What to know about M&A for founder-led businesses

October 2022 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

October 2022 Issue

For many founders, the decision to sell can be bittersweet. The excitement of a significant, potentially life-changing payday and the gratification of taking a company from formation to exit are often in conflict with anxiety over how the business will be operated post-closing and the extreme stress, time and expense of the deal process.

For acquirers of founder-led businesses, the opportunity to participate in the next stage of a company’s growth can sometimes feel burdened by a process that, with less deal-experienced founders, is subject to unnecessary procedural steps and delays.

M&A transactions involving founder-led businesses can present a number of special challenges for both sides of the deal. Below are a few key considerations, from the buy-side and the sell-side, for M&A transactions involving founder-led businesses.

Buy-side considerations

Work to reduce asymmetry. Most founders have dedicated the overwhelming majority of their professional time to creating, growing and operating their business, and comparatively little time learning about the process, nomenclature, market dynamics and other elements of M&A dealmaking. As a result, when it is time to sell, founders can feel overwhelmed by the numerous, burdensome processes required to prepare for and complete a deal (quality of earnings reports, creating the confidential information memorandum, management presentations, legal and accounting diligence, letters of intent, transaction documents, ‘redlines’, representations and warranties insurance, and more), much of which may be completely foreign to even the most savvy and experienced of founders.

While it is critical to maintain momentum in every deal, when on the buy-side, consider whether to try and reduce the ‘experience asymmetry’ that may exist in a transaction. Taking the time, in advance, to discuss typical deal processes and the reasons for their existence with a founder can often be beneficial for a buyer; it can build rapport and trust, helps founders to better direct their advisers and, in the long run, helps perpetuate momentum by demystifying the deal process and avoiding roadblocks that can be caused when founders are surprised by an unexpected element of the transaction.

Understand the founders’ motivations, including non-economic motivations. Of course, the primary drivers of most deals are purchase price and deal certainty. However, in contrast to institutional sellers, founders may have additional considerations that need to be addressed. For example, it may be important for the founder to maintain non-economic ties to a business, for instance as a director or with a different ceremonial title. Though potentially problematic, a founder may also have other legacy considerations, such as children who participate in the business, a company email account or philanthropic endevours related to the business. A founder may have particular concerns relating to post-closing treatment of employees, company culture and the future direction and purpose of the business.

Buyers should consider speaking candidly with founders about their thoughts on the company’s post-closing operations. Not every desire of a founder can (nor probably should) be considered or satisfied, but a healthy, robust and honest dialogue can help parties to come up with creative solutions and mitigate the risk that unexpected material issues arise later in the deal process.

Do not be afraid to ask difficult questions. In most non-distressed M&A transactions, a buyer will justifiably be focused on a strong record of financial performance and a path to continued growth and upside. Circumstances permitting, most buyers will spend significant time and energy understanding the drivers of a business from a financial and human resources perspective.

But where a founder is involved and emotionally invested in the business, buyers and their advisers can sometimes be reluctant to ask difficult questions about potentially sensitive topics. A buyer should ensure that it understands, and press its advisers to understand, how any change in the roles, responsibilities or influence of the founder will affect the company after closing. For example, does the company have an appropriate leadership and reporting infrastructure that is likely to withstand and thrive through and following the change of control? If the founder’s non-economic interests were relevant to the pre-closing operation of the business, would changes to the influence of those interests have adverse effects on the company post-closing? Does the founder have other economic or non-economic ties to the business that should be severed or amended in connection with the closing?

Sell-side considerations

Determine core principals. As a corollary to the need for a buyer to understand the founders’ motivations, founders should take the time, prior to initiating a deal process, to consider their own priorities for the transaction. In addition to purchase price, founders should take time to consider all of their economic and non-economic goals for the transaction and be prepared to articulate them clearly to their advisers and potential buyers.

Founders often make assumptions about the transaction, the post-closing operations of the business, and their role in it. For example, they may assume they will be able to continue representing the business after the closing or have unfettered access to company facilities, employees or resources. However, to the extent certain titles, access or perks are important to a founder, she or he should communicate that to the appropriate advisers or, where appropriate, the buyer.

Get advice on advisers. Founders without much M&A experience are often unaware of the types of advisers they need, or may benefit from, in connection with a sale process. Founders are often tempted to use advisers with whom they have a historical relationship or are otherwise directly or indirectly familiar.

Unfortunately, not infrequently, founders choose advisers who do not have the experience necessary to provide the type and quality of advice required to execute the deal in a timely, cost-effective way. Inadequate advisers can significantly hinder or delay deal processes, and ultimately add time, risk and expense for all parties.

Founders should consider seeking advice from multiple, experienced parties about the various types of advisers needed to properly execute a deal and take the time to interview multiple potential providers in each discipline. In addition, get advice on how to interview each category of adviser, including what questions to ask and the bases on which a founder should choose an adviser.

Ultimately, the familiar choice may be the proper choice. Even if so, a robust selection process will help educate the founder on the proper roles and responsibilities of the advisers and validate the embedded adviser as the appropriate person for the job.

Use advisers to their maximum utility. Each adviser in an M&A transaction serves a relatively clearly defined purpose. It is important to ensure that the adviser is devoting sufficient attention to fulfilling its specific purpose. In addition, founders should be reticent to ask their advisers to perform tasks that are outside their respective areas of expertise or competence. Founders should take time to understand the abilities, strengths and limitations of each of their advisers and use them appropriately as and when beneficial in a deal.

Once advisers are selected, founders should also challenge their advisers to clearly explain the deal process, expectations for the business, legal, accounting and tax positions of the buyer, and areas for potential friction and dispute. Founders need to accept ‘market practice’ as sufficient justification for adverse terms and should feel empowered to question their advisers’ assumptions about what is possible, appropriate and feasible with respect to any issue or deal term that arises.

In summary, acquisitions of founder-led businesses may present challenges that other M&A deals do not. By encouraging candid, robust dialogue between and among parties and their respective advisers, and working to understand the economic and non-economic motivations and needs of the counterparty, buyers and sellers can help to ensure a smooth, efficient and ultimately successful deal process.

Christopher D. Ahn is a partner at Proskauer Rose LLP. He can be contacted on +1 (310) 284 5656 or by email: cahn@proskauer.com.

Christopher D. Ahn

Proskauer Rose LLP