Buyer and Seller Protection Strategies During an Acquisition*
September 1, 2021 •Oak Street Funding
Business acquisitions are some of the largest transactions companies will undertake and always involve a certain degree of risk. There are many buyer and seller protection strategies to consider when closing a deal. Each of these provisions is designed to mitigate the risk exposure to one or both parties. So, when considering a purchase or a sale, it's beneficial for companies to become familiar with the various approaches to protect themselves when closing a deal.
Provisions protecting buyers of businesses
When an individual or a company decides to purchase a business, they take on various risks beyond the inherent challenges associated with operating a company. Buyers want to be confident the business they intend to acquire is exactly what is being represented – specifically, assets have been valued correctly and there aren't any hidden issues that may surface long after the transaction has been completed. The strategies that follow are often used to provide verification and increase confidence in the acquisition.
After the buyer and seller agree to proceed, there is a due diligence period during which the buyer is allowed to investigate the seller's company by being given access to a long list of confidential records and documents that includes tax returns, contracts with vendors, customer information, and bank statements. The seller should agree to provide all relevant information the buyer requests. Prudent buyers will conduct extensive due diligence to verify that everything the seller has represented about the business is accurate.
Representations and warranties
Purchase agreements typically include a section in which the seller makes promises about the business. These promises, known in the legal world as representations and warranties, are designed to assure the buyer that everything the seller has claimed about the company is accurate and truthful. That may include everything from confirming financial statements are factual, to verifying the seller holds legal title to all the business assets, to stating there aren't any environmental issues with the company's property. Generally, this section may clarify that the representations and warranties reflect the seller's knowledge.
The agreement may also include language indemnifying the buyer from any liabilities for business obligations or debts the buyer was unaware of at the time of the transaction. The seller may agree to a minimum and/or maximum amount of potential damages covered under this provision.
The buyer may request that the company's financial statements be reviewed and certified by an independent CPA firm. Sellers often obtain such certification before beginning the process of selling the company because it increases buyers' confidence in the company's financial health.
The buyer might ask for several years of the company’s tax returns as part of the due diligence process.
Beyond the agreed-upon price for the business, expenses such as attorney and CPA fees, closing costs, and other costs will be incurred as part of the process. The buyer should request a provision spelling out which parties are responsible for paying each type of expense. It’s critically important to ensure there is no ambiguity about who is incurring and paying for these expenses.
Provisions protecting sellers of business
Just as buyers want to ensure their interests are being protected, sellers of businesses also face inherent risks. The sale of a business typically results in a substantial financial benefit to the seller, who wants to ensure the funding promised by the buyer will be received. The seller may also be concerned about the hard-earned reputation of the business and wish to protect its valued employees, so it's essential to verify the buyer has the wherewithal to continue to operate the company going forward. That's why sellers often employ the strategies that follow.
Letter of intent
Before the seller is willing to disclose potentially sensitive information about the business, they will often require the buyer to execute a letter of intent, which is a non-binding offer to make the purchase. Typically, letters of intent will include the proposed price and terms of the purchase, explain that a purchase agreement must be negotiated, and usually have language stating that either party may withdraw from negotiations at any time. While the letter itself is not binding, it may include binding clauses, such as a non-disclosure agreement or a clause preventing the seller from offering the business to other potential buyers while the deal is being negotiated. Letters of intent generally also specify the period for which the spelled-out terms are valid (although the final terms may still be up for negotiation).
Sellers can require that all documents and terms related to the purchase be reviewed by an attorney they select. The buyer's attorney is legally obligated to represent only the buyer's interest, so it's crucial for the seller to have someone protecting their interests.
Just as buyers conduct due diligence of the business, wise sellers conduct due diligence of the buyer to verify their ability to purchase and maintain the business. This is particularly crucial if the buyer expects the seller to finance part or all of the transaction.
The seller can require a clear statement of the type of payment the buyer will make, whether that involves cash, bank financing, seller financing, or other options. In addition, a buyer may be expected to provide a letter spelling out their capital and debts, along with the names of any financial lenders expected to fund the transaction.
In some purchases, the seller may receive additional future payments based upon how well the business performs under the new owner. The seller should request documentation of an agreed-upon percentage or flat amount they will receive, as well as how long those payments will continue.
Closing a business deal requires significant due diligence from both the buying and selling side of the deal. Various buyer and seller protection strategies should be considered and implemented to ensure risks are mitigated and an equitable deal results for both parties. If you are thinking about buying or selling your business, and are considering leveraging capital in the deal, please feel free to contact us as we have experts in lending who have helped hundreds of clients make their business deal a reality. buyer and seller protection strategies
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.