"Legal Implications to Getting Your Deal Over the Finish Line"

August 27, 2021 Oak Street Funding

Legal implications

The following is the transcript for the recently recorded webinar, “Legal Implications to Getting Your Deal Over the Finish Line?” It has been edited for clarity. You can view the webinar here.

Kirsten Petras:

Hello everyone, and thank you for joining us today for our webinar, Legal Implications of Getting Your Deal Over the Finish Line, the third in our OnPoint series. I'm Kirsten Petras, Executive Sales Director here at Oak Street Funding, and I have the pleasure of leading our sales team as they work with borrowers like yourself to strategically use debt to grow their businesses. Many of our borrowers are utilizing debt to fund various ownership changes, be it an acquisition, a succession or partner buy-in structure. Given the number of businesses like yours that are changing hands here in the last year, we think that the topic of legal implications to actually get those deals across the finish line is front and center. Today I'm delighted to have a conversation with our Chief Counsel, Alicia Chandler, as we answer your questions about protecting yourself via your documents, structures, and agreements, when you both acquire businesses or take on business acquisition loans.

As I mentioned, welcome to part three in our OnPoint series, Legal Implications of Getting Your Deal Over the Finish Line. And as you see here on the slide, for those of you returning and first saw our options for funding the growth of your business, as well as our two-part underwriting sessions that we hosted, we thought that having Alicia join us today to talk about these legal implications was a nice dovetail into the overall process of actually getting the deals done.

And with that, I would like to welcome Alicia Chandler. As you can see, Alicia has spent a number of years as an attorney. Previously, she was with a local law firm here in Indianapolis and had the role of our outside counsel at that time. Alicia came in-house here to Oak Street about 10 years ago. Bringing her legal expertise in, and that expertise of M&A structures and documentation, has allowed Oak Street's processes to improve by both reducing turnaround time associated with the legal diligence aspect of underwriting, as well as the closing documentation process. Her role in the underwriting process contributes to shoring up structures and collateral positioning, which is essential to the success and strength of an Oak Street funded acquisition succession or partner buy-in, as we serve our insurance, wealth management, advisory, and CPA businesses. Alicia and her team also assist all the other business lines that Oak Street specializes in lending to.

Alicia and her family, including three dogs and a cat, live here in the Indianapolis area, but they're not far from her hometown in Cincinnati, Ohio, where she learned to love her Skyline cinnamon flavored chili, for those of you who know what I'm talking about, and actually is an avid fan of the boy band, 98 Degrees. Alicia, is there anything you want to add to that or your personal professional resume?

Alicia Chandler:

Kirsten, thank you for introducing me. I guess we figured with the two ten-year-old shih tzus and a nine-year-old cat, we'd go ahead and get a boxer puppy. You know with two teens, we just needed some more drama in our lives. So yeah, we're a little busy.

Kirsten Petras:

Yeah, you don't have enough hectic-ness going on with two teenagers and all those animals in your house and plus the animals that you work with here in the office, right? I'm sure that we don't always make every day so easy for you, but you know, we want to really jump in. Those of you familiar with Oak Street, you know our expertise lies in lending to businesses with intangible asset classes, and Alicia is a critical part to getting many of those deals done. I think we should mention that we do hundreds of acquisition loans a year. Some are a hundred thousand dollars, some are $10 or $20 or $30, $40 million. And not every single one of them have an attorney involved, so we think Alicia will bring interesting perspective to the questions you ask as the attorney here for Oak Street. She certainly has the expertise and experience to share, and you may glean some information from that today. I think you'll also understand that by learning a little bit today we don't want there to be a thought that you have to employ an attorney for every business decision that you're making. But, as we get into it here and answer some of our submitted questions that are focusing on the legal implications, I think we use this word “diligence” a lot. And as you see here on the slide, it says, "diligence protects you." You know, Alicia, what does legal diligence entail?

Alicia Chandler:

Kirsten, legal diligence is going to entail looking at what exactly the assets are that are being sold. Is it an asset of the company or is it the company itself with stock or a membership purchase? Who was selling the assets? You want to make sure that if you're buying from an entity that the entity is in good standing. We are going to be looking at the corporate formation documents and the like, and you're going to want to look at the contracts those companies have that they would be assigning over to you to make sure that they're in good standing, as well as the licenses of the individuals that are selling the assets or the business. And so that's, you know, you need to understand those among them with the intangible idea of why is this business or asset being sold -- what's the motivation behind the seller.

Kirsten Petras:

So, as you're talking about looking into good standings and some of the things that are discoverable to the people listening today, when would you suggest they begin the legal diligence process themselves?

Alicia Chandler:

Really the due diligence needs to start before we start talking to the acquisition targets. You can conduct research online yourself – you can Google people, you can search Facebook or LinkedIn, you can pull up their license searches with respect to a department of insurance or FINRA. All of that is publicly available, and it can even be as simple as talking to people in the industry. What is the reputation of the seller, you know, have they had any issues getting business references? So it really needs to start before you have those conversations.

Kirsten Petras:

I suppose if I'm in the seat of the seller, I can do the same thing for people that are approaching me about buying my business. We certainly find that with these relationship-based businesses, usually the preservation and the care of those relationships in the hands of someone else is front and center for a seller. So a buyer can do a little diligence of their own on the seller and vice versa. So, you know, listeners here today are aware, of course, that businesses like theirs are trading hands constantly. They also probably realize they work in a relatively small world, professionally -- it's not uncommon for a lot of buyers and sellers to already know each other, right? We hear that quite a bit. With the tidbits you just shared about, you know, looking online or checking in with the local filings of the businesses that they're looking to acquire. Do you have any experience where sellers did or did not take a formalized process because they had such a long-standing relationship with either the buyer or the seller, and then, you know, was there something that happened as a result of skipping a step?

Alicia Chandler:

Yeah, a lot of times what we hear is, “I'm friends with them or they're my mentor,” or “I know them well, they wouldn't do anything that would hurt me in the future.” So, no matter whether you think it's friendly or not, you really need to take care and do your due diligence. We’ve seen things such as, you know, we have a mentor-mentee relationship, the mentor let's call him Guss, he goes to sell it to Betty. Betty trusts him, they've been together for a long time. He sells it to her for, you know, right away she gets get them cash and then turn around and find out that a lien without their own, the business assets by big banks. And then big bank start calling Betty and says, "Hey, you owe me a hundred thousand dollars, I have a lien on your assets."

You know, and that, that does happen. There are sellers out there. And again, it doesn't matter if you think you're friends with someone or not. If you're not conducting your UCC searches to see if there's liens out there, you could get caught in a trap of owing debt for the prior owner on the assets or the membership interest. And sometimes even we have issues where sellers have come back and they've started soliciting the book that they sold to their friends. And then there's a drop in the commissions and revenue and other issues ensue when there's no revenue to repay future debt, whether that be to Oak Street or to another party.

Kirsten Petras:

You bring up a really good point there that the relationship and the professional friendship doesn't mean that they're withholding information, but maybe unaware of certain things, like in your example of the UCC. It's not front and center there, they're not in the business of buying and selling businesses, so something that's just not thought about ends up becoming quite the headache for someone if the steps aren't followed thoroughly. So, you know, certainly these are not all unique to just businesses like wealth management firms or CPA firms or insurance agencies that are largely comprised of intangible assets. In your experience in your M&A experience, are there differences in how someone should approach buying a business that is comprised of intangible assets?

Alicia Chandler:

I do think there are some differences, some unique aspects that you're going to need to pay attention to, and that starts with you know, it's intangible, you can't touch it, MC Hammer reference. But you know the nature of these assets are such that they can go away. If you are not there on the front end, checking on the status of these contracts with carriers or the custodian making sure you understand whether certain employees have large client relationships that can just walk out the door and keep it, and you don't have a good working relationship that will actually impact the revenue going forward. If there's just a lot of in my experience and our experience “touchy feely” that you need to get in there and really assess the relationship with not only the clients, but the employees who are going to be a huge part of that business going forward, and to make sure that you're all on the same page with how you envision treating the clients and taking care of your business.

Kirsten Petras:

So, you know, you bring up a really, really valid point about the, as you called it, the “touchy feely” part of it. Again, going back to that example of two parties who know each other really well, it may not even be those two people that trips things up in the future, but rather a key employee who isn't as excited about the new direction of a firm. And they may choose to leave and in doing so maybe, even without intention, clients follow them and therefore that revenue stream follows them. So, you know, understanding that revenue stream is front and center for our collateral structure and how we collateralize our loan, including these intangible assets, you know, being made up of that. What are the impacts of how you approach the legal review of document for buy-sell agreements specifically? How does that impact that? Are there things you're looking for that are different in those documents than maybe if somebody was selling something that had tangibility behind it?

Alicia Chandler:

Yes. One of the main things we focus on is looking for alignment with the seller and the borrower, or the buyer which would potentially be our borrower. We want to make sure that post-close, that that seller is fully engaged in an alignment, whether they stay in the business or not with the buyer, that they're not going to have the ability under the document to solicit or compete for the business, the very business that they sold and received a large sum of money for. We also want to make sure that the sellers' employees understand whether they have non-solicit or non-compete provisions within, whether it be an employment contract or just their various documents that they signed with the seller. You know, we also want to make sure that we conduct, and I think this is more general, but we conduct the UCC searches to make sure we understand there are any liens out there, whether it be from a bank or tax liens, IRS liens, that could be out there that could also cause a hiccup with respect to these businesses moving forward.

Kirsten Petras:

So one of the questions we did receive was about UCC liens. Could you take a moment and just explain a little bit more in detail: What is a UCC filing? Why do we file it? And then what do we include in our filing as, as we're identifying our collateral?

Alicia Chandler:

So you see the fan for uniform commercial code, but we call it a financing statement -- Essentially, any lender, including ourselves, when we make a loan, we take a lien on the entire business that includes all business assets, that we would file a lien in the state of dome file of that company, or that individual is there a sole prop and the UCC filing would have in it all business assets, including client lists, commission, streams, revenue streams, contracts, contact rights, intellectual property, anything else that you can think of with respect to a business and 90% of these are going to be intangible assets. Most of these companies that we work with, a desk or a computer is not really a material asset of the business, it's all wrapped up in the client revenue and the income.

Kirsten Petras:

So this is when people say we're trying to take their firstborn probably, huh?

Alicia Chandler:

Correct.

Kirsten Petras:

So we also have our clients sign a personal guarantee. We talked a little bit about this in our underwriting sessions, but one of the questions that came through from the registrants was about the personal guarantee: can you also file a lien on my home or personal assets if my business goes into default? How are those handled?

Alicia Chandler:

So a personal guarantee is a guarantee by you that the loan will be repaid in and of itself. A guarantee is unsecured. And so it is not a mortgage or a deed of trust on your personal home or property. In order to do that any lender would have to actually take steps to get additional documents signed. So it is not a lien on your personal, your personal home or your personal assets, your dog, your cat, your firstborn. The only time it would be secure is if perhaps you had a sledge of stock, but again, it's not going to be secured by your home or your personal assets.

Kirsten Petras:

So I know we do conventional lending, non-SBA structured lending. I believe it's a little bit more common maybe with an SBA loan, that there can be a lien placed on somebody's personal home or assets. Is that your experience as well?

Alicia Chandler:

Correct. The SBA loans that we've seen include a personal guarantee that is secured by the guarantors primary residence whether it's first, second, third, fourth lien on their home.

Kirsten Petras:

So what you're talking from the seat of what our personal guarantee entails in terms of not ultimately being secured, unless for some reason it should be.

Alicia Chandler:

Right.

Kirsten Petras:

Well, here in a moment, we're going to go over a list of what we see as the most common documents in an acquisition package, and we'll review on a high level our own loan documents. But again, recognizing we close hundreds of these loans a year where ownership is changing hands, you know, there are several more that are happening without a lender like ourselves involved. For the deals that we are a part of, do most of the people use attorneys to get their documents produced? I know I said something about it's not always necessary, but are you finding that people are using attorneys more and more?

Alicia Chandler:

You know, typically with the loans that we do we do not see attorneys that are involved, or at least it's not brought to our attention. I think as the deal sizes increase and the complexity increases, that's where you're going to see legal counsel get involved. But I'd say probably 75% of the deals that we see, we don't see attorneys that are involved with working with the documents for the buyer and seller.

Kirsten Petras:

Understanding this world's getting more and more specialized, do you have any examples of where maybe someone used an attorney who was really versed in M&A work or someone who, you know, I mean, I personally have a lot of relatives are attorneys -- I don't even know that they would do this kind of work, but I think I would call them for some advice on it -- Have you seen where something like that maybe actually gotten away have a good experience? Do you attorneys specialize in things where there could be a good attorney for this versus a not so great attorney for this?

Alicia Chandler:

Unfortunately, I do see that quite often someone will say, "Oh, I called my friend. He does wills and trusts. And he looked at my document and he had these thoughts and questions," or they do family law. Each attorney typically has something they specialize in or they know more about than other areas of the law. So I would definitely recommend, if you're going to get an attorney using someone that has knowledge of M&A work, whether it's in this specific industry is obviously more helpful. But M&A work in general is a step above and beyond just, you know, if it's some general practitioner that's just done criminal law or wills and trusts, I wouldn't do that. I definitely, you know, I'm thinking to the corporate world, I'm not going to give any friends' advice on criminal matters or family matters. So it's, you know, it's good to get someone that knows what they're talking about.

Kirsten Petras:

Do we ever have people reach out to us and we recommend they use a certain attorney?

Alicia Chandler:

You know, if I become aware or we've become aware of attorneys with other deals, we can throw out a few names, but, generally speaking, if people talk to friends in the industry, they're going to be able to find between that and the advisors that we see in the industry or the consultants, they are really good at helping buyers and sellers find attorneys that can help them work through some of these specialty areas that come with the intangible asset transfer.

Kirsten Petras:

That's a great point. There's so many consultants in these spaces and they themselves may even have some in-house capabilities to help assist with this part of putting the deal together. Well, as you can see, we did put a list, as we're saying, it should be relatively easy to navigate sometimes, although it does have complexities. If you wouldn't mind taking a second, Alicia, I've kind of touched on these documents that we have on the slide. Maybe give a little insight to what they mean, and then I do have some additional questions that are coming in that I'd like to ask you, but why don't you go ahead and give a little overview of what you have here on the screen?

Alicia Chandler:

Sure. On the, it's my left side, we have the acquisition documents and those are the things that we would expect a buyer and seller to bring to the table. When they're looking to the buyers looking to take out a loan with Oak Street for the purpose of the purchase. You know, whether it's an asset or stock purchase itself, there are a few things that we're going to look at. Obviously industry specific items are going to be in there, whether it's wealth advisors, CPAs, insurance agents, or the like, we want to look and see what's the seller intentions are like, kind of stay on as an employee, or are they going to retire? We're going to look at the non-compete non-solicit provision document for the seller going forward. We're going to make sure that the assets are free and clear of all liens and unconferences and understand, you know, what is the financing arrangement? Is it a note or an earn-out, you know, payment to the seller over a period of time? Those are some things that we're definitely going to look at along with the bill of sale, which actually transfers the ownership of those assets.

Kirsten Petras:

So one of the questions that came in is I'm buying a book of business. How long should the seller have a non-compete non-solicit?

Alicia Chandler:

So, before we delve into the timeframe, you know, I think the important thing to understand it within your particular state. We're talking about a non-solicit and a non-compete, those are two different things -- solicitation of the book versus competing or working in the industry. When you're talking about a non-compete or non-solicit, we have to remember this is not in the employment context, we're talking about it in a purchase context. And typically what we've seen is most states are more open to getting a longer period of time as reasonable when it comes to a purchase context, because the sellers just received a large sum of money. And so they've been paid to not solicit or compete for the book that they sold. We here at Oak Street, we like to see five years as a good period of time within which the buyer / borrower can get in there and get into that book and form those relationships with the clients and make sure that that revenue and client retention is sticky and it stays around for the long-term.

Kirsten Petras:

Does the seller have to exit the business entirely in a year or within those five years?

Alicia Chandler:

So the FDA I believe requires a one-year exit. What we'd look at is what are the intentions of the party and what works best for the transition. Sometimes we have people that just don't want to own a business anymore, but they want to stay on and they want to help transition the clients to the new buyer or borrower over a period of time. And that worked well for them because the revenue continues to grow. Sometimes we have sellers that truly just want to retire and ride off into the sunset with their money. And that's great. You know, and if it works for the transition, then that works for us as well. So it's very fact specific. We don't have a hard and fast school when it comes to that.

Kirsten Petras:

So you also have here about promissory notes or earn out agreement. When we're providing the loan, do we have a requirement where that needs to be a certain length of time in terms of repayment or structured for the earn-out?

Alicia Chandler:

So, while we prefer that the length of the earn-out or promissory note matches the term of our loan, we we've typically seen it, you know, I'd say maybe four or five years. What we're going to look at is the cashflow, whether the payment supports that. And also it goes along with the alignment of the seller and the term of the solicitation or competition. You know, the seller has skin in the game with some money that's growing they're not going to, logically, they're not going to take steps to do anything to harm the buyer because then that will just hurt their repayment stream as well.

Kirsten Petras:

So then these kind of work together as a package. What do we require as a bank lending for this kind of transaction? What do we require to see in the buy-sell agreement?

Alicia Chandler:

So I think, typically, we're going to look at the industry specifics and make sure we understand what asset or assets are being sold. We're going to need a specific description or pretty specific description. Whether it's a client list or producer code or whether it's the ownership -- we're going to need to understand exactly what is transferring hands. And we're going to need to understand, you know, if there are any outstanding obligations that those be satisfied. We're going to make sure that there's indemnification provisions such that if there is an issue, the borrower / buyer has the ability to go back to the seller and seek reimbursement for any costs that it may incur post-close, non-solicit, non-compete. The terms and conditions of the earn-out, if that is one of the pieces, how that will be calculated and how many issues between the parties will be resolved, if there is an issue going forward.

Kirsten Petras:

We just got another question: do we provide any buy-sell agreement templates, or any templates for these documents?

Alicia Chandler:

We do not. But I would think again, kind of going back to what we talked about earlier, that if you have consultants in the industry or other advisors, they typically have forms or you can find forms online. But we found that the consultants have been really good at helping buyers and sellers work together on these purchase documents to get them in.

Kirsten Petras:

Well, thanks for your overview on those acquisition documents we tend to see in the acquisition packet. You know, as we move to the other side of the slide here with our loan document, do you want to provide just a brief overview of the purpose of the documents?

Alicia Chandler:

Sure. So the master credit agreement is going to govern the global relationship, and I have the terms and conditions of the loan relationship, as well as representations -- more P than covenant. And it will set forth all the defaults under the loan on loan facility. The promissory note will have the stock, you know, the amount of the loan and the repayment terms, whether it's five years or 10 years. It would be the guarantee of say the principal or the owners that are involved. The security agreement is going to be the document that says you grant Oak Street a lien on all your business assets in exchange for the loan. The collateral assignment, or a stock pledge could come into play depending on the loan size, and that would be a pledge of your interest or assignment of your interest in the company.

The financing statement we touched on as well, that we would file with the state. Subordination agreement is what we require any sellers that have promissory notes or earn-outs to sign where they subordinate their payment to Oak Street payment. And if there is a default, we have the right to stop payments to the note or the earn-out and an assignment of purchase documents, which basically says that Oak Street or the seller and borrower agree that Oak Street has a right to an assignment of any rights under the purchase document.

Kirsten Petras:

So this is the package of information that people on my team would give their borrowers a little heads up on the, on the actual thickness of, of what they're about to receive. You know, we really only have about a minute left if you don't mind me kind of rapid firing some questions to you because we have some unanswered ones here. So we got a question from a person in the position of a seller, why do I have to subordinate my earn-out?

Alicia Chandler:

So in our world or a no-straight-size you know, it is important again, to keep the alignment. We want to make sure that, you know, the seller has received a sum of money from Oak Street to enable the purchase to happen. And if there is a note, we want to get that subordinated. So if there is a problem, we have the right to stop that payment and make sure that Oak Street gets paid first.

Kirsten Petras:

Got it. Real quick, and I may take a stab at some of these. We have somebody who's looking for startup financing. You know, as the way we lend in this space of startup financing is probably not the best fit for us. We're happy to reach out to that individual though and point them in the direction of a couple of places where they might find some help there.

The big question about, is it best to sell as a C Corp or an S Corp? You know, we work with entities of all shapes and sizes. And I would tell you that this type of question is probably best directed to a tax expert and one of the M&A, even tax attorneys that specialize in that as Alicia was talking about their specialization and in what form it should take. We would suggest you reach out to somebody there for that, that answer.

And then business lines of credit -- is it supported with Oak Street, and if not, do you have any recommendations? We do. While we're talking today about acquisition funding, we do offer funding for other uses, including the structure of a line of credit.

You know, Alicia, I think as we've approached 30 minutes here, I do want to thank you for joining and from what you shared, you know, the simplicity or complexity may play a role in whether or not somebody hires an M&A attorney to assist in the structuring or at minimum the documentation. There are a plethora of consultants in your spaces out there that do this every day and can be there to help you. Another point in the buyer's diligence process and our diligence process are not mutually exclusive, but rather they can compliment each other's efforts to ensure, you know, the legal implications are identified and structured for the alignment of all parties and their priorities, and ultimately the success of the deal.

So, you know, with that, I want to thank you. We have lots of questions that went unanswered today that we will reach out to those people that submitted them to get them answered. You see our contact information is there and be sure to join us for the next Oak Street Funding OnPoint webinar about the M&A market, if it is heating up or fizzling out, that I'll be a part of. And we're going to have a panel of M&A experts for that. Alicia, do you have any last words you'd like to share with our, the people that listen to us today?

Alicia Chandler:

No, I appreciate it. And again, I would just say, please do your due diligence, protect yourself, and it will go a long way. You'll be glad you did.

Kirsten Petras:

Thank you again, Alicia, for making the time and thank you to those that registered today and have a wonderful afternoon.

Alicia Chandler:

Thank you. Appreciate it.


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