Deal Structure

When two or more companies agree to merge or combine their businesses in an M&A due diligence deal, they must agree on a deal structure that outlines the rights and obligations of both parties. This document is a binding agreement between the parties. It indicates what each party is entitled to and what each is obliged to do under the contract.

The deal structure will usually include information on the following: 

The Purchase Price of the Transaction

First and foremost, the purchase price of a transaction is the main negotiation point for the lion's share of merging business deals. There are a few key points that you must know so you can be ready to determine the selling price.

What Factors Influence the Purchase Price in a Deal Transaction?

 First off, the factors that influence the purchase price are:

• Total Enterprise Value (TEV)
• Potential Cash Flow
• Unpaid Debts

Even though unpaid debts and operating costs do not show up in the TEV, it is included in the final purchase price. They must take into consideration all the liabilities that the company comes with and plan accordingly.

An excellent example of how these factors influence a purchase price is selling your business with an EBITDA of $5,000. Let's assume the potential cash flow multiplies the value by 4, giving a proposed transaction value of $20,000.

However, the company has a debt of $10,000, which also factors into the price. As for how to calculate EBITDA, the simplest way is to take the operating income and add that to the D= depreciation and amortization value.

How is The Purchase Price Determined in a Deal Transaction? 

A simple math problem determines the purchase price. With the numbers bitching in the previous section, Sellers can easily find the purchase price.

Multiplying the 5,000 dollars of initial EBITDA by four yields a $20,000 TEV. Subtracting the $10,000 in debt but adding whatever cash the company has on hand, in this case, $1,000, results in a purchase price of $11,000.

Remember, most purchase price considers the operating assets and operating liabilities, which gives shareholders their potential equity value.

What Are the Benefits of Negotiating the Purchase Price in a Deal Transaction?

Negotiating the purchase price is sometimes necessary for numerous selling endeavors because of extenuating circumstances. For example, if both parties, seller, and buyer, cannot initially agree on a set price, then there will be milestones set that may increase the value.

This arrangement gives the seller a chance to earn more money from the deal when they are aware of potential future conditions that will make their company voice more than the purchase price that was initially agreed upon.

Due to closing agreements putting a finite amount of time on how much a company can be worth before selling, this process becomes necessary. However, an earnout, an agreed payment after the closing date, ensures the seller gets their fair share.

What Are Some Strategies for Negotiating the Purchase Price in a Deal Transaction?

Legal documentation is a great way to ensure the purchase price is set in stone. The most commonly used documents are letters of intent, which the acquirer will sign, ensuring they buy the company at the aforementioned price.

Another effective method is to sell to multiple buyers, creating competitive tension, which can even drive up the price if done correctly. Telling a buyer about another potential purchaser willing to give more money may cause them to up their price.

Courting is the term for finding potential buyers for a company, and leverage is the amount of negotiation power a seller has. A seller's leverage is the highest when multiple buyers, roughly 4 or 5, are ready to make an offer.

Of course, once a letter of intent, LOI, is signed, the leverage is decreased immensely, and typically, one buyer remains. 

The Form of Consideration

Aside from negotiating a purchase price, a seller must also determine what form of consideration they will take from the buyer when structuring a deal. There are three primary forms that most transactions use:

• Cash
• Stock 
• Debt

Cash

Cash is the most straightforward consideration because it is a short and quick form of liquidation. However, there are multiple tax payments attached that the seller must consider before using this form of payment.

Taxes aside, cash is a favorite because the value of the money never changes from the day the letter of intent is signed to the closing payment date. That makes the process pretty straightforward and doesn't allow for any mishaps to arise.

Some common ways of paying with cash are using a cashier's check, certified check, or wire transfer. Wire transfers are usually the preferred method because it ensures same-day payment.

Stock

Stock payment is another consideration option that is much more involved than cash. The acquirer will buy several shares at a certain amount of money per share, which the target designates.

This exchange of money and shares is described by many as the exchange ratio. This ratio can either be fixed or governed by a mathematical formula that will produce a final value by the close date.

There are many caveats that all along with you link stock as a consideration, including restricted vs. unrestricted stocks, shareholder vote requirements, and accommodating for fluctuating stock prices.

Debt

Business owners can use debt to acquire companies and pay it back over several years. Many people do this, from fresh entrepreneurs to veteran CEOs.

However, this is more common with newer companies that must take on massive debt to pave the way for their future. They accomplished this by selling investors fixed-income products such as bonds, bills, or notes.

The investment loan, or principal, must be paid off at a later agreed date. 

The Allocation of Liabilities and Risks Between the Parties

As a seller of a lower middle market business in California, you take certain risks when trying to part with a business, but there are steps they can take to minimize as much risk as possible. For example, items such as representations and warranties provide information regarding the essential aspects of the business.

If the representations become invalid, the warranties are in place to give the seller the right to take their offer away. This situation is where sellers should hire a lower middle market business broker to draft contracts and check finances.

The Governance of the Combined Company

Once the liability and risk factors are in order, acquirers must still determine how they will create value for the newly obtained company. 

That is where the corporate governance process comes into play, as the Top managers devise strategies that will result in "value creation" and "value transference."

The new CEO and board of directors are tasked with creating an infrastructure for efficiency and profit. Those top executives are the internal mechanisms required to create value, but some external actors are also in place to ensure a company's success.

These actors or claimants comprise a slew of different outside individuals, but the main ones are shareholders, competitors, and the general public. These entities only come into play if the internal mechanisms fail to provide a profitable business.

The Process of Terminating or Amending the Deal

Another essential feature in a deal structure of selling a lower middle market business in California that sellers must come to terms with is terminating a contract. Ending an agreement is not as straightforward as other steps in this process. You need to know how to amend a contract after signing. 

Almost all contract terminations are governed by two types of agreements: Termination for convenience and termination for cause.

Termination for convenience is the rarer of the two and only happens when extenuating circumstances cause the contract to be less beneficial than it once was.

A great example would be when the Covid-19 pandemic started. With so many businesses shutting down their doors, a termination of convenience was for many active contracts during that period.

Another prime example is the devastating aftermath of the 9/11 incident that happened in 2001. Dangerous world events led numerous business people to prepare for the worst and terminate any unnecessary contracts.

Terminating for cause is the more common reason a contract would be discontinued or amended. These causes include breach of contract, failure to perform, or failure to act. Of course, there may be times when minor violations happen, in which case amendments become necessary.

Three Main Types of M&A Deals

There are three main ways a California lower middle market business owner can combine or control their assets with another's on the market. They do this primarily through:

• Asset Acquisition
• Stock Acquisition
• Merger

Asset Acquisition 

In an asset acquisition, the acquiring company buys all or some of the target company's assets. This deal often surfaces when the target company is exiting or selling off the entire or part of its business/company and needs to sell off its assets when the terms and price are met. 

A good example Is Google buying some assets of Android for 50 million dollars. This acquisition allowed the alphabet company to integrate its technology with smartphones worldwide.

Another great example Is Amazon acquiring Whole Foods. With that acquisition, the text giant can participate in the food market through Whole Foods.

Advantages of an Asset Acquisition 

It is relatively quick and easy to execute. As opposed to buying a company's stock Holdings, which can take place over several years, Owners can transfer assets relatively quickly. 

Disadvantages of an Asset Acquisition

The buyer may not be able to get all of the target company's assets, and some valuable assets may be left behind. Moving assets is not as clear-cut as it may seem because some need to be reassigned or re-negotiated in a contract.

For example, a truck company may want to app for stock Acquisitions instead of trying to transfer over the titles of over 3,000 vehicles.

Stock Acquisition

In a stock acquisition, the acquiring company buys shares of the target company from its shareholders. This deal is often used when the target company is healthy and does not need to sell its assets.

Owning more than 50% of the company's stocks will give a buyer complete control over the Executive decisions from there on out. For example, a seller who wants to give their 51% stake in the company over to another has the authority to do so because of their majority ownership.

Advantages of a Stock Acquisition 

It gives the buyer control of the target company since they are the person who holds the majority of the shares. That means they can make big decisions such as hiring and firing top Executives, relocating, and introducing new products or services.

Disadvantages of a Stock Acquisition

 It can take longer to execute than an asset acquisition. Since most business owners do not want to flood the market and wildly fluctuating stock prices, buyers will purchase small amounts of stock over a given number of months or even years.

Merger

In a merger, the two companies come together to form a new company. This deal is often used when both companies are healthy and want to combine their resources to create a larger company.

There are three types of mergers:

• Horizontal Mergers
• Vertical Mergers
• Concentric Mergers

A horizontal merger combines The two companies in an attempt to increase market share. A vertical merger gives two companies in the same field access to each other's resources and connects the supply chain.

A concentric merger allows two companies to come together and sell to the same customer demographic but with different products.

An example of a horizontal merger is the unification of Coca-Cola and Pepsi. Car companies that buy tire businesses are participating in vertical mergers. 

Finally, Coca-Cola's 2007 acquisition of Vitamin water was a concentric merger that allowed them to sell to the same customer base profitably.

Advantages of a Merger 

It gives the new company control of the target company's resources. With that control, the new company can use its new capital to keep selling existing products or introduce new ones.

Disadvantages of a Merger

It can be more complicated and time-consuming than an asset or stock acquisition. While stock Acquisitions can take many months, mergers often take years because one company has to absorb the other supply chain, employee base, and assets.

Deal Structure Final Tips

The right deal structure can ensure that the seller gets the best possible terms in the transaction. Negotiate better with an M&A deal team on your side.

1. Remember that the deal structure is critical to a successful business sale. Be aware of the different aspects of deal structure and how they can impact your business sale.

2. Negotiate a favorable deal structure to ensure a smooth transaction. This includes setting a fair price, agreeing to terms and conditions, and establishing a reasonable due diligence process.

3. Make sure you are prepared for the amount of due diligence required by buyers. This can be time-consuming and may require access to your financial records, customer lists, and other confidential information.

4. Allow for a sufficient escrow period to ensure a successful closing. This will give both the buyer and seller time to complete their due diligence process and finalize the transaction.

Conclusion

If you are a retiring business owner looking to exit your lower middle market business in California, here are five tips to get you started:

1. Don't wait until the last minute to start planning your exit. The process of selling a lower middle market business can take a long time, so it's important to start early.

2. Have a clear idea of what you want to get out of the sale. Know your goals and what you're willing to negotiate.

3. Choose the right type of buyer. Not all buyers are created equal, so do your research and find the right one for your business.

4. Be prepared for a lot of due diligence. M&A buy-side due diligence is when buyers will want to know everything about your business, so be ready to provide documentation and answer questions.

5. Be flexible with the terms and conditions of the deal. It's important to be open to negotiation to get the best possible deal for your business.

Rogerson Business Services, also known as, California's lower middle market business broker is a sell-side M&A advisory firm that has closed hundreds of lower middle-market deals in California. We are dedicated to helping our clients maximize value and achieve their desired outcomes. 

We have a deep understanding of the Californian market and an extensive network of buyers, which allows us to get the best possible price for our clients. We also provide comprehensive support throughout the entire process, from initial valuation to post-closing integration. 

Our hands-on approach and commitment to our client's success set us apart from other firms in the industry. If you consider selling your lower middle market business, we would be honored to help you navigate the process and realize your goals.

If you have decided to value and then sell your lower middle market business or still not ready, get started here, or call toll-free

  1-844-414-9600and leave a voice message with your question and get it answered within 24 hours. The deal team is spearheaded by Andrew Rogerson, Certified M&A Advisor, he will personally review and understand your pain point/s and prioritize your inquiry with Rogerson Business Services, RBS Advisors.

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