Seller's delight

Given the state of the economy, it is no surprise that many companies have turned to strategic reviews of their business models and the divestiture of certain assets or brands. Today's sellers face an economic crisis, unavailability of external financing, the collapse of investment banks, unmotivated private equity firms, unreliable strategic buyers and market uncertainty. In these tough economic times, the most important step in facilitating a successful strategic disposition is to select the right buyer.

The most important step in selecting a buyer is to set up a clear, streamlined and efficient auction process that will result in bids that are easily comparable. Bidding procedures must set a calendar with concrete deadlines, including the bid-package due date, the auction date (if applicable), the date on which the winning bidder (and, if applicable, backup bidder) will be selected and other relevant dates. The seller should list requirements of a bid package and criteria for a qualified bidder, and state that bids that fail to meet deadlines or lack required components may not be considered.

At a minimum, bid-package requirements should include a cover letter describing the proposed transaction structure; sources of external financing, financing commitments or agreements with co-investors; the level of buyer due diligence to be completed prior to signing; additional closing conditions the buyer would impose; a proposed closing date; and any other information necessary for the seller to evaluate the proposed bid. A package should contain an electronic markup of the form of purchase agreement (and any other transaction documents) provided to potential buyers, in a condition that the buyer would be willing to sign without further negotiation if the seller accepted all changes.

If practicable, it is most efficient to have buyers run their due-diligence review parallel with the auction process so that most buyer due diligence is completed before the bid submission deadline. Sellers typically use online data rooms for the due diligence review by prospective buyers.

Sellers must work with advisers to determine priorities for evaluating bids. Closing the deal is often more important than getting the highest price. Sellers should consider not only the proposed consideration but also the likelihood of consummation. Sellers must review bidders' purchase agreement markups for red flags indicating a lower certainty of closing, such as requirements for third-party financing or consents. The lure of a high price should not blind sellers to the objective of getting the deal done at an acceptable, if not the highest, price. Sellers must analyze all monetary components to get the full economic picture -- buyers can offer a high purchase price but include other mitigating factors, such as uncapped indemnity obligations or requiring an unrealistic amount of working capital or inventory to remain in the business post-closing.

Finally, a transaction's proposed structure may have profound tax or accounting effects on its economic value. Bottom line: if a proposed purchase price seems too good to be true, it very well may be.

Sellers typically rely on lawyers to evaluate issues presented by bidders' purchase agreement markups and to communicate those issues to the business team. The purchase agreement provided to bidders is typically very seller-friendly; however, bidders often return buyer-friendly mark-ups. This means that the seller is asked to provide increased representations and warranties, tighter covenants and less favorable indemnification provisions with lower baskets and higher caps. Often, additional restrictions are placed on how a seller can run its business pre-closing and what such a seller can do post-closing (e.g., through noncompete and non-solicitation provisions). Small changes to the purchase agreement can result in significant shifts in the economics and risk profile of the proposed deal. Getting a higher purchase price but having the increased risk of paying significant indemnification claims, or not being permitted to compete post-closing in a lucrative area because of a noncompete, may make a particular bid less attractive than it initially appears based on purchase price alone.

To effectuate a successful auction, sellers must make their expectations clear to potential bidders and work with their advisers to get a complete picture of each submitted bid, including the total economic package, the associated risks and the certainty of closing. Often, a careful look at these factors will lead to a transaction that closes at an acceptable price and with an acceptable risk profile.

James A. Grayer is a partner and Jodi Rosensaft is an associate in the corporate department in Kramer Levin Naftalis & Frankel LLP's New York office.