This post is part of my “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”  Below is a longer, more-comprehensive version of the VentureBeat post, which provides seven tips to entrepreneurs contemplating selling their venture.

Question 

I liked your posts on VentureBeat a few weeks ago about what to watch-out for as a buyer of a business.  What about if I’m a seller?  I’m the founder of a web-based music business, and I’m ready to sell and move onto my next venture.  Any advice would be appreciated.          

Answer 

Thanks, below are seven quick tips in connection with selling your company.

1)  Be Careful with Private Equity Buyers.  Private equity firms are in the business of buying and selling companies.  Accordingly, they are extremely sophisticated and savvy and are often represented by large, aggressive law firms.  Indeed, I used to represent private equity firms when I worked at two major law firms in New York City, and I understand very well how they operate. 

Deals with private equity buyers are generally more complex than those done with strategic buyers due to, among other things, the level(s) of debt added to the target and/or financial engineering.  Moreover, unlike most strategic buyers, private equity buyers usually require the selling entrepreneur to rollover part of his/her equity into the acquirer (i.e., to maintain skin in the game) and may include a financing condition in the acquisition agreement – which obviously adds a level of uncertainty to closure.  

2)  Negotiate the Material Terms in the Letter of Intent.  As I have previously discussed, your strongest leverage as a seller is prior to the execution of the letter of intent (the “LOI”).  This is the time when a solid investment banker will create a competitive environment (or the perception of same), and prospective buyers will be required to compete on price and terms.  One buyer, for example, may offer a higher purchase price, but require a “cap” (as discussed below) equal to such price; another buyer may offer less, but only require a 10% cap.  Accordingly, prior to choosing a buyer, you should negotiate and weigh all of the material terms of the offer, and the LOI should reflect such terms. 

3)  Sell Stock (Equity) Not Assets.  As a general rule, you should sell stock, not assets, for three significant reasons: (i) potential tax savings if your company is a “C” corporation (i.e., there will not be “double-taxation”); (ii) to pass the company’s undisclosed liabilities onto the buyer (subject, of course, to the indemnification provisions); and (iii) because it generally requires less documentation and less time to close (which means less legal fees).  Obviously, every deal must be structured with the assistance of competent counsel, including tax counsel; however, as a seller, you should be thinking about selling stock, not assets.

4)  Cap Your Potential Liability.  Obviously, you want to sleep well after you sell your venture (and enjoy the fruits of your labor).  Accordingly, it is critical that certain key provisions be inserted into the acquisition agreement to protect you post-closing.  One such provision is a cap on liability, which, as noted above, should ideally be negotiated in the LOI.  You should strive for a cap of 10% of the purchase price and should also try to minimize any buyer carve-outs.  Your message to the buyer is simple: inherent in any business are certain ongoing risks; thus, once the business is sold, the buyer should only be able to recover a limited amount of the sale proceeds (absent fraud).   

5)  Insert a Non-Reliance Provision in the Acquisition Agreement.  Another important seller protection that should be inserted into the acquisition agreement is a so-called “non-reliance” provision, which requires the buyer, in effect, to acknowledge that it is buying the business based solely on the seller’s representations and warranties in the acquisition agreement.  Indeed, such a provision is intended to prevent the buyer from suing the seller based on any oral statements, writings, projections, etc. outside the four corners of the agreement.

6)  Retain a Strong, Experienced Corporate Attorney to Watch Your Back.  This is obviously a bit self-serving, but you, as the seller, need a strong, experienced attorney to watch your back.  There is just too much at stake for you to be (i) utilizing an inexperienced lawyer (such as the guy or gal who formed the company or negotiated the office lease) or (ii) retaining the cheapest lawyer to save money.  Moreover, as the Madoff affair and other recent high-profile cases demonstrate, there are a lot of unscrupulous characters out there trying to take advantage of unsophisticated entrepreneurs.  

The bottom line is that a strong, experienced corporate lawyer will sober you and lay-out all of the significant legal risks; he will then push hard to negotiate reasonable protections.  If the sale sours post-closing and lawsuits are filed, well-drafted documents with appropriate protections become a kind of insurance policy.

7)  Get the Buyer to Pay a Termination Fee.  Finally, you should try to require the buyer to pay a termination fee if the acquisition agreement is terminated through no fault of your own.  This is sometimes referred to as a “reverse break-up fee,” which can be as high as 10% of the purchase price or as low as the total amount of the seller’s transaction expenses.  This is an issue that is often not addressed by middle-market sellers, but should be.

Conclusion

I hope the foregoing is helpful.  I currently have two sales of businesses on my plate and, I can assure you, that I am working hard with my colleagues to protect the sellers and make sure that nothing comes back to bite them.  If you have any questions, please shoot them to me through the comments section or via email at swalker@walkercorporatelaw.com.  Many thanks, Scott

This post is part of my weekly “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”  Below is a longer, more-comprehensive version than I posted on the VentureBeat site.

Question: 

My co-founder and I are friggin crushing it.  We launched our company about two years ago, and we now have an opportunity to buy a couple of struggling companies in our space.  We have lawyers we work with, but I was wondering if you could just give me a heads-up on some of the legal issues we should be thinking about.  Thanks!      

Answer:  

Last week I discussed the following significant issues: (i) executing an exclusivity agreement; (ii) avoiding negotiating the material terms in an LOI; (iii) doing adequate due diligence; (iv) buying assets, not equity; and (v) protecting against a fraudulent conveyance claim.  Below are five more issues to think about.

1.  Escrow a Portion of the Purchase Price.  An important step you can take is to escrow a portion of the purchase price (e.g., 15%) for a period of time post-closing (e.g., 18 months).  Indeed, escrows are relatively common (particularly where there are multiple sellers) because of the inherent unfairness of requiring the buyer to sue the seller(s) to try to get some of its money back for a problem or liability it never agreed to take on. 

Alternatively, you, as the buyer, can push for a hold-back (i.e., a right to hold part of the purchase price) and/or a right of set-off in deals where part of the purchase price has been deferred (e.g., where the buyer has issued a promissory note to the seller as part of the purchase price); however, escrows are obviously more amenable to sellers because the money is held by an independent third party and the buyer does not have the unilateral right to withhold payment. 

2.  Use Earn-Outs Only As a Last Resort.  Earn-outs (i.e., post-closing contingency payments) are often touted by unsophisticated investment bankers and counsel as an effective way to bridge the gap between what the buyer is willing to pay for a business and the seller’s asking price.  The reality, however, is that earn-outs often lead to major disputes and business problems post-closing and should, accordingly, be avoided if at all possible. 

On the legal side, a number of critical issues must be negotiated, including (i) the metric (e.g., revenue, EBITDA, profit, etc.) and milestones, (ii) measurement/accounting issues, (iii) exclusions/carve-outs (e.g., allocation of administrative or general overhead expenses, intercompany transactions and charges, etc.), (iv) the duration of the earn-out period, (v) the effect of acquisitions or dispositions relating to the acquired business and (vi) most significantly, post-closing operational control issues.  The amount of time and energy that is required to address adequately the foregoing issues can be extraordinary (often leading to pages and pages of provisions), and there will still be gaps because it is virtually impossible to anticipate every post-closing contingency. 

On the business side, earnouts usually create significant impediments to the integration process and conflicting interests between the buyer and the target post-closing — e.g., if the metric is revenue growth, the target may sign-up a number of new customer contracts that may not be profitable or in the best long-term interest of the business; if the metric is profit or EBITDA, the target may cut back on capital expenditures or other expenses (such as marketing or advertising) — particularly as the end of the earn-out period approaches.  Moreover, target management may lose its motivation if it is unable to achieve its goals and thus is never entitled to an earn-out payment.  The bottom line is that earn-outs are very tricky from both a legal and business perspective and should only be used as a last resort.

3.  Don’t Give Away the “Basket”.  One of the provisions sellers generally insist on in the acquisition agreement is a “basket” to prevent the buyer from “nickel and diming” the seller for any claims post-closing.  The size of the basket varies from deal to deal, but based on a recent study of the Committee on Negotiated Acquisitions of the American Bar Association (of which I am a member), the norm is approximately .5% of the purchase price. 

If you agree to a basket, there are a number of significant issues that you must address, including the following: (i) push for a “first-dollar” basket (sometime referred to as a “threshold”) as opposed to a “deductible” so that if its damages exceed the basket, the seller would be responsible for all of the damages (i.e., beginning with the first dollar); (ii) the basket should only relate to breaches of representation and warranties and not to covenants or specific indemnity provisions (this is a common mistake); (iii) any materiality qualifiers in the representations and warranties should be disregarded for purposes of the basket — otherwise there would be a so-called “double-materiality” problem (another common mistake); and (iv) there should be appropriate carve-outs to the basket, the most common of which include capitalization, due organization, due authority and ownership of shares.

4.  Include a Carefully-Drafted “MAC”.  From the buy-side, one of the most important representations and warranties of the seller (and closing condition if there is a signing and a subsequent closing) is that the business has not suffered a material adverse change (“MAC”) over a certain period of time pre-signing/closing.  Lawyers have a field day wordsmithing the definition of MAC — arguing over such issues as (i) the applicable period, (ii) whether “prospects” should be included, (iii) whether the target and its subsidiaries should be “taken as a whole” and (iv) of course, the exceptions. 

The bottom line, however, is that most MAC definitions are extremely ambiguous, and there is little case law to provide any guidance as to what constitutes a MAC.  Moreover, the leading Delaware case, IBP, Inc. v. Tyson Foods, Inc., suggests that the standard as to what constitutes a MAC is quite high — “measured in years, rather than months.”  Accordingly, the buyer must be careful about relying on a MAC to terminate an acquisition agreement (or otherwise to sue the seller for breach of the MAC rep) unless the definition includes specific objective criteria — e.g., a specific dollar decrease in EBITDA or sales, etc.  (Note: as a downsize protective measure, an expense reimbursement provision should be coupled with the MAC and other closing conditions.)

5.  Watch Out for “Caps”.  One of the most important and hotly-negotiated issues in any private company acquisition is the cap (or ceiling) on the seller’s damages.  Like other material terms in the acquisition agreement, there is no right or wrong answer (or “customary” or “market” amount): it all depends on the context of the transaction — i.e., the bargaining power of the parties, the risk profile of the target, the purchase price, etc. 

For example, in an auction context with numerous bidders expressing interest in a target, the cap may end-up being 10% or less of the purchase price due to the competition; on the other hand, if the target has a host of significant problems (and/or is financially troubled) and there is only one prospective buyer on the horizon, the cap may end-up being equal to the purchase price (or there may be no cap). 

The lesson here — and the key takeaway of this post — is that you, as the buyer, must fully understand the businesses that you are buying and the significant deal risks in order to make an informed judgment with respect to price and terms, including the cap.  Indeed, if the cap is less than 100% of the purchase price, you should generally push hard to include certain carve-outs.

Conclusion

I hope the foregoing is helpful.  Indeed, as I noted last week, acquiring another company is tricky and raises a host of significant issues that need to be buttoned-down.  If you have any questions, please shoot them to me in the comments section of this post or via email at swalker@walkercorporatelaw.com.  Many thanks, Scott

This post is part of my weekly “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”  

I have two goals here: (i) to encourage entrepreneurs to ask law-related questions regardless of how basic they may be; and (ii) to provide helpful responses in plain English (as opposed to legalese).  Please give me your feedback in the comments section.  Many thanks, Scott

Question

My co-founder and I are friggin crushing it.  We launched our company about two years ago, and we now have an opportunity to buy a couple of struggling companies in our space.  We have lawyers we work with, but I was wondering if you could just give me a heads-up on some of the legal issues we should be thinking about.  Thanks!      

Answer 

Wow – that’s a pretty broad question.  There are, in fact, many issues that you should be thinking about.  I will address five significant ones in this post and five more in part 2 next week.   

1.  Execute an Exclusivity Agreement.  Your first step in connection with a potential acquisition should be to execute a tightly-drafted exclusivity (or “no-shop”) letter agreement with the seller, granting your company the exclusive right for a period of time (e.g., 90-120 days) to negotiate with the seller and to complete your due diligence investigation.  Such an agreement is often part of a letter of intent (an “LOI”); however, from your perspective, as the buyer, it is generally advantageous to execute a separate letter agreement and skip the LOI (i.e., proceed directly to the negotiation and execution of a definitive acquisition agreement) for the reasons discussed in #2 below.

2.  Avoid Negotiating the Material Terms in an LOI.  The seller’s negotiating leverage is strongest prior to the execution of an LOI — particularly if an investment banker has effectively created a competitive selling environment or the perception of one.  (See my post on investment bankers.)  Accordingly, it is in the seller’s (not the buyer’s) interest to negotiate the material terms of the deal in an LOI.  You, as the buyer, can avoid this trap in one of two ways: (i) as noted above, by executing an exclusivity letter agreement and skipping the negotiation of an LOI; or (ii) by executing an LOI that includes a binding no-shop provision, but is otherwise non-binding (except perhaps with respect to expense reimbursement and/or other “special” provisions) and is as non-specific/general as possible. 

Either approach will give you not only strong negotiating leverage, but also the time and flexibility to complete your due diligence investigation prior to agreeing to any material terms – without getting into a bidding war with other prospective buyers. 

3.  Do Your Diligence.  A comprehensive due diligence investigation is critical to the success of any acquisition.  The fundamental purpose of due diligence is to validate assumptions with respect to valuation and to identify risks.  Accordingly, there are typically three separate investigations: operational/strategic, financial and legal.  Clearly, the scope of your investigations must be tailored to the particular transaction; however, it cannot be emphasized enough that most deals fail due to inadequate diligence — resulting in the buyer (i) overpaying for the target, (ii) assuming significant unknown liabilities and/or (iii) experiencing major integration problems.       

4.  Buy Assets, Not Stock (Equity).  It is generally in your interest to purchase assets, not equity, of the target for two principal reasons: (i) you will get a stepped-up tax basis in the acquired assets; and (ii) you will minimize the assumption of any unwanted liabilities.  Indeed, in a stock transaction or merger, the buyer assumes all of the target’s liabilities (known and unknown) by operation of law; in an asset transaction, however, the buyer only assumes those liabilities that are expressly agreed to in the acquisition agreement (subject to the doctrine of “successor liability” – which requires the assumption of certain liabilities as a matter of public policy).

5.  Protect Against a Fraudulent Conveyance Claim.  You need to be very careful if you’re going to be acquiring a “struggling” company.  One of the issues you need to worry about is a subsequent “fraudulent conveyance” claim by a dissatisfied creditor of the seller (which is a complex issue).  What happens is, after the deal has closed, a creditor would sue your company to avoid (or set aside) the sale on the ground that there was “actual” fraud (i.e., the sale was actually intended to hinder, delay or defraud creditors) or, more likely, “constructive” fraud (i.e., the sale was made for less than fair consideration or reasonably equivalent value and the target was insolvent at the time of, or rendered insolvent by, the sale). 

To minimize this risk, you must do two things: (i) build the best possible record that “fair consideration” or “reasonably equivalent value” was paid (e.g., by obtaining a fairness opinion from a reputable investment bank); and (ii) require that (A) the sale proceeds be used for the benefit of the seller and not be distributed to the seller’s stockholders and/or (B) adequate arrangements are made to pay-off the seller’s creditors.  (You can learn more about fraudulent conveyance and related issues in my post “Buying a Distressed Business: Ten Tips for Entrepreneurs.”) 

Conclusion

I hope the foregoing is helpful.  Indeed, acquiring another company is tricky and raises a host of issues that need to be buttoned-down.  If you would like to learn about some of the typical mistakes entrepreneurs make in connection with doing deals generally, you should check out my video “Five Mistakes Entrepreneurs Make in Dealmaking” on YouTube.

This post is part of my weekly “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”   

I have two goals here: (i) to encourage entrepreneurs to ask law-related questions regardless of how basic they may be; and (ii) to provide helpful responses in plain English (as opposed to legalese).  Please give me your feedback in the comments section.  Many thanks, Scott

Question 

We just got an offer to buy our company for a sweet pile of cash, but we don’t know what the next step is.  My father said we should hire an investment banker and let him handle the negotiations.  Do you agree?  Thanks.

Answer 

Congratulations!  Without knowing more about the deal and the proposed purchase price, it’s hard to say.  I practiced law for a number of years in New York City, and it was pretty rare not to have an investment banker involved in an M&A transaction.  Here in California, it’s a little different since most of the deals tend to be relatively small. 

A strong investment banker can add a lot of value — not only in connection with negotiating the material terms of the transaction, but also in valuing the company and making sure that you’re not selling too low.  A strong banker will also create a competitive environment (or the perception of one) and play bidders off of each other to make sure you get the best possible deal terms.  Indeed, Martin Lipton, a prominent M&A attorney in New York City, captured the value (and qualities) of a strong investment banker in his remarks at the Memorial Service of legendary banker Bruce Wasserstein here.

The problem in the lower middle-market space (e.g., $5-50 million sale price) is that it’s sometimes difficult for entrepreneurs to find a strong investment banker.  A lot of the bankers I have come across here in California are more like business brokers just trying to close two or three deals a year.  I have found that this creates a certain inherent conflict of interest – they don’t get paid if the deal doesn’t close; thus, some of them tend not to push very hard on the key issues. 

Moreover, middle-market investment banks often have relationships with certain buyers (e.g., private equity firms) and bring those same buyers lots of different deals.  Accordingly, they don’t necessarily want to rock the boat.

The bottom line is that you should talk to an experienced M&A attorney, and he or she can discuss the foregoing with you.  If you decide that you would like to retain an investment banker, you should ask the attorney for a few recommendations and then meet with them and choose the best fit.  Make sure you ask for references and talk to other clients they have helped sell their businesses.

If you decide that you do not need an investment banker, your attorney can help negotiate the letter of intent (or term sheet).  The letter of intent is very important from your perspective, and you want to make sure that all of the material terms of the deal (e.g., the “cap” on liability, the size of the “basket/deductible,” the survival period of the reps and warranties, etc.) are negotiated at this stage of the transaction.  I discuss this issue in detail in my post “Selling a Company: Ten Tips for Entrepreneurs” (see #5).    

Why?  Because this is when you have the strongest leverage – i.e., prior to the execution of the letter of intent. This is when, as noted above, bidders can be played off of each other.  Once the letter of intent is executed, you will not be allowed to shop your company around or talk to any other potential buyers pursuant to the no-shop provision (which is generally in all letters of intent).  Accordingly, if you don’t retain an investment banker, this is when you and your lawyer will need to button-down the key issues.

The buyer, on the other hand, is better served by simply keeping the letter of intent general (other than the no-shop provision) and then negotiating the key issues in the acquisition agreement when the other interested parties (if there are any) have gone away and your leverage is weakest.  I discuss this issue in detail in my post “Buying a Business: Ten Tips for Entrepreneurs” (see #2).

Conclusion

I hope the foregoing is helpful.  If you’re interested, there’s an excellent article in yesterday’s New York Times with respect to the role of investment bankers generally and Warren Buffett’s concern regarding their inherent conflicts of interest (see “Buffett Casts a Wary Eye on Bankers”).

Non-Bankruptcy Context

1.  Do Your Diligence.  A comprehensive due-diligence investigation is a fundamental buy-side component of any acquisition, but it is particularly important in connection with the acquisition of a distressed business due to, among other things, the likelihood of limited (or a lack of) recourse post-closing.  Needless to say, a rigorous analysis of why the business is distressed is critical — e.g., Is the business over-burdened with debt?  Are there any significant liabilities such as an adverse judgment or product liability claims?  Has the business lost key management?  Are the target’s problems merely related to poor execution?  Only after such an analysis has been completed can the entrepreneur and his/her transaction team strategize to develop an effective game plan in connection with the acquisition.  Indeed, it may very well be the case that the buyer’s only practical course of action is an acquisition in the bankruptcy context.

2.  Buy Assets, Not Stock (Equity).  Generally speaking, it is usually advantageous for an acquiror of a private company to purchase assets, not equity, of the target for two principal reasons: (i) it will obtain a stepped-up tax basis in the acquired assets; and (ii) it will minimize the assumption of any unwanted liabilities.  If the private company is severely distressed, however, there may not be tax benefits to an asset deal; it is nevertheless clearly the most prudent structure from a liability/risk perspective due to the greater likelihood of undisclosed/unknown liabilities of the target relating to the stresses of the circumstances, including potential tax liabilities, claims/lawsuits accruing pre-closing and perhaps fraudulent activities.  (The target, of course, will often push back and insist that the buyer take the entire company — warts and all.)  The bottom line is that every deal is different and must be structured and negotiated with the assistance of competent counsel, including tax counsel. 

3.  Take Steps To Protect Against a Fraudulent Transfer Challenge.  If assets from a distressed target are purchased prior to a Chapter 11 filing, a significant risk the entrepreneur buyer faces is a subsequent fraudulent transfer challenge.  Under federal law, state law and/or the Bankruptcy Code, the sale can be avoided (i.e., set aside) upon a showing by dissatisfied creditors or by a bankruptcy trustee subsequent to a bankruptcy filing that there was “actual” fraud (i.e., the sale was actually intended to hinder, delay or defraud creditors) or, more likely, “constructive” fraud (i.e., the sale was made for less than fair consideration or reasonably equivalent value and the target was insolvent at the time of, or rendered insolvent by, the sale).  Indeed, this was precisely the ruling in the recent Tousa Inc. case in federal court in Florida (see The Wall Street Journal article here).  Moreover, Section 544 of the Bankruptcy Code permits a bankruptcy trustee to utilize applicable state law to avoid such transfers for “reach-back” periods of six years or more.  To minimize this risk, a buyer must do two things: (i) build the best possible record that “fair consideration” or “reasonably equivalent value” was paid (e.g., by obtaining a fairness opinion from a reputable investment bank); and (ii) require that (A) the sale proceeds stay with (or be used for the benefit of) the target and not be distributed to the target’s stockholders and/or (B) adequate arrangements are made to pay-off the target’s creditors.       

4.  Sign and Close Simultaneously.  Another significant risk the entrepreneur buyer faces when acquiring a distressed business in the non-bankruptcy context is the possibility of the target’s Chapter 11 filing after the purchase agreement has been executed, but prior to closing.  In such event, the target would have the right to “reject” the purchase agreement, and the buyer would merely have an unsecured, pre-petition claim against the target for its damages (often worth pennies on the dollar).  Conversely, the target would also have the right to “assume” the purchase agreement thereby locking the buyer into a deal that, perhaps, may not look so good after weeks/months of the deterioration of the target’s business.  (Not to mention the possibility of a significant time delay in waiting for the target’s decision of rejection/assumption.)  The best way to eliminate this risk is to sign and close the acquisition simultaneously.

5.  “Hold-back” or Escrow a Significant Portion of the Purchase Price.  If the distressed target files for bankruptcy after the closing of the acquisition of its assets, the buyer’s claim for a purchase price adjustment and/or indemnification under the purchase agreement will be treated as an unsecured, pre-petition claim (again, often worth pennies on the dollar).  Indeed, certain indemnification claims may be disallowed if they are contingent at the end of the Chapter 11 case.  Absent a guarantee from a creditworthy affiliate or stockholder of the target (which will obviously be difficult to obtain), the best way a buyer can protect against this risk is to hold-back or escrow a significant portion of the purchase price.  An escrow/holdback is often used in connection with the acquisition of a healthy private company (typically 10-15% of the purchase price); however, if the company is distressed, the buyer should consider a greater amount.  

 Bankruptcy Context

6.  A Section 363 Sale is Usually the Way to Go.  The purchase of assets of a Chapter 11 debtor may be consummated either (i) under Section 363 of the Bankruptcy Code (a “Section 363 Sale”) or (ii) as part of the debtor’s overall plan of reorganization.  A Section 363 Sale is the more common method because it is faster and cheaper (i.e., it avoids the plan confirmation process – with its complex disclosure and voting procedures) and therefore minimizes the risk of a decline in enterprise value and/or a shortage of working capital.  From the buyer’s perspective, a Section 363 Sale is often more attractive than a non-bankruptcy acquisition for a number of significant reasons, including: (i) in most cases, the bankruptcy court will approve the sale of the assets “free and clear” of all liens and liabilities (other than those liabilities that the buyer expressly agrees to assume and, arguably, certain “successor” liabilities such as environmental and product liabilities claims); (ii) the approval of the bankruptcy court should bar any subsequent fraudulent conveyance challenge (as discussed above); (iii) the buyer will be able to cherry-pick assets and contracts (e.g., through the debtor’s assumption/rejection rights discussed above) in ways not possible in the non-bankruptcy context and assumed contracts will be “cleansed” of non-assignability or change-of-control provisions (except for certain contracts such as personal-services contracts and certain intellectual-property licenses); and (iv) State shareholder-approval laws and bulk-transfer laws generally do not apply to a Section 363 Sale.  Note that substantially all of the assets of both General Motors and Chrysler, respectively, were sold as part of Section 363 Sales – though Section 363 was not arguably designed for such sales (see, e.g., this article).

7.  It May Pay To Be the Stalking Horse.  A Section 363 Sale is subject to bankruptcy court approval after notice to interested parties and a hearing.  To ensure that the debtor has obtained the “highest and best” price for its assets, an auction will usually be conducted under the supervision of the bankruptcy court.  Accordingly, the threshold question for a prospective buyer is whether it should play the role of the “stalking horse” bidder (i.e., be the initial party to execute a purchase agreement with the debtor) — or just wait to see the final sale terms approved by the bankruptcy court and then decide whether to make a higher bid (assuming it has such an opportunity).  There are a number of advantages to being the stalking horse, including: (i) more opportunity to conduct an adequate due-diligence investigation; (ii) the ability to set the threshold price and terms of the sale; and (iii) the ability to negotiate certain deal protections and bid procedures, as discussed below.  The major risk to being the stalking horse, of course, is bidding too high — i.e., locking into a deal that may not look so good at the time of the auction.    

8.  Negotiate With All of the Relevant Constituencies.  In the non-bankruptcy context, a buyer generally negotiates solely with the distressed target’s management and need not deal with its creditors (except where the buyer is seeking amendments to debt documents or waivers, etc.).  In a Section 363 Sale context, however, there are a number of different constituencies — often with disparate interests — with which the buyer must deal, including perhaps secured creditors (e.g., first-lien and second-lien holders), unsecured creditors, equity holders (e.g., preferred and common stockholders), bondholders, landlords, indenture trustees, etc.  Indeed, it is imperative that the buyer understand the debtor’s capital structure and the dynamics of the various pieces and then keep all of the relevant constituencies “on board” throughout the negotiation process.  To be sure, a Section 363 Sale will generally require the support of secured creditors unless the sale proceeds are adequate to pay them in full.  If there are first-lien holders and second-lien holders, and the first-lien holders will be paid in full, but the second-lien holders will not, the second-lien holders may be able to block the sale.  Moreover, equity holders and/or unsecured creditors will often oppose a Section 363 Sale if their interests have not been adequately addressed (e.g., if only secured creditors are being made whole by the sale) and they think a plan of reorganization would be more beneficial to them — though a Section 363 Sale may generally be approved over their objection. 

9.  Focus on the Bidding Procedures in the Purchase Agreement.  If the buyer is willing to be the stalking horse, it must bear in mind the context of the transaction and the competitive environment discussed above (i.e., the likelihood of a subsequent auction).   Indeed, the purchase agreement that the stalking horse executes must be approved by the bankruptcy court and will serve as the bid document against which other parties will submit their proposals.  Accordingly, it makes strategic sense to keep the agreement as simple as possible and for the buyer to rely on its due diligence and the order of the bankruptcy court for protection rather than comprehensive representations and warranties and indemnification provisions (which will significantly discount its bid).  The most effective use of the stalking horse’s leverage is in connection with the negotiation of bidding procedures, including: (i) a bid deadline and an auction date, (ii) qualified bidder criteria provisions (e.g., no financing conditions), (iii) overbid requirements and matching rights, (iv) a termination fee and expense reimbursement provisions and (v) auction rules.        

10.  A “Pre-Pack” May Be a Good Alternative.  Time is often the buyer’s biggest (and least predictable) risk in connection with purchasing distressed assets in the bankruptcy context.  The debtor’s filing may, for example, trigger protracted negotiations among the various constituencies, unexpected claims, litigation, etc.  Accordingly, “prepackaged” Chapter 11 plans (“Pre-Packs”) — which may include a Section 363 Sale — are becoming more prevalent  (particularly in light of the increased costs and the difficulty of existing management to control the bankruptcy process under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the new bankruptcy law that went into effect in October 2005).  Indeed, where a company has a sound business model, but is overburdened by debt, a Pre-Pack may be particularly appealing to avoid the risks of purchasing distressed assets in the non-bankruptcy context (discussed above), coupled with the lower approval thresholds of Chapter 11.

1.  Execute an Exclusivity Agreement.  The entrepreneur’s  first step in connection with an acquisition should be to execute a tightly-drafted exclusivity (or “no-shop”) agreement, granting it the exclusive right for a period of time (e.g., 90 days) to negotiate with the seller/target and to complete its due-diligence investigation.  Such an agreement is often part of the letter of intent (the “LOI”); however, from the buyer’s perspective, it may be preferable, as discussed below, to execute a separate letter agreement and skip the LOI.  Indeed, if the buyer executes an exclusivity agreement with the target early on, it can avoid (i) getting into a bidding war with other prospective buyers and (ii) spending significant time, money and resources on due diligence without any assurance that the seller will not strike a deal with another party.

2.  Avoid Negotiating the Material Terms in an LOI.  Other than with respect to a no-shop provision (discussed above) and a Hart-Scott-Rodino filing (discussed below), there are generally no significant benefits to the buyer in executing an LOI.  Indeed, the seller’s negotiating leverage is strongest prior to the execution of an LOI — particularly if the target is represented by an investment banker who has effectively created a competitive selling environment (or the perception of same) — and thus it is in the seller’s interest (not the buyer’s) to negotiate the material terms of the deal in the LOI.  The buyer can avoid this trap in one of two ways: (i) by executing an exclusivity letter agreement and skipping the negotiation of an LOI — i.e., proceeding directly to the negotiation and execution of a definitive acquisition agreement; or (ii) by executing an LOI that includes a binding no-shop provision, but is otherwise non-binding (except perhaps with respect to expense reimbursement and/or other “special” provisions) and is as non-specific/general as possible (e.g., “this letter summarizes a proposal pursuant to which the Buyer would acquire the Target”).  Either approach gives the buyer not only strong negotiating leverage, but also the time and flexibility to complete its due-diligence investigation prior to agreeing to any material terms.  Moreover, it will minimize the risk that the LOI will be construed as a binding agreement between the parties — the major reason why a buyer should be circumspect with respect to the execution of an LOI — leading to potential damages if the transaction is not consummated.  (Note: an LOI does serve a useful purpose in deals greater than approximately $65 million — i.e., it enables the parties to make any required filing under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.)

3.  Do Your Diligence.  A comprehensive due-diligence investigation is critical to the success of any acquisition.  The fundamental purpose of due diligence is to validate assumptions with respect to valuation and to identify risks.  Accordingly, there are typically three separate investigations: operational/strategic, financial and legal.  Clearly, the scope of the investigations must be tailored to the particular transaction; however, it cannot be emphasized enough that most deals fail due to inadequate diligence — resulting in the buyer (i) overpaying for the target, (ii) assuming significant unknown liabilities  and/or (iii) experiencing major integration problems.  As I witnessed first-hand, the more-sophisticated acquirors (e.g., successful private equity firms) spend an extraordinary amount of time in the field (not in the data room) interviewing customers, suppliers, competitors, creditors and, of course, management in order to obtain a deep understanding of the target’s value drivers and business risks.  They also demonstrate extraordinary discipline and will walk away from a deal (regardless of the time and money spent) if they determine that they are overpaying and/or certain significant risks cannot be contained (see “Mistake #4” here).  In short, adequate diligence (coupled with rigorous analysis) is key.    

4.  Buy Assets, Not Stock (Equity).  It is generally advantageous for an acquiror of a private company to purchase assets, not equity, of the target for two principal reasons: (i) it will get a stepped-up tax basis in the acquired assets; and (ii) it will minimize the assumption of any unwanted liabilities.  Indeed, in a stock transaction or merger, the buyer assumes all of the target’s liabilities by operation of law; in an asset transaction, however, the buyer only assumes those liabilities that are expressly agreed to in the acquisition agreement.  There are nevertheless certain liabilities that, regardless of the asset-purchase structure, will be assumed by the buyer under the doctrine of “successor liability” as a matter of public policy, the most significant of which include (i) products liability, (ii) environmental liability, (iii) liability under “bulk sales” laws and (iv) certain employee benefits and labor issues.  Accordingly, the buyer must protect itself in the acquisition agreement against such liabilities with carefully-drafted indemnification provisions.  The buyer must also protect itself in an asset deal against a fraudulent conveyance claim by the target’s creditors by requiring that (i) the sale proceeds stay with (or be used for the benefit of) the target and not be distributed to the target’s stockholders and/or (ii) adequate arrangements are made to pay-off the target’s creditors.  Needless to say, every deal is different and must be structured and negotiated with the assistance of competent counsel, including tax counsel; however, the buyer entrepreneur should always be thinking about cherry-picking assets (with the caveats discussed above).   

5.  Tailor the Acquisition Agreement to the Particular Transaction.  The buyer’s initial draft of the acquisition agreement must be tailored to the particular transaction.  Indeed, this is not the time for the buyer’s counsel to use some off-the-shelf form (or “the agreement we used on that other deal”), with new names inserted.  Instead, the initial draft should reflect ongoing substantive discussions among members of the buyer’s transaction team regarding risk allocation, purchase price considerations, the diligence findings and the overall negotiating strategy.  The buyer’s counsel must, for example, specifically discuss with his client how aggressive the initial draft should be.  Perhaps from the buyer’s standpoint, the purchase price is so good and any significant risks deemed to be remote (or containable) that the buyer wants a “seller-friendly” (or “middle-of-the road”) draft to avoid losing the deal.  On the other hand, perhaps the target has so many potential problems, and the buyer perceives it is paying a full purchase price, that the agreement must be aggressively drafted, with broad representations and warranties and indemnification obligations of the seller to protect the buyer.  Needless to say, the role the buyer’s counsel plays is critical: he must understand the target’s business and the significant deal risks in order to protect the buyer and to ensure that the buyer is making an informed judgment with respect to price and terms.  Deals often take on a life of their own — with emotions and egos involved — and there is nothing more important on the buy-side than a lawyer who is watching his client’s back. 

6.  Escrow a Portion of the Purchase Price.  One step the buyer can take to protect itself is to escrow a portion of the purchase price (e.g., 15-20%) for a period of time post-closing (e.g., 18-24 months).  Indeed, escrows are relatively common (particularly where there are multiple sellers) because of the inherent unfairness of requiring the buyer to sue the seller(s) to try to get some of its money back for a problem or liability it never agreed to take on.  Alternatively, the buyer can push for a hold-back (i.e., a right to hold part of the purchase price) and/or a right of set-off in deals where part of the purchase price has been deferred (e.g., where the buyer has issued a promissory note to the seller as part of the purchase price); however, escrows are obviously more amenable to sellers (i.e., less controversial) because the money is held by an independent third party and the buyer does not have the unilateral right to withhold payment.  A few important points worth noting in connection with escrows: (1) the buyer should avoid limiting its recourse solely to the escrow without any carve-outs unless it is completely comfortable with the size of the escrow and has otherwise made an informed judgment with respect to the significant deal risks and terms; (2) the old pooling-accounting requirements of limiting escrows to 10% of the purchase price and one year in duration are no longer applicable; and (3) where there are multiple sellers, the buyer should require the sellers to appoint a representative who is authorized to make all decisions relative to the escrow (as well as other substantive issues).  This recent M&A Holdback Escrow Report  from J.P. Morgan underscores the importance of an acquiror utilizing an escrow to protect itself in the event of any indemnification claims against the seller (“[o]f the deals analyzed, 40% had claims filed against the escrow”). 

7.  Use Earn-Outs Only As a Last Resort.  Earn-outs (i.e., post-closing contingency payments) are often touted by unsophisticated investment bankers and counsel as an effective way to bridge the gap between what the buyer is willing to pay for a business and the seller’s asking price.  The reality, however, is that earn-outs often lead to major disputes and business problems post-closing and should, accordingly, be avoided if at all possible.  On the legal side, a number of critical issues must be negotiated, including the following: (i) the metric (e.g., revenue, EBITDA, profit, etc.) and milestones, (ii) measurement/accounting issues, (iii) exclusions/carve-outs (e.g., allocation of administrative or general overhead expenses, intercompany transactions and charges, etc.), (iv) the duration of the earn-out period, (v) the effect of acquisitions or dispositions relating to the acquired business and (vi) most significantly, post-closing operational control issues.  The amount of time and energy that is required to address adequately the foregoing issues can be extraordinary (often leading to pages and pages of provisions), and there will still be gaps because it is virtually impossible to anticipate every post-closing contingency.  On the business side, earnouts usually create significant impediments to the integration process and conflicting interests between the buyer and the target post-closing — e.g., if the metric is revenue growth, the target may sign-up a number of new customer contracts that may not be profitable or in the best long-term interest of the business; if the metric is profit or EBITDA, the target may cut back on capital expenditures or other expenses (such as marketing or advertising) — particularly as the end of the earn-out period approaches.  Moreover, target management may lose its motivation if it is unable to achieve its goals and thus is never entitled to an earn-out payment.  The bottom line is that earn-outs are very tricky from both a legal and business perspective and should only be used as a last resort. 

8.  Include a Carefully-Drafted “MAC”.  From the buy-side, one of the most important representation and warranty of the seller (and closing condition if there is a signing and a subsequent closing) is that the business has not suffered a material adverse change (“MAC”).  Lawyers have a field day wordsmithing the definition of MAC — arguing over such issues as (i) the applicable period, (ii) whether “prospects” should be included, (iii) whether the target and its subsidiaries should be “taken as a whole” and (iv) of course, the exceptions.  The bottom line, however, is that most MAC definitions are extremely ambiguous, and there is little case law to provide any guidance as to what constitutes a MAC.  Moreover, the leading Delaware case, IBP, Inc. v. Tyson Foods, Inc., suggests that the standard as to what constitutes a MAC is quite high — “measured in years, rather than months.”  Accordingly, the buyer must be careful about relying on a MAC to terminate an acquisition agreement (or otherwise to sue the seller for breach of the MAC rep) unless the definition includes specific objective criteria — e.g., a specific dollar decrease in EBITDA or sales, etc.  (Note: as a downsize protective measure, an expense reimbursement provision should be coupled with the MAC and other closing conditions.)      

9.  Don’t Give Away the “Basket”.  One of the provisions sellers generally insist on in the acquisition agreement is a “basket” to prevent the buyer from “nickel and diming” the seller for any claims post-closing.  The size of the basket varies from deal to deal, but based on a recent study of the Committee on Negotiated Acquisitions of the American Bar Association (of which I am a member), the norm is approximately .5% of the purchase price.  If the buyer agrees to a basket, there are a number of significant issues that it must address, including the following: (i) it should push for a “first-dollar” basket (sometimes referred to as a “threshold”) as opposed to a “deductible” so that if the seller’s damages exceed the basket, it would be responsible for all of the damages (i.e., beginning with the first dollar); (ii) the basket should only relate to breaches of representation and warranties and not to breaches of covenants or specific indemnity provisions (this is a common mistake); (iii) any materiality qualifiers in the representations and warranties should be disregarded for purposes of the basket — otherwise there would be a so-called “double-materiality” problem (another common mistake); and (iv) there should be appropriate carve-outs to the basket, the most common of which include capitalization, due organization, due authority and ownership of shares. 

10.  Watch Out for Caps.  One of the most important and hotly-negotiated issues in any private-company acquisition is the cap (or ceiling) on the seller’s damages.  Like other material terms in the acquisition agreement, there is no right or wrong answer (or “customary” or “market” amount): it all depends on the context of the transaction — i.e., the bargaining power of the parties, the risk profile of the target, the purchase price, etc.  For example, in an auction context with ten bidders expressing interest in a target, the cap may end-up being 10% or less of the purchase price due to the competition; on the other hand, if the target has a host of significant problems (and/or is financially troubled) and there is only one prospective buyer on the horizon, the cap may end-up being equal to the purchase price (or there may be no cap).  The lesson here (and the key takeaway of this post) is that the buyer must fully understand the target business and the significant deal risks in order to make an informed judgment with respect to price and terms, including the cap.  Indeed, as discussed in paragraph #6 above with respect to the escrow being the sole remedy, if the cap is less than 100% of the purchase price, the buyer should push hard to include certain carve-outs, including the seller’s breach of (i) any covenants, (ii) specific indemnity provisions (e.g., environmental, taxes, ongoing litigation, etc.) and/or (iii) certain representations and warranties (akin to the carve-outs to the basket).

www.youtube.com/watch?v=lHtZY6kPq-w

Mistake #1 – The Failure to Diligence the Guys on the Other Side of the Table 

Whether the entrepreneur is doing a venture capital financing, a partnering agreement with another company or is selling his company to a private equity firm – he must investigate the guys on the other side of the table.  This means determining the reputation of both the company/firm (if it’s not a marquee name) and the particular individuals with whom he is dealing.  Who are these guys?  Are they good guys or are they jerks?  Can they be trusted?  When they say they are going to do something, do they do it?  Do they add value?  Remember, in certain deals (such as a venture capital transaction), the entrepreneur will be, in effect, married to these guys for a number of years.  Accordingly, at a minimum, the entrepreneur should get references and speak with other entrepreneurs or CEO’s who have done deals with the guys on the other side of the table in order to make an informed judgment as to whether they are guys with whom the entrepreneur should be doing business. 

Mistake #2 – The Failure to Build a Strong Transaction Team

Every successful entrepreneur knows the importance of building a strong team, yet they often ignore this rule when putting together a transaction team.  Now is not the time for the entrepreneur to being using his buddy the divorce lawyer or the attorney who wrote his will to negotiate his financing or acquisition; nor is it the time to use his bookkeeper to handle tax and accounting issues; nor is it the time for the entrepreneur to play lawyer and start pulling forms off of the Web.  As I learned first-hand in New York, the quarterback of the transaction team should be a strong, experienced corporate lawyer – he’s the guy who is going to drive the deal, watch the entrepreneur’s back and help the entrepreneur build-out his team.     

Mistake #3 – The Failure to Run the Negotiations Through the Lawyers

The entrepreneur should do what he does best — i.e., build companies — and leave the deal negotiating to a strong corporate attorney (or an investment banker in the acquisition context).  Entrepreneurs are generally no match for sophisticated venture capitalists or private equity guys or corporate development guys who do deals for a living.  Accordingly, a smart entrepreneur will stay above the fray and let his corporate attorney run the deal – and business issues can easily be handled at an all-hands meeting (whether in-person or via conference call).  Experienced deal guys on the other side of the table may try to do an end-run around the entrepreneur’s lawyers, but the entrepreneur must remain disciplined and simply advise the guys that all negotiations are being run through his lawyers. 

Mistake #4 – The Failure to Check Their Emotions and to Remain Disciplined

Entrepreneurs (particularly those who haven’t had much deal experience) often become emotionally wedded to a particular transaction and are unable to maintain their objectivity the further along they get in the process.  Too often, an entrepreneur will fall in love with a particular deal — like the first-time home buyer — which will lead to poor decision-making and risky positions.  As I saw first-hand in New York City representing big, successful private equity firms, the best deal guys are masters at taking their emotions out of transactions and being extremely disciplined.  Indeed, they will generally walk from a deal if they get out of their comfort zone (e.g., with respect to the risk profile, price, etc.) — regardless of how much time and money they have expended.  It is critical that the entrepreneur understand this dynamic — and that’s why it is so important to develop a game plan early on — because once the emotions start playing havoc, you have to stay disciplined and stick to your plan (your dealbreakers, etc.) and be willing to walk, if necessary. 

Mistake #5 – Blinking First

There comes a point in time in just about every deal where both sides have dug into certain positions and the question becomes which side will blink first; e.g., in a venture capital financing, perhaps the issue is the liquidation preference or, in an acquisition, perhaps the issue is carve-outs to the cap on liability.  Whatever the issue, the lesson for the entrepreneur is clear (albeit difficult to execute): in order to maintain negotiating leverage and credibility, the entrepreneur should not blink first.  Indeed, if the entrepreneur has flatly stated that “this issue is a dealbreaker,” but then blinks and nevertheless agrees to go forward with the transaction despite not getting what he asked for, he will have completely undermined his credibility and will have his clock cleaned with respect to any other significant issues.  Like poker, if your bluff gets called, it will be difficult to bluff again.  Which brings us back to the important tip in #4 above: run the negotiations through an experienced corporate lawyer (or an investment banker) who does this stuff for a living.

1.  Be Careful with Private Equity Buyers.  Private equity firms are in the business of buying and selling companies.  Accordingly, they are extremely sophisticated and savvy and are often represented by large, aggressive law firms.  Deals with private equity buyers are generally more complex than those done with strategic buyers due to, among other things, the level(s) of debt added to the target and/or financial engineering.  Moreover, unlike most strategic buyers, private equity buyers (i) usually require the selling entrepreneur to rollover part of his/her equity into the acquirer (i.e., to maintain skin in the game) and (ii) may require a financing condition in the acquisition agreement – which obviously adds a level of uncertainty to closure. 

2.  Hire an Experienced M&A Lawyer Before You Hire an Investment Banker.  An experienced M&A lawyer will not only help protect the selling entrepreneur in the actual sale process, but also will help retain a strong investment banker and negotiate the banker’s engagement letter.  Indeed, investment bankers can (and should) be played off of each other to lower their respective fees — just like effective bankers play prospective buyers off of each other to get a higher sales price and better terms for the seller.  This approach can lead to substantial savings for the entrepreneur. 

3.  Get Your Papers in Order.  An easy way to instill confidence in prospective buyers is for the selling entrepreneur to deliver (or make available) a complete, well-organized set of diligence documents.  Accordingly, prior to initiating the sales process, the entrepreneur should ensure that the corporate books are cleaned-up, agreements are memorialized and/or updated to the extent necessary, public records do not reflect previously-released liens, etc.  Moreover, financial statements should be recast by experienced accountants to paint a more accurate financial picture of the business.

 4.  Develop a Game Plan.  Every deal is different — different players, different negotiating leverage, different risks, different timing — and it is thus imperative that the selling entrepreneur sit down with his/her transaction team and strategize to develop a game plan in connection with the sale.  The entrepreneur must communicate to the team, among other things, his or her deal-breakers, wish-list, problems and, of course, budget.  An experienced M&A lawyer will quarterback the transaction and ensure that the game plan is being executed. 

 5.  Negotiate the Material Terms in the Letter of Intent.  The entrepreneur’s strongest leverage as a seller is prior to the execution of the letter of intent (the “LOI”).  This is the time when a solid investment banker and/or M&A lawyer will create a competitive environment (or the perception of same), and prospective buyers will be required to compete on price and terms.  One buyer, for example, may offer a higher purchase price, but require a “cap” (as discussed below) equal to such price; another buyer may offer less, but only require a 10% cap.  Accordingly, prior to choosing a buyer, the selling entrepreneur should negotiate and weigh all of the material terms of the offer, and the LOI should reflect such terms. 

 6.  Sell Stock (Equity) Not Assets.  As a general rule, the entrepreneur should sell equity — not assets — for three significant reasons: (i) potential tax savings if the target is a “C” corporation; (ii) to pass the target’s liabilities (disclosed and undisclosed) onto the buyer; and (iii) because it generally requires less documentation and less time to closure (which means less legal fees).  Obviously, every deal must be structured with the assistance of competent counsel, including tax counsel; however, selling entrepreneurs should always be thinking about selling equity, not assets.

 7.  Insert a “Basket” in the Acquisition Agreement.  The buyer should not be permitted to “nickel and dime” the selling entrepreneur for immaterial breaches of the representations and warranties.  Accordingly, the seller should insert a basket (i.e., a deductible) into the indemnification section of the acquisition agreement (e.g., 1% of the purchase price).  The buyer thus would only be permitted to recover for its aggregate amount of damages in excess of the amount of the basket (though buyers will often insist that if its damages exceed the basket, the seller should be responsible for the first dollar).  Sellers should also push to include a mini-basket for individual claims — e.g., unless the buyer’s damages exceed $10,000 with respect to a particular claim, it does not get counted toward the basket. 

 8.  Cap Your Potential Liability.  The entrepreneur wants to sleep well after his or her business has been sold and enjoy the fruits of years of labor.  Accordingly, it is critical that certain key provisions be inserted into the acquisition agreement to protect the entrepreneur post-closing.  One such provision is a cap on liability, which, as noted above, should ideally be negotiated in the LOI.  Sellers should strive for a cap of 10% of the purchase price (or even less, with strong leverage) and should also try to minimize any buyer carve-outs.  The seller’s message to the buyer is reasonable: inherent in any business are certain ongoing risks, and thus once the business is sold, you (buyer) should only be able to recover a limited amount of the sale proceeds (absent fraud).   

 9.  Insert a Non-Reliance Provision in the Acquisition Agreement.  Another important seller protection that should be inserted into the acquisition agreement is a so-called “non-reliance” provision, which requires the buyer, in effect, to acknowledge that it is buying the business based solely on the seller’s representations and warranties in the acquisition agreement and its due diligence investigation.  Indeed, such a provision is intended to prevent the buyer from suing the seller based on any oral statements, writings, projections, etc. outside the four corners of the acquisition agreement.     

10.  Get the Buyer to Pay a Termination Fee.  The selling entrepreneur should require the buyer to pay a fee if the acquisition agreement is terminated through no fault of the seller (e.g., if the buyer is unable to satisfy a financing condition); this is sometimes referred to as a “reverse break-up” fee, which can be as high as 10% of the purchase price (e.g., in the sale of Neiman-Marcus) or as low as the amount of seller’s transaction expenses.  This is an issue that is often not addressed by middle-market sellers — but should be.