Five Issues That Arise In All Transactions
As 2017 gets rolling, I am just getting started on a few new buy/sell transactions, giving me the opportunity to reflect on some issues that commonly arise as buyers and sellers negotiate terms of their agreements. These issues probably will not surprise you, but if you are buying or selling a business — especially an auto dealership — the insight I provide here will prepare you for some of the human factors and resulting hurdles you may likely encounter.
Issue No. 1 — Holdback/Escrow
Holdback/escrow refers to whether, and how much, of the purchase price will be held back from the seller at the closing. There is more focus on holdback/escrow issues on a deal-by-deal basis than any other concern. Holding back a portion of the purchase price helps to assure the buyer that the seller has accurately represented the condition and operation of the business.
Each side in a transaction has strong feelings about escrow/holdback, and these feelings trigger two core issues that impact every person in every deal:
The buyer wants a larger amount held back for a longer period of time because they want the assurance that what they thought they purchased is what they purchased. The buyer also can use this amount to compel disclosure and transparency. The theory is that a higher holdback will incentivize the seller to be completely honest and open.
The seller, on the other hand, feels that the number should be low and the time short because they have provided full disclosure during the due diligence process and the buyer has all the information they need. The seller often will take a position of allowing the buyer to look at whatever it wants, but at the closing, the seller feels that the deal is done and they should be able to walk away from the transaction with payment in full.
As you can imagine, given these polarizing views, this issue is often the most contentious and, sadly, the last one resolved. Not only does this issue involve strong emotions of trust and fear, but it gets at the core of the transaction — money. It is the microcosm of the transaction.
Issue No. 2 — Property Condition
Property condition issues can range from inexpensive cosmetics to costly structural matters and roofing repairs. Just as a new homeowner, a buyer of commercial real estate wants the property to be in excellent condition. On the other hand, the seller has become accustomed to the condition of the business and may feel that nothing requires repair. Understandably, no buyer wants to get stuck with the tab for expensive repairs after paying hundreds of thousands or even millions of dollars for a business. On the other hand, the seller often feels that the buyer had ample opportunity to inspect the business prior to closing and should be well aware of the property’s condition.
Issue No. 3 — Diligence Timing and Access
Diligence timing and access refers to the point prior to closing when the buyer has an opportunity to research the business, and the seller is responsible for providing access to the information the buyer needs.
The seller wants the buyer to complete due diligence as quickly as possible before an agreement is executed. This makes sense for both parties; they want to be reasonably confident that the deal will move forward before spending significant amounts of money and time structuring and papering the deal. The tension for the seller is that the buyer’s due diligence often conflicts with the seller’s desire to keep the deal under wraps for as long as possible. Sellers often struggle deciding who will provide the information and who they want to let in on the fact of a potential sale.
The buyer is torn between the desire to push forward on diligence and the reluctance to expend resources when a deal is not yet in place. Buyers certainly want to get preliminary diligence to see if there is a deal to be had, but it is a very different issue to engage in a deep diligence dive when parties haven’t reached definitive agreement.
A common solution is for the buyer to agree to perform diligence prior to the deal, while the seller agrees to an exclusivity period, during which the seller cannot shop the deal and will focus on the buyer’s efforts.
Issue No. 4 — Financing Contingency
Whether you are buying a home or a business, cash is king. Buyers who can pay cash, without having to borrow (finance) often receive preferential treatment. When looking at two comparable offers, a seller will often choose the cash offer, even if it is less than one from prospective buyers who make their offer contingent upon obtaining financing. The reason is obvious — sellers do not want to waste time and resources and have their property tied up only to have the deal unravel if the buyer’s financing falls through. An offer with a financing contingency, understandably, gives sellers the jitters.
However, in today’s market it is almost unheard of for a buyer not to finance some aspect of a transaction given the size of transactions (this is especially true in the auto dealership space). Often, a buyer with more than enough capital and liquid assets will finance the transaction because that makes sound business sense or because they want to protect their personal assets or another business’s assets from being impacted by the new business. When financing a purchase, buyers cannot afford to assume that their loan will be approved. Lenders are increasingly taking a deep look into transactions before they approve loans. Buyers and sellers are often kept in the dark regarding the criteria lenders rely on to approve and deny a loan application. Neither party can move forward with confidence.
Issue No. 5 — Confidentiality/Privacy
Keeping a pending sale from becoming public knowledge is usually in the best interest of both parties, especially from an operational standpoint. Knowledge of a pending sale could distract employees and cause concern among suppliers and partners. However, the desire for confidentiality conflicts with the need to involve other parties in the transaction, such as the need to obtain an auto manufacturer’s approval to sell a dealership and the need to file an application for a license or permit. Any event that involves a third party runs the risk of disclosing the pending sale and triggering rumors and speculation.
In the auto industry, in particular, as soon as the manufacturer is alerted to the transaction, it is likely to become public knowledge to some degree. This is not always the case, but it is frequent enough that culturally in the industry buyers and sellers work with the assumption that the deal will become public upon submission to a manufacturer. Given this reality, there is friction over when to submit an application to the manufacturer. Buyers are more likely to be comfortable with notification early in the process because it will give the buyer more time to engage with the manufacturer and to work the approval process.
Sellers are more likely to want to wait for submittal to the manufacturer until the transaction is more fully complete. Often sellers want to wait until the buyer completes their diligence and all contingencies are met or are likely to be met. After all, why would a business owner want to cause a stir over an event that might not occur?
The solution for this issue, and to varying degrees the other issues I discuss here, is communication. When each party understands the reasons behind the other’s concerns, they can collaborate and compromise more effectively to ensure that each party’s needs are met and their concerns addressed. Without clear communication, empathy, and understanding, trust exits the stage, and fear steps in. The vacuum of misunderstanding is filled with the misinformation and suspicion that undermines even the best deals.
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About The Author: Stephen Dietrich is an attorney and author who has a passionate interest in the human side of business. His distinctive combination of legal and business knowledge, human insight, and dedication to clients makes him uniquely qualified to help corporate leaders and other C-level executives navigate high-value mergers and acquisitions, restructure transactions, and manage day-to-day operations. Through this blog, Stephen shares his extensive experience and unique personal and professional insights in the hope of stirring thought and dialogue that leads to ever deepening insights and understanding. For more information, please visit www.StephenDietrich.com.
Disclaimer: The information in this blog post is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Stephen Dietrich, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.
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