For successful entrepreneurs, the idea of finally selling the business – an end to 18-hour days, no more worrying about making payroll, no more anxiety about having nearly all your net worth tied up in a single enterprise – can look like an oasis, a future of prosperity with few worries.
From the scores of founder sales I’ve been an advisor on over the past 25 years, I’ve observed that, indeed, life can be very good after selling one’s business. But – and this is a major “but” – closing of the transaction is just the beginning of a process than can take a handful of years and, in some surprising ways, be just as stressful as the period an entrepreneur spent building his or her company.
The culprit: earn-outs that keep a goodly chunk of your sale proceeds in limbo; and post-closing claims about taxes, undisclosed liabilities, intellectual property, the accuracy of financial statements and more.
Think that’s someone else’s problem and it won’t happen to you? Figure you and your lawyer will negotiate around all those post-closing efforts to chisel you out of a fat chunk of what you spent decades building? Think again.
A 2013 study by Shareholder Representative Services (SRS), a firm that manages escrow accounts and other post-closing issues in hundreds of transactions large and small, finds that two-thirds of deals have money disputes arise after the closing. A maddening number of these disputes are initiated in the final week of an escrow period, just when Mr. Almost-Retired-Entrepreneur was getting ready to pack his bags for a long and well-deserved vacation.
Some facts from the SRS study you need to know before selling your business:
–Of 420 deals the firm studied, the aggregate purchase price was $66.7 billion. But just 76% of that was paid out at closing. A whopping 13% was held back for earn-outs. And about 10% was held in escrow in case claims surfaced.
–Size of the deals studied: 39% were more than $100 million; 38% $25 million-to-$100 million; 23% were smaller than $25 million.
–Software, IT services, business products and services, medical devices and biopharmaceuticals were among the sellers’ industries. Among buyers, 71% were public companies; 23% private or foreign; and 9% financial (as in private equity and more on that in a moment).
–In post-closing purchase price adjustments, buyers win 50% of the time, sellers win a favorable adjustment 22% of the time, and in the remainder there is either no adjustment or no claims arise. Two-to-one odds the seller gets nicked.
–Most claim sizes are less than $500,000, but SRS reports that in its 420-deal sample, 12% of the claims were $2 million or more, a handful more than $12 million. Painful.
–Is one kind of buyer more likely to make claims and seek to hold back money the selling entrepreneur was counting on? You guessed it: financial buyers like private equity firms file claims in 64% of their deals vs. 53% for privately-held buyers, 42% for public companies and 38% for foreign buyers. And the financial buyers seek a greater piece of funds in escrow when they make claims, too.
–Some good news for sellers. Time spent resolving claims in some instances has been reduced as contracts are better conceived. Most claims are reduced via negotiation.
–Earn-outs? Let’s hope you beat the average. Just 50% of non life-sciences sellers (life sciences deals are structured differently) hit their earn-out milestones, SRS reports, though a minority of those “failures” becomes “passes” after dispute and negotiation.
As you can see, your highly anticipated exit event can easily turn into an aggravation event. Good advisors and planning are crucial. But no matter how well a deal is structured, the morning after your closing party you add to your Founder/CEO job the title of CGPO, or Chief Getting Paid Officer.
Based on my own experience in negotiating deals and counseling sellers through the transaction and through life after the sale, here are four recommendations for avoiding post-sale battles:
1. Be honest with yourself about your company’s prospects. Even if you’ve talked a buyer into paying a price based on the upper range of performance, keep your own expectations reasonable, as you did when building the business.
2. Communicate. Surprises often occur because buyer and seller haven’t been talking candidly, some even avoiding each other.
3. No let up: expect to work just as hard in the earn–out period as you did building the business. Take care leading up to the sale to retain key employees so you’re not managing with an inferior crew post-sale.
4. Steel yourself. Even with these steps, conflicts with buyers will arise. Don’t be emotional. Negotiate hard and you’ll maximize your return.
Mary Josephs is the founder and CEO of Verit Advisors, a Chicago-based investment banking firm specializing in ESOPs. She led ESOP advisory groups at Bank of America, ABN AMRO LaSalle Corporate Finance and LaSalle National Bank.
Source: Forbes Business