When considering a sale of a green technology company, boards of directors, management and the shareholders they serve face many challenges in closing a deal and unlocking value. The following are 10 questions every seller should ask when selling a green technology company.
1. Is now the right time to sell the company?
Is the company performing well financially? If performance has improved recently or its financial projections show significant growth, what assurances can be provided to a buyer that the improve-ment will be sustainable? Will the company’s performance suffer as a result of management distrac-tion or from the company’s customers or employees becoming aware of an effort to sell the company?
2. Is the management team ready for a new owner?
Buyers often worry about the commitment of the management team to the business after the com-pany has been sold and may be expected to look hard at the team members who will be continuing with the company and who will need to be replaced. Having a strong management team positioned to continue with the company after a sale can add significant value.
3. What is the company worth?
Sellers should obtain outside advice and work with an experienced financial advisor to determine an appropriate valuation for the company. This determination can be particularly challenging for a company in an emerging category such as green technology because the size of the market may be difficult to ascertain and there may not be many comparable transactions. Also, many sellers have a “number” that they have decided is the right sale price for their company, but focusing on an arbi-trary figure can kill a sale at a fair and appropriate valuation (if the owner’s “number” is too high) or leave money on the table (if the owner’s “number” is too low).
4. Should the company agree to an earn-out?
Earn-outs are a popular way to bridge a value gap in a sale, especially for companies in an emerging category such as green technology, and they should be approached carefully. The devil is in the details. The interests of the buyer are sometimes not aligned with those of the seller post-closing. For example, the buyer could decide to slash the marketing budget and allocate the resulting funds to research and development, sacrificing short-term sales for long-term value. While this might be a sound business decision for the buyer, the earn-out was more likely based on near term profitability. If an earn-out is necessary, the general rule is to have the earn-out based on the highest possible point in the income statement (revenue) to avoid accounting manipulation by the buyer that adversely impacts the earn-out.
5. Should the company be sold to a strategic buyer?
Companies have a financial incentive to identify strategic buyers who may have synergies with the seller and accordingly could pay more than a purely financial buyer for the same company. It is par-ticularly true in green technology that the company’s board of directors and management often have the best sense of who might be a potential buyer. They should get involved in identifying possible buyers and formulating strategic reasons the company might propose to those buyers to do a deal. Different buyers sometimes have very different reasons for buying a company, and a seasoned knowledge of an industry and its players can be invaluable.
6. Should the company be sold to a financial buyer?
Financial buyers bring a different perspective to buying companies and focus on potential investment returns. Financial buyers may use one of several models to value the company:
* Projections. The company’s projections (as interpreted by a financial buyer) determine how much cash flow will be available to service debt as well as the value of the company upon its assumed sale 3–5 years after the sale (i.e., the exit value). The greater the cash flow, the higher the valuation.
* Debt/Equity. The amount of debt that can be used to finance an acquisition determines how much cash is required to be invested by a financial buyer, and the cost of that debt in turn determines how much cash flow will be available to the company and a financial buyer. Leverage is typically ex-pressed as a multiple of “EBITDA” earnings before interest, taxes, depreciation and amortization. The greater the amount of debt, and the cheaper that debt is, the higher the valuation.
* Internal Rate of Return. Financial buyers often evaluate acquisitions against a target “IRR” or in-ternal rate of return, often 30% or greater. The lower the targeted IRR, the higher the valuation.
7. What is the form of consideration being paid?
In a sale to a strategic buyer, the purchase price may be a mix of cash and equity. Generally, transac-tions are structured to limit the resulting taxes on the equity component of the purchase price. How-ever, there are limits on how little equity can be included in a sale and still have that equity be received on a tax-free (deferred) basis. Liquidity of the equity portion of the purchase price and how its is priced are also important factors to consider. Financial buyers generally pay cash, although they may permit or even require management to re-ceive equity in the acquired entity so that their interests are aligned with the buyer’s. In order to evaluate properly the value of such equity, sellers must fully understand the acquisition entity’s capi-tal structure and the rights of their equity. Roll-overs of management’s equity in a seller into equity in an acquisition entity can generally be accomplished on a tax-free basis.
8. Does the company have the stamina for a deal?
Time is often the seller’s enemy and the buyer’s ally. Buyers have a legitimate interest in conducting the most thorough due diligence possible before closing but may also consciously draw out due dili-gence and deal negotiation to wear down the seller. Sellers can try to avoid this by requiring that the buyer adhere to a timetable and by not allowing themselves to be worn down by the process. Sellers should try to avoid lengthy exclusivity periods and maintain focus on business operations so the buyer is not deterred by declining productivity.
9. Does the seller understand the legal terms of the deal and are they right for the company?
First time sellers do not always appreciate the effect of post-closing risk allocation on the purchase price. The negotiation and drafting of long agreements that legally document the sale may seem te-dious after a short, direct term sheet has been agreed to and a price determined. But in the end, it’s about what the seller gets to keep, and indemnification clauses and other post-closing price adjust-ment mechanisms in the final binding agreements can be traps for the unwary.
10. Does the company have the right advisors?
The most important thing a seller of a green technology company can do is to assemble the best pos-sible team of advisors. Financial advisors should be incentivized to maximize shareholder value by tying their compensation to closing a deal at the highest possible price, although this creates a hazard that they will also be incentivized to close the deal that pays the highest fees regardless of its merits. Seller’s should have legal counsel with significant M&A experience in emerging technologies to en-sure that they are getting the best advice possible in all aspects of a transaction, including financial, tax, accounting, legal and post-closing wealth management advice. A relationship of trust between a seller and its legal counsel can play a key role in ensuring that the seller gets the best advice and the best transaction possible.
Louis R. Dienes is a member of the Corporate Department of TroyGould PC in Century City. He has been a trusted legal advisor to boards, senior management, investment banks and investors in technology driven industries in mergers, acquisitions and divestitures, equity and debt financings, and business operations in more than $10 billion of consummated transactions. He is currently the President-Elect of the Century City Bar Association. He received his law degree from Stanford University in 1994.
(310) 789-1212 * LRD@troygould.com
Los Angeles Magazine Southern California Super Lawyer in Mergers & Acquisitions for 2009 and 2010.
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