In any business transfer, there is risk involved for both buyers and sellers. Unfortunately the risk cannot be completely avoided, and so, we wanted to take a closer look at the respective risk components involved on both sides.
“We try to minimize the transaction risks as much as we can,” says Achim Neumann, President of A Neumann & Associates, New Jersey, “however, obviously, each party needs to feel comfortable with the respective risk.”
We can essentially segment the respective transaction risks into two phases: pre- and post-transaction risk.
The pre-transaction risk assessment pertains more to the buy side: it represents the actual risk tolerance of a buyer. For example, comparing a long-term employed engineer or corporate employee that was recently terminated, and now looking for a business, to a “serial” entrepreneur who has owned three or four businesses before, demonstrates different risk profiles. Clearly, the former is in all likelihood better served by looking at a franchise than a free standing, start-up business.
In addition to the basic “comfort level,” there are numerous financial considerations. “Quite often we have buyers approach us that clearly stretch themselves to buy a particular business” says Mike Gersten, Director Marketing, Northern NJ & Southern NY. “Very often, we explain that there needs to be working capital and a ‘rainy day’ fund beyond the cash needed for the acquisition.”
Another more significant issue involved with pre-transaction risk applies to both parties— namely, the proper prequalification. Specifically, in our firm, a buyer has to provide detailed background information, sign a Confidentiality Agreement and provide complete financial documentation demonstrating the capability to perform an acquisition before any information is released. Unfortunately, many brokerage organizations take short-cuts during this process, eager to present a buyer.
Similar challenges exists on the sell side, requiring a thorough review of the company; a detailed interview conversation with the owner; an analysis of financials; and a properly prepared third party appraisal. Only such detailed preparation ensures that there are no surprises later on— for either side.
Once a transaction has closed, there are various post-transaction risks. On the buy side, there is obviously the risk of failing once a business has been transferred. Such failure can be due to external or internal factors.
For example, on the external side, if customers of the business have not been serviced properly and slowly started migrating to a competitor a few years prior, then the seller will have to “double up” in order to maintain customers. As a matter of fact, a change in ownership could actually be the best remedy for the business at that time. Potential other risks could include pending lawsuits, tax exposure or lack of ownership, particular, as it relates to intellectual property questions.
“Some of these external issues have been successfully addressed by introducing buyers to a highly qualified attorney.” says Gary Herviou, Director Marketing, Central NJ and Lehigh Valley, “Additionally, the proper deal and legal structure can mitigate some of this exposure.” Most prominently, the discussion about asset sale versus stock sale comes into play here.
Internally, a buyer may find that he really does not like a (purchased) business after all, or that he is not qualified to run the business despite all previous research, due diligence, and excitement.
On the sell side, the risks are quite defined, too.
Most importantly, if there is a “seller note,” as is common for most transactions, the seller has a credit exposure. This risk can be mitigated by non-business collateral, such as the buyer’s private home or portfolio, however, no seller wants to incur the costs of litigation to recuperate some of the transaction receipts.
Nevertheless, the matter is even more complicated if there are contingency payments, such as licenses on gross revenues or earn-outs based on cash flow. Setting the obvious aside—namely, the required audit capability of the seller and the seller’s trust in the buyer that proper financials are reported—the seller clearly carries a significant exposure, and is ultimately dependent on the management capabilities of the new owner.
In sum, there are a variety of different risk exposures for both sides, pre- and post-transaction. A qualified merger & acquisitions advisor can certainly help each party to define some of these risks and create solutions to mediate the risk incurred between both sides, which is one of the reasons our firm has been closing deals for thirty years and takes a premier spot among M&A advisory firms, with many pleased buyers and sellers.