Evaluate binding offers and purchase agreements

Evaluating offers

After potential investors have completed their due diligence they provide you with their binding offer, supplemented with a mark-up of the purchase agreement. Contrary to the non-binding offer, a binding offer is legally binding. If you accept the offer from a Buyer they are legally bound to comply with the conditions therein (same as you are legally bound as the Seller).

Evaluating binding offers is not so easy as just choosing the offer with highest price. Some additional important considerations:

Payment timing

Is there a deferred payment or earn-out?

A deferred payment means that a portion of the purchase price will be paid after a certain time (e.g., one year)

With an earn-out a portion of the purchase price is conditional and will be paid after a certain time and only if all conditions have been met (e.g., Management Team staying in the Company for minimum of a year and realization of a certain amount of revenues).

In both situations ensure you are confident that the Buyer is able to pay the amount in the future or request that the amounts are paid now in an escrow account.

Reading the purchase agreement

Definitions

Depending on whether your deal is structured as a locked box or using completion accounts the key financials items to check in the purchase agreement differ.

In a locked box the enterprise value to equity value bridge is added as an appendix to the purchase agreement. Meaning, the overview in this appendix will show to you the final net purchase price you will receive for your business. Due to the specifics of a locked box this price is “fixed” and cannot change.

When using completion accounts, the final net purchase price is only known after Closing (at the moment the Buyer, who is the owner after signing, has prepared the Closing balance sheet). The purchase agreement only includes the enterprise value. The final cash, debt and net working capital adjustment amounts are not known yet as they need to be calculated at a future closing date. The definitions of debt (indebtedness), cash (or restricted cash) and net working capital (peg or target) in the purchase agreement are critical, as these define how these positions need to be calculated at Closing!

Make sure that the indebtedness, cash and net working capital definitions in the purchase agreement are clear and do not leave room for discussion. Where possible, try adding account names or account numbers to each of the items.

Guarantees and indemnifications

Guarantee
A guarantee or warranty is a legal clause in the purchase agreement in which the Seller provides a statement on a specific area of the business. For example, the Seller needs to state in the purchase agreement that “All receivables are current and Seller is not aware of any collection issues” or “The financials of the Company comply with all applicable legal and accounting standards and have been filed timely with the respective authorities”.

In order to be compensated a Buyer has to prove that the guaranteed situation was untrue and can receive compensation for any damages that were incurred because of it.

Indemnification
An indemnification is more broad and provides the Buyer with protection should any costs with regards to a particular liability occur. For example, a Buyer can ask for a full tax indemnification, which means that if any tax claims arise post-acquisition which relate to the historical period prior to acquisition the Seller needs to reimburse the Buyer for these claims.

When assessing guarantees and indemnifications look at the maximum amount (cap), the time period (how long will you be responsible) and how are they funded (e.g., a portion of the purchase price in an escrow or portion of the purchase price to be hold back by Buyer). The less indemnities and guarantees the better for you as a Seller.

Requirements post-acquisition

Do they want you to be involved in the business post-acquisition? If not, how does the non-compete clause look and does that match with your future plans? The Buyer does not want you to start a similar business, but depending on how they formulate the clause it could be possible to start a related business.

Always involve your lawyer in assessing the binding offer and purchase agreement. The negotiation process on the purchase agreement are lengthy and in very legal terms. Be sure you understand the conditions to which you sign and sell your business. Do not be pressured to finalize and sign under a strict deadline.

Other considerations

Next to price and legal elements consider the type of Buyer and whether the plans of that Buyer match your desires of your business. For example, a private equity firm that wishes to integrate your business into one of their existing businesses will do so with the objective of realizing synergy advantages. One of the most common synergies is headcount savings. This means a large portion of the workforce of your business could be fired post-acquisition. Especially, “double” functions are at risk. There is no need for double support functions, such as accounting, HR, support, etc. Often only the employees directly related to the sales function will remain in the new business post-acquisition.

It is perfectly normal for a Seller to request the Buyer to indicate in the binding offer the plans it has with your Company. If you do not feel confident or have questions about it make sure you address those prior to signing. While a Buyer will not legally bind itself to any future commitments or plans with your business it is good to know their intent before regretting a sale to such an investor. If you have friends in your business you want them to have a good future and continue having them as friends. Given the size of your business it could even be of great importance to the employment in the local area where you live.

When evaluating an offer look further than only the financial or legal terms of the offer.

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