What Does Conditions Precedent Mean?
Conditions precedent is a term used to define all the significant points that need to be dealt with prior to closing a transaction. They are itemized in the letter of intent (LOI) by either the buyer or the seller, although it is usually the buyer who typically inserts them.
The more typical conditions precedent include:
- Meet with significant customers to provide comfort to the buyer that the potential purchase will not affect the relationship;
- Ensure that all financial statements used to value the target have been either audited or reviewed by an external firm of certified accountants;
- Ensure that all assets that form part of the transaction — including equipment, real estate and net working capital — are valued at their fair market value and 100% owned by the seller. An asset appraisal is usually conducted;
- Ensure that due diligence on the target can be conducted, and no significant issues are identified that may impact the target's valuation;
- Allow the buyer to secure either debt or equity financing that is suitable; and
- Ensure that all key personnel of the seller signs employment agreements post transaction.
Divestopedia Explains Conditions Precedent
The conditions precedent can usually be met without difficulty by a prepared seller. It is always best if the seller has been preparing for the sale well in advance, and has the majority of the due diligence information already compiled. A buyer will always appreciate receiving a well documented and organized due diligence package, rather than an attempt to piece things together at the last minute.
An area of risk for sellers is usually how a customer may react to the potential transaction. Usually, the sale of the business is not discussed with customers prior to closing in the event the deal falls apart. The seller must ensure he/she is present during the discussion with the customer to properly explain how the transition will occur and how the customer account will be taken care of. The customer wants to see the seller will still be available and feel like nothing will change.
A second area of risk is the outcome of any appraisal that may be conducted if the target is capital intensive. A buyer may reduce the purchase price on a dollar-for-dollar basis if the appraised value of the assets falls short of the expectation used in their valuation models. A seller is better off commissioning its own appraisal in advance, or at a minimum making sure the appraiser being used is qualified and independent. The appraiser will often provide two values — the orderly liquidation value (OLV) and the fair market value (FMV). The fair market value is the relevant one if the business is a going concern.