There are five (potential) roadblocks that we commonly see as an acquisition moves to a closing, when documents are signed, and ownership changes hands. Let’s review them, so you can work ahead of time to reduce the friction between you, as the seller, and the acquirer on these key deal features.
1. Definitive Purchase Agreement: The definitive purchase agreement (“DPA” or contract of sale) is a long, heavily legalistic document that is signed by the seller and acquirer at closing, transferring the company ownership. Accompanying the DPA are the disclosure schedules, representations, and warranties. Like the DPA, these are heavily legalistic documents that provide supplemental information about the seller’s company, all focused on limiting or defining seller and acquirer liabilities. All three documents are negotiated paragraph by paragraph at substantial legal expense to both the seller and acquirer. Typically, the acquirer presents the first draft of the DPA. As soon as you sign an LOI (letter of intent), your investment banker should be requesting the DPA from the acquirer, so that your legal team—often working at $1,000/hour—can start the change request process (a.k.a. “redlines”). The exchange of redline lines can take weeks, so get started early in the process. Pro tip: Be seated in a sturdy chair when opening your lawyer’s invoices. This puts you closer to the ground, thereby lowering your risk of injury when you pass out and hit the floor.
2. Net Working Capital: The NWC (e.g. how much cash is left in the business) is calculated right up until the day of the closing. It is dynamically updated with items such as the latest inventory value and the cash on the balance sheet, among other factors. Even though the NWC model is empirical and driven by a large excel file, there are points to negotiate, e.g. what’s included among pre-paids or accruals. Negotiate early on what’s in/out of the NWC figure. This can get very fairly detailed; we’ve seen last-minute delays at the closing because of disagreements over a few thousand dollars, even when the deal was valued in the tens of millions.
3. Non-compete: Acquirers rightfully expect that owners of the seller company (whether they stay on as employees or not) will sign non-competes, typically five years. Many acquirers ask for employees to sign them too. But non-competes for employees are almost always unenforceable, mainly because many state laws require an employee who did not receive “consideration” (money) as part of the acquisition to be exempt from non-competes. Clear this issue up early.
4. Negotiating as a group: Lawyers are essential to a successful closing, but we have found that lawyer-to-lawyer conversations rarely resolve contentious issues. The seller’s
lawyer will redline the offensive language in the DPA. Then the acquirer’s lawyer signals non-acceptance of the proposed change. This commonly goes back and forth at great expense to the seller and acquirer. The cure? We have seen the process expedited when the business leaders of the seller and the acquirer all get on the phone with the two law firms. There the business leaders can mutually insist that the hot-spot items be solved in real time, right there on the call.
5. A spirit of compromise: Discussions over contentious issues can get quite testy now and then. But compromise (“splitting the difference”) is the common result of even the most-heated conversations. At the risk of sounding pedantic, we urge our clients (who are almost always sellers) to assume the best intentions when an acquirer requests a deal point. And vice versa. After all, the seller has to answer to their board and their shareholders, very much as an acquirer has to answer to their investment committee, covenants in their bylaws, or risk thresholds that are set as corporate policy.
A spirit of compromise is key to any successful closing. It’s a matter of finding common ground that accommodates the genuine concerns of both parties.
