When engaging in discussions over any M&A transaction, the parties will plan out and schedule most of the process around the anticipated timetables for due diligence. All too often, parties are exclusively planning out the due diligence of the target company. Obviously, the target company is the only entity changing hands so its risk profile is paramount to the transaction. However, in today’s market, sellers have an increased interest in performing their own due diligence on the buyer.
As private equity structures have become more commonplace, sellers are finding themselves increasingly in the position of making a significant investment in their buyer and making increased commitments to continue their employment for several years following the closing.
Based on our experience, here are three areas we think sellers should keep an eye on to ensure a smooth transaction and a rewarding post-closing relationship with their buyers:
How a prospective buyer conducts itself during the bidding and due diligence process will tell you a lot about how they run their business. Very few organizations will come off as sloppy and unorganized if in fact they run their core business like a well-oiled machine. When bidders are bidding on your business, your investment banker has likely set some key dates and deadlines. If bidders repeatedly failed to meet those deadlines, their materials contain errors, and your interactions with them leave you with the impression that they are unorganized, then there may be issues with their core business that you may not discover until it is too late.
As a successful business owner, you know exactly how important it is to keep your business organized and that effort adds value to the asset that your business is. If one of your bidders doesn’t show that same level of attention to detail to their business, then perhaps they might not be the best match.
In the current market, nearly any private equity transaction either requires or offers the sellers an opportunity to invest in the private equity platform as part of the transaction. Sometimes sellers reinvest up to 25% or more of the value of their business into the private equity platform. If sellers are doing that, buyers should be willing to permit sellers to conduct an appropriate amount of due diligence into the sellers’ significant investment.
However, many buyers balk when asked to turn over due diligence materials about their firm. This is true even in spite of the fact that most private equity firms have readily available due diligence materials that were used for their initial investment in (and add-ons to) the platform. To this day, some buyers think that this kind of due diligence is inappropriate or “not market.” When buyers tell sellers throughout the sales process that they are excited to begin a partnership with the sellers, sellers should consider whether or not a specific buyer’s actions are backing up that verbal commitment.
- Selection of Counsel
Most business owners understand that legal advice is an important input in the overall risk profile of their business. There are two common mistakes that buyers make in the selection of their counsel that can have a negative impact on the seller’s likelihood of completing a transaction or the seller’s going-forward risk.
First, a buyer may hire counsel with the intent of eliminating risk altogether and bullying the sellers into unfavorable terms. Buyers are famous for playing a good cop, bad cop game with their sellers — telling them how important the partnership is and advising them to ignore all the legal battles over the contract. If the buyer is not willing to put pen to paper and commit to a true partnership on commercially reasonable business and legal terms, it is likely a sign they are not interested in a true partnership to begin with.
The second and sometimes most costly mistake is when the buyer hires unqualified counsel. This is a sign that the buyer is not savvy and may just be trying to get a deal done at a low cost. Cheap counsel can create significant deal risk when they do not understand some of the more sophisticated risk-sharing that is customary to M&A transactions. This could also reveal that the buyer does not have a good understanding of its own business and the legal risks it faces. The last thing that any seller wants before it makes a significant rollover investment is to see that a buyer has not appreciated the legal risks of its own business because it does not want to invest in the business or understand the value of good counsel.
David J. Kaufman and Nathan Viehl are members of Thompson Coburn's Corporate practice group.