The seminal event in a closely-held and/or family held business is the exit. It is often the one and only chance for the owners to generate substantial liquid wealth both for themselves and to pass down to subsequent generations. Exits almost always take place in what is known as an “M&A” (merger and acquisition) transaction. Such transactions can be like a football match. The idea is to get over the goal line which, in the M&A context, means the closing and funding of the purchase price. However, even the owners who have worked hard for years and are now in sight of the reward can suffer significant disappointment if they do not stay involved in the process. There are many examples of teams who saw comfortable leads evaporate in the fourth quarter because they lost focus.
THE GAME PLAN
After the owners ink the letter of intent (LOI), there is sometimes the temptation to simply “let the lawyers handle the details.” The post-LOI work is sometimes viewed as nothing more than “papering the transaction,” and not worthy of the owners’ significant investment of time, other than to be kept updated or consulted on the most important of matters. Many times, owners are emotionally already counting the money, and get annoyed if the exit is not closed immediately.
This is a potentially dangerous attitude. Attention to the details of the transaction is critical in order to achieve the goals of the exit; which usually mean maximizing the after-tax dollars to the owners with the minimum of post-closing exposure. It is also critical for the business owner to understand before the transaction is completed the integration of this capital event with other wealth transfer planning opportunities that can be highly valuable to the client in not only mitigating exposure to capital gain taxes but simultaneously being useful for enhancing the client’s existing estate planning strategies.
The LOI phase of a transaction sets forth only the general framework of the deal. Both significant opportunities and material risks can first appear during the preparation and negotiation of the definitive agreements, including representations and warranties, conditions to closing, post-closing covenants, purchase price adjustments, and earn-out provisions.
No matter how thorough and experienced one’s legal counsel may be, it is the owners who have superior knowledge of how their business actually functions on a day-to-day basis. Just as the failure of a small part can lead to the malfunction of an entire machine, so, too, can the errant word or phrase, although innocuous on its surface, cause an unintended result.
Thus, the owners are in the best position to address the following question: “How well does this work for ME and MY business?”
In order for the owners to fulfill their vital role, it is critical that they carefully read the draft documents submitted by counsel and understand what those draft documents say. They should pay particular attention to definitions, as a definition can make a material difference in how a provision is applied. It bears repeating: the owners should understand what each part of the document says. Accordingly, if they do not understand a provision, they should insist on clarification. The owners need to focus on the details even though it would be more pleasant to ignore them and hit only the high spots of the document.
Done correctly, an M&A transaction must be viewed as a process, not an event. Football has four quarters. Similarly, an M&A transaction has a process that must unfold.
The owners can help a great deal in keeping this process as efficient as possible (thus shortening the time to closing and minimizing transaction costs) by remaining engaged in the process. Drafts received from transaction counsel should be reviewed promptly. Attorneys are like passenger jets. Revenue isn’t generated by leaving the aircraft sitting in the hangar. If the responsible executive allows a significant period of time to pass between receiving the draft and responding to transaction counsel, it is likely that his attorney will attend to other major matters in the interim. Thus, your counsel will need to spend additional time to review file notes and previous drafts in order to refresh his memory with regard to the transaction at such time as comments are received.
Efficiency can also be enhanced by the owners providing thorough comments. Transaction counsel really does wish to know what the client thinks about the draft documents. Incomplete comments, or comments received piecemeal, can often lead to an unnecessary increase in the overall number of drafts of the documents needed to bring the transaction to an execution-ready status. Additional transaction costs often result. In addition, thorough comments increase the likelihood that material matters are determined and resolved sooner than later in the transaction process, generally resulting in a more efficient and less costly process, and achieving more of the owners’ objectives.