Private equity (PE) buyers offer business owners the option to sell part of their business while still permitting the owner to remain active in the company, and in doing so capture some future upside. Due to the nature of those transactions, business owners should consider key aspects to protect their interests. The following are five areas to carefully evaluate before making arrangements with a PE firm, along with some key questions to consider.
Assure Visions for the Future are Aligned
As the owner, you and the PE firm will be working together; therefore, you should understand the PE firm’s objectives and operating plan. Is it looking for a long-term investment or to sell in a few years? Will it fold your company into existing operations or will your company serve as the cornerstone for future expansions? What roles will you and your employees play in those future plans? Alignment of your mutual vision and goals with that of the PE firm is key for successful integration and a productive relationship.
Understand the Economics of the Transaction
While PE firms may offer a higher price, understanding the nuances of the structure and terminology is critical to evaluating your anticipated return on the transaction. Will the valuation be based on a historical value that may be relatively outdated when the transaction is consummated? Is there a mechanism for updating the purchase price if performance changes significantly? When will the purchase price be paid – at closing or over time? Will any part of the purchase price be contingent on future results and what level of control will you have regarding that performance? How will that future performance be measured?
If any of the purchase price is paid over time, will payments and security for that note be subordinated to a senior loan? What happens to that loan if the company is later sold, or if new financing is obtained?
From a tax perspective, will the proceeds be capital gains? Some transactions can be structured to preserve the “flow-through” nature of the equity you retain or “roll” into the new operations.
Understanding the economics up front helps avoid disputes that can break a prosed transaction.
Implement Satisfactory Governance and Employment Arrangements
Are there protections in place to help assure that you retain any management control, at least for certain matters? Will you and your key executives have employment agreements that provide severance protection if things do not work out? Will there be an incentive program, like equity options? These arrangements can help you continue to play an active role if desired and are fairly compensated for continuing to contribute to future success.
Rights Upon Exit
What rights will you have if there is a sale of some or all of the company? Does the PE firm receive its capital back first, and perhaps a preferred return, before you receive any proceeds? If the PE firm wants to sell its interests, will you have a right to “tag along”?
Seek Professional Advice
While every company sale is complicated, transactions with private equity are often significantly more complex due to the continuing ownership and operational involvement of the seller. It is prudent to have an experienced team of professionals, such as those at Jennings, Strouss & Salmon to guide you on the tax, financial, accounting, valuation and legal aspects of the proposed transaction. Getting that team in place before entering into negotiations with the PE firm can add significant value and help protect your interests.
Consideration of these and other critical issues can assist business owners with structuring a mutually satisfactory transaction with PE firms, speed up the transaction process, and facilitate a successful closing.
Richard Lieberman is chairman of Jennings, Strouss & Salmon’s Corporate, Securities and Finance Department. He has extensive experience in a broad range of business law issues, including mergers and acquisitions, securities, corporate governance, finance and banking, employment, executive compensation, bankruptcy and corporate restructuring, litigation and legislation.