Managing the Move – Keeping a Deal and School Operations on Track

A Recap of the 2019 CAPPS Presentation

By LeeAnn Rohmann, President/CEO, Legacy Education, LLC, Scott Haid, Partner, Weworski & Associates and Ron Holt, Lawyer, Rouse Frets White Goss Gentile & Rhodes

The thought of almost any kind of move or relocation conjures up logistical timelines, costs, problems…and headaches. This is all the more so true when the “move” is ‘moving’ or transferring the ownership of a postsecondary institution. The goal is to have the title to the enterprise quietly pass from one ownership group to another without disruption in daily classes and learning activities or worries among staff and students. But, from the moment that a current ownership group decides to sell until the day the keys are handed over, there is an enormous amount of work in the deal process that runs parallel for many months to regular school operations. That deal work – negotiations, due diligence, etc. – must be handled on a priority basis, but not at the expense of school operations falling off course. With some planning, it can be done…usually.

For the school owner who begins to contemplate an exit, the adventure begins with the effort to identify possible scenarios.

If there is not one or more family members or trusted employees that could acquire ownership through some combination of estate planning and purchase arrangements, other long-shot options are an Employee Stock Ownership Plan (ESOP) or sale to a nonprofit, the former tending to be limited to larger organizations due to cost and the latter currently being an uncertain option because the U.S. Department of Education (“ED”) generally has delayed or denied approval of these transactions. For most owners that leaves a sale to a for-profit buyer, which currently tends to be “strategic” buyers – those who already own schools and are seeking an opportunity to meet strategic goals. But some potential strategic buyers, with private equity ownership, are hesitant to act in today’s market given the upcoming 2020 presidential and Congressional elections and the related uncertainty about regulatory changes coming in the long-delayed Reauthorization of the Higher Education Act.

This means that a would-be-seller may need to devote considerable time and effort to find buyer candidates. Some people might like the thrill of the hunt, like President Donald Trump, who, in his 1988 book, “The Art of the Deal,” said he liked making deals because, “that’s how I get my kicks.” But most school sellers just want to get to the finish line as soon as they can. For them, one possible source of buyer candidates would be local and regional schools and school companies, which might include somebody interested in expanding. But, for obvious reasons, the would-be-seller might want to remain confidential and not openly approach its competitors. However, professional service providers used by the school – such as auditors, financial aid servicers, other third-party servicers, marketing firms and lawyers – might have knowledge of the plans of these other area schools and companies. If that approach does not yield any candidates within a desired time period, there is always the option of contractually engaging an intermediary or broker/investment banker on a commission basis. There are a number of such firms that focus on the private college sector.¹

For the seller, after getting past the basic decision to sell, there will be other decisions in the deal process about the timing of the sale, price and payment goals, deal risks and post-sale options. Typically, these decisions will be best made if the seller has assembled a selling team that together has evaluated the range of options and developed goals. Ideally, a selling team will include: all owners and family members; trusted senior members of management; legal counsel; a certified public accountant/tax advisor; and a broker or consultant. A selling team can also help to establish realistic expectations and to ensure that adequate preparation occurs before the selling process gets underway.

The question of when to go to market ideally should take account of any out of ordinary regulatory and operational issues. For example, is the school going through a renewal of accreditation or recertification of its Title IV eligibility? Is there an open program review? Is there a campus lease that will be expiring in the next 6 to 12 months? These circumstances might not rule out a sale, but, generally speaking, if matters like this are first resolved in a satisfactory manner, the seller will be able to attract a wider range of buyers and avoid possible delays in the deal process and purchase price escrow demands.

Perhaps one of the most critical steps a seller can take ahead of going to market is the round-up: retrieving and assembling into a secure, password-accessible online data room all relevant documents relating to the seller company and its schools. This will include, of course, business organization documents, basic regulatory relationship documents, campus leases, equipment leases, employee benefit plans, annual financial statement and compliance audits and enrollment reports, but also other materials that the team identifies as significant. By pulling these documents together in advance, scanning them to PDF files and loading them into an accessible data room that can be provided to qualified buyers, the prepared seller will have spared itself from some of the stress that will come during the due diligence process of a deal and also will have saved some time and energy for oversight of school operations. Along with the creation of the secure data room, the prudent seller will also spend the time and money to engage one or more outside consultants, such as a CPA or a Title IV consultant, to conduct a mock visit and a review of accounting records and Title IV student files so that any file deficiencies can be identified and corrected prior to deal due diligence.

Not to be ignored in the preparations is the management structure for school operations.

Larger school companies with a larger management team may be prepared to hand off oversight of the day to day operations to a junior manager if needed during pressing periods of deal negotiations and due diligence demands. In contrast, ownership of a smaller company or school, prior to pursuing a sale, probably will need to develop a trusted relationship with a junior manager by beginning to delegate responsibility for oversight of school operations. Another alternative for a smaller school might be to engage a management consultant who could provide assistance both with school operations and the deal due diligence process. If the ownership has decided to engage a broker, the broker will be able to help identify management consultants.

What are realistic seller price expectations in today’s market? Of course, the answer depends on many variables, including the school’s accreditation, locations, program disciplines and credentials, enrollment trends, revenues and profitability, strength on brand and competitive landscape and regulatory compliance. But, generally, most buyers begin their valuation analysis by looking at net income or modified EBITDA (earnings before interest, taxes, depreciation and amortization), adjusted to remove or add expenses that are either eliminated or added by the transaction, and then determine an appropriate “multiple” to apply to the modified EBIDTA figure. The multiple reflects the buyer’s assessment of both the risk and the opportunity posed by a particular school. Multiples paid in transactions in the past year ranged from 3 to 7 for accredited institutions and from 2.5 to 3.5 for unaccredited institutions. Also relevant to price is deal structure, meaning whether the buyer is buying the seller’s equity or assets, which could affect the tax outcome of the deal for the buyer and the seller.

A buyer might be willing to pay a higher multiple where the seller is willing to provide some form of “seller financing” by accepting payment of a portion of the purchase price through a promissory note payable over some post-closing time period and/or a “rollover” into buyer equity units. Both of these options introduce delay and risk for the seller, but they might provide the benefit of tax deferral – something that would need to be closely reviewed by a tax advisor. A buyer might also attempt to “sweeten” a proposal by offering a transitional employment or consulting agreement with performance-based bonuses. Some owners, however, may have no interest in remaining substantively engaged with the schools they are selling after the closing. The extent to which a buyer requires some kind of post-closing owner involvement probably will depend on whether the buyer has prior industry involvement, meaning this requirement is less likely with strategic buyers but more likely with financial buyers or first-time buyers.

All these considerations – the amount of seller’s modified EBITDA, an appropriate multiple, an acceptable payment structure and the extent of any post-closing transitional agreements – should be addressed by the seller’s team prior to going to market. Although the seller obviously should remain open to negotiations with a buyer, goals should be determined in each of these areas.

The equity rollover and the promissory note, while introducing some risk, might provide the benefit of tax deferral, but this is something that would have to be closely reviewed by a tax advisor.

Other structure issues that the selling team should be prepared to address involve some familiar accounting requirements and some new ones.

When reviewing the audited closing date balance sheet of the school, ED expects to see a 1:1 or better “acid test” ratio, so all buyers will insist on the purchase price being subject to a closing working capital calculation, which essentially compares closing date accounts receivable to deferred tuition. If the buyer is using long-term debt to finance part of the purchase price, the buyer may insist on an asset purchase in order to benefit from ED’s modified long term debt rule. The new real property lease accounting rules, requiring lease obligations to be recorded as long-term debt and the occupancy rights to be recorded as assets, may also impact the closing balance sheet in deals, perhaps adversely, which is a matter that the seller’s CPA consultant should be examining.

Once buyer candidates have been identified and appropriate non-disclosure agreements have been executed, the seller will provide high-level enrollment, program and financial information and eventually primary deal terms will be reached with a buyer and confirmed in a term sheet or letter of intent (LOI), or at least that is what you hope will happen. If an agreement has been reached on price and payment structure, the parties should be able to sign a term sheet or LOI in a few weeks or less. Efforts to add terms to the LOI that normally are negotiated in the purchase agreement, such as indemnification limits, should be resisted, because this extends the process and contributes to “deal fatigue” that can kill a deal. The LOI is used simply to confirm principal terms and commit the parties to an exclusive time period, usually 90 to 120 days, allowing due diligence and negotiation of a purchase agreement to proceed. And, unless the buyer is well known, it is advisable for a seller to require the LOI to include a requirement that the buyer produce a financing commitment letter within some reasonable time following execution of the LOI, such as 45 days.

The time period following signing of the LOI is when the seller and the buyer will be working the hardest, with parallel tracks of due diligence, negotiations on the purchase agreement and related agreements, preparation by seller of purchase agreement “schedules” with disclosures of information and efforts to gain consents from campus landlords and other third-party contractors. This is where the seller team’s advance preparation will help to provide organization and maintain sanity. In some deals, where the parties want to reach a closing as soon as possible, the seller will authorize the filing of pre-closing applications with ED, and, where required, the school’s accrediting agency and state licensing agency, shortly after the signing of the LOI.

While parties to a deal can control how quickly they move in due diligence and contract negotiations, they have no control over the pace at which the regulatory agencies conduct their review of pre-closing applications.

Accrediting agencies with pre-closing requirements (a small group) tend to act on applications at scheduled meetings announced on their websites, but the same is not true of ED. Up until two years ago, ED acted on pre-closing applications within 45 days or so, but now ED has been backlogged on pre-closing applications around the nation and has taken as much as six months to process these applications. Consequently, as an alternative, ED now offers so-called “abbreviated review” which takes as much as six weeks and only addresses whether a letter of credit is required and the amount. If a buyer chooses regular review, the processing time usually will be in excess of three months.

The bottom line here is that, even with the best preparation, the sale of an accredited, Title IV eligible school will involve a time period of at least four months and more likely six months or more. In contrast, with a non-Title IV accredited school, the process might take only four months, and, for the unaccredited school, it could be even shorter, depending on whether the relevant state licensing agency has any pre-closing requirements.

However long the deal process may last, one thing is certain – advance seller team preparation will make it easier to keep the deal on track and to also manage school operations in the ordinary course. And for owners who begin their exit planning a year or more before going to market, there may be options to add value and a higher price to their enterprise through various operational enhancements, such as one or more new academic programs, updated technology and systems, additional externships, online or hybrid delivery for some programs, and perhaps a new satellite or branch campus.

Most postsecondary school owners have spent a major part of their lives building a school enterprise and a legacy, and their schools are major contributors to the well-being of their communities. When they decide to sell, the change in the ownership of their schools will, of course, have immediate economic consequences for them, since they are “cashing out.” But new ownership may also impact the future direction and operations of the schools, which is why regulatory agencies examine proposed new owners. Given what is at stake, it is more than worth it for sellers to put in the time and cost for advance preparation and planning.

Reference

1. CER’s supplier directory contains information on some of these firms.

LEEANN ROHMANN is the President/CEO of Legacy Education LLC; dba High Desert Medical College & Central Coast College. They are nationally accredited colleges through ACCET. LeeAnn Rohmann founded Legacy Education to support her strong belief in higher education as the basis for building a legacy for students and their families. She is passionate about providing the best training in the strongest industries like healthcare, business and veterinary. LeeAnn began her career in higher education more than 25 years ago and has spent every day since working to provide a quality education.

SCOTT HAID is the Partner in charge of the Firm’s Financial Statement Audit Department. He performs financial statement audits, defined contribution audits and consulting services for the firm. He provides quality auditing services in an efficient and timely manner. He has experience in accounting, financial reporting, auditing and due diligence procedures. Scott is also instrumental in providing clients with guidance during the acquisition/sale process.

Scott earned his degree in accounting from San Diego State University and is a Certified Public Accountant with current membership in the American Institute of Certified Public Accountants.

RON HOLT leads the Rouse Frets DeLuca Law Group’s higher education practice and also handles business litigation and business transactions. Ron has been practicing law for over 38 years and over the past 27 years, Ron has represented institutions across the nation on program reviews, administrative proceedings, student claims, state and federal court litigation, changes of ownership, and accrediting and state licensing agency disputes. Ron is a past member of the Federal Affairs Committee of the Association of Private Sector Career Colleges & Universities (APSCU) and a past member and past chair of the Litigation Committee of CCA, APSCU’s predecessor. Ron is a 1979 highest honors graduate of Rutgers School of Law in Camden, New Jersey and a 1975 summa cum laude graduate of Evangel University in Springfield, Missouri.

The Rouse Frets DeLuca Law Group has offices in Kansas City, MO, Leawood, KS, Denver, CO and Cincinnati, OH. Other lawyers in the firm’s higher education group include: Chris DeLuca, Megan Banks, Nicole Polzin and Hank Driskell.