Funding Business Growth

Each month, Eric Duffee looks at a different piece of The Anatomy of a Deal – a series of easy-to-digest articles that break down complicated aspects of business transactions – helping you better understand terms + processes that can shape the direction of your business.

Sometimes the biggest risk to your deal is someone who isn’t even a part of the deal. Because businesses have a life of their own, they touch a number of different people who, frankly, don’t give a damn whether you get your deal done or not. Nonetheless, they may have the ability to hold up your deal for a number of different reasons. That’s a recipe for disaster. Some of the common third parties who may be involved with your deal include the following:

1. Customers and vendors – Sometimes your customers or vendors have certain contractual consent rights that may impact your ability to complete the transaction without their approval. Or, if those contracts don’t exist or can be easily terminated, they could simply refuse to go along with the deal if they don’t like it.
2. Employees – Sometimes the buyer won’t care whether it keeps the employees, but in most cases the buyer wants to ensure that at least the key employees remain.
3. Landlords – Many leases require the consent of the landlord in the event of a transaction.
4. Governmental agencies – Sometimes the deal requires approval from some governmental authority, whose motivations may be much different from yours.

At best, each of these third parties may require a significant investment of time and effort to get them comfortable with the deal when you’d rather be focusing on executing the deal and integrating the business. At worst, these third parties may use your deal as a convenient opportunity to renegotiate their own deals with you, using your potential transaction as a bargaining chip.

For example, several years ago we were working on a transaction for a Fortune 100 client that was selling a small business unit to another similarly large buyer. The landlord for one of the small facilities (rental rate was about $2,000 per month) was threatening to withhold consent unless the seller (a company with revenues of about $100 billion) would continue to guarantee the lease even after the buyer took over. Why? Because the buyer was only a $70 billion company. As such, the landlord was able to use its contractual consent right to force concessions that it really didn’t deserve.

In addition, once you start engaging with these third parties the chances of keeping the deal negotiations under wraps will erode quickly. Loose lips sink ships.

So what can you do? We’ve yet to see a profitable business that doesn’t involve multiple third parties, so you’ll need to figure out how to deal with them.

1. Limit the number of third-party interactions on the front end

• You can’t avoid all third-party interactions, but you can at least avoid handing them the gun to shoot you with. Many third-party consent requirements can be avoided by being careful when negotiating contracts with customers and vendors to limit consent requirements as part of a sale transaction.
• In addition, while you may have a good working relationship with your customers and vendors on a handshake basis, it may be wise to button up all key terms in written contracts that avoid the need to go back to these customers and vendors later on as part of a transaction.

2. Have a strategy for how and when to approach third parties. When you can’t avoid a third party, consider:

• Which third parties to approach – This is partially a function of your legal obligations (e.g., contracts that require consent of the third party) but also a function of the need to preserve continuity of the business relationship after closing.
• When to approach them – Usually, you want to avoid engaging with third parties until fairly far down the road of the deal negotiations so as to avoid an uncomfortable conversation with those third parties if the deal doesn’t go through. On the flip side, if you wait too long, you might find that these third parties are the only things holding up the deal. And, if they sense that they are the last missing piece to your deal, they might use this leverage to extract a pound of flesh.
• Who should approach them – There are a couple of dimensions to this question. The most obvious is to identify which of the seller’s employees have the best relationship with the third party…assuming those employees are excited about the deal and staying with the organization after closing. However, another consideration is whether and when to involve the potential acquirer in any of those discussions. If the buyer will be involved, the seller needs to be very comfortable about the state of the deal as well as its relationship with the customer/vendor, employee, etc. Otherwise, the seller may actually be introducing its customer/vendor or employee relationship to a potential competitor.
• What do you say – The answer, of course, is different for every deal and every third party. However, you’ll want to think about presenting the transaction from the vantage point of the third party: why is this good for them and/or why won’t this deal negatively impact them? If the deal presents an opportunity to expand the relationship, play that up. Even if you don’t anticipate that this will actually help the third party, focus on how this deal at least won’t inconvenience them in any way. If they’re used to working with a key person, it would be helpful if you can tell them that person will be staying with the company after the transaction. For employees, this will naturally involve a discussion about their continued employment and opportunities post-closing. The important point is to remember to focus on what the deal does for the third party more than what it does for you.

3. Have a strategy for those who aren’t willing to play ball

• If you get someone who simply won’t cooperate, you’ll want to have a plan for moving forward. Sometimes there’s a way to work around the third party. Sometimes you’ll have to be prepared to offer something to the third party to get them to play. Developing a strategy to deal with the difficult third parties not only becomes helpful if they won’t cooperate, but it also helps you prioritize your efforts toward these third parties.

Even with prior planning, you won’t be able to avoid all interactions with third parties. And, as a buyer, you’d rather find out if there are third-party problems before stroking a big check to the seller. As such, developing a good strategy early on for addressing third-party relationships is critical to ensuring a successful transaction.

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Next Month: Alternative Transaction Structures

Read last month’s piece: Employee Incentives - Part 2