Written By: Andrew Gelfand Read By: Christopher McKenna
Hooray! The owner signed a letter of intent to sell their company. Now the task of “soup to nuts” diligence begins – accounting quality of earnings, document accumulation, strategy and integration meetings, documentation. . . . The post LOI process is a second job. But, let’s not forget about the first job, running the golden goose! Many a deal has gone awry when the owner focused too much on the transaction and not enough on running the company, thus allowing the operating results to suffer. In addition to paying attention to the company during diligence and documentation, there are a number of “dos” and “don’ts” with respect to managing the company during the sale.
DO
- Run the Company in the Ordinary Course – The owner should continue operating their company as if they were not selling it. If the action is warranted under current ownership then it is warranted under the buyer’s ownership. If the sale is not completed, the company needs to be positioned to move on without missing a beat.
- Purchase and Maintain Inventory as Usual – Delivering less inventory to the buyer, especially inventory that has a long lead time, jeopardizes the acquisition for the buyer, reduces working capital in violation of the working capital target, and jeopardizes the company for the owner if the transaction fails.
- Pay Accounts Payable According to Terms – Not paying payables in the ordinary course decreases the working capital delivered to the buyer at closing. While the owner may believe that this is a neat strategy to increase the purchase price, the working capital target will be violated resulting in a post-closing payment to the buyer. In addition, the sudden change in payment pattern could jeopardize the company’s relationships with its vendors.
- Maintain Marketing Expenditures – If marketing is the engine that drives sales and profitability, then the owner has implicitly agreed to deliver the company to the buyer having made these expenditures to support future sales. If the sale of the company is not completed and the owner has slowed these expenditures, then sales momentum coming out of the terminated transaction would be disrupted.
- Make Capital Expenditures as Planned – If certain equipment is necessary to achieve the business plan, then the company needs to make these investments regardless of the ultimate owner. If it is the right investment for the owner, then it is the right investment for the buyer.
- Invest in Equipment Preventative Maintenance – Equipment must be maintained regardless of the owner. Deferring equipment maintenance increases the purchase price for the buyer since the cost is transferred from the owner to the buyer. In addition, it could jeopardize the operations for the owner if the transaction does not close.
DON'T
- Take Any Action that Could Jeopardize the Company – Many deals close and many do not. The company must be viable and robust if transaction discussions are terminated. Actions that could jeopardize the company include prematurely letting employees, customers, and/or vendors know about the transaction as well as failing to consider the dos and don’ts described above and below.
- Accelerate Sales or Make One-Off Deals with Customers – Accelerating sales via incentive pricing, trade terms, etc., artificially transfers future profit and working capital from the buyer to the owner and creates a sales shortfall for the buyer post-closing. This strategy is transparent and may lead to a post-closing claim against the owner.
- Take Actions Purely to Boost EBITDA – In addition to don’t #2, this would include any type of spending reduction that is not sustainable and could only be construed as an effort to boost EBITDA. Examples include unjustified headcount reductions, a reduction in employee benefits, deferring equipment maintenance, or unjustified changes to balance sheet reserves.
- Accelerate Accounts Receivable Collections – Sellers have been known to accelerate the collection of receivables pre-closing not understanding that the closing working capital will fall below the working capital target and require a post-closing payment to the buyer.
- Change Accounting Policies – Changes in accounting policies, particularly ones that boost EBITDA, are transparent to the buyer and their accounting advisors. Examples include changes to a) revenue recognition, b) reserve(s) policies, or c) capitalization policies. The result of these actions will not be accepted by the buyer.
While the foregoing list is not all inclusive, it is indicative of categories of actions to take/not take during the course of a transaction. As always, if in doubt, err on the side of caution or seek the counsel of an experienced advisor.