LOIs and Managing Retrade Risks When Selling Your Business
Selling a business or planning an exit is a complex process that many people will only ever do once in their lifetime. Starting early is important. Even if someone is a veteran at the M&A process, each transaction is unique and presents its own potential risks for a retrade scenario.
A buyer may trigger a retrade when the perceived value they were going to walk away from is no longer what they initially thought. Even the mention of a retrade can strain relationships and increase the likelihood of deal fatigue and a deal’s collapse.
Managing Retrade Risk
Many things can trigger a retrade. One of the most common is a seller not hitting a forecasted number during the transaction. However, a retrade can also be a function of misunderstanding. Transaction documents are fraught with technical jargon and terms that need to be clearly defined and understood to get the best results.
Downloadable Resource: Guide to Selling a Business
To minimize risk, sellers must be well-informed about the terms, especially during the critical Letter of Intent (LOI) stage, understanding how they may affect deal proceeds and remaining fiscal obligations.
A typical transaction is structured to be cash-free and debt-free–meaning any debts will reduce the proceeds for the seller. However, the seller may also be on the hook for cash outflows that are already committed to, even though they may be scheduled to take place after the closing. Those could include severances, earn-outs for other transactions, or off-balance-sheet liabilities, like bonuses.
Among the key terms for a seller to understand and vet fully are the definition for working capital, what is included in the debt number, and the structure of the deal in terms of what is paid upfront versus later. A seller must understand if the LOI is asking for seller financing, whether the buyer is wanting to defer payment due to an earn-out, and how much of it is an earn-out versus cash upfront. An M&A advisor can help structure payments based on future performance metrics that align with the interests of both parties. This may include adding escrows or holdbacks to retain a portion of the purchase price until certain conditions are met, mitigating downside risk for the buyer.
LOIs are non-binding but include a lot of information that can be sensitive to a business. It is not unheard of for a buyer to use the LOI as an entry point only to retrade.
To help a seller fully understand all of the terms in the LOI a good practice is to have all the advisors on their team—the tax people, accountants, M&A attorneys, and M&A advisors—go over the document with them and discuss and clarify each term.
An M&A advisor working for a seller should employ proactive strategies and provide expert guidance from the very beginning of the transaction process to help minimize the likelihood of a retrade. This will include finding any discrepancies in financial statements, uncovering all debts and liabilities, and having data to back up the seller’s story of value. An M&A advisor should have the perspective of a potential buyer in mind and be able to spot any red flags in a quality of earnings analysis. They will also help with continued monitoring of the target company's financial performance up to close to detect any potential issues early.
An experienced advisor understands deal structures that limit the acquirer's exposure to retriggering events, such as equity-based acquisitions or partial acquisitions. They can offer guidance in this area which is often new territory for a small or mid-sized company putting itself up for sale.
No amount of risk mitigation will eliminate the chance of a retrade. Engaging an investment banker to manage the transaction process as part of an M&A team can add another level of confidence, however. They can contribute to conversations around marketing, generating buyer interest, and the competitive landscape for a business. They can also be an asset in reaching the closing table smoothly by assisting with negotiations and deal structuring.
Redpath and Company
Redpath and Company help clients make more informed decisions that contribute to their financial well-being by providing proactive, innovative, and value-driven CPA and advisory services for closely-held businesses, private equity, government entities, and nonprofit organizations. Core commercial industries served include retail, manufacturing, distribution, construction, real estate, engineering, and technology. Areas of service expertise include audit and assurance; personal, business, and international tax; state and local tax; sales and use tax; and succession and estate planning. Redpath also guides clients throughout the entire business life cycle with M&A advisory services (corporate and deal strategy, transaction support, and integration); accounting and financial management outsourcing; and valuation services. The firm was founded in 1971 and is employee owned (ESOP). With offices located in St. Paul and White Bear Lake, Minnesota, the firm ranks as one of the top CPA and advisory firms in Minnesota and is a top 120 firm nationally. Redpath is a member of HLB International, a global network of independent advisory and accounting firms. For more information, visit www.redpathcpas.com.
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