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3 Things Buyers Worry About When Buying Your Business

by | Nov 9, 2022 | Corporate/M&A Practice

M&A activity has declined due to recession fears, the Ukraine War, supply problems and higher interest rates.  This has made deals harder to close and buyers more nervous.

All these factors have created pressure on valuations as debt has gotten more expensive and future economic prospects become uncertain.

The following are some of the concerns that buyers will have when buying your business.

Overpayment

One of the biggest worries is overpaying for the business and its assets.  This is especially true in a declining M&A market.

Solution no. 1

Purchase price adjustment (PPA).  90% of significant M&A deals have some type of PPA.

There are various metrics the parties can use:

  • working capital
  • cash
  • debt, or
  • a combination of two or more of the preceding

A significant majority of deals with PPA have separate escrows for the adjustment.

Solution no. 2

Earnout.   An earnout is an agreement whereby the buyer agrees to pay a portion of the purchase price from the operations of the newly acquired business.

The most common metrics are:

  • revenue and
  • earnings/EBITDA

Most earnouts will be about 22 months in length and represent approximately 33% of the total closing payment amount.

Undiscovered problems

Another major concern is finding out something unexpected about the business or its assets.  This discovery can impact the economic value of the deal for the buyer.

Solution no. 1

Representations and warranties.  The purchase agreement will contain various representations and warranties from the seller to the buyer that will last until or past closing.

From a buyer’s perspective longer is better so buyers will push to have the representations and warranties survive for as long as possible and at least 12 months from closing.

The most common undiscovered problem stems from tax liability that was not disclosed or was mis-represented.  Even the best representations and warranties in the deal document may not adequately protect from this situation.

Solution no. 2

Representation and warranty insurance (RWI). Most commonly created in favor of the buyer, buy-side RWI protects the buyer if something that the seller said in the deal documents turns out to be false.  Seller or buyer can pay for a RWI policy which provides flexibility in the deal structure.

The existence of RWI makes it more likely that a buyer will agree to a shorter survival period for representations and warranties which translates to a faster release of funds.

Solution no. 3

Holdback.  Buyers can require that a portion of the purchase price be held back in an escrow for undiscovered problems or to cover specific risks such as tax liabilities.

Sellers can reduce the need for this by providing accurate and timely information to buyers in the diligence process.  Sellers can also try and limit the duration that these funds are kept in escrow once the risk has passed, or the risk has been quantified with precision.

Inaccurate financial statements

Financial statements are intended to provide a fair description of the business’ financial condition and results of operations.

Purchase agreements typically contain statements that the financial statements were prepared in accordance with GAAP and fairly represent the financial position of the business and its results of operations and cash flows for certain periods.

Inaccuracies in the financial statements tie into overpayment and undiscovered problems concerns.

Solution no. 1

Quality of earnings report (QofE).  Seller or buyer can obtain a QofE  at any point in the process.   A QofE report helps a buyer understand the historic earnings and forward-looking performance of the business through rigorous financial analysis.

Solution no. 2

Audit.  Seller can have an outside CPA firm perform an audit of the business’ financial statements.  The auditor will focus on the company’s compliance with GAAP accounting standards in the preparation of its financial statements.

How YK Law Can Help

Our team of M&A lawyers works with both sellers and buyers. We monitor deals and analyze market standard deal terms. We help sellers obtain the best price.  We help buyers avoid costly mistakes.  Call us to discuss your goals before you buy/sell.