What happens after the alarm deal closes?
By Victor Harding
Just because your deal has closed and you have received the bulk of your purchase price, you are seldom home free.
Most sellers will have the following concerns that are part of almost every deal:
1. Honouring the reps and warranties contained in their agreement;
2. Living up to the terms of the non-compete or non-solicit that are part of most deals;
3. Collecting on the rest of your purchase price.
My advice to sellers about reps and warranties contained in the purchase and sale agreement is to have a good lawyer working for you. They will weed out any rep or warranty that is unreasonable.
Regarding the non-compete or non-solicit almost all sellers have to sign on their deal, this clause is important to the buyer and a reasonable request. Some buyers get overzealous in the scope of the non-compete and need some push back. I personally like non-solicits for sellers better than non-competes because they are more specific about what the seller cannot do, i.e. approach any customer that they sold to the buyer. However, buyers tend to use non-competes more than non-solicits. When all is said and done, I have not had problems develop with deals where I have acted for the seller.
As you might expect, the area where the real issues develop is No. 3: getting paid the rest of your purchase price. Some sellers are lucky enough to get 100 per cent of their purchase price at the closing. This does not happen often, although, in my experience, more often in the sale of guard or fire companies than alarm companies.
If you have not been paid 100 per cent up front, the remaining amount fits into one of three categories all of which have risks attached:
Vendor take back (VTB)
As a seller, you willingly agreed to take part of your purchase over time after the deal closes. VTBs are often done because the buyer did not have all the cash available to pay for 100 per cent up front. Lots and lots of deals are done with VTBs. Technically, the only thing preventing you from being paid with a VTB is time. As the seller, neither you nor your company has to perform in any way to get paid the VTB. Some VTBs come with interest paid on them; others with no interest. VTB can range from 10 per cent of the total purchase price all the way to 40 per cent and can be paid out over one to five years.
But let there be no doubt: VTBs represent risk to the seller. Sellers and their advisors need to look at the buyer’s ability to pay and their track record on other deals. Having the right to get your assets or shares back in case of non-payment is obviously desirable.
Earn-outs are often used in deals to help bridge a purchase price gap between what a buyer is willing to pay and what a seller wants. They can make up anywhere from 10-25 per cent of the final purchase price and usually are paid out over the first two years after the deal closes.
I am personally very cautious about the use of earn-outs and I avoid them where I can. If an earn-out is the only way to get the deal done, then big issues sellers have to pay attention to is, on what basis will the earn-out be paid, and will the company being sold be run in a manner similar to how it was before it was acquired. I strongly recommend basing any earn-out on the simplest variable possible such as revenue only. Where I see earn-outs used most of the time is by private equity firms. It is their way of making sure the owner stays involved and also to help meet the firm’s return on equity on the deal.
Occasionally, a buyer of shares of any kind of company will ask for a small holdback (five per cent) to cover off the possibility of undisclosed liabilities attached to the purchase of the shares. Here we are referring to items like more HST owing than originally planned. As the buyer of the shares is taking on all future liabilities of the company, such a holdback is reasonable as long as it is small in size, short in duration (three to six months) and defined specifically.
As most of you know, holdbacks of 10-20 per cent for a period of a year are very common in the sale of monitored accounts. It is just the way deals in the alarm industry are done.
The holdback is designed to protect the buyer from a large number of account cancellations in the early going. I personally think holding back more than 15 per cent in an account base sale is unreasonable unless the buyer has real reason to believe that the attrition is going to sky-rocket — in which case I have to ask why they bought the account base in the first place.
There are some steps sellers can take to protect themselves on attrition holdbacks such as attrition buy downs. The important point to note for sellers here is seldom will you get 100 per cent of your purchased price paid up front.
Buyers will use any one of these well-established tools to pay the seller out. Each of them presents their own risks. The show is definitely not over most of the time when the deal closes. But the issues can be managed with good legal, accounting and M&A advice.
Victor Harding is the principal of Harding Security Services.