M&A Monday: Last year after closing a deal, seller received $80 million and when the wire from buyer to seller sent, his final email said, “no backsies!”

In the months after, the buyer discovered widespread misrepresentations and fraud. The business was performing poorly and buyer was stuck with a sputtering business.

A buyer doe not like to imagine anything going wrong post-closing. However, I have seen misrepresentations, declining revenues, and duct-taped processes (literally and figuratively). A good M&A lawyer sees around corners, even when the client prefers not to.

Here are ways that I mitigate the post-closing risk for buyer:

  1. Post-Closing Incentives. The best way is for seller to be incentivized alongside the buyer.

(i) Rollover Equity. Part of the purchase price gets “rolled” into new equity in the buyer (not allowed by SBA 7(a) loans [oversimplification]). This preferred for PE and independent sponsors as it also reduces the equity needed.

(ii) Earn-Out. Part of the purchase price paid in the future on condition the seller hits certain revenue/profit targets (not allowed by SBA 7(a) loans).

(iii) Promissory Note. Part of the purchase price in a loan from seller to buyer paid over time. It can be contingent, secured, or guaranteed. (For SBA 7(a) loans, the contingency has to be based on maintaining past revenue, not achieving increased future revenue). See my prior post for a deep dive into promissory notes.

  1. Consulting or post-closing employment agreements. Sometimes sellers have good reason to disappear at closing (health issues, etc.), but usually the seller should have a consulting agreement or employment agreement (for SBA 7(a), it has to be a contractor and less than 12 months).

  2. Indemnification Escrows and Note offsets. Post-closing, buyer’s recourse is only as good as enforcement. Buyer can set aside part of the purchase price in a third-party escrow for###-###-#### months to ensure no skeletons fall out of the closet. If a Seller Note is used, a buyer can reduce such note for the loss one of those skeletons causes. (R&W insurance is also used.)

  3. Diligence. Sellers hate diligence requests. I get it, but issues are often found during diligence that can be handled pre-closing. Ask probing questions. Speak to employees. Read all open-source materials. Hire the right diligence providers (especially legal and FDD/quality of earnings).

  4. Strong legal documents. No one cares about legal documents until they need them. Sellers’ reps and warranties should be solid and clear enforcement mechanics should be included. No one likes long agreements and I have shortened my documents, but they must be strong and protective. Nothing is more frustrating than looking back at your documents and realizing you are not protected.

  5. Post-Closing Working Capital. The business will be more costly and capital-intensive after closing than anticipated. Set that money aside or have a line of credit.