Getting a Letter of Intent (LOI) signed with a company or individual you want to sell to is an accomplishment. For some, it is the only LOI opportunity that presents itself via either an unsolicited offer or a known buyer. For those who use an M&A Advisor, it may be the culmination of efforts after looking at many buyers and deciding on the right fit of culture, growth, and future wealth creation.
Unfortunately, some sellers already start cashing the check in their minds and mentally check out once they sign their LOI, thinking that their attorney will handle the rest. But that is far from what a seller should be doing, because unfortunately there are bumps in the road (almost always) before a deal is closed at the price and terms specified in the LOI. You can certainly mitigate some bumps with a well written LOI, but others pop up post-signing regardless of how well your LOI is written. While some of the bumps I mention below cannot be avoided, you certainly can do things to mitigate their impact on your deal by preparing in advance.
Here are some of the common bumps that can appear, and what to do to mitigate them:
Customer Reference Calls
Even if the buyer never mentions it during the due diligence process, trust me: they will want to speak to your top customers (5 – 10 depending on customer concentration). Be prepared for this in advance by checking in with your top customers to make sure they are happy. This is especially important if they are in the middle of a large implementation, when nerves may be frayed and costs have increased. None of this may be due to your implementation skills, but that doesn’t mean they won’t complain to a buyer. If this is a larger customer (10 – 15% of your revenue) and the call doesn’t come back glowing, then it will cause a major halt or change in terms at the 11th hour. Even if you think your customers are happy, you might consider a third-party customer satisfaction call. This means a person gets on the phone, has a real conversation with your customer, and asks a number of questions to ascertain how happy they are and if they plan on remaining with you long-term. This is not a time to rely on an electronic survey.
Sales Tax or Nexus Determination
Let’s face it, keeping current with the latest sales tax rules can be a full-time job. Especially when there are some states that don’t even require you to ever step foot in that state, yet will want you to charge sales tax for your products and services. Most sellers think they are on top of sales tax, but usually after a CPA firm does their due diligence, requiring you to list all products and services you sell in each state and where your remote employees are located, you will be surprised by the outcome. Usually, a very large, very unexpected sales tax liability is discovered. I find that most buyers don’t require you to pay this upfront unless it is very large and very blatant, but they will hold funds back for a period of time, and the liability will remain yours regardless of an asset or stock sale. Be proactive and make a list before signing the LOI that lists the states you do business in and what type of services you sell in those states. Then begin doing your own investigation on the sales tax rules, or better yet, get someone who specializes in that. You need to know in your own mind what this number might be so you can be prepared to deal with any pending liability.
Personnel Security Checks
More and more companies are performing security checks on their personnel. You may also be doing this now as part of your hiring process. But did you go back and perform security checks on your employees that have been with you over 10, 15 or 20 years? Probably not. It almost feels offensive to ask a long-time dedicated employee to do this, but you will sometimes be surprised at the results. Get your security checks done as part of preparing to sell. You can easily justify this to your team given all the concerns these days without letting the cat out of the bag that you are contemplating a sale. Trust me, this is much harder to do under the pressure of a deal closing, and you don’t want to be shocked to find out your most valuable technical person (just as an example) was charged with some heinous crime by an ex-spouse.
Women Owned Business Status
This could be an entire post on its own, as I have seen this in almost every transaction that has been women owned. If you are a woman owner with either a WSB/EDWOSB/WBENC or other status, this will raise a red flag during due diligence. Since most buyers are either male or part of a much larger controlled group, the women owned status must terminate as part of the deal. But the big question in the buyer’s mind is what contracts were secured because of this status. And what customers might you lose as part of terminating this status; especially if you have one or two large customers. The answer: who knows! Most women I represent always state that their status did not get the contract initially or help them keep that customer for many years. But how do you prove that? You simply cannot. You cannot ask the buyer; that would tip them off you are selling. You cannot know for sure a customer didn’t need to check a regulatory box at some point as part of hiring you.
Here is the only remedy to this problem: stop renewing your certifications, stop mentioning it in your proposals and then remove all reference to any of these from your marketing material and website. Make them non-existent if possible. Sure, there might be a customer that you lose because of this, but usually if you have been working with these customers for a long time, they don’t see the certification as a requirement to do business with you. Your value has been proven through your work, not your certification.
Key Team Member Feels Slighted
My mother always told me that money has a way of bringing out the worst in people. It turns out she was right, especially for those who have been with you a while and “feel” your success was attributed in part or largely because of their contribution. While this may or may not be justified, you need to deal with it proactively. More times than I like to say, I see this come up, even with the happiest and most cohesive of companies. Silent partners, Directors of Sales, Lead Engineers, Lead Developers, all come out of the woodwork with their requests to be paid part of the proceeds once they know a deal is in the works. I had one client actually go as far as having the sales director tell the buyer he needed part of the proceeds because he was solely responsible for the revenue and growth of the organization, and if he didn’t get it, he and his sales team would leave!
If someone has dedicated much of their career to you, even if not a shareholder, you should think about sharing not only the upfront cash, but incentivize them with later earnouts. I advise my clients to wait until the first draft set of the definitive agreements have been received before sharing this news with those you feel should prosper from this sale. Then let them know what you are contemplating and that their cooperation is needed to complete this transaction. In my book, Get Acquired for Millions – Part II – When to Disclose to Your Team, I write about certain legal documents you might want to draw up in advance to be clear on what you expect and how they will be rewarded; kind of like a mini sale agreement with them. Your buyer will be happy that you are rewarding the team and that they will be part of the future growth of the company.
Deal Fatigue Caused in Part by “Over Lawyering”
While this one is not as common as the previous points, it does happen. Usually, a seller selects a new attorney (not one that drafted his corporate documents and annual minutes) to prepare and refine the legal points of the definitive agreements. Occasionally, you will see an attorney who just takes it upon themselves to comment on everything. I have seen situations where virtually 50% of a (well written) purchase agreement is rewritten or redlined by counsel for the seller. Every nitpicky word is scrutinized, and documents are created in addition by seller’s counsel to be signed by either the buyer or the advisor. Overkill to the nth degree!
Sure, there is a time to argue “shall vs may,” jurisdiction and definition of the business subject to non-compete, as well as other important words, but this can lead to a seller being overly argumentative and ends up killing a deal. I represented one such transaction, and while it died due to exactly this reason, it was brought back to life and eventually did close. No seller likes to pay for attorney’s fees for a failed transaction. It is like falling on a knee twice before it scabs over.
Of course, deal fatigue can be caused by other reasons, but many times it happens in the legal process of arguing over things that, in the end, probably won’t happen.
Here is how to tell early on if the attorney you chose is going to over lawyer: first, have them review the NDA you will sign with your M&A advisor. Second, have them review the Advisor Seller Agreement. If the M&A advisor you chose is seasoned, so likely are his or her agreements. They have withstood more attorney scrutiny than just yours and have probably been modified along the way to be fair and complete. If you see too much redlining, it may be an indication of how they will mark-up the purchase agreement, and the size of your bill. It is worth the money to have another counselor review the same documents (maybe a referral from your advisor) and compare the two.
Accounting Has Some Hiccups
I would say 95% of self-brokered deals have some sort of accounting “hiccup”. By hiccup I mean over-reaching normalization add-backs, improper matching of revenue and expense, no deferrals for long-term contracts, improper classification of expenses or misclassified expenses that belong in the cost of goods sold. These hiccups are the top reasons why a deal gets retraded or reduced in price. This is especially common for those sellers using the cash method of accounting, but indicate they use accrual or GAAP accounting (they have AR and AP, so that means accrual to them). Of course, if you were an accountant in a former life or still are, then go on with your bad self and forge ahead. After all, you should have the cleanest books out there, but it doesn’t hurt for someone else to take a second look, especially for your addbacks.
If you don’t profess to know all the intricacies of GAAP or know what that even stands for, I suggest you get a compilation if under $5M in revenue, or maybe even a review. If you are over $5M, I highly suggest you spend the money and hire a local CPA firm that specializes in Quality of Earnings Report. This report will give your financials credibility and remove the stigma that comes with cash basis, QuickBooks-generated reports that can be changed easily on the fly. Sorry, but that is how buyers think.
This report will not only speed up the financial due diligence, but tells a buyer that you are serious about selling your company. These reports range in price from an average of $15K – $40K depending on the size and stature of the CPA firm. The higher your revenue and the larger your geography and size, the more you should lean toward a well-known regional or national firm, if only for credibility reasons. Trust me, it will pay for itself in the end.
Conclusion
Every deal is going to have some bumps, regardless of the size or whether you know the buyer well or not. It is just part of every M&A transaction. But there are things you can do in advance (ideally way in advance) of signing an LOI to help not only keep as much of the proceeds as possible, but also prevent the deal from going sideways or failing altogether. Preparation is always the best defense, and, of course, so is finding the right M&A advisor who will help you avoid and mitigate some of these and other bumps along the path of selling your company to the perfect buyer.
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