Exit Planning Exchange

By Laura Kevghas and Donald Richards

Top Five Buyer Blunders and How to Avoid Them

Many of the past Viewpoints we’ve published have advised sellers on how to secure a great deal in the M&A market. In this issue, we take a seat on the other side of the conferencetable to highlight five common and sometimes critical buyer mistakes that can be fatal to a transaction.

Some of these mistakes or misunderstandings can cause a seller to mistrust a prospective buyer. Others lead a buyer to present an offer that doesn’t meet the seller’s needs or interests.  In any case, they can result in a deal that’s in serious jeopardy.

Why This Matters:

Most buyer mistakes are avoidable. Being aware of how things can go wrong will help you improve your chances of sealing the deal.

1. KNOW the Real Decision-Maker(s)

Things can get off track right from the start if you don’t take the time up front to clarify key and hidden Decision-Makers in the seller’s world. John Kenny, Executive Vice President of Corporate Development for Iron Mountain, states that one of the most important factors that needs to be uncovered early on is whether the people that you’re dealing with on the seller side are the people who can actually approve a transaction. “I’ve seen a lot of cycles wasted and deals just never get done,” he said, “because you’re talking to someone who isn’t authorized to make a decision, or the board isn’t aligned with the sale.”

Although unfortunate, it is not unheard of for someone on the seller side to overstate how much authority they have to get a deal done. Mirus once had a principal of a seller represent himself as the sole decision-maker, only to have the partner committee turn down the letter of intent the principal had negotiated because his partners did not want to sell the company at any price!

Exaggeration of authority may be difficult to ascertain, and supports the idea of asking probing questions up front . Confirming as many deal-related details as possible early in the relationship helps streamline the deal process and keep it from derailing.

2. DON’T Focus on Price Alone

Some buyers assume getting the best price possible is the only thing that matters to a seller. In reality, many sellers have other goals that are important to them. Not taking time to uncover these objectives can be a big mistake.  John Kenny also advises learning as much as possible about the complete dynamics of a seller’s situation in advance. “One of the first questions to ask is why the asset is for sale,” he adds,“…and also understand whether it’s a distress situation and whether it’s been shopped for a while. Are they shooting for the whole market, or targeting you specifically?”

Mirus represented a client recently who wanted to ensure that his staff, many of whom had helped him grow the business for more than twenty years, had bright futures with the company post-acquisition. One finalist in the auction process,who didn’t believe this was a real objective of the seller, was dropped from the process despite a high proposed purchase price, when they indicated that they planned to cut employees and close facilities after the close of the sale.

Similarly, many entrepreneurs want to know that the company brand and culture they’ve spent years building–and which they believe support their company’s success–are going tobe maintained. Factors like these are often especially important when a family owned business goes on the market.

“Seller motivations are important, because if the seller cares about their brand, or their people, or their staff’s ongoing employment; and these factors don’t match up with integration into the new company, then you might as well stop–because you won’t be the preferred buyer,” adds Kenny.

3. Romance the Seller

Sellers want to believe a prospective buyer is really pursuing them and truly cares about the business the seller has built.  This is especially true if the seller is planning to stay involved with the business, but it can also be true even if the seller is planning to exit.

“You need to distinguish the different situations,” said attorney Les Fagen, a partner in the Venture Capital practice group at Cooley Godward Kronish’s Boston office. “If it’s a family-owned or founder-owned business, not spending time ‘romancing’ the seller can definitely be a problem.”

Taking time to get to know the seller, and letting the seller get to know you, are essential to building the type of personal bond that will help move a deal forward. Making sure that there are enough face-to-face meetings, spending time getting to know sellers and their key players, listening closely and asking good questions, and helping the seller learn about you are examples of the types of things a buyer can do to help a seller feel “wooed” and special.  At the end of the day, relationships buy companies.

4. BUILDING A Win-Win DEAL

Some buyers focus on winning during every negotiation with the seller, whether it’s related to the purchase and sale agreement, employment agreements or post-closing integration. Every purchase and sale agreement has numerous points that involve a give and take between buyers and sellers. Sellers can get fed up and walk away, simply due to the perception that a buyer is trying to shift all possible risks to the seller’s side.

“Being too aggressive in negotiating the indemnities in the purchase agreement is one of the more common problems,” Les Fagen elaborate(s) . “The seller wants certain limitations on liability, and the buyer wants all these protections in the document. Not wanting to intelligently assume risk on a buyer’s part is probably one of the most common reasons that deals fall apart.”

5. Organization

A seller can quickly lose confidence when a buyer doesn’t appear competent or knowledgeable in terms of how they approach the sales process. “One of the key success factors for an acquisition is earning the seller’s trust, that you will indeed be able to close the transaction,” pointed out Fagen. “The seller wants to know that the buyer has the ability, the wherewithal, and the determination to close and close promptly. I’ve seen a number of deals fall apart because the buyer took too long and didn’t keep the process moving forward.”

The due diligence process is seen by many sellers as a proxy for how they will work with the buyer post-closing.  A smooth due diligence process comforts the seller and his/her management team that the buyer’s company is also well run, and that integration and post-closing activities will be smooth and well-managed.

Planning for Success

Buying and selling a business can be challenging for those on both sides of the table. If you’re on the buyer’s side, understanding as much as you can about your seller in advance will help you anticipate and avoid the common mistakes discussed here. Through good planning, excellent listening and communication skills, understanding your seller’s motivations, and knowing your seller’s key influencers; you can become a successful buyer, and complete profitable transactions.

Laura Kevghas is a principal and Donald Richards is a partner at Mirus Capital Advisors, Inc., with a collective history of more than 150 buy-side transactions. Mirus is a middle-market investment bank that specializes in advising companies on strategic mergers and acquisitions. By combining a proven process, industry and  transactional expertise, creative thought, and personalized service, Mirus has completed hundreds of transactions for both public and private companies. Mirus is a registered broker-dealer and FINRA/SIPC Member. For more information, visit www.merger.com.

Investment Banking Services Since 1987 - 200 Wheeler Road, 4th Floor, Burlington MA 01803 • Tel: 781-418-5900 • Fax: 781-418-5999 • www.merger.com

Valmark Securities

WHAT IS A LIFE SETTLEMENT?

• A life settlement is the sale of an existing life insurance policy on the secondary market to a third party for fair market value.
• The owner sells policy in exchange for a lump sum settlement that can be higher than cash surrender value.*
• The third party institutional investor becomes the owner of the policy, makes premium payments, and collects the death benefit at the insured’s death.
• With institutional investors, policies are owned in large blind trusts with other policies.  This can help to assure client confidentiality.

CHARACTERISTICS OF A POTENTIAL LIFE SETTLEMENT CANDIDATE

• Insured’s age is 65 and older
• Life expectancy of 15 years or less
• Decline in health from original policy issue
• Life insurance policies with a net death benefit of $250,000 or more (no maximum)
• Policy type Universal Life, Survivorship Universal Life, Variable Universal Life and Convertible Term (Sometimes Whole Life)
• Owner can be an Individual, Trust, or Corporation
• Premium should be 5% of the Death Benefit (or less) and Cash Surrender Value should be 20% of Death Benefit (or less)

A FEW REASONS WHY YOU MAY WANT TO SETTLE YOUR POLICY

• Insurance is no longer needed and you would like to sell the policy for a lump sum cash payment
• Term policy is nearing the end of a term period. You can convert to a permanent product and receive, through a life settlement, proceeds for an asset that will terminate if not converted.
• Policies held within a trust are no longer meeting the original trust plan objectives
• Business is sold or changes are made that result in insurance no longer being needed
• Funds are required to focus on other personal needs such retirement, long-term care insurance, or family emergencies

*Actual offer will be dependent on your particular age and health status, the condition of your life insurance

In a life settlement agreement, the current life insurance policy owner transfers the ownership and beneficiary designations to a third party, who receives the death proceeds at the passing of the insured. As a result, this buyer has a financial interest in the seller’s death. When an individual decides to sell their policy, he or she must provide complete access to his or her medical history, and other personal information, that may affect his or her life expectancy. This information is requested during the initial application for a life settlement. After the completion of the sale, there may be an ongoing obligation to disclose similar and additional information at a later date. A life settlement may affect the seller’s eligibility for certain public assistance programs, such as Medicaid, and there may be tax consequences.

Individuals should discuss the taxation of the proceeds received with their tax advisor. ValMark Securities considers a life settlement a security transaction. ValMark and its registered representatives act as brokers on the transaction and may receive a fee from the purchaser. A life settlement transaction may require an extended period of time to complete. Due to complexity of the transaction, fees and costs incurred with the life settlement transaction may be substantially higher than other securities.

SECURITIES OFFERED THROUGH VALMARK SECURITIES, INC., MEMBER FINRA, SIPC RINGSIDE DR., SUITE 300 
 3 -5201

For more information, contact Dan Guglielmo, Trust Design, dam@ trustdesign.com.

By William A. Duratti

Recent changes to Mergers and Acquisitions accounting has given rise to new questions, confusion, and sometimes even hesitation over completing a deal. Requirements under FAS141R are behind it all, and companies will have to comply beginning in calendar year 2009 – a date that looms large for many who are considering business combinations.  However, the challenges presented by FAS141R should not stand in the way of intelligent deal making. Buyers and sellers alike will adapt to the salient changes and base their decisions on whether an acquisition is a good deal at the right time for them.  Even as their accounting and valuation teams make the necessary adjustments, they know that advantages can be gained from the new system. The changes under FAS141R complete a joint effort by the FASB and the IASB to improve financial reporting for business combinations and to promote the international convergence of accounting standards.

FAS141R will cause some major changes and fluctuations to post-merger balance sheets. Understanding the new guidance, modeling deals accordingly and gauging impact on the financial statement before closing the transaction will help reduce any potential negative effects.  Complications arise due to the tricky nature of fair value and deal modeling, especially when estimating intangibles like unresolved contract contingencies. Calling in valuation specialists mitigates the damage that can result from poor assessments. When financial analysts evaluate transactions and earnings, they’ll be looking for how fair value was applied and what normalized earnings will look like on a forward looking basis.  This is especially timely as fair value under FAS141R will follow the guidance of FAS 157 and is defined as: “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measure date.”

Major changes to this definition include the marketparticipant perspective, exit price and more reliance on observable inputs, all of which create more difficulty in financial reporting for business combinations.

When all is said and done, these revisions mean that company leaders can expect ups and downs. When it comes to M&A activity, an acquired entity will likely cause turmoil in financial statements until the merger stabilizes over a number of reporting cycles.

The most significant changes coming under FAS141R include:

1. TIMING OF DEALS AND REPORTING

The biggest challenge for financial departments may come with the increased emphasis on timing and a growing list of disclosure requirements. FAS141R provides a more stringent timeline for reporting business combinations, and if deadlines are missed then provisional amounts must be reported for incomplete terms. That means not having the most qualified information, which can lead to more serious issues down the road.  There is a grace period of one year after the deal is closed – called the “measurement period” – during which provisional items can be adjusted.

Also, the expanded disclosure requirements make meeting the deadlines even more difficult and often will force a company to speed through the process. A deeper planning process and having the right team in place early will help avoid sacrificing quality and accuracy for speed.

2. CONTINGENT CONSIDERATION

Perhaps the most significant accounting change is the requirement that the purchase price of a business combination now include the fair value of contingent consideration. This change could significantly increase the upfront purchase price recorded on deal transactions, as well as increase the volatility of subsequent accounting.  The contingent consideration will be recorded by the acquirer as a liability at fair value as of the transaction date and will need to be adjusted to fair value at each subsequent reporting period. Given the major uncertainties as to future amounts and timing of payments of the contingent consideration, the fair value of this liability may materially fluctuate over time as more information is obtained.

Companies putting contingent payments into the deal structure will need to closely assess fair value of the 2 contingency. There is no predicting the future, but modeling and understanding the shapes that a deal can take will help mitigate the potential fluctuations in reporting.

3. IN-PROCESS R&D (IPR&D)

Under previous regulations, companies could record the fair value of IPR&D as a period cost of a transaction.  FAS141R, however, requires that the fair value of IPR&D be recorded as an intangible asset on the balance sheet. If the IPR&D does not come to fruition, it will subsequently need to be written down to its fair value, potentially zero, resulting in an impairment charge to the income statement.

4. DEAL COSTS

Acquisition-related costs such as negotiations that involve banking and legal fees were traditionally reflected as deal costs that could be capitalized along with the purchase price, but FAS141R calls for these items to be expensed immediately as period costs.

5. ASSETS AND LIABILITIES ARISING FROM CONTINGENCIES

FAS141R improves the completeness of the information reported about a deal by changing the requirements for recognizing assets and liabilities that arise from contingencies. An acquirer is now required to recognize these elements as they arise from both contractual contingencies and noncontractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Again, post-merger adjustments to the fair value of these contingencies can create significant fluctuations in reported earnings.

ACTION ITEMS

With these items and others looming large at the beginning of 2009, companies that are pursuing acquisitions should take a few important steps to solidify their position.

• Re-assess current deals to determine the impact that FAS141R might have, and consider if it will be beneficial to close after the deadline passes.

• Be certain that the right teams are in place to understand and apply new fair value concepts to aspects of a transaction.

• Instruct teams to prepare for the new guidelines and adjust their approach as best as possible to minimize impact on the balance sheet and fluctuations in future reporting.

Despite the changes and action items that accompany FAS141R, the reasons for sourcing and completing deals should remain the same. Company leaders will still strive to make decisions that are strategically sound for their business or come at a good investment price at the right time. The fact is, pre-141R accounting was already a mystery to many. Adjustments will come from the valuation and accounting side to ensure that deals go through smoothly and under the best possible terms.

Material Discussed in this Insight is meant to provide general information and should not be acted on without obtaining professional advice tailored to your firm’s individual and specific needs. This information is for general guidance only and is not a substitute for professional advice.

By Stanley H. Davis and Kathryn B. Earle