Friday, August 12, 2011

Keeping Your Hard-Won Purchase Price. Risk Allocation in Business Sales, Part 1 of 3

Purchase price is everything in business sale transactions. From the initial inquiries of a possible buyer to the heated battle over EBITDA in a letter of intent, purchase price is the primary, if not only, focus of many sellers of human-owned business. Investment bankers or business brokers who facilitate the sales process do little to dampen the price fixation; after all, they get paid a percentage of the deal. So, I get to be Mr. Downer and ask: “What about indemnification?”

Purchase Price is Great, If You Get to Keep it.

Most first-time sellers of a business are shocked to learn that fabulous purchase price they just negotiated is at risk for years, if not forever. Even worse, they could potentially lose it all and more. Yes, you can sell a business for $10 million and end up paying the buyer $15 million in damages. But it doesn’t have to be like that; the risks of the business can and should be clearly allocated by the sales contract.

Risk allocation occurs in all kinds of business contracts. Earlier this summer, I covered one aspect of risk allocation—indemnification against one’s own negligence (I screw-up, you pay) --in the context of a lease provision that was upheld by the Colorado Supreme Court. In this mini-series, I discuss a much broader, and inevitable, question: what liability does the person who sold a business have to the person who bought the business?

Unfortunately for anyone who has ever read a fifty-page, single-spaced, purchase agreement typical of many middle-market business deals, the answer comes around page 40 (just before you get to the really good miscellaneous stuff, like a Construction section’s “Including means including but not limited to” and “words of the masculine or neuter gender shall include the masculine, neuter and/or feminine gender”). The seller usually stalls somewhere between pages 2 and 8, where the purchase price and terms of payment are described, and quits for good in the high 20’s/low 30’s; a two page representation and warranty on ERISA compliance often does them in.

My most valuable advice to sellers: after you read how you get the purchase price, flip immediately to the indemnification section where you learn when you have to give back the purchase price. Even if you never read the next two installments of this mini-series you will be ahead of most sellers. Leave the middle 30 or 40 pages of warranties and representations to your lawyer to walk you (and your leadership team) through in the process of preparing “disclosure schedules,” which I’ll cover in Part 2 before explaining in Part 3 why a carefully drafted indemnification section is a seller’s best friend.

1 comment:

  1. thanks for the heads up! Indemnification clauses will be emblazoned within my head from now on.

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