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May 15, 2001
7 Min Read
This article is the last in a series designed to help molders and buyers of molders position for possible benefit through merger and acquisition activity. Our author is Debbie Douglas, managing director of the Douglas Group, a private investment banking firm that represents plastics company owners in the sale or purchase of businesses.
This is the final article in our series about injection molding merger and acquisition activities. The first several articles talked about the fine art of cashing in from the seller's perspective. Then, in response to reader requests, we shifted to the buyer's perspective. Most of the focus to date has been on the courtship process, and getting to commitment. However, even after buyer and seller believe they have a deal, 90 percent of proposed purchases or sales fail between that first handshake and final consummation. This article focuses on the pitfalls between handshake and close, and how to avoid them.
As buyer and seller near the stage where both feel that they have struck a deal, the parties become eager for a commitment of some sort. For the buyer, the most desirable path is to sign a classic "letter of intent." Such a letter often commits the buyer to working through the diligence process and to drafting a purchase agreement. It also forces the seller to stop discussions with other potential buyers. This exclusive dealings commitment is often referred to as a "stop-shop," or a "no-shop."
Such a letter of intent offers little risk to the buyer in that he has the right, during due diligence, to back out without penalty. For the seller, however, the no-shop commitment does present risk. If all alternative courtship stops, rejected buyers may be lost if needed again later. If rejected today, but called back again later, buyers typically wonder what soured the original relationship. They feel that competition for the deal is lessened and that therefore they are in a competitively superior position.
As a result of these push/pull dynamics, negotiation over the letter of intent is important and should be handled with care by both sides.
There is a wide range of creative alternatives to consider at this stage to tailor the commitment to meet the objectives of both sides. For example:
A deposit may be required from the buyer, subject to forfeit if the buyer changes his mind.
The letter may provide for some type of modified exclusivity. For example, the seller may allow one buyer to progress to due diligence, but still retain the right to continue talks with other suitors.
A timetable may be stipulated, with agreement that if certain tasks are not completed by specific dates, the commitment becomes void. Such tasks include due diligence, financing, and a definitive purchase agreement.
"Walk away" fees may be established, which allow one or both parties to walk away from the transaction at any time, provided that they pay a stipulated amount.
The list of creative solutions is extensive, but there are two fundamental points: Don't underestimate the power of the letter of intentâ€”it can have critical binding elements; and never regard a letter of intent as a black/white, accept/reject alternative. Remember to think creatively about obstacles and compromise if necessary to create something that works for both sides.
Keep in mind that no deal is complete until both parties understand the fundamentals of the transaction format. What, specifically, is the purchaser buying? Is he buying assets, assets and liabilities, or stock? The difference between a gross asset purchase and net asset or stock purchase is enormous in that the seller may or may not be required to pay off liabilities postsale, using his proceeds.
Beyond that, the difference between a stock and an asset format can have enormous tax consequences, especially for a C corporation seller. If the seller simply sells stock, his tax will normally be at a capital gains rate of about 20 percent. If he sells assets, he will pay tax on gain at the corporate level (say 40 percent), and tax again at the personal level when he liquidates the corporation to get the tax out for personal use (another 40 percent). Thus, in the aggregate, the difference in taxation may be the difference between an effective tax rate of about 20 percent vs. one of more than 60 percent.
Control of Advisors
The next stumbling block in the late completion stages involves derailment by outside advisorsâ€”attorneys, CPAs, bankers, and so forth. All too often buyer and seller naively think that they have a completed deal when they've only agreed on price. Then they step back and leave attorneys, accountants, and others to work out the details. But the devil is in the details. It is critical for the earnest buyer or seller to keep advisors on track with the crystal clear instruction to close the deal.
Choose advisors who can control their egos and who understand that their job is to get you to successful closure with the best possible terms. Never accept assertions from any professional advisor that "it's always done this way." In spite of having heard that phrase 1000 times, I can absolutely assure you that it is not always done any one way!
Keep in mind that tenacity, creativity, and intelligent consideration of the needs of both sides can overcome any obstacle.
Representations and Warranties
Every sale transaction invariably requires the seller to make certain representations and warranties about what he is selling. Buyers want promises that they have been presented with truthful and complete information before they pay.
Sellers often become nervous about what they are asked to attest to and want to limit everything to the "best of their knowledge." The seller feels that by deciding to sell, he has chosen to relinquish the risks of ownership, along with the rewards. If he can't be rid of the risk, then why sell?
There is a happy medium. It is reasonable for buyers who are paying an aggressive price to request certain assurances. At the same time, it is reasonable for sellers to step away from all future risk (anything relating to postclose occurrences) and to have limited exposure to risks from the past (ceilings on indemnifications, certain "knowledge" limitations, and reasonably short time limits for identifying problems).
Employment agreements are often much sought after, with buyers looking for every possible hook to keep the seller drawn in after the close.
The wise seller keeps the postsale employment agreement as short as possible, with the freedom to renegotiate after a time if he's not happy. No seller can really know how he will feel about continuing employment until he's had time to work with the buyer. We've had sellers who couldn't wait to leave and then, postsale, found that they loved their new role. Suddenly their administrative headaches are gone, and they find themselves again doing what they love. Suddenly, work is fun again.
On the other hand, we've had sellers who thought they wanted a commitment for a five-year employment term and found, postsale, that they wanted out in six months. They simply couldn't adjust to the fact that others now have the final authority on major decisions.
Neither buyers nor sellers should presume to know what they will want after a year of working together. Shorter time periods provide flexibility in case things don't go as expected, and keep healthy pressure on the buyer and seller to treat one another well in anticipation of future negotiations.
Injection molding acquisitions and divestitures can offer tremendous opportunities for both buyers and sellers that are above and beyond the pace of progress possible through internal success alone. Wise acquisitions fuel growth and strengthen strategic position. An astute sale can secure wealth to reward a lifetime of hard work.
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