products and distribution channels. Figure the percentage of sales by product line, review the pricing policies such as discount structure and discuss the product warranties.

Marketing
Ask for a list of the top 50 customers and sales breakdown by country (if export), and the company’s market share compared to competitors. Discuss the potential of gain or loss of market share and the extent a barrier exists to entry for new competition.

Manufacturing
Tour the production facility to evaluate the condition, utilization and capacity. Find out the age of the facility, the square footage, the cost and current value, and whether it is owned or leased. Review the manufacturing process: master schedule, flow chart, shifts, employees, lead time by product, manufacturing time by product, amount of outsourcing, key suppliers, etc.

Human resources
Discuss the names, positions and responsibilities of the key management people. Understand the relationship with labor, the employee turnover and the incentive bonus plan.

Balance sheet
Concentrate on three items for due diligence purposes. The accounts receivable balance and aging should be scrutinized in relation to the bad debt analysis and reserves. A list of the top twenty-five accounts receivable is helpful. The inventory analysis should be sub-totaled to include raw, work-in-process, and finished goods, and should include turnover rate, order completion rate, aging, reserve amount and policy for write-offs. The accounts payable aging, payment policy, and various credit terms are important to analyze.

Environmental problems
Ten or twenty years ago there was little or no concern for ground contamination, water pollution or asbestos problems. Nowadays, these can be a major reason transactions are aborted.

Patents, trademarks and copyrights
Are these intangibles transferable? In one case, a machine tool manufacturer had licensed the well known brand name to an Asian company, thus diluting the value of the goodwill for the potential buyer. Do not assume anything in regards to these items as valuable patents to the business may be in the name of the individual, not the company.

If the selling company is a divestment from its parent, one has to be concerned to what extent the financials are consolidated or separated. For example, what assets and liabilities are carried on the parent books, e.g., real estate and bank debt? What expenses are carried on the parent books such as product liability insurance? If so, what is the history of claims, settlements and insurance costs? As a subsidiary, what is the status of the pension plan obligations, i.e., overfunded or underfunded? And what is the status of the retirement health benefits, i.e., obligations and costs? Such a divestment can be more complicated for those conducting the due diligence. Four areas of particular concern are as follows:

• That all costs are properly reflected whether it is products or services being bought or sold between the two entities.

• Business between the two entities is at an arm’s length basis and items are not bought and sold because of the inter-company relationship.

• The division or subsidiary has the quality and depth of management to successfully operate independent of the parent company.

• To what extent the parent company has access to services at favorable rates substantially reduces the cost to the division or subsidiary, e.g., accounting, tax, legal, insurance, benefits, information services.

The purpose of the due diligence will help you determine whether you want to go forward with the transaction or whether you want to re-negotiate the price and terms of the deal based on your findings. If you are going forward with the deal, you want to be sure you will be receiving the assets you expect, that there will not be any unexpected liabilities or unexpected expenses post acquisition.

In reviewing the highlights of due diligence, it is important to keep three points in mind.

• Verify the critical elements of the acquisition. Concentrate on the key issues of the target company and its industry. If you are buying a high-tech company, concentrate on transferring intellectual property without encumbrances. If you are buying a consumer product company, concentrate on possible product returns or recalls. And if you are buying a heavy manufacturer, concentrate on environmental issues.

• Weigh the risk/reward factors of doing the deal. Small repercussions may be acceptable, but disasters must be avoided.

• The net result of due diligence is not necessarily a “go or no-go” with the acquisition. You may still want to buy the company, but due to certain circumstances you may deem it necessary to re-negotiate the deal by changing the price or structure.

In conclusion, when a buyer and seller sign the Letter of Intent, they certainly have reached a milestone. Unfortunately, “The Deal Is Not Almost Done” as the title of this article suggests. To paraphrase Winston Churchill, “It is not the beginning of the end, but the end of the beginning.”

This is how the LOI has been defined by Stanley Foster Reed, author of The Art of M&A: “A Letter of Intent is a pre-contractual written instrument which defines the respective preliminary understandings of the parties about to engage in contractual negotiations. In most cases, such a letter is not intended to have a binding effect except for certain limited provisions. The Letter of Intent crystallizes in writing what has, up to that point, been oral negotiations between the parties about the basic terms of the transaction. While the Letter of Intent is usually non-binding, it does create a moral commitment and allows the buyer to proceed with the extensive due diligence process with a feeling of confidence. Conversely, the seller is required to withdraw the company from the marketplace and not discuss the potential sale with anyone else.”

Letters of Intent are written after the two parties have had a serious discussion on the price, terms, conditions, and time period of the proposed transaction. In my experience buyers will usually submit a LOI after they feel they understand the parameters of what a seller will accept.

In many cases, the buyer uses the LOI as the initial basis of negotiating. If there is reason to believe that the two parties are fairly close to agreement, the buyer will draft a second LOI. If the buyer is experienced or is working with an experienced intermediary, it may not be necessary to involve a lawyer at this time. It should be noted, however, that lawyers resent being pulled into the deal after the LOI, and if it is necessary to make a material change in the future, it becomes very difficult to do so.

The LOI is at the heart of the transaction and reveals key issues early on in the process. Before you, as the seller, sign the LOI, I urge you to solicit a second or third opinion from a transaction attorney, a competent intermediary, or a corporate appraiser. A few hours spent with these professionals at approximately $200 to $300 per hour would be well worth the expense. Although their advice should be taken seriously, ultimately you have to make the decision.

Deconstructing the Letter of Intent
The elements of the Letter of Intent are as follows:

• The price of the company
• The form of purchase: is it a stock or asset sale? What is being purchased and what is not?
• The structure: cash, notes, stock, non-compete or consulting agreements, contingencies?
• Management contracts: for whom, duration, and incentives
• Closing costs and the responsibilities of the buyer and seller, such as environmental due diligence and title searches
• Representations and Warranties: boilerplate legal statements
• Brokerage fees: who pays and how much
• Timing for completion: drop-dead date for due diligence and financing period as to how long before money is exchanged and final closing takes place
• Insurance: proof of insurability; what happens with policies?
• Disposition of earnings before closing and viability of non-ordinary expenditures before closing (conduct of business)
• Access to books and records, key customers, and key employees prior to closing
• Disclosure of any outstanding non-compete agreements or obligations with third parties
• Stipulation of confidentiality of buyer (a breach could cause the seller to sue the buyer): The buyer promises not to disclose information about the seller to outsiders and to not disclose that negotiations are underway.
• Seller will take the company off the market for a designated period of time of forty-five to sixty days (a breach could cause the buyer to sue the seller).

Data Needed Before Reaching a Letter of Intent
Let us assume that the buyer has visited the seller two or three times; he or she has received three years of financials, understands the compensation and add-backs, and is now ready to make an offer. Based on all the information at hand and on the buyer’s best judgment, he or she tells you that they are prepared to draft a Letter of Intent with a purchase price of $5 million of which $3 million would be paid at closing. Additionally, he or she states their intention of making an asset purchase or stock purchase.

If the seller indicates you are close enough to have the buyer draft a Letter of Intent, then the following items will probably be requested:

• Annual financial statements with footnotes for last three years
• Listing of shareholders and key managers showing name, age, shares owned, current position, years of service, annual salary, fringe benefits, last raise, and breakdown of bonuses between discretionary and formula basis
• List of all contractual obligations
• List of top twenty customers, substituting letters for actual names followed by annual sales for last three years
• Description of bonus or incentive system
• List of accounts receivable at signing
• Add-backs or any earning adjustments that probably would not be incurred under new ownership
• Real estate, machinery, and equipment appraisals (if any)
• Breakdown of inventory between raw, finished, and work in process (Banks do not lend against the latter.)
• Amount and description of capital expenditures for last three years and estimate of future needs
• If a stock purchase, then a copy of loan documents
• If a stock purchase, then listing of life insurance policies showing insured, face value, any cash surrender value, and annual premium
Once the LOI Has Been Delivered
The next step is for the buyer to deliver the Letter of Intent, preferably in person to the seller and to explain each item point by point. There are now a number of issues you will have to be aware of, including price, terms, the chemistry with the buyer, non-financial issues, and how fast the buyer can close.

Usually, when the buyer and seller strike a deal, the quicker the buyer can secure the financing, complete the due diligence, and draft the Purchase and Sale Agreement, the less chance both parties will change their mind. After the Letter of Intent is signed, an expeditious closing will take place between sixty and ninety days, assuming there are no major glitches such as environmental issues. It will be a time-consuming job to bring the deal to a successful close.

When the Letter of Intent is delivered, neither party wants to lose momentum. Allow plenty of time for discussion. Expect to come to an agreement on the non-binding Letter of Intent by at least the second meeting.

The intermediary and owner should predetermine their negotiation strategy. Before you begin negotiating the LOI, you should know your lowest price (although you may not play it), identify key issues to both the owner and the buyer, and anticipate the responses of the buyer. You should also determine before the meeting whether you or your advisor will be the major spokesperson. Perhaps if there are some negative comments about the buyer that need to be expressed, they should be mentioned by the intermediary (bad guy) but not the owner (good guy). Such negatives could include previous aborted deals or a perceived lack of capital for acquisitions. Such comments would show the buyer you have a good understanding of the merger and acquisition business. Furthermore, the owner can tell the buyer he cannot sell the business for less because he has other potential buyers who have expressed interest in purchasing the company.

The signing of the Letter of Intent triggers the buyer’s commencement of the due diligence process and his ability to secure the necessary financing. The seller’s team will want to check out the buyer to know whether he or she is creditworthy and whether the buyer is committed to completing the deal. An individual’s credentials should be examined more closely than if the buyer is a corporation.

A buyer will probably verify his or her financial strength by presenting detailed financial statements and emphasize their liquid assets. As the seller’s intermediary, you should request that the buyer submit a list of potential lenders or investors for this proposed acquisition. Aside from the buyer’s financial posture, you will want to know about his or her personal characteristics, so take time to meet with the buyer socially. You want to maximize the likelihood of a successful sale.

Make no mistake, this is likely a do-or-die period. According to hearsay, 50 percent of all deals fail at the Letter of Intent stage. Another 25 percent of all deals fail at the due diligence stage, and 15 percent of all deals fail at the documentation stage. Only 10 percent of all potential deals make it all the way to closing.
The Critical Ingredients
The critical ingredients in the Letter of Intent include the following:

1.  The proposed purchase price
2.  What the down payment would be
3.  The size, length, and interest rate of a note and how it would be secured
4.  Other considerations affecting the price, such as partial earn-out based on a predetermined formula
5.  A list of contingencies

The contingencies would include the arrangements under which you, the seller, would stay on. If the seller leaves, then an agreement on the length and terms of any training period as well as a non-compete agreement should be addressed. Other contingencies that will probably be requested by the buyer include: a review of the company’s financial records, an examination of insurance policies, the availability of vendor and customer contracts, and assignment of the lease.

It is customary for agents who broker small companies with sales of less than $1 million to ask the buyer for a good-faith deposit of $5,000 to $10,000, but this is not common for middle-market transactions.

The cost for due diligence is the burden of the buyer. Depending on the complexity of the due diligence, it can cost the buyer of a middle-market company between $10,000 and $100,000. If the seller backs out of the deal for any number of reasons including “seller’s remorse,” the buyer has no recourse unless he has a so-called breakup fee written into the LOI. While the latter is desirable for the buyer, it is very hard to persuade the seller to comply.

The success or failure of completing the transaction hinges on the LOI. Upon signing the agreement, both parties are morally but not legally committed to do their utmost to complete the transaction. The outcome depends on the results of the due diligence, the ability to put the deal back on track if it is temporarily derailed, and attention to detail and speed without loss of momentum.

The important goal is the signing of the Purchase and Sale Agreement after the due diligence has been completed. The buyer’s greatest fear is not knowing everything about the company; that due diligence did not uncover everything. And the seller’s fear is that information will leak out—that the employees, customers, and suppliers will hear about the deal prematurely—or the buyer really does not have enough money after all.

Checklist of Items in Letter of Intent
This is what you will see when you receive a Letter of Intent:

1.  Description of the buying organization, such as place of business and owners.
2.  Statement of price, structure, contingencies, and exactly what is being purchased.
3.  Description of any notes: their interest rate, term, amortization provisions, whether or
    not they are secured or unsecured, negotiable or non-negotiable: Will the buyer have
    the “right to offset” part of the note if the seller does not meet
    certain conditions in the Purchase and Sale Agreement?
4.  Specification of management contracts: for whom, duration, and what the incentives are.
5.  Explanation of closing costs, including intermediaries fees as to who pays what.
6.  A statement that representations and warranties will be a part of the Purchase and Sale Agreement.
7.  Description of profit-sharing arrangements.
8.  A list of contingencies that have to be resolved in order for the transaction to be completed
    (environmental studies, title transfers).
9.  Planned changes to be made, such as management and continuity items (will the plant be relocated?).
10. Estimated date of closing.
11. Transferability of insurance.
12. Reconciliation of debts or collections with shareholders.
13. Continuity of business until closing date.
14. Access to books and records.
15. Description of consulting and non-compete agreements.
16. The adherence to confidentiality by both parties and the understanding that the
    Letter of Intent is non-binding and that the seller will take the company
    off the market for a specified period of time.
17. A consideration of whether the parent company (if there is one) should also
    sign the Letter of Intent and/or if the guarantors of the selling company’s obligations
    (if there are any) should also sign the document.
18. Whether to create an escrow account to handle post-closing adjustments to the
    purchase price to reflect changes in inventory, final audited financials, or collections
    of accounts receivable to offset seller’s contractual claims.

Conclusion
Because the LOI is a non-binding agreement, if so stated, the buyer has the comfort level of knowing he or she can back out. The chances are slight, however, that either the buyer or seller can materially change the price and terms of the deal after both parties have entered into the LOI, except if there is a sudden and unexpected downturn in the company’s performance.
One of the biggest concerns you may have is whether the buyer has the financial resources to complete the transaction and to have the reserves in case the business needs another infusion of capital. The seller is entitled to receive financial information from the buyer.

David Broadwin, transaction attorney for Foley, Hoag & Eliot in Boston, says: “You
should devote careful attention to LOI [Letters of Intent] not only because they memorialize the terms of a proposed transaction and give the principals a feeling that they have reached an understanding, but also because they exert a profound influence on the definitive documentation of the transaction.”

1. Don’t Neglect Running Your Business
A major reason small companies with sales under $20 million become derailed during the selling process of the business is the owner becomes so consumed with the pending transaction, that he neglects the day to day operation of the business. During the selling process, which can take six to twelve months from beginning to end, the CEO/owner typically takes his eye off the ball. Since the CEO/owner is the key facet to all aspects of the business, his lack of attention to the business invariably affects sales, costs and profits. Then the potential buyer becomes extremely concerned when the business flattens out or falls off. Before long the potential buyer gets cold feet when the business turns south and the deal craters.

Solution: For most (CEOs/owners) selling their company is one of the most dramatic and important phases in the company’s history. This is no time to be overly cost conscious. At this point the CEO/owner should retain, within reason, the best intermediary, transaction lawyer and other advisors to take the pressure off him so he can devote the necessary time to run the business.

2. Placing Too High a Price on the Business
Obviously many owners want to maximize the selling price on the company which has often been their life’s work, or in fact, the life’s work of their multi-generation family. The problem with an irrational and indiscriminate pricing of the owner’s business is that the mergers and acquisition market is too sophisticated to fool professional acquirers. As a result, the business usually does not sell at the inflated price, and if the owner finally does receive an offer at a more reasonable figure, the process ends up taking twice as long as normal, thus increasing the risk of the information prematurely leaking out… which often blows the deal.

Solution: By retaining an expert intermediary and/or corporate valuation appraiser, you should be able to arrive at a price which is fully justifiable and defensible. Perhaps you might add an additional ten percent on top of their professional opinion for negotiating purposes, but if you set too high a price you could easily just be spinning your wheels. To be on the safe side, you might receive two opinions: one from your intermediary and one from your appraiser. If you set too high a price, you may end up with an undesirable buyer who fails to meet his purchase price payments and/or destroys the company from the seller’s corporate culture.

3. Breaching the Confidentiality of the Impending Sale
In many situations, when the selling process encompasses too many buyers over too long a time with too loose a system of transferring information, confidentiality is breached. It happens, perhaps more frequently than not. The results can change the course of the transaction and in some cases, the deal is called off by the owner out of frustration and disgust.

Solution: Using intermediaries in a transaction certainly helps reduce a confidentiality breach but limiting the number of potential buyers and shortening the period of time to complete the closure process also helps. A thorough clandestine approach to the selling process is paramount. Creating a believable story to tell senior management such as the pursuit of a joint venture or strategic alliance is recommended.

4. Not Preparing for Sale Far Enough in Advance
Most small business owners decide to sell their business somewhat impulsively. The major reason for selling is boredom and burn-out, and much further down the survey list of reasons is proper retirement age or lack of successor heirs. Unless the owner takes several years of preparation, chances are the business will not be in pristine condition to sell.

Solution: Having audited financial statements for several years in advance of the company being sold is worth all the extra money, and then some, compared to an accountant’s compilations and reviews. Buyers are suspicious of statements that are not audited… as they should be! Buying out minority stockholders, cleaning up the balance sheet, settling outstanding law suits and sprucing up the factory housekeeping are all important. If the business is a “one-man-band,” then building management infrastructure will give the company value and credibility.

5. Not Anticipating the Buyer’s Request
A buyer usually has to obtain bank financing to complete the transaction. Therefore, he needs appraisals on the property, machinery and equipment, as well as other assets. If the owner is selling real estate then an environmental study is necessary. If a seller has been properly advised, he will realize that closing costs will amount to 5-7% of the purchase price; i.e., $250,000-$350,000 for a $5 million transaction. These costs are well worth the expense, because the seller is more apt to receive a higher price if he can provide the buyer with all the necessary information to do a deal.

Solution: The owner should have appraisals completed before he tries to sell the business, but if the appraisals are more than two years old, they may have to be updated.

6. Only Negotiate With One Potential Buyer
Leverage comes in various ways. Historically, sellers are able to ratchet the price up when there is more than one buyer in the running. Businessmen are like athletes that become caught up with the excitement of the competition.

Solution: Amongst other things, the role of the seller’s intermediary is to create a competitive situation with buyers either informally or by use of an auction. The seller needs to have a third party (intermediary) to orchestrate this process.

7. Seller Wants to Retire After Business is Sold
It is a natural feeling for the burnt-out owner to take his cash and run. However, buyers are very concerned with the integration process after the sale is completed, and whether the customer and vendor relationships are going to be easily transferable.

Solution: If the CEO/owner were to become the chairman for one year after the company is sold, the chances are that the buyer would feel a lot more secure that the all-important integration would be smoother and the various relationships would be successfully transferable.

8. Inflexibility in Structuring the Transaction
Many deals crater because the owner wants all cash at closing, will not accept any contingent payments or will not accept an asset transaction.

Solution: A strong team of advisors who are experienced in successfully completing transactions will be able to determine the net after tax difference between various offers, or the present value equivalent, or the risk/reward factor of contingent non-secured payments.

9. Negotiate Every Item
Being boss of one’s own company for the past ten to twenty years will accustom one to having his own way… just about all the time. The potential buyer probably will have the same experience of getting his own way.

Solution: Decide ahead of the negotiation what are the very important items and which ones are not critical. In the ensuing negotiating process, the owner will have a better chance to “horse trade” knowing the negotiating and non-negotiating items.

10. Too Much Time Allocated for Selling Process
Owners are often told that it will take six to twelve months to sell a company from the very beginning to the very end. For the up-front phase, when the seller must strategize, set a range of values, and identify potential buyers, etc., it is all right to take one’s time. It is also acceptable for the buyer to take two or three months to close the deal after the Letter of Intent is signed by both parties. What is not acceptable is the phase during which the company is “put in play”, (the time between identifying buyers, visiting the plant and negotiating,) to take more than three months. Otherwise, if the deal drags it is unlikely to close. The pressure on the owner becomes emotionally exhausting and he tires of the process quickly. Solution: Again, the seller needs to have a professional orchestrate the process to keep the potential buyers on a time schedule, and move the bids along so the momentum is not lost. The merger and acquisition advisor or intermediary plays the role of coach, and the player (seller) either wins or loses the game depending on how well those two work together.

Facing Reality
If you want to sell your company by attracting the strongest potential buyers who will offer you the best deal in terms of price and structure, then you should consider the following: – confide in a few of your top managers, especially the CFO – contact on a confidential basis most of the industry players including some competitors – release an Offering Memorandum to potential buyers, after a confidentiality agreement has been signed, which will disclose a substantial amount of confidential material on your company – allow some potential buyers to walk through your premises and operations during working hours – provide access to some of your more important customers and vendors as part of the due diligence process prior to the final signing of the Purchase & Sale Agreement.

Breaking Down the Barriers
For those of you sellers who are already paranoid after just reading the paragraph above, let us discuss each of these points. – Assuming you have a company with several million dollars or more in sales with a financial officer or controller, it will be difficult to pull all the financials together without enlisting the confidence of a few key people in the company. One way to enlist their faith and loyalty is to confidentially tell them your plans, tell them of your need to secure their cooperation and offer to reward them with three or more months of additional salary if they stay with you through the closing. Alternatively, you could offer them phantom stock in the company so they would participate in the equity. Another approach is to tell your key people that you are planning to recapitalize the company by selling some of the equity so that the company has the necessary capital to aggressively grow the business.

–  Contacting the industry players which are potential buyers should be done by a
   third party such as an investment banker so the identity of your company is not
   identified until a confidentiality statement is signed by the buyer and approved by you the seller.

–  The buyer needs to have enough information on the company in the form of
   documentation to determine whether he wants to proceed and to be able to present
   a price range prior to a visit with management.  The process is to boil down the
   best candidates to just a few.  The seller may choose not to show this Memorandum
   to some of the closest competitors.  The critical part for the seller is to enforce
   a strict timeline on the process so that the shorter time period the Memorandums are
   “out and about” the better.  Therefore, a request for a price range by interested buyers
   should be within a month, with expectations of letter of intent, purchase & sale agreement
   and final due diligence to consume no more than three more months until closing.

–  When it comes to walking prospects through the company facilities, I would hope that
   over the years there have been numerous customers, insurance agents and bankers who have
   also walked through.  In any event, buyers want to see a “going concern” and not a flashlight tour at night.

–  The final consideration of whether you should allow the buyer access to some of
   your key customers and vendors should only be done at the last possible moment, prior
   to closing, and should be done on a case by case basis.  Alternatively, if the principals
   of the acquirer are forbidden to speak to the key relationships to be sure the business will
   remain intact with the new entity, then due diligence firms are often retained to conduct interviews.
   Specifically, the due diligence firm will call under the aegis of conducting a marketing survey to measure
   the satisfaction of “their client” which of course is the undisclosed potential buyer.  While the seller
   may abhor letting the buyer exercise these privileges, sometimes there is no choice.  In other words,
   if the buyer absolutely insists on conducting this type of due diligence, particularly if you, the
   seller, has a certain degree of customer concentration, then you must concede or find another buyer.

A Case of Paranoia
A number of years ago I was retained to sell a “print-on-demand” printing company with annual profitable sales of $7 million. At the time, selling prices for printing companies were stable because consolidation in the industry was very active. The owners had decided to sell, because they were burnt out and wanted to extricate themselves from the company’s debt in which they had personally signed. The owners had sold the company some years earlier, but after the buyer reneged on the notes, the owners repossessed the company. Naturally, the owners had a distaste for the mergers and acquisitions process and viewed me as their new investment banker with a certain amount of skepticism.

As I commenced the selling process with the printing company, I could sense the nervousness and apprehension of my client. Initially, I could not call the principals at the office and we had to meet “off campus.” It wasn’t until later on that they established my presence as the company’s consultant. In spite of my clients’ paranoia, they ironically were in the process of selling their building to payoff their mortgage and had installed a huge sign on the premises: “Building For Sale.”

While the printing industry is huge with an estimated 37,000 printers nationwide, the obvious buyers for small printers, such as my former client, are those located in the immediate region. Reluctantly, and somewhat stupidly, I let my client exclude about two dozen other printers who were considered too close a competitor for me as an investment banker to contact. As the story unfolds, I mistakenly called the ABC Printing Company, an alias name, which was one of the companies excluded from the target list of potential buyers. Part of my problem was that ABC had changed its name, and I had failed to make the connection. While I received a blind confidential agreement that was signed by ABC, the CEO of the latter had guessed the name of my client. I flatly denied the identity.

As the story continues, I told my client of the events and when he heard of my mistake, he went absolutely ballistic. He called his attorney, and I was immediately fired and the assignment was turned over to my partner. Still, at this point, ABC did not know for sure that I represented the company which he had guessed was for sale.

My partner wisely convinced our client to swallow their pride and meet with the interested buyer. After numerous meetings and extensive negotiations, my former client sold the printing company to ABC. In fact, ABC was the only company that made an official offer. What a turnaround of events!

From this experience of a paranoid seller, one can learn several lessons: – do not be too restrictive on which buyers can be approached as it could limit the possibility of a successful transaction. – mistakes do happen on matters of confidentiality, so it is very important to keep one’s “cool.”

A Breach of Confidentiality
Quite a few years ago, I was retained to sell an office supply manufacturer. The company with $10 million in sales was nicely profitable, but it had a customer concentration problem which scared numerous potential buyers.

After an extensive search for acquirers, I finally identified another office supply manufacturer with sales of $50 million which was very interested in my client. The buyer signed the traditional confidentiality agreement and before long it appeared that there might be a deal. For some unknown reason, the CEO of the acquirer felt that it was a “done deal” even though there was no signed letter of intent, much less a signed Purchase & Sale Agreement. At this point, the CEO started to talk to other people in the office supply industry about their pending acquisition… specifically by name.

When my client heard about this blatant violation of confidentiality, he immediately withdrew the company from the market. My client was tempted to sue the former potential acquirer, but in this type of situation, the plaintiff has to prove damages such as loss of orders, loss of employees, etc. To my knowledge, there were no losses.

Over a year later, our client was still withdrawn from the M&A market, but was resolicited by a $125 million competitor. By now, my client’s sales had increased to $18 million. Fast forward, my client sold for about twice the price it was offered previously, and everyone had forgotten about the devastating breach of confidentiality some time before.

From this experience, we can appreciate that even though confidentiality is breached, the game is not over. In fact, in this case, the selling company was extremely lucky, for it sold for considerably more money in spite of and because of the confidentiality breach.

Losing a Key Employee
One of the first companies I sold as an investment banker over fifteen years ago was memorable because I was fortunate to overcome adverse circumstances.

My client was a hydraulic press manufacturer producing Reaction Injection Molding machines for plastic parts. Most of the orders were received from the Big Three U.S. automobile companies. Unfortunately, the auto companies refused to pay progress payments on these $250,000 machines so as business increased, there was insufficient working capital to meet the delivery dates. As a result, the owners decided to sell their company.

I was retained to represent the seller, and, of course, I drafted an Offering Memorandum. In the memorandum, I developed an Organization Chart of all the employees, supplying the actual names of the senior management team. Later, I went to market and contacted other plastic machine manufacturers both in this country and Germany. None of these companies were interested in making an offer, so I decided to contact other companies which used hydraulics as its core competency. Fortunately, I identified and qualified such a company that was interested in acquiring my client. Negotiations broke off and months went by without further communication. Then the acquirer in a clandestine manner hired my client’s chief engineer and hydraulic expert whose name was specifically documented in the Offering Memorandum. The situation was very gloomy because there were not only no remaining buyers, but the company’s most important technical expert had been stolen by one of the potential buyers. But then, without warning, the previous buyer re-entered the picture with a satisfactory new offer and miraculously the company was successfully sold.

From this experience, we can appreciate that while there are often upsetting episodes in the process of selling a company, it seems that eventually the situation is remedied. Fortunately, this story had a happy ending also.

My experience is that owners are overly concerned with confidentiality and that it is a myth that in the selling process you will lose customers and employees. On the other hand, you should be very careful regarding confidentiality. The following suggestions should be considered.

1. Realize that there is a “Catch 22” between keeping the selling process totally
   confidential and contacting numerous potential buyers in order to create a
   hotly contested bidding process to secure the best deal.  The more companies
   you contact, the greater the risk for a leak.  The critical aspect for maintaining
   confidentiality is to keep to a fairly short timetable, moving forward to a closing
   as soon after the Offering Memorandum has been released as possible... maybe four
   months total.  Don’t let the process of selling a company drag.  There is always a
   chance of a leak that the company is for sale, but hopefully the deal will be completed
   before there is serious damage.

Conclusion

Not all the possible mistakes in selling a company will happen and mistakes that happen
are seldom devastating.  Fortunately, the adverse myths in selling a company are never realized.

Alternatively to the above scenario is to go to only one or two buyers to reduce the risk of a
leak, but realize that doing so also reduces your chances of obtaining the best price.

2. Create a reasonable story that you can tell the employees as to why there will be strange
   people walking through the facilities from time to time.  For example, you could say that
   you are recapitalizing or refinancing the company in order to grow it more aggressively,
   such as adding new product lines through an acquisition.  If you decide not to use the above
   explanation by using a “smoke screen,” then at least be prepared to have an answer if someone
   confronts you with the question:  “Are you selling the company?”  Aside from the above explanation,
   another way to respond is to say that if you are approached by someone like General Electric, you
   have to consider your options.

3. If you are preparing to sell your business, you should prepare a war-room, or more specifically,
   numerous secured file drawers containing all the pertinent information needed by a buyer’s due
   diligence team.  Such items would include all legal documents, contracts, leases, financial statements,
   patents, alliances, etc.  If you accumulate this material over several months before you contact buyers,
   then you will not be scrambling around at the last moment causing suspicion with the office staff.

4. Retain a third party intermediary such as an investment banker to act as a buffer to channel all
   information between the buyer and you, thus reducing the potential of a confidential breach.

5. Condition the employees to seeing strange people (buyers) walk through the facility, by very
   early-on in the selling process having other unrelated people, such as customers, vendors, bankers,
   etc., walk through the facility.

6. The investment banker will need to communicate with you on almost a daily basis, particularly when
   the buyers need numerous questions answered.  Therefore, you can not encumber the selling process by
   restricting the free flow of information via telephone, email or fax.  Perhaps all telephone conversations
   could be done by cell phones, or all faxes to your private fax.  When using email, be careful that a slight
   mistake by the sender doesn’t send the message into a general company mailbox, which might be picked up by
   the MIS manager.  For example, if the email address is rrobb@atlantic.com and the sender uses
   robb@atlantic.com, it will go into the general mailbox which could be initially seen by the wrong person.

7. Constantly remind buyers of the importance of confidentiality.  Signing the confidentiality agreement
   is essential, but verbal reminders are also important.

8. And finally, get organized!  You will have a lot of paperwork, documents, memoranda floating around
   your desk and office.  Place them in three-ring binders and lock them up or lock your office door.

“The modest unassuming and subservient John D. Rockefeller, Jr. was overly burdened with his father’s obligations, but he surprised all as an astute bargainer. When the indomitable J.P. Morgan was seeking the Rockefeller’s Mesabi iron ore properties to complete his assemblage of what was to become U.S. Steel, it was Junior who went head-to-head with the financier. ‘Well, what’s your price?’ Morgan demanded, to which Junior coolly replied, ‘I think there must be some mistake. I did not come here to sell. I understand you wished to buy.’ Morgan ended up with the properties, but at a steep cost.”

Sellers’ Ten Mistakes
1. Selling your business is emotional and distracting. It is very important to retain professional advisors including an investment banker to do the “heavy lifting” when selling a business. Do not neglect running your business, otherwise sales and earnings will deteriorate and the potential buyers will back off. Move quickly with the help of your advisors.

2. Many sellers dream about their company’s worth based on their “sweat equity,” Wall Street comparisons, etc. The merger and acquisition marketplace is fairly efficient, although it is not formalized like the real estate industry in which all sales are public knowledge and all properties have assessed values. However, placing too high a price on the business can be a mistake. If the company does not sell in a reasonable period of time, the business becomes shop worn and tarnished. There is a greater risk of confidentiality becoming breached the longer the selling process. A higher price often requires the buyer to use greater leverage, thus possibly jeopardizing the debt payments and/or the sellers’ notes. For a variety of reasons, it is usually the best for the seller to arrive at a win/win arrangement with the buyer.

3. Maintaining confidentiality should be more than just having the buyer sign a Confidentiality Agreement. A premature breach of confidentiality can blow the deal. The seller should constantly remind the potential buyers of the confidentiality requirement and take all precautions accordingly such as having the relevant mail addressed to his or her home instead of the office.

4. The purported number one reason for owners of private companies selling is “burn-out.” The tendency is for the owner to work like a dog until he or she “hits the wall”…. then sell out immediately. Time out! Do not sell impulsively. Ideally the owner will plan ahead carefully: clean up the balance sheet, settle all litigation, solve environmental problems, and pay the extra money for audited financial statements one or two years in advance of selling. The latter could increase the company’s value by up to 20% more by generating “believable” financials.

5. Many sellers will not anticipate the requests of the buyers. Acquirers usually require bank financing and that means appraisals of the property and the machinery and equipment. Both of these items take time, so have it done before the seller goes to market. Other items to anticipate would be the total closing costs; e.g., intermediary, attorney, accountant, banker. On a $5 million transaction, that could cost $350,000 and up.

6. Negotiating with only one buyer at a time is frequently the choice of the seller principally because the seller finds it too confusing to negotiate with two or more potential buyers at one time. This is a big mistake, because the seller loses the leverage of competitive offers when only dealing with one buyer at a time.

7. Sellers usually want to retire after selling their business. According to Michael Selz, staff reporter of the Wall Street Journal, owners will receive considerably more money if they are willing to stick around after the deal. M&A Today reported this in an article in our January/February 1994 issue in which Selz cited a specific example of a seller receiving 20% more for his business, because, by staying aboard, it helped reduce the risk to the new owner.

8. Naturally, most sellers want all cash at closing but it is estimated that less than half of middle market transactions are structured that way. In many deals the structure is more important than the price, so if a seller is inflexible on structure, it can be a major obstacle and most likely a deal breaker.

9. Negotiating every item or almost every item is much less effective than keeping your powder dry for the more important issues. If a seller tries to win every point of contention, the buyer may just walk away from the deal. Most successful transactions are a win/win scenario for both parties.

10. Some sellers want to take their time throughout the selling process probably because they equate the length of time as being careful. Jack Kellogg, an experienced transaction attorney, states that deals which drag, don’t close. When the company is in play, move quickly for the close.
Ten Tips on Selling
1. The decision to sell is not irreversible, but it should be firm. In a family business, it is important that it is not just the majority owner and/or CEO, but that all the family members who have some ownership or who work in the business are brought into the selling process. Hopefully they are in concert with the decision to sell. For non-family private businesses, all stockholders should be apprised of the situation.

2. Decide up front who is going to be the ultimate manager of the selling process so there is no ambiguity later on. Decide whether it should be the majority owner, the CEO, the investment banker or some other logical person.

3. Set time frames on the selling process in order to have milestones; e.g., completion of selling memorandum, contact buyers, Letter of Intent, close, etc.

4. Partner with real professionals. Improper advice could cost you tenfold later on. In retaining an attorney, be sure he or she is a “transaction” attorney, not a trust attorney. Make sure the intermediary properly screens and qualifies potential buyers.

5. Communicate with your banker about what you are doing. Bankers not only hate surprises, but if they are surprised, may not be cooperative when you need them most.

6. Target buyers which would perceive your company to be the most valuable.

7. Openly recognize certain “on and off” balance sheet items such as customer pre-payments, work-in process billing, contract obligations, lease obligations, legal threats, etc.

8. Negotiate “stay agreements” with top management so they will not jump ship before the business is sold. Depending on the situation and the importance and number of people involved, a stay agreement could be equivalent to anywhere from two to six months salary.

9. Set up a complete file in one place of all relevant information the buyer and/or his due diligence team will ultimately request; e.g., contracts, distribution and purchase agreements, leases, licenses, intellectual property documents.

10. If a buyer indicates he or she will be submitting a Letter of Intent, tell them right up front what items you want to be included in the document: – Price and Terms – If asset purchase, what assets and liabilities are to be assumed – What contracts and warranties are to be assumed – Lease or purchase of real estate – Responsible for what employee contracts or severance agreements – Time schedule of due diligence and closing
Understand The Buyer’s Concerns
The buyer is usually aware that the founder, owner, and CEO is principally responsible for running the business. If the company has no depth of management or is perceived to be a
“one man band,” the price for the business will be discounted. It is not wise for the CEO to overly brag about himself or let the seller know he has not taken a vacation in three years and works twelve hour days.

The buyer is particularly concerned whether the earnings are really there or was last year a spike in earnings? Will the earnings continue? Is the seller justified in all those add-backs? Almost all businesses have “some” travel and entertainment (T&E) expenses.

As a seller, be prepared to answer these questions: – How do you grow the company? – What is the Company’s competitive advantage? – If you had a million dollar windfall in the Company’s checking account, what would you do with it?
Deal Breakers
You are ready to go to market to sell your business. WAIT! You should be aware of the eight prevalent deal breakers.

• An undisclosed material fact surfaces at the due diligence stage or just prior to closing such as the loss of some major accounts, a product recall and, of course, environmental problems.

• The seller, a C Corporation, figures out the amount of the double capital gains taxes in an “asset sale” and tries unsuccessfully at the last moment to convince the buyer to do a “stock sale” which would be a single capital gains tax.

• At the purchase and sale agreement stage, the buyer wants his note uncollateralized and wants a hefty escrow account or an overbearing list of “reps and warranties.”

• The chemistry between the buyer and seller was never really established, so when the deal runs into road blocks for a number of reasons including the egos of the advisors, there are no personal relationships to bridge the differences nor to get the deal back on track.

• The buyer is undercapitalized and just before closing, the buyer is unable to raise the necessary cash to do the deal.

• Seller’s remorse happens more often than one might expect. It is like a bride backing out of her wedding the day before. In this case, the seller realizes that his life’s work, the company, is too important and he or she cannot part with it.

• The deal lags and either buyer and seller loses patience and walks away from the deal.

• The seller loses control of the deal either to the buyer or to one of the advisors. The seller is not accustomed to the selling process and succumbs to the other players. Out of resentment, he or she picks up their marbles and goes home.
Conclusion
Like the story of John D. Rockefeller, Jr. in the beginning of this article, the seller should portray himself as one who does not have to sell. He should negotiate on his own turf for psychological reasons and realize that most successful transactions have a win/win attitude by both parties.

1. The industry As part of an acquirer’s assessment of the target company, he should review the industries in which the potential seller’s customers and suppliers operate. This method of due diligence is frequently called a SWOT analysis in which the buyer reviews the Strengths, Weaknesses, Opportunities, and Threats of the potential acquisition candidate’s competitors. For example, with the consolidation in retailing and the concurrent rise of Wal-Mart, Home Depot, Staples, and others, power has clearly passed from the manufacturers to the retailers. When Rubbermaid with annual sales of $2.2 billion tried to pass on a much needed price increase to partially cover the higher resin costs, Wal-Mart with an annual sales of $83 million balked.

2. The compensation
An acquirer should assess the target company’s compensation of personnel at comparable levels of responsibility. For example, a high-tech public company from Boston made an offer on a smaller company with a proprietary product. Part of the reason the target company was so profitable was the owner paid his employees minimum wages with virtually no benefits in a facility with minimum overhead. If the acquirer absorbed the target into its own system, it would be compelled to equalize the compensation of the seller’s employees thus vastly reducing the stated profitability of the target. Conversely, if the target’s management and employees had a much higher compensation than the acquirer, it will be difficult to merge the two companies without having personnel problems.

3. Capital expenditures An acquirer should determine to what extent the machinery and equipment of the target company needs to be replaced in order to be up to date with the competition, thus adding a further cost to the acquisition price. Or, rapidly growing companies may require annual capital expenditures which exceed the normal depreciation expense thus modifying projections and ultimately affecting the transaction price.

4. Internal controls

An acquirer, especially a public company, is often far more sophisticated in financial controls, systems and reporting than the target companies. Some companies grow so fast they do not have time to put proper controls in place, but these companies are often out of control. For example, an $11 million retail chain came very close to selling a minority interest to raise essential working capital. The potential investors ultimately lost confidence because the financials were not audited and the five stores did not control their inventory through a Point of Purchase (POP) perpetual inventory control system at the check out counters.

5. Inventory obsolescence

An acquirer should pay particular attention to the target company’s product life cycle, particularly in the high tech industry. The buyer should question the seller’s inventory reserve policy to be sure it is adequate to cover the inevitable write downs.
6. Cash flow statements For buyers, evaluating cash flow statements is more important than evaluating the target’s balance sheet and income statement. The acquirer should verify that the seller will continue generating positive cash flow after the acquisition when the extraordinary and non-recurring items have been eliminated and the new debt service has increased.

7. Discretionary costs
An acquirer should be aware that some sellers prepare the company for sale by maximizing profits through a reduction of managed costs such as advertising, promotion expenditures, research and development expenses, maintenance, etc. These cuts will eventually hurt the company’s long-term prospects.

8. Financial covenants If a buyer plans to exercise a stock transaction, one of his major concerns should be the covenants which will be assumed with the bank notes, leases and rentals. The lenders, leasors and landlords will have enforceable covenants such as balance sheet ratios, debt coverage percentages, etc. If an asset transaction is to occur, then the buyer should not be rushed into agreements without proper time to negotiate the covenants.

9. Anti-trust
A buyer does not have to be a Fortune 1000 company to be immune from having to notify the Federal Trade Commission when two competitors merge. The Hart-Scott-Rodino Anti-Trust Act requires the commission be notified if the buyer intends to acquire a middle market company of considerable size. The buyer should consult with their transaction attorney on the various requirements.

10. Tender offer
If a buyer is thwarted when approaching the management of the target company, the buyer should determine whether the controlling stockholders are outside of management. If so, a friendly tender offer can be made directly to them on the assumption that the actual owners would be more receptive than the president who could well be a minority shareholder and who would be particularly concerned about losing his job.

Think hard about the question, “What am I buying?” Intellectual property, especially know-how, is becoming increasingly important even in businesses not primarily service in nature. The most important element of due diligence may be dividing the mindset of key employees; first you must figure out who they are and then read their minds.

Due diligence is a critical function. The statement seems obvious but due diligence is subtle and difficult. If it isn’t done thoroughly, the buyer is operating in the dark; if it is done thoroughly, the seller may be badly hurt. (Imagine an infestation of nematodes swarming through your business talking to your employees and examining your records.) Representations and warranties in the draft P&S Agreement are useful not only for the obvious reasons but also as an aid in discovering information about the seller and the target company. It is especially important for a potential buyer to examine inventory carefully, inasmuch as inventory is seldom completely clean. A ploy that sometimes helps is for the seller to retain the inventory and buyer to purchase it on an as-used basis.

Valuation is an important exercise but usually the value thus determined is not the purchase price. The business will be bought for whatever the seller will take for it. The challenge to the buyer is to figure out how to swallow the acquisition costs in spite of the business’s problems. The buyer should focus on what he can do with the business, especially whether the cash flow will be there to support the purchase price. Remember the buyer wants to make money for himself, not just support the seller in his old age. Given the earlier remarks about the importance of emotion, it is essential that the buyer remember that he has no cure for cancer; if the deal comes too easily, look out.

Critical mistakes
A critical negotiating mistake buyers sometimes make is to aim to “win” or to try to destroy the other side as in an adversarial legal matter. A paranoid mindset, “Am I being cheated?” takes over. The result will either be no deal at all or a lopsided deal. Lopsided deals end up in court. For example, the high profile sale of Rockerfeller Center to the Japanese and the recent breakdown of relations between the seller/mortgagee and the buyer which led to the filing of a bankruptcy petition. Unless the deal is balanced, beware!

Perhaps the most common mistake made by a buyer after it has acquired the business is to give inadequate attention to the financial aspects. The average entrepreneur considers himself a perfectly adequate CFO. He is wrong. If he is an adequate CFO, he probably isn’t an adequate entrepreneur. Access to strong financial capability and the use of those talents will save many situations which otherwise would fail. Parenthetically, the computerization of the manufacturing operation, especially a perpetual inventory, is becoming an essential tool for survival. No company will survive unless it knows its costs accurately and in real time.

Negotiating
In approaching a negotiation, the first problem is determining who the decision maker on the other side is. Lots of jaw bones have been worn out in pseudo-negotiations with the wrong person.

Once the decision maker has been identified, it is important to establish a rapport with him. Unless the head of the buying group and the decision maker on the seller’s side are able to work together, the consummation of a deal is highly unlikely. At some point, a social dinner including the seller’s spouse may be an ideal way of furthering the negotiation.

At some point in every transaction, usually fairly early, it is important that parties leave the meeting with some psychological bridge having been crossed, all sides wanting to make a deal. From there one, the negotiation will take on a life of its own and be much more likely to close. Nevertheless, each negotiator must always leave the impression that he is able to walk away from the acquisition if it does not go according to his wishes. Neither side can afford to let the other believe that it is desperate. Good guy/bad guy roles are useful when negotiating as a team. Also, it helps if the real decision maker on your team is not in the negotiating sessions.

The final transaction is usually couched in a fashion that it has many facets so that it is all but impossible to determine the “price.” It is almost true that the seller’s price can always be met if the buyer is allowed to set the terms of payment. For instance, a common provision is that the patriarch’s son will be employed by the business for several years or possibly the seller will be left with a 10% interest in the ownership. Usually this latter is accompanied with some sort of call provision residing in the buyer. Contingency earn-outs based on post-closing performance are the sources of much controversy; they seem to be useful mostly as a fall back device to break an impasse.

Other important points
• Be a student of the tax law. All acquisitions revolve around taking maximum advantage of the tax laws to benefit both buyer and seller.
• Knowledge is all powerful. Know not only the law but all you can about the target company and its owners.
• Negotiate on your own turf for psychological reasons.
• Be sure to control the drafting of the P&S Agreement and other documents. While it is customary for buyers to do the drafting, if the seller can seize that function, the seller will have an advantage.
• Keep the momentum going. Deals that drag don’t close. Energy and zeal are critically important.
• It is important that the buyer have enough money not only to make the acquisition, but to run the business thereafter. If he has only 100% of the funds available, the business will probably fail as a result of unforeseen needs. If he has 200%, he will probably be about right. If he has 1000% of the needed funds available to him, his chances of failure go up again because sloppiness will creep into the operation.
Advisors/professionals
The buyer should be sure he has the right lawyer. For instance, in Massachusetts, there are about 37,000 lawyers but perhaps fewer than 5,000 are experienced in doing M&A transactions. (The other 32,000 are not interested in telling you that they are not skilled in this field.)

The seller’s accountants always oppose the transaction. The buyer’s accountants normally favor the transaction, but think that the price should be about half of what it is being negotiated. Whichever side you are on, make sure your lawyer is a skilled business lawyer and that your accountant thinks that the Internal Revenue Code is the world’s most interesting reading.

One of the buyer’s best allies can be his banker. Bankers abhor surprises, so frequent and candid communication is essential. Establishing good working relationships with loan officers has become difficult in recent years as banks have become more bureaucratic and tend to look upon customers as adversaries, irrespective of claims made in the bank’s advertising. Banks love personal guarantees because the guarantees take the risk out of the deal for them. If a banker is too aggressive in looking for a personal guarantee, which after all is a statement by the banker that he doesn’t trust the deal, take a good look at your deal to see if it is too thin so that he must have your personal credit behind the deal. If the deal seems strong enough, resist executing unlimited personal guarantees. Limited personal guarantees may be all right to give the banker assurance of your commitment when things go wrong.

Corporate business appraisers can be very helpful, but as noted above, not necessarily for establishing the purchase price of the business. Appraisals tend to be on the low side of the final price. Because bargaining power of the parties vary so widely, the bargaining power tends to be more determinative of the acquisition price than the appraisal.

Final words
Buyers normally want to acquire assets and sellers want to sell stock. Tax considerations may cause these choices to be reverses. A seller’s insistence on a stock deal need not be a deal buster because there are other ways for a buyer to protect against unknown liabilities.

As a potential buyer, watch out for the “Life Monument Syndrome.” Many potential sellers find that talk of selling the business is an ego trip, sometimes a way of keeping an obstreperous employee-son-in-law in line. If the owner of the target company is totally inflexible, the potential buyer should be ready to abandon or postpone the acquisition project.

Inasmuch as the biggest deal breaker is usually the disparity of the price between the buyer and seller, and the negotiation is usually a colloquy to bridge the difference, one approach is for the buyer to say, “This is the way I see the valuation. What do you see?” Or the buyer may respond to the seller by saying, “I have trouble with your valuation, but if you will allow me to suggest flexible terms, we may be able to get together.” Be careful how you say to an owner that you have trouble with his valuation; nobody likes to be told his baby is ugly.

Business Checklist

Date
Name of business
Address
Rating
General Impressions — Exterior
Location
Parking (if applicable)
Exterior appearance
Signage __
Physical condition of property