This article was contributed by Aaron Ghais, a deal lawyer at Shulman Rogers that has helped his clients buy, sell, and finance businesses, and has closed over 350 deals worth over $2.5 billion in the past 20 years.
Buying another company requires a big commitment and should not be undertaken lightly. As the Buyer, you’ll need to line up financing, put together a deal team and pay their professional fees, divert a significant portion of your attention away from your main business to get the deal done, and engage in a sometimes frustrating and prolonged series of discussions and negotiations, among other things.
The tougher the process, the more likely it is that you’ll ask yourself repeatedly: Is this worth the cost and effort? At what point does it make sense to give up on the acquisition?
Both are good questions, and you and your advisors should be constantly on the look-out for warning signs that the deal will not go through. The sooner you can spot potential “deal killers,” the sooner you can try to address them before they become fatal to your acquisition and the sooner you can back out of your deal before the costs outweigh the benefits in the long-run.
So what are some of those “deal killers”? There are many, but here are four “deal killers” that frequently rear their ugly heads:
1. Disorganized Seller
This one is easily spotted early in the process. For example, you ask the Seller for copies of all signed customer contracts and it takes weeks before you get even an incomplete collection of contracts, and many of the contracts you receive are unsigned. Or the Seller’s financial records are messy and you discover that the target business has lots of old accounts receivable and no effective collection system in place. Or the Seller’s capitalization table, showing who owns what equity in the company, is incomplete, out of date, or otherwise inaccurate.
Although not fatal in any one instance, a Seller’s mess will become your mess if you close the acquisition, and it may take a lot more time and money to get to closing than you’d like.
2. Surprise Disclosures by the Seller
A surprise disclosure could come anytime in the process, so gird yourself. Ask the Seller to tell you upfront about any problems that could impact deal value or post-sale operations. Also ask upfront for the documentation and information you’ll need to review during your due diligence process and press the Seller for quick and complete responses. Complete an initial and quick review of the provided documents to spot “deal killer” issues.
And get a draft purchase agreement to the Seller as soon as possible so the Seller can start preparing its disclosure schedules describing exceptions to certain representations in the purchase agreement. If you ask for a representation that there are no lawsuits pending against the Seller except as described on a disclosure schedule, you might just get a draft disclosure schedule listing some highly problematic lawsuits that you really don’t want to inherit.
The due diligence process is a sorting-and-sifting process that takes time, but the more effectively and quickly you can force the Seller to disclose potential liabilities and issues that could affect the deal’s value and viability, the better.