When negotiating a company sale, buyers and sellers may not always see eye to eye, particularly when it comes to the perceived risks associated with the business for sale. Simply put, buyers and sellers may view certain risks differently based on their experience and comfort level with such risks. Sellers typically are able to remain calm and collected about their company’s risks because they are accustomed to managing those risks on a day-to-day basis. For the buyer, however, it is a whole different ballgame — with some of the risks introducing too much uncertainty into the deal. In the course of their due diligence, the buyer needs to determine “if I buy this company, precisely what risks will I be assuming, how do I put boundaries around those risks, can the seller retain any of those risks, and how does the allocation of risk between the buyer and seller impact the valuation?” Getting past the “outsider’s” perception of these risks can be challenging for the buyer and could be a dicey part of the negotiations for both the buyer and the seller.
For the most part, buyers are likely to make a bigger issue of certain risks than sellers, because again, the seller has grown accustomed to managing their company’s risks (or working around them).
However, how those risks are perceived, particularly by the buyer, is important because ultimately, their comfort level — or lack thereof — with those risks will pervade every aspect of the deal, including valuation, terms, structure, indemnities, earnouts, etc.
Some examples of company risks that may “spook” buyers include:
Dependence on a critical vendor
Key employee risk
Under-funded pension and/or Multiemployer Pension Plan Amendments Act (“MPPAA”) liabilities.
Other post-employment benefits
Country dependency risk, i.e., dependence on a material or resource that is only available from one country in the world
Again, how a buyer perceives these risks can create some challenges in how a transaction is completed — if it closes at all. Sometimes, however, owners can “optimize” a deal to sell the company to a specific buyer who understands the type of risk they are taking on, even if that buyer does not offer the highest price. Take, for example, the sale of a company that makes cellulose sponges. The manufacture of cellulose sponges is a caustic process that is destructive to the manufacturing facility and is subject to significant environmental compliance and environmental risk. A strategic buyer made an offer to acquire the company, but it was not clear if they offered the highest price since the company had not been marketed for sale to various buyers, including private equity groups. As a result, the CFO encouraged the shareholders to explore the sale of the company to a private equity group to potentially increase the price.
In this case, the strategic buyer really was the “best buyer” because they have similar environmental compliance requirements in their own business and understand the associated risks. They still undertook a thorough environmental assessment; however, they understood the scope of the environmental compliance and did not overanalyze the environmental portion of the transaction. In other words, it was not a risk that would cause the strategic buyer to walk away from the transaction. By contrast, a private equity group buyer likely would have put the sponge manufacturer through environmental due diligence hell. The private equity group’s view of the environmental risks would have pervaded every portion of the transaction from that point on.
In another scenario, a client was targeting the acquisition of a company with a large under-funded pension liability and other post-employment benefits thrown in for good measure. The buyer was “up in arms” about assuming these liabilities. For the seller though, it was not as big a deal. While the seller did not like the risk, the seller knew how to handle it because it was something the seller had already been managing for many years.
There are risks involved in every company sale, but how buyers and sellers perceive those risks can make or break a deal and impact whether or not the transaction closes. Like two individuals on either side of a conversation, buyers and sellers are likely to interpret the risks differently. With that said, the onus is on the owner to identify the group of buyers that understand the attendant risk and can put it in the proper context so that the owner and the buyer can enter into a successful sale transaction.
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