It has been reinforced to me throughout my academic career that in quality writing and presentations every component should have a purpose that can be identified to enhance the product as a whole. This is true whether the end product is a song lyric, fictional literature, movie script, business presentation, or legal documentation. As a thirty-year mergers & acquisitions professional, I have worked with attorneys who have drafted concise, comprehensive purchase & sale agreements and other ancillary transactional documents and lawyers who have ownership of far-reaching verbiage that has addressed the necessary and irrelevant by employing a one size fits all approach to papering a deal.
When going backpacking in the mountains, it is important to bring with you everything you may need for a range of potential situations and conditions, especially if assistance is days away. It is prudent to avoid packing items that will not be used or that do not have the potential to address an unexpected occurrence. This same conceptual perspective can be applied to the legal documentation associated with buying or selling a privately held company or family business.
The following is the perspective of a fifty-year business brokerage firm that has successfully closed over 4300 transactions related to the legal documentation associated with facilitating a deal.
Non-Disclosure Agreement
Every buyer & seller engagement related to the potential purchase & sale of a company should begin with execution of a non-disclosure agreement (NDA) by a potential purchaser. If information gets into the public domain that a business is for sale it can damage the entity’s relationship with employees, customers, and vendors. A buyer operating in good faith will be in alignment in wanting to mitigate potential damage to a company, as they are contemplating being a successor in executive management of the business. The important components of this agreement should be able to be addressed in one page. The agreement should not prevent a buyer from looking at other companies, even in the same space, or limit their ability to operate an existing business model, as before they obtained confidential information. It should prevent the potential buyer from using information obtained for competitive advantage if a transaction is not completed.
Indication of Interest or Memorandum of Understanding
As the President & CEO of an M&A firm that almost exclusively represents the sell side of business purchase & sale transactions, I have never been able to identify a reason for a client to sign an IOI or MOU. It has been my experience that the primary purpose of these documents is to allow a buyer to take the business off the market with no firm commitment to proceed to mitigate competition for the acquisition target. COMPETITION IS GOOD in negotiations from the side of the party that controls the item. This is true whether it is a one-of-a-kind piece of art or a business. Remember that each business is unique. Even the most cookie cutter franchised business model is different location to location based on the knowledge, experience, and skill of the staff; tax environment of geographic place; and cost of labor, occupancy, and materials in the local market.
Letter of Intent
It is my opinion that execution of a comprehensive letter of intent is the most important foundational element for the successful purchase and sale of a business regardless of whether the transaction value is five, six, seven, eight, or nine figures. A Letter of Intent (LOI) should establish all important business terms of a transaction between the buyer and seller. Elements addressed can include price; financial terms; post transaction transition employment/consulting; non-competition agreement prevented activities & area; tax allocation; timing; etc. The negotiation of these terms is the domain of the buyer & seller with facilitation by a knowledgeable, experienced, skilled intermediary. If the parties cannot reach agreement on the price and/or the compensation & term for transition support by existing ownership, does anything else really matter? It is not prudent to accrue significant legal expenses if agreement is not reached in these areas. It is recommended that prior to commencing these negotiations that an environment of full disclosure between the buyer & seller be established, so that each side can make decisions from a foundation of knowledge. It is reasonable for a buyer to want to review multiple years of financials; understand staffing & customer concentration issues; and working capital & CAP-EX budget considerations before being asked to take a definitive position. It is equally reasonable for a seller to know all parties in the buyer’s acquisition group; the sources of capital supporting the acquisition; the signature power backing a buyer (Gregory Kovsky | Why a Business Owner Should Review the Buyer’s Personal Financial Statement or Balance Sheet Before Starting Negotiations (ibainc.com)); and any plans that could impact company employee retention before signing a Letter of Intent. Again, like in the case of NDA’s, a concise LOI is preferential over a far reaching one. The document should be able to be understood by the parties, their attorneys, their accountants, and bankers and/or investors with limited ambiguity related to the intent and objectives of the signatories.
Purchase & Sale Agreements
Lex Friedman recently facilitated an interesting podcast discussion related to Neuralink (https://youtu.be/Kbk9BiPhm7o?si=llBRHSsRXM66AJkX). The first component of the podcast was with Elon Musk. One piece of that conversation that resonated with me was a discussion on engineering the Neuralink. In that conversation, Elon Musk conveyed that when he is engineering something that he often asks his team to remove 10% as a quality control step to prevent superfluous elements or components that diminish productivity. He said in the interview, which is obviously true, that if something needed is removed it can always be reincorporated. I believe this concept can be applied to transactional legal documentation associated with the purchase & sale of privately held companies and family businesses. I am 100% on board for comprehensive legal documentation that addresses high and low probability potential future scenarios in an effort to mitigate future liability for the parties or provide a reference guide for how to deal with likely and unlikely future situations after the transfer of ownership. What I dislike are overbuilt documents or one size fits all agreements that contain clauses that obviously do not relate to the company being sold or are unenforceable. Examples I have witnessed include a clause about liquor licenses in a purchase and sale agreement related to a bookstore; verbiage about multiple year indemnification periods for product warranties for businesses selling perishable items with shelf lives of weeks; and employees being asked to sign non-competition agreements that are unenforceable under state law. The objectives of the purchase & sale agreement in a transaction involving a privately held company or family business is to create an environment of full disclosure, clearly convey the intent of the parties, and to mitigate trailing liability. Done properly, legal documentation can be both efficient & effective. I recommend when reading any legal document to ask the following: am I or the other party getting value out of the verbiage, does the language enhance clarity, and does it provide protective benefits. If the clause cannot be placed into any of these three categories, it is likely extraneous and has the potential for removal.
I am the type of person that can do business by verbal agreement, looking someone in the eye, and shaking their hand. If I have the right party on the other side of the understanding, nothing else is necessary. Unfortunately, in today’s world, it is often prudent not to do business in this “old school” manner. If legal documentation is necessary, it is my recommendation to use concise language, that a child would understand, if possible. https://youtu.be/AR6eXWNJzoY?si=uazcHnMuOGYYIxFc
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, legal, accounting, banking, and wealth management communities on subjects relevant to the purchase & sale of privately held companies and family 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”.