March 2012 FEI-Louisville Newsletter
BUYING HALF OF A BUSINESS
Ernest W. Williams
Stoll Keenon Ogden PLLC
It may sound mathematically-challenged, but buying half of a business may be twice as hard as buying a whole business.
Several business strategies may lead to a partial business divestiture – a desire to withdraw from a particular product line or type of business; a decision to leave one geographic area; or, a decision to sell some brands in order to concentrate efforts on other brands that are being retained. An example is Yum! Brands selling its Long John Silver’s and A & W restaurant brands, allowing Yum! to focus more on its other brands.
What constitutes a “complete” business will be in the eye of the beholder. A collection of business assets that one suitor views as the ideal complete package, may be viewed by another bidder as having excess assets, while a 3rd prospect views it as lacking needed functions.
A purchaser’s due diligence skills will be tested in a partial acquisition, beginning with developing a comprehensive understanding of what is not being sold, determining whether the purchaser’s existing business has the ability and capacity to handle the missing parts of the acquired business or whether additional assets or personnel must be added in order to operate the acquired business.
Many parent holding companies may have separately organized subsidiary entities that use personnel or facilities of the parent or of other entities within the larger corporate group. Among functions often centralized and not held in the subsidiary or division to be divested are:
Another part of due diligence that will be more difficult is the review of financial information. Even though the seller-parent’s financial statements may have been audited, in many cases the divested business unit will not have separate audited financial statements. Allocation of costs among internal units – immaterial to the consolidated entity – may not have undergone thorough scrutiny. Both the seller and the buyer will need to anticipate the additional time and expense that is likely to be spent by both of them and their advisors in order to sufficiently review, understand and be comfortable with financial data.
Hopefully, the seller will have anticipated most significant financial issues and gathered necessary information in advance to streamline the process.
Careful planning will be required for dealing with employees, especially those whose duties affect both the divested business and the retained business. There may be friction between the parties regarding which employees have the best relations with important customers or other key talents.
If the buyer already has sufficient personnel to operate the divested business, then the seller will likely be faced with the expense of terminating some of the employees. All other things being equal, a seller will view more favorably the offer of a bidder that will result in fewer employees being terminated.
If the seller needs employees to stay with its retained operations, then the seller may expect that it will be required to provide the services of those employees to continue their functions for the purchased business during a transition period long enough for the buyer to hire and train new employees of its own to fill those positions.
The seller faces a double risk if certain employees leave during the transition period. The seller needs their services for its retained operation and also needs to provide their services to the buyer during the agreed post-closing period. The seller may wish to adopt a bonus or retention plan for such employees to give them a special incentive to stay with the seller and to also satisfactorily perform for the divested unit. The buyer will also want to make sure that incentive programs remain in place during the transition period, especially for those “shared” employees involved in sales.
Once it is decided which employees will be retained by the seller and which will transfer to the buyer, either or both parties may want to require a nonsolicitation covenant from the other party – that is, an agreement not to hire away each others employees in the applicable business unit for an agreed period of time.
Assignment of Contracts
In virtually every acquisition, attention is directed to the issue of whether contracts include provisions prohibiting assignment or allowing termination in the event of a change of control. In a carve-out transaction, these concerns are heightened.
An important vendor may supply both the divested business and the retained business. Even if the contract may be freely assigned, this would not allow the buyer and seller to divide up the contract in whatever manner they may desire. Negotiations with the vendor will be required by one or even both of the buyer and seller. If the prices under the contract are favorable to the business (e.g., prices are below current market), then the transaction may result in increased costs to both the divested business and the retained business.
Software licenses and other information technology are another example of contracts that may require extensive negotiations with 3rd parties in order to split up the business.
If the seller retains production assets that are necessary for the divested business and the buyer does not already have production capability, then a continuing supply arrangement will need to be negotiated, at least for a sufficient period for the buyer to establish its own production or contract with a new supplier. This can be a particularly ticklish situation if the buyer is retaining operations that compete with the divested business.
A motivated seller who is interested in maximizing the sale value must recognize that it will need to remain involved in the business in some manner for a reasonable transition period in order to provide the buyer with comfort that there will not be a material hiccup in the business after closing. These are not situations in which the seller can cut all ties at closing.