Mergers and Acquisitions

Portrait of Father and Son EntrepreneurIf you sell your family-owned business to a private equity buyer, the buyer will most likely pay a portion of the purchase price with equity in the buyer’s new company, rather than with cash. The equity that you receive in the buyer’s new company in exchange for a portion of the equity in your existing business is commonly referred to as “rollover equity.”

Rollover equity stakes typically range from 10 to 20 percent of the buyer’s new company. Rollover equity is beneficial to the buyer because it reduces the cash portion of the purchase price and aligns the seller’s interest with the success of the new company.

While the rollover equity component reduces the amount of cash that the seller receives at closing, rollover equity can also benefit the seller. If the equity rollover is structured properly, the seller will not pay tax on the value of the rollover equity until there is a future sale or liquidity event with the buyer’s new company. Rollover equity also gives the seller a potential “second bite at the apple.” If the buyer grows the acquired business (either organically or through additional acquisitions), the seller will participate in the future growth of the business and will profit from a future sale or IPO of the new company.

In our experience, private equity buyers may also allow family-business owners to hold their rollover equity in a trust or a family limited liability company or partnership, which creates opportunities for future gifts and estate planning.

It is important to carefully consider the rights and restrictions that will be attached to your minority equity position in the new company. For example, your rollover equity may be in the form of common equity in the new company, while the private equity buyer owns preferred equity with financial and governance rights superior to yours. There also will be restrictions on your ability to transfer your equity in the new company. In addition, the buyer will likely have “drag-along” rights that will enable the buyer to require a sale of your rollover equity in a future sale or liquidity event approved by the buyer (even if you don’t like the deal).

While there are a number of tax, corporate and estate planning issues to consider and negotiate, including a rollover equity component in the sale of your family-owned business can be mutually beneficial to the buyer and the seller.

How Much Should I Expect to Pay An Investment Banker To Sell My Family-Owned Business?In our last blog post, we highlighted the benefits of retaining an investment banker for the sale of your family-owned business. As you might expect, investment bankers do not work for free. In today’s blog post, we outline the typical fee structure for a middle-market investment banking firm that you might retain in the sale of your business.

Investment bankers typically charge a success fee or transaction fee, along with a retainer fee. The success fee is usually a percentage of deal value. The deal value includes the amount of cash and the fair market value of securities or other assets that you receive in the sale (and would include, for example, the amount of debt of your business that is assumed or paid off by the buyer at closing). Deal value also customarily includes the amount of any installment note payments, releases from escrow, or earnout payments made by the buyer after closing, but you should not pay a success fee on post-closing payments unless and until the payments are actually made by the buyer.

The percentage of deal value may be fixed (such as 2 percent or 3 percent), but can also be structured as an adjustable, formula-based success fee where the percentages change at certain amounts or “break points.” For example, the success fee might be structured as 1.5 percent for deal value up to $20 million, 2 percent for the portion of deal value in excess of $20 million up to $30 million, and 3 percent for any portion of the deal value in excess of $30 million. The success fee is typically subject to a minimum fee that the investment banker must be paid at the closing. In our experience, the minimum success fee usually required by experienced, middle market investment bankers is $500,000-700,000.

Investment bankers try to lock in the success fee and protect themselves against your terminating their engagement before the closing occurs. The engagement letter will likely include a “fee tail” period that remains in effect for nine to 12 months after the engagement is terminated. If you terminate the engagement before closing and then later complete a transaction on your own (or with another investment banker) during the fee tail period, you will still owe the success fee to the first investment banker. You may be able to negotiate certain exceptions to the fee tail. For example, the investment banker may agree that the fee tail applies only to buyers that the investment banker contacted about the deal during the engagement.

Investment bankers customarily require payment of an up-front retainer fee when the engagement begins. The retainer fee is generally non-refundable, but should be credited against the success fee due at closing. In our experience, the typical retainer fee ranges from $50,000-100,000 in middle-market transactions. You will also be required to reimburse the investment banker for out-of-pocket expenses.

While the success fee, the retainer fee, the fee tail period, and the expense reimbursement are common elements in almost every engagement letter, you should remember that the dollar amounts, percentage amounts, break points and many other terms in the engagement letter can and should be negotiated. If properly structured, the engagement letter terms will motivate the investment banker to help you achieve your goals in the sale of your family-owned business.

Should You Hire An Investment Banker To Sell Your Family-Owned Business?Yes. In almost all circumstances, the buyer (whether a strategic buyer or a financial buyer) will have more financial resources and will be more experienced in buying and selling businesses. Retaining an experienced and effective investment banker will help you level the playing field.

If your goal is to maximize price, you need to get as many offers as you can and take the highest one. You will not achieve the highest price without a competitive process. An investment banker should know your industry and the best potential buyers. The banker should get to know your business well.

With your help, the banker will prepare a confidential memorandum (or “book”) about your business, including historical financial information, financial projections, and information about operations and customers. The investment banker will then contact and solicit offers from as many potential buyers as possible and then help select a smaller group with the best potential to close on the best terms for you. If the banker knows your industry well, the banker should already have a short list of potential buyers for your business before the engagement begins.

In our experience, though, good investment bankers do much more than just identify potential buyers and then wait until closing to collect a fee. They also:

  • assist with financial modeling;
  • propose and analyze different transaction structures;
  • analyze and compare the offers from different potential buyers;
  • help to manage unrealistic expectations about price and other deal terms;
  • organize and manage the seller’s due diligence disclosures (typically through a virtual, on-line “data room”); and,
  • once a buyer is selected, assist the seller and its counsel in negotiating the definitive acquisition agreements.

Negotiations with a potential buyer can be heated at times and involve some degree of posturing by both sides. A good investment banker can also serve as a buffer between you and the buyer, either helping to defuse tensions or, in some cases, acting as the “bad guy” on your behalf. Having an investment banker to act as the bad guy during negotiations can be especially helpful if you will be required to work with–or for–the buyer for some period of time after closing.

It can be challenging to run your business and manage the sale process at the same time. The sale process may take up to 12 months. You will better serve your business if you stay focused on management and day-to-day operations and let an experienced investment banker run the sale process for you.

Please stay tuned for our next blog post: “How Much Should I Expect to Pay My Investment Banker When I Sell My Family-Owned Business?”