larry gennari

Five Common Deal Mistakes to Avoid

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By Lawrence Gennari

This has been an historic year for M&A and has many companies and management teams wondering whether an exit next year might be in the offing. As strategic planning for 2017 continues, decision makers planning for an exit should avoid five common mistakes in the process.

  1. Forgetting to do due diligence on your own business. How will your business look to a potential buyer? Every sale or financing starts with due diligence and that means corporate books and records and significant contracts should be in good order. Now is the time to complete stock option or restricted stock grants, estate planning transfers or issuances long promised but not papered. In connection with new grants or stock awards, the Company may want to consider securing or updating a so-called 409A valuation of the business, to establish “fair market value” for tax purposes. Also, consider necessary changes to important contracts, leases or customer agreements. Better to negotiate those now, instead of during the compressed time frame of a contemplated sale.
  2. No Competitive Process. Separate from a tax oriented 409A valuation to set option prices, should the Company pay for an outside enterprise valuation now to get a sense of what’s “market”? Not necessarily. An overall “enterprise” valuation won’t necessarily tell the business owners what a company is worth. For that, you’d need a competitive process, most likely run by an experienced and practical investment banker with experience in your market segment. Many companies make the mistake of talking to only one potential partner or in reacting to an unsolicited term sheet from an interested party. Due diligence commences, negotiations quickly follow, and the team finds itself confronting the often difficult choice of status quo versus sale to one particular buyer. Remember: terms, conditions and equity valuations improve only in the context of a competitive process, with multiple suitors with terms sheets bidding against each other. The executive team should consider how to create such a process or meet with investment bankers who know how to make that happen.
  3. No Plan B. Resist the temptation to put off a needed management shakeup or customer contract price negotiations just to maintain the status quo. Projections for 2017 should include a go-it alone strategy, with realistic plans for personnel, marketing and cash flow, including any necessary equity or debt infusions to increase top line revenues for the longer term. Hope for a game-changing transaction is not a substitute for a real time operational and financing strategy. Chances are, finding and negotiating the right transaction will take months, especially if a competitive process is in play. Any team would want the leverage of continuing the business in the ordinary course while the auction/sale process is ongoing.
  4. Avoiding the hard questions in the letter of intent. The letter of intent will set out expectations for both sides as well as the parameters for continuing negotiation. In many cases, the sellers should spend a lot more time on two basic questions: (i) what is the purchase price and (ii) under what circumstances will I have to give some it back. Is the purchase price at closing satisfactory or is much of it dependent on earnout payments, which provide for contingent purchase price payments over time, the details of which still require negotiation? What are the indemnity obligations for any breach or inaccuracy of the sellers’ representations and warranties and are they capped, limited or do they survive the closing for a very long time? What are the terms of any continuing employment, including non-competes and severance? Sellers will save a lot of time and money if they invest the time hammering out these issues for the letter of intent instead of waiting until the deal is at the documentation stage.
  5. Structure matters. The Company should be engaging its accountants and lawyers about tax and structure planning now. What are the tax implications of the proposed deal structure? Next year’s tax code proposals could bring big changes and thoughtful structural changes now could yield significant efficiencies next year. Also, if the team is not familiar with “installment sale” structures, which provide for deferred tax treatment of sale proceeds, they should consult their legal and tax advisors and get up to speed.

Financial pundits are suggesting an uptick in corporate finance activity in 2017. A proactive exit planning strategy—and avoiding typical mistakes—will best position your company for what lies ahead.

Gennari is a partner at Gennari Aronson LLP and an Adjunct Professor at Boston College Law School where he has taught Mergers and Acquisitions, Corporate Finance and now a separate seminar “Advising the Entrepreneur.” He can be reached at lgennari@galawpartners.com.

Pitch Perfect

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Scott Berinato, author of the captivating book: “Good Charts: The HBR Guide to Making Smarter, More Persuasive Data Visualizations,” joined us on May 5 to talk about data visualization and how we all might make more compelling presentations, including via powerpoint.

Scott reminded us that today’s discourse, whether through USA Today, cable news or even billboards, often is an “argument of charts” and the President now uses charts in the State of the Union address.

Scott’s advice to presentation planners is to go back to “the fundamentals” of communication:

*We all love charts and brain science now confirms that we access and process information from shapes, images, tables and graphs at least as readily as words, if not more so.

*You are never NOT persuading in a presentation.

*Every chart is a manipulation of data to persuade and the actual visualization of information on a slide is the manipulation tool.

*Good Charts provides great practical examples of how to prepare data and charts to persuade and not simply inform.

*Context matters—the focus should be on what you are trying to say and how you consider that for every single slide.

*Don’t forget to think through how the chart will be displayed. Is the presentation in a small room or a ball room and will the audience be able to see and process your charts?

*We often judge charts based on font, colors, grammar and not necessarily substance in the first instance. Scott says “our brains react to pretty things.” Think primary colors and consider emphasis and isolation of words and phrases in charts.

Scott’s book is an easy and essential read for anyone who might be called on to present to a board, investors, or a potential strategic partner.

What we learned in 2015

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Welcome to 2016!  We are excited to bring you another year of insightful and informative events.  But, for anyone who missed some of our events of 2015, a few of the more popular ones are available for viewing through the links below.  Check them out!

Remix Strategy: The Three Laws of Business Combinations

Alliances, partnerships, acquisitions, mergers, and joint ventures are no longer exceptions in most businesses — they are part of the core strategy. As companies look to external partners for acquiring strategic resources and capabilities, they need a practical roadmap for ensuring these relationships generate value.

What’s In A Name?: Brand as Competitive Advantage

For companies large and small, across a variety of industries, brand is paramount. Learn about the latest social media, intellectual property, and other strategies for building and maintaining a brand.

The Science and Art of Compensation
The are myriad ways to structure compensation strategies that are motivating, rewarding, and good for business.  Learn about the variety components that can contribute to a plan and how to assess and create compensation plans for you team, advisors, and board members.

Crowdfunding: The SEC (finally) speaks……..but will anyone really care?

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Last Friday, the SEC released its long awaited proposed rules for crowdfunding or put another way: how to find investors online. The new rules and proposed amendments are designed to assist smaller companies with capital formation and provide investors with additional protections.

The final rules, called “Regulation Crowdfunding,” permit individuals to invest in startups via crowdfunding transactions subject to certain investment limits.  The rules also limit the amount of money startups can raise using the crowdfunding exemption, impose disclosure requirements on companies for certain information about their business and securities offering, and create a regulatory framework for the broker-dealers and funding portals that facilitate the crowdfunding transactions.

The rules would allow companies to raise $1M online through crowdfunding in a 12-month period by expanding the universe of investors beyond typical angel investors and those who otherwise are “accredited” within the meaning of the securities laws. In fact, under the new rules, people who never would have thought about investing in startups will be able to go online and invest their hard earned money in early stage companies and promising entrepreneurs.

So these rules will revolutionize the way companies raise seed and series A rounds, provide new and much-needed capital alternatives, bring the arcane regulation of securities into the 21st century, and allow companies to raise money faster and more efficiently than ever before all the while harnessing the infinitesimal power of the Internet—right?

Not so much.

  1. Fees. All transactions relying on the new rules would be required to take place through an SEC-registered intermediary, either a broker-dealer or a funding portal—and that means transaction fees. The rules don’t contemplate that companies will be selling securities to a new category of investors directly from individual company websites.
  2. Information Requirements. Companies that rely on the recommended rules to conduct a crowdfunding offering must file certain information directly with the SEC —including financials that are reviewed or audited by an independent accountant. They also must provide this information to investors and the intermediary facilitating the offering. On top of that initial filing package, companies relying on the crowdfunding exemption also then would be required to file an annual report with the SEC and provide it to investors. Compiling all that information, whether financial statements or updates for investors in a form appropriate for filing with the SEC, won’t be cheap, easy or fast.
  3. Unsuitable Investors. Companies undaunted by the additional time, expense, and information requirements of the new rule would be able to reach a new group of less wealthy and less sophisticated investors online and worldwide. Even investors with a net worth or net income of less than $100k will be able to invest.

 

What could possibly go wrong with that scenario?

Hmmm…..do companies that hope to attract institutional or strategic investment at a later round really want a large group of unsophisticated investors in their cap table? I’ll bet that the answer will be “no” for most promising companies.

Many successful companies get started with a few smart well-heeled investors who can fend for themselves in all matters financial while in turn attracting others like them. Finding and interacting with those potential investors in person, whether through an angel group or old-fashioned serendipity is far more effective than searching for random strangers with money online.

I wish the SEC would focus on how best to allow incentives for those angels themselves to receive commissions (for introductions to other angels) than on “democratizing” investments in early stage—and therefore—risky enterprises, but that is a post for another day……

In short, I don’t see the new rules changing much about the way thoughtful entrepreneurs go about developing a financing strategy, at least in the near term. We’ll hear much more about these rules in the days to come.   The new rules and forms should be effective in about six months.

Will your plan for angel funding fly?

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Even in these challenging economic times, angel investors can, and do, provide an essential source of funding for emerging businesses, often filling the gap between funds from friends and neighbors and a round of venture capital.  When considering angel funding, keep a few things in mind:

Once you’ve found a potential angel investor, how do you seal the deal? The answer to this question is as wide and varied as the angels themselves, and entrepreneurs should listen before they offer an angel transaction terms.  Most angels will lay out terms in up to three significant areas: control, dilution, or current value or return. An angel interested in control is hands-on and often demands a board seat, veto power over certain operational decisions and prompt disclosure of financial information. If dilution is the angel’s hot-button issue, he or she might want straight percentage or full-ratchet protection, understanding that these provisions may fall in a subsequent venture funding – but only after a negotiation with the angel. Alternatively, if the angel investor prefers convertible debt instead of equity, an option to convert the note at a discount on a subsequent round of financing (e.g. an additional 10 to 25 percent on top of principal and accrued interest) often is added.  Finally, some angels seek current returns – typically in the form of modest but regular cash dividends or percentages of revenues. The key for the entrepreneur is to match the rights and preferences specifically to the angel’s hot button – nothing should be given to an investor without a reason.

Where do you find an angel? Let’s start with the basics. Angel investors are high-net-worth individuals who invest with their hearts and their minds. This generally means that angels invest based on either a warm feeling about the entrepreneur – because of a personal or professional connection – or a good feeling about a market space or industry.  Savvy entrepreneurs probably know potential investors already, including former bosses, mentors or significant customer contacts. Those who are less connected or less experienced can find introductions to local angel groups through their accountant, lawyer or other advisors. Entrepreneurs also should identify local area angel investor groups, such as Launchpad Venture Group. Although these groups often require significantly more “due diligence” and majority approvals, businesses may attract the interest of one or more angel investors, even if the group declines to invest.

How much do they invest? Although the dollar amount invested varies widely, most angels invest between $50,000 and $250,000 individually and $250,000 to more than $1 million as a group. Many angel investors stagger their investments, putting some money in initially with the rest pegged to business or technology development milestones. In addition, many angels anticipate and like to participate in any subsequent venture financing rounds.

Are angels worth the hassle? Well, that depends on how you might define “hassle”.  Many angel investors are now requiring board seats, and that can be both positive and negative. Most people become directors for three reasons: to add value by virtue of their experience and contacts; to learn something as the enterprise grows; and to make money. Here the focus is on the latter. Angel directors can add value in the form of business contacts, operational experience or financing strategy. However, given the investment focus, an angel director also could end up being quite controlling with different and definite opinions on topics ranging from employee compensation to direct versus indirect selling. To this end, some entrepreneurs are building in term limits for angel directors right from the start as a condition of the investment.

Angels can and do fulfill an essential role in funding emerging businesses and are worth of consideration as a funding option.  But, the smart  entrepreneur should be certain to consider both the pros and cons – before accepting a check.