There are always events that inevitably happen during the course of selling a business that create bumps in the road. A snag comes up in diligence that the seller needs to address. The buyer and seller disagree and the transaction pauses while they re-negotiate the terms of the deal. Or a customer, vendor or employee issue arises that the owner must handle before the transaction can move forward.
Issues like these are generally unforeseen or unanticipated and must be dealt with as they arise during the sale process. However, there may be other issues that the owner knows about or should have known about, prior to or early on in the deal that they did not or chose not to address. These issues can then come back to slow down or even derail the transaction at the eleventh hour. We call these “transaction SNAFUs.”
Here are 6 avoidable transaction SNAFUs:
Failure to address cross-collateralization issues with the company’s lender: In this scenario, the owner of the company also owns the real estate occupied by the company; however, the real estate is housed in a separate legal entity. The lender that provides the credit facility to the company also provides the mortgage financing to the real estate company. Finally, the operating company credit facilities and real estate company mortgage are cross-collateralized and the operating company may guarantee the real estate loan since the operating company is typically the primary or only tenant of the building. In a typical sale transaction, the owner would seek to sell the operating company, repay the debt associated with the operating company, retain the real estate, retain the real estate mortgage, have the cross collateralization (and operating company guarantee) released, and lease the real estate to the buyer of the operating company.
The senior lender will likely object to this transaction for several reasons. First, as a policy, the bank may only lend against industrial real estate if it is owner occupied; said differently, the bank does not lend against industrial investment real estate, which would be the new characterization of the loan. Second, the bank would not have the benefit of the operating company collateral (or guarantee) post-closing, which was incorporated into the bank’s original mortgage underwriting. Finally, the bank’s underwriting of the credit was based not only on the value of the underlying real estate, but also on the credit of the tenant. From the bank’s perspective, the operating company and real estate company are virtually one and the same. Said more directly, the basis for the original real estate underwriting and loan has changed for all of the reasons described above.
Solutions to the real estate SNAFU include i) proactively refinancing the real estate mortgage with a new lender that is comfortable bifurcating the operating company and the real estate company or ii) planning to use some of the proceeds from the sale of the company to repay the mortgage debt, in each case so that the bank cannot delay or derail the transaction.
Not keeping minority shareholders in the loop about the deal: The owner may assume that if they believe the proposed sale transaction is a good transaction for all of the shareholders then minority shareholders will concur and just go along with the deal. However, shareholders who were not kept apprised of the transaction may prove to be uncooperative, which could end up delaying the transaction. These minority shareholders may still believe that the transaction is good for all shareholders including themselves; however, they may prove to be difficult late in the transaction simply because they felt slighted in the way the sale news was communicated to them. Once again, this is an issue that can largely be avoided provided the owner makes a concerted effort to keep all shareholders informed during the sale process.
Not addressing required consents: Again, an owner may misjudge whether key parties — customers, vendors, landlords, or others that have consent provisions in their agreements with the company — will in fact consent to a change of control. The owner may deem it advisable to float “trial balloons” with some of these constituents prior to a transaction to gauge the mood of these key constituents. The owner may also need to leverage their relationships with key parties to gain their consent. Failure to do so could result in a delayed closing, or in the worst case scenario, a busted deal.
Not taking care of key employees: The owner may assume that employees who are critical to the sale process, such as the chief financial officer (CFO), will selflessly take on the “second job” of facilitating the sale process. If they are owners, this may be a valid assumption. However, if the owner has not “taken care of” their key non-owner employees — promising them bonuses that are contingent on closing the sale — key employees could become ornery, unhelpful, or downright disruptive to the sale effort. Everyone in the company should be working toward the same end — closing the transaction — but if the owner has not taken the necessary steps to secure key employees’ buy-in at the outset, any lack of cooperation or collaboration could negatively impact the deal’s outcome.
Failing to confirm that divorce decrees are iron clad: Before entering into a sale process, it is critical for owners to confirm that any divorce documents are crystal clear regarding an ex-spouse’s rights in the event of the sale of the company. Not doing so could cause the owner even more heartache if a disgruntled ex-spouse seeks financial restitution from the sale of the company.
Hoping for the best: It has been said many times by many famous people: “hope is not a strategy.” However, sometimes the owner will be aware of an issue and hope that it will just go away or somehow resolve itself during the course of the transaction. This seldom happens, so owners should be mindful of such issues and address them proactively rather than “hoping for the best” that they will just go away.
There will always be hiccups that arise during the course of a transaction. However, transaction SNAFUs like these can be avoided if the owner addresses them proactively rather than allowing them to languish and hoping that they will magically disappear. In addition, the owner who has been thoughtful and proactive about preparing their company for sale is one who will not only orchestrate a sale process that achieves their objectives, but will also maximize the likelihood that the transaction will in fact close. As such, it is in the owner’s best interests to address potential transaction SNAFUs prior to the sale process rather than choosing to ignore them and hoping for the best.
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