Mergers and Acquisitions For Dummies (95 page)

To demonstrate the importance of considering local customs, consider this story. A Buyer I worked with years ago acquired a company whose custom was to pay a $100 Christmas bonus to all employees. When the Buyer gathered the employees for an announcement after the particularly difficult acquisition, the employees were worried that the new owner, a large PE firm, would cut that annual goodie.

Instead, the new owner announced the Christmas bonus would continue, and that each employee would also receive a special bonus of $500, paid immediately. Although paying people a bonus is no guarantee of making friends, continuing the annual bonus and adding a special bonus made talking about increasing the accountability of employees and discussing how employees would be compensated and rewarded for achieving goals much easier.

No matter what you do, you're going to irritate someone. You can't manage a business trying to please everyone. Don't worry about it.

Instituting accountability

A new owner often has a challenge with increasing the accountability of the acquired staff. Many companies face a large shock when they go from being owned by a single owner to being part of a larger company or PE firm with increased and more-exacting standards. The following sections cover some areas in which you as a Buyer may need to address accountability in your acquired company.

Focus on the customer

Remember where your money comes from: your customers. As amazing as it sounds, employees can get so busy with the minutiae of their daily tasks that they can take their eyes off the reason why they have a job: the customer!

As a new owner, you may find you need to install a renewed focus on customer service and sales. Tying employees' compensation to increased sales (or customer retention) may be necessary for a company to make sure it doesn't lose sight of the most important part of the business.

A simple test for an executive or owner is to ask employees to explain what the company does. Far too often, employees don't have a strong sense of the company's core business. All employees need to know and understand that what they do and how they interact with clients directly impacts the buying decision of a customer.

Introducing cost-benefit analysis

The flip side to revenue is expense. The difference between revenue and expense is profit, and profit is the only reason we do what we do.

New owners commonly find that the former owner rarely said “no” to the staff. Every idea employees had — good, bad, or indifferent — got a shot. As the new owner, you need to communicate that the company can't afford to take a risk on every single idea because the company needs to remain mindful of costs.

Instead, inform employees that the company is willing to take some chances and will reward employees when the chances pay off. But if that chance-taking results in a failed product or bad marketing program, the cost of that failure may come at the loss of a promotion, raise, annual bonus, or (if the failure is egregious enough) even someone's job.

Communicating rules and responsibility

Part of the process of refining the operations of a company is to make sure the employees know exactly what is expected of them. Clearly communicating new rules, expectations, and goals and (preferably) tying clear rewards to achievement helps improve morale and goes a long way toward establishing the legitimacy of your authority.

Most employees will adjust to a manager who is strict as long as that person is also fair and impartial and holds all employees to the same high standards.

Recognizing hard work earns the right to play

The balance between the goals of a business and a rewarding personal life is important if the managers of the business want to achieve goals. Expecting employees to log long hours and sacrifice only works if you also encourage those employees to take some time for themselves. Count on employees to take vacations and take full advantage of paid holidays, especially if you're demanding changes from the employees. Kick them out of the office and tell them to go home.

Delegate responsibility and authority

Instituting accountability means delegating authority and responsibility and then, ideally, getting out of the way. Don't be afraid of other people's ideas. Delegating responsibility only is a recipe for disaster. If you want results, make sure people have the authority to get the job done. If you're going to hold people accountable, you must give them the leeway to execute their plan.

Firing people

Firing is an unfortunate side effect of business. Although I believe in giving people chances to perform and show they're part of the team, sometimes employees just don't buy in to the new way of operating. If you don't have buy-in from your employees, especially your managers, you may need to ask certain people to do themselves a favor and leave; if they don't leave on their own, you need to show them the door.

Firing people boils down into three basic camps: firing for cause, firing due to job performance, and firing due to redundancies. Firing for cause is pretty straightforward: You're canning the employee because of an explicit bit of wrongdoing. Embezzlement, cooking the books, committing or abetting a crime, and so on are all reasons to fire someone for cause. Firing for cause is the least painful of all employee terminations. The person deserves to be fired.

Letting someone go due to poor job performance is a trickier affair. The person may have given her best efforts to do the job but fallen short of the job's goals and expectations. This situation can be difficult, especially if you personally like the employee. But if you paid a person a base salary of $100,000 expecting her to generate $1 million in sales, and she generated only $10,000 even though you clearly laid out your expectations and gave her the tools to succeed, a change is necessary.

When letting someone go for cause or poor job performance, make the conversation short and to the point. Simply say, “It's not working out; I'm letting you go.” Ideally, if you have the personnel resources, you can turn the process over to an HR person and leave the room after you've delivered the news. Don't belabor the process. The HR person should make sure all necessary paperwork is in order, including a severance check if that was part of the fired person's package or expectation.

The final part of the termination trifecta is the most difficult situation: laying off people due to job redundancies, which isn't uncommon in the M&A business. Most managers prefer to avoid laying off otherwise-good employees strictly due to business reasons. Paying severance and/or assisting an affected employee with finding another job can help soften the blow, but firing is unpleasant business.

No one likes to get fired, but don't let that prevent you from making a change when you need to.

Part VI

The Part of Tens

In this part . . .

I
n this part, the famous
For Dummies
Part of Tens, I discuss some thoughts you should ask yourself before you sign an LOI. I also provide some pointers on avoiding common M&A mistakes. Finally, I give some of my thoughts on bridging valuation differences between Buyers and Sellers.

But that's not all! You also get an appendix full of helpful information, including online resources for many facets of the M&A process, some mock M&A documents, and an extensive list of the info required for due diligence.

Chapter 19

Ten Considerations Prior to Signing an LOI

In This Chapter

Getting a handle on the deal and payment setup

Keeping an eye out for warning signs

M
oving forward with an M&A deal means that both sides sign a letter of intent (LOI). Although the LOI is an important step, rushing and carelessly signing an LOI without fully understanding it can create plenty of problems. To help you avoid problems and increase the odds of a successful closing, this chapter presents ten issues to consider before signing an LOI. Check out Chapter 13 for the nitty-gritty on LOIs.

Is the Deal Too Good to Be True?

This caution is especially true for Sellers. That great deal that Buyer is dangling may be nothing more than a Trojan horse, a ruse to lock up you, the Seller, with exclusivity for a period of time before coming back with a lower price after you've been out of the market and are therefore in a weaker position. Even if Buyer isn't trying to pull a fast one, he may not be able to line up the capital needed to actually close the deal he's offering (see the following section).

As a Seller, you need to be brutally honest with yourself about your company's value. Frankly, an experienced advisor can be a huge help here. Does the company really warrant the high price Buyer is offering? See Chapter 12 for more on valuation.

How Is the Buyer Financing the Deal?

Does Buyer have the cash, is she planning to tap a bank line, or is she asking Seller to help with the financing? Does Buyer already have access to sources with cash, or is she planning to shop for investors after signing the LOI?

As a Seller, carefully vet potential Buyers and their fund sources. If Buyer is private and is unwilling to share financials, ask for a letter from her bank stating that the bank supports her acquisition plan.

How Much Cash Is in the Offer?

A great offer with a high valuation may not be what it initially seems to be. Does Buyer pay 100 percent of the proceeds at closing? Is any hold back or any sort of contingent payment (such as notes or earn-outs) involved? Is stock part of the offering price? In other words, does Seller have to jump through hoops to get his money?

Weigh all the merits of each deal and not just the valuation number; an offer with a lower deal value but all cash at closing may be a better deal than a higher valuation comprised of contingent payments, because the former may be more likely to result in your being paid in full.

What Are the Conditions of Escrow?

How much money is held in escrow, and who controls its release? In a very general sense, the amount of money held back in escrow should be 10 percent or less of the purchase price, and that money should be released to Seller within 12 to 18 months. Other considerations include how the reps and warranties are associated with that escrow and who receives the interest from the escrow account. Chapter 15 digs into escrow in more detail.

Is the Deal a Stock or Asset Deal?

The age-old issue in M&A is the stock deal versus the asset deal. Sellers usually prefer stock deals because of preferential tax treatments. Buyers usually prefer asset deals because those deals lower Buyers' risks of
successor liabilities
(legal problems for Buyer as a result of issues that occurred before the company was sold).

Frankly, perhaps the better question here is, “Does the deal type even make much difference to you?” Depending on variables far too numerous and disparate to recount here, Seller's specific tax situation may mean the difference between the tax consequences of a stock deal and those of an asset deal is negligible. And Buyers may not really need an asset deal. If the reps and warranties are strong enough, the successor liabilities issue may not be as large as it seems.

Both Buyers and Sellers should speak with their attorneys about the specific deal at hand and their specific situations when determining what type of deal to accept.

How Does the Deal Settle Working Capital Issues Post-Closing?

Does the deal include a
working capital adjustment
(adjustments made to the purchase price after closing, based on the actual balance sheet values)? A working capital adjustment can be a major lurking surprise, especially for Sellers. Sellers should make sure all current liabilities are in fact current! If not, Seller may face a substantial post-closing adjustment.

Along those lines, Buyers should note whether all Seller's receivables and payables are current or whether she's slow to collect receivables and pay her bills, especially if Buyers are assuming the accounts receivable and accounts payable as part of the deal. Buyers need to be careful about assuming payables that should have been paid months ago. Paying overdue bills is Seller's responsibility! Flip to Chapter 17 for more on post-closing issues.

Is the Inventory 100 Percent Salable?

Inventory can be another pain point for Buyers and Sellers. A Buyer operates under the assumption that she can sell all the Seller's inventory. If the Seller has obsolete inventory, the Buyer may press for a post-closing adjustment.

Hiding obsolete inventory from a Buyer is an unwise plan. A Seller who doesn't address the issue of inventory salability is asking for trouble! Sellers need to bite the bullet and either write off inventory prior to close (thus reducing earnings and possibly the valuation) or brace for a large post-closing adjustment (see Chapter 17).

Who Pays Off Any Long-Term Debt and What Happens to the Line of Credit?

Make sure you're clear on who's responsible for the Seller's long-term debt and any short-term lines of credit. Either the Buyer assumes it or the Seller pays it off.

Seller shouldn't assume Buyer will simply pay off the debts of the business. If Buyer is going to pay off the business's debts, he'll first subtract those debts from the proceeds of the business sale.

What Are the Tax Implications of the Seller's Accounts Receivable?