Cold, hard cash. There’s really nothing better. That feeling as it enters your bank account is tough to beat, as the reward for your life’s work is finally in your hands. Provided it wasn’t deposited with Silicon Valley Bank, you can now relax.
The exact opposite feeling is experienced in a share-for-share deal, as anyone who sold their business to the likes of EOH or Steinhoff will tell you. The latest capitulation on the JSE is Transaction Capital, a company that was a darling of the South African market until this week. Not the darling, as there are a handful of companies in that category.
Despite the existence of market commentators who magically develop perfect hindsight after something like this, it’s not so easy to see these things coming. Owning shares in another company is always a risk, especially when you don’t have all the details of everything going on.
In the same way that the buyer of your company goes through an extensive due diligence, a share-for-share deal means you need to do the same on their business.
That’s not always possible or practical.
Should you always say no to shares?
There’s a lot to unpack here.
These are some of the things that you need to consider:
- If you play hardball for a 100% cash deal, will the entire thing fall over?
- Can you negotiate a higher price that is part-shares and part-cash, which gives you the cash amount you would’ve been happy with anyway, leaving the shares as cream on top?
- Are there good strategic reasons for the businesses to belong together, and are you willing to be part of that journey?
- Taking this deal out of the equation, would you be willing to buy shares in that company and part with cash for them, at the same valuation at which they are being offered to you?
That last point is critical. Acquirers tend to favour share-for-share transactions when their valuation is simply too high and they know it. Companies want to issue shares at premium valuations and buy them back at low valuations.
If the share-for-share structure is being pushed hard, then you need to ask yourself why. If the buyer thinks it’s a great deal, then it probably isn’t a great deal for the seller. There is an unavoidable conflict of interest here.
Sometimes, a share-based deal can be made to work for the seller. It can be used as a negotiating tool when it comes to earn-outs, as the seller might be willing to accept a higher proportion of shares, but only on an accelerated basis. Remember, an earn-out is a structure that delays the payment of the purchase price to the seller based on certain milestones being achieved. This is designed to reduce risk for the buyer.
And that’s the entire point – a battle to manage risk
When accepting shares, the biggest risk is that the value collapses and you’re left with decorative share certificates and a lot of broken dreams. Aside from a two-way due diligence and getting experts to help you understand that company, the best way to manage this risk is simply to have a mechanism that turns the shares into cash as soon as possible.
In a private deal, this would take the form of a put option. It gives you the right to force another party to buy your shares at a predetermined price and at an agreed point in time. It’s easier said than done to negotiate this (and to actually receive payment), so share-for-share deals in the private space are highly risky even with the best advisors on your side.
When selling to a company whose shares are listed on a stock exchange, the seller has a much better chance of turning them into cash. There may or may not be a lock-up period, after which the shares can be sold on the open market.
Don’t forget the tax
Be sure to discuss the deal with a tax advisor before you sign it. The very last thing you need in this world is a huge tax bill and no cash available to settle it! Remember, even if you are paid with shares, value has changed hands and this is a taxable event unless there are specific exclusions available (which do exist).
How can we help?
Our service offering is constantly evolving, as we find new ways to bring our corporate advisory experience to founders who haven’t had access to these services before. We are particularly excited about bizval bootcamp, a highly interactive session that is designed to identify areas of weakness in your business before you go into a due diligence process.
As part of a bootcamp, we can also discuss various exit options with you and explain some of the key concepts that you’ll come across. In some cases, we might even be able to introduce you to a potential buyer!