The Four Phases of a Deal: Phase 2; Deal

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This is the metaphorical “meat” of the deal – where things “get serious”.  The first element of this phase is the transmission, review and indexing of due diligence documents.  While this step is routinely dismissed as ministerial, it is often the most insightful step.  After all, the majority of the deal process involves understanding and, where necessary, mitigating the information asymmetry between the buyer and the seller.  The direct insight that due diligence provides is indispensable.  Often, what is as important is what is not transmitted.  The documents that the seller doesn’t have advises the representations and warranties more than the documents they do have.  For example, if the buyer asks the seller for any documents related to environmental hazards on the seller’s property/premises, and the seller has no such documents, the buyer should draft documents that include an unqualified warranty regarding potential environmental hazards.

Shortly after due diligence begins in earnest, drafting of definitive documents will begin.  The primary document, usually the purchase agreement, is the most important document.  Its counterpart, the Disclosure Schedules, is where the due diligence is indexed and cross-indexed so that the parties can map due diligence against the representations and warranties in the primary documents.  Due diligence is a collaborative process with the seller as the primary producer of due diligence and the buyer as the primary producer of disclosure schedules.  If due diligence isn’t adequately reciprocal, the deal will be challenging to conclude.  In other words, a seller who isn’t making disclosures easy is typically hiding something – and you can be assured that buyer feels the same way.

As the principals negotiate the equitable and quantitative terms, their attorneys work to both translate these terms into legal language.  Additionally, the attorneys advise those same principals on advisable modifications, amendments and omissions to their agreed-upon terms dictated by applicable legal restrictions, administrative regulations or past practice(s).  This is an example of the attorneys’ traditional, primary responsibility in Phase II: accurate translation.

Phase II also includes building the corporate architecture (including organizing/incorporating new entities) and the corporate governance.  These tasks are particularly sensitive to the nuance between stated client objectives and the legal language that addresses them.  Some of the most common considerations are: limitation/compartmentalization of liability, privacy, control, taxation, compliance, and optics.  Any suggestion that one of these elements should be accommodated at the expense of the others is likely misplaced and made in service to an objective which the principals do not share.

Development of necessary financing documentation can be undertaken by third party financial interests (e.g.  lenders), the SBA, or even investment bank/bankers.  Nearly seventy percent (70%) of business sales involve some form of seller financing and, while the majority of document drafting originates with the buyer’s counsel, seller carried financing documents are commonly originated by the seller’s counsel.

Phase II, even in the best of circumstances, represents the most work-intensive phase for counsel, and consequently, the most fee-intensive phase for the parties.  It is also the time where an adversarial posture between the parties and/or their attorneys is likely to surface and prove challenging, inefficient and expensive.  The overwhelming majority of transactions and the primary documents produced in service to them cannot “simply” be accomplished by changing out the names and quantitative elements of a previously used or “form” contract.  Of course, there are certain nearly compulsory elements of documents that represent best practices within a particular firm, jurisdiction and/or area of practice which (a) are in the contracts for a reason and (b) represent 10-20% of the substantive language in an agreement.

In some transactions, the attorneys will lead substantive negotiations (as well as the necessary translation), but these instances are increasingly rare.  There is little value in having an attorney, who necessarily knows less about their client’s business and goals than the client him/herself, to represent those equitable interests at the negotiating table.  It is similarly of little to no value to have the parties/principals, who necessarily know less about contract drafting than their attorneys, to propose contract language.  In other words, a successful and cost-efficient Phase II relies primarily on everyone staying within their roles of comparative advantage.

The conclusion of Phase II is frequently represented as the conclusion of the deal, itself, the closing.  This seminal event is, by far, the most important milestone in the transaction, but rather than marking the finish line, it more accurately marks the “halfway point”.

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