In parts one and two of this article series, we discussed the natural experiential advantages that a business buyer’s team would bring to the table in a business sale transaction; identified buyer attacks on the transaction value during the negotiation and LOI process; and offered approaches you can use to hold your ground against this formidable opponent in regards to the working capital adjustment, benchmarks and earnouts. In this article, we continue to view this negotiation process like a fencing match; buyer thrust, seller parry.
The Due Diligence Surprise
Thrust – “We noticed that your average billing per customer is smaller than our average billing rate, we are going to have to adjust our value.”
Parry – “What about the memorandum, the detailed customer lists, the monthly billing report that you reviewed prior to executing the LOI didn’t you understand? Our price is firm. If you want to adjust, we are cancelling the LOI and we are back on the market.”
Thrust – “We noticed that you had a spike in this particular type of revenue which is unusually profitable. We do not believe that this is sustainable and are going to have to adjust our bid to account for that.”
Parry – If you analyze it correctly, last year was pretty much the norm for this type of revenue. The year prior was actually the outlier and much lower than average. Secondly, if you truly allocated corporate overhead to this income category, you would find it about the same level of profitability as our other lines of business. No adjustment is warranted.”
Okay, we held our own during that round. Now it is just a formality to get the purchase agreements signed and provide our wire transfer instructions. Not yet, pick up your sword.
Unreasonable Reps and Warranties
Thrust – You receive the definitive purchase agreement from the buyer’s attorney and it looks like you have to rep and warranty your first born in order to get the deal signed. All of a sudden you see escrows and holdbacks, and guarantees that were not mentioned in the LOI. Much of that is pretty standard stuff, although it will be very slanted to the benefit of the buyer.
Parry – No material changes to the deal economics allowed. “We signed the LOI and provided you a no-shop in order to allow you to perform due diligence. We were very detailed in our LOI in order to compare your bid with others that were very close. Without any legitimate finding of misinformation in the due diligence process, the economics remain the same.”
As for the scary reps and warranties, holdbacks and escrows, we let our lawyers talk with their lawyers. It is almost like they have the lawyers’ secret pinky handshake and they carve through this language with clarity and precision. What it usually boils down to is what is reasonable and customary in transactions that are similar to this one. If there are any remaining issues, they identify them and ask the seller and his/her advisor to work them out with the buyer. By this stage, these final points are settled constructively.
Delayed Closing Date
Thrust – “Oh, just one more thing, you are going to throw in the floor mats and the undercoating at no charge.” We tell our clients to expect this because it is just the nature of the buyers. Here is how it is manifested in a business sale transaction. The closing date is set for September 30, month end. “We want to move the closing date back to October 7 so we can take a look at your month end numbers. Do you have any concerns?” No, we just want to make sure things are on track.
Parry – Not much we can do about this one but try to anticipate what they may be looking at for that final attack on value and to prepare our counter attack. This one is a little trickier, however, because in prior attacks we had the luxury of time in order to strategize and craft our response. This one is usually real time where emotions are on the jagged edge. We ask our client to prepare a response to our anticipated last minute objection and then we, as their advisors, take the first attack. We want to have the client stay above the fray and preserve their relationship for the upcoming partnership together. If that effort is not accepted and the buyer insists on an adjustment based on, “It looks like you are not tracking to hit your first year earnout target,” we prepare the seller with, “You know that we put in the earnout in order to align your interests with ours going forward. I have a good deal of transaction value tied to hitting our targets and I would not have signed this agreement unless I was fully confident that I would collect every dollar of that earnout.”
Stalemate
Unfortunately, in spite of my best efforts, I view a stalemate as the best outcome we can hope for once we are off the market. As you can see, the leverage totally shifts to the buyer. The price is never increased during due diligence and contract negotiation. There is pressure to even keep the business flat during this process because a good deal of the owner’s attention and emotions are going to be focused on the process of selling his/her business as opposed to just running his/her business. So our process is to make it evident that there are several qualified buyers that are very close in their offers to the winning offer. If there is buyer bad behavior we can simply plug in the next best bidder. The other major strategy we employ is to recommend our client execute a very detailed-, formula- and example-driven LOI.