The overriding consideration for an attorney representing either the buyer or seller of a business is helping his client to obtain the greatest benefit from the transaction. In most cases, maximizing what your client achieves is accomplished by effectively addressing what the other party is seeking to achieve as well. This leads to so-called "win-win" deals, where each party leaves the closing feeling that he has been dealt with fairly and has achieved the value that he sought from the transaction.
Where one or both parties try to use their bargaining power to beat down the other side, the aggravation and suspicion engendered tends to reduce the willingness of the parties to be open, develop mutual trust and compromise – the essential elements of deal-making. In every transaction, the parties will confront multiple problems and challenges. Successfully resolving those problems and challenges is how deals get done. Unlike litigation where there is often a clear winner or loser, in acquiring and selling businesses, both sides will lose if a deal that makes sound business sense does not get done.
The keys to success in deal-making are:
1 Identifying and addressing the key issues up-front
2 Tailoring deal terms to try to meet each side’s main objectives
3 Working with an experienced team of professional advisers
4 Being open-minded, flexible and understanding in negotiation
5 Avoiding surprises: surprises sink deals
6 Providing full disclosure to the other party, especially from the seller to the buyer
Addressing the Key Issues Up-Front and Tailoring Terms to Meet Each Side’s Main Objectives.
One cannot emphasize enough how important it is for all involved to identify and address the key issues early in the deal-making process. That includes determining what each party is really seeking to achieve in making the deal. Certainly, each party’s goals will include monetary objectives: the seller will want a fair price for his business and the buyer will not want to overpay. But, with privately-held businesses, price alone is seldom the determinative issue. Deal terms and tax considerations are usually also important. Often, the seller wants to have some assurance that his employees will remain, that the business will continue to operate in a certain manner, and/or that he and his family will have certain benefits after the sale such as medical insurance.
Examining the potential business, legal and tax issues at an early stage is especially important in structuring deals and proceeding expeditiously to closing. These issues can greatly affect the purchase price, the risk that the buyer is taking, and the amount of money that the seller receives after taxes. So, attempting to outline even the basic terms of the deal without addressing these issues is likely to lead to a lot of wasted time and effort. For this reason, the parties’ attorneys should be involved early on, at least in structuring the basic terms of the deal and in preparing the Letter of Intent. In fact, at this stage, both buyer and seller should be assembling and consulting a team of advisers to assist them with regard to financing, tax, estate planning, and legal issues.
Unfortunately, many buyers and sellers have the misconception that they will save money on legal fees if they develop the terms of a deal without having experienced attorneys and advisers involved. Nothing could be further from the truth. At least half the time that a buyer and seller come to experienced attorneys with the terms of a deal, the attorneys have to tell them that they should start all over again. Often, the parties will have not considered the tax implications of the deal, especially for the seller. For example, the sale of assets of a C corporation can result in a high percentage (sometimes, almost half) of the purchase price going to pay taxes. An alternative may be to sell the stock of the corporation instead. The sale of stock is usually taxed at the capital gains rate: 15% federal and 3% state. On a $5 million transaction, the difference in taxes could easily be $1.0-1.5 million. Sure, a stock purchase presents a somewhat greater risk to a buyer than the acquisition of assets. But, perhaps the seller would agree to reduce the purchase price by $0.5 million in order to induce the buyer to accept a stock deal. Done right, both the buyer and seller may gain by transforming the transaction from an asset to a stock purchase.
Frequently, the buyer and seller will tell their attorneys that they have agreed on how to address certain important issues. But, when the attorneys ask each of them to state what the terms of their agreement are on a given point, you find the parties are not in agreement. Just like a boy and girl courting, a buyer and seller will often "talk around" the hard issues: hearing what they want to hear and telling the other what he wants to hear. When this occurs and the attorneys are expected to prepare agreements reflecting the "agreed upon" terms, the deal will be renegotiated all over again in the context of preparing and finalizing the Purchase Agreement. In these situations, the attorneys’ time and legal fees mushroom – and, all too often, the deals sour and fall apart.
Working With An Experienced Team Of Professional Advisors.
The prescription for getting business deals done is to bring in experienced attorneys, advisers and business brokers, if brokers are involved in the deal, before the Letter of Intent stage so the key issues and the objectives of the parties can be identified, evaluated, addressed and resolved upfront – preferably before the Letter of Intent is finalized. If this is done, the Letter of Intent becomes the blueprint for preparing the Purchase Agreement and the other closing documents. The parties and their attorneys then only have the minor terms of the deal to resolve. Typically, at that stage, buyer and seller have developed mutual trust so that they are already working on how to transition the business.
Having attorneys and advisers involved earlier actually:
• Increases the probability of the deal closing
• Tends to lower the legal fees, sometimes substantially
• Saves the parties’ time, money and frustration
Involving attorneys and advisers so that key issues can be addressed early also saves money, time and effort in those situations where a business deal should not be done. From time to time, a business may seem attractive to a buyer. But, on further examination, it has financial or other problems that would make it difficult for the buyer to obtain financing or would present too many risks for the buyer. Again, neither the buyer nor seller gain by negotiating deal terms and preparing closing documents until the key problem is dealt with to the buyer’s satisfaction.
Perhaps, if the company is financially distressed, that means having the company file a bankruptcy petition and setting the stage for the buyer to purchase the assets of the company out of bankruptcy. Purchases of assets out of bankruptcy are typically pursuant to a federal court order stating that the assets are sold free of all liens, claims and encumbrances.1 That can provide significant protection for the buyer of the assets, even from an insolvent company.
Another common issue is what bank financing the buyer can obtain and on what terms. If the buyer cannot obtain enough financing to pay the full purchase price, the seller will have to consider taking a promissory note from the buyer and/or reducing the purchase price. In that situation, the parties might reach a basic agreement at the outset on terms but then wait to see what financing the buyer is likely to be able to obtain – before the parties proceed further with the transaction.
Being Open-Minded, Flexible And Understanding In Negotiation.
Whether the parties can agree on the basic terms of a deal frequently depends on being open-minded and flexible as well as trying to understand what the other party is seeking. As noted earlier, finding deal structures that reduce taxes for the seller is fertile ground for helping the parties reach agreement on the major issues of a deal.
One of the biggest unknowns in buying a business is what the revenues and cashflows of the business are likely to be in the future. While some businesses, such as established funeral homes, have fairly predictable revenues and cashflows, the revenues of many businesses are not predictable at all. They may have sales concentrated in a few customers, in faddish products or in highly cyclical products or services. Sometimes, a buyer will claim to have a new product or product line that will revolutionize the industry. In those situations, buyers (and their banks) are likely to base their offers on the revenue level that the selling company is reasonably assured of reaching, rather than the often more optimistic projections of the seller. To induce the seller to sell, a buyer may provide for the seller to be paid additional amounts if certain sales or profit thresholds are obtained. These additional payments are called "earn-outs." They can bridge the gap between what a buyer is willing to pay and what a seller is seeking.
Another common impediment to deals is unknown potential liability exposure from future environmental, products liability or warranty claims. If these are potential issues in a deal, the parties should call in experts in those fields including experts in obtaining insurance to cover those risks. Fifteen years ago, few buyers would even consider buying a business with a potential environmental problem. Today, environmental issues are often addressed to the mutual satisfaction of the parties through the use of experts, remediation programs and insurance.
If a buyer is genuinely interested in buying a business and the seller is willing to be flexible, a structure that reasonably protects both buyer and seller can usually be structured. But, the key issues should be addressed directly upfront and, to succeed, both parties have to keep an open mind.
Avoiding Surprises: Surprises Sink Deals
The primary focus of this article is the need to address the key issues and goals of the parties upfront. That is because what gets done or does not get done at the outset will affect the entire deal-making process.
Once the basic terms of the deal have been agreed upon, the principal reasons that deals do not get done are surprises. Surprises kill deals. Surprises kill deals because they destroy credibility and trust. Deal-making among businesses, especially privately-held ones, depends on the parties having some basic level of trust and believability. A buyer can never know everything about a business before the closing, even if he engages an army of accountants, consultants and attorneys to conduct due diligence. If a buyer finds out that he has not been informed about something that he considers material, the buyer begins asking himself "What else did not the seller not tell me?" Suddenly, the buyer begins viewing all information that the seller has provided, or will provide, with suspicion.
What has not been disclosed to the buyer is far less important than the fact that the seller did not disclose it. The surprises that kill deals typically relate to matters and information that would never have jeopardized the deal at all – had they just been disclosed by the buyer early in the deal-making or due diligence process. Yet, for some reason, most sellers are reluctant to disclose anything that might be considered adverse to a prospective buyer.
Experienced deal-making attorneys know that, when they represent the seller, they really need to do their own "due diligence" with the seller early on, preferably before the Letter of Intent is signed. That way, the attorney can uncover issues, matters and information that need to be disclosed to a potential buyer or at least reviewed by the attorney and his client at an early stage. Often, the attorney or the client can bring in outside experts or resources who can tell the seller (and, if need be, the buyer) what can be done to remove or alleviate the problem. Solving problems or showing the buyer how to avoid or deal with them often is the key to keeping a buyer interested and getting the deal done.
Providing Full Disclosure To The Other Party, Especially From The Seller To The Buyer.
Full, written disclosure is another key to avoiding surprises – and reduces the risk of the seller’s liability after the closing. The best protection for the seller is to have a full set of disclosures in the form of Schedules to the Purchase Agreement. The Schedules are typically keyed to various representations and warranties in the Agreement and, if put together properly, provide a "snap shot" of the company, its business, contracts, employees, liabilities and customers as of the closing date.
The Schedules deter arguments, claims and lawsuits by buyers because most claims by buyers involve allegations that the seller did not disclose material information. Often the seller’s attorney can avoid claims by the buyer and potential lawsuits by pointing the buyer’s attorney to the Schedules that contain the very information that allegedly had not been disclosed.
Such Schedules not only protect against post-closing claims, but they help the seller’s attorney identify potential problems and issues that need to be addressed (or disclosed) early in the game. A seller’s attorney should emphasize early in the process the need for full disclosure of potential issues and require the client to agree. At the outset of the representation, the attorney can give the seller client a set of representations and warranties from a typical Purchase Agreement and ask that a Schedule be put together for each representation. The seller will have to put together the Schedules sometime before closing in any event. Putting a draft set of Schedules together early on in the process allows the seller’s attorney to better identify and address potential issues upfront and gives the buyer a sense that the seller is providing full disclosure. That, in turn, builds credibility and trust which, in the end, allow most business deals among privately-held businesses to get done.
Everybody related to a transaction wants to walk away with a good deal. By applying the above principles, the parties can come to a win-win resolution where a transaction is closed and both parties have met their goals.
1 See section 363 of the Bankruptcy Code, 11 U.S.C. §363
Mr. Wentz is a Senior Partner of the law firm of Fewkes Wentz & Strayer, Naperville, Illinois, where his practice focuses on mergers and acquisitions as well as antitrust, corporate, contracting, financing, and licensing matters. He is the Coordinator of the Entrepreneurial Roundtable of the University of Chicago Graduate School of Business (www.gsbroundtable.com), which meets monthly at the Illinois Institute of Technology’s Wheaton campus and is open to the public. Mr. Wentz has received several awards for his M&A work and for his work with small businesses and entrepreneurs, including the Business Ledger’s Entrepreneurial Excellence Award. Mr. Wentz is a graduate of Brown University and the University of Pennsylvania Law School and received his MBA from the University of Chicago. Prior to practicing in Illinois, he was attorney advisor to two Chairmen of the Federal Trade Commission and was Associate General Counsel of the Civil Aeronautics Board during airline deregulation. Bill Wentz can be contacted at 630-527-8552.