22 Mistakes Made By Sellers In

Mergers And Acquisitions

Richard Harroch
Contributor
AllBusiness
Contributor Group
Small Business Strategy
This article is more than 6 years old.

Selling a company is often difficult and time consuming. The merger and
acquisition (M&A) process is one that requires careful planning, competent
professionals assisting the target company, and an understanding of the
deal dynamics involved in the negotiations. CEOs and companies that have
not been engaged in many M&A transactions frequently make mistakes that
can result in a less favorable price or terms that would have otherwise been
obtainable —or even kill the deal altogether.

The following is a list of common mistakes made by private companies

attempting to sell themselves:

1. Not being prepared for the extensive effort and time the deal
will take. Successful exits through M&A are not easy. They are time
consuming, involve significant due diligence by the buyer, and require both
a great deal of advance preparation as well as a substantial resource
commitment by the seller. Acquisitions can often take 6 to 12 months
or more to complete.

2. Failing to create a competitive sales process. The best deals for

sellers usually occur when there are multiple potential bidders and leverage
of the competitive situation can be used to obtain a higher price, better deal
terms, or both. Negotiating with only one bidder (particularly where the
bidder knows it’s the only potential buyer) frequently puts the selling
company at a significant disadvantage. Sellers must try to set up an auction
or competitive bidding process to avoid being boxed in by a demand for
exclusivity by a bidder. By having multiple bidders, each bidder can be
played off against the other bidders to arrive at a favorable deal. Even the
perception that there are multiple interested parties can help in the
negotiations.

3. Not having an appropriate NDA. A well-drafted nondisclosure

agreement (NDA) is essential to protect the company’s secrets and
proprietary information, particularly when the bidders are strategic
competitors. While it is not necessary when first contacting a buyer with
basic information about the selling company, it will be a mistake to engage
in extensive disclosure during an M&A process without an NDA in place,
one that includes special M&A-related protections for the seller. The NDA
will require the potential buyer to not disclose or use confidential
information of the seller and restrict the buyer’s ability to contact
employees, customers, and suppliers. The NDA also should prohibit the
buyer from soliciting or hiring any employees of the seller if a deal is not
consummated, for a designated period of time.

4. Not having a complete online data room. An online data room

contains all of the key information and documents that a bidder will want
to review. This will include key contracts, patents, financial statements,
employee information, and much more. An online data room is extremely
time consuming to put together, but is essential to successful completion of
a deal. A properly populated data room established early in the M&A
process will not only allow buyers to complete their due diligence more
quickly, but also will enable the seller and its advisors to expeditiously
prepare the disclosure schedule, a critical document in the M&A process.
But almost every seller underestimates how important this is, and how time
consuming it is to get complete and correct.

5. Hiring the wrong legal counsel. You shouldn’t have a general

practitioner or general corporate lawyer guide the seller through the M&A
process or negotiate and draft the acquisition documents. You must have a
lawyer who primarily or exclusively handles mergers and acquisitions.
There are many difficult and complicated issues in structuring M&A deals,
putting together acquisition agreements, and executing the transaction.
You want a lawyer who understands the issues thoroughly, understands
customary market terms, understands the M&A legal landscape, is
responsive with a sense of urgency, and who has done numerous
acquisitions.

6. Not hiring a great financial advisor or investment banker. In

many situations, a financial advisor or an investment banker experienced in
M&A can bring value to the table by doing the following:

 Assisting the seller and its legal counsel in developing an

optimal sale process

 Helping to prepare an executive summary and confidential

information memorandum for potential buyers

 Surfacing up and contacting prospective buyers

 Coordinating meetings with potential buyers

 Coordinating signing of NDAs

 Assisting the seller in properly populating the online data room

 Coordinating the seller's responses to buyer due diligence

requests
  Prepping the management team for presentations to the
potential buyers

 Assisting in the negotiations on deal terms and price

 Advising on market comparable valuations

One tip prior to hiring a financial advisor or an investment banker: have

them give you a list of likely buyers, with annotations listing their
relationships with senior executives of those buyers. You want an advisor
that has strong relationships with the likely buyers and can get their
attention.

7. Not negotiating the terms of the financial advisor or

investment banker engagement letter. The first draft of an
engagement letter is generally one-sided in favor of the financial advisor or
investment banker. Companies that just sign or minimally negotiate such
letters are making a huge mistake. These letters are negotiable, and savvy
legal counsel/deal professionals typically negotiate on the following issues,
among others:

 The compensation payable to the advisor is typically a success

fee, based as a percentage of the ultimate sales price. What is
often negotiated is the percentage (for example, the bankers
will want 2% or more, the company will want a fee closer to 1%
but possibly increasing if certain sales price thresholds are
met). The calculation of the fee owed should also exclude
various items, such as any portion of the purchase price
attributable to the cash that the company has on its balance
sheet at the closing, or contingent purchase price payments
that may never be made.
 Whether there is a minimum fee payable on a sale regardless of
the purchase price (companies want to avoid this, but bankers
want to make sure they are getting adequately compensated for
their efforts).

 How long and under what situations a “tail” applies (when a fee
will be due after the engagement letter is terminated but the
company subsequently is sold). Companies try to limit this tail
to 6 to 9 months and only for potential buyers that signed an
NDA with the company during the terms of the engagement
letter.

 The amount of any upfront retainer payable to the banker (it is

common that the retainer is waived and the advisor or banker
is paid nothing unless a transaction is successfully completed).

 The amount of any expenses reimbursable to the investment

banker (usually a cap is negotiated with a requirement that any
amounts expended must be “reasonable”).

 The circumstances where the engagement letter can be

terminated without any liability and without a tail applying (for
example, if the key banker departs from the banking firm or the
banker breaches the engagement letter).

 Whether the banker will deliver a fairness opinion and the fee
for such opinion.

 The scope of indemnification protection to the banker.

 An outside termination date when the engagement letter will

automatically expire.
  A restriction/representation and warranty regarding any
conflicts of interest by the banker.

8. Having an inadequate understanding of competitors and

market comparables. A well-informed seller will have a deep
understanding of the competitive landscape, as the buyer will be asking
many questions about how the seller is differentiated in the marketplace.
To avoid having unrealistic selling price expectations, the seller needs to
understand how other comparable companies are being valued in the
marketplace. If your competitors have sold for multiples of 5 times
revenues or 10 times EBITDA, you will need a compelling rationale why you
should be valued much higher (for example, you have greater growth, better
technology, etc.)

9. Having incomplete books, records, and contracts. Due diligence

investigations by buyers frequently find problems in the seller’s historical
documentation process, including some or all of the following problems:

 Contracts not signed by both parties

 Contracts that have been amended but without the amendment

terms signed

 Missing or unsigned Board minutes or resolutions

 Missing or unsigned stockholder minutes or resolutions

 Board or stockholder minutes/resolutions missing referenced

exhibits

 Incomplete/unsigned employee-related documents, such as

stock option agreements or invention assignment agreements
Deficiencies of this kind may be so important to a buyer that the buyer will
require certain matters to be remedied as a condition to closing. That can
sometimes be problematic, such as instances where a buyer insists that ex-
employees be located and required to sign invention assignment
agreements.

See: 20 Key Due Diligence Activities in an M&A Transaction

10. Not having a complete disclosure schedule far in advance. A

disclosure schedule is the document attached to the acquisition agreement
setting forth a great deal of required disclosures relating to outstanding key
contracts, intellectual property, related party transactions, employee
information, pending litigation, insurance, and much more. A well-
prepared disclosure schedule is critical to ensuring that the seller will not
breach its representations and warranties in the acquisition agreement.

Accordingly, this is an extremely important document to have ready

quickly, and it is very time consuming to get correct. But virtually every
company gets this wrong, requiring multiple drafts that potentially delay a
deal. And disclosure schedules prepared at the last minute are more likely
to be poorly prepared, creating unnecessary risks for the seller and its
stockholders.

11. Not negotiating the key terms of the deal in a letter of

intent. This is one of the biggest mistakes made by sellers. A selling
company’s bargaining power is greatest prior to signing a letter of intent.
As Richard Vernon Smith, an M&A partner at Orrick, Herrington &
Sutcliffe in San Francisco, has said: “The letter of intent in an M&A deal is
extremely important for ensuring the likelihood of a favorable deal for a
seller. Once the letter of intent is signed, the leverage typically swings to the
buyer.” This is because the buyer will typically require a “no shop” clause or
exclusivity provision prohibiting the seller from talking to any other bidders
for a period of time. The key terms to negotiate in the letter of intent
include the following:

 The price, and whether it will be paid all cash up front, all stock
(including the type of stock), or part promissory notes.

 Any adjustments to the price and how these adjustments will be

calculated (such as for working capital adjustments at the
closing or for a “cash free/debt free” deal).

 The scope and length of any exclusivity/ no shop provision

(which is always in the best interests of the seller to keep this as
short as possible, such as 14 to 21 days).

 The non-binding nature of the terms (excluding with respect to

confidentiality and exclusivity).

 The amount of any escrow and a provision stating that the

escrow will be the exclusive remedy for breaches of the
agreement (and any exceptions from this exclusive remedy,
such as for breaches of “fundamental representations”).

 The length of any escrow.

 Other key terms to be included in the acquisition agreement

(discussed in the next section below).

12. Failing to negotiate and agree upon a favorable acquisition

agreement. One key to a successful sale of a company is having a well-
drafted acquisition agreement protecting the seller as much as possible. To
the extent feasible and depending on the leverage the seller has, you want
your counsel to prepare the first draft of the acquisition agreement. Here
are some of the key provisions included in the acquisition agreement:
 Amount of the escrow holdback for indemnification claims by
the buyer and the period of the escrow/holdback (the typical
ideal scenario for a seller is 5-10% of the purchase price for 9 to
12 months). In some deals it may be possible to negotiate for no
post-closing indemnification by the buyer and no
escrow/holdback.

 The exclusive nature of the escrow/holdback for breaches of the

acquisition agreement (except perhaps for breaches of certain
fundamental representations, such as capitalization and
organization of the company).

 The conditions to closing (a seller will ideally want to limit

these to ensure that it can actually close the transaction
quickly).

 The adjustments to the price (a seller ideally wants to avoid

downward adjustment mechanisms based on working capital
adjustments, employee issues, etc.).

 The triggers for earnouts or contingent purchase price

payments.

 Where stock is to be issued to the selling stockholders, the

extent of rights and restrictions on that stock (such as
registration rights, co-sale rights, rights of first refusal, Board
of Director representation, etc.).

 The nature of the representations and warranties (a seller

wants these qualified to the greatest extent possible with
materiality and knowledge qualifiers). Intellectual property,
financial and liability representations and warranties merit
particular focus.
  The nature of the covenants applicable between signing and
closing (a seller wants these to be limited and reasonable, with
the ability of the company to get consents if changes are
needed, with the consent not to be unreasonably withheld,
delayed, or conditioned).

 The scope of and exclusions to the indemnity (baskets, caps,

carve outs from the indemnity all being important issues).

 The treatment of employee options

 The terms of any employee hiring by the acquirer

 Provisions for termination of the acquisition agreement

 The treatment of any litigation against the seller

 The cost for obtaining any consents and governmental

approvals

 The allocation of risk, especially concerning unknown liabilities

As David Lipkin, an M&A partner at the law firm of Morrison & Foerster in
San Francisco, has said, “A well-drafted M&A agreement will reduce the
risks of not closing the deal, mitigate the potential post-closing risks, and
ensure that the expectations of the target company and its stockholders are
met. One of the worst mistakes a seller can make is to assume that a ‘middle
of the road’ approach to each issue will offer it appropriate protection.”

13. Not appreciating that time is the enemy of all deals. The longer
an M&A process drags on, the higher the likelihood that the deal will not
happen or the terms will get worse. The seller and the seller’s lawyer must
have a sense of urgency in getting things done, responding to due diligence
requests, turning around markups of documents, and the like. It is also
essential that one seller representative is delegated authority to make quick
decisions on negotiating issues so that the deal momentum can be
maintained.

14. Not having an experienced M&A negotiator lead the

negotiations. It’s critical to have an experienced M&A negotiator leading
the negotiations. That can be the CEO if he or she has relevant M&A
experience. But you need someone who is a match for the buyer’s
sophisticated lawyers or corporate development team. Often though, the
smart CEO will want to avoid being seen as difficult in the negotiation when
the buyer will be expecting the CEO to stay on after the acquisition. And the
savvy CEO will be aware of the conflicts of interest that will arise. The
selling company wants to avoid acrimonious negotiations, as this could
eventually kill a deal if the buyer determines that there won’t be a cultural
fit. The CEO or the Board may then determine that it will be more
appropriate for the lead negotiator to be a representative from the Board,
an M&A Committee of the Board, or a representative from a major
shareholder in collaboration with experienced M&A counsel.

15. Negotiating the deal without regard to tax considerations. The

tax structuring implications of a deal can have a significant impact on the
net economic return to the stockholders. Buyers often prefer to do asset
purchase deals as those can provide a “step up” in tax basis (and may
mitigate the potential of taking on unknown liabilities of the seller). But
sellers will usually prefer a stock sale or engaging in a reverse triangular
merger, as this eliminates the risk of “double taxation” present in many
asset deals, and enables the seller to avoid the burden and expense of
winding up the company's remaining assets and liabilities.

16. Neglecting the day-to-day operation of the business during

the M&A process. The process of selling a company will be hugely
distracting and time consuming. Nevertheless, management must keep its
eye on the ball and ensure that the business continues to grow and operate
efficiently in line with projections given to the buyer. One of the worst
things that can happen in an M&A process is for the selling company’s
financial situation to deteriorate during the process. This may kill the deal
or result in the buyer renegotiating price and terms.

17. Failing to communicate the vision and strategic fit. The selling

company’s CEO must be able to effectively communicate to bidders the
company’s vision and significant growth prospects. Regardless of the
company’s current performance, unless the buyer is excited that the
company will continue to scale and be significantly more valuable to the
buyer in the future, a deal at an attractive price will not happen. If the buyer
is a strategic buyer, you have to be able to articulate the synergies and
strategic fit of combining with the acquirer.

18. Absence of credible financial projections. The buyer will expend

a great deal of time doing diligence on the company’s current financials and
future projections. Having unreasonable projections or unrealistic
assumptions will adversely affect the credibility of the management team. If
the management team does not know the company’s key metrics cold and
lacks the ability to convincingly demonstrate the reasonableness of the
projections, this will give the buyer pause.

19. Not considering change of control provisions in key

contracts. If the selling company has key contracts, licenses, or leases that
require consents from third parties in connection with a change in control
of the company, it is critical that these consent requirements be identified
early on in the process. The same holds true with respect to important
governmental permits. Counsel will need to be deeply involved in
identifying and evaluating these requirements. Then a plan should be
adopted to obtain those consents in a timely manner. A buyer may insist
that those consents be obtained prior to a closing of the sale.
20. Not adequately taking into account employee-related
issues. Transactions will typically include a number of employee issues.
The questions that frequently arise in M&A transactions are the following:

 What is the acquirer’s plan for retention and motivation of the

company’s employees?

 How will the company’s stock options be dealt with? (From the
seller’s perspective, it is desirable to have the acquirer assume
all the options but count only the vested options toward the
purchase price.)

 Do any options accelerate by their terms as a result of the deal?

Some options may be a “single trigger” (accelerate by reason of
the deal closing) and others may be “double trigger” (accelerate
following the closing only if employment is terminated within a
defined period of time). The option plan and related option
grant agreements must be carefully reviewed to anticipate any
problems.

 Does the company need to establish a “carve out” to pay

employees at the closing, or a change in control bonus payment
to motivate management to sell the company?

 How do the investors make sure that the buyer’s incentive

arrangements to the management team do not adversely affect
the price payable to the shareholders?

 Will payouts to employees related to the deal trigger the excise

tax provisions of Internal Revenue Code Section 280G (the so-
called “golden parachute” tax)? If so, the seller needs to obtain
a special stockholder vote to avoid application of this tax
liability.
21. Not understanding the negotiation dynamics. All M&A
negotiations require a number of compromises. It is critical to understand
which party has the leverage in the negotiations. Who wants the deal more
—the buyer or the seller? Are there multiple bidders that can be played
against each other? Can you negotiate key non-financial terms in exchange
for a concession on price? Is the deal price sufficiently attractive that the
seller is willing to live with indemnification obligations that are less than
optimal? It’s important to establish a rapport with the lead negotiator on
the other side and it’s never good to let negotiations get heated or
antagonistic. All negotiations should be conducted with courtesy and
professionalism.

22. Not carefully negotiating earn-out provisions. An earn-out

arrangement provides a selling company or its stockholders the potential to
recover an additional payment following the closing, dependent on the
financial performance of the business or achievement of designated
milestones. The inclusion of an earn-out provision in an acquisition
agreement can be useful in bridging the valuation gap between a seller and
a buyer. But earn-out provisions frequently lead to disputes and even
litigation unless carefully and thoughtfully drafted. Here are the key points
to negotiate:

 What are the realistic financial milestones to be achieved before

the earn-out is payable? Buyers tend to prefer profit or EBITDA
metrics, whereas sellers prefer metrics that have less chance to
be manipulated, such as gross revenues. Usually, metrics which
are easy to measure and verify are beneficial to the seller.

 What overhead and extraordinary liabilities will be excluded

from the calculation if the milestones are based on profit or
EBITDA?
  What is the timetable for the earn-out? Over one year or several
years?

 What payments are required as milestones are achieved?

 Is the earn-out payable in a lump sum or sliding scale?

 Is there a cap on the earn-out payments?

 What protections does the seller get to ensure that the buyer
will take reasonable best efforts to operate the business in a
way that won’t artificially decrease the earn-out? (for example,
will the buyer promise to adequately fund the business post-
closing?)

 What happens if the buyer itself is subsequently sold? Does

that buyer then assume the earn-out obligation or are the earn-
out payments then accelerated?

 How will disputes be resolved? (Arbitration is typically more

desirable for a seller.)

 Can the buyer offset indemnification claims against the earn-

out?

 What information, auditing, and inspection rights will the

seller get?

It’s important to understand that earn-out provisions are fully negotiable

and the likelihood of getting paid is significantly dependent on how well the
provision is drafted.