Top 5 Deal Protections for Business Buyers
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In the complex world of business acquisitions, Buyers face a myriad of risks and uncertainties. Buyers navigating these challenges must ensure that their investment is protected both during and after the transaction. We’ll evaluate five important deal protection strategies for Buyers to consider when acquiring a business.
Strategy #1: Rollover Equity
One of the best ways for Buyers to mitigate risks when acquiring a business is to utilize rollover equity to fund a portion of the purchase price. Rollover equity is a purchase mechanism where the Seller receives stock or interests in the business post-acquisition as part of the sale. Sellers will receive rollover equity in the Buyer’s acquisition entity or the existing entity, subject to the terms of the transaction documents and corporate governing documents. When negotiating rollover equity, Buyers should consider the percentage of equity to be rolled over, the duration of the hold period, and the rights associated with the received equity, such as voting rights and profit shares. Rollover equity can be lucrative to Sellers and mitigate Buyer’s post-acquisition risks, as Sellers will continue to have an economic interest in the business following the sale and Buyers can ensure that Sellers remain vested in the success of the business.
Strategy #2: Personal Guaranty
Requiring a personal guaranty from the owners of Sellers can be a powerful tool for Buyers to protect their investments. A personal guaranty is a legal assurance provided by the owners of a selling entity, where the owners of the selling entity agree to be personally liable to the Buyer for any misrepresentations and hidden liabilities. Negotiating a personal guaranty involves careful consideration of its scope, duration, and limitations, ensuring that it provides the necessary protection to the Buyer while also being acceptable to the owners of the selling entity. Including a personal guaranty can significantly mitigate the Buyer’s risk and increase the confidence in the integrity of the deal.
Strategy #3: Representations & Warranties
Representations and warranties are fundamental components of a business acquisition. Representations and warranties are legal declarations made by the Seller and can cover a wide range of topics, such as previous lawsuits, financial accuracy, legal ownership of assets, and potential liabilities. One of the most important aspects of representations and warranties are to ensure the Buyer has a clear and comprehensive understanding of the business they are acquiring by facilitating disclosures from the Seller. Representations and warranties also create legal recourse against the Seller if the Seller’s statements are found to be inaccurate and can trigger a liquidated damage clauses as part of the transaction documents.
Strategy #4: Holdbacks
One of the best ways for Buyers to mitigate post-acquisition risks is to “holdback” a portion of the purchase price. Holdbacks are a strategic tool used in business acquisitions where a portion of the purchase price is placed in escrow and withheld for a certain period after the closing. Holdbacks are designed to protect the Buyer against post-acquisition contingencies and undisclosed liabilities, such as pending litigation or patent applications. The terms governing the holdback must be carefully negotiated since the Seller will not be receiving all of their sale proceeds at closing and Buyers and Seller must ensure that the transaction documents provide clear processes and procedures for distribution of the funds. However, holdbacks offer Buyers a practical and effective solution to safeguard against potential risks and unknown liabilities that may arise after business acquisition, by ensuring that a portion of the purchase price is made readily accessible to the Buyer.
Strategy #5: Insurance
Insurance has become an increasingly popular tool for Buyers to utilize when structuring acquisitions. Insurance can protect against almost any type of loss that could arise after the closing, including losses arising from undisclosed liabilities or Seller performance. One of the most important benefits offered by insurance is the ability to recover from a solvent, collectable party and transfer the risk of loss from the Seller to an insurance provider. Representations and Warranties (R&W) insurance is a popular form of insurance for Buyers to utilize that can protect against losses resulting from the Seller’s breach of their representations and warranties. Careful evaluation of the insurance policy terms, including coverage limits, exclusions, and premiums, is essential to ensure that it aligns with the Buyer’s needs and specific risks of the deal. Still, insurance can offer an important layer of protection that ensures Buyers are fully compensated following a Seller’s breach of its obligations under the deal.
Buyers are confronted with a multitude of risks and uncertainties when acquiring businesses. Rollover equity, personal guaranties, representations and warranties, holdbacks, and insurance are mechanisms for Buyers to utilize when acquiring businesses that can mitigate risks and protect the Buyer’s investment. By carefully implementing these strategies, Buyers can protect against potential post-acquisition surprises and losses.