How to Approach M&A Negotiations

Hello Ma Friends. This podcast is brought to you by Firm Room, an M and A science company. Twenty years ago, virtual data rooms would come to your office to scan documents to put on servers. That's why they charge per page. However, now in 2022, with everything in the cloud, it makes no sense to charge per page. That's why we created Firm Room, a virtual data room that's intuitive, built for public company security standards at a fair price. It's only $500 per month. Check it out with a free 14 day trial. Visit firmroom.com again. That's firmroom.com I'm Kisan Patel and you're listening to M and A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals. I'm your host, Kisan Patel, CEO and founder of M and A Science. Joining me today is Larry Foreman. Larry is a senior manager at Deloitte. We'll talk more about what you do at Deloitte, but today we're going to talk about what do you need to know when approaching M and A negotiations. Larry, if we can kick things off with a little bit about your background?

Yeah, I've been Deloitte as a senior manager about six years now. More of my work at Deloitte involves strategic alliances, ecosystem formation and other negotiations with third parties outside of the firm. Many times it involves early stage technology companies trying to figure out a way to bring their technologies into Deloitte for the benefit of our clients. So I ended up doing a fair amount of negotiation in terms of deal shaping, deal structuring as part of that. But prior to joining to Deloitte, I spent pretty much 20 plus years in the M and A world doing more acquisitions than divestitures, but a fair number of divestitures as well. So I've been on both sides of the table, whether I'm on the buy side looking to buy companies that are strategic to the company I work for, or on the sell side where we decide that a company or business unit that we own is no longer strategic to the business. So I played internal investment banker, put together the confidential information memorandum, looked for prospective buyers and went through the whole sales process. So I can talk about being on either side of the table and negotiations from either perspective.

Let's kick things off with going through the pillars of negotiations.

Negotiation can mean a lot of things to a lot of people. There are some people that want to try to get the very best out of the deal and in the process probably push things too far. So one of my pillars is try to be fair, try to find a middle ground, simply because with most negotiations, particularly in M and A, it's not one and done. Even though you might be selling a business or buying a business, if you're selling a business, you still may have a longer term relationship with the buyer simply because there's a period of time where there are balance sheet and other adjustments that take place. There could be shared customers. There could be a number of reasons to have to collaborate with the seller or the buyer. So you want to have a cordial relationship. You don't want people to feel like they were had and therefore they're going to be difficult on anything that might come up that's unexpected, where you need their cooperation. I try to do deals that are fair to both sides. Obviously, if I'm the buyer, then I want to get my best deal, or if I'm the seller, I want to get the most out of the transaction. All of that has to be within something that's reasonable and defensible. Another part of it is be open and clear as to what you're trying to do, why you're trying to do it. And in the process, I think you build something that's extremely valuable in negotiation, which is trust. So if there's not trust between the two parties in the negotiation, it leads to rather extensive negotiations and sometimes deal breakdown. So I think it's better off to set the tone of being open and honest. Admit when there's an issue. If you're on the selling side, when you put together the memorandum, disclose everything, the good things about the company, but also disclose the things that need work or need attention, what you're doing about it or what you're not doing about it, and why, and what you might do to help the buyer in that case mitigate those things as they take on control of the business. So by setting the trust early, it allows you to deal with the unexpected in a way that doesn't blow up the deal. So those are two things that I think are pretty fundamental to negotiation. Another part probably is that if you're going to ask for something in a negotiation, give a reason for it. Don't just ask for something and then expect the other side to understand it. Because they may then be reluctant to even consider it. Whereas if there's a reason for it, they might say, I understand, that's why you need that. Let me see what we can do. They may not concede it completely, but they may come up with an alternative that works just as well. Help them problem solve with you. I think the best way to do that is really to set the context early on in the deal. So if you're selling a business, why are you selling the business? Explain it. If you're buying a business, explain your strategic rationale. I wouldn't say things that will cause the price of the deal to go up, but I would explain that. Here's our hypothesis on buying the business. Here's what we expect to do with it once we buy it. And therefore, if there are things that show up in the due diligence process that are counter to those hypotheses, the other side can understand why it's an issue for you and why that adjustment in the deal value or in the operating model or something else that goes along. Because a lot of times you might buy a business, but you might need the seller to continue to provide some interim or supporting services until you can fully integrate the business into your organization.

What I took away was, one is be fair in a sense that you got to be mindful. That's got to work for both sides. Second is full disclosure, being open, honest. The third, empathy. Just understand the other party and their perspective.

Exactly. That starts to build the bridge that you need, or the bond, the trust you need to get the deal done. Because I've seen a lot of deals where sometimes the unexpected shows up in the due diligence process and you don't want people to think that you are hiding things from them. Because then it leads to the question of, well, if I don't know this, what else don't I know? That tends to raise the risk profile of the deal to the buyer. And in doing so, sometimes that just scares them off. They're too afraid of what they don't know. Whereas if there's something that comes up and you go, look, I told you what I knew. I wasn't aware of this. Let's talk about it. Let's talk about the economic impact to you or the operational impact to you and see what we can do to resolve this matter. Then you got a chance for an open dialogue. If you don't have the dialogue, then a lot of things will fall down.

What are the key phases in the M and A process when negotiation occurs?

I hate to say something that's to, how do I say, sarcastic, but in this case, almost every phase of the deal process involves some form of negotiation. I'll highlight a couple phases in particular. One is right at the beginning, when you're putting Together a letter of intent, or if you want to call it a memorandum of understanding or an indication of interest. All those things tend to mean the same thing to me, where you're basically setting out the business terms for doing the transaction, including financial terms, legal terms, and other things that matter to you when you're offering up the indication of interest. Things within the indication of interest that get negotiated are sometimes the price range, sometimes not. Because if the price range is broad enough, then usually the two sides are comfortable starting. Although if I'm going to give a range, which I'll do sometimes I usually explain what I mean by the range. If it's absolute perfection and exactly what I expect or better than I expect, then the top of the range is likely. It's more likely I'm going to come in the middle of the range. And if there's some issues that are detractors of the deal, then I might come in closer to the bottom of the range. If there are a lot of things I don't expect that can't be resolved, then the deal may just fall apart. I want them to understand the range isn't automatically going to be the top of the range unless the business warrants it, but other things could be. How long do we have a period to do the deal? From the time we start working to the time we have to close. What's the period of time? Is it 90 days? Is it 180 days? That matters. A lot of times to the seller, you want to talk about your process and why it takes what it takes to get to final closing, because you could have a fair amount of due diligence that you do up front, but there may be secondary due diligence that takes place later simply because there are some things the seller doesn't want to expose until they know there's a deal. Simple example might be they don't want you to see their software code until they're pretty close to knowing that the transaction is likely to happen at a price that they are finding acceptable. They also may not want you to talk to customers. Even though I think customer due diligence is pretty useful to the buyer. The seller doesn't want to spook a customer or two because somebody's talking to them about transaction. And oftentimes you have to mask that as more of a market research kind of process than a true customer due diligence process. So there's some things that are going to extend the process. So you might actually say within the first 90 days we're going to do this, and then afterwards we're going to come back to you and tell you what further due diligence we need to do and set the stage for that. The other part of it is nobody really knows how long the deal is going to take because we don't know how long it's going to take for the contracts to be negotiated. For example, we can set a specific period of time for the due diligence, but contract negotiations can be short and sweeter. They can be prolonged depending upon the issues that come up in due diligence and also the posture or posturing of the legal teams. I try to keep the lawyers from doing anything but the legal terms and get the business people to focus on the business terms and have the business people manage their lawyers. But it doesn't always work that way. So sometimes the lawyers get into a discussion, sometimes more esoteric than it needs to be, of all the what ifs instead of focusing on trying to get the deal done, I fondly called the lawyers that want to get the deal done as the deal makers and the ones that seem to want to prolong it as the potential deal breaker breakers. I've told a few lawyers a few times in discussions that we're not going to get very far if we continue down this path, which usually stops everything and gets people to reset their thinking. So if I get a lawyer on the other side that's trying to change the business terms, I'll usually turn to the business leader on the other side and simply say, I'm confused. Am I negotiating with you or am I negotiating with your lawyer? And I've done that a few times and it's rude, but it gets the job done.

We're going to expand more of that. Well, it sounds like we got negotiations all across this deal life cycle in multiple ways.

We do. When you get through the due diligence, if you're the buyer, let's say you might find some things about the company or the target you're buying that are not what you expected. And then the question is, how does that impact your valuation of the business? And if you're an honest broker about it, you'll go back to the seller and say, look, these are the things that we find problematic. To me, they're value detractors. And I'm not quite sure what kind of valuation readjustment needs to take place here. So if you can fix these things before we close, that's one thing. If there are things that can't be fixed in a timely fashion, then I want a concession on the valuation because it's not what I thought I was buying. That's a hard conversation to have. But if you're reasonable about it in the sense that you explain why it's a value detractor and why you think the value adjustment you're asking for is reasonable, you usually can find a middle ground on that. If you just go in and say, I think the deal is worth half of what it was, you're probably going to have a seller that just walks away again. The goal here is, if there's a deal to be done, get the deal done. I've been in some situations where I'm on the other side, I'm selling the business, and the buyer has said to me, there are some things here that I think are material to the deal, materially adverse to the deal, and I'm not sure what to do. The first question I would ask in that kind of situation is, well, is the reason you started out to do the deal, are those reasons still there? In other words, is there a rationale for this transaction? If the answer is yes, then, okay, let's figure out a way to meet in the middle and reduce the risk from your point of view or get rid of or mitigate the things that are bothering you. And once we do that, hopefully we can find a financial or economic adjustment that works. And I sat down there, we ticked off every single issue that the buyer had. We ended up making an adjustment to the value. And in the process of doing that, I got the deal done. But the first thing was to reaffirm or have the potential buyer tell me, yes, I want to do this transaction, because otherwise we're just wasting each other's time.

That's a great example. Can we focus on loi? What are the terms negotiated in loi?

How long you have an exclusive period with the particular seller? They may say you have to get the deal done in 90 days. And you might say, that's not going to work for our process. But here's what I'll get done in 90 days. And then at 90 days, I'm going to ask for an extension in order to do the rest. So it could be how long negotiation is going to go on or the due diligence and the whole buying process is going to go on, which includes the development and contract negotiation. It could obviously involve the people that are going to come over. In other words, am I buying the whole business? Am I buying part of the business? Am I getting the engineering team I need or not? You lay those things out Sometimes they'll say, you're only going to get some of the people, and here's why. Or you might say, I don't want any of the people. All I want is the technology. I want a transition plan where I get to work with your engineering team for six months to transition over to our firm and then we're done. All the major elements of it can be negotiated in the loi. I don't usually see that much negotiation going on there, other than over price and timing. But any of the other major elements. If I'm buying this business because I want the people, then one key issue may be that I have to get at least 80% of the people to sign on before we'll do the deal. If that's a deal stopper at the beginning, then we need to talk about it. Generally that's more of an issue towards the end of the process, but it may be something you lay out in the indication of interest upfront and any other major issues for you, whatever they might be. For example, when I'm selling, I might say that I'm willing to sell you this business, but it excludes the following elements because that's part of the mothership that we're not giving up. Or I might say that I want to sell you the business, but I want a license back of certain key technologies for a period of time, and that's a given. If that's not something that's acceptable to you, then we need not waste each other's time. So in that ioi, whether it's going one way or the other, I would make sure that the key business terms are laid out.

What about some of the more sensitive areas? When we think about information that we want to review in diligence, like the customer list, source code, names of employees, things like that.

A lot of times when it's a technology purchase or technology sale, there's certain sensitivity about exposing the technology or key traits secrets to the other side. What I would say is you can break the due diligence into two pieces where you can say there's an initial tech review that'll be kind of at the architectural level to understand how your product is constructed or how your platform is constructed without getting into the gory detail and actually looking at exposing the code, and then do secondary due diligence when you're closer to making the seller feel that the deal is going to take place. So when there's high certainty the deal is going to take place, usually the seller's a lot more willing to expose More sensitive aspects of the company. The alternative to that on the technology side is pretty straightforward. There are third parties that will do technology reviews and only provide you the buyer back a report on what they've seen. But you're not being exposed to the code. You're getting answers like is the code well constructed, what kind of technologies are involved, how much open source is in there, are the open source licenses appropriately handled or referenced? All of those things could be done by a third party with without exposing the code to you, the buyer. Especially if it's a situation where they're selling to someone who they feel might be a competitor and if the deal breaks down, it's going to be damaging to them. So that's the two ways I would think about that. On the customer side, it really gets down to, I think, certainty of close before they're going to expose the customers to you as the potential buyer because they don't want to make the customers feel like this deal is going to get sold to this new company. Maybe we should find another company to buy the technology from. You can request a fair amount of customer information and get back answers that are mass. So for example, if I'm doing due diligence, I could ask the seller to provide me a list of the top 10 customers. Perhaps give me the industry, but don't give me the name of the customer. I want to see the revenues for the last three to five years so I can look at revenue trends with that particular customer. Are the revenues growing in those top 10 or are they declining? Or is the top 10 wildly different every year? So I get some sense of the continuity of the business without ever having to talk to the customers. So if I see high customer churn, that's going to tell me something without even talking to the customers themselves. If I see customers that are sticky that stayed there year in and year out, that's usually a good sign of stability for the business. So one could assume that those customers aren't going away. And as you can imagine, recurring revenue is far more valuable quality wise than one off revenues. So a customer that has a long term relationship is better than a customer that's brand new in some ways. Although I want to look at new name customers at the same time, I'm more concerned about buying a business if it's the same old customers every year and not a bunch of new names. So I want to look a combination of the existing customers that have been there for three, four, five years and I want to look at how many new names come in Every year because that's the sort of the new recruits, that's the next part of the spread growth spurt of the business. So I want a combination of both. But I don't have to see their names.

Those are great scenarios and examples. Pricing, you gave some general approaches around renegotiating prices, but how about when it comes to this loi, when you're introducing that initial price?

Here's what I would say is the most common approach. If I'm looking at a business, hopefully they have some sort of confidential information memorandum or they have some basic information they're willing to provide on the financials of the business and their financial forecasts. I would then take their information as gospel. In other words, this is what you told me. So I'm going to run it through my models and I'm going to base the valuation on what you said. If it turns out during diligence that what I find you've told me is not indeed what I see and you can't reconcile the two for me, then the price is going to change because I'm going to redo my model. And I've seen that happen a number of times where we've gotten in and we realized that the way they constructed their financials isn't the way we would look at financials. And we're usually looking at GAAP numbers. And therefore we come back and say we've taken your numbers and we've adjusted it based on the following needs, accounting needs or other needs. Here's why our valuations changed. So if you give me numbers that are the real numbers, at the end of the day, not much is going to change in the valuation model. If I'm going to have to adjust your numbers for a number of different reasons, then I'm going to probably come back and say the valuation is going to be different. And I've seen that happen. It's not a fun conversation to have, but it's one that's necessary otherwise you're probably going to overpay for the business.

So you get the first offer in. Typically people want to counter, is it like the common thing? Put a price out there and they're like, I'll take it. There's typically some back and forth. I'm curious to just hear from your experience. You obviously worked on a lot of these deals and I'm just really curious of just what have you typically see. It seems like what I see most of the time it's you want the buyer to put the offer price up first.

True. I'VE seen it done both ways. I'll give you a silly example. So I was looking to buy a small business run by a couple of founders, engineers. It was a two person business and someone in our firm wanted to buy this particular technology and roll it into a bigger platform that we had. And I asked the partner involved, I said, what do you think this particular group expects to get for the business? And he gave me a number. So during the first call with the two entrepreneurs, I asked them what they thought their business was worth. It's a loaded question. You never know what kind of answer you're going to get. And the number they came back with was 2x, what our guys thought they had talked about. When you get into a situation where somebody's expecting something unreasonable, I think the best thing to do is simply end the conversation quickly and politely. So I said to him, gentlemen, I really appreciate your time today. Thank you for the number. It's way out of line with what we're able to consider and I wish you a lot of luck finding that somewhere in the open market. And hung up. Well, the partner, needless to say, was furious because he thought I'd blown the deal. And I explained to him, I said, you had this number that you thought you'd negotiated with them, and they're saying it's 2x that. So there's a misunderstanding somewhere. 24 hours later, they called back and they came in with a number lower than half. And they ended up doing the deal for basically one third of the number they asked for. So I just had to call their bluff because I think they thought we're a big company and we should overpay because we can. And yes, we can overpay, but why would we? We're schooled in this process. It was one way to negotiate it. Generally it doesn't require that kind of drama. It's more of running DCF models, discounted cash flow models based on the numbers and coming back. And the numbers usually we surface or offer up aren't usually radically different than what their banker advisor or even their CFO might say would be a reasonable number.

I like how you prompted them to at least get the range or get an idea where their head's at and.

It'S good to do it. Sounds like a silly thing to do, but sometimes I've found where. I remember one deal where I was buying a small consulting firm during the height of the Internet bubble, and the people in the firm I worked for at the time thought we were going to pay something on the order of $10 million for this very small business. But it was a very important business to us. We needed these consultants to do some things that we thought we could generate a significant amount of revenue for before we put an LOI in front of them. Although I had an LOI with the 10 million DOL number ready to go, I asked the guy what he wanted and he thought about it for a minute and he said, I think I'd be happy with about 7 million. No, I probably could get by with 5. So literally he came back with a number half of what we were willing to offer. So we took his number and we said, okay, we'll try to get you to five. Him not realizing that he had already have the number we were willing to pay. And we ended up around 4.5. So it was a win for him because he got most of what he wanted. It was a big win for us because we saved five and a half million dollars.

That's how I lear, you should always push to get the other party to put a price up first.

If you can't, if they're willing to do it. In this case, he was. So it did save us money.

You get the starting point, it goes from there. So say if you put in your initial offer in a company, they come back counter 50% higher. And at that point, are you focused on understanding why sitting there and just.

Giving them a smirk isn't going to get you where you want to go? The first thing I would do is say, okay, help me understand how you value the business and how you value the different components of the business. Because I'm not getting the same results from my analysis and I'm using fairly standard approaches to doing the valuation. And sometimes it comes down to things that I didn't even know were there. For example, we have this rather large contract that's pending that's not in the projections yet, but we think it could be worth X and therefore we're adding that the valuation. In that case, I might bifurcate the deal and I might say, look, based on the business you have today, not including the potential bird in the bush that you're talking about, I think the business is worth X. If you get this other contract and it's worth what you say it's worth, I think that's one situation in which I might consider it an earn out. In other words, if you get it, then I'll pay more. But if you don't, I don't want to pay for it because it's not done yet. I'VE done a few deals that have worked out that way where in one case the deal didn't happen, the transaction happened, but the deal that they were proposing that they were going to get or arguing they were going to get didn't happen, so I didn't have to pay for it. Another case it did happen and we paid up. We had to understand what their basis does for the high valuation, create some terms around it.

Never split the difference, only if it's.

A reasonably small range, just to get the deal done.

Otherwise, never split the difference.

Sometimes you don't, sometimes you do. I would say if the range is small enough and we're arguing half a million dollars on a $40 million transaction, it's not going to make that much difference at the end of the day, if it's a half a million dollars on a million dollar transaction, I'm not sure I would pay off again. It's got to be reasonable and defensible because I'm working for someone and I'm working for the firm, I'm working for the shareholders. And I don't want to do something for the shareholders that isn't going to pay off at the end of the day. Because any M and a practitioner can tell you that once you do a deal, you live with it a long time, good, bad or otherwise. So you want to do a good deal, you want to have good report outs. When you say, how's it working? How did the deal go? Not only upfront, but how's it working now that we own it, Are we realizing the forecast that we made for this business? If not, why not? What's changed in the market? What's changed with the company, which changed with the direction of the mothership? A lot of things can affect the valuation and the results, but you want to understand what the delta is, what the variance is. And so I'm careful about doing deals that I think I can live with a long time and they can get scrutinized for a long time because they will be.

I like how you look at the whole big picture, long term range on it. Do you ever get in a situation where it's very much like nickel and dime, all of a sudden accounting for 5,000 on that $5 million deal and what happens.

I've been in situations where it's been negotiated ad nauseam. I remember taking a 15 page, an agreement that we put in front of a particular buyer and he turned it into a 90 page document because he wanted to negotiate basically every line of the agreement. And in the process of doing that. It expanded the agreement a lot. It also ran up his legal fees significantly. Mine, too. More importantly, it extended the deal a long enough time that the sponsor of the deal on his side almost walked away. Since he was the M and a guy working for this senior executive, he realized that probably wouldn't be good for his career if he was blowing a deal that one of the senior sponsors wanted done. And the senior sponsor called me out of the blue and said, I don't know why you're prolonging this deal. And I said, I'm not the responsible party here. Let me explain what's going on. I think you need to manage your M and a person better. And when I explained to him what was happening, all of a sudden things started moving quickly. You're trying to meet someone in the middle. You're trying to get a deal done. You're not trying to be difficult. But some of the things that this particular person was asking for were beyond unreasonable. He was asking for all kinds of indemnities related to a particular bill that was going through Congress that hadn't passed yet and wasn't fully understood. But he wanted an indemnification on it. And I said, we're having a hard time doing that simply because we don't know what the bill looks like and you don't know what the bill looks like. If you want to be specific about which things you want to be indemnified for, write them down and send them to us. But we're not going to give you a blanket indemnification of something we don't understand. He just wouldn't get off that issue. So finally, I basically wore him out because I can be very patient and I can repeat things ad nauseam until somebody gets it. I don't recommend that. But if it's the kind of party you're negotiating with, then that's what you have to do. I also got to his attorneys and explained to them that we weren't going to concede that point, and they could decide whether they wanted to advise their client to persist or not. They basically told their client to stand down because they thought he was being unreasonable to I had trust with the parties I was negotiating with because everything that I had said to them I could validate. I could point to and say, here's the facts behind what I'm saying. It wasn't just posturing and negotiating for the sake of negotiating.

You had your position. You stood your ground.

It was funny because after we got the deal done, we did get it done. We had a closing dinner and the MA person on the other side said to me after he had several glasses of wine that he felt that he had really out negotiated me throughout the whole process because he got every term in the contract that he wanted and I conceded term after term. And I said, yeah, you did. You got a lot of concessions on the contract. I said, but the one thing you didn't get a concession on was the price. I hate to tell you this, but you probably overpaid a little bit because that's the only thing I cared about. I was selling the business. He turned green, didn't talk to me again. That was that. But when you're doing a negotiation, focus on what you really need. It's not to try to one up somebody, it's not try to out negotiate them. It's try to find the middle ground that works for both sides. And I was doing that. But he was so focused on the contract he forgot to focus on price. And it wasn't like he overpaid a lot, but he probably could have gotten us to concede something. Now I've seen concessions where somebody more senior being the organization gets involved and doesn't understand the dynamics of the particular buyer. When I'm on the sales side and as soon as the buyer coughs, they start taking dollars off the value. That kind of knee jerk reaction, just silly. It's better to be much more rational about it. When somebody says, well, I can't do this deal at this price, don't throw money at them. Just simply say, give me your reasons and tell me what you want me to adjust and I'll think about it. And always give yourself time to think. Don't try to negotiate everything on the spot. A lot of times the best thing to do is say let me think about it and then get back to them with a rational response. Because if you try to negotiate when everybody's heated, something dumb will happen for some side.

So don't do it, nap on it or sleep it over.

Yeah.

What are some examples of due diligence surprises and, and how they were negotiated to save the deal?

Let me start with something on due diligence. That's going to sound silly, but if you're a seller and you're putting together your confidential information memorandum to present to the prospective buyers, diligence the business yourself as if you were a prospective buyer. Discover everything you can about the business so that you can fairly represent it to prospective sellers so you're not caught flat footed with a bunch of Surprises that the seller finds in due diligence. And then you look stupid, like, why didn't you know about this? But I had that happen to me, even though I thought I did a fairly good job of diligencing the business. So this one particular buyer looked at the business we were selling, and it was a piece of a much larger business. And he said, I can't give you the value you want because of your contracts. Turned out that we had one salesperson who wasn't managed very well or managed very closely who had made some concessions to a couple key large customers and basically made it very difficult for us to go back to any of those large customers and sell them new licenses because of the way he had written the contract. When I realized that was the case in the contract and I somehow missed it in my reading of it and our lawyers missed it, I had to concede, you're right. That particular big customer who has that particular contract, it's going to be difficult to get much revenue out of them. And you were expecting, I know, to do a land and expand once you're there, go into other departments of the company and sell more seats. We're going to have to concede something on the price for that piece of. Now, had I seen that, I probably would have tried to mitigate the agreement or renegotiate the agreement before we went out for the sale if I could do that. And a lot of times there were things that we identified that were problematic and we could go back to customers and fix the agreements. We could limit liabilities with certain customers because we had one contract where it went on and on, it never seemed to get done. We basically settled with the customer so that it was finished so it wasn't a black hole from the buyer's point of view. So whenever there's an issue that can be mitigated, either mitigate it before closing or at least show process to get it mitigated so you don't end up with the big value subtraction as a result of it. That happens from time to time in deals. There are other times where there's a lot of closing requirements that take place. Simple example would be, and this gets negotiated too. If there aren't automatic assignment clauses in a change of control, then a lot of times the buyer will look at that and say, how do I know the customers are going to move over with me, me? And the answer is they should move over. They like the product. They've been using it for years. Why wouldn't they? A smart buyer could say I want those assignments done before I take possession of the business. So you have a signing period where you get everything ready to go. And then between signing and closing, you go in and you let the customers know that you're doing this transaction and you want them to agree to an assignment from you, the seller to the new buyer and explain to them why it's good. And you might have to argue about what percentage of those buyers have to come over or what dollar value of those contracts have to come over before you close. So that's something that gets negotiated towards the end of the deal as opposed to the front of the deal. But it just depends upon what pre closing conditions are imposed by the buyer.

You got some variables and you got some knobs to turn between price adjustment and finding ways to mitigate the issues.

Yeah, and sometimes there's non economic issues too. There are certain key individuals that the buyer has identified that are must haves for the business. Business. Then you may, between signing and closing, have to go through the process of getting those people to sign on to the new business. Not an uncommon thing. Once in a while there's one or two people that can hold you up and delay the process significantly. And in some cases you want to go to them and say yes, you're key to our organization and obviously you'd be key to any buyer. And in recognition of that, we're going to provide you some incentives to move over and stay over. So there's a two part set of golden handcuffs. The first one is help us close this deal and you'll get a bonus for doing so. And the second is there'll be stay bonuses if you remain at the business for 6 months, 12 months, 18 months, whatever the number is. And those things can be negotiated in terms of six months or 12 months or 24 months, which people fall into that category. And who pays for is it when the buyer says I'm offering you 25 million and 2 of it's for stay bonuses. So therefore it really goes to those employees to make the deal happen. It doesn't go to you, the seller and go into your pocket. Pocket. That's a negotiation. Or it could be, no, I'm sorry, you're going to have to pay the stay bonuses yourself, Mr. Buyer. We're not paying for it. I've seen it done both ways in another negotiation that takes place. So percentage people that need to move over, what kind of dollar is going to be used for golden handcuffs or stay bonuses and the like, all those things are negotiated that's why I said flippantly at the beginning. Almost everything in the deal gets negotiated at some point, but some things are really critical to making sure the deal works.

What are examples of deal breaker issues that come up during the contracting process?

Sometimes it has to do with limitations of liability. There are some things where you're saying you're going to be able to sell them the business and you have the right to do that. If you don't own your own IP and you're trying to sell it, then I think you should be giving a high indemnification to the buyer because they're buying something they think you have right and title to. So in those cases, those things may be almost unlimited liability. In other cases, the liability might be limited to an amount that's negotiated between to the two parties. No matter what happens, the ultimate limit of liability is a million dollars. And then the question is, okay, how much of that limitation of liability might be in a holdback. In other words, I'm going to buy the business for $25 million, but I'm going to put 2 million of it into escrow and I'm going to wait until the first year goes by to make sure that there's nothing that shows up that wasn't disclosed in the schedules of the transaction documents. And therefore I have a one year period to offset those liabilities I had to incur as the buyer from that holdback account. And the question is it an escrow account or is it just an amount that the seller just pays you because there's no escrow? And then so you could negotiate the escrow. How big is it? What percentage of the deal is it? How long does it last? When does the escrow account come into play? For example, you could have a concept of a basket basket that says the first $100,000 in things that turn out to be liabilities for the buyer don't count. So up to $99,999, the buyer eats it at $100,000. Maybe every dollar after that is something that the seller has to pay back to the buyer. Or it could be when it hits $100,000, it goes back to zero, so that you pay everything. So until it gets to $100,000, you pay nothing. But as soon as it gets to 100,000, you start paying everything and you put a cap on that and those caps get negotiated. So the size of the basket, what's counted against the basket and how long it sits out there are all things that get negotiated in the legal agreements. And everybody has their market value concept on that or what market is meaning, what's customary. So the buyer has his idea what's customary, and the seller has his idea what's customary. And they don't always agree. So you get a lot of interesting esoteric discussions between the lawyers saying, on the west coast we do it this way, on the east coast we do it that way. So I've seen some pretty interesting arguments which is always beneficial to the person arguing.

Of course, these are good examples. Escrow the different disclosure schedules to limit liability.

Yeah, and disclosure schedule is a key thing. If I were to caution anybody in terms of working on a contract, on a sales contract or acquisition agreement, I would say pay very careful attention to the disclosure schedules because the disclosure schedules, when done properly, tell you what you're getting and what you're not getting. Don't leave those the last minute because if you do, chances are they'll get messed up and you won't really get what you thought you were getting or you might have sold something you didn't think you sold. Pay attention there because that can really mess up a transaction. And people are very slow to put those schedules together because they're tedious and they need to be reviewed. So make sure you have time to get them and review them them, not just put them into the agreement at the last minute and hope they're right. Because more often than not they're not right. They take some work, some iterations.

We should be reviewing those.

Besides legal, definitely the business owners, the business sponsor for the deal has to understand what he's getting. Is he getting what he thought he's getting? Are the things that are on the schedules that are being transferred over to the buyer, all the things that he asked for. Because there could be situations where some things are left out by design. In other words, the seller saying, I'm going to sell you this business, but I'm not going to sell you this and this because it's part of a larger agreement with the customer and I can't sell it to you. And so you're not going to get it. So the buyer needs to make sure he understands what's in the box and what's out of the box, so to speak. That's why the disclosure schedules are so important. But I've seen it way too many times where the schedules come in at the very last minute and they don't get the attention they deserve. To answer your question, the financial people should be looking at it, the business people should be looking at it. If you just leave it up to the lawyers, unless the lawyers really know your business extremely well, you're probably only going to get a legal point of view and not a business point of view of you.

If they only made them fun to read, that would probably help things out.

Oh, they're not fun to read. There's nothing fun to read about a disclosure schedule.

I think that's a reason nobody wants to read those things.

Yeah, it's like reading the side of the ketchup bottle to see what's in the ketchup. But if you're allergic to something that's important to do in this case, you want to know what's in it. That's what I would say. Read the documents and don't expect your lawyers to do all your legal due diligence for you. Hopefully they'll have good associates who read them and point out all the exceptions, and therefore you could deal with the exceptions. If I were doing the deal, I would be looking at the documents myself, especially the largest customers or the most critical customers, to make sure I understood how those documents are constructed. Because there may be something the lawyers don't see that you see that presents an operational business issue as opposed to a pure legal issue.

Do you have an example of a closing requirement that delayed a deal for longer time than you expected and why.

The assignment clause process took a long time with one particular company. Because they wanted 80% of their revenue of the customers assigned, and that required about, in this case, 20 or 30 customers that we had to go to get the assignment. The customers aren't in a big hurry to do it. Yeah, get in line. I've got lots of work to do this week, this month, this year, to have to read your agreement and agree to it and so on. Even though an assignment provision could be a couple paragraphs at the most, it basically says, here's the new buyer and you want to sign this agreement to the buyer, and the buyer is going to perform on the agreement. Seemed pretty straightforward, but sometimes that takes a while to get done. I've seen particular key individuals hold up a deal because they wanted to get more money, and let's say they were making $200,000 a year, and they sense the opportunity, that they're the kingpin on the deal, and they come back and they say, yeah, I'm happy to transfer over, but I want $300,000 a year and I want a $300,000 signing bonus. You're not behaving very nicely. If you're the reason we can do the deal or not do the deal, then let's see what we can do that makes everybody happy. And so sometimes we've had a negotiation, things like that, and they've been protracted negotiations. One time that was really an exception, but could happen to, I guess, anybody is we were the buyer. We came across an agreement with a particular company that we just weren't comfortable doing business with. And unfortunately for us, the seller was right in the middle of the work that they were doing for this particular company, this particular client of theirs. Basically we got to the point where we signed the transaction documents, but we refused to close those until they basically ended the relationship with that client. And it took them a while to finish up one of the phases of work they were nearing completion on and getting out of all the subsequent phases. And actually, I think they ended up conceding some dollars to the client by discounting the second or third phase, whatever the last phase was that they had to do in order to get out of it. Because we would not take that client on. Just a client we had experience with before and we didn't want to deal with them again. And that delayed the deal about six weeks on a deal that should have only taken six weeks to do. But it was their client that they had and we didn't know about it going upfront. And the first set of due diligence lawyers didn't notice the contract. One lawyer who was helping us on other things said, who's the company? And when we mentioned the name, he goes, we're not doing the deal. He said, we will not do this deal with that company involved. So I had to scramble and get them to figure out a way to get out of that particular relationship. Then they, they did, but it took six weeks. Another time is we were doing a deal in Australia. We found out that we had to conform to all kinds of Australian laws that we weren't aware of and some disclosure laws that we weren't aware of as us. So we ended up going to Australian council, getting their advice, doing the disclosure. I think we had to disclose something and put it out in the public for 30 days before we could close the transaction by law, which gave anyone who had a problem with the company a chance to present their issues, their liabilities that the company had incurred. Fortunately, no one showed up and complained about anything. So the deal got closed, but it delayed it by 30 days just because that was the way it worked there. Didn't work the same way in the States. Fun stuff happens when you go across the pond or over to the Pacific.

Anything can delay a deal. So this one came up from a prior conversation we had about when you have to inform customers about the deal before closing and around. Hey, doesn't that violate the NDA? You give customers an NDA. How does that work?

Yeah, that's a good legal question. Generally what we would do is we would have the seller go to the client and say, look, we're going to go through a transaction process. We're going to sell the business, we're selling it to a company we believe will be a really good steward of the business and we'd like you to talk to them. So the customer gets to decide at the end of the day if they're going to talk to us or not. So it's a way for the customer to give permission to give their name out. If the customer doesn't give their permission, then the seller is probably not going to give us the name. So that's the way it usually works.

You go through the seller and have.

Them, have them do it. Now, if I can keep the seller off the call, so I'm having a call directly with the client, with their client and I can ask the questions I want, I'm happier. But a lot of times it's a three way call. It's the seller is there, shepherding the client. There's the buyer there, which would be me in this case. And I'm asking the client a scripted set of questions because the seller doesn't want me to ask too many questions that are real different than what he expects me to ask. I can ask a question in a way where if the client's not happy, I'm going to figure it out.

I think we touched on this one earlier. What do you do when lawyers overstretch on the negotiating table?

A couple things. One is again, if the business person's in the room, I might ask him how important this is to him. Is this a legal issue or is this a critical business issue? And if he says, I'm not even sure I understand the issue and I go, unfortunately I do. And this is not something we're going to concede. So we can talk about it for the next two hours or we can move on. And I've said it as bluntly as that, and guess what? They move on. Now if it's a critical issue, then I ask the attorney. I said, why is it so important to you? I'm missing your point because my lawyers and I don't get it. If they can convince us that we're missing something and it is important, then maybe we concede it. We're not always right. It works both ways. But if the lawyer is just trying to show his ability to make the deal more complicated, then we're usually not very patient with that. We want to get a deal done. We don't want to gloss over the importance of stuff, but we also don't need to make sure that every bit of minutiae is just worded exactly the way the other side wants it worded. Wordsmithing is nice, but I have a degree in English. I can write as well as most. I'm not going to try to rewrite every word in the contract. Waste of time for everybody. We'll indulge them and try to understand what they want, but if it's not something we can conceive, we'll just tell them we can't do that. Not going to fly. Or as they say down south, that dog don't hunt.

How do you distinguish between legal points and business points?

If the word liability is involved, I usually think of it as more of a legal point or indemnification or all the good legal words that are in these agreements. Business points are usually more related to dollar terms for the value of the business. So for example, if the lawyer says. If their lawyer says to me and he's the seller's lawyer or the buyer's lawyer and he goes, we're not going to pay that much because of this and he's changing the economic terms of the deal, the business terms being the economic terms. That's when I turn to the business person and say now who am I negotiating with, you or the lawyers? Because I thought you were setting the business terms and they're just trying to get the contract written to satisfy you. Because that's what the lawyers are supposed to do. They're supposed to help you with diligence, tell you what some of the risks or liabilities are. But they're also trying to put down in words what the two sides are agreeing to. And if we have an agreement in principle, what we're going to do and they're changing the words that don't conform to that agreement, then there's a problem. And that's when I call nonsense on the lawyers or call them out.

What are other things that are holtly negotiated, hotly negotiated.

A lot of times it's funny stuff. In other words, non compete clauses. I'll give you one that's silly. We were trying to sell a business to a rather large company and they came back with a non compete clause that wasn't just extended. In other words, we couldn't compete with them for five years, which is a really long time. Usually non compete clauses are maybe a year or two, which basically means you're not competing with the business that you're selling to them them for one to two years. That way you're not selling them a business and immediately going out and starting a new business that's the next gen and beating them in the market. That's not the intention of a sale of a business. Generally buyers are somewhat cautious about that. So the period of time that you are non competing with them is something that's negotiated. I've seen one or two years, but sometimes I've seen as long as five years. But then the definition of the business is really critical here. It's what is the business that you're selling? Because if you're a big company, you're selling off a business unit you have lots of other businesses you have, and you don't want to get caught in a situation where the definition of the business you sold and therefore can't compete against somehow keeps you from or impinges on the existing business. You're keeping the mothership. And I've seen it written so broadly that sometimes the business you're selling gets written so broad that now the parent company can't do some of the things they used to do. And I had one comical situation come back to me where they'd written the description of the business so broadly. I said, if that's your definition, I think you're overreaching, but if that's your definition, I'm good with that. But the price just went up by a billion dollars and this was a $75 million transaction. And the guy said, I don't understand. I said, well, you're buying the whole company because if we can't compete, you're basically telling us the mothership, the business that we own, and we're conveying this little piece to you. You're saying we can't be in our business business so you just have to buy all of us if that's what you want. That very quickly he sat down and said, oh, I see. He said, how would you structure? And I said, it's really simple. You describe in 50 words or less the business you think you're buying from us. And he did. And I said, okay, that's a good definition of the business. That's what we're not going to compete with. Everything else is off the table. So we got the deal done for the 75 million but I was willing to sell him the whole company for a billion. The market cap at the time was 800 million. I figured that was a good trade for us get 200 million on a transaction action. It didn't happen though. They were big enough to buy it, but they didn't do it. Yeah, non competes business, non competes. Now there also could be individual non competes in there too, but that's a separate issue. That's a secondary matter.

We mentioned earlier about when someone's comp expectations relatively high and figuring that out with the post close scenario.

You mean in terms of negotiating that at the very end of the deal or you're talking about not taking on very expensive employees? Because I've seen both. We've had a few situations where a founder is being paid an extraordinary amount of money. Money because he owns the business and he can pay himself whatever he wants. And we've explained to that founder, if he's going to come over that this is the market value of someone in that particular position as a business unit manager, assuming he remained the business unit manager when the business comes over, this is what we would pay. If that's not acceptable, then we're going to find another business unit manager. We're not paying you what you'll be paying yourself, which is not a market rate at all. You're going to make your big money on the sale of the business, but you're not going to make huge dollars on the salary. You're going to get paid a salary that's reason reasonable for the job you're doing. And if you don't think we're being reasonable, we'll put you in touch with a couple of headhunters that can tell you what is reasonable. So you can go out in the open market and get a number if you don't think we're being reasonable. And usually that works. Or sometimes they just won't come over, which is fine too. I mean you just have to plan on that. Just know it up front or know it as early as you can, let's put it that way. And there's surprises at the end. I've seen actual transactions where unfortunately for the buyer, they bought a business they thought they were getting getting a guy that was going to be their business leader. And three months into the gig he quit. Didn't even care about the golden handcuffs because he was just too unhappy, just walked away. So I would caution a buyer that just because you're putting golden handcuffs out there doesn't mean you can treat the new employees without respect. So be careful because it's like any employee, they have the ability to walk out the door. And sometimes they'll walk out the door no matter how much money's at stake. I had one guy walk out the door door when there was a $3 million set of golden handcuffs. He just didn't like the business and he left. And $3 million wasn't persuasive to him. To me it's persuasive, but it wasn't to him. So there you go.

Things that meant more than the money.

Exactly.

Larry, what's the craziest thing you've seen in M and A?

Oh my gosh. Craziest thing I've seen. I don't know if it's crazy, but it's an interesting way of looking at M and A. I was working for a company down in Atlanta that had a very good software company product and a very good telecommunications platform that went along with it. But what they didn't have was a really strong consulting business that could take the software and help the client implement it. We did some product support and things like that, but really get the value out of the product. This was my non M and A M and A deal. So I ran into a partner from, at the time it was called a big eight, Big eight accounting firm. Now there's the big four. Like Deloitte being one of the big folks four. This big eight accounting firm remained nameless. There was a particular partner who was doing work in our space, but he didn't work for us. He was just doing work for clients in our space. Called me up one day and he was complaining that he thought the business unit he was in at the consulting firm was going to get shut down. And there was him and a bunch of other senior associates, senior managers, whatever, that loved doing this kind of work and didn't want to go do other things within the firm. They weren't being asked to leave. They were just being told that they were going to de emphasize this business business. So my non acquisition was to simply say, who are the top three people in your group? And he said, he told me who they were. And I said, how much are you likely to make this year if you were to continue? And he told me and I said, I'll guarantee you that much if you'll come over. With one caveat. You not only have to come over and do the kind of work you're doing, but you need to recruit everybody else. You can recruit out of that group, because I want a group that's 50 to 100 people large. I need to. I paid nothing other than the salary and a guaranteed bonus and ended up with a 25, 30, almost $50 million business unit for free. So that was a cheap negotiation.

That's pretty cool. You want to come over here and do that with us?

The opportunity presented itself. Sure. I'd be happy to give you some free advice.

We'll talk later. We'll talk. That was a fun story. I liked it.

It's true. And I mean, we did very well. We ended up competing with a small company called IBM. They were surprised that all of a sudden we had all this consulting horsepower we'd never had before. And when we competed with them too, they were like, where did you guys get these people? We go, we didn't even buy them. We just recruited them. We could have done it as an M and A transaction, but the big eight wasn't trying to sell them. They were just trying to shut it down. So their shutdown was our benefit.

I see some great entrepreneurs that are good at that, created a lot of value by that approach.

They have. Good consultants are worth their weight in gold. They're rainmakers and these guys were.

Hey, Larry, thanks for the time. I learned a lot, had a fun conversation about negotiations.

Yeah, I'm happy to negotiate with you whenever you want, but I'll be fair, I promise.

I'm going to come practice. Absolutely. Thanks very much. Here's to the deal. Thank you for taking the time to explore the world of M and A with our podcast. Please subscribe for more content and conversations with industry leaders. If you like our podcast, please support us by leaving a five star review and sharing it. I enjoy hearing feedback and connecting with our listeners. You can reach me by my email. It's Kison K I s o n dealroom.net M&A Science is sponsored by Dealroom, a project management solution for mergers and acquisitions. Additional educational content is available on Deal room's blog@dealroom.net blog. Thank you again for listening to M and A Science. See you next time. Views and opinions expressed on M and A Science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.