The Finishing Touch: Post-Closing Priorities in a Business Sale

By John Zayac, CBI

No two business sales are alike. However, as wide-ranging as IBG’s 1,200-plus successful closings have been, they typically follow six key steps:

1. Assess the business and its market.
2. Package and prepare the business for sale.
3. Market the business to top buyer candidates.
4. Maximize value through a controlled auction process.
5. Close the transaction.
6. Provide post-closing assistance to our client.

While steps 1 through 5 predictably generate most of the excitement, in many deals it is the “boring” one – post-closing assistance – that provides another opportunity for IBG’s advisors to differentiate themselves from the competition.

A major part of our job is to anticipate, before the sale closes, issues that might arise after closing, to ensure that (a) they are clearly spelled out in the purchase agreement and (b) their post-closing impact is minimal or can be avoided altogether.

In general, post-closing tasks encompass a broad range of action items – financial adjustments, legal and administrative cleanup, and addressing residual conflicts – to achieve a clean deal, promote business continuity, enhance the success of the new owner, and ensure that the deal fulfills the seller’s major objectives.

KEY POST-CLOSING ISSUES

In our experience, within that broad range of issues, a handful of high-priority post-closing matters consistently surface:

• working capital reconciliation;
• escrowed proceeds;
• earnouts;
• ensuring that the parties have capable professional advisors;
• transaction bonuses; and
• transition service agreements.

For the purposes of this article, I asked two of my IBG colleagues, managing partners Tim Atwell (Colorado) and Matt Frye (Oklahoma), to add their perspectives on some of the most common post-closing issues.

Working Capital. In negotiating price in a business sale, the buyer and seller typically agree on a net working capital target (or peg) that serves as a historical benchmark for determining the amount of net working capital (NWC) that will be transferred from a seller to a buyer at the closing. An estimated NWC amount is agreed to at closing, but a reconciliation, or “true-up,” between the estimated and actual totals, must be performed post-closing.

To the extent there is a gap between the estimated and actual amounts, the purchase price will be adjusted, up or down, to ensure that the purchase price reflects the true financial position of the business at the time of sale.

“A working capital reconciliation occurs in nearly every deal, generally about three to six months after the close,” notes Matt Frye. “While the term ‘net working capital’ suggests a combination of cash on hand and current receivables and payables, for some types of businesses it also includes inventory. One of our recent deals involved a post-closing inventory audit, and we helped the seller through that process.”

Our role in this step normally begins in the early stages of the deal, when we help the seller negotiate a realistic NWC “target” with the buyer. That process can involve many variables and questions; for example, exactly what will be the formula for calculating actual working capital, and how will we define current assets, current liabilities, and inventory quality?

Our involvement continues after the closing, when we help facilitate the true-up process. If the reconciliation leads to a dispute between the parties, we are prepared to work with our client’s accounting and legal advisors (or facilitate introductions to advisors if needed) to protect our client.

Escrowed Proceeds.  Placing in escrow a portion of the purchase price is another method by which the parties can address uncertain or changing conditions.

“In nearly every IBG transaction, a percentage of the price is held back in escrow to ensure that the conditions of the purchase agreement are met,” says Tim Atwell. “Then, as benchmarks are reached, seller representations and warranties are confirmed, or debt balances become more certain, the retained funds are released at the appropriate time.

“One such scenario might involve capital projects that either were completed during the pendency of the sale, or were incomplete on the closing date. Before and after the sale, we may need to help the parties agree on how they will allocate overhead, labor, materials, value, etc., based on the percentage of completion.

“In all cases,” Tim emphasized, “we work hard to minimize the size of the escrowed amount and to make the hold-back period as certain and short as possible.”

Earnouts. Post-closing issues can also arise when the seller agrees to take a portion of the purchase price in the form of an “earnout.”

As my IBG colleague Gary Papay (Pennsylvania/North Carolina) explains in his article, “Earnouts: Bridging the Gap in Price Negotiation,” an earnout involves a “certain future dollar amount that the buyer agrees to pay to the seller based on the performance of the business after the transaction is completed.”

An earnout requires careful planning (pre-close) and post-closing tracking of the agreed-upon financial benchmarks to protect the seller’s interests.

Professional Advisors.  Success for buyer and seller in each of the three above categories – working capital adjustments, escrowed proceeds, and earnouts – requires having a solid team of professional advisors across accounting, tax, and legal. Adding payroll, HR, sales tax, and technology – including software integration – to the list of potential post-closing issues, one can quickly see why IBG advises all clients to have an experienced and cohesive team of professional advisors (across a variety of disciplines) ready to hit the ground running before and after the closing date.

With thousands of successful business sales and post-closing transitions across the country, we maintain an active database of professionals that have shown their ability to function effectively in the crucible of a major deal and preserve its value.

Transaction Bonuses. Another post-closing item that should be addressed pre-close is planning for any “transaction bonuses” that a seller (or in some cases, the buyer) intends to pay to key employees as part of closing, to motivate them to stay with the company and maximize its value.

Such bonuses are normally paid at the time the deal closes, and they can be structured as a percentage of the sale and/or a fixed amount, paid in a lump sum and/or in installments.

In many deals, these bonuses are spelled out up front, and both parties are aware of it; in others, the seller wants to keep that arrangement private. We encourage our clients who plan to pay transaction bonuses to make the buyer aware of the arrangement early, as a matter of transparency, and to ensure that the buyer is aware of any terms and conditions that might affect these employee relationships.

Transition Service Agreements. Under a transition service agreement (TSA), the seller agrees to provide the buyer with specified services for a defined period of time after the close, affording the buyer time to integrate the business and achieve a smooth transition.

“A request for a TSA usually originates from the buyer,” Tim Atwell observed. “It offers a layer of protection that the acquired company’s business systems and operations will continue as normal, and the buyer will be able to utilize the company’s existing infrastructure, during the initial integration period. Many of the buyer’s systems may not be up and running on day one, so a TSA helps to bridge this gap period and support a successful transition for both the business and the team.”

OWNERSHIP TRANSITION: OUR ROLE

Many M&A firms place a high emphasis on easing the ownership transition by introducing the new owner to employees, customers, and suppliers. At IBG, we typically get involved in that process only if invited.

“Most of our buyers are experienced in that process, and they have their own approach,” said Matt Frye. “If we have a role at all, it is to accurately portray the seller and the buyer as the heroes of the transaction, to help them communicate to the employees and managers that, under the new owner, the sale will be a really good growth opportunity for them professionally and financially.”

Matt’s comment includes a very important word: opportunity. At IBG, creating opportunities is our unifying purpose – opportunities for sellers to take their newly achieved liquidity and pursue something new and exciting; opportunities for buyers to take a good company and make it (or the buyer) stronger; and opportunities for the company’s employees to grow and prosper under the new ownership.

Over our long history, IBG’s 1,200-plus transactions have an 86% closing rate – more than three times the national average for our profession – backed by our tenacity in seeing successful deals through to their ultimate conclusion. To explore how we can help you pursue new opportunities for the next chapter in your business career or personal life, contact an IBG Fox & Fin M&A professional.

John Zayac is a co-founder of IBG Business and managing partner of IBG’s Mountain States / Pacific Northwest region.