The answer is a resounding, maybe
A company owner recently put his company up for sale. Interested parties arrived to kick the tires of the business and a particular company submitted a Letter of Intent that was accepted and due diligence began. Early on in the due diligence, the acquirer’s team identified issues with the seller’s customer multi-year contracts and not only did this slow down the deal, but it also caused the acquirer to reduce their offer after reading the documents.
Having multi-year contracts can very much help build your company worth because they represent visibility to future revenue. But, your company worth can be negatively impacted and your exit process negatively impacted if an acquirer throws a red flag over language your team has accepted in contracts. Here are just a few of the more common red flag items:
- Firm fixed pricing – if your long-term contract locks you in regarding your pricing or only allows for small escalators despite your business being exposed to potentially higher material or labor costs, this can reduce the benefit of having the contract. If you have to accept related language, at a minimum ensure you can raise prices to fully offset any cost increases you become faced with.
- Company Ownership Change of Control – avoid accepting language that requires you to first tell the other party you’re contracted with that you’re planning to sell your company and you have to tell them before you are allowed to talk to anyone else. The only language to accept would be that you have to notify them within a reasonable amount of time after the sale has been completed, not before.
- Right of First Refusal – this language says when you decide to sell, you can’t speak to any third parties about buying your business until you first tell the party you have the contract with because they have the first right to consider acquiring it. Only once they decide whether they want to acquire your company will you know what path to take. This language locks you in to only negotiating with them (leaving you no negotiating leverage because you don’t have the ability to have multiple parties fighting over your business) or they have to give you a formal release of this contract language which can take time to get. Any way this plays out, it can very much impact the valuation placed on your business and it can definitely slow down your exit process.
- Sharing of Intellectual Property – avoid language that has your IP being shared with third parties. This occurs sometimes when your part or your service is then used as part of the customer’s solution and they believe that by combining your product or service with theirs, this entitles them to lay claim to some of your IP. No acquirer will want to pay you a premium for your business when knowing that a third party also has declared rights to your IP.
- Limits of Liability – acquirer’s don’t like language that has your company having a future unlimited exposure if your product or service could be challenged in how it performed. If it’s deemed that your product or service contributed to a failure and a party comes to you for damages relief, you’ll want language that does put some limits on your exposure as unlimited exposure will definitely be cause for concern for the acquirer.
There are a few lessons to be learned here. First, the seller mentioned above should have engaged with a professional that does deals for a living. This would have led to a due diligence dress rehearsal prior to starting the exit process. It’s during this rehearsal that any issues with contracts would have been flagged and attempts could be made to remedy the issues prior to bringing the company to market or at a minimum, be able to position the matter with the acquirer versus them bringing it to your attention.
Next, there are 3 additional things to have in mind. First, ensure that whoever in your company is negotiating customer and vendor contracts knows to look for these clauses sometimes embedded deep within the pages of the document. Second, ensure that a contract attorney is involved at least on the larger impact agreements. Third, negotiate contracts wearing two sets of glasses. Wear your glasses so the language is good for you and your business today but also wear the glasses of a future acquirer as having that lens can help you avoid future headaches when trying to sell your business.
Avoid working hard these next few years only to find out that your deal to your euphoric outcome is impeded because of legal language you signed up for today. Meet with your team and discuss how you manage negotiating these contracts to ensure nothing will fall through the cracks.
