Chapter 16

Knowing What to Expect on Closing Day

In This Chapter

Rounding up the closing’s participants

Executing the actual closing

Considering working capital adjustments

After the due diligence is completed and the purchase agreement finalized, closing time is nigh. Closing the deal occurs on a day called, ingeniously enough, closing day, where both parties sign the agreements and the money changes hands.

Although this setup seems simple and pretty straightforward, failure to be prepared can cause unexpected problems. When you’ve gotten this far, the last thing you want is to have the deal fall apart at the last minute because of a lack of planning.

In this chapter I introduce you to a day in the life of a closing: what happens, what to expect, and how to successfully close a deal.

Gathering the Necessary Parties

In the olden days (you know, before the advent of the Internet), closing day meant lots of people gathering in an office, signing a boatload of documents, perhaps haggling over last-minute details, and exchanging the money.

Today, most if not all closings are virtual, meaning they occur by fax and e-mail. Each party gathers in its respective lawyer’s offices, signs what it needs to sign, and faxes/e-mails the signature pages (not the full documents) to the other side. The lawyers assemble the documents, confirm everything is in order, and make the instructions to wire the money.

Then it’s done. The deal is closed.

Representatives from Buyer and Seller (that is, the owners and executives of both companies) are present at a closing, along with lawyers for both sides. Accountants, investment bankers, financing sources may also be present — they should at least be available by phone in case anything goes wrong.

Being prepared before closing is imperative; being unprepared increases the odds of tempers flaring, problems arising, and delays occurring. You don’t want hiccups. The longer the closing takes, the greater the odds something goes wrong and the closing falls through. To increase the odds of a successful closing, the deal-makers (investment bankers) and lawyers should have all the business and legal aspects of the deal worked out. The lawyers should be prepared by having all the necessary documents laid out and ready to be signed.

Believe it or not, closing an M&A transaction is actually highly anticlimactic. No bells and whistles, no soaring music, no quick cut to a celebration in a tony watering hole. When the deal is done and the money has exchanged hands electronically, you simply go back to work or head home. It’s just another day.

Walking Through the Closing Process

A closing should occur like a well-oiled machine, with steps that are well laid out and planned in advance. As a general rule, a closing should take less than two hours. Essentially, a closing should involve the considerations in the following sections, although variations to the following may exist.

Reviewing the flow of funds statement

The flow of funds is a very detailed list of the sources and uses of money — where the money comes from and where it goes. It’s typically created in the days right before the closing and is among the last steps of the process. Usually Buyer is responsible for compiling this document (usually a spreadsheet). The statement lists everyone and every entity that is either providing money for the acquisition or getting money as a result of the closed deal, the amount of money being contributed or collected, all necessary contact information (company name, contact name, maybe a phone number), and wire instructions (bank, account number, and routing number).

Typical entities that show up on the flow of funds include the Buyer’s and Seller’s advisors (investment bankers, accountants, lawyers, and any other consultants), any bank or entity holding a debt that’s being paid off at closing, and any vendors Seller has been slow to pay who are owed money. After all entities have received their cut, whatever is left over flows to Seller. After Buyer has compiled the flow of funds, he circulates it to Seller and any other advisors who may need to review the document for accuracy. Seller (and her advisors) should carefully check and double-check the document for accuracy and immediately contact Buyer with any corrections.

Advisors should be included in the flow of funds statement. Advisors who wait until after the deal closes to submit a bill will find their chances of being paid greatly diminished.

Take a look at the flow of funds statement in Figure 16-1. Buyer is contributing $13.3 million and obtaining $4 million from a bank, plus another $2.5 million from a mezzanine fund. The mezzanine fund is also known as subordinated debt, meaning it’s subordinate (or second in line) behind the bank loan (also called senior debt). In addition, some executives from Buyer are contributing an aggregate amount of $700,000.

The purchase price of the business is $20 million. However, based on the purchase agreement, a working capital adjustment of $200,000 in Seller’s favor needs to be added to the price. (See “Making a working capital adjustment” later in the chapter for more info on this adjustment.) Buyer owes his advisors a total of $300,000, to be paid at closing. So in this example, Buyer needs to bring $20.5 million to the closing in order to make a $20 million acquisition.

The flow of funds statement in Figure 16-1 is severely simplified from the flow of funds statement you’re likely to see in a real deal. In an actual flow of funds, you may see many more sources of funds; many more uses, such as fees the funding sources earn for providing the funding; and notations referring to Buyer assuming Seller’s debt.

Buying or selling a business doesn’t simply involve transferring money from Buyer to Seller. In other words, Seller doesn’t walk away from the closing with a pile of money and a pile of bills. Instead, the Seller pays off her debts, including debts to lending sources, vendors, taxing authorities, consultants, and any other creditor, at closing. In addition to debts, money for the escrow account is deducted from the sale price.

Figure 16-1: A sample flow of funds statement.

In Figure 16-1, Buyer brings $20.5 million to closing. However, because Seller owes the bank and her advisors money and needs to put money needs in escrow, she actually receives only $11.79 million. Buyer wires that amount to Seller and also wires money to every other party that is due money at closing.

Buyers, make sure the Seller pays off all debt, especially any and all outstanding tax bills. In fact, Buyers should not close until every outstanding Seller debt is extinguished. If you assume control of a company and Seller hasn’t paid off a debt, that creditor is liable to come after the company — in other words, the new owner: You. That’s why Sellers usually are the ones who remit those payments (using Buyer’s money) at closing.

Also, Sellers may want to make estimated payments to taxing authorities (for income taxes or capital gains taxes as result of the transaction) at the time of the closing. These authorities may or may not be represented in the flow of funds, but paying them off along with the other debts may be beneficial simply because Seller gets those payments out of the way and thus reduces the odds she’ll forget to make the payments or she’ll spend the money before making required payments to the sundry taxing authorities. Speak to your tax advisor for the best way to handle your specific tax situation.

Make sure wire instructions are correct, and make sure each entry has an entity name and a contact person. Making an error or omitting this information may cause a delay in a party receiving its money.

Signing the final purchase agreement and other documents

After both sides have approved the flow of funds statement (see the preceding section), the closing proper begins. This time is when both sides sign the final purchase agreement and sometimes other agreements, such as employment contracts, noncompete agreements, non-solicitation agreements, leases, and so on. The documents pass back and forth as I describe in the earlier section “Gathering the Necessary Parties,” and then all that’s left is paying out the money.

Generally speaking, both sides agree that the deal isn’t final until both parties sign all documents. In other words, being the first to sign a document doesn’t put you in some sort of danger that the other side will balk at signing the documents and thus leave you on the hook.

Distributing the funds: Show me the money!

After all the necessary agreements have been signed, Buyer funds the deal by obtaining money from his sources and distributing that money to Seller and any other party that appears on the flow of funds statement.

A typical funding occurs as follows:

1. Money from Buyer and any other funding source (such as a bank) comes into a Buyer-controlled account.

2. Seller’s debt, including bank loans, notes payable, promissory notes, loans by shareholders, and so on, is paid off with Seller’s money.

3. Seller’s advisor fees, including legal, accounting, investment banking, and so on, are paid off. These expenses come out of Seller’s money.

4. Money is wired to the escrow account.

5. Money is wired to Seller’s account.

6. Buyer’s advisor fees are paid off. Buyer usually pays these expenses.

Although wire transfers are highly recommended for most deals, cashier checks may be a suitable alternative for smaller deals where the total proceeds are less than $1 million. Speak to your advisors about the recommended course of action for your specific deal.

Schedule your closing at an appropriate time of day so that you can complete the transfer. You can’t close a deal at 11 p.m. because you can’t wire money that late! Most closings begin in the morning with the goal of closing by 2 or 3 p.m. Eastern Time because that’s the nominal cut off time for banks. So even though wiring money after that time isn’t unheard of, plan on closing by 3 p.m. Eastern.

Popping the champagne

After the wires are sent, both sides should contact any advisors or team members not present at the closing and inform them of the happy news. Your advisors can then constantly check their bank accounts waiting for news of their wire transfer.

And you’re done with the deal. Pop some champagne, celebrate a bit, and start spreading the news, ’cause the deal is closed.

It’s not a deal until the wires clear. Make sure you’ve received your money before you celebrate a successfully closed deal.

Tying Up Loose Ends Shortly after Closing

Closing a deal really doesn’t mean the deal is completely closed on closing day. That’s not a version of “how much wood would a woodchuck chuck,” it is a reality of M&A. In most deals, Buyer and Seller have little bit of work to conduct after the deal closes.

Allowing time to fully close the books

Although the deal is closed as of the closing date, a company can’t produce an accurate balance sheet on that very day. Depending on the business, 30 to 90 days are necessary to fully close the books. For that reason, the closing uses an estimated balance sheet.

At some agreed upon post-closing date, the parties make adjustments to that closing day balance sheet based on the fully closed books. In some cases, Buyer pays more, and in other cases Seller receives less. Often, this adjustment is made to the money in escrow.

Making a working capital adjustment

Most purchase agreements include an adjustment for working capital. Prior to closing the deal, Buyer and Seller agree to the amount of working capital that Buyer is purchasing.

Working capital is the difference between assets that can quickly be converted into cash (accounts receivable, inventory, and prepaid expenses) and the bills that are due immediately (accounts payable, wages payable, interest accrued, and unpaid liabilities). Think of working capital as being the same thing as cash.

At closing day, the parties adjust the purchase price based on the amount of the company’s working capital. Working capital adjustments help prevent a Seller from simply not paying bills prior to closing; cash belongs to the Seller, so he may be inclined to sell off inventory and accounts receivable and stop paying bills in order to generate cash. In that scenario, the Buyer assumes a business with huge debts at closing. For example, if both sides agree working capital should be $1 million at the closing date but the closing day balance sheet shows $1.2 million in working capital, the Buyer pays the seller an extra $200,000 at closing.

If the Buyer has to pay more at closing, it’s because she’s purchasing more cash. Say you agree to buy a car for $5,000. Would you be willing to pay $5,100 if that car also included a $100 bill on the dashboard? The net expense to you is the same, $5,000. The same principle applies to a working capital adjustment.