Whether you are buying or selling a business, the transaction goes through the same steps. However, they are viewed from different perspectives. Sellers may not want to fully disclose all the blind spots while Buyers will want otherwise. Nasir and Matt battle it out in this Buyer vs. Seller to determine who has the advantage!
When it comes to selling a business, some of the most critical work is done before you even make your first phone call. A letter of intent serves as a way for both parties to get on the same page and lays the groundwork for what each of you can expect from the other.
Buying or selling a business is a complex process. It’s not just about talking about purchasing or selling the company’s assets. For prospective buyers, it’s important to understand that buying a business is not all about the numbers. Thorough due diligence of all facets of your target company is necessary for you to make a meaningful offer.
Representations and warranties are the biggest reason that verbal agreements are so risky. Representations and warranties set a floor on the quality of the purchase, define each party’s responsibilities, inform both parties how they can end the deal, and help structure payments.
Signed, sealed, and delivered. The signing and closing of a transaction is often the most critical stage in the process. It can either be smooth or cause delays that could undermine the transactions.
Full Podcast Transcript
NASIR: All right. Welcome! We are talking buyers and sellers, acquisitions, mergers. It’s a lot more than what you would think.
MATT: That depends on what side you’re on.
NASIR: Everyone in business ends up at this point at one point in time.
MATT: It’s a very interesting dynamic. This is kind of a very weird interaction.
This is Legally Sound Smart Business where your hosts – Nasir Pasha and Matt Staub – cover business in the news and add their awesome legal twist. Legally Sound Smart Business is a podcast brought to you by Pasha Law PC – a law firm representing your business in California, Illinois, New York, and Texas. Here are your hosts, Nasir Pasha and Matt Staub.
NASIR: All right. Welcome! We are talking buyers and sellers, acquisitions, mergers. We are going, once again, head-to-head – Matt and I – taking different perspectives. This time around, we’re not flipping a coin. Matt and I discussed it prior, and I am taking the buyer’s point of view.
MATT: That means I’ll be taking the seller’s point of view.
NASIR: That would be weird if you also took the buyer’s point of view, so that’s good.
MATT: Well, obviously, there’s not a lot of positive results from the pandemic, but one thing I’ve noticed that has happened that’s been a positive is there have been a lot of transactions between companies – like you said, mergers and acquisitions, things of that nature.
We’ve seen quite an uptick of representing buyers and sellers in those sorts of transactions just because of the nature of it. I don’t know necessarily if they were more motivated and what the actual reasoning was, but – at least in my opinion – there’s been an increase in those sorts of transactions.
NASIR: Absolutely. If you looked at the stats on M&A in general, it’s a lot more than what you would think. You would think that – because of uncertainty, because of this, because of inflation – things would actually slow down, but that doesn’t seem to be the case. M&A attorneys are quite busy.
We’re talking about buying or selling a business. We’re general practitioners. We work with medium to small-sized businesses, but everyone in business ends up at this point at one point in time. Sometimes, it’s in the beginning because you’re acquiring a business that you’re starting perhaps. Maybe entering a new career. Or you are selling a business – maybe your baby that you’ve been with for 10 or 20 years. Also, in-between – maybe you have rapid growth and you’re ready to move onto the next phase of your life.
Of course, buyers and sellers are coming at complete opposite perspectives. It is an interesting relationship because both sides want to get a deal done, but a deal done at a point that both are happy. And so, even though these parties are trying to move a deal forward, there’s still strategy involved, there’s still negotiation involved, and depending upon a multitude of factors will end up changing the result. Hopefully, it’s a good deal for both parties.
MATT: Yes, that’s the interesting part from our perspective – and, I guess, for any lawyer that’s involved in this. Like you said, it depends on what side you’re on, and you take a completely different stance and negotiation of the terms depending on whether you represent the buyer or the seller which obviously makes sense, but it’s just a very interesting dynamic. We’ve even had clients where we’ve represented them in one capacity as a buyer and then, down the road, in a different capacity as a seller.
NASIR: But the same business, right?
MATT: Yes, for the same business. It’s interesting how that works out.
NASIR: Yes, we’re going to go through it. At least I’m not going to focus too much on the legal terms. We’re going to make some presumptions here. You’re going to have counsel. We’re going to hopefully talk about more practical aspects of when you have that conversation with your attorney, where your attorney may be coming from and pushing you a certain direction, negotiating certain business terms that are pretty common from each perspective, and also give some insight on maybe even how attorneys look at this.
There is a lot of client management – which is an attorney term – when it comes to these transactions because, for the most part, your clients – or most people – aren’t going through mergers and acquisitions multiple times per year. It’s a once in a lifetime event in some cases – unless you’re in private equity or something to that effect.
Let’s get right into it.
MATT: I was going to say you’re completely right. I’d say the most classic example is the one-time sell-off from a business that’s cultivated, and they’ve reached the point where there’s a lot of value in there and they can sell it. Of course, you have the ones that are on the other side and acquiring left and right. But, yes, a lot of times, from our clients’ end, it’s individuals that aren’t familiar with the process, so there’s a lot of educational aspects on our end to lead them through the process.
NASIR: Right. Well, let’s get right to it.
The first stage of pretty much every acquisition. It’s very rare that you don’t have some kind of term sheet, letter of intent, so-called pre-definitive agreement kind of period where you’re either sending an offer and outlining the terms of the sale or even sending a solicitation of a sale instead of an offer – or solicitation of an offer, I should say – and the terms for that sale.
It’s not dissimilar to how real estate transactions work. You send the offer and see if it’s accepted. The difference is, typically, in a real estate transaction when you’re buying a home, your realtor or your real estate agent will send an offer with pretty much the purchase agreement and all the terms there. And so, all the seller has to do is sign, the buyer signs, and the contracts are done. When it comes to any kind of major acquisition, typically, you have some kind of writing prior to an enforceable purchase agreement. That document is typically called a letter of intent.
MATT: Yes, and that’s a good way to differentiate it from the real estate perspective versus this business transaction because what you’re going to put in the letter of intent – I shouldn’t say “what everyone does” but what you should do – is going to be all the parties have agreed upon, the material terms of the transaction, but it’s not going to give you the full definitive documents terms like that as opposed to a real estate transaction.
A good letter of intent is going to have obviously an agreed upon purchase price and any of the material terms that the parties are going to agree upon. Of course, there’s going to be back and forth on how everything should be structured, but you should have a good framework. A good LOI is going to be a good framework for what the transaction is supposed to be.
so, as a buyer, it makes sense for me to start with this. I would say, for the most part, buyers are the ones doing the first draft of an LOI. I’m making the offer. I want to tell you how I want to purchase your business.
Some of the things that I think are important to me as a buyer is, for the material terms that I want, I want to make sure that we don’t move on in definitive agreements, so I’m going to put it in there. But there might be certain things that I don’t want to be too detailed with because maybe I need to learn more about your business before I really paint myself in a corner and make it harder for me to negotiate later. One of those things is the purchase price.
As a buyer, there are a lot of ways for me to approach that. If I know your business really well and I feel confident that whatever purchase price that I’m willing to agree to now is probably going to stay the same, then I don’t mind putting a dollar amount in there. But, sometimes, it could just be based upon some kind of multiple of earning which, of course, the seller may say, “Well, my earnings are X, and I’m willing to pay 5X or whatever multiple of that earnings,” and I can come up with a purchase price.
But if I’m an experienced buyer, I also know that, when it comes to earnings, those need to be looked at closely, and possibly adjusted. And so, a lot of sophisticated buyers will actually make the purchase price a calculation. Even if I put a dollar amount, “It’s five million dollars based upon a quality of earnings report that is based upon X number of multiples.” It’s some kind of backup language that gives me some wiggle room to negotiate if I need to later.
MATT: Yes. On the seller’s end, I would like certainty. Ideally, I would have a set dollar amount that I’ve agreed to because that way I know there’s no wiggle room – whether that’s a combination of a dollar amount and some sort of earn out or something of that nature. The more certain I am of whatever I’m going to receive in total consideration at the end of the day, it’s going to be what I’m going to want on the seller’s end.
NASIR: Absolutely. I don’t want to say this is a very controversial thing because – remember – LOIs are typically nonbinding. Maybe we should just jump into that. From a buyer’s perspective, I’m willing to be bound by certain terms. Confidentiality? I don’t mind. Whatever documents you’re going to give me in exchange for this, I don’t mind being bound to that.
But, for pretty much everything else, I want my hands free. I want to be able to take my time in the transaction, due diligence. I want to be able to renegotiate everything, if I can, on a go-forward basis.
MATT: On my end, I would like it to be not that way. As the seller, preferably, I would like the entire thing to be binding – meaning, once you’ve signed off on the dotted line there, you’re locked in, and we can set some sort of period of time on it, but you’re basically locked into the transaction and you can’t back out unless there’s some sort of legitimate reason why because we’ve gone through the process of finding you having initial discussions, disclosing things. And so, I want to make sure you’re not just shopping this around and trying to find something else.
NASIR: Right. Even though that’s the desire of the seller, for the most part, it’s rare that you have any kind of real concrete binding terms at the LOI stage. It’s just the nature of it. There’s just too much uncertainty. You want to get something in writing quickly, but when it comes to drafting documents, and when it comes to due diligence, those things take time.
Regardless of the law firm, regardless of the transaction, if it’s anything of significance, you can act quickly. We’ve done transactions and we’ve seen transactions that are very complicated that are done in a very short period of time, but the gap of information from day one to whatever the last day is can be very huge. And so, it just doesn’t make sense to have a lot of terms that are binding.
But there is one term from a buyer’s perspective that I think is important to be binding and that is a no-shop provision. I’m putting in an offer. Depending upon the size of the transaction, I’m going to be spending tens – if not hundreds – of thousands of dollars on large transactions before I even decide to sign on the dotted line, so to speak. If I’m going to do that, you guys can’t be shopping around. You guys can’t be even talking to other prospective buyers waiting in line for me to say yes or no. That’s not fair. It doesn’t make sense for me.
MATT: I can respect that from the seller’s perspective. The way we’ve countered that before is to just make the window short enough where the buyer can’t just be taking their time and not getting things in order. Obviously, from the seller’s end, we have to provide a lot of documents. We can be responsive and do that, but I want to make sure at the same time that the buyer is not just slowly working through the process. We can shorten that window and give you some sort of exclusivity period, but once it gets Day 75 or whatever it is, then it’s a different story.
NASIR: Yes. Exclusivity periods – let’s talk about what’s typical. 30, 60, 90 days – that’s what’s typical. Most transactions – even complex ones – can be complete within three months for most small businesses, but I would say that agreeing to some kind of finite term is agreeable. Sometimes, a compromise, if I’m looking for 60 or 90 days and the seller is not looking to do that, then maybe working some kind of extension. “We’ll do 30 days with an option to extend.”
It’s kind of the same thing, but what it does is it allow the seller some kind of check to make sure that there’s progress being made. What the seller doesn’t want to see is, of course – this is speaking on behalf of the seller for a second – the buyer not doing anything until the last week of that 30-day period, and then asking for an extension. They want to see some good faith efforts in doing so.
In contrast with what you find with public companies is not a no-shop provision but a go-shop provision which is the opposite. It allows public companies to explicitly – even after they’ve engaged or even entered into a purchase agreement – shop around for other potential buyers while, in this punitive time, they can still terminate the purchase agreement. Of course, that’s the opposite of a buyer-favorable term. Not as common, I would say, in the nonpublic sphere.
MATT: Right. I know you’re not the biggest basketball fan, but—
NASIR: I’m going to be medium-sized.
MATT: If you don’t know, there are restricted and unrestricted free agents. With the restricted free agents, basically, another team can make an offer for X number of years, X number of dollars, and then the team that that player was on has the opportunity to match it. I don’t think it’s the exact same thing, but the go-shop provision reminds me of something like that. “See what else you can find, but we feel pretty confident in this offer, and we think it’s going to ultimately be what you’re looking for.”
Another thing that often comes up at the LOI stage – and it’s something that we can talk about at every stage of the acquisition, but let’s just talk about it now – is this concept of asset versus equity purchase. It’s something that we’ve talked about in the past.
By the way, we have a whole series called Behind the Buy where we actually walk through a client of buying a business and every aspect of that. I think we even have a whole episode on asset versus equity sale as well.
In essence, buyers tend to want an asset purchase. As the acquisition and the complexity of the business actually gets bigger, it’s actually more likely to be an equity purchase because of the nature of how these transactions go, but the reason why we – as buyers – want an asset purchase usually is because it is the cleanest way to ensure that any liabilities that exist prior to the closing is not going to follow me as a buyer. It’s not to say that the equity purchase isn’t going to do that because, even if I’m buying a business as equity, I’m going to make sure that liabilities prior to closing are still not mine, but just from a risk management perspective, it is the best way to minimize that previous liability.
MATT: Right. Obviously, from the seller’s perspective, it’s the opposite. We would want an equity purchase because we’re not trying to sell off bits and pieces of the business. If you want buy, you have to buy everything.
Going back to the house analogy, you can’t just buy three of the four rooms. You have to buy all four rooms. If something comes up, you can have ways to protect yourself, but what we’re looking to do is to put everything into one pool and then sell it off. You can run from it from there after closing.
NASIR: See, it’s easy to say buyers want assets and sellers want equity. It’s a little complicated. Everything from taxes to when it comes to certain contracts that you want because one of the downsides – or upsides, depending upon how you look at it – of an asset purchase is that, when you talk about liabilities, we’re also talking about certain contract agreements.
If you have a contract agreement with a client which is a revenue-producing contract, you may not be able to automatically assign that agreement in an asset purchase whereas an equity you may be able to. But the opposite is true, too.
If there is a space lease which comes with what is an expense contract, it’s a liability, but if I’m buying a business – like, a store – I need to be able to occupy that store. That means I need to be able to have that lease assigned to me as part of the transaction.
What I would say about this is that – whether it’s an asset purchase or equity purchase – I don’t think it’s too much of a buyer-versus-seller issue, but a lot of nuances surrounding that can be solved where both the buyer and seller are happy – content is probably the better word – because, if the buyers were to buy liability in an equity purchase, then there are things that you can do to eliminate your liability. If the seller is worried about being able to offload certain liabilities – for example, for an alarm company, what are they going to do with a service contract once they sell the business? – that might be something that the buyer agrees to assume. It’s in these details where these things can be resolved amicably between the buyer and seller.
NASIR: I just realized, one thing that’s interesting about this is it’s not really buyer versus seller because we both have an interest to get a deal done. It’s much different than our previous topics of employer versus employee and California versus Texas.
MATT: No, I like to be the seller. I disagree with that. I lost my train of thought.
Oh. Even if it is an equity purchase, what’s going to be required from your end is obviously going to be disclosure of any liabilities, and then certain contingencies in place, and indemnifications.
The buyer that’s appropriately structured is going to have all those protections in place in order to account for anything that’s known or unknown. It’s not like you’re doing a storage unit purchase where you can’t see what’s in all of the boxes inside and you pay a set amount of dollars. You do still go through the due diligence process. Again, protect yourself as adequately as you can from the buyer’s perspective.
NASIR: Right. That leads into the next phase. If I’m taking on any kind of liabilities, I need to understand what those liabilities are. If I’m buying a business, I need to know exactly what I’m buying.
Typically, after an LOI is signed, there is a period – usually during the exclusivity or no-shop period – there is also a due diligence period or a lapse. This is a period where a buyer can look into the business to see if there’s anything that I need to verify whether to move forward or not. As a buyer, I want everything. I want full transparency.
I want to be able to ask for anything and receive anything I’m looking for and use that information to determine whether I’m going to purchase the business, whether or not I’m going to renegotiate – whether it’s the purchase price because I see something that I don’t like, whether it’s changing the terms of the agreement, whether it’s going from an asset to an equity or vice versa – because of how I’d like to structure that.
Frankly, I don’t care if I’m being invasive because I’m putting in a lot of money, so I need to see everything. That means I want to interview your employees. I want to visit. If it’s a physical location business, I want to go to your warehouse. I want to go to your storefront. I want to see with my own eyes how you run your business – the ins and outs of it – so that I understand what I’m getting into.
MATT: As the seller, I don’t really like that part. I may allow you access to a key employee here and there, but I don’t want you interviewing employees. Ideally, we would not disclose that there is going to be a potential sale. In my opinion, there are only bad things that can happen at that point once employees catch wind that it’s going to be switched over and under new management essentially.
I understand where you’re coming from, but I would like to run everything through me personally and not have you walking around asking questions and getting people to start talking amongst themselves about what’s going on with this new person that showed up.
NASIR: What if we did something like that one show where the boss or the CEO of the company becomes the cashier of his business for the day? What if we do something like that?
MATT: Undercover Boss.
NASIR: Undercover Boss! Yes. What if we did something like that? No, I’m just joking.
Obviously, that’s the dead hammock. On one hand, I want everything. On the one hand, you don’t want to disrupt your business. Okay. I get that. What are some compromises? Well, you offered interviews with key employees. Especially with higher or upper management, disclosing of the potential sale is relatively common because they may be required to help produce some of the documents, and maybe they benefit from the sale, or maybe they’ll be coming aboard in the sale. Also, it depends upon the timing.
I may be able to make you feel more comfortable in doing employee interviews if it’s after definitive agreements or if it’s towards the end of a due diligence period. That might give you some comfort. Also, look, if I’m going to go to your store, I don’t mind doing it after hours. If it’s during hours, doing it subtly – by acting as a customer or under some other guise, take me around in some other capacity, and I’ll play the role. I used to act, so…
MATT: You mentioned the word “disrupt” which I think is something that’s not thought about because, obviously, the due diligence process can be and usually is burdensome for both sides but particularly for the seller because they have to compile everything and get it over to the buyer. People often forget they still have to run their business as well.
NASIR: And I have an interest in that. I don’t want the employees to necessarily know the sale because I don’t want them to have some kind of mass exodus because they think they’re all going to get fired because maybe I want to hire them, and maybe I want to control that transition a little bit.
MATT: That was the second point I had. The one reason I would be fine with you talking to certain employees would be if they were deemed key employees and, in order for the transaction to go through, they had to stay on because, oftentimes, you’ll have certain employees – typically, if you have one or multiple owners, whatever higher-level employees – part of the transaction in order for it to close is they’re going to stay on – whether there are time restrictions on that or what-have-you.
But the buyer wants to be assured that these people at least need to be here to tell us what to do because they’ve been the ones day in and day out. They know the inner workings. They need to be here. Ultimately, what we do with them, that’s a different story, but they still need to come along after the purchase is done.
NASIR: Right. Let’s talk about the quality of earnings process.
To generalize a little bit, the buyer is typically more sophisticated than the seller. That’s the nature. Usually, something bigger is buying something smaller. Of course, that’s not always the case, but that’s often the case.
Because of that, you’ll have buyers that, in order for them to meet their own fiduciary duties to their investors, to meet their standards of practice, they will want to verify financials in a way that you – as a seller – just aren’t going to be used to. While a buyer may be required or get their financials audited every quarter, a seller may not even come close to that and may just have a bookkeeper – not even a CPA – looking over their shoulder on these kinds of things.
And so, our request when it comes to looking at your financials, I’ll tell you now, most likely, you’re going to be surprised about how we’re going to verify your financials. It may be in a way that you’re not used to, and it may actually end up being an adverse result to what you think your actual earnings are.
Something that’s going on right now that’s very common – and this goes both ways – is making adjustments on quality of earnings because of recent events – specifically COVID. For healthcare, COVID really messed things up as to how you look at a business in acquisition because, in a lot of healthcare businesses, you’ve had a huge surge of different things – revenue, et cetera – and a huge surge in expenses. In order to value a business, making some assumptions of what’s going to happen in healthcare in the future, you can’t assume whatever happened in the past two years is going to keep happening. But that applies to non-healthcare as well.
Those kinds of adjustments and reviews – whether it’s done by the buyer themselves or some kind of third party – is something that I think a lot of sellers are often not used to. There’s this very typical conversation after the quality of earnings report comes out from a relatively sophisticated buyer and it kind of has that moment with the seller of the reality of what they’re actually looking at for their business.
MATT: That’s going to happen, you know. At this point, on our end, the seller has disclosed certain information, but the buyer may have different opinions on things, or – once they dig into it – come to completely different conclusions. That’s definitely not uncommon for them to see that and for there to be some sort of discussions after the fact.
NASIR: You know, this does happen. Any kind of due diligence – whether it’s quality of earnings or just general information – can be used as negotiating tools. If I get a quality of earnings report that produces valuation that is less than one originally expected, I’m going to renegotiate. When we start drafting definitive agreements, that new purchase price is going to be reflected in there.
MATT: You’ll even see that post-closing, too. There might be some sort of working capital adjustment where the seller side comes up with their figure, and then the buyer side will have – let’s say – 90 days to come up with their figure at the time of closing and there might be differences there, too. It even happens after the fact.
NASIR: Right. Something relevant to what’s going on right now is Elon Musk’s tender offer for Twitter. I don’t know exactly what stage it is right now, but one of the things that he’s talking about is so-called due diligence regarding how many fake users there are on Twitter.
Outside looking in, it’s an obvious move in order to either delay or adjust the purchase price. If whatever Twitter is representing in the public is to the percentage of Twitter users being fake is lower or higher than the reality, then that would be a significant difference in valuation.
This kind of quality of earnings or whatever you want to call it – any kind of due diligence – swings the needle. It makes a big difference. It can change things dramatically. I’ve seen some crazy stuff where the seller has an idea of what their business is making, but then you get some real professionals and finances in there, both buyer and seller at the same time realize how much the business is really worth. That can have some dramatic effect.
MATT: It’s a good thing I had the binding LOI as the seller.
MATT: So, I’m not too concerned about that.
For the most part, it can only go down. Of course, who’s controlling that due diligence process? I’m controlling it as the buyer. I’m the one that’s going to be pointing out all the bad stuff. It’s that old adage that – as attorneys we say, and this is relevant for any kind of disputes or criminal matters – “when a client first comes to you with a controversy, whatever facts they tell you are the best facts that you are ever going to get” because it’s only going to go down from there because, from there on, you’re going to uncover what the other party’s perspective is, what other facts there may be that may be bad for your client.
And so, when you do an assessment in giving feedback to your client, you have to assume that this is the best-case scenario. It’s not going to get better from there. It’s very similar as a buyer when you’re buying a business. It’s hard sometimes to create that expectation for sellers because sellers may be the opposite. “When they actually look into our business, they’re going to be impressed. They may even want to pay more. Or may be willing to pay more.” But that’s very rarely the case.
MATT: Well, unless they have the go-shop provision, then it could actually end up being more. I think that’s one of the advantages of having that. But, yes, you’re right overall. It’s basically the opportunity for the total consideration to decrease. This isn’t Pawn Stars where someone walks in with a coin and they think it’s probably worth $500 and they’re like, “Actually, we’ll give you way more for it.” That’s not a very, very common scenario.
NASIR: Right. That’s a very funny analogy.
I think the only times prices may go up is if there’s some kind of market change or if there’s some kind of fundamental change in the business which does happen. It’s like, “Hey, between the LOI and the purchase agreement, we just picked up this new contract that’s worth a billion dollars.” That can change things.
MATT: Yes, I’ve seen that on the real estate side. If you locked into an agreement and the market went crazy – like it has the last couple of years. But, yes, you’re right. Again, it has to be something unexpected, out of the ordinary, not in the normal course of business that happens typically for those scenarios to arise.
At some point, attorneys start putting together definitive agreements. I’m not even sure it’s worth getting into the details of this because, at this point, the major components should be subtle between the parties, and it’s the kind of subtleties that the parties are discussing. At this point, usually, attorneys can just handle this on their own. You don’t need a huge amount of input from the principles on this, but some of the things that I think clients tend to not spend as much time as they should on are these concepts of warranties and representations.
When I am buying a business, I want the seller to warranty and represent that everything that they have provided us is completely accurate, 100 percent true, and that there are no surprises and that I’m not walking into a trap. Just as an example, there’s a ton of warranties of representations. They can be very long, depending upon the type of business and what’s going on.
A basic one, for example, “I want you to warrant that anything that you’re doing and everything that you’ve been doing is completely legal because I’m going to walk in and start operating your business pretty much as is as I make changes, and I don’t want to be walking in where, all of a sudden, I’m breaking the law from day one.”
Another common warranty in representation is that whatever information you’ve provided to me – all the finances and all the documents and so forth – I want to make sure that it’s not only all accurate but it’s exhaustive. If I ask for all the contract agreements, my expectation is that you gave me all the agreements. I don’t want to buy a business and then find out later that I have to pay this guy to do my landscaping every week because I have a contract with them – something like that.
MATT: I can allow the accuracy one. That’s fine. I’m not going to misrepresent things. As burdensome as it is, the exhaustive providing everything you’re asking for, I can probably do that as well.
But, as the seller, the issue I might have would be representing that everything that we’ve done is 100 percent legal. It comes off bad, but the issue is – what’s the phrase? – you don’t know what you don’t know – like, “Well, I think I was doing everything correctly, but what if I was supposed to register as a foreign entity in this state but I just didn’t know.” “What if I was supposed to get this permit and I wasn’t intentionally doing anything wrong, but I just didn’t do it?” There are ways to try to get around that. It’s not just 100 percent like you’re representing everything. You know, there are different reasonableness standards, but it’s tough from the seller’s perspective because—
NASIR: College standards.
MATT: Yes, the buyer’s going to ask for everything you’ve done is correct. Well, again, I think I’ve done everything by the book, but what if I haven’t and I don’t know? Obviously, if there’s something glaring, that’s a different story, but there’s going to be gaps. That’s just part of it.
NASIR: Yes, and there are certain things, certain representing warranties that I’d be willing to agree to only to the extent that you know. But then, there are some things that I don’t care if you actually know or not. I want to make sure I’m warranted against that – like, accuracy, for example – because even if you don’t know you made a mistake, I need to make sure that it’s not a mistake as an example.
But one of the problems I have as a buyer is that you can make all the warranties and representations in the world, but who’s making the reps and warranties? Is it the seller in the sense that it’s a seller entity that’s selling the assets? Or is it the seller if it’s an equity purchase? The reason this is relevant is that, if there is a breach of that warranty in representation, who am I suing?
What party am I suing? Does that party even have any money to pay me? What if I’m buying a business that is full of debt? Let’s say they have a million dollars in debt owed and I’m going to purchase it for 1.2 million. I’m going to pay 1.2 million, but a million dollars at closing is going out the window. The seller doesn’t have much money anyway, so who am I going to run after?
Some of the ways that I’m going to solve this is (1) maybe I’ll have personal guarantees or personal liability for reps and warranties – but again that depends upon that actual individual being worth something. Or (2) I can actually get insurance or require the seller to get insurance against representing warranties which can be expensive but does exist. Or (3) I just take the risk. That’s part of buying a business. I’m just adding that in there because the reality is that is part of an inherent risk of purchasing any business.
MATT: Yes, and what you’re talking about is requiring the beneficial owner/s of the actual seller to sign off on those, too. It makes sense and you’ll see that it’s pretty common.
Contrary to my side, the other way would be what you’ll have is disclosure schedules and, basically, within all the representations and warranties, they’ll ask for certain information or certain documents. As a seller, my obligation then is to disclose that information that’s requested within those documents, and part of the representations are what I’m providing to you as the buyer is completely everything that falls in line with this certain section of the representations and warranties.
That’s going to be very common as well. You’ll see that pretty frequently just because the buyer, again, even though they’ve received everything or likely have received most – if not everything – during the due diligence process, they want to make sure that the seller is disclosing these are the only things within these certain subcategories that are going to apply within these different representations and warranties.
NASIR: That’s absolutely correct. You have to deal with these things. Like I said, I think clients tend to take these too lightly. It has to do with the transaction itself. These issues come at the end. From a buyer-seller perspective, they’re ready to get it done, ready to close by the time they sign the LOI – let alone 90 days later when you’re actually closing and figuring out final reps and warranties – possibly earlier than that as well.
Speaking of closing, most of the time, if you do it right and efficiently, closing is a non-event. We’ve talked about this in the past, right?
NASIR: But there are some issues that come up. You know, there are things like closing statements that need to be reviewed at approved – kind of a final checklist of things that buyer and seller may be fiddling with – things that, early in the transaction, you’ve already agreed that we’re going to deal with at closing.
Inventory, for example – you need to do an accounting inventory. Some businesses require a literal time of day that is turned over from buyer to seller, and that may be relevant, depending upon the business. Arranging those kinds of things within days before closing. There are some things, different perspectives from buyers and sellers that come up.
MATT: Right. Obviously, every transaction is different, but what you’ll see is things just ramp up very quickly at the end. Documents as well. From the seller’s perspective, what I like to see is any sort of time – basically, if I need to provide this document at least five days prior to closing or whatever it is – to have those restrictions removed. Basically, whatever you need to be provided, we’ll provide it, but it will be prior to closing. We can’t do it five days because then that just pushes the transaction out even further.
I think, for the most part, the buyer is going to be fine with that too because, for this close, they want to get the deal done. They don’t want to push this thing out a couple of days just because there’s some sort of X number of days requirement that I needed to provide this document. Again, at the end, the floodgates have opened and there’s just a rush to finalize everything, put it all in place, sign off on everything. But, like you said, the closing, if it’s a good one, it should be an uneventful event.
Well, buyer versus seller – who won this round? I’m pretty sure we both won. We got a transaction done.
MATT: I won because I got the consideration.
NASIR: That’s true. Well, I got the business.
MATT: Well, you didn’t read all the representations and warranties that I had snuck in there.
NASIR: I just skipped that over. I did my Undercover Boss of the day and that’s all I needed to really understand the business as a cashier.
MATT: Four hours of makeup prep to make you look like a completely different person.
MATT: That’s where your time was spent.
Again, it’s an interesting dynamic. This happens in any kind of business transaction. Even as attorneys, I tend not to like calling the other party’s counsel as the opposing counsel because, for the most part in business, the other party is not your enemy or an opposite. In fact, it is the style of cooperative negotiation that has been proven to be very effective in business and figuring out solutions – not necessarily compromising. It’s not about just meeting in the middle but understanding the other party’s perspective. Hopefully, that’s what this is bringing out.
Buyers and sellers have different interests. There’s no doubt. But there are ways to get to the same point and get both parties happy and content, as I said before, to get a transaction done. Ultimately, that’s the goal for the most part. There’s almost always a transaction there that’s good for both parties. Very rare is it one-sided.
MATT: Yes, I think that’s a very good way to put it. I always refer to it as buyer’s counsel or seller’s counsel when I talk with our clients about it.
NASIR: You don’t say enemy counsel?
MATT: No. Well, yes, like you were saying, from the attorney perspective, the goal is to finalize the deal. Obviously, there’s going to be back and forth, and there’s likely going to be each side disagreeing on terms or how something should be worded or included or excluded, et cetera. But, at the end of the day, both parties are working towards the same goal – the finish line of closing the transaction.
It’s not like your typical two attorneys on different sides of the table. There is some sort of collaborative effort because, again, everyone is trying to get to the same point. We might disagree on what paths you’re going to take there, but you’re still trying to get to that finish line of closing out the transaction. You’ll often even see a closing celebration or dinner or something like that, too. All parties will be there – including attorneys – and everyone’s shaking hands.
NASIR: At the least, there’s the traditional congratulations email thread.
MATT: Very true.
NASIR: Because there’s like 50 people involved. At least there’s that, especially when no one’s seeing each other in person or in the same city.
MATT: You’re different because you said you were an actor, but I’m not an actor. I’ve never been in a movie, but I imagine it’s similar to that where you’re just working so intimately with these people for a set period of time and then it’s just done. Then, you just don’t talk to them – maybe ever.
NASIR: It is true. You don’t interact with them often again.
MATT: You can.
NASIR: It’s a pretty decent analogy because, especially counsel to counsel, you do spend a lot of time dealing with each other – good and bad. Hopefully, you run into each other again – hopefully, on a good transaction.
We didn’t really talk about bad deals and walking away. There are bad deals. Your job as a buyer or seller or your counsel’s job is to make sure you walk away from a bad deal. Again, it’s very rare that there is just not something that both parties should be able to accept, but deals fall apart all the time. Not every deal has to happen.
MATT: Yes, and I was going to mention this earlier and forgot, but that due diligence process, to me, that’s the make-or-break period of time. You might feel differently, but it’s typically the buyer that’s going to be the one walking away. Hence, that’s why they want certain terms in there – the nonbinding terms of the LOI – because usually it’s going to be a case where the seller might have oversold something or maybe didn’t fully disclose everything. Maybe they didn’t even know. I don’t know. And then, the buyer is like, “Well, now I’m digging into it.” I know we’ve mentioned before – they walk away or renegotiate the terms, particularly whatever the purchase price is going to be.
NASIR: Sometimes, you may have seller remorse.
NASIR: But you’re right. It’s not as common. That’s why seller’s remorse is not a term that anyone’s really heard of.
NASIR: All right. That’s our episode. Thank you for joining us.
We are so thankful for you listening. Don’t forget to follow us on social media as well as view our podcast – if you’re listening – on YouTube. If you’re on YouTube, you can listen to the podcast as well. I don’t know why you’re not listening to the podcast and just viewing us on mute. That would be weird. But, if you are, unmute that. Or you can also just listen to the audio.
MATT: Or you can do it concurrently. You could pull up the YouTube, mute it, and then listen to the podcast for just the audio. That’s another option.
NASIR: That’s actually what I do, interestingly enough.
MATT: Good. Like the person that watches a basketball game from their local team and then mutes the TV and listens to the local broadcaster do the actual calls.
NASIR: Or at the game, right? I’ve seen people pull up their phone. They go to the game and they pull up some kind of live feed or whatever.
MATT: Yes, you don’t see that as often. But, yes, you are right about that. I always thought that was odd for the people that did that. Sorry if that’s one of you. I’m sorry.
NASIR: I don’t apologize at all. I think those people are crazy. All right. Well, thank you so much for joining us. Let’s close it out.
MATT: Keep it sound and keep it smart.