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Startups and angels: Along the way to success

Wednesday, August 22, 2018 

By: Tim Keane, ACA Member, Golden Angel Investors

This post originally appeared on Tim’s blog.


Preparation: Key to Successful Private Transactions, especially in Hot Markets

For leaders of private, closely held companies, selling the company is an important and critical event in their lives.  There are several important considerations in managing the sales process to maximize results, avoid both delays and failure to close, all centered around preparation for the entire selling cycle.

In mid-2018 private equity transaction prices are at very high levels. This is good news for well prepared sellers who are able to execute on best practices when selling. 

Even in hot markets, however, a lack of preparation will produce a less than optimal outcome. 

Using an Auction Process

Extensive experience underlines the expectation that an auction process is the best process for achieving a good outcome. Of course, experienced buyers sometimes try and convince sellers not to hold an auction for a variety of “reasons.” The end result, intended or not, is usually much lower price and poorer economic terms for sellers. 

In an auction process, the seller – or most likely, their investment banker, will prepare an offering document, (including a non-disclosure agreement) circulate to probable interested buyers, solicit bids, pick two or three of the best to negotiate with, and come to an acceptable, and painless close. 

If the company is in a market with good fundamental characteristics and is attractive among the companies available for sale, an auction will most probably work well, because the process should attract multiple competitive buyers. 

Putting the company in that position is the single most important thing a buyer can do.

Here’s how in five steps.

I. Develop Comparable Sales Data and Align your Offering

It’s important for the seller to be informed about what the current market pricing is for similarly situated companies, and what the components of that price are. A thorough review of comparable market transactions will include an understanding of which specific metrics support the most attractive multiples in the market. (and the more recent the better.) This begins with customer acquisition costs and resulting lifetime value and may include earnings as a percent of sales, revenue growth over time, sustained growth rates, sales per employee and other industry-specific metrics. Investment bankers and industry trade groups are good sources of this kind of information, for instance. 

Based on these facts, develop a buyer’s view of your company. If a seller has any concerns here, consider engaging a sell-side quality of earnings analysis. This will help you see your earnings through a seller’s point of view.

Clean Up Financial Statements

If financials are not “clean” this is a great time for sellers to remove extraneous expenses and balance sheet items, such as shareholder loans, non-operating assets, and the like.  If possible avoid major adjustments on the P&L. This may mean operating for a year or more prior to a sale offering if the seller needs to remove personal items from company expenses. Buyers will look past these items for an excellent company, especially in a competitive situation, but their presence leads to deeper questions about other potential pitfalls and variances. 

Base The Offering on Market Comparables

Build the sale offering based on this information. This will include the unique story of the company, its growth opportunities and its position in the market as well as its place in the comparables list based on its performance against these industry metrics. Highlight company strengths and opportunities and identify known risks. Proactively explaining risks and mitigation plans and achievements is a highly valued trait of successfully acquired companies. 

Include Data Analytics about your customers

In today’s acquisition environment, one of the biggest differentiators can be the company’s ability to describe customer acquisition cost and lifetime value objectively. Many companies only allocate marketing budgets based on some percent of sales and don’t adequately differentiate between the cost to get a new customer and the much lower cost to retain them and describe their long term profitability. Buyers who see this data will be more comfortable with growth projections that are based on objective data-driven historical facts. 

The more attractive the company is on objective, quantifiable basis, the more likely that its offering will be attractive to multiple buyers, shifting leverage in the selling process. 

Plan For Probable Terms 

Construct a range of value expectations and review carefully current, comparable terms that may be proposed by buyers. Some highlights include:


 Consult your tax advisor at this stage about tax implications of various seller requests, such as asset vs. stock sales, favorable tax treatments available with certain sale structures, and so forth. I’ve seen situations where these tax consequences more than made up for lower overall valuations. We’ve recently participated in a private transaction that was QSBS (Qualified Small Business Stock, a federal program) eligible and was exempt from Federal capital gains tax. 

Withholding of Proceeds:


A sometimes overlooked area is the “holdback,” a portion of the purchase price held in escrow for some agreed to time period. This money is intended to be used to guarantee the accuracy of the seller’s representations and warranties about the business. In a competitive market, and where the purchase prices exceeds $10MM, a seller may consider asking the buyer to purchase insurance to cover this guarantee. It’s expensive (2% to 5% of the holdback, generally) and comes with an underwriting fee in the mid five figures. It also has limits as a percentage of the purchase price (10% in many cases), and may not eliminate the need to hold back a portion of the proceeds as well. However, it helps assure the holdback will be returned as the underwriting requirement brings a lot of objectivity to the holdback negotiation. 


This portion of the purchase price is held in escrow until certain agreed upon milestones are met. This is similar to, though not the same as, an earn out. A milestone payment may be predicated upon a completed future order, the retention of certain customers, or similar objective requirements. Competitive bidding can reduce the size, complexity, timing and quantity of milestone payments. 

Earn Out

An earn out payment is based upon achievement of financial results. An example might be a payment as a percentage of future EBITDA or revenue. Earn outs based on future financial performance that is not in the control of the seller post sale are often contentious and problematic.  

Seller Note

Because private equity transactions are normally leveraged, buyers will often ask sellers to be the most subordinated lender in a transaction. Again, a competitive process may reduce or eliminate the need for a seller to accept this. In reality, a seller note is often structurally similar in risk to a preferred equity with a fixed interest rate without the potential equity upside.  

Equity Reinvestment

If the seller who would own reinvested equity is leaving the company post transaction, and is being asked to take some or all of the proceeds in stock, a clear understanding of the terms of the new equity is essential. If the new owners have the ability to dilute the stock in the future, or in other ways reduce future economic benefit, it is important to seek agreement about how the equity will be redeemed, under what circumstances, and when. Sellers should be fully acquainted with the risks associated with holding equity, as well as with the potential upside. 


Another term to prepare for is a request for exclusivity in negotiations. 

At some point in a successful sale, buyers may request that sellers sign an exclusivity agreement by agreeing only to negotiate with them until a conclusion or breakup is reached. 

There are good reasons for a seller to enter into an exclusivity provision in negotiations. If the seller has seen several offers and has quantitatively-based reason to believe these offers are representative of the market price, is satisfied with the proposed price and terms, and the buyer has demonstrated consistent, documented, trustworthy behavior, a provision to enter into an exclusive negotiating period may reduce burdens on management, speed the transaction and build toward a good relationship. It also potentially reduces information leaks that may be harmful to the company in the event of a busted transaction.  

However, exclusivity periods can be used to stall while watching performance, especially if managers are distracted by the process itself and valuation discussions have included forecast results in the next quarter or two. Disclosing information can be used to squeeze the company during the same process. 

Buyers who believe exclusivity makes sense in a given negotiation may consider limiting their exposure to risk by limiting the time period to very short intervals, and requiring reaffirmation of price and terms at each (biweekly?) time period. If there is any slippage, consider reopening conversations with others. 

(In one case, the seller disclosed the investor’s and employee’s eagerness to exit. In addition, the seller’s balance sheet was not strong. The buyer asked for and was given an exclusivity period and direct access to key managers. 

The buyer then persuaded the seller and his managers to suspend new sales activity during the course of the negotiation for “market confusion” reasons.

The seller had no advisors to rely upon for decision making. 

 Unfortunately, the tactic worked all too well. The Company did not have a good alternative to a sale. 

The employees were convinced this was a great event for them by the buyer and were obviously eager to close. 

Diligence dragged on for months, based on a variety of new issues that arose each week.

As sales fell and cash pressure built, the buyer lowered the offer and in the end the company accepted a 50% reduction in the sales price as an alternative to running out of cash. Part of the leaders rationalization for doing this was the promise of a bright financial and career future at the acquirer. A year later he was suing them for wrongful termination.)

In retrospect, the right answer here was to develop more alternative buyers and only then, if the original buyer was still favored, to agree to a short, exclusive diligence period. A reference check may have provided information about the aggressiveness of the buyer. It wasn’t done either. Of course, agreeing to full employee access coupled with the “stop selling” decision and lack of good advisors are all mistakes.

II. Construct an Attractive and Believable Alternative to Selling.

Decide what the minimally acceptable price and terms are, considering the factual information gathered. Then build an alternative plan contingent on the inability to obtain a desirable transaction. Included in this thinking should be a broader definition of selling to include leveraged recapitalizations and family succession planning. 

Plan for Capital Requirements

The ability to continue the business, strong capitalization and an excellent sales force, product development, positive cash flow and marketing plan are substantial components of an alternative scenario. AQ detailed understanding of customer acquisition costs is a central part of this plan. The unfettered ability to simply continue the business, especially when obvious to buyers, is a strong alternative.  More cash enhances seller alternatives and diminishes buyer power.  

In the case in which a sale is highly desirable, and not all of the above are present, the plans for a good alternative may include the ability to attract short-term investment from current investors, or to extend lines of credit from your bank.

The assumption here is that alternatives come into play when the seller is down to one buyer who may try and create negotiating pressure, or an array of unacceptable terms. Absent a good alternative (especially when it becomes apparent to the buyer), price and terms pressure increase.

(Recently, a buyer, late in the process made an 11th hour reduction in price believing the company had no good alternative. The well-prepared seller presented his alternatives and explained that they were all superior to a reduced price. The buyer withdrew his offer, walked away and returned three weeks later, reluctantly agreeing to the original terms. 

The seller explained that the alternatives were working pretty well and raised the original, previously agreed to, price.  The buyer complained, but complied. This was all based on having that real alternative locked and loaded. The seller had also designated one person – not her – to negotiate with the seller. This layer of separation provided time to continue to grow and manage the business free from transaction distraction. Interestingly, it also increased the buyer’s respect for the business and its management.)

III. Construct a Diligence “Room”

Ask knowledgeable advisors what information the buyer will likely ask for. (If you were buying rather than selling, what would you want to know?) Use standard diligence checklists to thoroughly review all possible information requests. Prepare this information carefully, and cautiously. 

Standard disclosures include financial matters, customer centric data analysis, an overview of intellectual property, customer sales history and contracts, supplier agreements, litigation history, employment contracts, practices and issues; past and current performance to budget; tax matters; regulatory issues and insurance, for instance.

Disclose in Layers

Savvy sellers and their advisors can, and usually should, disclose information in layers. Summary data about employees, customers and suppliers can be provided initially, for instance. However, access to detailed information and access, for example, to employees, customers and suppliers shouldn’t come until late in the process. A best practice would be disclosure of sensitive information tied to final buyer commitment.

Sellers need to be cautious about the actions of the buyer related to information they’ve gained in the process. For instance, it’s possible for buyers to influence employees and create divergent incentives in the post sale period. These incentives can potentially cause the employees to create pressure on sales price and terms. Sellers should assure themselves that management incentives are completely aligned with the seller’s goals for the transaction.

 (The seller’s company was growing very rapidly. The seller’s budgeted sales growth in the next quarter would be up 20%. Buyers had submitted offers and the leading buyer found out what the next highest bidder’s price was.  

The buyer then asked for and the seller agreed to an exclusive negotiating period.

The buyer extended the diligence process till the end of the following quarter and built an acquisition model using the sales growth as the primary factor in the price. When the distraction of the transaction caused sales to slip, the price was reduced by the buyer to just more then the second offer. The company sold for about two-thirds of the original sales price and eventually, post transaction, doubled market share.

Management was differentially incented from ownership and “moved over” to the the buyer’s point of view, hastening the acceptance of the lower price.)

By the time this has happened, it’s probably too late. As previously noted, developing an alternative that aligns management with sellers is an imperative in the selling preparation process. 

Seller’s Goals Are Important

Be aware that a substantial portion of diligence is the seller himself. Buyers assess not only negotiating strengths and weaknesses but also personal goals and aspirations. That process can also form the basis of a good working relationship going forward. Sellers who can get comfortable with honest and appropriate self disclosure can be disarming and help achieve a good outcome. Of course, several competitive offers make self disclosure less risky!

Check out The Buyer

Sellers should always ask for and check buyer references early in the diligence process. Thorough vetting will assure sellers of the quality of offer and background of the buyer.  Buyers who are motivated to build strong relationships as an essential part of a good business will welcome sellers who take these actions. 

IV. Assign Roles to Advisors 

These may be Company directors, advisors, investors, attorneys or accountants. This may include reviewing buyer requests, seller decisions, terms and risks. Agree in advance who will need to approve negotiated terms.  Plan for short term review requests and meetings.  

 Use Process to Provide Time to Consider Requests

Consider informing the buyer that you have to seek approval from your advisors for proposed terms and concessions. In this way, you buy yourself time to carefully consider requests. The discipline created by agreements to review steps with advisors, even if they do not have decision making authority, can create a safety valve to avoid pressure to make decisions hastily.

V. Choose an Intermediary 

An experienced and skilled professional is often the biggest advantage a seller can have. 

This is often an investment banker. Prefer one who is experienced in your industry and if possible who only sells, and whose transaction sizes closely match what is anticipated in this specific transaction. Get a firm commitment in advance about who in the firm will lead the deal.  

Expert intermediaries should have very good knowledge of the market and be able to identify buyers and their appetites and risk profiles as well as their typical deal terms. They make money by getting better prices and terms for sellers. One major component of their process is to bring multiple buyers to the table and add their expertise to help balance the relationship between buyer and seller.  

Check References and Style

Good reference checking on the seller’s part is a requirement.

In my experience, the best intermediaries have an orientation to be cooperative, positive, and seek to complete the transaction while single-mindedly seeking a fair, evenhanded transaction. 

 It’s amazing how often I see advisors who think aggressiveness and tough behavior is the right card to lead with. While this may get deals done, it has the potential to derail a transaction. 

In Conclusion

The ultimate balance between buyer and seller is to not have to sell and be able to have good, confirmed walk away alternatives. This is usually not an easy position to get to but it pays great rewards to sellers who have the discipline and savvy to achieve it. 


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