A critical function of a sell-side advisor during an M&A transaction is the creation of a comprehensive buyer list. During the screening process of potential buyers, your M&A advisor must be thorough in their analysis of both potential strategic and financial buyers. This detailed analysis can heavily contribute towards the success of a sell-side M&A engagement. Several factors are examined when developing a buyer list including but not limited to the financial capacity of an acquiring firm, potential synergies, and current market share.

If the list of potential buyers isn’t well-researched, there’s a risk that the “right” buyer may miss the opportunity to bid on the company. This could be an expensive mistake for the seller.

It is crucial that the sell-side advisor understand the potential buyers and what might motivate them. Having a thorough understanding of their strategies, operations, and financial stability is essential in marketing the business for sale. Your M&A advisor must help potential buyers understand how synergies can be realized through the acquisition of a client’s firm. This is an important step as it will help the potential buyer to truly understand the value of the business for sale.

Boutique investment banks with a global reach are capable of developing a comprehensive worldwide prospective buyer list. A list that is not limited by geographies, language, or customs will allow the best possible acquirer to be discovered so that the best value and terms can be derived for the seller. M&A experience is equally important as investment banks with decades of transaction experience will be more capable of helping potential buyers understand the synergies that can be realized through acquisition, are better equipped to deal with buyers from around the world, structure the transaction, and know how to manage the process to a successful conclusion.

In M&A transactions, an escrow or a holdback is used to ensure that certain conditions are met by the seller before an agreed amount of funds is released. These structures help allocate risk between buyer and seller and are common in middle-market business sales.

If an escrow is used, a third party known as the escrow agent holds the funds until receiving instructions that certain obligations have been satisfied and the funds can be released. Most of the time, the escrow agent is a large, reputable bank or trust company that provides this service.

In middle-market transactions, escrow and holdback structures are often heavily negotiated and can materially impact a seller’s net proceeds, timing of payment, and overall risk exposure.

How Escrow Accounts Work

The escrow agent holds the funds pursuant to an escrow agreement executed at closing. That agreement governs how claims are submitted, the required notice procedures and timelines, dispute resolution mechanisms, the conditions for release of funds, and the investment of escrowed funds along with the allocation of interest.

In most transactions, escrow funds are invested in low-risk instruments. The interest earned is typically paid to the seller upon release, although this is negotiable.

Despite the fact that escrow accounts are very common in M&A transactions, the specific terms can vary greatly. The average escrow amount typically ranges between 10 percent and 20 percent of the purchase price. The holding period generally ranges from 12 to 24 months following closing. In certain situations, however, both the percentage and the duration may be increased depending on the perceived risk of the transaction.

Why Escrows Are Used

Escrows are designed to protect buyers against unforeseen financial losses after closing. Buyers are often concerned that undisclosed liabilities may surface once the transaction is complete.

Funds are typically released to the seller at pre-agreed times. Sometimes, partial releases occur as early as six months after closing. It would be unusual for the entire escrow to be released that early, but buyers and sellers frequently agree to release portions after six or twelve months if no claims have been made.

The funds are released only if all agreed obligations have been fulfilled. If unknown liabilities arise, or if the seller fails to meet certain pre-agreed conditions outlined in the Purchase and Sale Agreement, the buyer may have the right to recover amounts from the escrow.

Provided the agreed conditions are met, escrow funds ultimately belong to the seller. Buyers do not expect escrow funds to be returned to them. Rather, the escrow serves as a protection mechanism in the event issues arise.

Because the funds are held by a neutral third party and can only be released in accordance with the escrow agreement, escrows can reduce a seller’s risk of not being paid.

The Alternative: Holdbacks

The alternative to an escrow is a holdback. In this structure, the buyer simply retains a certain percentage of the transaction consideration instead of depositing it with a third-party escrow agent.

In some transactions, a holdback is used to secure a specific known risk such as a pending tax matter, while general indemnification risk is covered through a separate escrow.

The primary risk of a holdback is that the funds remain in the buyer’s possession. If the buyer were to go bankrupt or otherwise become unable to pay, the seller could face increased credit risk. While such situations are uncommon, this risk is one reason many sellers prefer the added protection of a formal escrow arrangement.

Representation and Warranty Insurance (RWI)

In recent years, representation and warranty insurance, often referred to as RWI, has become more prevalent in middle-market transactions. RWI allows an insurance policy to cover certain breaches of representations and warranties, which can reduce the need for larger escrow amounts.

For sellers, this can increase cash received at closing, reduce post-closing exposure, and improve overall deal competitiveness. However, RWI does not eliminate escrow entirely and often excludes known risks. It is typically used as a complement to traditional escrow structures.

Escrow accounts and holdbacks are important tools for allocating risk in M&A transactions. While they are standard components of many deals, their structure, size, and duration can significantly affect a seller’s ultimate proceeds and risk profile.

Written by Don Grava

Versailles Group, Ltd.

Founded in 1987, Versailles Group is a boutique investment bank that specializes in international mergers, acquisitions, and divestitures. Versailles Group’s skill, flexibility, and experience have enabled it to successfully close M&A transactions for companies in the middle and lower-middle market. Versailles Group has closed transactions in all economic environments, literally around the world.

Versailles Group provides clients with both buy-side and sell-side M&A services and has been completing cross-border transactions since its founding in 1987.

More information on Versailles Group, Ltd. can be found at

www.versaillesgroup.com

For additional information, please contact

Donald Grava

Founder and President

+617-449-3325

The decision to sell your business is one of the most difficult decisions a person will ever make. It is not only a major financial decision, but a personal decision as well. Each instance is unique and the selling of a business requires attention to detail on many issues, some of them complex.

 
There are several reasons why it may be time to consider selling.

• If it’s difficult to raise the capital needed to grow the business or you believe it is too risky to do so.

• If too much of your net worth is “locked” in your company, you may feel it is time to diversify this wealth.

• If you are nearing retirement or are experiencing health problems, you may want to find a new owner or partner to continue your legacy with your employees, customers, etc.

• If you want to pursue a new business or hobby, you may want to “unlock” the value of your company and be compensated for all the hard work and time you have put into it.

Versailles Group’s eBook, “When to Sell Your Business” has a more detailed look at these issues. It can be downloaded from our website.

After deciding that you may want to sell and have determined that it is a good time to do so, there are some important items to address: (i) What is the expected value of the company? It is important to have a realistic expectation of what a buyer will pay and always be mindful of the fact that this is an important decision for the buyer as well. (ii) How are you going to engage the right buyers and get them interested in your company? The best way to do this is through a broad based approach that searches for potential buyers around the world. The best buyer for your company may not always be the obvious one or one in your country or even on your continent.

M&A experts can help you address these and the myriad of other issues that come up when selling a business. Selling your company is an important process and it should be done professionally in order to maximize the value and terms. It is also important to have proper legal and accounting representation.

As one can see from the chart below, global M&A, as we’ve reported before, is flying high!

M&A activity for the 11 months ended November 2014 is at a record high since 2011 as buyers and sellers are coming together at a very rapid pace. Our belief is that many companies and entrepreneurs want to get deals done before interest rates increase, there is a change in US President, or there is another economic or political crisis. Many people remember the depths of the Great Recession and are taking the necessary steps to ensure their companies and personal net worth are better protected from any future economic downturns.
Buyers are strengthening their companies and sellers are paying off debt, diversifying, and in some cases retiring. What are you doing to increase or protect your shareholder value?