15 Common Mistakes CEOs Make When Selling Their Company
Selling a company can often be difficult and time consuming. The mergers and acquisitions (M&A) process requires careful planning, competent professionals to assist the target company, and an understanding of the deal dynamics involved in the negotiations. CEOs and companies that have not engaged in many M&A transactions frequently make mistakes that can result in a less favorable price or terms that would have otherwise been obtainable. Sometimes these errors can even kill the deal altogether.
The following is a list of common mistakes made by CEOs of private companies attempting to sell the company:
Mistake #1: Not being prepared for the extensive effort and time the deal will take.
Successful exits through M&A are not easy. They are time consuming, involve significant due diligence by the buyer, and require both a great deal of advance preparation as well as a substantial resource commitment by the seller. Acquisitions can often take six months or longer to complete.
Mistake #2: Failing to create a competitive sales process.
The best deals for sellers usually occur when there are multiple potential bidders, and leverage of the competitive situation can be used to obtain a higher price, better deal terms, or both. Negotiating with only one bidder (particularly when the bidder knows its company is the only potential buyer) frequently puts the selling company at a significant disadvantage. Sellers must try to set up an auction or competitive bidding process to avoid being boxed in by a demand for exclusivity by a bidder. By having multiple bidders, the seller can play each bidding party against the other to arrive at a favorable deal. Even the perception that there are multiple interested parties can help in the negotiations.
Mistake #3: Not having a complete online data room.
An online data room contains all of the key information and documents that a bidder will want to review. This will include material contracts, patents, financial statements, employee information, and much more. An online data room is extremely time consuming to put together, but is essential to successful completion of a deal. A properly populated data room established early in the M&A process will not only allow buyers to complete their due diligence more quickly, but also will enable the seller and its advisors to expeditiously prepare the disclosure schedule, a critical document in the M&A process. But almost every CEO underestimates how critical this is, and how time consuming it is to get complete and correct.
Mistake #4: Hiring the wrong legal counsel.
You shouldn’t rely on a general practitioner or general corporate lawyer to guide you through the M&A process or negotiate and draft the acquisition documents. Instead, you should use a lawyer who primarily or exclusively handles mergers and acquisitions. There are many difficult and complicated issues in structuring M&A deals, putting together acquisition agreements, and executing the transaction. You want a lawyer who thoroughly understands those issues, understands customary market terms, understands the M&A legal landscape, is responsive with a sense of urgency, and who has done numerous acquisitions. The CEO’s bias will often be to use existing company counsel, but this is almost always a mistake.
Mistake #5: Not hiring a great financial advisor or investment banker.
In many situations, a financial advisor or an investment banker experienced in M&A can bring value to the table by doing the following:
- Assisting the seller and its legal counsel in developing an optimal sale process
- Helping to prepare an executive summary and confidential information memorandum for potential buyers
- Surfacing up and contacting prospective buyers
- Coordinating meetings with potential buyers
- Coordinating signing of NDAs
- Assisting the seller in properly populating the online data room
- Advising on market comparable valuations
- Coordinating the seller’s responses to buyer due diligence requests
- Prepping the management teams for presentations to the potential buyers
- Assisting in the negotiations on deal terms and price
One tip when hiring a financial advisor or an investment banker: Have them give you a list of likely buyers, with annotations listing their relationships with senior executives of those buyers and recent deals done with them. You want an advisor who already has strong relationships with likely buyers and who can get their attention.
The first draft of an investment banker engagement letter is generally extremely one-sided in favor of the investment banker. Companies that just sign or minimally negotiate such letters are making a huge mistake. These letters are negotiable, and savvy legal counsel/deal professionals typically negotiate on the following issues, among others:
- The compensation payable to the advisor is typically a success fee, based as a percentage of the ultimate sales price. What is often negotiated is the percentage (for example, the bankers will want 3% or more, the company will want a fee closer to 1% to 2% but possibly increasing if certain sales price thresholds are met). The calculation of the fee owed should also exclude various items, such as any portion of the purchase price attributable to the cash that the company has on its balance sheet at the closing, or contingent purchase price payments that may never be made.
- Whether there is a minimum fee payable on a sale regardless of the purchase price (companies should avoid this, otherwise there may not be an alignment of interest between the company and the buyer)
- How long and under what situations a “tail” applies (meaning when a fee will be due after the engagement letter is terminated but the company subsequently is sold). Companies try to limit this tail to 6 to 9 months and only for potential buyers that signed an NDA with the company during the terms of the engagement letter.
- The amount of any upfront or monthly retainer payable to the banker (it is common that any retainer is waived and the advisor or banker is paid nothing unless a transaction is successfully completed)
- The amount of any expenses reimbursable to the investment banker (usually a cap is negotiated with a requirement that any amounts expended must be “reasonable”)
- The circumstances where the engagement letter can be terminated without any liability and without a tail applying (for example, if the key banker departs from the banking firm or the banker breaches the engagement letter)
- Whether the banker will deliver a fairness opinion and the fee for such opinion
- The scope of indemnification protection to the banker
- An outside termination date when the engagement letter will automatically expire
- A restriction/representation and warranty regarding any conflicts of interest by the banker
Mistake #6: Having incomplete books, records, and contracts.
Due diligence investigations by buyers frequently find problems in the seller’s historical documentation process, including some or all of the following:
- Contracts not signed by both parties
- Contracts that have been amended but without the amendment terms signed
- Missing or unsigned Board of Director minutes or resolutions
- Missing or unsigned stockholder minutes or resolutions
- Board or stockholder minutes/resolutions missing referenced exhibits
- Incomplete/unsigned employee-related documents, such as stock option agreements or confidentiality and invention assignment agreements
Deficiencies of this kind may be so important to a buyer that the buyer will require certain matters to be remedied as a condition to closing. That can sometimes be problematic, such as instances where a buyer insists that ex-employees be located and required to sign confidentiality and invention assignment agreements.
To the extent that key contracts or leases may require consents for a change of control transaction, those consents should be identified early, and a plan should be put in place to obtain those consents.
Mistake #7: Not having a complete disclosure schedule far in advance.
A disclosure schedule is the document attached to the acquisition agreement setting forth a great deal of required disclosures relating to outstanding key contracts, intellectual property, related party transactions, employee information, pending litigation, insurance, and much more. A well-prepared disclosure schedule is critical to ensuring that the seller will not breach its representations and warranties in the acquisition agreement.
Accordingly, this is an extremely important document to have ready quickly, and it is very time consuming to get correct. But virtually every company gets this wrong, requiring multiple drafts that potentially delay a deal. And disclosure schedules prepared at the last minute are more likely to be poorly prepared, creating unnecessary risks for the seller and its stockholders.
Mistake #8: Not negotiating the key terms of the deal in a letter of intent.
This is one of the biggest mistakes made by sellers. A selling company’s bargaining power is greatest prior to signing a letter of intent. As Richard Vernon Smith, an M&A partner at Orrick, Herrington & Sutcliffe in San Francisco, says, “The letter of intent in an M&A deal is extremely important for ensuring the likelihood of a favorable deal for a seller. Once the letter of intent is signed, the leverage typically swings to the buyer.” This is because the buyer will typically require a “no shop” clause or exclusivity provision prohibiting the seller from talking to any other bidders for a period of time. The key terms to negotiate in the letter of intent include the following:
- The price, and whether it will be paid all cash up front, all stock (including the type of stock), or part promissory notes
- Any adjustments to the price and how these adjustments will be calculated (such as for working capital adjustments at the closing or for a “cash free/debt free” deal)
- The scope and length of any exclusivity/no shop provision (which is always in the seller’s best interest to keep as short as possible—say 15 to 30 days.)
- The non-binding nature of the terms (excluding with respect to confidentiality and exclusivity)
- The amount of any escrow and a provision stating that the escrow will be the exclusive remedy for breaches of the agreement (and any exclusions from this exclusive remedy, such as for breaches of designated “fundamental representations”)
- The length of any escrow
- Other key terms to be included in the acquisition agreement (discussed in the next section)
Mistake #9: Failing to negotiate and agree upon a favorable acquisition agreement.
One key to a successful sale of a company is having a well-drafted acquisition agreement protecting the seller as much as possible. To the extent feasible and depending on the leverage the seller has, you want your counsel to prepare the first draft of the acquisition agreement. Here are some of the key provisions to negotiate in the acquisition agreement:
- Amount of the escrow holdback for indemnification claims by the buyer and the period of the escrow/holdback (the typical ideal scenario for a seller is 5-10% for 9 to 12 months); in some deals it may be possible to negotiate for no post-closing indemnification by the buyer and no escrow/holdback
- The exclusive nature of the escrow/holdback for breaches of the acquisition agreement (except perhaps for breaches of certain defined “fundamental representations,” such as capitalization and organization of the company)
- The conditions to closing (a seller will ideally want to limit these to ensure that it can actually close the transaction quickly)
- The adjustments to the price (a seller ideally wants to avoid downward adjustment mechanisms based on working capital adjustments, etc.)
- The triggers for earnouts or contingent purchase price payments
- Where stock is to be issued to the selling stockholders, the extent of rights and restrictions on that stock (such as registration rights, co-sale rights, rights of first refusal, Board of Director representation, pre-emptive rights, etc.)
- The nature of the representations and warranties (a seller wants these qualified to the greatest extent possible with materiality and knowledge qualifiers); intellectual property, financial and liability representations, and warranties merit particular focus
- The nature of the covenants applicable between signing and closing (a seller wants these to be limited and reasonable, with the ability of the seller to get consents from the buyer if changes are needed, with the consent not to be unreasonably withheld, delayed, or conditioned)
- The scope of and exclusions to the indemnity (baskets, caps, carve outs from the indemnity all being important issues)
- The treatment of employee options
- The terms of any employee hiring by the acquirer
- Provisions for termination of the acquisition agreement
- The treatment of any litigation against the seller
- The cost for obtaining any consents and governmental approvals
- The allocation of risk, especially concerning unknown liabilities
As David Lipkin , an M&A lawyer in San Francisco, notes, “A well-drafted M&A agreement will reduce the risks of not closing the deal, mitigate the potential post-closing risks, and ensure that the expectations of the target company and its stockholders are met. One of the worst mistakes a seller can make is to assume that a ‘middle of the road’ approach to each issue will offer it appropriate protection.”
Mistake #10: Not appreciating that time is the enemy of all deals.
The longer an M&A process drags on, the higher the likelihood that the deal will not happen or the terms will get worse. The CEO and the company’s lawyer must have a sense of urgency in getting things done, responding to due diligence requests, turning around markups of documents, and the like. It is also essential that one seller representative is delegated authority to make quick decisions on negotiating issues so that the deal momentum can be maintained.
Mistake #11: Having the CEO negotiate the deal terms.
In my experience, it is often a mistake for the CEO of the selling company to negotiate the deal. CEOs and entrepreneurs often do not have relevant M&A experience and generally are no match for the buyer’s sophisticated lawyers or corporate development team. Moreover, the smart CEO will want to avoid being seen as difficult in the negotiation when the buyer will be expecting the CEO to stay on after the acquisition. Just because someone is a great CEO does not make them a great M&A negotiator or able to orchestrate an appropriate M&A process.
The selling company wants to avoid acrimonious negotiations, as this could eventually kill a deal if the buyer determines that there won’t be a cultural fit. Often, a representative from the Board, an M&A Committee of the Board, or a representative from a major shareholder in collaboration with experienced M&A counsel will be more appropriate and effective as lead negotiator. Having said that, the CEO is crucial to the process in that he or she is best positioned to articulate the business and its upside for the buyer.
Mistake #12: Neglecting the day-to-day operation of the business during the M&A process.
The process of selling a company will be hugely distracting and time consuming. Nevertheless, the CEO must keep his or her eye on the ball and ensure that the business continues to grow and operate efficiently in line with projections given to the buyer. One of the worst things that can happen in an M&A process is for the selling company’s financial situation to deteriorate during the process. This may kill the deal or result in the buyer renegotiating price and terms.
Mistake #13: Absence of complete financial statements and credible financial projections.
The buyer will expend a great deal of time doing diligence on the company’s current financials and future projections. The CFO or controller of the selling company must be prepared to provide comprehensive financial statements and underlying schedules, and to fully answer questions related thereto. Having unreasonable projections or unrealistic assumptions will adversely affect the credibility of the management team. If the management team does not know the company’s key metrics cold and lacks the ability to convincingly demonstrate the reasonableness of the projections, this will give the buyer pause.
Mistake #14: Not adequately taking into account employee-related issues.
Transactions will typically include a number of employee issues. The questions that frequently arise in M&A transactions are the following:
- What is the acquirer’s plan for retention and motivation of the company’s employees?
- How will the company’s stock options be dealt with? (From the seller’s perspective, it is desirable to have the acquirer assume all the options but count only the vested options toward the purchase price.)
- Do any options accelerate by their terms as a result of the deal? Some options may be a “single trigger” (accelerate by reason of the deal closing) and others may be “double trigger” (accelerate following the closing only if employment is terminated within a defined period of time). The option plan and related option grant agreements must be carefully reviewed to anticipate any problems.
- Does the company need to establish a “carve out” to pay employees at the closing, or a change in control bonus payment to motivate management to sell the company?
- How do the investors make sure that the buyer’s incentive arrangements to the management team do not adversely affect the price payable to the shareholders? (It is best for the seller if price and key terms of the acquisition are agreed to before incentive arrangements are negotiated.)
- Will payouts to employees related to the deal trigger the excise tax provisions of Internal Revenue Code Section 280G (the so-called “golden parachute” tax)? If so, the seller needs to obtain a special stockholder vote to avoid application of this tax liability.
Mistake #15: Not understanding the negotiation dynamics.
All M&A negotiations require a number of compromises. It is critical to understand which party has the leverage in the negotiations. Who wants the deal more: the buyer or the seller? Are there multiple bidders that can be played against each other? Can you negotiate key non-financial terms in exchange for a concession on price? Is the deal price sufficiently attractive that the seller is willing to live with indemnification obligations that are less than optimal? It’s important to establish a rapport with the lead negotiator on the other side and it’s never good to let negotiations get heated or antagonistic. All negotiations should be conducted with courtesy and professionalism.
In the end, one of the biggest mistakes made by CEOs in M&A deals is “negotiating by concession.” If the CEO continually makes concessions to a buyer hoping that this will lead to a final deal, the opposite often happens—the buyer comes to believe that the seller is desperate to sell and can keep asking for additional concessions.
Copyright © by Richard D. Harroch. All Rights Reserved.
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a large venture capital fund in the San Francisco area. His focus is on investing in Internet and digital media companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, FoxBusiness, and AllBusiness.com . Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal -bestselling book on small business. He was also a corporate partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, strategic alliances, and venture capital.
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