Hello all. I have a deal under LOI that’s very near closing. However, we’ve run into a problem. The company (makes a type of consumer equipment and accessories) sources its main product from a large manufacturer in Asia (let’s call them LargeCo), and its main accessory from a small manufacturer also in Asia (SmallCo). SmallCo used to make the main product as well, until some unspecified rift happened that killed the relationship 8 years ago. The seller has dementia and can’t elaborate on what happened, and the seller’s wife, who has been running the business the last couple years and is eager to sell and take care of her husband, doesn’t know what happened either. Through an intermediary’s putting in a good word on their behalf, about 6 months ago, the company was able to put through an order of accessories from SmallCo without difficulty, and the products were delivered on time and with good quality and at a good price. The seller’s wife emailed to thank them for the order and to introduce me as the prospective buyer. SmallCo took this opportunity to say that there was an unpaid invoice from 8 years ago for about $200k which, unless paid or settled (he offered 50%), would mean he won’t do any work for the company going forward, including under my ownership. He also won’t release the tooling.
The accessory is a popular product and demand driver, and a big reason for customers to upgrade to the more expensive line of the main product.
The seller’s wife is trying to get LargeCo to make the accessory, since SmallCo is no longer a reliable vendor. LargeCo would need to create tooling to do so, which would cost $90k. The seller’s wife says she can’t afford this, and is requesting/demanding a cost share where I’d cover about half the tooling outlay.
I hate this idea because a) I’m being asked to chip in for something that ultimately fell apart through no fault of my own, and who knows whether SmallCo or the company/founder were at fault, b) I signed an LOI under the assumption that the company could source all of its products without significant additional investment, c) working capital on the deal is tight and a line of credit isn’t available (SBA lender involved doesn’t offer them and it was a tough deal to get through with any lender), and d) the SBA lender will likely have to reassess the deal based on the change in terms, which will add delay (it’s a seasonal, winter-heavy business) that the seller also says she doesn’t want because she is eager to go take care of her husband full time. But all that said, I don’t know if it’s worth walking away from a $1.4mm deal over a $45k dispute.
While I can survive the broken deal costs, walking away here probably does mean the end of my search.
Any advice on how I should be thinking about this? Just bite the bullet and split the costs? Walk away given the late curveball? Any thoughts appreciated; I’m just trying to get my head around a not-very-easy judgement call. We’ve been post-LOI for about 5 months now so I want to make sure I don’t let “sunk” investment (time, due diligence costs, legal bills, etc.) or emotion cloud my judgement.
Sincere thanks for reading a long post and best wishes for a happy new year. I regret that I have to post anonymously to maintain confidentiality but please know that you have my gratitude.
Last minute deal snag
by a searcher from The University of Chicago - Booth School of Business
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First, with respect to the monetary size of this issue, I agree with ^Searchfunder member, ^Searchfunder member, ^Searchfunder member and ^Searchfunder member - the $45K in question is only ~3% of the transaction value and is really only 'noise'. So your 'big picture' perspective should be that the deal shouldn't abort over this small amount.
Second, in the context that you are dependent on SBA financing (which you said was hard to obtain), I would also draw your attention to the insightful comments from ^Searchfunder member and ^Searchfunder member. Both of them are highly experienced SBA lenders. As an ex-banker, I support Lane's concern that lack of full disclosure to your SBA lender may imperil your SBA guarantee, so if things go south you'll be financially naked without the SBA guarantee at the time when you need it most. That's not a situation you want to be in!
Third, as ^Searchfunder member, ^Searchfunder member and other have noted, what other surprises may be lurking in the darkness of a business where the owner has dementia and his wife doesn't have reliable knowledge of the past? Since your due diligence missed this one, how confident are you in your due diligence with respect to the rest of the business, both operationally and financially?
RECOMMENDED RESOLUTION: Assuming that you genuinely believe this is a fundamentally desirable business and want to acquire it, you need to mitigate the potential financial impact of further hidden surprises without changing the terms of the deal (which may screw up your SBA approval). That means you need to avoid changing the purchase terms (i.e., don't pay additional $45K at closing, don't introduce a seller note that wasn't part of the SBA-approved deal) and keep the payment to SmallCo outside the deal. That would require a side agreement with the seller for them to contribute $45K from their sale proceeds to the SmallCo payment, and the best way to control that is via an escrow managed by your legal counsel. That would enable you to earn brownie points with SmallCo for clearing their old unpaid invoice and to keep them as a supplier. Finally, you may also want to consider requiring a second escrow at closing in an amount and for a sufficient period of time to cover potential risk of other similar undisclosed issues (say, $50,000 for 6-9 months after you assume control).
And finally, GOOD LUCK! As ^Searchfunder member said, "Welcome to world of M&A".