The process involved in buying or selling a business can be a daunting task to seasoned professionals. To first-time buyers or sellers, it can be absolutely overwhelming. Consequently, whether you are a buyer or a seller, you should have a team of professionals to advise you at each step of the process. That way, you can focus your attention on “the deal,” because after all is said and done, an acquisition is a deal between two people. You should never lose sight of the deal, even though at times you may feel you are buried beneath a mountain of financial, accounting, tax, and legal details.
This article is the first of a three-part series that addresses the negotiation process. It concerns the perspective of the parties. Subsequent articles will address negotiating the purchase price and important deal terms other than price.
To understand why a person is negotiating a certain way, you need to consider the person’s perspective. This sounds obvious, doesn’t it? Buyers want to buy cheap, and sellers want to sell dear. Well, that’s true, but there is a lot more to it than that. Whether a person is a buyer or a seller affects the person’s view of many important terms of the deal besides the price, such as how risks are allocated, the form of the purchase price, and the type of deal. It also affects the person’s bargaining power differently at different stages of the negotiations.
DEALING WITH RISK
A seller usually knows a great deal more about the business being sold than the buyer does. Because the buyer is dealing with the risk of the unknown, he or she will want to learn as much as possible about the business, in order to reduce that risk. The seller, on the other hand, will try to disclose enough of the bad things about the business to preclude the buyer from having recourse following the closing, but not so much that the buyer decides to walk away from the deal.
In dealing with the risk of the unknown, a buyer will seek two distinct types of protection: (i) the ability to walk away from the deal, because, on closer examination, the company proved to be different from what it initially appeared to be and (ii) the ability to seek compensation from the seller following the closing, if the buyer learns that the company is not what the seller said it was. The first type of protection is found in a section of the acquisition agreement called the “conditions to closing.” The second type of protection is provided pursuant to the “indemnification” provision, which generally allows a buyer to recover from the seller if any of the representations that the seller makes prove to be false.
WHAT THE SELLER RECEIVES
In addition to the amount of the purchase price, the seller will be concerned about its form. At one end of the spectrum is a price that is paid in all cash at closing or paid pursuant to a certified check or a wire transfer of money to a designated account. At the other end of the spectrum is an unsecured promissory note for the entire amount of the purchase price. In between are such things as stock, a secured note, or a combination of cash and some other form of consideration. If a buyer pays with a note, the seller needs to be concerned about the creditworthiness of the issuer of the note and what security the buyer is providing to secure the payment of the note, such as a pledge of the stock being purchased or other collateral. If a buyer pays with stock, then the seller is not only selling his company, he or she is making a significant investment in the buyer, which means the seller will need to know a lot more about the buyer. If the stock is publicly traded, then the price probably fluctuates, and so the parties will have to determine at what point, and by what method, the number of shares to be received by the seller will be determined.
THE FORM OF THE DEAL
The form of the deal (i.e., whether it is a stock, asset, or merger transaction) can have significant consequences with regard to the relative risks assumed by the parties, as well as the tax consequences of consummating the transaction. If a buyer purchases the stock of a company, the buyer would be responsible for all of the liabilities of the company, both known and unknown. Therefore, the buyer should go to great lengths to determine the company’s contingent liabilities, tax exposures, and other possible problems. One way to do this is to require the seller to make various representations about the company and then include an indemnification provision that requires the seller to compensate the buyer in the event any of those representations prove to be false. A buyer of assets, on the other hand, is less concerned about such risks, because he or she does not automatically assume all of the liabilities of the company, both known and unknown. Instead, a buyer of assets generally assumes only those liabilities that he or she agrees to assume. The form of the deal will also affect who pays what taxes. The parties will want to structure the deal, if they can, in a way that minimizes the tax liability of both of them.
THE STAGE OF THE DEAL
Finally, the stage of the negotiations in which the parties find themselves will affect their relative bargaining power. Generally speaking, a seller will want to negotiate as many significant deal points as possible before the definitive agreement is drafted, a purchase price is determined, and an announcement of the deal is made, because it is during this phase that the seller has the most leverage. These deal points may include employment agreements, the terms of any notes that are part of the purchase price, the rights related to any stock received, including when and how the number of shares to be received will be determined, etc. After an announcement is made, the seller’s leverage changes. After the seller’s creditors, employees, suppliers, customers, and competitors learn of the deal, the seller will be concerned that if the deal fails to close (regardless of the stated reasons), everyone will assume it is because the buyer discovered something bad about the business. Realizing this, a buyer may take the approach of agreeing on price and “leaving the details to the lawyers,” which would put the seller at a disadvantage. Alternatively, if the buyer is concerned that another bidder may approach the seller, then the buyer may want to “lock up” the seller before an announcement is made.
To create some structure to the deal before the agreements are drafted, and to determine whether the parties truly have a meeting of the minds, they can prepare a written term sheet, which is sometimes done in the form of a non-binding letter of intent that sets forth the basic terms of the deal. Although such letters are typically non-binding, they are extremely important in establishing the agenda of the negotiations, and they can have significant persuasive value.
As you can see, a person’s perspective affects the entire negotiating process. In short, when you’re negotiating the purchase and sale of a business, “where you stand depends on where you sit.”
Bill Venema is the Practice Area Leader for Business Law in the Atlanta office of Holland & Knight LLP, a multi-national law firm with over 1,250 attorneys. He specializes in mergers and acquisitions, corporate and securities law, and the licensing of intellectual property. His clients include start-up companies and venture capitalists, as well as large multi-national corporations. He is a frequent speaker at seminars, has been practicing law for over 20 years, and is a graduate of the University of Virginia School of Law. In addition to his law degree, Bill earned an MBA from Georgia State University and a BS (Engineering) from the U.S. Military Academy at West Point. Before entering private practice, Bill was an Army officer in Germany, the Republic of Panama, and various stateside assignments. You can contact Bill at wvenema@hklaw.com or by calling 404-817-8581.
Copyright © 2002 by William H. Venema
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