We’ve come to the end of our 7-part series on selling an emerging growth company, and now it’s time to seal the deal. The closing is the crucial final step in the sale, where ownership of your company officially changes hands.
The actual closing is a fairly straightforward affair, and not unlike the closing of a real estate purchase. Two main things will happen. First, the finalized deal documents, signed by all relevant parties, are exchanged. The signing may take place at the closing, but in some instances, the documents may be signed ahead of time. Second, the buyer pays the agreed purchase price to the seller. Once these two things are done, the business officially belongs to the buyer.
As simple as that may sound, there are some final details that can prevent your closing from going smoothly. Before the deal is completed, you need to work out the following issues.
Getting Third Party Consents
Needing to get the consent of a third party can throw a major wrench into your plans to sell. In order for the sale to close smoothly, you need to have determined in advance what third parties will need to consent to the transaction.
The type of third party that most often needs to consent to a merger or acquisition is a counterparty to a contract of the selling company. As part of the sale process, you and your lawyer will need to go through the contracts of the business and determine which will be transferred as part of the deal, and for each transferred contract, whether the consent of any third party is needed. In many circumstances, contracts are freely assignable, meaning that they can simply be transferred to the buyer as part of the sale.
There are two chief exceptions to this rule:
- when the contract has an anti-assignment clause or
- when there is regulatory issue that prevents assignment.
The way the sale is structured can also have an impact on whether third party consents are necessary. If the sale is structured as an asset sale, then an anti-assignment clause will require consent of the counterparty, unless there is an exception in the clause for an assignment that is part of a sale of the business. If the sale is structured as a stock sale, then in most cases an anti-assignment clause will not trigger a consent requirement unless the contract defines a sale of equity as an assignment. In addition to anti-assignment clauses, some regulated industries prevent the transfer of contracts unless the consent of the counterparty has been obtained.
Once you have determined which contracts require consent to assign, the next step is then to contact those parties with whom those contracts were made, and obtain their consent to the assignment. While this may sound tedious, a failure to do so could derail your closing. In any event, it’s crucial to do thorough due diligence of all your third-party contracts to determine what third-party consents are necessary.
In addition to contractual counterparties, for some industries and for certain large deals, regulators must consent to the transaction. If the target belongs to a regulated industry, there is a good chance the regulatory license or permit cannot be transferred without the consent of the regulator who granted the license or permit. In addition, transactions larger than approximately $80 million may require notification of Federal Trade Commission and the Antitrust Division of the Department of Justice.
Post-Closing Escrows, Earnouts, and Purchase Price Adjustments
Even though you’ve likely settled on the purchase price long before the closing, that may not be the end of the story. There are certain adjustments to the purchase price that occur at closing, soon after closing, or a few years after closing that have great impact on whether you receive payment for the full value of your business. Here are a few of them:
- Purchase Price Adjustments. It may be necessary to make adjustments to the agreed purchase price at the time of closing, or even afterward, to account for any changes in the financial condition of the company. This is meant to ensure that the buyer pays the correct price for the business. If there’s a lengthy pre-closing period during which the business does better than anticipated, pre-closing adjustments may be called for to reflect the change in value of the company. Post-closing adjustments can be necessary for many reasons, including prorated expenses, or changes in the value of accounts receivable and inventory at the time of closing.
- Earnouts. Some deals involve earnout arrangements, in which the buyer agrees to pay extra after the closing if the company achieves certain pre-set performance targets. Earnouts are most common in cases where the parties struggle to agree on the value of the company or the business is expected to grow significantly after the closing. Startups and emerging companies can often benefit from earn-out arrangements.
- Escrows. If the parties agree, a portion of the payment price may be held in an escrow account for the purpose of paying post-closing price adjustments or potential indemnification claims. Any escrow funds not used by an agreed-upon expiration date will be paid to company’s stockholders.
While the whole process leading up to the closing can leave you feeling exhausted, it’s all worth it to make sure that everything goes off without a hitch. If you take the time to address all your potential loose ends in advance, you’ll be able to breathe easy at the closing and enjoy the culmination of all your hard work.