Evading Transaction Roadblocks: Strategies for Common Late-Stage Dealbreakers
After completing the arduous task of preparing to sell a business and agreeing to the terms in principle for a transaction in which a business owner will sell his or her “life’s work,” selling business owners (“Seller” or “Sellers”) often experience a feeling of relief and envision a smooth trip toward the “finish line” – the closing date. However, the last portion of the road to a closed transaction can include one or more roadblocks that create unrest or even panic for the Sellers, leaving them frustrated, confused or exasperated by the unwelcome surprise(s).
Although these late-stage conflicts remain unpleasant, such issues are not impassible and, if considered appropriately, can even result in an additional benefit to the Seller. We examine a few of the most common types of transactional roadblocks and important considerations for developing a path around them to continue advancing toward Closing.[1]
Continuing Diligence and Renegotiation
It is not uncommon for a business purchaser (the “Purchaser”) to continue due diligence, especially examination of a target’s financial performance, after both the Seller and Purchaser have agreed to the general terms of a deal (generally, “Continuing Diligence”). In most cases, Continuing Diligence includes further review of ongoing financial statements or related accounting data. The results of this Continuing Diligence may motivate a Purchaser to attempt to renegotiate the agreed upon purchase price either in quantitative (e.g., adjusting the dollar amount the Sellers will receive downward) or qualitative (e.g., shifting a portion of the cash consideration to another form of consideration, such as equity in the Purchaser’s business, or deferred payment obligations made by the Purchaser over time) respects.
One of the most critical aspects of such a renegotiation is the Seller and the Seller’s team (including the advisors such as accountants and lawyers) understanding the Purchaser’s reservations and preparing a considered, well-supported response. For instance, a Purchaser may reconsider the purchase price for a business due to the Purchaser’s evolving opinion that certain of Seller’s revenues are unlikely to be sustained or are attributable to irregular events.
However, if prepared with an analysis that confirms revenues are expected to sustain or increase, a Seller could stand to benefit in such a case. In response to a request for a downward purchase price adjustment, the Seller may rebut the Purchaser’s arguments to make a downward adjust or even agree to receive a lesser dollar amount at closing, while also adding an “earn out”[2] component to the overall purchase price, through which the Seller would have the opportunity (“upside”) to earn additional consideration (perhaps even more than the original dollar amount) based on the business’s continued financial performance.
Surprise Liabilities and Indemnity Implications
Continuing Diligence (and Seller’s required preparation of associated disclosure schedules to the purchase agreement) often unearths additional operational or administrative issues that potentially expose the Seller and Purchaser to legal liability. For example, Continued Diligence may cause a Purchaser to conclude that the business, in some respect, failed to adhere to laws or regulations that govern the operations of the business (generally, “Applicable Law”). In this example, although a Seller may offer an arguably valid legal opinion as to why its past conduct did not violate Applicable Law, the Purchaser and Purchaser’s counsel may disagree. In such a case, the Seller must confront the possibility that the business was not, in fact, operating in compliance with Applicable Law while the Seller maintained the business. Further, the Seller must also understand the practical implications of any potential compliance issue on indemnification obligations set forth in the purchase agreement.
Typically, the items discovered through Continued Diligence and disclosure schedule preparation result in a finite number of “Specific Indemnity” items for which the Seller retains all liability arising from the conduct at issue — regardless of whether such liability arises before or after Closing. Moreover, as a consequence of the potential for operational consequences arising out of the Specific Indemnity items, the Purchaser may attempt to increase the amount of purchase price held in escrow pursuant to the terms of the purchase agreement and/or lengthen the period of time that such funds are held in escrow. In light of these material implications, the Seller and Seller’s counsel should consider the scope of any Specific Indemnity items and attempt to narrow the scope of each Specific Indemnity item as much as is practicable to leave Seller with only a discrete, particularized item for which the Seller remains liable.
Third-Party Delays
In every transaction, crossing the finish line in a timely (and orderly) manner often depends in part on the cooperation of various third-parties, such as landlords, vendors, payors and governmental authorities. While a Seller may need only to notify certain third-parties as to the pending transaction, other third-parties, pursuant to the terms of the agreement between the Seller and the third-party, must grant the Seller prior written consent to assign its contract or agreement to the Purchaser. In addition, regulatory bodies and licensing/accrediting agencies may require notice and/or need to consent to a sale transaction and associated license transfer, change of ownership, change of control, etc. For example, as noted in a previous Health Law Observer post, “many states, such as Pennsylvania, impose notice requirements in the event of a change of ownership (or “CHOW”), of a licensed health care facility.”
Ultimately, the flexibility of the Purchaser to close without a required consent or approval (or “close over” the issue, in transactional parlance) largely depends on the materiality of the third-party. For instance, if a Purchaser is satisfied that a stubborn, third-party vendor will allow the Purchaser to assume the Seller’s contract with the vendor despite not obtaining prior written consent to assign or transfer the contract (or the Purchaser has sufficient contingency plans if not), then the Purchaser may be more likely to agree to close over the missing consent.
However, in circumstances involving material liability risks, such as a commercial lease that allows a landlord to impose harsh financial or operational consequences if the Seller’s lease is transferred to the Purchaser absent landlord consent, the Seller and Purchaser may work in unison to resolve the issue. For instance, if the aforementioned landlord has knowledge of the transaction and is “slow playing” the parties, then the Seller and Purchaser may agree to close the transaction and continue to work together, in good faith, to facilitate the assignment on terms agreeable to all parties involved.
Preparation Is Key
Although the issues discussed in this blog entry are certainly unpleasant, none are fatal to a deal that is on its “home stretch” progressing toward closing. Both the Seller and the Purchaser will have invested tremendous energy, time, and expense to make the proposed transaction a reality. Therefore, navigating these roadblocks becomes a matter of assessing the risk or liability, developing a sound strategy to address the impediment, and efficiently negotiating or collaborating with the Purchaser to address the issue. Working closely with experienced transactional counsel may help streamline negotiations and approaches that yield advantageous benefits within the larger deal.
[1] Please note that this blog entry contains non-specific commentary on general considerations for transactions and is not intended to constitute particularized legal advice regarding any subject matter, including, but not limited to, negotiating the points discussed herein.
[2] Negotiation of earn-out consideration is a complex exercise that requires careful examination on a case-by-case basis and, accordingly, is only referenced in this article for illustrative purposes.
