Legal Watch/RMR: 7 Deadly Sins

It’s not eternal damnation, but might feel like it. Commit any of the seven deadly sins I’ve identified in my 20 years of counseling buyers and seller through hundreds of transactions, and you will suffer—loss of time, loss of money and perhaps the worst fate of all—loss of the most lucrative deal you could make. Read them below and then go forth and sin no more.

1. Retain your brother-in-law, the world’s greatest real estate lawyer, to close your deal. I am continually amazed at parties, both buyers and sellers, who use counsel who have no industry expertise. I will never understand how sellers who may have spent their lives building a successful security business who undertake the single most important transaction of their lives led by professionals with absolutely no experience with industry deals, or how to overcome obstacles—and there are always obstacles and issues—to get a deal closed. Inexperienced professionals cannot understand the scope of certain risks, how to avoid them or where the real landmines may be hidden. Why pay them their hourly rate to learn on the job?

2. Conduct inadequate due diligence. What’s the last and worst circle of hell? Finding an expensive problem after closing. Just ask a buyer who gets stuck paying seller’s $10,000 unpaid state sales taxes or a seller who experiences a buyer’s stingy reputation paying holdbacks. No matter which side of the deal you are on, the most important advantage in any transaction is knowledge. The better your knowledge, the better your deal. Experienced buyers examine a seller’s company with a magnifying glass. Sellers should do the same before the buyer does in order to identify and address potential issues that may delay closing or affect the purchase price. Think of it as a “business physical” to help you get in shape before embarking on the biggest transaction of your life. In my experience, this sort of an investment pays seller a handsome return on exit.

3. Over promise and under deliver. An acquisition is an extraordinarily sensitive process with a great deal at stake. Both buyers and sellers want to get a deal done, but they have competing interests. Egos also may be involved and emotions may play a large role, especially when a seller is selling a life-long or family business. Much of the deal process is about building trust and every statement or act by either side has potential consequences—including on the deal price. Sellers shouldn’t say things they can’t prove and support and buyers shouldn’t promise more than they can deliver. I’ve seen more than one deal crater because one side or the other said one thing and did another.

4. Ignore seller’s contracts. In an industry in which contracts are essential to limiting liability, many sellers surprisingly still have completely inadequate contracts. A poor quality contract (or missing contracts) can cause a buyer to significantly slash the purchase price, require seller to re-contract the base before a postponed closing or as a condition of getting an escrowed holdback, or even provide buyers with an excuse to walk from the deal completely. Some recent contract-related mistakes I’ve seen include contracts that are expressly non-assignable, residential agreements that omit the FTC required three-day right of rescission or contracts that have such jumbled text that the contract’s term is impossible to determine. The discovery of these issues during the deal brought the transaction to a screeching halt, forcing seller to spend time, energy and money to address these issues in order to get the deal closed.

5. Traffic in accounts on commingled or uncontrolled communication paths. A short parable: Shortly after closing one of my first deals, my buyer-client re-pointed purchased telephone lines to its central station. The acquisition agreement included detailed representations and warranties that all of seller’s accounts were on the purchased lines and that no other accounts were commingled on those lines. The central station soon began to receive errant signals from unknown accounts. Buyer immediately pointed the lines to back seller’s former monitoring facility and seller was obligated to pay the rather sizeable bill for re-programming accounts to a new clean telephone line. (Fortunately, no fire signals went unanswered.) Don’t suffer a similar fate. Review the records carefully and consult the monitoring facility. Make sure your agreement provides ample protection on this and other important technical industry issues. And if you’re a buyer, get title to the phone lines.

6. Misrepresent attrition. Attrition is a key metric for every knowledgeable buyer. Every seller (and every buyer) has attrition—normal attrition (e.g., customer moves, bankruptcies, deaths, etc.) and extraordinary attrition (e.g., related to a specific sales program). A seller should not orally represent its annual rate of attrition unless seller KNOWS its representation is factually accurate, has the records to prove it and can calculate attrition using an industry-acceptable formula. The generally accepted industry norm is about 12 percent, which means that for a seller who over promises and under delivers on a key deal metric such as attrition by representing a six percent rate, for example, the buyer’s purchase price will be subject to a six percent reduction, since buyer’s purchase price was premised on the lower attrition metric. Industry diligence experts can help sellers identify the true rate of attrition (calculated on an annual static pool basis) to ensure accuracy before entering into the sales process. Contact me and I can provide the formula.

7. Ignore aging. Pricing of an industry acquisition is premised on “performing” RMR and one of the requirements is that payment due for a particular account be within an agreed-upon time (usually 60 to 90 days). Plenty of sellers scramble before closing to get subscribers to pay open invoices in order to qualify accounts as performing. Why not start that process years ahead of time with disciplined collection efforts? Late payers always exist, but with a disciplined collection effort, sellers can limit their downside risk on exit.

 

 

Eric Pritchard co-chairs the electronic security group at Kleinbard Bell & Brecker LLP. Pritchard focuses his practice on the electronic security industry with an emphasis on acquisitions. This column does not constitute legal advice; contact an attorney with specific questions.

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