Building a strong business to provide for, or pass on to, successive generations is a dream that motivates many successful entrepreneurs. Along this journey, however, you may encounter opportunities to sell all or a portion of your business or to expand your business through a joint venture relationship. These events are sometimes referred to as “strategic transactions.”
Understanding how the strategic transaction process works will help you prepare for the transaction and reach the best outcome for your business and stakeholders. We will explore the strategic transaction process by looking at the people and the steps involved in a typical strategic transaction, as well as the unique terminology often used in discussing these events. This article will focus on the people who may play a role in the strategic transaction process (as part of your transaction team or otherwise) and, in general, how these professionals may be compensated for the services provided.
The stakeholders in your business comprise the first, and usually most important, people that may be involved as you consider the desirability of entering into a strategic transaction. The term “stakeholder” is used to describe the broad group that may be impacted by a strategic transaction and generally includes not only the owners of your business but also its board of directors (or managers), employees and other personnel, creditors, customers, vendors and suppliers, as well as the surrounding community and relevant government agencies. Fiduciary duties and other contractual and legal considerations may impact the terms and conditions upon which these various stakeholders may benefit financially from a strategic transaction, but the impact of a strategic transaction on these stakeholders (particularly employees) is often an important consideration for owners.
The management team is normally the group responsible for investigating and pursuing a potential strategic transaction under the supervision of the board of directors (or other governing body of the business) for the benefit of your owners. You may consider entering into special bonus agreements with key members of your management team prior to embarking on a strategic transaction process in order to compensate them for their loyalty and service and to ensure their assistance throughout the process and during post-transaction integration. For example, a transaction bonus agreement providing for a special bonus to a key employee upon closing of the strategic transaction and/or a retention bonus agreement providing for a special bonus if the key employee remains employed in the business for a period of time after closing the transaction (e.g., one year).
Your accountants can help ensure that your financial statements are accurate and complete and cast your company in the best light from a financial perspective, as well as advise on the tax impact of various strategic transaction structures. In most cases, the financial terms of a potential transaction will be developed based upon the earnings of your business before deductions for interest, depreciation, and amortization (EBITDA). In addition, your accountants, in conjunction with your management team and other professional advisors, may assist you in identifying certain expense “adjustments” (or “addbacks”) to your financial results, which may boost EBITDA (e.g., unusual, one-time expenditures or expenses likely to be discontinued by a buyer of your business). An important first step for many private businesses is translating cash-based financial reporting into accrual-based financial reporting (in accordance with GAAP), which may provide a clearer picture of, and increase the confidence of third parties in, the financial results of your business. Accountants can help with this conversion in a manner that will withstand scrutiny if and when a potential buyer or joint venture partner retains its own accountants to conduct financial due diligence and to prepare a quality of earnings (QofE) report, which focuses on the quality of the income attributable to the core operating activities of a business. In most cases, your accountants will be compensated either on an hourly or project fee basis and will expect to be paid regardless of whether you move forward with or complete a particular strategic transaction.
An investment banker, financial advisor, or business broker will help you identify and analyze the various types of strategic transaction opportunities available to your business. The scope of assistance that you will receive from an investment banker, business broker, or other financial advisor should be documented in an engagement letter. In the event that you decide to sell your business through an “auction” process, these advisors play an important role in preparing marketing materials, identifying and soliciting potential buyers or partners, and soliciting preliminary bids (indications of interest) and final offers (letters of intent) from interested parties. Investment bankers and financial advisors will work with your management team and your accountants to develop the financial information critical to achieving a fair valuation as well as with your attorneys to organize the due diligence information and process. Traditionally, these advisors are compensated based upon a percentage of the transaction value, payable only upon the successful completion of the transaction (success fees), which can be structured in various ways (e.g., flat percentage, increasing percentage at higher transaction values). Additionally, it is not uncommon for these advisors to request a modest retainer at the front-end of an engagement (credited against the success fee) as well as reimbursement of certain out-of-pocket expenses incurred in connection with the engagement.
Your business insurance broker or advisor plays an important role in a strategic transaction process by providing information regarding risks and exposures previously addressed by your company under its insurance program as well as past claims experience of your business. This information merits careful review and can materially impact the value of your business to a potential buyer or partner. In addition, your company’s insurance team can advise on the impact a strategic transaction may have on your company’s insurance program and any adjustments necessary to ensure the appropriate coverages remain in place (which may include coverage for claims made after closing a transaction but related to events occurring before closing – sometimes referred to as “tail coverage” or as an “extended reporting period”).
Your personal insurance agent or advisors can also provide valuable assistance to you in connection with preparing for a strategic transaction. Experienced life insurance professionals often bring creative thinking to the process. Similarly, personal lines (home, auto, medical) insurance agents can assist in evaluating changes, if any, that may be needed to your or your family’s personal insurance coverages based upon the outcome of a strategic process, particularly if it results in a material change in the composition or ownership of your assets and/or the source of coverage for certain risks (e.g., the distribution of automobiles from the company to the owner or loss of company-provided medical coverage). In most cases, both business and personal life insurance professionals are compensated through commissions or fees related to the purchase of insurance products and do not charge or receive additional compensation for assisting in this manner in connection with a strategic transaction.
Similarly, your estate planning and personal tax advisors should be consulted as early as possible in connection with a strategic transaction process (preferably before the process commences). Your estate planning and personal tax advisors can assist you in structuring your assets (including ownership interests in your business) in order to minimize the tax impact of a strategic transaction on you and your family. These advisors may also present you with options of not only passing wealth through successive generations but also supporting charitable causes that are important to you in a tax-efficient manner. Generally, estate planning and tax counsel would be compensated on an hourly fee basis for these services.
Finally, your transaction legal counsel (attorneys) will play a fundamental role in building a solid transaction team (including engagement letters, bonus agreements, and confidentiality agreements, as applicable) and managing due diligence, negotiating key documents, and coordinating and executing the overall transaction process and post-closing activities. Your long-time personal or company attorney will be invaluable as a trusted advisor throughout the entire process, but companies (and owners) are generally best-served by retaining counsel experienced in strategic transactions (such as mergers and acquisitions) to lead the process. As will be discussed in the accompanying article on the strategic process, dedicated transactional attorneys can help identify and address issues at the outset that, unless handled at an early stage, may negatively impact the value of your business and the results of your transaction process. Additionally, experienced transaction counsel will manage issues that arise in the course of due diligence and help structure and negotiate a transaction that achieves the objectives most important to you and your stakeholders.
Achieving the best outcome for you and your stakeholders (which may include rejecting a potential transaction and continuing your current strategy) is highly dependent upon having a realistic assessment of your company’s current situation, the strategic options available, and the risks associated with the various alternative courses of action available to you – the types of issues that competent transaction counsel will help you evaluate in the course of the engagement. Importantly, information you share with your attorneys may remain protected from disclosure under the attorney-client privilege. (In some cases, it may also be advisable to have your attorneys retain certain types of advisors to cover information provided by these advisors under the attorney-client privilege.) In most cases, your attorneys will be compensated on an hourly or project fee basis and expect to be paid regardless of whether you move forward with a particular strategic transaction opportunity.