Sharing the Risk in M&A

I sold a business in 2022.

One of the best pieces of advice that I got going into the M&A process at that time was to approach the negotiating table from the perspective of "sharing the risk".

What does this mean?

Well, at its core M&A is just about getting a deal done.

One party is selling a business. The other party is buying that business.

First, there is a kind of funny dance you do to put a value on the business. But really all you're doing is justifying a price for the bundle of assets that make up the business as a whole. Customers, employees, cashflows, IP, etc. etc.

And then you sit down together so the buyer can attempt to poke as many holes in the deal as possible, and the seller can convince the buyer the deal is a good one.

Lots of things come up as contentious points of discussion:

• How much working capital to leave in the business
• Customer retention risks
• Employee retention risks
• Accounting agreement
• Executive compensation
• Incentives & commissions
• How to divvy up the assets
• Where the money goes
• Mitigating legal risks
• Lowering the price
• Raising the price
• And so on and so forth

This is where 'sharing the risk' comes in.

For example, with employee retention.

Let's say only a few key people know the business is being sold.

The buyer will say, 'well, your employees are a major asset to the business. We want to be sure they won't leave after we close the acquisition.'

And for various optics reasons, the seller may not want to tell everyone the business is being sold.

With a fixed mindset, as a seller you might say 'no, I don't want to do that'.

And a fixed mindset buyer might say, 'deal or no deal'.

And you have to agree on guaranteeing employees will stay, or dropping the requirement.

But with a mindset to 'share the risk', you have room to negotiate.

You say, 'I completely understand you want to be sure that business continues as usual. Let's find a way to share the risk.'

And so you might agree on something like:

• Structure part of your earnout to be contingent on a few key employees staying for at least 6 months post-close, but not all.
• Announce the acquisition to the team after the deal has been negotiated and finalized but before it's signed to get general buy-in but not hold up the deal for retention guarantees.
• Make the deal contingent on key executives signing employment agreements with the buyer before the asset purchase agreement is signed.
• Plan new employment contracts to be sent for signature to employees right after close.

...and that is the art of sharing the risk.

As a seller of a business, I found that very helpful.

As a buyer, the same principles apply

In due diligence you are looking for reasons to turn down the deal if it doesn't check out.

And you want to push for good terms with the seller:

• Putting more money from the purchase price in an earnout vs. cash on close.
• Guarantees and protections in case problems happen after the acquisition.
• As much money in working capital as possible.

All of these things are asks you push the seller to begrudgingly accept through negotiation.

Approaching the conversation to 'share the risk' is a helpful mindset!

It's an honest and transparent way to negotiate that puts you together on the same side of the table.

And it aligns incentives between buyer and seller so that you both are operating the business in the same direction.

Recently, I helped a founder sell his business. The buyer set an earnout target of $xxx,xxx additional free cashflow above levels at close.

Later, I spoke with the founder again. He had closed a large deal that hit the earnout target with multiple months left in the earnout period.

He was shifting focus to other business ventures because he could make more money there.

Sometimes it's all too easy to forget... it pays to be on the same team

Why do sales executives get compensated so much? Sometimes even more than the CEO?

Well, they bring home the bacon.

Show me the incentive, and I'll show you the outcome.

You may be counterparties in M&A but there are ways to align incentives.

Especially around sharing risk.

When I sold my agency business we originally talked to 35 interested buyers.

There was a huge range of deal structures that came out of that.

One buyer wanted to put in place a massive performance earnout structure that would have tripled or quadrupled the purchase value if we hit it.

Another buyer bid under the valuation we floated but guaranteed more cash and certainty.

Others wanted different concessions and benefits and considerations.

So I thought about the sale of the business less as a singular, one-time event, but more of a point in time where we reset the opportunity on the table for all the equity holders, and took a few chips off in the process.

Sometimes equity gets rolled over in acquisitions.

But this is just one possible structure for the beautifully infinite ways that a deal might be done.

A friend of mine who's very good at enterprise sales once advised me to look for as many angles on a deal as possible:

• Get commission up front
• Get a percent on the back-end
• Get performance upside
• Get paid to do the deal
• Get advisory fees
• Bring your companies in to service the deal
• Etc. etc.

So in one deal you end up with 4 or 5 different revenue streams in the form of various commissions and incentives adjacent to the deal.

And the lenses to use to find your deal angles, is sharing the risk.

Everyone likes to no-risk pay-for-performance: 'only pay if we get results'.

Everyone likes risk protections: 'don't pay if there are problems'.

So with the right ways to share the risk, an elegant win-win-win deal can be done.

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