The Process of the Sell Side Transaction

Sale process is basically transitioning of a business from one owner to another. For seller the process can be an emotional one. In case of a mid-market, the sale process can take from as little as four months to more than a year. Generally, there are several steps to be covered to have a successful and effective sale transaction. Hence, it can seem very daunting for the parties involved, especially the seller. However, we have divided the entire process into five stages to simplify the transaction. These include:

• Preparation Phase
• Market Phase
• Diligence Phase
• Negotiation Phase
• Transition Phase

Each phase has their own distinctive characteristics but all are equally vital to the process. Since the process is very fluid, sometimes these phases can overlap in timing and execution. However, before diving into detail of these phases, let’s first see how the current COVID-19 crisis would affect the sale process and what measures you can take to prepare your business for post-COVID sale.

As the pandemic swept the world, everyone has been bracing themselves for the very worst. Many business owners who were planning to cash out and retire are worried that they won’t be able to do so for years because of this pandemic. Would anyone want to buy or sell a business during COVID-19 crisis? But nothing could be further from truth. Investors with capital are always looking for lucrative opportunities despite the market conditions.

While delaying the sale process is very unfortunate but we would encourage you to be hopeful. Based upon the M&A activities prior to pandemic and the liquidity remains in the market, deal activity will again resume as we move past the current crisis. However, entrepreneurs should be aware that post COVID-19 sale process might look different that general norm followed so far. We can expect buyers to focus on following questions:

• What steps were taken to manage cash during the pandemic?
• How did your business perform during COVID-19 shut-downs and delays?
• How did COVID-19 impact your historical earnings and near-term forecast?
• Will the reaction to COVID-19 create any structural changes in your industry?

We have listed some recommendations below to help you navigate through these questions and to proceed with the sale process once market revives:

1. Keeping Business Solvent: This may seem lame but staying solvent doesn’t only mean keeping the business open during this crisis. While evaluating your business, buyers will focus on how you managed the cash levels during the pandemic as this will be a great indicator of your company’s ability to generate and manage future cash flows in a healthy economic environment.

2. Calculate the Impact on Your Business:  Buyers would definitely like to know the financial impact of the pandemic so they can properly value your business. This is make your last 12 months earning look ‘normalized’ which is a key driver of business valuation process. You should consider following items:

• Revenues lost that won’t be made up with future demand
• Delayed sales i.e. revenue that wasn’t earned in current period but will buffer forecast
• Supply Interruption
• Impact of Layoffs
• Insurance Claims for Business Interruption (if any)
• Grants/Loans from Government or forgo of any loan
• One-time cost due to business disruption (idle facility cost, cost to set up remote working etc.)

Further, it is advisable that in addition to computing historical impact on the business, you also revisit your 2020 & 2021 forecast. Obviously any forecast that would have been done at the start of the year will no longer be valid. Buyers would like to know the impact of COVID-19 on future projections of your business and industry as a whole.  

3. Customized Corrective Measures: COVID-19 pandemic has created an opportunity for entrepreneurs to prove themselves during these challenging time and businesses that are able to perform comparatively better than others might receive a premium on the market upon a post-COVID sale. Therefore, the owners should make a strategy and take corrective measures to survive this economic crisis. Some Examples:

 

• Focus on the products that are in demand
• Provide remote services
• Reduce overhead spend
• Offer favorable payment terms

Analyze your business structure and customize your plan to suit the current situation. Don’t forget to document them so as to show the future buyers!

4. Redefine Your Expectations: Economic slowdown due to COVID-19 will cause buyers and their lenders to be wary. Banks might be overwhelmed with emergency government funding programs and non-bank lenders would be dealing with their own liquidity issues. Also, impact of shut down due to pandemic will cause more uncertainty regarding the future earnings of the business. Many buyers might want to put a clause of ‘earn out’ i.e. a certain part of the purchase price would be paid if the business reach at an agreed level of targets.

So step back and define your goal from this sale. Also, reconsider that whether sale is a right strategy or given the shift in your industry, maybe a gradual exit or a partnership through minority equity would more appropriate to maximize your value.

In addition to above, business owners need to utilize this extra time wisely and take all necessary steps to improve their business. While cash may be tight, you can make improvements that can increase valuations in the future.

Now let’s discuss all phases listed earlier in detail:

Before the actual process starts, the seller and advisor need to team up and prepare the business to be sold. In simple sense, the business should look attractive to buyers and in interest of the seller, be positioned to attain its maximum value. We have already laid out various steps that one can take to increase the value of a business in previous articles of the series. The preparation phase could include:

An information memorandum (IM) is a key document that is prepared to allure the potential buyers. IM contains the every minute detail of the business and is shared with the target list of suitable buyers. Analysis of the financial statements is also an integral part of the preparation phase. This includes not only the current and past data but also the projections for the growth for the period to come. Other important information that a seller should compile is list of key employees and their roles and responsibilities. Further, one should also provide customer list, infrastructure detail including office space, factory (if any), capacity and equipment at facilities to prospective buyers. Information about company owned intellectual property should be shared with the buyer as it can positively influence the transaction. All this information is stored in a virtual data room that will handle the distribution and storage of all the classified documents.

Preparation phase is the essence of a successful sales transaction. Companies spend between one to three months to prepare this entire information. A buyer may judge the financial information first but he will take a holistic approach while deciding to submit an offer. Once all the information is rightly pieced together, the seller moves onto next phase which is the marketing phase.

After the preparation phase is completed, the sell side team will reach out to all the entities from the prospective buyers list. The advisor will then share an investment teaser which provides an overview of the opportunity with the buyers who have shown interest in the transaction. Each potential buyer will perform his own analysis of the prospect company to decide whether the said business matches their acquisition criteria. Interested parties will then move forward to sign a confidentiality agreement (NDA) to ensure that all the data exchanged between the buyer and seller is safe between both parties. Once the NDA is executed, information memorandum will be shared with the buyer to help him analyze the risk, benefits and terms of the investment. Buyers who decide to pursue the transaction will present an Indication of Interest (IOI) which will provide initial parameters on valuation and deal structure. This phase takes around one to two months depending upon the number of companies that review the business.

This is a more formal and official phase of an M&A transaction. Sellers are now clearer on which buyers are interested and a range of valuations and deal structure for the transaction. The advisor along with the seller should shortlist the buyers that approved to continue with the process. On the other side, buyers will perform a detailed diligence of the business which is a kind of investigation of operational, financial and legal history of the company. Due Diligence brings out the flaws as well as any hidden benefits of purchasing the business. It is a thorough process and most of the time buyers use the assistance of tax consultants, lawyers, accountants and bankers. This is a phase where serious buyers gain momentum.

Sellers conduct a formal management presentation for the buyers’ team to further highlight the positive aspects of the business. These presentations are more than marketing materials and will cover all facet of the company. As part of due diligence, buyers are also allowed to visit the facilities and sites of business for physical verification. This whole phase can take one to three months and after that the interested buyers will submit a Letter of Intent (LOI) that helps the seller to determine the best fit to meet his/her objectives. Buyers negotiate prior to the selection and at the end one acquirer is selected as the winner of the bid.

The acquirer and seller begin a complex process of handing over the business, once the winning bid is determined. Most of the operational, business and financial aspects of the transaction are not clearly defined yet. The purchase price and structure of the deal outlined in LOI is only an initial agreement between both parties. All the small but crucial details are to be finalized. In this phase, buyer and seller will negotiate and complete the following agreements:

• Purchase and Sales Agreement: This is a settlement agreement of the complete sale process as followed within the limits of original LOI. Apart from other details, it contains the purchase amount and timing, seller’s and buyer’s representations and warranties, purchase price adjustments, the form of transaction and dispute resolution and arbitration protocol.
• Transitional Service Agreement: A service agreement is made in cases where seller will provide transitional support to the buyer. This may include accounting, human resources and other management position. The agreement should clearly state the services covered, the fees for the scope of services mentioned and additional charges for the services other than that stated in scope of services.
• Non-Competition Agreement: This agreement restricts the seller from engaging in direct or indirect competition with the buyer for a specified period of time. Violation of this agreement can result in legal action against the seller.
• Vendor Financing Agreements (if any): This agreement comes into play when there is a gap between the purchase amount and the financeable asset base of the seller. It determines the security arrangements to protect the seller from the risk of default, and the amount, timing and interest rate associated with the financing.

This is a very critical phase and can take around one to two months. These documents are binding and neither party can step back once these agreements are finalized and executed.

This is the final phase which involves transitioning of business from the seller to the buyer after the business is sold. Having a strong transitional service agreement can limit the conflicts and be helpful in smooth transition. At this point seller wants to make sure that all of his corporate knowledge, relationships and responsibilities are properly transferred to the new owner.

This marks the end of the sales transaction. It may seem a daunting and complicated process but as mentioned earlier having an advisor who is an expert in dealing with the intricacies of M&A transactions can help to smooth things out. If you are contemplating selling our buying a business, you can reach out to our experts to guide you through this one of the crucial decision your life.