Buyers are often quick to submit a "letter of intent." Such letter generally describes price, and asks for seller "permission" to begin due diligence. In the same document, the buyer requests seller to agree to a commitment to deal only with them, as the exclusive buyer. Others must be told of such exclusive arrangements, with no further courtship, or information to, any other buyers.
This arrangement works only to the advantage of the buyer – and immediately weakens the seller position. We often request a nonrefundable deposit before acceptance of exclusivity. Or we go directly to a firm definitive agreement. If all else fails, we at least try to go to a very detailed letter of intent, with all significant matters worked out and agreed – before committing.
We recently closed a sale for a client who had been talking to and courting the same buyer for over 2 years. The company was a mineral products company, with an excellent competitive buyer market. However, the one buyer they had been talking to (for a long time) could never seem to formally decide to pull the trigger. We were hired to help, and we brought in numerous alternative buyers. When the original suitor returned, with a markedly higher all-cash price, we still wouldn't sign with them until we had a deposit. (It was the only way we could be comfortable that they actually would continue through closing – and if they were unwilling to take that plunge, we had a half dozen other, even stronger strategic suitors, who we were confident we could reach agreement with). We received a deposit and improved terms, and closed the deal 60 days later.
We represented a 70-year-old owner in sale of his company and it was a difficult transaction, due to a very heavy single customer dependency, but we ended up with several strong offers. One of the offers was for $13 million for 75% of the company. We had 2 other offers at around $15 – 16M for 100%. Our seller, at the age of 70, was not eager to keep holding a 25% interest. The offer for 75% came from an equity group, with one young executive who was to step in as CEO. None of the suitors at this point had volunteered a deposit, in spite of our requests. The young eager executive who was to run the show for the 75% equity group pulled $50k from his personal savings account to put as a nonrefundable deposit on the deal. (By non-refundable – this would only be the case for a discretionary change of heart by the buyer. If the information we had provided proved to be untrue or materially incorrect – the buyer would have gotten the money back). In spite of the relatively small size of this deposit, our client was impressed by the firm decision the young man had made, and by his confidence that he could close – and that his equity fund would stand behind him. Our seller accepted his deal.
For Retained Equity – Protect Your Backside.
Today many of the offers in the buying marketplace are coming from well-funded equity groups. These groups often prefer to leave some portion of the equity in the hands of the seller and their top management. Such seller-retained equity typically varies in percentage – but most common sizes of amounts to be retained would be 10% to 30% of equity. These retained equity interests can be a wonderful boon to the seller who wants to stay on for a few years – or even to the departing seller who has lots of confidence in the future of his company.
For example, in the scenario we just discussed for the seller who accepted a 13M offer for 75% of his company it worked out wonderfully for both parties. About one year later, almost to the day, the equity fund came back to buy the remaining 25% at an agreed contract price of 4 x pretax cash flow (slightly below the original price for the other 75% - but reasonable to our seller - given the one customer concentration). The company had done so extremely well during that one year that the last 25% brought our seller over $7 million. Our client was happy, and the buyer now has a parade of inquiries from new funds, eager to take the company onward and upward.
One of the first retained equity deals we did was almost 10 years ago – for an industrial painting company. The owner had set a particularly generous bonus for our firm if total proceeds exceeded a certain (very high) threshold. None of us ever expected to get to that total pricing, but we negotiated a strong and long-lived bonus for our seller client, if the company continued to increase profits. The net result was payment to our seller (and to us) for about 6 years post closing. (Our seller used to joke with us that he couldn't believe how much he was paying – and for how long it continued – but he said it was his happiest big expense every year!)
