Small Business Acquisition Deal Pitfalls to Avoid

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April 8, 2024
Negotiating Your Acquisition
Small Business Acquisition Deal Pitfalls to Avoid

The longer the process, the higher the likelihood that the deal will not happen. The seller must have a sense of urgency in getting things done, responding to due diligence requests, turning around markups of documents, etc. One seller representative must also be delegated authority to make quick decisions on negotiating issues so that the deal momentum can be maintained. We've compiled a selection of common mistakes made during negotiations for you to avoid.

1. Adjustments

In some deals, buyers seek to protect themselves by including an adjustment. Upon completion of the transaction, the buyer’s accountants finalize the account positions to determine the net assets of the company to evaluate whether the purchase is greater or lower than the PSA. If the price is greater than the value, the buyer will be granted a reconciliation payment. An alternative to the post-completion price adjustment is the “locked-box” approach in which the seller makes a detailed and specific commitment as to the value of the business’s net assets at closing. If the business suffers major losses or the sellers strip out dividends, any buyer without these safeguards will be financially exposed. Frequently, Buyers and Sellers do a simple PSA and don’t address that the value of the assets changed. Buyers should think about this issue and include it in their PSA.

TIP. Evaluate whether payouts to the seller or employees will fall under the “golden parachute” tax provisions of Internal Revenue Code Section 280G. If so, the seller may need to obtain a special shareholder vote to avoid this tax liability.

2. Poor Tax Advice

Sellers often usually prefer a stock sale to eliminate the risk of “double taxation” and to avoid the expense associated with an asset transfer or winding up and transferring the company's assets and liabilities to a special purpose vehicle (SPV). Conversely, buyouts and Search Funds prefer asset purchases which include a “step up” tax benefit that also may mitigate the potential of unknown liabilities.

3. Ineffective Dispute Resolution

All negotiations require compromise. All negotiations should be conducted with courtesy and professionalism. In the run-up to closing, arguments over money and adjustment are common. The PSA can ease these problems by providing independent experts to conduct valuations and provide their expert advice on issues in dispute and arbitrate if necessary.  It is important to understand the perspective of both parties and which party has the leverage. Often, the parties agree on valuation and method to get to valuation before negotiating the actual PSA. In addition, consider any terms that can be negotiated in exchange for a concession on price.

4. Third Party Consents

The selling company may have key customer or supplier contracts, licenses, or leases that require third party consent to allow a change in control to occur. The same holds concerning important government permits. Plan to obtain those consents as early as possible and as a condition of closing. No disclosure schedule which defines the required disclosures relating to outstanding key contracts, intellectual property, related party transactions, employee information, pending litigation, insurance, and much more. A well-prepared disclosure schedule is critical to ensuring that the seller will not breach its representations and warranties in the acquisition agreement. Most deals are delayed by disclosure schedules, which require multiple iterations and if prepared at the last minute are more likely to create unnecessary risks and work.

If there are negotiation issue(s) that cannot be overcome, or if there appears to be resistance consider enlisting a trusted, unbiased third party for help. This is an expensive option however, unbiased negotiators can then disclose their respective terms privately, then identify any overlaps, and zones of possible agreement (ZOPA) as well as the best alternative to a negotiated agreement (BATNA).