Executing the deal –Seller’s perspective
Understanding the M&A lifecycle
Signing the deal to buy or sell a company is often the most memorable moment for those involved in an M&A transaction. However, even though a lot was accomplished by signing, the deal is not yet done by then; after signing closing procedures need to be executed. After the first celebrations the Seller, especially in the case of a completion accounts mechanism, will need to continue to be involved to ensure the deal value is maximized. The previous steps of the M&A lifecycle all impact this phase. In this article we will take a closer look at the execution of the deal – as seen from the Seller’s perspective.
A smooth transition
The share purchase agreement (‘SPA’) for your business or a part thereof has been agreed and signed with the Buyer. At this stage, the Buyer and business that is going to be divested should start preparing for the post-merger integration. In our earlier article we have already described what this means for the Buyer - for instance, when it comes to regulatory limitations. So, for you as a Seller is it time to sit back and relax? Not quite. - There are a number of major points of attention, preparation activities and actions for you as well. Loyalty of the management team of the business may already start to shift to the new owner. A smooth transition from you to the new owner, as well as the value you eventually receive for the deal, depend on this stage.
Inform the Buyer of your business
Understandably, the Buyer expects that the business is being run as usual until closing. As a matter of fact, this is usually specifically included in the SPA. But as much as this makes sense, it can be a little tricky – for you. For instance, between signing the deal and its execution, there might be a need to decide on discretionary spend on marketing. Best practice is to provide updates to the Buyer of your business on a regular basis and be transparent and fair, without being naive.
Controls over reporting of the disposed entity after signing
Also, you must ensure that SPA-specific items are tracked and substantiated where necessary. Often there is a capex settlement included in the purchase price mechanism. If such a mechanism is included additional tracking of the capex spend and related balance sheet positions is highly recommended. Additional scrutiny from the Seller to ensure these qualify under the settlement mechanism can benefit the proceeds from the sale. Even if there is no settlement mechanism included for capex it is beneficial to have additional controls over capex. New investments in e.g. machinery will most likely not be to your benefit, as the future positive impact on production and /or reduction in maintenance costs will not be for the benefit of the Seller and you may rather retain that cash.
We note that in certain instances management of the business which is divested (target) already feels part of the new structure, and can be eager to please the new owner, at your expense.
Purchase Price Determination
As we have described in previous articles, there are two main mechanisms to determine the final purchase price: completion accounts and locked box. Completion accounts are based on the financials of the acquired business at (a future) closing date, whilst for locked box accounts financials at a date in the past are used. It is important to monitor what has been agreed in the SPA, and to make sure that you track and have supporting information for these balance sheet positions. Closing can also have an impact on e.g. transfer pricing updates and charges which are often performed once a year during year-end. The impact of breaking up fiscal unities and the determination of taxable result for each entity in the fiscal unity up to completion, can also result in discussions; especially in a locked box mechanism.
In case of a completion accounts mechanism, the financial statements at closing are the starting point for the closing accounts. The completion accounts can be prepared by the Seller or the Buyer. As management of the divested business is part of the Buyer’s organisation after closing, it is, from a Seller’s perspective, recommended to have the completion statements prepared by the Seller.
At closing/ completion, the financials that serve as a basis for the completion accounts should be prepared with the same rigour as when performing year-end closing procedures for the preparation of the annual report. It is essential that the finance and tax teams are instructed to plan and perform year-end procedures on closing date. Especially for the tax positions this can be quite a challenge, since tax cycles usually run from January to December and substantiation of deferred positions or contingencies is usually not performed on an interim period. To be able to adhere to the deadlines as stipulated in the SPA it is recommended to perform a dry run of the closing to ensure all departments involved are aligned on the requirements needed at completion.
Based on our experience an audit of the statements is usually not required, the statements are not communicated to third parties and only require an agreement between the Seller and the Buyer. To ensure the statements are prepared in accordance with the SPA and that sufficient support is obtained to substantiate the balances. Often a third party is hired to ensure a smooth process, usually this is a team from the vendor due diligence provider.
If Buyer and Seller agree on a locked box pricing mechanism, a fixed price is determined based on the balance sheet of the (target) company at an effective (economic ownership) date prior to signing date. Since the locked box mechanism constitutes a delay between economic transfer and payment for the transaction, the Buyer usually has to pay interest over this period to compensate you for the delayed payment (or alternatively put, for the cash flow generated by the business from effective date up to closing that is for account of the Buyer). On the other hand, you, as the Seller, need to compensate the Buyer for leakage of value that may have occurred in this period. Leakage is part of the definitions in the SPA and relates to money that flows to the Seller in the period of Buyer’s economic ownership; an obvious example is dividend. After all, this will affect the Buyer’s cash flow. To avoid discussions after closing, it is crucial to keep in mind what has been agreed upon in the SPA concerning leakage and to build in controls long before the transfer of the company, preferably starting at the locked box date. A final note on the locked box mechanism: usually, due diligence will have been performed before this date. But if not, the Buyer will most likely need the relevant audited accounts.
Just a few thoughts we wanted to share around the execution of a deal from a Seller’s perspective.
The M&A cycle in a nutshell
Below we have embedded a picture of the M&A lifecycle and a short description of each phase. We have published a series of articles on each step of the M&A lifecycle, sharing stories and thoughts about each of these phases of the M&A lifecycle to offer you insight in the entire process and help you benefit from the promised returns of a deal. In the lifecycle we will emphasise the integration of your steps and actions, and what might happen if you deal with every step in isolation.
Identify the Right Deal. Either through active selection of companies or business units, or by reacting to offers in the market (one-on-one or by auction). This phase involves setting corporate strategy, identifying growth areas or selling non-core activities.
Pricing and offer. Initial pricing of a company and assessing how easy or difficult integration or separation is going to be, as well as which legal and tax structure will be most suitable (and its impact on pricing).
Perform due diligence. What do we buy? It is crucial to assess the real value of the company, the presence of ‘skeletons in the closet’, financial aspects such as balance and cash flow as well as non-financial analyses (e.g. company culture, integrity, operational synergy benefits, and operational analysis of real estate).
Execution. After the due diligence phase, a Sales and Purchase Agreement is drafted, the relevant authorities are informed and consulted, and the ‘closing’ procedures are executed.
Deliver the Promised Returns. After the transaction has been completed, the expected results must be achieved – how to realise synergies and to prevent that in a future strategic re-assessment the new business will be considered as a non-core activity and be resold (without any added value).
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