KUHN CAPITAL Monday, March 19, 2018
Dispatches from the front

What Buyers Owe Sellers (Besides Cash)

Over the years we’ve seen too many promising M&A courtships brought down by a steady accretion of minor deal process missteps and miscues that, taken together, finally prove fatal. It’s death by duck bite.

Deals die from such apparently minor cuts since these incidences erode one or both of the two ingredients key to every successful deal: trust and the willingness to compromise.

This is a tragedy, and not just because we lose our contingency fee: it’s because these pratfalls can be avoided with a little aforethought and when they’re not, they leave both sides with nothing to show but lost time, expense and reputation. To head this off, we list below a few of the more common errors committed by buyers. (A later Dispatch will address the sins of sellers.)

Now you may think that some of the behaviors we will warn you against are obvious. But keep in mind that the buyers who commit these faux pas are found frequently, and they tend to be of a type: they are often large, successful older organizations without much M&A experience. If they're also seeking to buy substantially smaller and dissimilar businesses, they're even more prone to error.

Such buyers may have been insulated for years from much external contact and in their self-sufficiency, they’ve forgotten that outsiders aren’t schooled in the peculiarities of their often highly political inner world. What appears to be well-established SOP to them is in fact murky and baffling to those outside the corporate walls. This attitude feeds dangerous seller ignorance -- sellers who don’t understand the buyer’s argument rationales, M&A process or motives withdraw trust.

My Kingdom for Clarity
From the outset, buyers owe sellers a clear explanation of who makes the final decisions over purchase terms and post-close integration issues, or at least the process by which such decisions are reached.

Unclear decision processes make sellers worry whether they’re walking into a “used car lot” scenario where they negotiate in good faith to reach a hard-fought compromise only to find that the issue is now subject to a second review and possible modification by some mysterious higher authority, a Wizard of Oz behind the curtain. Confronted with this, sellers lose their desire to compromise simply as a matter of self-defense.

For this reason and others, before initial seller contact the buyer must formally establish an M&A team that is empowered to negotiate on behalf of the buyer’s board. The team’s objective is to make the best deal possible and present it to the board for a simple up-or-down vote. Of course, they may beforehand receive guidance from the board regarding the parameters under which they operate, but once underway the team operates autonomously up to the point of final commitment. This means that the board must itself have trust in the business skills of its own team.

Use All Good Speed
The buyer’s letter of intent (LOI) fires the starting gun on the M&A transaction process. As such, it must define the dates by which the parties expect all subsequent stages to conclude. These dates (e.g., for completion of due diligence, deal structure and valuation, post-close integration planning, due diligence, final purchase agreement language, execution and close, etc.) are deliberately set to press the parties forward, and the seller may fairly regard any subsequent unexplained delay with suspicion.

That’s because sellers under an LOI usually have more to lose from delay than buyers. They must temporarily ignore operating issues to deal with exhaustive buyer information requests (about which more below); they are vulnerable to leaks that may undermine employee morale; competitors may exploit the situation to question the seller's future in the marketplace; and many LOI’s bind the seller to a “standstill”: to cease communication with, or commitments to, any other buyers for its duration.

Therefore, unless a break-up fee is involved, the seller rightly deserves assurances that the buyer’s intentions are genuine and that both parties will move through this uncomfortable period as rapidly as possible. The antidote to seller LOI-period anxiety is a demanding calendar that rewards the seller’s trust with speedy buyer performance.

Wrap Due Diligence in a Bow
Here’s some of the ways we’ve seen buyers go wrong in managing due diligence:

• The list of data requests, complied by a buyer’s attorney ignorant of the dialog to date, consists of pages of boilerplate questions that have already been answered.
• After the seller responds to the list, the buyer produces another list of additional questions that could easily have been anticipated and incorporated in the first list.
• After obtaining answers to the second list, the buyer launches yet another investigation, this one headed by an outside consulting group with no knowledge of the process to date.
• The buyer fails to negotiate the rules under which he may contact the seller’s clients. To sellers, this is sensitive stuff: they are rightly protective of these crucial relationships and mishandled contacts by prospective buyers can do material market damage.
• A related buyer mistake is the failure to integrate due diligence findings into the structure or terms of the purchase agreement. For example, the buyer who undertakes thorough investigations of the seller's client relationships can avoid imposing overelaborate controls on closing balance sheet values for aged accounts receivable.

What’s Done Is Done
Once language is settled upon in a purchase agreement passage, it should be regarded as writ in stone. To use another analogy, reopening settled issues after the fact is tampering with the lock on Pandora’s Box. In addition to raising questions in the seller’s mind about whether negotiations have been proceeding in good faith, doing so also carries the risk of delay and, worse, of rebounding in the buyer’s face. We’ve seen cases where a buyer insisted on re-opening a settled issue only to have the seller return to the table with his own set of newly escalated demands.

Beware the busy buyer’s attorney in this case. Some less-experienced counsel can be mightily tempted to burnish their image in the eyes of their clients by realizing last-minute “improvements” that eventually lead to a cratered deal.

Like any rule, this proscription against fiddling with finished work does not always apply. Rarely, both parties may realize mutual gains by revisiting language that permits additional horse-trading. But buyers who propose to re-open an issue must pair it with a reward for cooperation lest the road ahead dead end.

The Perils of Loose Lips
We've occasionally seen buyers allow proprietary seller data to escape into the marketplace, albeit nearly always inadvertently. Buyers' salespeople are particularly porous vessels. In their enthusiasm, they brag to clients about the benefits of the pending acquisition.

On purpose or not, such leaks can not only kill deals but form the basis of subsequent litigation. Amazingly, many buyers guilty of these sorts of sloppy internal controls are surprised by the heated reactions of an injured seller. This casual attitude gets to the heart of the matter: the fact that an M&A dialog is taking place and that proprietary seller data has been entrusted to the buyer is real serious business. Buyers must keep all information related to the deal on a need-to-know basis within the confines of the M&A team!

About What’s Next
A final source of seller concern is what life will be like post-close. So before that date approaches, buyers owe their targets thorough joint planning sessions that address such subjects as how the transaction will be announced to employees, clients and the public; operating budgets; reporting relationships; employee benefits; hiring/firing plans; and a sharing of the “vision thing”.

Such exercises aren’t undertaken simply to calm jittery target staff. Instilling their confidence in the future also advances the interest of the buyer by enhancing morale and reducing turnover. After all, in the business services and technology industries that Kuhn Capital specializes in serving, the target’s employees are often the most valuable asset in play.

Ryan Kuhn

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