Over the course of my career, I have been involved in quite a few acquisitions - three, of my own companies, and several more for friends, business partners, and entrepreneurs I've mentored.
I'm currently helping the owner of a service business sell her company. You may recall that in most situations, profitable service businesses sell for one-times sales. We started with a number a slightly higher than that because the company is growing and next year's revenues look promising. Ultimately, though, negotiations were a bit different than other acquisitions I've been involved with. The big question was how do you guarantee future revenue? After all, this is a service business. Perhaps the clients won't want to work with new owners. Perhaps the employees will object to the sale and will leave, jeopardizing the client income. Clearly, there is risk for the new owner.
Standard practice in this situation is to adjust the price downward for the risk and possibly add performance incentives/additional compensation if certain revenue goals are met. We did something else. We decided to set the price at one-times 2015 sales. In the interim, we set an estimated price and reduced the payments on the note for the first year to ensure solid company cash flow. At the end of 2015, we'll adjust the note and associated payments to reflect the final price. The new owner has zero risk in case of lost revenue, and assuming the business continues as it has, the former owner is guaranteed a nice upside. Sounds like a win-win.
Once the terms were agreed and we had a transition plan in place, the acquirer sent everything off to his attorney who has done quite a few deals in the Silicon Valley. What came back was a bit of a surprise. It was an Asset Purchase Agreement.
As an asset purchase, the new owner would be buying all of the seller's contracts, all licenses held by the seller, the company names (including domain names), URLs, trademarks, patents, intellectual property rights, etc., all processes, trade secrets, know-how, documents, advertising materials, insurance policies and interests in insurance claims, rights in all confidentiality agreements, rent, prepaid expenses, goodwill, all physical property including computer equipment, copiers, printers, keys, pencils, erasers, - you get the idea, we need to specify every asset owned by the company, both tangible and intangible.
Interestingly, it excluded cash on hand and all accounts receivable.
It also required termination of all employees (though not stated, theoretically, the new owner would rehire the employees).
So, was this structure in going to further the aims of the new and former owners? Both want to keep employees. Both want to maximize revenues. Both wanted to have the company continue to operate as it was to ensure a smooth transition. Well, with an asset purchase structure:
- The current company would cease to exist. All clients would have to sign new contracts with the new company or explicitly assign their existing ones. There would be significant risk of losing clients who might not want to sign with an unknown company. They trusted the one who serviced them for years.
- The employees would have to be rehired and work for a new company they didn't know.
- With all the cash and receivables going back to the original owner, the company would need an immediate infusion of cash to continue operating.
The attorney balked. The big issue was liability. In an asset purchase, you don't take on the liabilities of the company, only its assets. This reduces risk for the buyer. With a share purchase, you buy the whole company including its liabilities.
We sat down with the acquirer and discussed the implications of the Asset Purchase and how it would adversely impact 2015 revenues and would require upfront cash to fund operations. We also suggested that to protect him from 'unforeseen' liabilities, the original owner would indemnify him.
Although his attorney pushed back, he argued that the risk to the success of the business with an Asset Purchase outweighed the potential liabilities of a Share Purchase, particularly with the protection provided by indemnification. The attorney ultimately agreed and drafted a much simpler contract.
Don't get me wrong. Asset Purchases can be useful and are often necessary. If you have a company that is failing, it's best to protect yourself from liabilities with an Asset Purchase. If you're cherry-picking technologies or products or people, an Asset Purchase may make sense. If you don't want to transition clients, customers, and/or employees, an Asset Purchase works.
But if you want a very smooth transition of clients, customers, products, etc., consider a Share Purchase. Acquisitions are by their nature disruptive. You should do anything you can to avoid making them more complicated than they need to be. If it makes sense to operate the subsidiary you've just acquired in the long term, great. Keep things as they are. If not, fold it in slowly. Transition.
In my experience, Transition is the key to success of any acquisition. In many cases, Share Purchase makes this much easier.