A few days ago we published a piece on due diligence, focusing on one of the many financial “tests” that buyers often do prior to closing a transaction in order to have some assurance that their assumptions about the financial health of the transaction are sound. We looked at the Net Working Capital test (NWC) and discovered that even though the idea of the test is straightforward, ensuring that it is done accurately is vital, hence the need for professional help.
Today I thought we would shift our focus from the financial side of the due diligence equation and provide you with insights on the legal arena. One of the complicating issues, as you can imagine, is legal M&A due diligence.
For example, the following section is actually a document from a potential buyer sent to one of our dealmakers. Have a peek at what is going to be required of the seller by this buyer:
Representations, warranties, and indemnities will be typical or “market” terms. Representations and warranties of the Sellers shall include, but not be limited to, representations and warranties regarding ownership, capitalization, transaction expenses, tax, compliance with environmental, ERISA, and other laws, financial statements, receivables, undisclosed liabilities, absence of changes, contracts and commitments, absence of litigation, licenses and permits, customers and suppliers, employee and labor relations, product liability / warranty, intellectual property rights, insurance, affiliate transactions, compliance with regulations, and prohibited payments.
Representations and warranties will survive for 18 months with the following carve outs: environmental, compliance with laws, tax, and ERISA representations and warranties, which will survive for the statute of limitations, and fundamental representations and warranties (consisting solely of ownership, capitalization, authority, and affiliate transactions), which will survive indefinitely.
As we get further into diligence we will provide more specificity to these provisions and commit to negotiate in good faith for a fair and reasonable allocation of risk. The cap on seller’s indemnification for breaches of representations and warranties will be $1.8 million, with a Purchase Price cap for breaches of environmental, compliance, tax, ERISA and fundamental representations and warranties. These items are subject to final diligence but are based on our diligence to date. Seller’s liability for indemnification obligations (and other obligations under the purchase agreement) will be on a joint and several basis. Indemnification claims will be subject to a $200,000 ‘tipping basket.’
OK, if you read that closely, you are now out of breath. And if you are a business owner and you don’t have an M&A advisory team (which at a minimum should include an experienced M&A consulting firm and an attorney) and you get this from a buyer, you should be shaking in your boots!
How do you know if any of this is comprised of standard legal M&A terms? For all you know, your buyer could be taking advantage of your lack of M&A experience and creating a transaction that is completely to their benefit, not yours.
If you have an M&A advisor, like Generational Equity, and an experienced M&A attorney working with you, they would be able to walk you through this type of request in short order and protect your interest.
I bring this topic up because it is consistent with a conversation I recently had with Brad Whitlock, an M&A attorney with Scheef & Stone LLP. We have worked with Brad on a number of transactions over the years. He has decades of experience in M&A law and was able to provide us with some fantastic input for business owners to be aware of:
Closing a deal without professional help is possible; however, closing an “optimal” (as Brad puts it) deal with a premium buyer and creating a deal structure that benefits you is clearly your goal, and doing so requires professional guidance and consultation.
One more point to be made: When you look for legal advice to close your deal, look for an attorney, like Brad, that focuses on M&A law. This is a very specialized field and even though your family attorney that set up your trust could legally review your docs, he/she will most likely be working on their first M&A transaction. Requests from buyers, like the one above, might be new to them, causing your deal to progress far more slowly than if you have an M&A attorney with 30 years of experience.
Take a look at the segment above regarding reps and warranties: If any of that confuses you, causes you to scratch your head, or even makes you grimace in pain, then you need professional guidance.
Fortunately, Generational Equity, the leading M&A advisory firm in North America, is here to help. We have closed more deals over the past few years than any other firm in our niche (the lower middle-market – deals valued below $150 million), according to Thomson Reuters. If you would like to see if our skills are a good match for your needs, call me at 972-232-1125 or send me an email at email@example.com. I will be glad to discuss our services with you and connect you with the appropriate member of our team for further information.
Thanks again Phil and feel free to have a future client call me if they would like a referral. You are a true professional!Andy Graham, Vice President, Modern Heating & Plumbing
The help you provided us during each step of this process made us feel very comfortable and confident we were selecting the right approach to transition our Company.Andy Graham, Vice President, Modern Heating & Plumbing
I would like to thank you and your firm, Generational Equity, for being our valued advisors in our journey.Bil MacLeslie, CEO, ipHouse
We thank you Eric and Generational Equity making our dream come true.Larry Moore, Owner, A Company Portable Restrooms
I must say that I have never worked with a more driven, competent and focused individual as Don Ho.Jay Dinnison, Owner of Sharpe Mixers
Your wisdom and experience were invaluable to me during this once-in-a-lifetime transaction.Ralph Noblin, President of Noblin & Associates
Thank you again for all your guidance and support. Any company will achieve what they intend, if they have you on their team!Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
Generational Equity’s assistance was invaluable in compiling and marketing our business.Bil MacLeslie, CEO, ipHouse
Tom Staszak is one of the most professional people I have dealt with in my last forty years of business. You’ve got a great group of people and you have built a truly professional organization.Michael J Polarek, President, Paragon Packaging
The process was much more involved than I expected and your help, experience and advice was a big factor in making the negotiations go as smoothly as possible.Terry D. Wickman, President, Keytroller
Michael worked tirelessly, He followed every lead meticulously and urgently to make sure nothing was missed.Robert Evans, President and CEO of Mealtracker Dietary Software
Generational Equity educated and informed us – so that we could be on the upside of a good decision (to sell).Bil MacLeslie, CEO, ipHouse
We knew it would be a difficult task to have someone really understand our business and our market, prior to researching a possible buyer, so it was imperative that we found someone of your caliber, with definite proven experience in this area.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
I quickly recognized that Don was working for Sharpe Mixers above all else, and held our interests above others.Jay Dinnison, Owner of Sharpe Mixers
I wanted to write you a quick letter to express our appreciation and our delight on the outcome of helping us through the process of our recent sale. We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Terry D. Wickman, President, Keytroller
We were happy to see the interest in our company and what we cherished has not just a valuable company but an important company to the communities we served in.Larry Moore, Owner, A Company Portable Restrooms
We will highly recommend Generational Equity and Musa Jagne to any business owner about to embark on the same process.Karen S. Williams, CFO, BW Manufacturing
I couldn’t have asked for a better team than Michael and Deborah. We couldn’t have done it without them.Robert Evans, President and CEO of Mealtracker Dietary Software
We are extremely pleased with the way Generational Equity handled the sale of our company. Your associates, Tom and Chris, did an outstanding job of getting us (me) through the process.Michael J Polarek, President, Paragon Packaging
We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
Bruce and I wanted to take this opportunity to thank Generational Equity for assigning Musa Jagne to our transaction. In Bruce’s words, “Musa did one hell of a job for us!”Karen S. Williams, CFO, BW Manufacturing
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