In designing the livable definitive purchase arrangement, there are often matters likely to extend to a period beyond closing, which require thoughtful definition and planning, in advance of solidifying the agreement. This article is intended to discuss a handful of pertinent post-closing residual matters, and to explore the ways that a departing seller may protect his interests, for those post-closing time periods after sale is complete.
Minority Stock Ownership
One fairly common element of a sale may involve the selling shareholder being asked to retain a minority percentage of stock. This most commonly occurs when the buyer is an equity fund, and when the owner is asked to continue to hold some portion of stock, either as he remains employed, or potentially as he continues to consult on an ongoing basis for the entity. Common mechanisms to consider include:
Identification of the potential future timing for the seller to be “bought out” is typically arranged ahead of time in the basic purchase agreement. If the seller is employed, the parties may agree that the seller’s retained stock will be repurchased if he ceases employment. (Or, in some cases the seller may have the option to call for such buy-out when he leaves, or he may allow it to remain invested.) For such buyout it is important in advance to establish how such stock repurchase would be priced, and what the timing would be for payment. Pricing would usually be established at the date the seller employee gives notice, and such pricing might tie to a fixed multiple of then current earnings, usually similar to the multiple which was paid by the buyer for the base purchase at the outset. (This way the seller can benefit from increases to value since the date of sale.)
Timing for value calculation may be based on a rolling 12 months before the trigger event, or it may be an annualized YTD tally, or it might even roll back to the last completed year end for the company.
Calculation of such imputed “value” may specifically exclude impacts of certain buyer-dictated elements, such as payments to a parent entity, or other unusual costs or revenues not believed to fairly impact value for the retiring seller.
Timing for payment should be specified relative to the notice date. Such payments may be allowed to be made over a period of a year, or even two or three years forward from the date of seller exit. Interest amounts and timing for their payment would of course be specified also.
Certain other protections for the seller who retains stock post close should be inserted to protect value. We would normally fight hard for stipulation that there shall only be one class of stock, until the seller is fully bought out. The owner (or buyer) who may devise multiple categories of stock can easily circumvent the seller holding a residual interest, if desired. Thus it becomes critical to ensure that no superior “class” of stock can take precedence and offer shareholder benefits that the seller does not participate in.
Sometimes a seller may find a minority stock holding adversely impacted by future acquisitions. If a highly desirable acquisition candidate is identified, the buyer may find it “worthwhile” to offer that new seller a disproportionately large ownership. We have sometimes arranged, in anticipation of such situations, a provision stating that any new additions of ownership are prohibited without our seller consent. Or the buyer (now majority owner) might need to offer repurchase of seller minority residual before consummation of a deal which would dilute our seller.
Debt retained by exiting seller
Sometimes sellers may be willing to allow a portion of their purchase price to be financed by them, for the buyer. In those cases, details are needed for interest rates, payment terms, and timing for repayment, before acceptance of such proposal.
Additionally, other elements may be required by the seller, to ensure reasonable risk assumption regarding the debt agreed. Exited seller shareholders will generally finance only a portion of the debt undertaken in the purchase, and senior lenders or other investors will fund portions of the debt. Seller retained debt may be protected to some extent in forward operations, by limiting additional debt to be incurred in any position senior to the seller’s notes, or by prohibiting add-on acquisitions until the original seller has been repaid.
Sellers may even retain security collateral interests in certain assets to further ensure repayment. Such security interests would need to be for assets not pledged to banks or other lenders. (We have seen situations where company excess land holdings were pledged as collateral to sellers, or where certain sorts of intangible assets could be used to collateralize and protect seller debt.)
Bonus commitments to seller shareholder employees
Often sellers who remain as employees of a buyer may have some portion of their compensation paid on the basis of some bonus arrangement. In those instances, matters to consider and delineate to offer seller/employee protection might include:
If bonus tally is to be based on earnings, specify that no other related party (buyer benefit) expenses are to impact seller income tally for bonus.
If further or add-on acquisitions are to be considered, it may be appropriate to exclude all unusual non-operating costs of such activities from tally of any bonus.
If bonuses may be added for other employees, consider omitting those from bonus tallies for seller bonus from ongoing operations.
Rental of real estate by seller to ongoing acquired entity
In some cases, the seller owner may hold real estate separately and lease it to the acquired company on an ongoing basis. Those arrangements can be sensible and livable for the seller, but we suggest consideration of certain “protections” for the seller lessor.
Lease term will often be established based on an expected reasonable time period for the entity to thrive and grow in current space. However, it is also prudent to request longer term notice, for when the buyer owner may decide to depart for other facilities. We generally suggest a minimum of a 6-month notice for any such change.
If there are major building modifications that are required by the buyer, lease terms should clearly stipulate seller consents required, to ensure that the seller can protect reasonable building utility for life after.
While certainly not all inclusive, these are a handful of the issues we commonly see which should be satisfactorily resolved in advance of final acceptance of any proposal. We try to ensure that total seller exposure for all deferred payment matters don’t exceed 20 or 25% of aggregate pricing, in any case. If total pricing is strong, higher amounts of deferred pieces may be more tolerable, but all such deferrals are invariably at risk. If the price wouldn’t have been adequate without those benefits, the seller needs to be acutely aware that they are taking real risk by acquiescing to large deferrals.