Our friends at Aberdeen Advisors, an M&A advisory firm, recently published a series of articles 14 Mistakes to Avoid When Selling Your Business and it inspired us to pull together a series focusing on mistakes we see on the legal side of merger and acquisition transactions. The below mistakes are ones our firm’s professionals have encountered over their combined decades of deal experience and we are committed to helping our clients avoid them as they progress through a M&A transaction.
1. Failing to Carefully Review Representations & Warranties for Accuracy
The representations and warranties made by a seller in the transaction documents are some of the most important items in the transaction. Sellers who skim, or worse, don’t even read, the representations and warranties are bound to open themselves to liability after the transaction closes. The representations and warranties are where a seller states that the company isn’t involved in lawsuits, that the financial statements are accurate, that the company has paid its taxes, etc. A misrepresentation can lead to significant financial penalties for a seller and it is extremely important to verify that each representation and warranty is accurate.
2. Failing to Complete Disclosure Schedules
Disclosure schedules are the exceptions to the representations and warranties discussed above. For example, if a seller is asked to represent and warrant that the company isn’t involved in any lawsuits, but it, in fact, is in a lawsuit, then the seller would need to insert a clause such as “With the exception of those items contained on Schedule 1.1, the company is not…” and list the lawsuit and a brief description of it on Schedule 1.1. A mistake in not including a material piece of information on the disclosure schedules can result in significant financial penalties.
3. Failing to Negotiate Indemnification Provisions
Indemnification provisions are the enforcement mechanism of the representations and warranties discussed above. Negotiating favorable provisions will often involve creating “baskets” which prevent indemnification payments to the buyer from the seller unless the amount is over a certain threshold, to avoid “nickel and dime” claims. Sellers should also seek indemnification caps, and a time limit on the duration of the indemnification exposure. Indemnification can also be limited to what are considered “fundamental” representations and warranties. A good deal attorney will work with you to tailor indemnification provisions that help you sleep well at night after the deal closes.
4. Having Contracts that are Unassignable
Business owners considering a sale of their business should analyze all of their key contracts, including vendor and sales contracts, to verify that they are assignable and to ascertain whether they may only be assignable with consent. In the event one or more key contracts are not assignable, a buyer may lower their offer or, worse yet, they may walk away from the transaction altogether. Learn more HERE.
5. Not Seeking a Breakup Fee
Negotiating the sale of your business and engaging in due diligence can be a significant disruption to both your time as well as the operations of the business. We work with our clients to minimize the disruptions, but they still occur and, if the deal doesn’t go through, then it’s frustrating to look back at the lost productivity and the possibility of having sold to another buyer. That’s why we encourage our clients to negotiate a breakup fee if they’re concerned about the deal not going through. This is especially true if you are agreeing to exclusively negotiate with a single buyer, setting aside other opportunities. A breakup fee forces the buyer to put skin in the game and provides a small cushion to the seller in the event the deal doesn’t occur.
6. Not Protecting Your Confidential Information
Some clients are overly protective of their confidential information while others aren’t nearly protective enough. It’s important to get any potential buyer under a non-disclosure agreement (“NDA”) and to decide in advance what information should be shared – and when. Thinking in terms of buckets of information, disclosures can be phased; for example, (a) initial disclosure without an NDA; (b) additional disclosure with an NDA; and (c) information that will only be transferred after an executed letter of intent is in place, or as late as the closing. Things like customer and vendor lists, trade secrets, selling tactics, etc. are incredibly important to protect and a good deal attorney will work with you to craft a strategy for selective disclosure as a transaction progresses.
7. Not Hiring a Team of Experts: legal counsel / investment banker / accountant
Assembling a competent deal team is one of the most important decisions a seller can make when contemplating a sales transaction. A good accountant will ensure your books are in order, minimize the disruption and questions raised on financial matters during due diligence, and provide critical tax mitigation consulting. A good investment banker will market your business to buyers to which you likely don’t have access and will generate strategies to maximize the value you receive for your business. Finally, a good deal attorney will negotiate deal documents that protect your interests and ensure you walk away from the deal with as little post-deal exposure as possible.
8. Failure to Secure Intellectual Property Assignments
Another mistake often seen in M&A transactions is the failure of business owners to get an assignment of intellectual property to make clear that the company owns intellectual property that may have been created by a co-founder who is no longer with the company, or an independent contractor who was engaged to develop high-value technology. Buyers want to ensure that their investment is going to be protected and won’t be stripped away because the high-value intellectual property turns out never to have been clearly assigned to the company. Buyers prefer certainty and therefore they will be seeking clearly documented assignments (or “work for hire” language in contracts) that make ownership of IP indisputable. Prior to starting a transaction, business owners should carefully analyze their intellectual property ownership and documentation thereof to ensure that all intellectual property that should be owned by the company is, in fact, owned by the company. If not, then getting prior owners, former employees and independent contractors to assign the IP to the company well before a transaction begins will eliminate a potential source of conflict.
9. Poor Accounting/Inventory/Management Systems
I once represented a client looking to purchase a business in the unglamorous industry of tire distribution and sales in Middle America. The deal was perfect for our client’s interests and on paper earned handsome profits for its owner year after year in a period of less than perfect economic conditions. Unfortunately for the seller, though, his multi-million dollar company hadn’t implemented computer-based inventory systems. At the end of the day, our client chose to walk because the headache of conducting accurate due diligence was too much for him to stomach. If the company had upgraded its systems prior to marketing itself, then (assuming the accounting and inventory it presented our client was accurate) it would have been an easy deal to close. Before going to market, conduct an audit of your company’s systems – do you have modern or market equivalent management systems? Is your accounting accurate and on a modern system?
10. Failing to account for lifestyle adjustments in sales price / post-sale lifestyle
I have worked for multiple clients whose company afforded them a lifestyle that, if they no longer owned the company, they wouldn’t be able to afford. Whether it is company expensed trips that double as vacations, leased vehicles, a boat or even a plane, these are all factors that should be seriously weighed when contemplating selling your company. Speaking with your investment advisor, analyzing your budget and true cost of living, and learning what your company might be worth in the market are all important steps to take prior to going to market with your company.
If you’re considering selling your business, or have questions about how to address any of the issues identified above in your company, then don’t hesitate to reach out as we always enjoy speaking with business owners.
This blog was written by Hunter Business Law Attorney David Kronenfeld.
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