Buying or selling a company is exciting. Maybe you are growing your business by acquiring a competitor. Maybe you are selling a company in which you invested your life savings and decades of effort. This may be the most significant transaction you have ever done.
So … what follows are some ways you can really mess it up.
Skip the letter of intent: A letter of intent summarizes the key terms in plain English. Some people skip the letter of intent and go straight to a lengthy and complicated final purchase agreement. Then they get bogged down in the details before reaching a clear agreement on fundamental terms.
A non-binding letter of intent creates confidence that both sides agree on fundamental terms, like the price. A good letter of intent builds positive momentum. The letter of intent should state clearly that it is non-binding. That means there is no deal until the parties sign a formal purchase agreement. Your lawyer can provide the right language to make sure it is non-binding.
Fail to check out your buyer: Not everyone who wants to buy a business has the financial strength and ability to follow through. Carefully evaluate your buyer. If the deal is contingent on financing, does your buyer have a real chance of getting financed?
Sometimes the flakiest buyer is also the one who offers the highest price. The flaky buyer figures there is nothing to lose. Think hard before agreeing to sell your business to someone you have not checked out.
Save on legal fees: Nobody likes to pay legal fees, but an ounce of prevention is far cheaper than a pound of cure. I once met a man who had agreed to sell a business he took 20 years to build. The buyer gave him what looked like a boilerplate agreement. He did not run the agreement by his lawyer, saving a couple thousand dollars on legal fees.
When the deal ran into trouble, the seller learned the agreement was missing some key terms and was one-sided in the buyer’s favor. The buyer sued him. Although the seller ultimately prevailed, he spent a lot of time and money fixing a bad situation.
The accidental deal: A formal Asset Purchase Agreement is easy to spot. But it is also possible to strike a deal without meaning to. Remember all those times you told your key manager or a family member that someday you would sell the business to him? Remember the emails you exchanged with an interested buyer about the price and terms you wanted? How about all those phone calls you had with a potential buyer?
If you are not careful, the other person may believe you already have a deal. People have gotten themselves sued by interested buyers, a key manager or even a relative who argued the business was promised to them.
Sign an agreement without reading it: Yes, I know the purchase agreement is 40 pages long and includes a lot of confusing legalese. Still, take the time to read it. Ask your lawyer about anything you do not understand. Have your lawyer make a plain English punch list of the key terms. You may find some surprises.
If the deal goes bad, you can count on the other side to go back through the purchase agreement line by line looking for any advantage. You do not want to be surprised by what is in your own agreement.
Tell your accountant later: Some people call their accountant only after striking a deal. Big mistake.
If you are buying a company, have your accountant carefully review the target's financial statements. If you are a seller, your accountant can calculate the cash you will receive after all taxes are paid. Your accountant can help you find the best tax structure for your deal.
For example, did you know that even if you purchase all the stock of a company, the parties can agree to treat the transaction like an asset purchase for tax purposes? This lets the buyer mark up the assets to fair market value and depreciate them again. This technique is known by the catchy name "section 338(h)(10) election," which your accountant knows more about than you or I.
Get deal fever: Buying or selling a business is exciting. Once the process starts, there is lots of activity and the momentum builds. It can be hard to stop the deal train once it gets rolling.
During the process, there will be surprises, and most of the time the surprises are not good ones. Sometimes the buyer will insist on a price reduction. Periodically during the negotiation process, both buyer and seller should assess whether the deal still makes sense and meets their objectives.
Do an earnout: Buyers and sellers often disagree about price. The seller says the future is bright and justifies a high price. The buyer wants to pay for the business as it exists today, not as it might perform in the future. Buyers and sellers sometimes use an “earnout” to bridge the gap.
An earnout means the buyer will pay one price at closing and agree to pay an additional price if the business achieves specified performance targets in the years after the closing. But often an earnout simply trades today’s disagreement over price for tomorrow’s disagreement over outcome.
Earnings can be manipulated. Earnout formulas can get complicated. The seller often blames the buyer for ruining the business and unfairly depriving the seller of earnout payments. I have seen an earnout dispute end up in a formal arbitration. Both parties spent months and big legal fees duking it out over whether the buyer had run the business in a way that cheated the seller out of a big earnout payment. Treat an earnout as a last resort, not an easy fix.
Drag out the process: If getting the deal done is important to you, then get it done ASAP. Time is a deal killer. New events crop up between the time you sign the agreement and the time you close the deal. Maybe the Dow falls 1,000 points and everyone gets nervous. Maybe your team is so distracted by doing the deal that your business metrics deteriorate. Maybe your people get nervous due to all the uncertainty and a key person leaves. Move swiftly before (bad) events jeopardize your deal.
By steering clear of these pitfalls and tapping into the experience of a good lawyer and accountant, you can avoid messing up your deal.
Harvey Koning is a corporate lawyer in the law firm of Varnum LLP. He focuses his practice on helping new and established businesses achieve their objectives. He can be reached at email@example.com.