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Merging Risks and Rewards

What to look for—and look out for—in a merger or acquisition

You’ve built a successful business and now there’s an acquisition on the horizon with a nice payday to reward the fruits of your labor. But don’t plan that getaway just yet; lawyers focusing on mergers and acquisitions say now’s the time to work harder than ever.

“You’ve got to continue to run your business during a prospective sale process,” says Kenneth M. Silverman, an M&A attorney at Olshan Frome Wolosky in Manhattan. “Attending to everything that’s related to the transaction can be full-time job number two.”

Consulting with an M&A attorney can ease that burden, and earlier is always better—ideally before the letter of intent is negotiated and signed.

“Business owners don’t always appreciate the relevance of the letter of intent,” Silverman says of the largely nonbinding document that lays out the terms and structure of the transaction. “Sometimes people think it’s a throwaway. But the letter is supposed to lay out what the deal is, and parties don’t generally like it when the opposite party decides to deviate because they’re trying to just deal with sensitive terms down the road.”

And while most aspects of the LOI, especially the sale price, are subject to due diligence, some terms—like exclusivity periods and confidentiality—are binding, says John J. Crowe, M&A attorney at Pryor Cashman.

“The first thing you need to do is check with your tax group,” Crowe says. “The way the deal is structured could have different tax implications.” His other first step is to make sure clients have a nondisclosure agreement in place before they share any financial or other information.

Once all the terms are nailed down in the LOI, due diligence begins, where a big obstacle to a smooth process—and a glaring red flag to potential buyers—can be sloppy corporate housekeeping.

“If your corporate records are a mess, that can lead to due diligence questions by the other side, and it’s not something you can clean up and fix right at the beginning of an M&A process,” says Silverman.

He says clients should expect to provide detailed materials and information, and make representations and warranties, related not only to the business, its finances, debts, warranties, etc., but also to more hot-button topics like cybersecurity, privacy, and sexual harassment.

“There’s always more in terms of representation and warranties,” Silverman says of potential areas covered by due diligence. “Targets don’t get to take things out and say ‘this isn’t relevant anymore.’ There are topics business owners may discount as not really applicable—and that may be true—but they still may be asked about it, and those are things that are high on the [other side’s] annoyance factor. Being obstinate or combative generally doesn’t serve the client well.”

Compiling all the necessary information is even more complicated if you’re trying to keep the deal quiet, Crowe says, since you may need to interact with employees who keep records. Other potential pitfalls include getting consent from third parties.

When it comes to the actual payment terms, Crowe advises sellers to be wary of earn-outs. It’s always better to get cash up front. You may think the financial targets for earn-outs can be reached, based on your current business, but that may not be true when someone else is running it.

That’s also an important mindset for negotiating the post-sale relationship.

“Some people think ‘I’ll sell, and then I’ll go and compete,’” Silverman says. “But buyers generally don’t want you to go out and compete right after you sell the business. That’s something owners need to think about. Do they want a position going forward? Do they want to separate entirely? Do they want to stay in that industry?”

On the buyer side, the red flags include missing records or any attempts to gloss over or hide problems.

“It can be difficult for prospective buyers to walk away,” Silverman says. “There are times when a lawyer might say, ‘Do you really want to buy this company with all these warts that we all recognize? You still want to take on that liability?’ But we’re not there to kill a deal. We’re there to make sure a client makes an educated decision and weighs all relevant risks and rewards.”

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