5 Key Components for Minimizing Risk When Closing an M&A Deal

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.” Charles Dickens, A Tale of Two Cities

It’s quite possible that Charles Dickens was talking about M&A transactions when he penned the opening lines to A Tale of Two Cities. At some point in any M&A deal, Mr. Dickens’ words will ring true. Whether you are on the buyer or seller side of the deal, capitalize on the positive and minimize your risk by considering the following strategic key components to closing an M&A deal.

1.      Get Your Team In Place

The most important component of any M&A transaction is to ensure you have the right team in place. The external team should be comprised of legal counsel, valuation experts, investment bankers, accountants, and others, who not only have the experience in closing deals to ensure the business makes it to the finish line, but who also have the specialized skills to handle the nuances of the transaction. Failing to assemble the right team, as early as possible, simply exposes the business to unnecessary risk.  Even at best, money could be left on the table, loopholes in drafting could lead to litigation exposure, intellectual property mis-steps could result in failing to acquire essential components of the business, and tax implications could be costly.  

2.      The Price Is Negotiable … And Be Creative

When it comes to negotiating the price, everything should be considered. The business won’t sell at 10x EBITDA if your market comparables are selling at 5x. The business charging forward with increasing annual revenues may not be lucrative if product liabilities are showing up in the inventory from production one year ago. These considerations, along with others, such as the seller’s management team – and whether they stay or go – all have an impact on price. And even after you’ve drilled down and considered EBITDA, market trends, legal liabilities, management transition, and employee buy-in, you still need more than one bidder at the table to discern what the market is truly dictating as far as price. What happens after both sides have done their research, exchanged rounds of numbers, and still can’t close the gap? Be creative – consider an earn-out, retained minority interest, or royalty schedule. Under any circumstance, explore all possibilities and don’t let an initial gap in bare numbers chill the transaction.

3.      Due Diligence Matters

Due diligence is the heart of the transaction and strategy is key. On the seller side, establishing an on-line data room is one of the best ways to control the dissemination of information. Only authorized users can be granted access, and the seller can ascertain who has reviewed documents and for how long. Before the buyer ever virtually steps into the online data room, the company records should be reviewed for completeness and organization. On the buyer side, in addition to considering UCC filings, land records, court records, audited company financials, inventories, and historical records, the buyer must review contracts, employee matters, potential liability problems that have not yet arisen, shareholder records and minutes, and incomplete files. Sometimes the biggest red flag is not the actual document itself, but the manner in which the company records were maintained. Don’t forget to consider intellectual property. Are domain names maintained, patents filed or pending, and trade secrets protected? Are licenses in place, including software licenses? While it’s easy to consider only the product on the shelves, ensure that the intellectual property considerations are not over-looked.

4.      Read The Fine Print – It Matters

While having the right team in place is essential, you, the buyer or seller, must be in agreement with the details. If you don’t know or understand – ask. Is the purchase for stock or assets? Are you taking on liabilities and transitioning contracts or buying assets only? Pay attention to your representations and warranties. If you’re buying, are you comfortable with the escrow hold-backs to ensure the seller’s representations and warranties? And, if you’re the seller, does M&A insurance in lieu of an escrow-holdback help ensure that you walk away with your bottom-line. Know if there are competition restrictions post-close. If the parties negotiated a lower price with a seller earn out – is it feasible or is the seller walking away from money on the table due to an inflated estimation of the company’s success post-close? Read the fine print and ask because you are the holder of the transaction.

5.      Positive Transition Is Key

And when the deal closes, the deal is not done. It all hinges on the transition. The purchase agreement is clear, complete, and understandable. Due diligence was thorough, vetted, and substantiated. But on Day 1 post close, the buyer walks into a new company that must continue to run and grow and the seller walks out of a company that was often all-consuming. On the buy-side, consider whether long-term employee retention incentives are necessary, such as a stock employee retention plan, employee contracts, or non-competes. Consider whether your new team needs confirmation that the company will continue to run well or that the company is on the precipice of better days. On the sell side, get a plan in place. Take time off, visit with your investment banker, and spend time with your family. Get ready for the next adventure. If you have questions about closing an M&A deal, contact an attorney at our Sioux Falls, Sioux City, or Omaha office today!