I have been informally coaching a business friend who runs a non-technology business. This CEO is a first time seller, has recently agreed to a term sheet with a buyer, and is ready to begin due diligence and negotiation of the stock purchase agreement. My CEO friend has decided to use an attorney recommended by me. I have worked with this law firm and this attorney in the past. The firm is a boutique, focused on small and mid-market businesses. The attorney is experienced, pragmatic and all business. She manages transaction negotiations well and stays focused on the important issues without getting bogged down in the small ones. Very importantly, she understands how to translate legal terms and their implications so that the CEO can readily understand and make intelligent judgments.
My CEO friend asked her to prepare a budget for her legal fees to complete this transaction. Her response, paraphrased below, is insightful to all first-time sellers. To set the stage, our transaction is a stock sale of a company with revenues of <$5M for cash plus an earn-out. The letter from the attorney highlights the importance of getting your M&A advisor involved early in the process, well before the term sheet has been agreed, rather than this late in the process. Heres why.
The attorney explains As we discussed, legal fees for a seemingly straightforward acquisition can be difficult to predict. The facts, as set out in the most recent term sheet I have reviewed, indicate that you will have two or three complex documents including the Stock Purchase Agreement (SPA), the Earn-Out Note (Note), and a combination Consulting/Non-compete Agreement. The terms of the earn-out are pretty complicated and will likely involve some rounds of negotiation regarding revenue that counts towards the earn-out milestones. In addition, Im unclear about your anticipated role and your compensation in the buyers strategy to grow through additional acquisitions. We have a few other variables to consider including the variable of pre-close organizational clean up and due diligence preparation. Another important variable will be the efficiency of the buyers counsel and management. Outside counsel can sometimes spend a lot of time and effort negotiating details that really have little impact on the overall outcome.
As you move into a transaction, you can control some of these costs yourself. It is very important that you manage the due diligence and discovery process with an eye towards preparing the SPA schedules that are accurate and comprehensive. Many clients view diligence as an early stage activity, prior to and separate from the negotiation of the SPA, presuming that just because they have made their contracts and corporate history available for inspection that they are finished with the history telling part of the deal. In fact, most SPAs require a thorough listing of much of the material presented and reviewed in due diligence as part of the schedules of exceptions, disclosures, and carve-outs. Your history telling helps to put these facts into context and hence, addressed properly (for you) in the SPA.
A second cost and time management variable relates to the management of expectations regarding opposing counsel. Your transaction is too small to justify bringing in a name brand large legal firm to close but that may be exactly what your buyer may do since they are a large, multinational firm. If the buyer does choose to do that, you could anticipate doubling the legal fees on your side.
What this straight-forward communication from the sellers transaction attorney points out is that, even thought a term sheet has been agreed, there is still a significant amount of work and negotiation of the commercial terms of the deal to be completed. As a seller, this is not good news. Your negotiating leverage and your willingness to walk away from the deal actually decreases as you progress farther and farther through the due diligence and SPA negotiations, even as the balance of compromises on contract terms moves toward the buyer. The sellers tendency, especially first-time sellers, is to begin visualizing the comfortable life after the deal before the deal has closed. This slow walk results in a progression of compromises that, once complete, have actually moved you far from your original criteria for a good deal. Efficient transactions are most often completed when the term sheet is comprehensively negotiated with the assistance of an experienced advisor while your leverage is strongest. Only then can due diligence become confirmatory, not exploratory, and the legal team can focus on memorializing rather than negotiating the commercial elements of the agreement.