Deal Killers in the Purchase & Sale of a Business
Successfully facilitating the sale of a business from letter of intent to completed transaction is a sophisticated, nuanced process requiring knowledge, experience, and a strong professional skill set. The road to a completed deal has numerous potential “deal killing” obstacles that can be enhanced or diminished in the transactional turbulence created by the buyer, seller, and their professional advisers. As a 24-year business broker who has successfully facilitated over 300 transactions, I have experienced and problem solved through the full spectrum of “deal killing” transaction elements that occur in every transaction, 1 in 10 transactions, and 1 in 100 transactions. My goal in every transaction I facilitate is to serve as an experienced, knowledgeable resource to my clients regarding what is standard & reasonable in the sale of a privately held company or family owned business. The following are three of the common “deal killing” dead end paths and obstacles that need to be overcome in a transaction involving the purchase & sale of a business.
Preliminary Agreement with Limited Knowledge
Negotiating the skeleton business terms related to the purchase & sale of a business in a letter of intent (LOI) can be an exciting activity for entrepreneurs. The selling business owner will often have their ego stroked by parties who are eager to develop positive rapport and have a sincere interest in the history & performance of a business. In addition, the negotiations will allow first sight of the “light at the end of the tunnel” for a business owner wishing to end one chapter of their life and start another (Often in the form of the conversion of a business asset to cash to facilitate retirement). On the opposite side of the transaction, the buyer will likely be excited to have identified a potential business for acquisition, especially in the robust marketplace that presently exists in the middle market, and be motivated to negotiate a LOI that will provide them with preferential position to purchase the business. The natural inclination in this enthusiastic environment is for the parties to rush forward and try to reach preliminary agreement. This inclination should be suppressed, as it is likely not in the best interest of either party and can increase the probability of future deal failure. The primary reason this natural inclination should be avoided is that it is “best practice” to only enter into a letter of intent from a position of knowledge. It is not in the best interest of the seller to pull the business from the market prematurely (potentially with exclusivity of negotiation obligations), lose the positive negotiating element of market demand to potentially enhance market value, and become engaged to a buyer without properly vetting their financial capability to get the deal done and as a match for the executive leadership and corporate culture of the business. On the buyer side of the transaction, it is prudent to properly vet a business before spending significant time, energy, and resources pursuing a company that has components where the potential deal may not survive scrutiny in full sunlight. In a professionally facilitated transaction, it is recommended that an environment of full disclosure between the parties with a proper non-disclosure agreement in place be created prior to reaching agreement on a LOI. This slow walk down through this early stage of a business sale will enhance the probability of a transaction being successfully completed and make the risk inherent transaction stage of due diligence less likely to kill the deal by making it more about verification than discovery.
Paralysis by Analysis
Entrepreneurship is an inherently risking occupation. A review of the career path of most successful entrepreneurs will find periods of achievement and struggle. Business buyers come in a spectrum of levels of risk acceptance. The risk acceptance of a specific business buyer will be observable during the due diligence stage of the transaction. All business acquisition due diligence should start with the acknowledgement that it is impossible to know everything about any business or industry and that forecasting the future performance of a business has variables in the equation that cannot be known with certainty ranging from the economy to the competitive landscape to retention & development of employees. Due diligence is important for both parties, for the buyer it is the process which facilitates acquisition with “open eyes” with the best opportunity for future success. A comprehensive due diligence is in the “best interest” of the seller because it creates an environment of full disclosure which will mitigate post transaction trailing liability. The task for a business broker in a professionally facilitated transaction is to facilitate a comprehensive due diligence by the buyer in an efficient, timely manner. Successfully facilitating this process employing “best practices” takes significant knowledge and experience. Due diligence is one of the most common deal graveyards in the mergers & acquisitions world. One of the most common causes of deal death during due diligence is “Paralysis by Analysis” by the buyer. This is the situation where a potential business buyer gets bogged down on the path to a completed transaction analyzing information unwilling to the reach a “thumbs up or thumbs down” decision on whether the deal is a go. It has been my experience that in many of these situations the issue is not the information being analyzed, but the psychological reality that a final, potentially life changing career decision is being made. This is a situation where a business broker often needs to put on their psychiatrist hat and have a “heart to heart” discussion with the buyer regarding why they started down this path in the first place and mutually create a cost benefit analysis of the decision at hand. This is a difficult conversation to have and successfully navigate if a business broker is not knowledgeable, experienced, and willing to listen and problem solve through the mental & emotional barriers preventing progress. It is also a conversation a business owner should have the expectation their business broker can successfully perform when they engage their services.
Absolute versus Conditional Representations & Warranties
A knowledgeable, experienced business broker will recognize the portions of the purchase & sale agreement that are most likely to cause confrontation between the parties and their business attorneys before the first word of the documentation is drafted. One of the sections of the agreement where confrontation commonly occurs are the clauses about representations and warranties. The legal verbiage in this section of the purchase & sale agreement is critical to insuring “good faith” negotiations occurred between the parties and all relevant information was disclosed. It is strongly recommended that both parties engage experienced, knowledgeable business attorneys when negotiating legal documentation related to the purchase or sale of a privately held company or family business. The most important document that will survive closing is the purchase & sale agreement. If it is not drafted correctly the tools available to address trailing issues will be diminished. An established business broker should have the ability to offer quality referrals of business attorneys to the parties if they do not have appropriate representation for the transaction.
There are commonly two types of representations and warranties in a purchase and sale agreement. The first type of representations and warranties are absolute. These are representations and warranties where the party absolutely without equivocation takes a position. On the seller side of the transaction a common absolute representation is that the financial information presented to the buyer is accurate. It is reasonable for a buyer to expect an absolute representation in this area because if the financial books & records are not accurate then the price to be paid for the business and one of the foundation blocks behind the motivation to purchase the business is faulty. On the buyer side of the transaction a common absolute representation is that they have the ability to complete the transaction financially. If a buyer cannot make this representation, then there is a probability they are wasting the seller’s time, energy, and resources exploring an acquisition of the business.
The second type of representations and warranties in a purchase and sale agreement are conditional. These are representations and warranties where the party can make a statement with conditions. On the seller side of the transaction a common conditional representation is that the seller is not aware of any pending litigation against the company. This conditional representation is made, often with the additional verbiage of “to the best of my knowledge”, because it is recognized by both parties and their legal counsel that it is impossible for a seller to know about all, if any, potential pending litigation against the company if the intention to sue the business has not been disclosed by a potential damaged party. In addition, legal verbiage in the agreement should be added to address how such litigation will be addressed in action & financially because the methodology for resolution of the situation may differ between the parties. On the buyer side of the transaction a common conditional representation is that the buyer will have the ability to complete the transaction on a specified date. The reason that this representation may need to have a modifying condition is that there may be issues beyond the buyer’s control that impact the transaction date (e.g., availability of acquisition financing from a lending financial institution).
The situation where this can be a “deal killer” between the parties and their legal representation in a business purchase & sale transaction is when one side desires an absolute representation and the other desires a conditional representation. The verbiage “to the best of my knowledge” has significant legal implications in a court of law and attorneys take the deployment of the verbiage very seriously. If agreement cannot be reached when to employ an absolute and when to employ a conditional representation a deal can die. The role a business broker can play in facilitating this negotiation can be very valuable to the transaction because they can convey to the parties what is reasonable & standard based on years of knowledge & experience gained listening & learning from business lawyers providing advice to their clients in similar situations and facilitating negotiations for past clients. This recognizance of the situation can be different than the information & guidance provided by legal counsel because the attorney’s recommendation would likely mitigate liability at a superior level than what may be necessary to complete the transaction. Every entrepreneur knows that business decisions often create risk that from a legal perspective may not be prudent. Equally, most entrepreneurs recognize that if they listened to their attorneys 100% of the time and eliminated all risk that they would miss out on many business opportunities.
The three situations conveyed are only three of many potential “deal killing’ scenarios that can occur in the purchase & sale of a privately held company or family business. One of the primary roles a business broker in a transaction serves is as an experienced, knowledgeable guide & resource throughout the transaction. My firm, IBA, has a successfully facilitated over 4000 transactions in the Pacific Northwest for our clients If you are considering starting down the path toward a sale of your business, we would welcome the opportunity to provide an overview of the road forward and the services we provide our clients. We promise each of our clients a well-lighted path with multiple options to overcome potential obstacles. A river can be crossed by bridge, boat, wading, or swimming. It is important to know the best option before employing a methodology. A person would feel foolish if they employed the time, energy, and resources to build a bridge when they could wade through a river and continue forward without substantial impact.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.