Legal Updates

Know When to Hold ‘em and Know When to Fold ‘em – Managing Deal Fatigue in Mergers and Acquisitions ~ Part 1

Anyone who has ever purchased a car or bought a house knows that purchases and sales of large assets are stressful, time consuming, expensive and involve more paperwork than expected. In many transactions, either or both parties reach a point in the process where they just want the process to be done.  In corporate transactions, this point in the decision making process can be dangerous because parties agree to liabilities, indemnities, potential losses, reductions in the purchase price, broad or too narrow non-competes, unreasonable or unlikely forward measured financial requirements and generally unfavorable terms, or they cut corners on due diligence simply to make the process stop.  Alternatively, either or both parties throw their hands up and walk away from a good deal, not because of the deal terms, but out of frustration with the process.

My partner, Ken Barbe, has astutely termed this behavior “Deal Fatigue.”  We liken it to the point in a torture session where the individual being tortured is willing to say anything in order to make the torture stop.  Decisions made as a result of Deal Fatigue can have long-reaching fiscal, legal and mental impacts. Accordingly it is important to manage Deal Fatigue to the extent possible so that parties do not make a bad deal or walk away from a good deal.

Managing Deal Fatigue During Due Diligence

Deal Fatigue can be prevented before the buyer or seller even entertains the possibility of a transaction.  Once a non-disclosure agreement is signed and discussions begin in earnest, it can be avoided during due diligence by all interest holders: recognizing the complexity and necessity of the process; committing to the process; and remembering the goals and limitations of the individuals involved in the process.

  • Prevent

Corporate transactions often go sideways during the due diligence process because of the time and stress placed on the seller, the seller’s employees and the seller’s overall organization. This is particularly true during third party transactions — transactions between a buyer and seller when the buyer lacks intimate knowledge of the seller’s business. Deal Fatigue can, however, be prevented by maintaining organized and clean corporate accounting and other similar records throughout the life of the business. Complete and accurate record keeping can significantly reduce the due diligence burden on both sides.

At a minimum, many buyers will demand to examine a company’s previous five years of accounting, corporate and general operational records. If there are open liabilities with statutes of limitations or contractual obligations extending beyond five years, buyers will also want to examine records going back as far as necessary to evaluate the risk associated with those liabilities and contractual obligations. As a general rule, business owners should keep accurate and organized corporate and accounting records, pay taxes, file tax returns timely, keep separate companies separate, avoid intracompany loans, maintain good internal controls and good management practices, and prepare (or have prepared) quarterly and annual financial statements even if they are just produced through QuickBooks or similar accounting software. If possible, and not overly financially burdensome, the company should have reviewed financial statements or even audited financial statements. If a business has good internal practices and recordkeeping, then supplying information and providing access to documents and information during the due diligence process will be much less torturous.

  • Recognize

Oftentimes, clients, and sometimes both parties together, walk into their accountant’s or attorney’s office and say “we have a handshake deal and this should be a simple transaction.” Deal Fatigue and frustration can be prevented simply by recognizing that no corporate transaction is simple.

Think about the complexity of buying or selling a house: the house has to be staged, repairs have to be completed, the parties have to hire attorneys and/or real estate agents, the buyer must obtain pre-approval for a loan, and a title/escrow agent has to be retained. Once a sales contract is agreed upon, there are inspections, an appraisal, bank requirements, title insurance, title commitments, and more negotiations. While sales of businesses can involve real estate, when they do so, the real estate is just one portion of the company’s assets and liabilities. For example, business sales involve employees, the benefits available to those employees, potential environmental liabilities, operational risk exposure, contractual obligations, non-disclosure agreements, trademarks, patents, licenses, business loans, non-competes, and, sometimes, subsidiaries, affiliates, or other related companies, government authorities, or publicly traded stock.

The more assets, more liabilities and more stakeholders in the company, the more considerations involved and the more complex the transaction. Even the sale of a small private company with one owner entails many areas of risk and revenue generation that must be explored and negotiated.

  • Commit

At the outset of a business transaction, the parties must be willing to commit to the process. They do not have to commit to the deal. But the parties must be willing to commit the necessary time, personnel, effort, and financial resources to a particular transaction. Parties should not fool themselves into expecting the process will be short, simple, inexpensive, or without stress; possessing these unrealistic expectations will simply create frustration and result in Deal Fatigue.

Both buyers and sellers must be willing to commit necessary inside resources (such as upper management’s time) as well as outside resources (including attorneys and accountants) in order to engage in the transactional process. They should also keep in mind that “transactional process” refers to both negotiating actual documents as well as the due diligence process.

Committing the necessary time and resources is difficult for many owners, particularly small business owners, and creates copious amounts of stress. Both upper management personnel as well as the small business owners generally have their hands full running the business; and, oftentimes, due diligence becomes a second job turning what were previously 12 hour days for small business owners into 18 hour days. Again, the cleaner and more organized the corporate records, the less painful, stressful, time consuming and expensive the due diligence process can be; however, even a squeaky clean, impeccably run organization will be required to expend time and financial resources throughout due diligence. A poorly run organization can expect to spend additional time and money to eliminate any problems resulting from its deficient or lax internal practices.

  • Remember

The parties need to remember that they are engaging in a transactional process in order to make some sort of a deal, whether that is a merger of two companies, a sale/acquisition of all the company’s assets or stock, or an acquisition of a portion of a company. In order for the transaction to work, it is important for both parties to keep in mind each party’s goals and obligations.

Buyers want to know the risk they are taking on by entering into the deal, and the only way to explore those risks is to obtain, review and analyze information from the sellers. Sellers want to protect their interests (e.g., client base, financial information, trade secrets, etc.) while also satisfying the buyers’ information needs. Both parties want to make the best deal possible but there is only so much available personnel time and resources. Once the sellers produce information, buyers are going to need time to analyze it; and buyers need to recognize that sellers have to be able to operate their businesses as well as attempt to comply with all due diligence requests.

Stay Tuned for Part 2 (Managing Deal Fatigue During the Negotiation Process).