EXIT STRATEGIES: The professional legal firm

The type of advice and assistance which a professional legal firm can provide includes help in the following areas:

Review purchase agreement

The purchase agreement would often be prepared by the vendor’s lawyers, however, this protocol varies in different countries. In addition, some buyers insist on having their lawyers prepare the contract. This is a complex legal document which few entrepreneurs will have ever seen and certainly few would understand in any depth. The professional legal firm can draft the documents for you or construct the terms and conditions and identify any harsh or unusual conditions which the buyer has requested and assist in the renegotiation of those where the buyer prepares the document.

Review warranties and indemnities

The vendor would normally be expected to provide warranties and representations and indemnities to the buyer. These can often be renegotiated to be less harsh. The professional legal firm will know what is reasonable and what is not. This is one area where proper preparation, good reporting and compliance systems and good governance can significantly reduce the exposure of the vendor.

Review employment or non-compete agreements

The buyer will expect the key executives and major shareholders to enter into employment agreements and/or non-compete or restraint of trade agreements. The professional legal firm can ensure the terms and conditions associated with these agreements are reasonable.

Preparation of disclosure letter

The vendor should be prepared to disclose any issues which may effect the decision of the buyer to purchase. They should also identify any potential liabilities of the business. The professional legal firm can advise on the types of disclosures and how the letter should be worded to best protect the sellers and to ensure there is no avenue for redress on the part of the buyer if events do not go to plan.

Review corporate documents

As part of the preparation for the sale, the professional legal firm will review the corporate documents which authorize the firm to undertake business to ensure it meets the requirements of the buyer. This review would normally extend to board minutes, shareholder agreements, option schemes and any material contracts the firm has entered into.
Depending upon the size of the transaction, the vendor should plan for approximately 5-10% of the sale price to be spent on their professional services fees noting that smaller transactions are likely to have a higher percentage associated with advisors fees.

Not all professional services firms have the necessary experience to undertake this type of work effectively. The entrepreneur should not assume that their current professional services provider has the expertise to properly advise them in this area.

They should seek independent advice as to which professional services firms are best equipped to handle the transaction they wish to enter into. Before they start to incur costs for this service, they should undertake some due diligence and investigate the extent to which the referred firm has a track record of success in working with clients on sales and acquisitions of similar sized businesses or to similar sized acquirers.

Asking for references would not be unreasonable and they also should ask for a list of transactions which the professional services firm has participated in and some details of the work performed for the clients involved. People move between professional firms and so the firm should ensure that the expertise is still with the professional services firms. They should ask to be allocated an advisor with personal experience in these types of transactions.

Some advisors, whether they be accounting, legal or corporate finance executives, are so locked into a traditional model of firm value that they simply “don’t get it”. They will want you to undertake a conventional valuation based on historical earnings, a conventional information memorandum and won’t grasp the impact of the opportunity which the buyer can extract from the potential and/or strategic value in your business. Certainly you and they will have difficulty trying to put a value on the business if it is based on the buyer’s potential rather than your net worth or profitability and your advisors may be uncomfortable going forward on that basis.

However, if you have clearly identified potential buyers which have expressed interest in an acquisition, this should provide a good base from which they can assist you to prepare the business for sale.

If your initial discussions with a professional advisor show you that they want to take you down the conventional path, you should move on and find one that you feel can best represent the potential in your business. Ask them to provide you with references to similar sale transactions they have advised on.

Entrepreneurs and investors who have not participated in large transactions are often concerned about entering into relationships with Investment banks, larger accounting and legal firms and often hesitate because they feel the larger firms carry considerable overhead and this gets passed back down to the client in higher fees. It is certainly true that the larger firms typically have higher charge out rates but they also need to compete for services of the smaller clients and so it is not unreasonable to ask for a smaller charge out fee given the size of the firm.

The larger firms do have an advantage of being national and international organisations and having specialists in most areas and this can be to the benefit of the smaller firm involved in complex trading transactions. When it comes to contracts and agreements which can materially effect value dilution, a little more up front may better protect the value of the firm on ultimate sale. This would certainly apply to IP agreements, option schemes, shareholder agreements and any acquisitions which the firm enters into.

The larger professional advisors have a decided advantage in M&A transactions. They see them often, they regularly advise on both acquisitions and sales. Larger accounting and legal firms are often asked to undertake due diligence work on behalf of larger corporations and thus are very familiar with the entire process.

Larger firms are taken seriously when it comes to negotiations and thus can better protect the entrepreneur who has never experienced these types of deals.

In the end, it may come down to spending a little more over a longer period to be better prepared than spending a lot near the end closer to the transaction. The business is likely to be better managed and be less risky as a result of more professional preparation. At the same time, the impact of a large professional firm in the deal process can enhance the reputation of the seller and may result in a better price being negotiated. Certainly it should speed up the due diligence process which in itself can have a significant positive effect on deal price. It should also speed up negotiations as the buyer knows it does not have to educate the seller about normal terms and conditions of a sale.

I have often been asked why I used a big four auditing firm with my last venture given that the business when it started only had a dozen staff and, when sold, had only grown to 30 employees. My answer has always been to show the impact on the final due diligence and deal discussions and to ask whether the person asking the question thought I received value for money.

My last business went into free fall after several large software corporations decided to enter my market with similar products. All my prospects were their customers as our supply chain optimisation software sat alongside a large ERP system such as those sold by SAP, Oracle or Peoplesoft. When these corporations announced that they were going to develop their own supply chain optimisation solutions, their customers decided to wait for the integrated solution from their main software vendor. Thus I found myself in a situation where I had 30 staff and no prospects. Naturally we decided to sell the business before we were forced to close the doors.

This was my fourth software business and I had the experience of working through the sales process for the earlier ones. I also had been through the due diligence process for raising venture capital twice and taking on a large corporate loan. I knew from those experiences that being prepared for due diligence was a critical part of getting a quick decision. I also knew that the quickest way to get through the due diligence process was to ensure that the professional advisors I used had high credibility. Basically, I wanted to have all my source documents accepted without question. The only effective way to achieve this is to have the biggest and the best.

When you are selling a business to a large, perhaps, global corporation they are going to undertake a very extensive and sophisticated due diligence. They will almost certainly use a large auditing firm and a highly respected legal firm.

In order to uncover the risks and problems in your business, these advisors are going to review everything. The only way you can speed up this process is to demonstrate to them they don’t need to audit most of the historical information because they will be able to rely on the documents produced by your own advisors. My approach was to push back hard and state that any additional audit was wasting my time and the buyer’s money but that I was willing to provide warranties for the quality of the information presented. In any case, if there was a subsequent problem, they could always go back and litigate against my advisors who would normally have much deeper pockets than me.

This last business of mine was sold for six times revenue to Peoplesoft in a period of just over two weeks. Given that it was losing over $1 million at the time, whatever additional fees I paid to my advisors was well and truly worth it. When you are dealing with large corporate buyers, it is best to have good quality advisors in order to be very well prepared for the due diligence and the negotiations.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. A series of free eBooks for entrepreneurs and angel and VC investors can be found at his site here.