Getting to Closing
Getting to the closing date is a lot more challenging than most searchers think. Many things can happen that cause deals to fall apart. Just knowing what to expect during the closing time-frame is helpful in preparing for a roller coaster of emotions and stress. I observe that 60% percent of the searcher’s time is consumed while driving to close a signed LOI; yet when searchers land their first LOI, they are already dreaming of where to park their car every morning at the business they will purchase! Don’t jump the gun!
A review of recent search transactions shows an average of 3.2 LOIs per search, with a range of 1 to 9 LOIs. Furthermore, searchers spend from 1 week to 11.5 months on an LOI, with the average being 2.7 months. Getting to closing on the “final” deal averaged 5.6 months, with a 2.5 to 11.5 month range. Failure to close is a lot more common than getting to close; sobering statistics for any searcher. Many things can happen that are out of your control; best to get the transaction closed before they do!
Start with a well-constructed LOI
Searchers have learned that packing in as much detail into the LOI saves time during the closing process. This may entail iterative rounds of LOI negotiations, but deferring hard discussions with sellers on a variety of details until the middle of due diligence often is very damaging to the “trusting” relationship you are looking to nurture with the seller – and increases your chance of a failed deal.
Working capital adjustment language can be very confusing to the seller and it is best to put it on the table at the start, as it can represent a huge swing in cash flow when trued-up. Even the concept of 12 month “escrow” standard in most legal agreements needs to be surfaced early. Hammering out details on inventory obsolescence and is important to layout before starting due diligence. Include them all in your LOI instead of saying to the seller that you will work these out in the legal documents.
Being able to refer back to the LOI that the seller’s note is “subordinated” to the bank debt helps with credibility if presented in the first draft received by the business owner. The length of the non-compete and how it will be paid along with continuing compensation for owners are important to nail down before starting the LOI period of exclusivity. Likewise, if funded searchers are unable to provide a personal guarantee on the seller note, this should be well understood in early IOI discussions.
Language used during closing can be very confusing to the seller. The Purchase and Sale Agreement (P&S) may be called the Asset Purchase Agreement(APA) or even an Operating Agreement (OA) and sometimes the LLC Agreement. Brokers, depending on their background, may use different names for documents than do the lawyers. Searchers have to provide translations for all of these to avoid confusion in the seller’s mind.
Be prepared to repeat yourself regularly, and constantly search for “understanding” when things are confusing to you or the seller. The business owner will appreciate your efforts for clarification. Both you and the seller have probably never been through this before, which may be a source of common bonding.
Mistakes will be made along the way, however the searcher may be the only one to review the documents in detail. There will be no one checking your work, so be sure to double-check and pay close attention to document details. You may not be able to write legal documents, but you will have to learn how to read them!
Sellers call most of the shots, you just control the process
Searchers have seen deals in which the seller “walked away” 5 times during the final 10 days before closing, and still get across the finish line while others never came back! Owners can dig in their heels for small issues knowing that they are in the driver seat. You need them to be actively engaged in the business during closing; checking out early may put the business at risk during the 5 month average closing process. Being prepared to know what is a “must have” and a “nice to have” from the seller can be a critical distinction.
Observe intently for changes in the seller’s attitudes and behavior when the closing time period inevitably extends longer than they expect. Over promising a closing in 60 days can impact your credibility. Utilization of deadlines and tracking delays and missed promises by the seller or their team will help if you are being held to the exact closing date by the seller.
Sellers who stop the closing process often cite these time delays and say “I just changed my mind, and have decided not to sell”. You may never hear the “real” truth and motivation. Indeed, they may have decided that they just don’t want to turn over their “legacy” to you and there is nothing you can do about it; but you may not hear it in those words. Best have this happen early in the process so you can move on.
Be wary of the business owner who has “poor” advisors. During the negotiation process this may play to your favor, but during closing discussions it may be more difficult for the seller to understand what “common” practices are, slowing the deal or killing it altogether. Privately suggesting that the seller consider more experienced advisors has worked for some searchers. Know when to use your own legal team to deliver bad news or when it makes better sense to deliver it directly to the seller yourself.
Most sellers restrict access to their employees, customers and vendors in fear of damaging their credibility if the deal falls apart. However, as trust develops between searcher and seller, these boundaries begin to drop away. It is always better for the searcher to get this deeper-level engagement early in the closing process to reinforce the psychological commitment with the business owner to follow through with the transaction and not back out.
Paul Thomson at Scottish American was actually hiring/firing and making key decisions for the business, at the seller’s request, a full 3 months before closing. Another searcher spent the last 30 days living local to the seller and visiting the business daily to be sure nothing slipped in the closing schedule yet still missed his target by 2 weeks.
Frequent dialog with the seller during this stage is a must. Don’t let more than two days go by without having an update with the seller to insure them that you are on track to close; phone call, in-person visit, email or even text. Your silence will too often be viewed with trepidation by sellers who seem always paranoid that the deal will fall apart. One searcher regularly took the owner and spouse to dinner without any “deal” discussions to focus on building their relationship.
This is a lot like herding cats
With the exception of the searcher, the parties needed to get to closing such as the seller, banker, accountants, appraiser, lawyers representing seller, searcher and bankers – all have other demands on their time. Your single deal is just another day in a file folder for them. The challenge is to be getting the “unfair” share of their time and keep them on target toward getting the transaction done.
Many of these resources can serve to strengthen the trust between you and the seller. In one case, an accountant who was brought in to assess the QOE (Quality of Earnings) for both the banker and the searcher impressed the seller, despite being very tough and competent. Doren Spinner of Muir Beach stresses how important it is to just be available and accessible: “Calls, emails, and signature requests are coming fast and furious and most everything is time sensitive. Never wander far from a fully functional office. Tapping off a quick text message won’t do it.”
Start early dialog with your investors, especially a few of the most influential ones. An early “teaser” on the deal and an “ask” for investment appetite, will help mitigate surprises. Of course, they will want a full CIM, just like the bankers, but this can usually be deferred to later in the process. Be prepared for as much as 30% of your funding to drop out, and in some instances there may be some “shortfall surprises” just before closing. “Over-raise” your funding requirements to mitigate any final re-negotiations; seek out investors who may want higher allocations. Max Sadler at Union Square Capital was able to fall back on a willing senior lender to provide additional funds.
While a few searchers have utilized their investors to interface directly with sellers, you want to be sure you are doing it for the right reasons and objectives. In some instances, this has backfired and sellers have become intimidated or confused.
Once the QofE is completed, you have term sheets from banks and commitments from investors, much of the closing activity is around the legal documents. The level of legal detail for first time searchers is much higher than they may have been exposed to in any prior experience, thus raising anxiety levels, so it pays to get started on these quickly. It is always a good practice to convince sellers to let your team “prepare” the documents, rather than “reacting” to and heavily red-lining the seller documents. Be watchful of rising legal fees and don’t hesitate to ask for weekly summaries of costs from you own attorney. A recently-closed search had a $680,000 in legal bills at closing, much to the searcher’s surprise. Self-funded searchers are seeing legal costs from $15K to $50K for their deals.
While searchers are probably viewed by many resources as challenging “first time” clients, you want to be sure they are effectively representing your desires during the process. Two days before closing, one searcher had to remove his own attorney when he discovered that the lawyer was not accurately representing the searcher’s position on many critical items. Luckily, the seller communicated this quickly enough to avoid having the deal fall apart.
Often times, it is the “lower-level” staffers that have more of an impact on getting things done than the higher-level partners and managers. More than one searcher has benefited from keeping open dialog with these support staff far below the Partner and Manager level to keep their deal moving forward. Bank tellers, paralegals and assistants can be helpful in bailing you out when you need help urgently.
Surprises will happen, get over them and move on
Discovering a tax lien or 3 years of unpaid taxes may or may not derail a deal. In one case, a key manager had a heart attack 2 weeks after signing the LOI and upon return was disappointed to learn about what had been negotiated for him; the deal was changed, and closing happened. In another, the bank misplaced an investor’s check – throwing chaos and doubt into the outcome for a few days!
A sudden illness in a seller’s family, or in one case, the seller himself halted the process, leaving the searcher at the altar. One deal was derailed when a previously silent partner became suddenly demanding. In another case, the workers compensation carrier reneged the day before closing on their previously bound insurance package, but by the next day the searcher had found a less-expensive backup willing to step in.
A more common deal-breaker is a 3-month decline in revenue or income that is not in line with projections or past history. Sellers can become embarrassed and unwilling to re-negotiate terms, and in one instance pointed out that the searcher was just not mature enough to handle these “slight” ups and downs in their business; the searcher had to walk away two days before closing. One of the biggest reasons for deal failure are financial diligence that does not support EBITDA provided, and a failure to raise sufficient funds to support a “too high” offer. The alternative is just as challenging with all of the documents, projections and estimates based on history and the seller expecting to see a higher valuation – hold fast!
As the closing table comes nearer, expect a lot of “hands to be out” for a variety of licensing fees, expert evaluations, down payments or even some COD charges once vendors recognize that you are a different entity than they have been dealing with. You may even have invoices from the lender’s lawyer who you can’t “speak” with because they work for the bank. Be sure to raise enough funds to cover all these contingencies.
Many of these issues can be overcome, but as one searcher reflected, it seemed like he had just scaled the last hill, when another one popped up ahead of him that was even higher.
Expect an emotional roller coaster
The most common issue facing searchers is the length of time that closing takes, 2-3x longer than they anticipated, were promised by their professional resources and most importantly “promised” to the seller. Faced with the dilemma of scaring away the seller with an overly long time frame, most searchers communicate shorter time-frames, only to have them broken. Best, if possible, to be honest up front by stating a range and communicate progress regularly. Pre-negotiate costs with your own resources up front, instead of a “time expended” basis. Expect delays, delays and more delays which will drive you crazy – stay relaxed, this is just part of the process!
Knowing the statistics about failed LOI’s, searchers learn to avoid thinking too hard about the future, for fear that it will just not happen. There will be lots of personal adjustments, in addition to learning how to run a business. In reality, the “frenzy” of closing will diminish rapidly and the pace of learning the business and understanding the capabilities and opportunities will be at a much slower pace. (See Blog Post on Taking over the business)
This can be a very lonely time. The pipeline for other deals must be cultivated. Devoting at least 2 days a week to non-closing search activity is very challenging, and most searchers make the mistake of not being as diligent at this as they should. Reaching out to other searchers is especially useful at this time. Ben Murray from New Forest observed that, “Lots of times I asked former searchers what they did and it saved a lot of time and worry.”
One partnered-search team regularly scheduled walks in the local park together to have time away from the “deal”. Others raise their level of exercise to compensate for the adrenaline drain on their systems. More than one searcher reported the importance of having their spouse’s support and willingness to just “listen” at the end of particularly difficult days. At the actual closing have someone along with you while you sign 200+ documents!
Be sensitive to the reaction that the seller may be having to this process. Provide some hand-holding and listening to their own concerns along the way to reduce both their and your stress levels. Don’t be surprised at the seller excitement of looking at buying a fancy sports car or new vacation home mixed with feelings of sadness and loss of leaving their business behind.
During closing, no one has same sense of urgency to make it happen than you do. Being forceful, assertive, and pushy will serve you well during close, and later as an entrepreneur. Many searchers reflect back that they spent too much time on due diligence analysis about the industry and formulating their own future plas for the business and this level of over-thinking prevented them from closing sooner. You have limited time during your search so must always be asking yourself “will this deal close”, not “is this a good deal”.
Little details matter a lot and you are responsible for dealing with them. Be prepared that the reward of actually closing fades quickly as you are immediately faced with the daunting and entirely new task of running your own business. Despite this, it was your goal when starting a search, so take at least a little time to celebrate reaching the finish line at closing.
Feel free to share some of your own best practices or experiences in dealing with these issues in the blog comments. I encourage comments and dialog, allowing all to learn from both my views and the views of others – a virtuous learning cycle. Jump right in!