How to obtain maximum value when selling

How to obtain maximum value when selling

The Seller’s Perspective: Is Cash Really King?
If you’re selling your company, one of the most important things to consider is the method of payment. Will you receive cash, debt, stock, or other consideration? That is, literally, the multimillion dollar question.

Most business owners prefer to receive cash, at least initially. As they say, “cash is king.” It’s simple, easy, and it gives owners a sense of closure that no other alternative can offer. Yet in many transactions, cash isn’t always a feasible option, or even necessarily the best option. Instead, business owners should always consider legitimate alternatives to cash, such as debt, stock, and contingent payments. The seller, with his M&A advisor should weigh the respective pros and cons of each appropriately. Below is a brief overview of these options:

Cash
Sometimes, an all-cash payment will make the most sense for the seller. If you don’t trust in your buyer’s long-term stability, solubility or ability to run the merged company then “taking the cash and running” may really be your best bet, regardless of whether or not the buyer offers you a better deal. Nobody wants to be paid in debt, stock or other contingent payments when all it gives you is a stake in a “sinking ship.”

Getting paid in cash is also a good idea if you’re in a hurry to completely divest from your current company or industry. Cash can offer you a fresh start and an ability to diversify your wealth. This would not be true of a stock, debt, or contingent payment deal.

Sometimes, the decision to choose cash as payment isn’t necessarily so simple. If the economy is weak, it may be difficult for the buyer to generate cash. And even in a good economy, a buyer still might give you a better deal if you accept some part of the consideration in debt, stock, or other contingent payments.

Alternative #1: Debt
If your buyer has good credit and you can get a higher valuation, you should strongly consider accepting some debt (usually in the form of promissory notes) as payment. This may also enable a buyer that you’d like to work with in the future to complete a transaction even though they didn’t have enough cash to close the transaction. If the credit is good, then even with debt, you’ll eventually be paid the same amount in the end—or possibly even more, depending on the interest rate. In some cases, you may actually find that buyers are willing to pay more for your company if you’ll accept debt. When it’s easier for buyers to finance, after all, it’s also easier for buyers to pay a higher price.

Of course, debt carries its fair share of disadvantages. For starters, it’s riskier than cash, since you’ll likely be counted as a subordinated lender. That means that if your buyer goes bankrupt, you’ll only be able to reclaim your money after other, more “senior” lenders have already taken their share. And unlike cash, you won’t be receiving all of your money up front, since the debt will be only paid off over time, usually two to five years.

Alternative #2: Stock
In other instances, the buyer may offer you their stock as payment. Frequently, this is offered in addition to cash or debt. Buyers often do this when they want to keep you involved with your company, even after you sell it. If you trust the long-term prospects of your buyer, accepting a stock payment can very easily become the most lucrative option of all. You can often receive a better deal from buyers if you accept stock instead of cash, and unlike debt, the theoretical rate of return on a stock is limitless. Many times, a seller makes a very hefty return on future increases in the stock price.

Obviously, this option isn’t ideal for those who want to make a clean break from their businesses and retire from the industry altogether. Stock is also riskier than cash or even debt. If the buyer goes bankrupt, stockholders are the very last in line to get their money back.

Alternative #3: Convertible (Debt) Securities
Convertible debt securities aim to combine many of the upsides of debt and stock payments, with none of the downsides. Essentially, a convertible debt security is a piece of debt (often a bond) that can be optionally be converted into a stock at a given “conversion price.” If you don’t want to choose between debt payments or stock payments when selling your company, payment via convertible debt securities may be a good solution. You receive the aforementioned benefits of debt, including regular interest payments and more bankruptcy protection, while also gaining the benefits of stock, such as the ability to share in the buyer’s future profits (if you convert your security).

Nevertheless, convertible securities are not without disadvantages. They tend to offer lower interest rates than regular debt, and their conversion price is usually set well above the current market price of the buyer’s stock at the time of transaction. To summarize, if you’re lucky, compared to stock, convertible securities will give you equivalent returns with lower risk. If you’re unlucky, then compared to debt, convertible securities will give you lower returns with equivalent risk.

Alternative #4: Contingent Payments
The most common contingent payment is the traditional earnout. Essentially, the seller will pay these amounts based on the future performance of the company. Most of the time, these arrangements are for relatively short periods of time, i.e., 12 to 36 months. This form of payment works best when the seller stays with the business and has an ability to influence the outcome.

There are as many forms of other types of contingent payments as people have the imagination to think them up. Versailles Group was involved in a transaction where part of the seller’s consideration was an annual payment of $1 million for the rest of his life. Provided that the seller, his investment banker, and lawyer analyze these alternatives thoroughly, they can be very rewarding for the seller.

Conclusion
At Versailles Group, we strive to keep our clients fully informed of all possible options during an M&A transaction, especially on the all-important matter of payment methods. That’s how to maximize value when selling.

As a boutique investment bank, our best interest is served when our client’s best interest is protected. Since 1987, this fundamental value has constantly reaffirmed Versailles Group’s position as a leading M&A advisor to middle market companies around the world. If you’re interested in selling or buying a business, please contact us for a free consultation.