Sell-Side Readiness with Eric Green & Patrick Degnan Part 2

Thinking about selling your business someday? In part two of our Cascade Conversations series on Sell-Side Readiness, Cascade Managing Director Eric Green and Patrick Degnan, Attorney at Clark Hill Law, explore how early planning and thoughtful deal structuring can lead to better results at the closing table.

They share the advantages of having a clear strategic plan, explain key concepts like rollover equity, and discuss when to start valuations for estate and gifting purposes. Plus, you’ll hear about a practical checklist to help business owners assess their readiness and take proactive steps toward a smoother, more successful exit.

Enjoy all our Podcasts | Visit us at Cascade-Partners.com | Follow us on LinkedIn 

Transcript

Announcer:

Welcome to Cascade Conversations. Join the Cascade Partners team and our network of trusted advisors as we work to demystify the details, terminology and strategies of acquisitions, divestitures, financings, performance improvement and restructuring.

Eric Green | Managing Director at Cascade Partners

(Continued from Sell-side Readiness: Part I)

One of the things that we’ve been encouraging our clients to do—we generally represent family-owned business, single or maybe dual shareholders. This business has been their life for many decades, and they’ve built it up and have strategic plans, etc. And then when they sell, they generally retire.

So, we’ve encouraged our clients to think about a five-year strategic plan post-sale: What are you going to do? What would you like to do? Whether it’s charitable, whether it is recreational, etc. Why I think this plays into preparedness is deal structure and understanding what’s important to the seller way in advance of the negotiation of that agreement. Maybe you could respond to that.

Patrick Degnan | Attorney at Clark Hill, PLC:

Yeah. Very similar. I deal with lots of people who when, when they sell, they they’re more or less saying, “I’m done. I’m ready to be done working.” So, in those situations you have to look at what the buyer wants from the seller in terms of staying on. There’s often a retention period because, you know, where you have a company where 2 or 3 people are integral to the success of it, they don’t want to close the deal and have those people just run away. They need to transition the business, so, they’re going to be retained for some period of time.

Depending on the buyer, I mean, I love as much cash in closing as possible…

Eric Green:

Most sellers do; sellers do. (laughs)

Patrick Degnan:

Yeah, most sellers do. But a lot of times there will be rollback. Certain components to it can be really, really profitable. Sometimes you see seller financing where, essentially, you’re deferring to receive the purchase price over a year or 2 or 3 years. Maybe you’re getting interest on it.

It’s not as attractive from an investment standpoint. You’re basically getting you’re getting an interest rate, but it doesn’t give you as much freedom instantly as you might want. You’ll see earn outs from time to time. Those can work. They can be challenging. They’re typically based on financial metrics of a business year or 2 years following the closing. If you hit them, there’s a big number. If you don’t hit them, there’s nothing.

And so in terms of planning, it is sort of how much you are committed to the transition period. How much tail risk, I guess we’ll call it, are you willing to accept maybe for a better number in total? (But it may come later). So, it’s a lot about you just don’t want to be surprised. You don’t want to have somebody that really is serious like, “I don’t want to work again in a year.” And they find out, not only are they working, they’re really hoping that they don’t have a lot of reps and warranties to deal with, that the earn out may work. You know, all these other things.

So very, very important things.

Eric Green:

Yeah. Like thinking about that five-year vision for themselves as a person is helpful in structuring how the deal works.

I want to ask you down a thread about the role over equity. And, for those that haven’t heard it, oftentimes, a buyer will ask to take some of the proceeds and invest alongside us in this next level of growth. And right now, private equity and platform investing, is a real hot topic where there’s a large company, and the large company is buying smaller companies, and maybe they would buy a company like ours—that’s happened to us directly—and to roll over some of the cash into the deal. You can get some economic arbitrage right out of the gate.

So, it’s a worthy conversation when you’re putting together the purchase agreement.

Patrick Degnan:

Certainly. I mean you’re going to benefit from that buyer’s capital from day one if you’re rolled over. So yes, it can play out very nicely. And you’re talking about, more or less, private investment, private equity, types of returns, which typically are going to outpace public market. Types of returns. So, it can be a really good move.

Eric Green:

So, in that five-year strategic plan that we’re encouraging is also a component of working with your wealth manager to understand what kind of cash you need to live the lifestyle you want.

Patrick Degnan:

Right.

Eric Green:

Maybe one other thread on that is gifting and the tax implications. I know you’re not necessarily tax specialist, but you deal with this all the time; when should a company start doing valuations for gifting? And what triggers a kind of valuation for the enterprise once they’re in an M&A process?

Patrick Degnan:

Yeah. And I do lots of tax work. It’s actually kind of how I ended up doing M&A work—they’re sort of a natural fit with each other. But the gifting component, that’s such an estate planning question and it has so much to do with who’s getting it, when they’re getting it, what they’re going to do with it. How much control is the person gifting it want to have over what they’re doing with it?

The valuations of those things are fairly strict. You have to have a conforming valuation. The best way to do it is to have a third party do it. It’s expensive. People sometimes resist that. There are other ways to get there, but the third party one is the safest thing to do by far.

Eric Green:

And doing that as part of the sell-side preparation of valuing the privately held company before you get into the process could be of tax benefit?

Patrick Degnan:

Yes, yes.

Eric Green:

So, I’m an ex-military guy, as you know; Navy engineer. So, we love checklists. We run our day by checklist. So, is there a sell-side readiness checklist that you have or a diligence item? How do you go about this if someone engaged you to help them get ready?

Patrick Degnan:

Yeah. And I do a fair amount of work on the buy-side too. I’m, kind of passionate about the sell-side, but the buy-side, in my role, I would take a buy-side diligence checklist: Let’s go through what you have in your company right now. Can we give you these documents? If we do, what do they say?

You go down that line and sometimes there are things that people have never thought about that are legal issues. And, you know, intellectual property things. You see that.

Eric Green:

Am I compliance?

Patrick Degnan:

Yes, compliance. Numerous things that people are running a business and they’re running it successfully. But these are like esoteric, legal, technical things that if they don’t become a problem while you’re running the business, people tend to think that they aren’t going to be a problem when you go to sell it. And that that isn’t the case because, fundamentally, a buyer wants to de-risk the transaction as much as they can. And those are sources of risk.

Eric Green:

So, that’s a great way to wrap up our conversation. I appreciate you coming and having this with me. We’re out a second deal in the sports construction business, as I mentioned. And we just got the band back together. So, I’m glad to be a part of the team with you.

So, thank you [Patrick] for the conversation.

And thank you for listening.

Announcer:

Thank you for joining us for Cascade Conversations. For more information, please visit cascade-partners.com or call (248) 430-6266.