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Launch Series Ep.5: Legal Diligence and Structuring with Scott Alderman and Alex Temel – Ep.187

Today’s episode is the fifth in our Launch Series, in partnership with Trilogy Search Partners and Pacific Lake Partners.

Episode Description

Ep.187: Alex (@aebridgeman) is joined by Scott Alderman (@Scott-Alderman) and Alex Temel (@AlexanderTemel).

Today’s episode is the fifth in our Launch Series, in partnership with Trilogy Search Partners and Pacific Lake Partners. This discussion focuses on the deal structuring and legal diligence process in a search acquisition, and I’m joined by Scott Alderman, partner at Trilogy, and Alex Temel, partner at law firm Sidley Austin, for the conversation.

During the episode we cover the key steps in the legal process, timeline, how to mitigate risk, working with sellers, staging, reps and warranties, and much more. We broke the conversation into the key stages of a deal and special considerations to make along the way and ended with advice for entrepreneurs when working with legal counsel.

Finally, if you haven’t already, be sure to listen to our four previous episodes on industry research, starting a search, the diligence process, and working with sellers.

Listen weekly and follow the show on Apple Podcasts, Spotify, Google Podcasts, Stitcher, Breaker, and TuneIn.

Learn more about Alex and Think Like an Owner at

Clips From This Episode

Helpful Advice for Entrepreneurs Working with Attorneys

Most Frequent Deal-Killers

Ravix Group — Ravix Group is the leading outsourced accounting, fractional CFO, advisory & orderly wind down, and HR consulting firm in Silicon Valley. Whether you are a startup, a mid-sized business, are ready to go public, or are a nonprofit, when it comes to finance, accounting and HR, Ravix will prepare you for the journey ahead. To learn more, please visit their website at

Hood & Strong, LLP — Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at [email protected]

Oberle Risk Strategies– Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.

If you are under LOI, please reach out to August to learn more about how Oberle can help with insurance due diligence at Or reach out to August directly at [email protected].

Interested in sponsoring?

(00:05:01) LOIs: Key components and legal timelines

(00:16:36) Pitfalls in Pre-LOI Due Diligence

(00:20:09) What happens between the LOI and drafting a purchase agreement

(00:22:49) Ways to reduce risk in the legal process

(00:26:35) How to avoid conflict between parties

(00:32:57) Reps, warranties, and covenants

(00:38:58) Where to hold your ground and where to make compromises

(00:40:52) Economic drivers of a business

(00:43:10) Most frequent deal-killers

(00:45:27) Adjusting processes and cadences based on the experience of the seller and their advisors

(00:49:59) Helpful advice for entrepreneurs working with attorneys

Alex Bridgeman:  Well, thank you both for coming on the fifth episode in the Launch Series. This one focuses on deal structuring and a lot of the legal aspects of a search acquisition. Goals for the episode are going to be walking through the legal process of acquiring a business, some key levers that drive the economic outcome of that acquisition and then maybe some pitfalls or areas to avoid within a deal process. But Scott, perhaps a good way to start would be just getting an overview and a feel for the initial part leading up to the LOI and then maybe the key components of the LOI, and then we’ll jump over to Alex and go back and forth.

Scott Aldermman:  That sounds great. And Alex, thanks for having us. I’m super excited to be a part of this next chapter of the Launch Series, which I’ve really enjoyed to date. And so, maybe just to describe the overall arc of the legal process and how that interweaves with the commercial side of a transaction. Initially, an entrepreneur connects with the business owner, and if there is some sense of a mutual fit and intent, there’s an exchange of information over time, where the entrepreneur’s evaluating how attractive the business is and what he or she would pay for it, while the business owner is ascertaining is this someone that I would want to sell my business to. Sometimes along the way there, the entrepreneur may provide a document that’s often called an Indication of Intent or IOI. That’s a very high level, non binding indication of how the entrepreneur would value the business and what the key terms of a deal might be. And that’s just a very early forcing function to determine if the two parties are in the same ballpark on a few key terms like valuation. But at some point, the entrepreneur determines that it’s time to make an offer for the business to the business owner in the form of an LOI or letter of intent. And this is where the sort of first significant legal lift can happen. And the LOI defines the critical terms that the buyer and seller agreed to and provides a framework that will be used to inform the purchase agreement, which we’ll talk about in a bit. And if an LOI is signed, there’s a series of due diligence workstreams that occur in parallel prior to drafting the purchase agreement, which is the ultimate governing binding agreement for the sale. A place to start might be, what are the typical key components of an LOI? Those would include, what are you buying? I mean, typically, we’re buying all of the assets of a company, but it could be a stock purchase, or often, certain assets might be carved out of transactions such as real estate or if the owner owns an airplane through the business, things like that. Second, what is the price or consideration that’s being paid? The biggest component is usually upfront cash, but it could also be a promise to pay a portion of the purchase price in the future through a seller note and/or an earnout tied to the future performance of the business. The LOI typically states that when you’re buying the company, it will come with a typical amount of working capital in the business on day one. The intent there is to make sure you’re acquiring a normally operating business that isn’t going to have a liquidity crisis on day two. And then usually there’s a notion of some kind of escrow account that some of the purchase price that’s held back to mitigate certain risks, and we’ll talk about more about that as we go forward.

Alex Temel:  One of the critical pieces of creating the first draft of the LOI is to take a step back and look at, and this goes to Scott’s first point about what are you buying, and figuring out whether it’s assets, equity, and/or the type of business, and are you buying the whole thing or part of the business. In most deals, you’re buying 100% of the business, and you have to make an assessment of whether it’s assets or equity. Ideally, we always want to purchase assets so that we can identify which liabilities we’re taking and which ones we leave behind. But in a lot of targets that are already set up as corporations, sometimes you have to buy the equity or the stock of that business. So that’s often a front-end discussion with the seller. But recognize that we would prefer to lead with an asset deal than an equity deal, both for liabilities and for tax purposes. But that’s not always feasible and realistic. So if you end up buying the stock of a company, it just leads you down a different path than if you buy the assets of the business.

Alex Bridgeman:  And how much diligence should be done prior to drafting and signing an LOI?

Alex Temel:  So, from a legal perspective, generally very little. What we often do is might have a half hour conversation with the seller and their counsel if they’re available. Often, they haven’t necessarily hired counsel. I found it very helpful to have a half hour conversation at the front end to identify that we’d like to buy assets, is it feasible, does it trigger any third party consensus, etc., etc. But you want to limit that because that can be even done generically in the term sheet or the LOI, and the LOI will set forth those six parameters that Scott went through to define whether we have a deal or not. And if you can’t get an agreement on the high level six items, some of the minutiae and details below it become less relevant. But a lot of it is a decision by the entrepreneur and the searcher as to how much certainty you want and requires depending on the deal dynamics. If you have a non competitive process, where you’re not competing just to get to exclusivity, I like to see people try and get as much information as they can upfront. But often the deal dynamics are such that you’re going to punt some of the more difficult challenging things like exact structure until later on in the process. So ideally, you would have a good amount of information in order to decide what type of structure, assets, equity, etc., etc. But if the deal dynamics don’t allow it, my advice is get the term sheet signed up, we can figure that out afterwards.

Alex Bridgeman:  That makes sense. And maybe as a foundation for discussing pre LOI, LOI, purchase agreement and onward, I think it might be helpful to set up what is the timeline for when each of these things happen. So you mentioned relatively little legal work is done at the LOI stage. When would that change? When does legal come in? How long does it generally take? With and without debt, and then maybe some other things that might affect timeline. But just broadly give me a high level overview for the legal timeline. I think it’d be a helpful place to start.

Alex Temel:  Yep, absolutely. So let me start with the broader timeline. I’m typically seeing four to five months in terms of from a transaction, meeting a seller that’s ready to sell to a potential closing. If you think about that five month timeline, there is typically a full month and a half or two of what I would call business diligence, making sure that on the technology side and on the investor side that there’s overall support for that. Let me pause for a moment. Scott, where do you see like the right or the sweet spot of the amount of time that the searcher should spend on that business/tech diligence as a general matter, again, indications of interest from the investors?

Scott Aldermman:  Yeah, well, I think it’s really situation specific. But ideally, the searcher has met several times with the seller. He or she has had a chance to review, say, three years of financial statements. If there’s a technology element to the company, maybe some initial discussions with a technical expert who’s participating in the process. And really another thing that’s really important is just learning- really getting to know the seller and understanding the seller’s expectations and what their lifestyle wishes are post acquisition, maybe what their spouse’s lifestyle wishes are, and some of those softer elements can be just as important as the commercial elements.

Alex Temel:  Yeah. One of the big critical pieces in terms of that timeline, Alex, really relates to is it a brokered deal or not. Sellers that have hired brokers tend to prepackage a lot of the front end work, so they’re more organized, and it condenses what I’ll call the pre legal period. Sellers that are cold called and have not really spent the last year and a half or a year working with a banker about the concept of selling their company, there’s often a lot of dialogue and discussion and preparation that comes in before I get involved. But let’s take a situation where LOI is signed, and there is 90 days of exclusivity. You will find exclusivity periods between 60 and 120 days with 90 tending to be the more common period. What I advise folks is that if you have a non levered deal, so if there is not debt, I need five weeks from start to finish to get you to a closing. So do not start the true legal process until five weeks before. And within that five week period, I can get done all of the M&A work, I can get all of the equity work done relating to the investor funding portion of the transaction. And pre that five weeks starting the clock, you want to start your Q of E, and you want your Q of E to be timed essentially that at that five year five week mark, your Q of E provider can give you a thumbs up on the deal. Your Q of E will not be done, but they’ll give you that preliminary response that says there are no huge issues or no red flags. And you have presented those initial findings to your lead investor or lead investors and they have shown overall support for the transaction. That’s really when you start the legal clock. If there is a leverage, you need at least six or seven weeks. That’s the critical distinction. Because lenders, even though they will tell you they can do it in four weeks, they never get a deal done in four weeks. It’s really six weeks from start to finish, from the time a term sheet is signed. So, it’s somewhere between that four and six week mark, depending on the nature of the deal. But you really want, before you start the legal clock, your preliminary Q of E, your preliminary tech diligence if there’s critical tech, and you want to know your lead investor or investors are supportive of the deal. That’s kind of to me when you start the time clock. Now prior to that, we will send out a due diligence request list. Because what happens in every transaction is the sellers get antsy. They want to know that the lawyers are working. So we have a due diligence request list that we will prepare and tailor for the target business that gives the seller a couple of weeks to prepare, create the data room, collect that information, and then at that five or six week mark, we are ready to start full bore towards the closing process.

Alex Bridgeman:  Any pitfalls within that initial pre LOI diligence period or drafting the LOI to avoid and look out for?

Alex Temel:  From my perspective, the most critical things to identify at that stage are on the legal side, whether you have the right structure and third party consents or regulatory approvals. If you have a deal that is regulated, and you need a third party to provide an approval, I’ve had transactions where the buyer and seller think they can close in for weeks, and it turns out, we have a six month regulatory approval process that upsets everybody. So to me, in that first week, seller and their counsel, you need to identify third party consensus to get the deal done and identify whether structurally there’s an issue. So for instance, if you have 100 owners of the business, and you have to flip it to a merger, that’s going to add time to the process. So at that very front end, you want to identify, as you’re calling them, pitfalls, things that will slow down the process because that will just be a shock to everybody.

Scott Aldermman:  I would just add, Alex mentioned investor support, and really throughout this process, even prior to signing an LOI, but certainly in that period between an LOI and starting work on the purchase agreement, you want to be bringing along your investors and making sure that you have adequate support to fund your acquisition at the end of the day. That’s a process, and you may not have 100% enthusiastic support on day one. And it’s not unusual that not all of your investors participate for whatever reason, and you may need to bring in an outside investor or two to fill an equity gap. But you just want to make sure that you aren’t investing all this time and hard due diligence costs without having that critical mass of support behind you.

Alex Temel:  Yeah, it is typical and I see regularly three to four investors in your group not participating in the acquisition. And it’s often the smaller ones. But sometimes it’s one of the larger ones. And then it’s a function of the balancing act of when you bring in the gap investor, when’s the right time, when’s the wrong time, speak to your lead investors about who might want to do super pro rata. Because there’s a preemptive rights notice period; that tends to happen a few weeks later. And what I tell everybody is the preemptive rights process, which is the formal one when you notify your investors and the investors have the opportunity to opt out of the deal, when you send those out as an entrepreneur or a searcher, you should pretty much know with 95% certainty what the answers from the individual investors are going to be at that point in time. That is not a surprise document. So I encourage everybody to have regular conversations with their investors. And the pitfalls that I see are the entrepreneurs that believe that if they wait longer to engage, the investors will become somehow more favorably inclined for the deal. I’ve actually found the opposite. It’s the constant engagement, constant update without being annoying, but giving material facts and the Q of E results, etc., etc. is a critical part of that engagement with the investor.

Alex Bridgeman:  So, the LOI being a precursor to the purchase agreement, what needs to happen after the LOI is drafted before you start drafting the purchase agreement? What happens next?

Alex Temel:  Yeah, there is always tension between the process of drafting the purchase agreement and the signing of the LOI. The seller tends to believe that once the LOI is signed, that a purchase agreement should be produced in a matter of days thereafter. And on the buy side, we always have to have a discussion about the dynamics of the deal and what is the ideal period of time between the LOI signing and the purchase agreement. In a perfect world where there are no deal dynamics driving the timeline, specifically, on the legal side, we would have an opportunity to do a few weeks of due diligence of reviewing the company, reviewing their contracts, understanding the employment arrangements, and the other specifics of the deal so that we could factor them into the drafting of the purchase agreement. There will be components in the purchase agreement that are not covered by the LOI. And if we rush into drafting a purchase agreement, we end up with a more generic document that has footnotes that is subject to diligence and subject to other things. So, you can produce the document but it is not as fruitful and productive of the document. So, in an ideal world, I would have two full weeks of legal due diligence to review documents, have discussions with the entrepreneur about what positions you want to take in the document. And then also, if there are difficult issues, have an opportunity to speak with the lead investors about those difficult issues, and then produce the document. So ideally, it would be two to three weeks. And again, think about it from a five to six week period. I never get that ideal situation, unfortunately, because it’s always that the seller wants something sooner, so you go in the middle. So basically, we take 10 days from the time the LOI is signed to produce an initial draft of the purchase agreement. That’s the general timeline. That will be a 85% good document, 15% with blanks or to come and things to be decided in the process. But that’s enough to send it over to the seller, have them have concrete things to work with, while we back fill all the items of lack of knowledge that we didn’t have because I’m not getting the due diligence.

Alex Bridgeman:  You mentioned about trying to reduce risk and delays ahead of using legal. Given that legal is going to be one of your larger if not the largest costs, what are some helpful ways to reduce risk and ensure a smoother legal process once that begins?

Alex Temel:  This is, again, deal dynamics and point of tension between honestly always entrepreneur and lawyer. All of the searchers I work with have form LOIs that I give them. That is a three page document that goes through the nine critical things that will be negotiated, whether it be price, working capital, indemnification, escrows. And each time most of the entrepreneurs see that, they have a pause and say, boy, I’d really love to send over a two page document, not a four page or a three and a half page document. And it’s fine to send a two page document or just handle five of the nine items or four of the eight items, but recognize that those will have to be negotiated at some point. And my guidance, and I know there’s, within the industry, different people and different approaches to this, is that your time and the entrepreneur’s time and the investor’s time is their most valuable asset. So I like to know upfront whether there’s going to be a meeting of the minds between buyer and seller and have found very few deals where people have punted hard issues to the back end hoping that they work out. And I hate to see entrepreneurs use six weeks of their 18 month period on a transaction that’s not going to happen because they don’t address things at the LOI stage. So the best way to decrease that uncertainty is, I think, the uncertainty comes in two forms. One is meeting of the mind between buyer and seller. And the second one is do you have investor support. And the sooner you and the more effort you put in at the front end of the transaction to address those two issues, leads you to greater success in the backend.

Scott Aldermman:  Yeah, and I would just add, I think searchers sometimes get different advice from different investors on how soon should you try to get a company under LOI. I mean, on one extreme, there’s the idea that just get it under LOI and under exclusivity as soon as possible, and we’ll figure out everything after that. And I think, to Alex’s point, that introduces a lot of risk. And the more time you can spend getting to know the company and getting to know the business owner and the more detail you can include in that LOI, the greater the chances that there isn’t going to be a really unpleasant surprise post LOI.

Alex Temel:  Yeah, I think the other piece is for the entrepreneur to have a conversation with their legal adviser and be very open eyes about the terms that you might agree to in an LOI. Often, I see things agreed to in an LOI like earnouts or put call rates, different things relating to the acquisition or the rollover component of it, that ultimately the investors say no to, and they’re not going to agree to. So you want to get that out up front. If the deal is such that it requires an earnout, have a conversation with your lead investor or investors so that you can go through the dynamics of why this is a good idea in this transaction, because in 90% of them, it’s a terrible idea. But in this one, it may be required and may be necessary. But have it upfront. Because I have seen investors walk away simply because there’s too much complexity that potentially could have been avoided with a heart to heart conversation.

Alex Bridgeman:  It might be helpful to go over a couple of those types of conversations. What points or structure elements often lead to those hard conversations the most, and which ones are helpful to bring up closer to the start of the process versus leaving towards the end?

Scott Aldermman:  Well, one of them that Alex mentioned was earnout. And sometimes, an earnout structure can be necessary and really helpful to, for example, bridge a small gap in valuation expectations, and maybe there’s an opportunity to base a fraction of the purchase price on the next 12 months’ financial performance, tying it to revenue target or an EBITDA target. I think where we’re often presented with structures that don’t make a lot of sense is when a large percentage of the consideration is in the form of an earnout and/or the measurement stick of the earnout spans quite a long time like multiple years. And in those situations, the chance of the searcher and the seller getting sideways over time just is much higher because the searcher is going to want to operate the business as he or she sees fit. And over time, if that’s inconsistent with the business owner or the seller earning his or her earnout, they’re going to take an issue with that.

Alex Temel:  A couple other key points that I see come into play, the rollover and the terms of the rollover, and whether the seller is simply selling the business and moving on to the next phase of their life, or are they going to retain a percentage. If they’re going to retain a small percentage, say 5% versus if they’re going to retain 30%, that can become a very real issue and the rights that they have, because as most of you know, the base of the equity documentation here is a majority rules, and there are no special people in the cap table. So, the question becomes, should a rollover holder who might own 25% have extra rights relative to the other investors. So that’s often a point that you want to have up front that their dollar will be treated like every other person’s dollar, and they will not have special rights. Maybe they have a board seat, depending on the amount of the position, but even that often is up for debate, whether it’s a perpetual board seat or they get it for the first year or two years. Next items, if there is a seller note and seller financing, the terms of that instrument become very controversial at times. So you might have some very basic parameters in terms of interest rates. And I’ve seen certainly in the last year, seller notes and the rates on those notes have become more of an issue than they were before because it used to be, if you go back three years ago, and you said they could get 8% paper, they thought they were getting a great instrument. Now 8% paper doesn’t look so good. It’s been creeping up to 10 and 12%. And the term of that, relative to if there’s debt financing, because sometimes the seller note, sellers think, oh, I’ll have it outstanding for two years, but you have a senior facility for five years, and you have to work through that balance. Next big issue is the role of the seller. What will they be doing on a go forward basis? And again, the entrepreneur needs to think about it from two perspectives. What’s realistic in terms of do you need them? If it’s a generational business, do you need them to be there to support you in the next phase? That is equally as important as what is their expectation, and what do they want to do? Because I have seen deals fall apart, not over monetary issues, but the person is selling the business, and they really want to be a steward, for better, for worse, for the next 18, 24 months, and the entrepreneur says no, no, we’re going to now run it. Figuring out if there’s a meeting of the minds there is really important. We’ve talked about the earnout. And maybe the last item is the treatment of what I’ll call purchase price adjustments, whether it’s working capital or debt, if it’s a software business versus deferred revenue. Those can be in certain deals, massive relative percentages. I’ve seen transactions where the deal price is $11 million, but there’s a $3 million deferred revenue number. And you have to figure out whether that’s treated as debt and cost of goods sold. So in most cases, interestingly, it’s hard to say there’s a specific roadmap of these are the six items, but when a deal is in front of you, it’s not hard with your advisors and your lead investors to identify what those critical five or six points are. And then you just have to make strategic decisions on each of them.

Scott Aldermman:  Just to add to that, I think it is very typical that the seller is a stakeholder in the go forward business through one of the means that Alex described. We may have an equity rollover, maybe there’s a seller note, has some kind of role in the company, maybe a landlord. And one thing we have just learned that is while everyone goes in with the best of expectations, it doesn’t always- the relationship between the entrepreneur and the seller doesn’t always work out. And so, when you look at all those elements that allow the seller to be a stakeholder in the go forward business, magnitude is important. I think you want the seller to be incented to support the go forward business. But if they have too much at stake and the relationship sours, you want to be able to just go your separate ways without too much distraction, and that can be hard to do if the seller is, say, the largest stakeholder in the go forward business.

Alex Bridgeman:  What about reps, warranties, and covenants? Are there any in particular to pay special attention to?

Alex Temel:  Yes, yes, and yes. It really depends on- which ones depends on the type of business you’re acquiring. There will be in any purchase agreement probably 26 representations of warranties, and of the 26, I would say there are going to be five or six that are actually important. You can cut out the fact that I said there are 20 that are unimportant, but there are five or six that are really important. And those are going to depend on the business. The financial statements rep is going to be a critical one. The IP rep will be a critical one. The capitalization rep will be critical. And then the other three will be dependent on the type of business you’re buying. And if, for instance, you’re buying a company that has a strong customer concentration, the material contracts and the five largest contracts might be critical. But if it’s a type of business where they have 1400 customers and they’re selling water coolers to the customers, that’s not particularly meaningful. If they’re providing- if it’s a warranty business, the warranty business, the warranty rep will be important. So there will be a base set of ones that are critical. But then there are going to be three or four on top of that that you really want to focus on. And that’s part of, going back to what I referenced before about being able to and having the opportunity to do due diligence, that you then can tailor them appropriately for the business. Because one of the things you’ll find that upset sellers quite a bit is when you send them a generic set of representations and warranties that are not tailored for the business. So, it says, you’ve provided copies of every single contract that you have. Well, if they go back to that 1500 buyers of water coolers, and you ask for 1500 contracts, that just creates antagonism right off the bat. So you just want to be thoughtful about doing that. The critical piece of the reps and warranties, they serve two purposes. And I think it’s important for us to pause and think about both purposes. One is to provide us with a description of the company that we’re buying so that you have on day one a full ability to step in and run the business based on the picture of the company that they’re providing and the reps and warranties, including the disclosure schedules. That’s the informational part of the rep and warranty process. The second half of that is actually from a protection of liability perspective and indemnification, that if something goes wrong or it’s different than the picture that they gave you, you have an ability to go back after the seller and/or the company that sold the assets. So as you prepare and think through the reps and you have the conversations with your legal adviser, everybody should pause and figure out is this a representation about risk allocation, which is the liability point, or is it a due diligence informational one, that when you start making changes to the base case, understand what is it that you’re giving up. And in certain companies, giving up the informational part of it will be okay. In other companies, giving up some of the liability protection will be okay. But you don’t want to do it accidentally. You want to do it thoughtfully.

Scott Aldermman:  And Alex, I don’t know if you’d agree with this, but it seems like this is an area from a process standpoint where the timeline can really drag out. Because even if you agree to those reps and warrants, then there are the disclosure schedules which support those and lay out all the exceptions. And in my experience, that’s an area where the seller is often unprepared to, doesn’t appreciate how much work is goes into preparing those schedules. And sometimes, we can be very late in the process and the light bulb goes off that we still are expecting these schedules, and that can cause a lot of consternation and delays in the transaction.

Alex Temel:  Absolutely. And you want to have that conversation very upfront with the sellers and their counsels, frankly, on not the introductory call but the second call, you should raise immediately about the disclosure schedule process, trying to understand is it the law firm for the seller that’s going to help prepare them? Do they have internal capabilities used to do them? But put them on notice about how challenging it’s going to be. And when you’re doing the reps and warranties, think through what’s the scheduling burden on the company and work with them and acknowledge. I will say that if it comes as a complete shock to the seller side or it does become a gaining item, that the lawyers on the buy side have made a strategic mistake. So, you never want to get to that place. You want to have those conversations upfront. And it’s often through putting together on the buy side a closing agenda and a closing timeline that lays out that we expect when we deliver the purchase agreement to you, you’re going to start working on the disclosure schedules immediately. And then you’re going to deliver to us a first draft of those disclosure schedules within a week. One of the critical things and where you see delay is in deals that have leverage and banks, the banks want to see those disclosure schedules as well. So, it’s not just a document for the buyer and their investors. It’s also for all the third parties who are going to look at them. So really critical and important that people are aware of what the timing gaining items are in the deal, and disclosure schedules is always one of them.

Alex Bridgeman:  And within this due diligence process, where are there points that could be given on to the seller versus where should an entrepreneur generally hold their ground, if possible?

Alex Temel:  So I’m going to say at the outset, of course, I’m the lawyer on the phone, none at the outset, meaning you shouldn’t give on any, but what you should do is have a frontline conversation. And I recommend this in all deals, that there be a conversation with management on the other side, whether it’s a seller or their key people, for the lawyers to understand the business so that we can target diligence properly and have a front-end half hour conversation, 45 minute conversation. We can target our due diligence request lists and follow ups specifically to about the business. And then after you have that 45 minute call, have a discussion with the entrepreneur and potentially a lead investor, if they’re so inclined, about where are the areas of sensitivity? And where are the true economic drivers of this business? The fact is, if the seller is trying to hide something, you’re not going to figure it out through the diligence process. If they’re defrauding you, it’s very difficult to figure that out or solve that mystery. But what you want to do is be tailored and targeted to what’s important and what are the economic drivers of the business that you’re acquiring. And it’s very difficult for the lawyers and certainly, you have to understand that it tends not to be the lead partner that is doing the legal diligence, it’s the younger associates. So, you want to make sure that everybody on the deal team has an appreciation of the material aspects of the business you’re buying. And then you can identify what’s a waste of time, what’s valuable, etc., etc.

Alex Bridgeman:  Can you dive into that concept just a little bit more, identifying the economic drivers of a business and explaining them to your counsel and your team?

Alex Temel:  Yeah, absolutely. Let’s go back to the example of the water coolers and buying a company that has 2000 equal sized customers versus a company that has four customers that are 80% of their revenue. If you have 2000 customers, let’s start with and hope that they’re all effectively on a form document or a form purchase agreement; they may or may not be. But you know by definition, that if there are 2000, roughly equally sized customers, if 25 of them go away, that’s not a blow to the business. It may not be ideal. And you’d like it to not happen, but it’s not a go or no go decision. Let’s contrast that to a company that has four customers or 80% of the business. You want to dig into those four contracts. You want to know if they’re assignable. You want to know what the terms are. You want to know if there’s most favored nation pricing. So, there you would target on those four and not versus the 2000. So that’s an example of the business driving it. I’ll give you another. Here’s another one. If the company has customers that are government entities versus non governmental entities, you want to understand that government contracts are cancelable. You want to know what is the procurement process or RFP process in that business. Those are not things that you can open up a textbook and figure out. You have to talk to the owner. You have to talk about how they’ve sourced those clients and get that feedback so you know how to critically look at those agreements, as opposed to just a generic summary. Because everybody knows from a legal perspective, government contracts are cancelable at will. That doesn’t mean that every contract could be cancelled in a day. It might be an act of a local municipality that has to go through a six month process, so you know that that contract is good for at least however long. You can know when the legislative session is. Those are examples of what I’m talking about.

Alex Bridgeman:  And where, within the purchase agreement, what aspects or terms do you see most often killing deals?

Alex Temel:  Truthfully, very little in the purchase agreement. In a properly done LOI, very little in a purchase agreement will kill a deal. It’s the things that you don’t cover in the LOI that appear for the first time in the purchase agreement. So, for instance, let’s say you did not introduce the fact that there is going to be a working capital adjustment or a minimum cash or you’re going to buy the business debt free, cash free. And suddenly, now there are four pages of adjustments to the purchase price in the purchase agreement that yield, let’s say, it’s a $12 million deal, and that’s $5 million in purchase price adjustments. That is a deal killer. But it may have killed the deal early on. But not only have you potentially killed it because of the economics, but the relationship factor of wait, you waited till now to introduce that when you knew it was going to be a problem. It’s those types of things. Most of the pure legal issues we sort through; it’s the business issues that are built into or not built into the LOI that kill deals.

Scott Aldermman:  And sometimes, during due diligence, you find out something about the business that may make the price you agreed to in the LOI not make sense anymore. And I think that is a reason why it’s important to- the business owner understands what was the justification of the price that you offered for the business. So, there’s something you can point to in the event you need to ask for an adjustment to the price. So, for example, your price is based on a particular EBITDA run rate or an assumption that certain customers were going to remain active customers through the point of close. Reshapes are not very common. But if you have established those justifications upfront, there can be a path forward to work through that.

Alex Bridgeman:  How do you adjust your process and cadence to the level of experience of the seller and/or their advisors, assuming they have them?

Alex Temel:  Well, one, they better have them. So let’s assume they have them. I think the right question is, what’s the level of sophistication, and it is probably 60% of the- it is a 60% driver of the overall timeline and process. In other words, very early on, you have to assess both the sophistication and experience level of the seller and their counsel, because they tend to work hand in hand, and the banker, because you have to understand that after every discussion and every call that is a group call, that side of the table is going to go caucus. And you have to figure out whether there’s an adult in the room or somebody who has done this many times to separate the emotional aspects of it from the substantive aspects of it. And if you have experience on the other side, there can be very difficult conversations and difficult negotiations, but they tend to not be explosive ones that become deal breakers in the sense of people just walk away because they’re pissed off or deal fatigue, etc., etc. So let’s take the most extreme where it’s not a baked deal. It’s a person who has been running a business for 50 years, has not been through a sale process, and they’ve hired their best friend from high school who is now a lawyer. So, you’ve got the extreme of lack of sophistication, lack of experience. There, it’s as much a hand holding exercise, and you do tailor the documents and you tailor the timeline and all of the aspects to make it, frankly, softer and gentler so there aren’t surprises. And there you have real conversations about when do you introduce this concept or this idea. Because often, in those situations, it’s not the substance of what you’re presenting, it’s how and when you present it. And you make the discussion, a lot of the discussion is, okay, let’s say there are five items. Which of these things am I going to talk to the lawyer on the other side about, or which of these things am I going to have the you, the entrepreneur, talk to the seller directly about or a combination there of. In many deals, we have a belief that a group dynamic is better. And then in other deals and other sellers, people decide it’s a one on one. And then if it’s a really difficult issue, you make the investor be the bad person. And we all want it a certain way, but the investor said no. And they’re the big bad wolf in the background. So, that’s where one of the things I really enjoy about this entire industry is there’s a playbook in the private equity world and the venture world about how you do things, when you do things. There was much less of a playbook when you’re talking about smaller M&A with people who have owned their business for 20, 30, 40 years, families, I think Scott referenced before how people’s significant others feel about transactions, etc., etc. That’s kind of the art side of this business and this industry that I enjoy so much that is really reading the people on the other side of the table and adjusting on the fly to what’s working and what’s not.

Alex Bridgeman:  Anything to add, Scott?

Scott Aldermman:  No. I would just have that the family dynamics can be really interesting. I mean, we recently closed an acquisition where a family member was running the business and sort of running the process. But there were multiple family owners in the business- family owners of the business and also a couple of family members in the business. And it can just make for a very complex dynamic because all those family members have to keep sitting around the table together at Thanksgiving. And so you need to find a way to find common ground with everybody’s needs.

Alex Bridgeman:  In closing out, it might be helpful to hear a little bit about helpful advice for entrepreneurs working with their attorneys. So as an attorney, what makes your life easier, more straightforward? What defines a helpful or smooth process with an entrepreneur versus a more difficult one?

Alex Temel:  Scott, I’ll let you take that one. I’d say the first and most important thing is regular and constant communication so that the lawyer is always on the same page as the entrepreneur. And constant communication also means honest communication, where I believe that the role of the advisor is to, one, be there as a confidant but then also be there as a source of rationality so that when one or the other has an idea that there’s an open forum and discussion, and before you take action, bounce it off someone, because often, entrepreneurs find themselves, especially later on in the process, they find themselves almost becoming sellers in a business. And it’s the job of the advisors, both legal and I’d say investors, to keep them grounded and centered on what makes sense for them for this deal right now and then for the next seven years or five years. Because it’s really difficult to get a business under LOI, it’s really difficult to close on a business, but I will tell you, it’s a lot harder to run a business for five to seven years than it is to do the front end. While you’re involved in the M&A process, it seems awful, it is awful, but the running it is even harder. And I can tell you, a five to seven year run of a bad business is worse than not buying that business in the first place. So I think that understanding what you’re getting yourself into and honestly assessing that but having those discussions because your advisors will be- you will be at places, and the analogy that I use is, you’ll be at the edge of the pool, and you’re going to look down and you’re going to see no water, or at the edge of the boat, and you have to, upon occasion, be willing to jump off and trust those advisors. And if you splat, you splat, but hopefully that partnership and that team will get you through those difficult times because it is a whirlwind of up and down. There’s nothing easy about it. But the euphoria that you will feel for closing the deal will not compare to the euphoria you’ll feel in selling it after a good deal. So that should be the end goal, not simply closing the first deal.

Scott Aldermman:  And I’ll just pile on with something that Alex said earlier in the conversation. Going back to the LOI stage, it’s just really- don’t be penny wise and pound foolish in terms of soliciting the advice of both your investors and your counsel and each brings something to the table. And you can avoid a lot of problems down the road by making sure everyone’s had a chance to pipe in and point out what you might not want to put in that LOI or what’s missing from the LOI.

Alex Bridgeman:  Fantastic. Well, thank you both for sharing your time on the fifth episode of the Launch Series. I really enjoyed the conversation. So thank you for sharing a little bit.

Scott Aldermman:  Our pleasure. Thanks, Alex.

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