I am not an attorney. I did not go to law school. I do not provide legal advice. I am a mergers & acquisitions intermediary. I have negotiated and facilitated successfully to close over three hundred transactions involving the sale of privately held companies during my thirty years in this profession. My firm, IBA, has sold over 4300 businesses since 1975 in Washington & Oregon. One of the benefits of this level of achievement has been that my IBA colleagues & I have had the privilege of witnessing 1000’s of purchase & sale negotiations between lawyers, top tier and otherwise, related to asset and stock sales. The deals have had as parties publicly traded corporations (domestic & foreign), privately held companies (domestic & foreign), non-profit organizations, private equity, search fund backed buyers, partnerships, and individuals. The lead IBA business broker for each transaction has read the associated legal documentation, requested our client make the effort to understand what they are being asked to sign, heard concerns from both the buyer and seller sides of the table related to the verbiage, and observed the shaking of hands when middle ground clauses got everyone to “YES”.
Many people dismiss the value of a M&A intermediary in the negotiation of transactional legal documentation, essentially saying “Get out of the way and leave that to the lawyers”. The following are five reasons why a prudent party selling or buying a business should not and instead select a M&A intermediary that brings value in this area for representation.
- A business broker looks at legal verbiage from the perspective of achievement. They know where the middle ground has been in previous transactions and heard the legal justifications on both sides why the final text was “reasonable & equitable”. This information is shared willingly for free.
- An attorney is inclined to focus on the worst case scenarios they have experienced rather than what is commonplace in terms of outcomes. For example, a divorce attorney is likely to have a different view of marriage than an estate planning lawyer.
- A M&A intermediary is paid on completion of a successful business sale and not financially rewarded for confrontation between the parties. Their objective is to create an environment of collaboration between the parties, so the end goal of the seller (A sale at a fair value) and buyer (A purchase facilitated with transparency that will allow for an appropriate return on investment) is achieved.
- Lawyers are incentivized to create confrontation in negotiations. Most attorneys charge in six-minute increments of time. Each clause that results in negotiations can accrue transactional expense for the parties.
- If attorneys talk directly, expense is accrued on both sides of the table. A party cannot talk directly to opposing counsel without their attorney being present. Both parties can talk to the M&A intermediary or each other at any time without restriction. If a M&A intermediary facilitates discussion between the parties and the buyer & seller then provide drafting instructions to their legal counsel, no expense is accumulated during that problem solving conversation. Said another way, the conversation can go as long or have as many sessions as needed to find middle ground with no accumulation of expense.
It should not be forgotten that neither the M&A intermediary, attorneys, CPA’s, or bankers are buying or selling the business. They are professional advisors. Those are roles exclusively left to the parties.
It is important to have professionally drafted legal documentation for any business purchase & sale transaction. It is a general truism in law that the more knowledge & experience you want for protection the higher the cost. It is not IBA’s recommendation to value shop for attorneys. In a perfect world, the purchase & sale agreement and associated ancillary documentation (e.g., non-competition agreement, seller promissory note, employment/consulting agreements, etc.) should be regarded similarly to an insurance policy providing guidance on how to deal with a spectrum of situations. In an overwhelming majority of IBA facilitated transactions, the purchase & sale agreement is placed in a safe or safety deposit box and never referenced again by the parties after the deal is done. In a select few transactions facilitated by IBA, the parties need to reference the documentation to address post-closing issues that have developed. In those cases, it is critically important that quality legal guidance was present at time of purchase or sale and that the documentation clearly conveys how a situation should be addressed. Broker Note: It is often prudent to enlist more than one attorney in a transaction to ensure appropriate expertise is obtained. A strong M&A attorney working on purchase & sale agreement drafts depending on the transaction may need support from lawyers with knowledge related to employment, tax, unions, environmental issues, or transfer of licenses. Multiple state operation sales may want to consult with attorneys in each relevant jurisdiction to identify any laws or precedents that could impact the deal.
I could write a year of blog articles covering all the legal associated issues I have experienced in the transactions I have facilitated since 1994. That knowledge is willingly shared directly with our clients and indirectly with IBA clients by the large team of M&A intermediaries working out of IBA’s seven offices I have mentored & support. However, the following is business advice for addressing two of the most common areas for confrontation/confusion between the buyer and seller in business purchase & sale transactions.
Representations & Warranties
There are two types of representations and warranties, flat & modified, in business purchase & sale agreements. A flat representation is when someone can attest with 100% certainty that something is accurate. A modified representation, commonly employing the verbiage “to the best of my knowledge”, is when someone can attest they believe something is true or it is true with exceptions, typically detailed in a disclosure schedule. In most M&A transactions, attorneys will negotiate which type of representation and warranty is appropriate for each specific situation. From a business perspective, representations and warranties should be looked at as “hunting licenses” for future litigation and should be treated as one of the most important sections in a purchase and sale agreement. You do not want to get these wrong. Examples of flat representations that a seller should be able to make are that they have the legal authority to do the deal and that the tax returns filed with the IRS are accurate. If these facts are not true, the transaction should not happen or the seller should be financially liable for making false statements that impacted a buyer potentially paying an inappropriate amount for a privately held company. Similarly, a buyer should also be able to make the flat representations that they have the legal authority to do the deal and the necessary capital to close.
An example of a common modified representation that many would believe could be a flat representation involves violations of law. In every transaction I have facilitated there is a representation that the seller is not in violation of any laws or regulations. An honest, law-abiding business owner may not hesitate to sign an agreement where they say this is 100% true without any equivocation. However, a good attorney will protect their client in this case by adding, to the best of my knowledge, even if the entrepreneur is not aware of any relevant situation. The reason for this change is “we all don’t know what we don’t know”. What about a delivery driver who gets a parking or speeding ticket with the company vehicle and fails to report or pay it? What about if a company does business in a jurisdiction where a license is required or a tax is due and the appropriate action is not taken? The five legal words, “to the best of my knowledge” provide coverage in those situations to ensure honesty, even if the violation is not material.
The collection arm of representations and warranties in a purchase and sale agreement is the indemnification clause. The indemnification clause conveys when and how a party, commonly the seller, in a business purchase & sale transaction will be responsible for post-closing liabilities. It has been my experience that there are three important components that need to be negotiated related to indemnification.
- The first component is the maximum amount the seller will indemnify the buyer for if things go bad. The common high-water mark in terms of value is the amount paid for the business by the buyer. This ceiling makes logical sense because in a catastrophic situation prior to sale the seller, as the owner, they could have likely closed the business behind their corporate veil limiting their loss to the value of the company. An example of this situation could be a pharmaceutical product with adverse side effects sold by a company. If the lawsuits/claims against the company exceeded its value then the business would likely be shuttered and closed. This is also an example of why we need strong government consumer protection mechanisms as it is not in the “public good” for parties to be able to sell detrimental “snake oil”. It is common in a professionally negotiated sale for a M&A intermediary to be able to negotiate a lower value in terms of high side indemnification based on the risk for the buyer and the assets included in the sale. In most IBA facilitated transactions, IBA negotiates the business terms (e.g., MONEY) and the attorneys negotiate the legal terms.
- The second component of indemnification negotiated is how long the buyer has a “hunting license” to pursue the seller post sale. In a stock sale for tax related issues, this often mirrors the statue of limitation for the IRS to audit the company. Other time periods can be significantly less. It is important to push the edge in terms of setting expiration dates for indemnification. A burden should be placed on the buyer to investigate any areas of concern after the acquisition and bring them forward in a timely manner.
- The third element of indemnification to negotiate is the type of indemnification basket to have in place in the agreement. The common options are a deductible basket or tipping basket. Conveyed in business language, a deductible basket operates similar to an auto insurance deductible. If a claim or claims exceed a deductible level, then the seller is responsible for everything above that amount up to the negotiated indemnification ceiling. In contrast, a tipping basket may have a similar threshold, but if the amount is exceeded then the seller is responsible for all claims from dollar one. As an example of the difference between the two, consider the sale of a manufacturing company that post sale had a warranty issue related to product sold by the previous owner which the buyer needs to address or risk losing customers. If the threshold for indemnification was $100,000 and the claims equaled $125,000, the tipping basket would result in the seller having the reimburse the buyer for $125,000 in expense while the deductible basket would have only had them pay for $25,000. Significant difference. Broker Note: It is important to negotiate as high of a threshold for the indemnification basket to commence as a possible when representing a seller. This mitigates the buyer nickel and diming the seller post sale for non-substantial issues.
Knowledge, experience, and skill matter in the sale of a business whether you are selecting a lawyer or M&A intermediary. IBA welcomes the opportunity to collaborate with the legal community as part of any transaction team. IBA is happy to provide recommendations for attorneys who have impressed us with their dealmaking abilities on behalf of our mutual clients.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities 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”.