You finally decided to sell your label company (your baby), retained an intermediary, and an offer was made and accepted. You are now under what is known as a Letter of Intent (LOI). Hopefully, that is the stage in the process you are in (ie: under LOI); if not, please call me.

I used to think being under a LOI was 75% of the way to a closing, but I am not sure any longer. It is perhaps only 50% depending on how much the terms of the LOI were negotiated and agreed to prior to signing. The balance of this column will assume for the moment that you and the buyer had successful negotiations and got most of the salient points of the transaction committed to writing (ie: the LOI).  

You have now entered the phase of the transaction called Due Diligence (DD). According to Merriam-Webster (an actual dictionary for those under 50), due diligence is: “The care that a prudent person would exercise in the examination and consideration of facts and circumstances to avoid harm.” 

In a business context, DD specifically refers to the “research and analysis of a company or organization done in preparation for a business transaction,” like a merger or acquisition. The process involves investigating a company’s finances, operations, and legal standing to ensure it is as represented before sealing a deal. 

WARNING: The DD phase of the sales process will be very painful to Type-A entrepreneurs, which includes the vast majority of owners in the Wonderful World of Print. 

Up to this point (pre-LOI stage) you most likely produced fairly high-level information to (hopefully) several prospective buyers in an effort to entice at least one of them to make an offer leading to the LOI. It is now time for the buyer with whom you signed the LOI to look-under-the-hood, so to speak, and ask a great number of additional questions.

Prior to signing the LOI, you and the buyer were just dating. The LOI is equivalent to being engaged. You are now getting to know one another much better, and it will hopefully lead to the buyer’s attorney producing an Asset/Stock Purchase Agreement (or marriage). 

Most M&A transactions that our boutique consulting firm sees are purchases of the assets the company (“C” or “S” corporations or LLCs) and not the actual stock. This is because the buyer will not want to expose itself to prior liability, as well as being able to step-up the assets for depreciation (ie: tax saving) purposes.

At this point, you will hear that your transaction will be done on a cash free/debt free basis. What this means is that you get to retain the cash on your balance sheet but be expected to deliver the company’s assets on a debt-free basis. In other words, you will have to pay off any debt on the books, either at or prior to closing. 

Total consideration for your transaction

Component #1 of your consideration for the sale of your label business is the purchase price the buyer has agreed to pay. This can either be in cash (cash is king!), a seller note, or possibly a contingent earnout. 

Component #2 of your consideration for the sale of your label business is being able to retain the cash on your balance sheet. While this concept may be a given to most reading this column, you know that when you were running the company that you could not deplete all the cash. Many sellers do not view this as consideration, but I personally feel consideration is everything you either retain or receive, including cash retained.

Component #3 of your consideration for the sale of your label business will be the most difficult and that is the amount of working capital that you will be expected to deliver to the buyer at closing. This is where a lot of money can either be made or left on the table.

Investopedia defines working capital as a company’s short-term financial health measure, calculated as the difference between its current assets and current liabilities. It represents the capital a business has available to cover its day-to-day operations and short-term debts such as paying suppliers, rent, and interest within one year. For purposes of this column, we will only use pure working cap defined as accounts receivable plus inventory minus accounts payable. I have seen the following used in our over 300 transactions during the past 38+ years:

1. Seller retains his/her balance sheet: Seller retains A/R, buyer pays for inventory (most often as used over 12-month post-closing) and A/P. The net becomes consideration.

2. Seller delivers a 1:1 ratio of A/R to A/P and buyer pays for inventory as used over the 12-month post-closing. Any excess becomes consideration. 

3. Buyer wants to compute the average amount of working capital over either the Trailing Twelve Months (TTM) or the Trailing Twelve Quarters (TTQ).

Just getting to the amounts in #3 can be an exercise itself. And then when you do, sometimes that amount is more than should be delivered to the buyer at closing. Keep in mind that the more working cap you deliver to the buyer, the less goes in your pocket as consideration. Usually the working capital target is fixed. If not in the LOI, then it will be in the APA and subject to adjustment 90 to 120 days post-closing. If the amount delivered at closing is less than the target, it will be deducted from the amount held back (hopefully in escrow) at closing. If the amount delivered at closing is more than the target, then it will be added to the hold-back/escrow. It is a good idea for sellers to manage their balance sheet from the time the LOI is executed until closing to make sure the working cap amount is at least somewhere close to (or even less than) the target. A good intermediary firm will help you with this calculation and can basically mitigate the transaction fee you will have to pay them during this single step in the process. 

Component #4 of your consideration for the sale of your label business will be your physical facility, assuming you own it privately and lease it to the company. If the building is currently an asset of the company (along with equipment, etc.), you should talk to your CPA and/or attorney about getting that off the balance sheet and in a separate legal entity right now. (They should have encouraged you to do that prior to this anyway.) If you own the building privately, when was the last time you had it appraised? Which should have included Fair Market Rent (FMR). There is money to be made or lost here.

If all of this sounds a bit complex and frankly beyond you, you are not alone. You are an expert (well almost) at running your label company, but the sales process is uncharted waters for you. You will need sound sage advice from your CPA, attorney, and an intermediary experienced in the sale of label companies to get the most money for what will likely be the biggest sale of your life.

Jim Anderson is the Founder & President of Scottsdale, AZ-based Corporate Development Associates (CDA). CDA is a boutique Merger & Acquisition consulting firm that has focused 100% on the printing industry since 1987. Website: www.printmergers.com. Contact Jim via email: janderson@printmergers.com or cell/text: 602-432-0426