Column: Does the sale of a company have to be a zero-sum game?

by Dean Nordlinger, partner, PilieroMazza PLLC

In every sale-of-the-company transaction, there is a seller and buyer. But, that does not mean the sale transaction has to be zero sum game in which there must be a winner and a loser.

A sale transaction is a journey and process, not a sprint. On the journey, there are transaction hurdles which frequently cause some ups and downs and are tricky issues to sort out. Typically, in order to overcome transaction hurdles and successfully close the sale transaction, both parties must be willing to engage in a bit of “give and take.” Otherwise, the sale transaction likely will stall and die on the vine. In fact, some people say the tell-tale sign of a successful sale transaction is one in which post-sale both parties are a little bit dissatisfied with the outcome.

With that said, let’s use the following sale-transaction summary and look at a few examples of transaction hurdles to see how a seller and buyer might craft a win-win outcome.

Sale Transaction Summary

• The parties have signed a letter of intent and are engaged in exclusive negotiations.
• Seller owns 100% of a company named TargetCo, which is for tax purposes an S corporation.
• Total sale transaction consideration is equal to $35 million
• $25 million cash at closing, $5 million in escrow, and $5 million earn-out which is payable if TargetCo achieves certain financial metrics post-sale.

Example 1: TargetCo Misses Its Financial Projections

In the course of performing its confirmatory due diligence, the buyer determines that TargetCo is not tracking to its original revenue projections due to the loss of a key task order under an ID/IQ contract and also due to some of the seller’s awarded work being put on hold due to budgetary constraints and uncertainty.

From the seller’s perspective, the purchase price should remain the same because the the loss of one task order should not devalue TargetCo and there are still significant revenue opportunities; also, TargetCo should get full credit for the delayed revenue.

From the buyer’s perspective, a portion of anticipated TargetCo revenue will not be captured, and the delay on awarded work raises questions about both TargetCo’s growth prospects and TargetCo’s financial forecast.

Rather than kill the sale transaction, perhaps the seller and buyer could move forward by agreeing to share in the risk of the changed circumstances, as follows: keep the purchase price at $35 million but reduce the cash at closing, for example, to $21 million and increase the earn-out to $9 million. In that way, buyer could backload more of the purchase price and not overpay for value it may not receive; and seller could still receive the $4 million, albeit backloaded, if certain financial metrics are achieved post-sale.

Example 2: TargetCo Litigation Liability

A couple years ago, TargetCo entered into a teaming agreement with one of its competitors to partner on a procurement. The prospective partnership fell apart, and TargetCo joined forces with another third-party company and won the procurement. TargetCo has been earning significant revenues from this awarded contract. The former teaming partner (Competitor) believes TargetCo engaged in foul play and six months earlier initiated a $5 million law suit against TargetCo.

From the seller’s perspective, the purchase price should remain the same because Competitor’s claims are completely baseless, and the law suit therefore presents no real risk to the overall value of TargetCo. From the buyer’s perspective, the buyer is not responsible for the seller’s preexisting dispute with Competitor; there is no guarantee Competitor would not prevail if the lawsuit ran its full course; and it will cost significant dollars to defend the suit if it is not settled.

Rather than kill the sale transaction, perhaps the seller and buyer could move forward by agreeing to share in the risk of the changed circumstances, as follows: the buyer believes the worst-case value impact on TargetCo would be $2 million, so keep the purchase price at $35 million but reduce the cash at closing to $23 million and increase the escrow to $7 million, using the additional $2 million in escrow to fight or settle the litigation going forward post-sale. In that way, the buyer could backload more of the purchase price and not overpay for value it may not receive, and the seller could still preserve substantially all or some portion of the $2 million if and once the law suit is settled or finally determined for $2 million or less.

Example 3: Buyer Wants an Asset Sale, Seller Wants a Stock Sale

For a variety of business and tax reasons, the buyer would prefer to purchase the assets of TargetCo, whereas the seller would instead prefer that buyer purchase the outstanding stock of TargetCo.

Rather than kill the sale transaction, and with TargetCo being an S corporation, perhaps the seller and buyer could move forward by doing a stock sale but, for tax purposes, treating it like an asset sale. In that way, both parties’ interests could be achieved. And, often there is a way for buyer to enjoy a stream of income tax benefits from this transaction structure, while at the same time making the switch tax neutral to seller.

Summary

In sum, there are no perfect sale transactions. Sale transactions involve allocating risk between seller and buyer. Sale transactions need not be a zero-sum game. Most issues can be negotiated to a viable resolution. As seen above, win-win solutions can be fashioned to overcome transaction hurdles and successfully close a sale transaction.

Dean Nordlinger is a partner with PilieroMazza PLLC and heads the Business and Corporate Law Group. For over 25 years, PilieroMazza has helped businesses successfully navigate legal matters including government contracting, litigation and labor, employment and corporate law. Visit www.pilieromazza.com.

EXCLUSIVE INSERT: Top 100 SDVOSB opportunities in FY2016 and beyond

Will there be a shutdown again?

WOSB sole-source in effect Oct. 14

Federal contractor survey shows ups and downs

Column: Does the sale of a company have to be a zero-sum game?

Washington Insider: