You have built and run a successful staffing business and now have decided it’s time to sell. Prospective buyers of your business are likely to be experienced in acquiring staffing firms and may even be a competitor; however, this is likely your first sale. What should you do to help level the playing field?
In this article, I address preliminary matters sellers should consider before beginning negotiations to sell. Then I provide an overview of the acquisition process.
Before beginning any discussions with a potential buyer, sellers should assemble and confer with an acquisition team consisting of its broker, accountant and acquisition lawyer to understand the value of its business; the business, tax and legal issues involved in the proposed transaction; and any alternative structures or solutions that may exist. After assessing its bargaining position, a “game plan” for the negotiations should be prepared. Since neither party usually gets everything it wants when negotiating, sellers should prioritize their goals to enhance the likelihood of getting what is most important.
The first considerations in preparing for negotiations are (1) what are the seller’s needs and goals, and (2) what is the seller’s bargaining position. For example, although obtaining the maximum price at closing for the business is always a priority, is it the seller’s highest priority? Are the seller’s owners prepared to stay on with the business after the sale is completed? Is the seller willing to accept a large earnout, or significant deferred payments that although “guaranteed” (not contingent on operation of the business after closing) may not be secured? Are the seller’s owners willing or desirous to retain an ownership interest in the business after closing. Is the seller willing to accept additional contingencies to the buyer’s obligation to close, such as the buyer obtaining financing for the purchase on specified terms and conditions, obtaining a favorable tax ruling on the sale, signing employment contracts with certain key employees, obtaining consents from customers and other parties for the assignment of all written contracts, and obtaining assurances of a continued level of business?
An analysis of the seller’s bargaining position is also an important preliminary consideration. Is the seller in a desirable niche market or does it otherwise have an attractive business mix, has it been experiencing rapid growth, does it have above average margins, is it sufficiently large (companies with annual sales in excess of $20 million are most attractive to larger buyers), does it have a sufficiently broad customer base (few or no dominant customers), does it have stable experienced management that will stay on after the sale is completed, in the IT space is its use of`corp-to-corp contractors a modest percentage of its overall consultant workforce, is it in an attractive (high growth) geographic area? Failure to sufficiently assess a seller’s bargaining position can result in not getting all that the business is worth, accepting terms that will increase the risk of the sale not being completed, or accepting terms that will increase the risk of not getting paid.
What are the principal issues a seller should address?
(a) Purchase Price. A seller needs to understand not only the dollar amount but what is being purchased. For example, a purchase price of five times adjusted pre-tax earnings may seem like a good price for the purchase of the business. However, if the buyer is also getting the net worth of the business, it will be paying a lower multiple for the firm’s goodwill (in an asset transaction, the seller often retains the current assets of the business, such as cash, accounts receivable, marketable securities and security deposits, as well as the liabilities of the business).
(b) Payment Terms. Terms include the length of time for any deferred payments, whether they are “guaranteed” or subject to an earn-out, and security for the deferred payments. Deferred payments are frequently for 1 – 2 years after the closing and are sometimes “guaranteed” and sometimes contingent on performance of the business.
(c) Financing Requirements. One of the first things a seller or its representatives needs to determine is whether the prospective buyer is financially “qualified” – does it have the current ability to pay for the deal from available cash funds, existing lines of credit or authorized shares of stock (if the buyer will pay for all or part of the purchase with its stock). If financing must be obtained by the buyer, a seller needs to assess the likelihood of the buyer being successful in obtaining the financing, the time delay that may be entailed, whether it is worth proceeding in light of the risk that the buyer may not be successful, and, if so, what conditions should be requested.
(d) Structure. Staffing acquisitions generally involve either the purchase of stock (or membership interests in the case of an LLC) or assets of the seller. The structure to be used is usually determined (at least initially) by the buyer, depending largely on tax and liability concerns (in a stock or membership interest purchase, the buyer receives all of the assets and inherits all of the liabilities of the seller’s business). Despite the additional risks involved, buyers frequently purchase stock or membership interests when acquiring larger staffing firms, since fewer consents are needed from third parties and immediate onboarding of staff and temporary employees/consultants to a new entity is avoided, allowing for a simpler and quicker transaction.
Stock or membership interest purchases have become increasingly popular in recent years with the increased presence of private equity buyers who generally will require the seller to retain a 20% to 30% ownership interest after closing, and with the use by sophisticated buyers of tax elections (such as Section 338(h)(10) of the IRS code in the case of a stock purchase and Section 754 of the IRS code in the case of a membership interests purchase) which allow the buyer to treat the purchase of stock or membership interests as the purchase of assets for tax purposes and obtain a step-up in basis of the seller’s assets.
Asset deals are currently preferred by buyers of smaller staffing firms because the buyer can purchase only those assets that it wishes to own, and generally assume only specific liabilities of the seller that it wishes to assume. In addition, based on current federal tax laws, a buyer of assets can step up the basis of the assets purchased and then write off over 15 years the goodwill of the staffing firm it purchases. This can mean a significant tax savings for the buyer, since the largest component of the purchase price of a staffing firm is generally its goodwill (the amount by which the purchase price exceeds the book value of its assets). However, if the seller is a “C Corporation” for tax purposes, selling assets can result in additional corporate level taxes that would not be incurred if the shareholders sold stock. In that case, a seller will need to negotiate either to cause the purchase to be structured as a stock sale or to structure the sale so as to minimize the corporate taxes.
(e) Closing Contingencies. Will the closing contingencies be limited to standard terms (such as that all representations about the seller’s business be true at closing and that there have been no material adverse change in the business since the purchase agreement was signed), or will the buyer ask for significant additional contingencies?
(f) Employment or Consulting Agreements for Shareholders or Members. If the shareholders or members are to continue with the business after closing, employment or consulting agreements for –two to five years are frequent. Apart from base compensation, a seller should explore what incentive compensation can be obtained. A buyer reluctant to offer a greater earnout in the purchase agreement where it will be written off over a 15-year period and not contingent on the shareholders’ or members’ continued employment or consulting services, may be willing to offer part of it in an employment or consulting agreement where the shareholders or members are at risk of not receiving the additional payment if their services are lawfully terminated by the buyer, and the buyer can expense the payments as paid.
(g) Non-Compete, Non-Solicitation and Non-Raiding Covenants. After closing, the shareholders or members will be required not to compete with the buyer, not to solicit or do business with customers of the business, and not to solicit, hire or engage employees/consultants of the business. Such provisions are generally for –three to five years and within some geographic area surrounding the location of the seller’s business. As with most issues, the length and scope of these covenants are subject to negotiation.
These issues can be more successfully negotiated by the seller before agreement in principle is reached, when the buyer is reaching for commitment and everything is negotiable.
Selling a staffing firm is a complicated transaction. To properly structure an acquisition, as well as to minimize the risks throughout the acquisition process, it is essential for a seller to use legal counsel, brokers and other professionals with substantial acquisition experience in the staffing industry, and to consult with those professionals before commencing discussions with potential buyers. It is easier, and ultimately less expensive, to structure a transaction properly from the start than to try to correct a poorly negotiated transaction.