Let’s start with some numbers:
- Between 70% and 90% of mergers and acquisitions fail.1
- 75% of business owners profoundly regret selling their business within 12 months of finalizing the transaction.2
- 100% of business transactions involve human beings on both sides.
Now you may ask: “wow, those first two statistics are shocking, but the third is obvious. What gives?” Great question.
Liquidity event planning involves a lot of moving parts. Sellers focus nearly all their attention on price, valuation, tax and other financial terms. Marching orders to sell-side deal teams often sound something like: “I [the seller] want the highest price while paying the lowest tax. You [lawyers and investment bankers] deal with the boilerplate.” Yet for the seller, it is this all-too-common focus on “dollars” that explains why failure and regret is so endemic in the world of M&A.
Below, we outline how the common denominator in all transactions is the people, not the granular deal terms. How more often than not transactions fall apart because the parties fail to align often-disparate value systems and goals, and plan accordingly should those same factors lead to conflict. We also discuss how these human elements require their own due diligence, which in turn allows you to ask the “right” questions upfront and build proper incentive structures and protections into the transaction documents in the event of a later business divorce.
“Can’t we all just get along?”
Short answer: not usually.
Properly planning for a liquidity event requires understanding that people may not get along.3 Business coaches and psychotherapists have written extensively on the reasons for this, some of which include:
- Misalignment of values and ethics
- Misalignment of personal and business goals
- Misalignment of expectations
- Cultural and personality mismatch
- Misunderstanding of deal terms
Objective exploration into these topics is seldom a focus of pre-transaction diligence. Sellers frequently do not think about these issues, or if they do, they assume the deal team has them covered. Due diligence, however, should not be wholly outsourced to those with an incentive to “make a deal” when the consequences of failure can be personally and financially devastating. Sellers should take the laboring oar to understand their counterparties (the good, the bad and, the ugly) and then act accordingly to protect themselves. This process starts by embracing rationality and critical thinking.
Transaction Diligence: The Three W’s (Who, What and Why)
Transaction diligence involves marshalling and analyzing large volumes of information. Think of it as a search for “truth,” as diligence arms sellers with tools (data and information) to protect themselves from their own biases, feelings, beliefs and “gut instincts.”
Take yourself back to school when many of us learned the so-called five “W’s” (the who, what, when, where and why) – an analytical construct used to assess the completeness of a given piece of writing. In M&A, at least three of the “W’s” (who, what and why) are useful to frame the types of questions you should pose to yourself and your counterparties.
For example:
- Who is the buyer and why are they doing the transaction?
Probe the buyer and their principals’ personalities, values, veracity, management style, station in life and personal goals. Understand motivations and whether outside investors are involved. Is the transaction motivated primarily by financial considerations or other considerations such as long-term business growth? Strategic buyers may have different goals and intentions than financial buyers (e.g., private equity). Understand your post-sale role. Sellers often are unprepared to go from being in control to a complementary player post-transaction.
- What are the buyer’s post-sale plans for the business and are those plans reflected in the transaction documents?
This is a common source of conflict as pre-sale verbal promises, inducements and side agreements often do not come to fruition post-sale. You should insist that all material promises be turned into clear and enforceable written agreements.
- What are the red flags?
This requires objectivity and self-reflection. Address the “no” case before consummating a transaction (i.e., what are the reasons not to do the deal). Is the buyer insisting on terms that conflict with your values or behaving in a manner that raises alarm bells?
- What are the respective companies’ cultures, and why are they a “fit?”
Assess personality compatibility and cultural alignment. A mismatch of management styles, company practices and value systems can make or break a transaction.
“When Bad Things Happen to Good People” 4
They do. Even the best due diligence may not preclude future conflict. Expectations may not meet reality, or worse, sometimes people lie. Mitigating these risks requires building what is akin to a “prenuptial agreement” into the transaction documents.
Some key points to consider:
- Draft transparent and clear transaction documents.
Use the three “W’s” as a guide to draft and review contract terms. Ensure material terms, including “buy-sell,” retirement and post-sale control provisions, are comprehensive in all respects. Make sure you, and not just your attorneys, understand them. Address any ambiguities and do not assume gaps will be filled later.
- Post-sale roles.
Will you continue to be involved as a partner, employee, owner, consultant, etc., with the sold business? If so, for how long and on what terms?
- Non-Competes/Restrictive Covenants/Earn-Outs/Forfeiture Clauses.
Will you be subject to some form of noncompetition restriction (non-compete, non-solicitation, no-hire, etc.) post-sale? While many states outright prohibit or strictly limit noncompete provisions even in the sale of business context, you should consider whether alternative structures better align the parties’ incentives and culture while protecting the goodwill of the sold business. For example, instead of non-competes that may prohibit you from competing for several years following a sale, use earn-out and/or forfeiture for competition clauses that afford you the freedom to compete and practice your post-sale trade but create financial disincentives if you choose to do so. This approach acknowledges that people will respond more positively to incentives as opposed to threats. Be wary of those taking the opposite approach as it can give you key insight into the buyers’ culture and how they plan to operate the sold business.
- Choice of Law, Venue and Dispute Resolution Provisions.
Parties see the often-prolix choice of law, venue and dispute resolution provisions as “inside baseball” legal boilerplate. They are not! When disputes happen, these legal issues become paramount as fights over what law applies, where the dispute will be heard and what forum will hear the dispute consume countless billable hours and frustrated calls with litigation counsel. Consider including mandatory, informal mediation as a condition precedent should a dispute arise. A buyer who will agree to informally mediate future disputes may be someone less interested or inclined towards conflict. Consider striking a sensible balance on what law/legal venue should apply (i.e., where is the sold business primarily located, where do the parties live and work, etc.) Use common sense. If counterparties insist on unreasonable provisions that overtly advantage one side of the transaction, walk away.
“[P]robabilities are not about the world; they’re about our ignorance of the world. New information reduces our ignorance and changes the probability.” 5
Reducing transaction risk is not a scientific exercise with clear, predictable outcomes. Rather, the foresight we gain from asking the right questions and using rationality guides us to make better decisions. We can never be “right” all the time, but we can reduce the possibility of being wrong. For sellers, this starts by acknowledging that truth is what matters most. Whether that truth sets you on a path to success or ultimately scuttles a transaction can never be known. In the end, it is the probability that we have some control over.
About the Author:
Todd Hyatt is the Co-Founder and General Counsel of Torren Management.
This content is provided for general informational purposes only, and your access or use of the content does not create an advisory relationship between you or your organization and Torren Management, LLC. By accessing this content, you agree that the information provided does not constitute legal, investment or other professional advice. This content is not a substitute for obtaining legal advice from a qualified attorney licensed in your jurisdiction and you should not act or refrain from acting based on this content. This content may be changed without notice. It is not guaranteed to be complete, correct or up to date, and it may not reflect the most current legal developments.
- Harvard Business Review, March 16, 2020.
- Exit Planning Institute Readiness Survey.
- Indeed, the Carnegie Institute of Technology reports that 90 percent of all people who fail in their life’s vocation fail because they cannot get along with people.
- Rabbi Harold S. Kushner, 1981.
- Steven Pinker, Rationality: What It Is, Why It Seems Scarce, Why It Matters, 2021.