How Private Equity Firms Structure M&A Deals with Jon Dhanawade

21:50So as soon as we start looking at NDAs, companies perk up pretty quickly that there's more sensitivity because it's direct competition. How do you start thinking about that as even just negotiating? We can generally talk about what NDA is, the purpose of it. How do you get that right balance for both parties for me to do my diligence to get this offer in? But at the same time, I understand from their perspective, and that's not our intention is to get some intel to compete better with them. Walk me through that. So your primary objective from the buy side is understanding, number one, the customer relationships that the target has.

22:25And number two, bringing those relationships over. Is that sort of an accurate? It is. And I want to strike a line between, we want to understand it so we know the business of what we're buying. I want to know, one, what's their saturation of customers? Those are a few anchors that we got to look at as big risks. But how diversified is their customers? And then how sticky their customers are. Hey, we're not trying to get a strategy to come coach all your customers. It's just, this is part of us valuing your business is really understanding the strength of your customers. And there is a piece that we want to get a sense of when we have a thesis of upselling your customers to our other product, our flagship product.

22:59We'd want to at least understand the profile. We want to know which ones are corporate buyers versus investment banks that all they do is do transactional sales because that's not the winners for us. The ones that we can sell ongoing subscriptions because they're pragmatic about doing M &A, those are the winners. There's like a line to draw in there. It's sort of interesting because the number one consideration from the target side is exactly what you just mentioned. How can we share this information with you, the potential buyer, and ensure that you don't then turn around and solicit our customers if the deal doesn't happen?

23:30And the right balance to strike is number one, can you limit the number of individuals who are given access to information? From a sell side standpoint, you want to ensure that the buyer is able to conduct a diligence. And sometimes what you do is you have a smaller team of individuals on both the buy and sell side who share the information and talk about it and examine the information. So you can limit the people who have access to the information and are able to examine it on the buy side. That's one. The second is, and this is probably the easy one, non-solicit of business relationships and executives at the target.

24:01The worst outcome for the target would be letting you in into the hen house, sharing all this information with you. Maybe three, four, five, six weeks later, you say, you know what, we're not interested. We don't have conviction about this investment. And then day one, you turn around and start soliciting those customers because you've had the ability to investigate. So how do they protect against that? Having some form of a non-solicit in the NDA that says, hey, we're going to share this information with you. Maybe we share it with a subset of folks on your side, maybe just even your attorneys.

24:28But for a period of time, if the deal falls apart, you can't then turn around and solicit, number one, our employees, and number two, our relationships. The limit who's got access to the information and then a non-solicit. Right. Be the key clause that you want to have in there. That's right. Are there things from a buyer's perspective? I guess buyers, like you get in there and just get all the information you can. From a buyer's standpoint, information is power. The more information you can get from a financial standpoint, the best would be having a one-to-one with a customer. As you can imagine, most sellers are not going to be comfortable with that, to have some sort of a customer call.

25:01Usually those customer calls happen really on the eve of a closing when you're very, very close. But how can you limit that information gap as much as possible? Part of that is financials. Part of that is looking at contracts. Part of that is looking at how much revenue they've brought in, key customers have brought in over time. Is this sort of recurring revenue? For how long has it been recurring revenue? What are the contracts you're currently under? Is it just an oral agreement of some kind? You'd be shocked how many businesses there are out there where it's a handshake. There's no contractual agreement.

25:27There's nothing that binds that customer to keep coming back for services over time. That's a really bad place to be as a buyer. If you acquire a business on the basis of the strength of customer relationships of a target, but the contracts, number one, are not long lasting. Maybe they're on unfavorable terms and you're stuck with those contracts. Those are good points. On this NDA, if we're looking at a deal out of the country, the jurisdiction is always a big question. How do you sort of compromise that? Is there like a standard on that? If you're a US company looking at something in Europe, where do you decide the jurisdiction?

25:58That's where it gets tricky, especially when you're looking at cross-jurisdictional deals. that's when you have to ensure that you're engaging counsel in appropriate jurisdiction. Because number one, enforcement can vary too. We think about the clauses themselves, but do they mean anything? Can you actually enforce it? Can you rely on the strength of the provision? And that's where it gets significantly trickier when you're looking at a business with cross-border operations. So that is tricky. What about IP? I had one of the NDAs where they wanted to strike out using the information to create a competing product.

26:29And it's like, well... The one thing that I frequently see is, what is the use of the confidential information? When we think about confidential information, just for simplicity, secret sauce, what makes the target? And the target's going to say, I'll share all my secret sauce with you. You're only going to use it to investigate whether or not you want to do a deal with me, which I think is pretty fair. What they don't want to do is share all that with you, and then you turn around and use it to compete with them or otherwise do something that harms your business model. That then becomes the purpose of the use of the confidential information.

26:58What's the real recourse on this stuff? Like say you say, yeah, yeah, yeah. You know how people are. There's those people in business that are the shady ones. You sign an NDA, you did this, and all of a sudden you create a competing product. And obviously you used the information we provided to do that. Is there some real recourse? These NDAs stand up? Specific performance would be the recourse. You go to a judge. You'd have to sue them. And you'd have to say, hey, look, we signed this piece of paper. This piece of paper said they wouldn't do this. And then the hard part becomes proving it. While the facts may ostensibly seem obvious, going to court and saying, this person created this product on the basis of information that I gave them, and now they're competing with me, that gets to be the harder part of it.

27:37Now, I will say that reputation means something, especially in this space. So people tend not to for that reason. If you get the reputation of someone who gets the ability to look under the cover and then walk away and compete with them and do that a few times, reputationally, it's going to harm you. Okay, so we get NDA signed. We start going through, I sent an initial diligence list, usually like 10, 12 things I asked for. Only 10 to 12. This is why we should work together. I'm doing really small deals. Just so you know, the fees are definitely a lot smaller when we start doing smaller deals.

28:05But there's always a starting place. I feel like it's a build a good relationship, get in early. So there are small deals that we're looking at. And it's only 10 to 12 items. You don't want to scare the small business owner away. We typically ask financials and then some of the demographics around the customer base, employment, and the typical things. Any outstanding lawsuit, stuff like that. Right. Then we try to understand their tech stack, know what that's going to look like. So I will start building a model and start looking at what that's going to look like. So we get a sense of what valuation is going to be.

28:36And we have some management meetings so we can really get some confidence that we're actually going to work well together. And then I get to that point when I want to start putting an LOI. That's why I want you to teach me some real negotiations. And I also want to understand the risk at the LOI stage too, because it usually sends something that's like non-binding. It's like, I want to see if we can at least generally agree on a premise that we're going to make this deal happen before we start investing a bunch of time and money into this. Okay, so let's say we're on the same deal. We've got 10 million revenue, 2 million EBITDA, and I'm a value-based acquirer here.

29:09So I want to keep it pretty simple because I feel like what happens is there's flexibility. It's not direct. It's not like, hey, I'm coming in to buy all cash. As a smaller company, privately held, I want to preserve as much cash as possible. Right. Either A, I can go out and I can shop private credit. If the seller wants all cash offer, I can shop private credit. That's going to be high interest. I'm going to pay anywhere from 12 % to 16 % interest. So in that case, I'm going to be more conservative when I offer. I'm probably going to offer a 4X EBITDA, let's say$8 million. Now, if the seller is willing to hold some paper and I'm getting a more favorable interest term, 5%, 7%, whatever it is over four or five years, that's very much more favorable.

29:54I'm happier, more confidence. It means I'll pay more. Is there some rollover equity component also more favorable or earn out? And then with those things, knowing that this person's bought in with me, I would likely push that out to 5x EBITDA and say, okay, I'm willing to spend 10 million. Teach me how I should structure things. Do I start off low, then come back with some of these things? Do I sort of offer multiple options on the table and be like, hey, let's choose your venture here? Do I sit down and really think about what my preferred is and push that way? Do I forecast of what their counter move is?

30:29Because everybody always counters no matter what. Nobody accepts the first offer. Push me. Like if somebody first time putting an LOI in, how should I think about really structuring this deal? It's sort of interesting because the worst place you can be is having agreed to something at the LOI stage, notwithstanding the fact that it's non-binding. You start to work on documentation. you start doing more diligence. Yeah, that's the normal way you do it. You dig in a bit deeper after you have an LOI. You then realize the business has issues that you hadn't previously identified, which go to price, and then you cut the price.

30:57And I've seen that happen time and again. That's a really tough place to be. The number one thing I would say is build in some flexibility in the LOI. You can say that here's our valuation subject to certain assumptions, and you should lay out those assumptions. And really good PE firms do a nice job of that. hey, we will pay you X or some multiple of X, or we're valuing your business at X, but it's on the basis of this. And that's subject to additional diligence, including accounting, financial, and legal. And it sounds a little wishy-washy. It avoids the harder conversation down the road, which is a seller feeling that you are walking back a deal.

31:32That's a much harder thing. And at the end of the day, when you get rid of all the paperwork, you're dealing with people. And if someone's lost their trust in you because they feel like you're backing out of a deal that they thought you had made, it makes executing that deal much, much harder. I like that. So here I can start thinking about the terms, which I'm a deal guy. So that's why I probably jump on that right away. I like how you want to frame it with, we're building it around these assumptions that if QOB is good, you're going to have some solid quality of earnings, we're not going to see some surprises there that there's some revenue that wasn't reported the right way.

32:02Even taking your example, where the customers are important and you think you can upsell some of them, it's based on the assumption that based on what you've provided to us so far, this is what the revenue has looked like over the past 12 months or so or a longer period of time. And this is what we expect it to be going into future. And we expect that these three top customers stick around for an amount of time. Can you give an example of that? I've seen that where I've looked at a deal and it was three customers represented 70 % of their revenue. So then I'd 100 % want to have a contingency that, hey, these customers renew a contract with us.

32:33No, absolutely. And in businesses where I've worked on where the concentration of customers is limited to a handful of customers, the deal as contingent on revised contracts being in place with those customers from and after to closing. Stated otherwise, before you get to sign executed paperwork that's binding on the buyer from and after to closing, you have to have revised contracts with those customers in place. And usually long-term ones to ensure that investment is worth it. Yep. Very good. Protect yourself there. Absolutely. In this case, if I had a thesis that was assuming, because I was saying, hey, we're going to upsell 10%, I would want to assume that 25 % of their customers are corporate clients.

33:12And they told me that 25 % is customers. But I would add that in, is that this is subject to the 25 % of your customers are corporate clients. And you know what? It's interesting. If the seller pushes back on it, the national reaction there is, tell me why. Because if they have said to you, hey, don't worry, that's true, it would be a cause for concern if they're pushing back on something that they'd otherwise identified as being true. If there's something in the roadmap, They had a really cool AI thing they were building and we know we need their CTO locked in and committed. I might have that subject to a retention of your CTO.

33:46In fact, I was working on a deal earlier today, large companies acquiring a startup, and it's an AI based startup. But the key to the acquisition are the people and really to people. The entire premise is, hey, from an after to closing, for a period of 90 days, a transitional period, these individuals are going to coach up our folks. We've identified 10 people. They're going to coach them. They're going to train them to use the AI product that we're acquiring. And the closing won't even happen unless those two individuals enter into longstanding employment agreements and some equity agreements.

34:18It's sort of baked into the LOI. Quite literally, a few hours ago, it sent out the LOI for that deal that I just mentioned. Those are common things. I can have my assumptions around what I expect the finance to look like, certain things around the customers, certain things around employment retention. That's right. Any other things that you see is pretty common that you want to put in there? Not all PE firms do this. Two other things that are important is, I know people don't want to incur legal fees at the LOI stage. But at least with the relationships I've built with PE firms, they feel comfortable calling me and knowing that, hey, at least John will give us a look over to ensure that there are no real issues.

34:51Two things that have popped up. One is structurally. If you're telling someone that you're going to do an asset deal or an equity deal, it really behooves you to have a conversation with your attorney to ensure that that's feasible and gives you sort of the end goal that you're trying to achieve. And number two, that you're setting it up from an indemnity standpoint or from a seller obligation standpoint that protects you. Those two things can become real sticking points. If there's a real tax consequence to the seller later on down the road, or tax consequence even worse to you as a buyer that you hadn't contemplated down the road, or you've identified issues that are massive issues, but your LOI says it's, let's say, a walkaway deal with no indemnification that again puts you in a fork in the road where you have to have these really tough conversations where the seller said, that's not actually the deal we agreed on a few months ago.

35:35And that's when emotions start to rise. It's better to have some caveats for those things or dig in with the help of your counselor or accountants at the LOI stage. And you can do it efficiently. And I do it all the time. And I'll give you an example. I was representing a mid-market fund and they have a really well-run construction fire alarm business. They're looking to expand their footprint across the Midwest. And they were interested in a business based in one of the Midwestern states. And they had pushed forward with an LOI pretty fully baked, but they know me by now and they called me right before they signed.

36:05And I looked at it and I said, okay, let me just look up this company. I looked it up and I had an associate run a few searches. Come to find out a few years ago, a predecessor to that company had filed for bankruptcy. And that had not been disclosed to my client. And then the founder started another business and there's some legacy risks associated with it. And I'm oversimplifying at a high level not to disclose facts from the deal. But fast forward about a week later, the client, as a result of the issues we identified because of the call that they made to me, said, you know what? This actually changes our investment thesis massively.

36:38We're not interested in the deal. And I never want to be or have the reputation of someone who doesn't help. Lawyers should help facilitate commercial plans and processes. But the firm actually called me after a fact and said, thanks for helping me or make a big mistake. It was actually a massive issue. That's a tough one. It's like, yeah. And you don't want to find that out 30 days into diligence. I know. That's like way more expensive and painful. And I don't blame them because none of this had popped up on their end. And that's why I'm there. And it just gets harder and harder to walk away from a deal the more in you get.

37:09There's a bit of inertia. You've gone to your investment committee. You have stuck your neck out there. You sold them on an investment thesis. You sold them on a company. You're really excited about it. You've gotten to know the owners. You've made all these visits to the site. There's a buzz created. The idea there is as you start to identify issues, you try to minimize it. It's human nature to minimize it because you've built up this idea that we're going to acquire this company. So sometimes it's a lot easier to say, you know what, this is probably not the right move for us at the early stages.

37:35It's increasingly harder further down you go. I guess there's like a structure component that you may want to think about. Right. Which human tax perspective, asset, stock sale. And then what was the other one? indemnification obligations, which not all private equity firms do it, but some of my favorite clients do where they take one of two approaches. One, they lay out their preferred indemnification structure in the LOI itself. There are pros and cons to that. The pro is you're very clear up front on what the expectation is. So you don't have that battle. And the con is you scare your seller away.

38:07That's right. And it forces you to have that conversation up front with a seller. You have to strike that balance. It should not look like an indemnification provision in a purchase agreement. that's where people go off the beaten path. And it's a bit too much. But the flip side of that is if you tell a seller, particularly a founder-owned business, owner of a founder-owned business, hey, we're going to acquire a business and you get to walk away, you get to go retire. And you start to do some diligence and you identify some real issues. Let's say it's a car wash business. I've had a few of these.

38:33Go to acquire it and folks have been dumping chemicals in the backyard for a while. And there's some real issues with the business. That real issue requires you as a buyer to come out of pocket for some of those losses. That doesn't seem fair. And you want the seller to be on the hook for stuff that they've done historically as it relates to the business before you showed up on the scene. There should be some concept of that in the LOL. Interesting. Otherwise, the seller is going to say, you told me, look, I'm in my mid-60s and I thought I was retiring and going to Florida. Now you're telling me of the$2 million you're going to give me, you're only going to give me $500 ,000?

39:01That doesn't feel like the right deal. What about other things I feel like when it comes to the wire, you start bickering about working capital adjustments and things like that? So far, we've talked about high-level purchase price components, but the real meat and potatoes is the business operating in the way that you've represented to us. And once you start digging into QAV and networking capital and how far back you're looking for purpose of establishing a peg, those are always tough conversations to have with people. But this just naturally has to happen later. I feel like otherwise you're front-loading way too much.

39:31The way I've seen clients cut it is they agree at the LOI stage that there may be a purchase price adjustment escrow and they just leave it at that. Like high level, there'll be a reasonable, mutually agreed upon purchase price adjustment escrow and a mutually agreed upon purchase networking capital target. It makes sense. I do think the balance is not being too in the weeds that you scare away your prospective target, not being so high level that you forget to identify an issue that may become a bigger issue down the road. Can we go back to the negotiating the deal, like the raw meat terms? I gave you my range, 4 to 5x.

40:06We're kind of between 8 and 10 million. It's almost like, look at the purchase price, but then there's a structure this way. And I wanted to use those different tools and we could make it funny just to, I want to know like how you'd use each one. I also want to learn what's the market kind of range that you typically see. There's obviously cash, which I, you know, if I have cash, I have cash or I'd go get the private credit, little private credit market. Just boom. I have that expensive cash to put in. And then there's a bucket for the seller note. Which is cash later. I viewed as cash now and then cash later, your seller note.

40:40It is cash later. So I'm going to be paying you over a period of time with interest, which I like. So it's like, you're going to get that money. You're just going to get it later. And then there's the other bucket, the earn out, which is similar, but different. And maybe we can talk between a little bit of the difference between those two, because it is like payments pay later, but I'm going to hold you on the hook to certain milestones, which I think doesn't end up well. We'll talk more about that because I'm curious your perspective. Then there's role of equity, which it seems like more and more interesting that when I start seeing those as opportunities to bring in folks to go for the ride to.

41:13No, absolutely. And role of equity to me is, it's sort of interesting because it kind of depends on who the seller is. If they're advanced in their career where they don't contemplate doing what they're doing for much longer, then the concept of not getting cash at the time that they close and instead getting an instrument of security for which the payment may not be made for three, four, five or longer years, obviously you're going to get liquidated at the time that the private equity sponsor sells the company in the future, that may not be as attractive to someone who's towards the tail end of their career.

41:44So it would probably be more preferred for somebody that I can keep in the business for another three or four years. Yes, exactly. To come along for the ride. A motivator for you and for them to have that person side by side. Because if the person is going to be out in a year, then it's not going to want them on the cap table because they're not, they're deadweight at that point. The consideration there is if they are going to be out of the cap table and you're giving them substantial roll over equity stated otherwise you don't want to pay them a lot of cash. The conversation then becomes, okay, what sort of control rights do they have associated with that equity?

42:15Do you really want to have a passive owner with substantial consent rights? And that is always a tricky situation to have. And then at that point, you might as well get a PE that can actually be a right PE could be more accretive. Yes. I've seen that happen a ton where folks have said, you know what, the right way to do this is maybe a club deal. We put in 70 % of cash. Another sponsor comes in for 30%. Maybe that's a better way to do it. And then we just give the cash to that seller. Right. Okay. So, you know, if you're in a role of equity, it sounds like you should have high confidence that this is just like a P partner, a real partner that you want to live with.

42:47And if it's not, if it's a person who's leaving in a year, one solution is an earn out that you pay them in a year, you know, at the time of contemplative retirement, but it's contingent on hitting some transitional goals and metrics over the course of that one year. So you've seen that earn out's as short as one year. Right. saying, hey, I want to make sure you're doing a good... What would be examples of milestones to have? You'd set up key transitional metrics. Let's take the data room business. Let's say there's certain tools built in into the data room that you're acquiring that you'd like to ensure that your team knows how to properly utilize effectively within six weeks.

43:20Maybe that's one example. And I'm thinking of a deal for which I signed an LOI earlier today where the idea was, we want these handful of people on our team to know how to utilize this AI technology within six weeks. not just use it, but to use it fluently. And of course, a key legal term is in the reasonable discretion of the buyer. Ability to use this tool and is up to speed in the reasonable discretion of the buyer. So we really build on what are those key things that need to happen. In this case, it's a one-year transition. If we had that more partnership alignment for long-term, hey, we wanted this person for three or four years, then we may stretch that earn out for a longer period.

43:55And it'd be based on totally different other milestones. It would have to be. It could be integrating technology together. It could be revenue type of goals. Finding someone else. Let's say the person is a CTO, helping attract and train their replacement. Maybe that could be train a replacement to your reasonable satisfaction. I would generally prefer to do a seller note just to make it so straightforward. So how do you use seller notes? Do you look for, instead of balloon payments, do you look for payments at set intervals over time? Is that how you... I'm used to, yeah, more of a conventional amortized.

44:31I'd want it a little longer, like a five-year. Yes. But you see everything I've seen on private credit, so interest only with a big balloon payment. That's right. Which in this market, there's so much money floating around. And so, yeah, somebody at some point will either redo that debt again and keep an interest payment going forward, or you swap it out for equity. I ask because that's what I'm more commonly used to seeing is some sort of an accrual of interest pick, which is picked over time, and then a balloon payment at the end of it. That being said, there are exceptions. And I have had deals where a seller note is cash pay.

45:02So you establish an interval, set intervals, and you pay. Now, it's not nearly as common as the first scenario I described, but I have seen that. There are real issues there. Does the business have cash to make those payments in the future? That being the key concern. So they would have big chunks of cash that get almost like the buy-down. Okay, you're one. We're going to pay this big principal payment. Yes. Obviously, you'd have to ensure you get a basket in your senior. And it's tough to even amortize a note now. Back in the day when valuations used to make sense, you could do that. You could be like, hey, hold this five-year note, finance 80 % of this, and we're good.

45:34You're going to have a great, healthy note. You got confidence I'm going to pay it. Right. Win-win. Nowadays, it's like that's the interest only at the high interest rate makes more sense to do versus having something that's amortized with directly the seller. If I was representing the seller in a circumstance, that's where you do a little bit of reverse diligence. Are you confident in the fact that you're going to get this payout? in the future on the time period you expect it to get paid out? Or is it going to be a situation where that note needs to be restructured or may need to be restructured at some point?

46:02I'd give them a high level of confidence. That's right. And I've had that happen over the past couple of years, unfortunately, too, where portfolio companies are undergoing restructuring, out-of-court restructuring specifically. And in those situations, you have to examine the indebtedness of those portfolio companies, some of which are notes, some of which are true traditional third-party lenders. Those are painful conversations to have. What do you mean? Do you look at the financials? Hey, this is like a two to one debt ratio coverage. It seems like it's pretty healthy. Part of it is also looking at the reputation of the sponsor.

46:29Because ultimately, when you think about it, who is the sponsor who is acquiring that business? And what have their portfolio companies looked like? And have they been in a situation like this before? And if they were, how do they address it? It takes a little bit more diligence on the sell side, but it's an important investigation to undertake. You know, so I kind of figure out the path we're going based on the scenario of what makes sense in this structure. Obviously, I want to deleverage the risk and get the right balance that works for both of us. In terms of the negotiation, how do I make sure I don't do too much or too little, right?

47:02I don't want to come in too low, offend a person, and they write me off. I don't want to come in and say, hey, here's my highest and best offer. The 5X owner holds 40 % as a note. They come back and we want 6X. I'm like, no, this is like the best offer I got. It's sort of a take it or leave it thing. How do I get that right balance so that negotiation goes smooth? Do I take a person out, get them a couple of drinks and then pull the offer out? What's like the best way to make that as smooth as possible? It's funny because just by happenstance, my career is over the years, we went through various industries over the past couple of years.

47:37A lot of I've been in the HVAC space. And I only bring that up because they're businesses that are truly people driven for people. And the one thing I've seen sponsors, especially the ones I work with, do really well is focus on the individuals. So before they get to a point in time where they're talking about purchase price and what a consideration looks like, they've really gotten to know the sellers really well. And that is getting in the same room with them. That's going to their place of business. It's getting to know their interests. And by the time the purchase price conversation comes around, you're talking to someone who you know really well.

48:08They're a friend. They're your friend. It's a lot harder if you get an offer out of the blue from Joe Schmo, and he says, Hey, this is the best offer I have. It's probably easier to write that person off if the offer doesn't fit what you're looking for. But if someone has spent two, three months with you, and they've come to your place of employment six or seven times, and taken out to dinner a few times, and you've talked about interest, maybe you've gone to a few games, and they've shown real interest in the business, and they've shown you that they want to grow the business, and they show you why they care about it, and then they give you an offer, that's just a different conversation.

48:38The reality is in any M &A transaction, sellers are going to want more and the buyers are going to want to pay less. And I don't think you ever get away from that balance. But the way you balance it out, the best way is getting to know people and spending the requisite amount of time with them. It's the best advice that's tried and true. And it should stay on top of mind as I work on a company's first deal. It's particularly true, I think, for their first deal. Because I tell this to young associates all the time, because when you're working on a deal and you're a junior associate, disclosure schedules and diligence are the bane of your existence.

49:07And sometimes when you're working with founders, you're explaining to people who have a full-time job, hey, you have to disclose all this stuff on all these schedules as an exception to the reps or as responsive to the reps. And sometimes associates get annoyed with that. They're like, oh, this is taking longer than it should. I'm up late at night. This person's sending me one-off comments. And I say, for a moment, just take a step back and think. This is a seminal moment in this person's life. They've worked on this business for sometimes a decade, sometimes longer than a decade. It's been in a family.

49:33And this is a big payout for them. This may be the most important point in their life. Think about it through those lens and then approach the task on hand. And I think it'll give you a different perspective. That's almost the same view of being the counterparty too, right? And building that relationship, but you're so right. It is. I'm looking at two deals and I'm struggling with that because one deal I'm going down that path and I'm taking the time to build a relationship proprietary deal. The other one has an advisor, not an auction, but it's still represented it. And they're still soliciting offers and doing like a semi sort of targeted process, which I don't like because they are, They're gatekeeping.

50:08They're literally throwing the fence up. They're taking the founder off the CCC threads. And it's like, go talk to us. And then we'll set up another call with them. And it's why this is already a turnoff. This is like hard to... I got to go through your parents to go on a date type of thing. It's not fun. It makes it hard. It's funny because that brings me to another point, which is choose your advisors carefully. Because when you think about it, your advisory function, whether it's a banker or a lawyer or accountant, is to help facilitate the deal. The worst mistake that I've seen people at my position do is to be abrasive or otherwise be an obstacle to deal getting done.

50:42That's not your job. Your job is to advise your client. And the overall objective is to get a deal done. And you advise your client of the risk and liabilities along the way, of course. But don't get in the way of a deal getting done. That's a really good point. Sometimes communicate with them and I think they mean well. I just got to get them to understand. I need to have six, seven visits. It takes time, but that's how mid-market and lower mid-market PE firms I've been doing it successfully for a very long time. And that's one of the deals I need to focus on is the ones I can play a little longer on.

51:08I get a little bit of that. You've probably seen it. I'm just a little impatient and want to get deals done. But it's almost like you want to grade your relationship to know that you have high confidence in the relationship. Yes. To sort of have that confidence in the foundation of doing the deal. And then the rest of the stuff will actually flow a lot easier. And that's the key difference between what you were describing, a proprietary deal, which is really requires some relationship building over time. You've sourced it through a relationship-based channel versus an auction process that's come in here, who's the highest bidder, going to continually get pushed for best terms, and then one person gets picked.

51:41What would you do in the situation where you have the advisor, they're pushing to get some early terms on the table. I want to build a relationship. They want to know, is this worth investing our time? They want to see the early terms. What would you do in that situation? I'd almost want to... The way I might approach it is maybe almost back into how you arrive at those terms. Okay. So they're pushing you for terms. I assume they're economic terms, is what you're referring to. What are you going to pay us? You sort of level with them. You say, look, I would like to provide you with those terms now.

52:08But to do that, I need a little bit more information. Some is specific to a target, financial and otherwise, which we can diligent. Some of that is getting to know the seller, right? And in the absence of that, I can't get you the information you need. I understand why you need it. But to get there, and we have the same objective to get there, I need to be able to do X, Y. That's the way I would frame it. And frankly, if at that point in time, they continue to push back, then that to me is a red flag as a buyer. Because that advisor is serving exactly what I said as an obstacle to getting the deal done.

52:34Yeah. I might be able to go back and say, hey, look, I'm really interested in the deal. But there is some, even a VP of engineering brought up, there's a big cultural differences between our engineering team. It's like, I can't really move forward until we really have a level of confidence in how that's going to play out with his relationship with the management team and the leadership team. Which is fair. And frankly, I would think that a seller where certain employees are going to get assimilated into the go forward business would share that same concern. I would hope that they would want that same objective to play out.

53:03Cool. Let's talk about diligence. One of the pillars of buyer-led M &A is synchronizing diligence and integration. This is the crux of making deals successful is when you have integration well thought out, really making sure you have a clear, executable plan from day one. What are the biggest legal red flags that you look for in diligence just to really ensure issues don't become roadblocks after the deal closes? The first is, how is a target currently conducting its operations? How are they currently doing the things that they're doing? And two, where it takes a little bit of analysis, how should they be doing it?

53:38That's an examination from a purely diligent standpoint. Hey, they're a payment processor. They're subject to these regulations. They should be doing X, but they are doing Y. And then, of course, you give your client the remedial actions that you think need to be taken post-closing. That's where an advisor really adds value. The second piece, just from a deal execution standpoint, is looking for items whose resolution is outside of your client's control. Are there liabilities associated with the business or that have been incurred already and you don't know what the quantum is that your client's going to be on the hook for?

54:10How do you address those? Are there consents? You mentioned the data room example. is there a contract that Target Data Room has with their number one customer that says, in the event of a change of control, that customer gets determined at a contract immediately? That's outside of your control. How do you manage for that risk? Let's go back to a Data Room example. Let's say there's a key customer contract that's a 10-year contract. So you're going to be on the hook, just for example purposes, for nine years post-closing. What are the terms of the contract? What are you going to be bound by from an after to closing?

54:41So what are the shoes of the seller that you're stepping into? Obligations. Yes. So how your business operates, what are all the obligations, what are the obligations your customers have to you? There's a change of control. They can just walk away and say goodbye. Right. You sort of figure out how to mitigate that risk. You got some crazy long-term vendor agreement you might not know. You might be some licensing, some code somewhere that ping an astronomical amount. And some of those you walk away from. Real estate is a classic example that everyone gives. So you have a business that has a bunch of leases everywhere, and you have a landlord with a 2 ,500 square foot spot somewhere in the middle of nowhere who wants to play hardball.

55:17They want an uptick in rent because the consent's triggered under the lease, but it's not really material to the business. In that situation, maybe as a buyer, you say, we'll close over it. Landlord wants to determine it to lease, so what? It doesn't matter. But if that's the headquarter location for the target you're acquiring, that's a totally different consideration, right? If you're counting on using that space for whatever the target may do, then you're going to pay attention to it. I remember having one of those conversations before. I had one. It was remarkable. Sometimes when you read these leases, it says a change of control, landlord consent required.

55:47One of the things the GoFord Aquire needs to provide is proof of financial solvency. They have your resources. Representing a large PE fund, we're acquiring this business out west. And the landlord was like, I don't know what this PE firm is. And we were like, here's a website and see how much assets in their management they have. A very well-established fund. They were like, yeah, that's not good enough for us. We need financials. Wow. It ended up being more so of a headache than it should have. And believe it or not, the CFO of the fund had to put together a letter of some kind to get this landlord comfortable.

56:17For strategic reasons, this location was important. But it was just one of those examples where it was so obvious we were good for the money. But seller kept pushing. And in this particular case, our client said, you know what? It's important enough to us. Let's just write something up and get it to them. How does this work? We're going through this deal. We're going through diligence. You're obviously working on the purchase agreement. Right. Like what you just described, I can't be in the weeds of all this stuff. I count on my COO and our functional leads. You have a CFO there, we have an HR lead, and then we have some of the department leads.

56:47How do I orchestrate all this to pick up on those things that you described so we don't miss something and some of their concerns get addressed as well? It's an important question because frequently what happens is once a deal's in motion, the key is, are the right stakeholders getting to look at and apply on some of these things that you're agreeing to in a deal context? The one thing I always ask up front is, who are the right folks on the buy side who I need to be interfacing with? So I always proactively ask the question. Ensure that they have an opportunity to look at the right, not just agreements, but even schedules.

57:18We've talked about disclosure schedules and otherwise. Ensure that people are getting eyes on. Have an opportunity to look at it before the train has left the station. So I always focus on ensuring that the right people get eyes on. And the second is, so I put the onus on myself. Number one, ask the question and socialize the information. And number two, being available. Your job is not to be in the weeds, but my job is. My team has to be really in the weeds and ensuring they're corresponding with all the right stakeholders. Make sure they're all talking to you. I always ask clients, who's advising you?

57:45Setting aside sort of internal stakeholders, who's your benefits advisor? Who's your insurance advisor, if you have one? Who's your accounting advisor? I just get all their data point because if I have a question on insurance and how insurance policies work or benefits, it's just a lot easier for me to pick up the phone and call Joe, who's representing you on benefits, and say, hey, man, I'm seeing this from a diligent standpoint. This is how the agreement's set up. Does that work? Does that make sense? It's a lot easier for me to have that conversation. Guess what? By the time I get it to you, it's synchronized in a way that reflects what your advisors as a whole think is the right answer.

58:17Can I just put you in a Slack channel? It's funny because we have Teams chat. When I started practicing, no one texted or didn't. It was always very formal. And now, at least internally, I made it super informal. Text me, send me a Slack, send me a Teams chat, call me on my cell. People are scared to call people. I believe in calling. You have a question, pick up the phone and call someone. It's the easiest way to do it. Don't send me an email. Don't send me a treat. It's just call me. Yeah, let's keep our paper trail light. We're not working on those deals yet, bud. Right. Do the whole deal over phone calls.

58:49What are the biggest mistakes people make when it comes to M &A during diligence or even early? Teach me the things not to screw up. It again, sounds super simple, but a lack of communication sounds so simple and so trite, but you'd be shocked how many deals happen where the right people are not talking internally on the buy side. And that's when things tend to fall through the cracks. If you don't, as an advisor, have the right lens through which you're approaching diligence, you're probably missing what's important from your client's perspective. And here's an example. A target has 300 customers, and you want to move really quickly on diligence.

59:21One question I always ask is, hey, look, you want to move quickly on diligence. Let's say it's an auction process. You want to make a bid in a week. We have access to a data room. You really want to have a high level of certainty. And of course, ours are finite. What if we look at a list of the top 20 customers over the past four years? We identify the customers who are really important to you. What if we really dig down really hard on those customers? Does that work? Simple question. A lot of people just forget it. There's no benefit to you if I look at all 300 contracts. There's a massive benefit to you if I drill down to the core of the earth on 20 that are important to you.

59:52That's just one example. So communication. The other thing on the legal side is getting caught up in inertia. These things are hard. When it's two or three in the morning, you're working in an agreement, maybe you're on calls all day till five, that's when you started drafting stuff. And your human nature is, I just need to get this off my plate. I need to fire off this email. I need to fire off this document that I can go to bed. Fight that instinct. Go a little bit slower. I prefer when people are slower, but they get it right, as opposed to moving really fast and dropping stuff. I would rather tell the client, I'm really sorry.

1:00:20I know we talked about, you're going to have this at 5 p.m. I'm going to need an hour or two longer to make sure it's right. And I'll get it to you when it's right. Then to get it to you at 5 p.m. and then have a bunch of comments where we just miss stuff, obvious misses. And my clients know me enough to know that when I ask for a little bit more time, it's because at the time that I get you something, it's the end product you're looking for. So are you trying to say yourself some headaches over here? When I'm calling you at midnight, where the hell is this contract? It's funny. And I've developed really good relationships with clients where that's sort of the relationship we have.

1:00:51They'll call me and they'll say, look, this is a hard ask and we know it's a hard ask, but take the time you need to make sure it's right. And I'm usually pretty upfront about it. If I had a deal over the summer, last summer, July 4th weekend and nowhere accelerated to where we really wanted to close this thing for business reasons, but we were really far apart, including on fairly early stage diligence, because it kind of was sputtering for a period of time. A client called me and said, hey, can we close it by X date? You never want to say no. The idea is to get to yes. But it was July 4th weekend and folks were out.

1:01:20So I had to sit down with them and say, why don't you give me an hour to kind of look at where we are. Canvas to landscape. And I'll come back to you with a timeline that I actually think we can hit. More importantly, we can hit it and do the job well. I came back. It was slightly longer than what they had initially asked for. But the sellers agreed to it because guess what? They themselves weren't going to be able to sort of match the speed that the buyer wanted. And it was done right and everyone was happy. Sometimes it's that. And sometimes, you know what? The flip of it's true too. There's a real reason to get it done and we all need to suck it up and do it.

1:01:46And that happens too. Get the right people involved in diligence and take your time. Don't miss important details. What's the craziest thing you see in M &A? For me, what's always fun is when you're acquiring a founder-owned business and it's been owned by someone or it's been in your family for a long period of time, they have something off their side. That's also running through the payroll of the business. And I've seen everything from one was a fried chicken restaurant associated with a business that did absolutely nothing with it. Another guy had a large Ferrari collection. Another guy had a Ferrari collection.

1:02:18Ferrari collection. So you see a whole lot of things happening, particularly when you have unaudited businesses. We found our own unaudited businesses. One guy had a large art collection in his office and we were like, hey, are you going to remove it? Does it come with the business? These seem like strange questions, but questions that pop up all the time when you're doing these deals with, again, someone who's run this business from the ground up for a very long time. The craziest thing is always when you don't think, similar to the story I described, you don't think a deal is going to happen or it's not happening at the pace that you thought it was going to happen.

1:02:46And almost overnight, it's get it done. This is a fun and great conversation. I appreciate taking the time to help me become a better M &A scientist. Thank you. I appreciate the opportunity. Fellow M &A scientists, love to hear from you, especially if you've made this far. I really appreciate you listening in. I hope you learned some things. I love to get feedback on this. I know we've been diving deep on a lot of more legal topics lately. If you have some other ideas of topics I haven't covered yet, reach out to me on LinkedIn and feedback in general. However, I can get better at this. I'll take the criticism.

1:03:14Until next time, here's to the deal.

1:03:44have. We're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email, Kisan, K-I-S-O-N, at mascience.com. Or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter. Again, that's mascience.com. Here's to the deal.

1:04:27Views and opinions expressed on M &A Science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely education.