“But I Want it Now!”
Post by Mark W. Siler
If the fiscal cliff taught us anything it’s that Americans love to procrastinate. Purchasers of businesses are no different. However, another effect of the fiscal cliff was that, following the 2012 Presidential election, many business transactions which may have normally occurred in 2013 were pushed into 2012 due to the uncertainty with respect to future tax rates and policies. This gave clients and their lawyers about 7 weeks to complete the transactions. Given the compressed time period, some normal steps in the process needed to be accelerated or skipped altogether.
In most transactions, the buyers believed that the business they were targeting would make money. They believed this because they looked at the business for a while and did their financial due diligence. That is, they looked at the financials provided by the seller and ran the numbers. However, many decided to put legal due diligence on the fast track or skip it altogether. This can prove disastrous for a buyer. Important factors which might be uncovered in a buyer’s legal due diligence include whether there are licenses held by the seller which are necessary to operate the business and are not transferrable to the buyer, whether the business has unpaid or future tax liabilities, or product warranty or liability claims that have been made against the business and which may lead to more litigation in the future. These are items that will not necessarily be uncovered in a financial due diligence process but which could have significant impact on the ability of the buyer to operate the business profitably.
There are important parts included in all purchase documents including the representations and warranties. The representations and warranties contained in these documents generally reference schedules either to specifically list items that are requested in the representation or warranty or to specifically carve out certain items from the representation or warranty. How do these relate to the legal due diligence? It is impossible to complete the schedules without having completed your legal due diligence. Incomplete schedules mean increased risks for both the buyer and the seller. When legal due diligence is given very little time the buyer opens him or herself up to missing something which may impact the buyer’s ability to operate the business profitably. On the other hand, the seller opens him or herself up to liability because something which was required to be included on a schedule is not there. Therefore, he or she has made a representation or warranty that is not true as of closing of the transaction and now has an instant indemnification liability.
While the fiscal cliff is behind us, one lesson which can be taken away from working under such a compressed timeline can be used in the future. It is important to have a realistic timeline when acquiring or selling a business. It is important not to skip steps just for the sake of “getting the deal closed.” It is understandable that all sellers of businesses want their money as soon as possible and that often buyers are quite excited at the prospect of operating their new company; however no buyer wants to be faced with an unprofitable business and no seller wants to face a large indemnification liability because they skip steps in the important legal due diligence process. Therefore it is always important to ensure that proper attention is being paid legal due diligence and often times it’s easy to tell whether it has been by looking at the schedules to the purchase agreement.