There are essentially three kinds of sellers in merger and acquisition (M&A) transactions: (i) the private seller, which is usually has small group of owners (entrepreneurs or family); (ii) the public company seller; and (iii) a big company selling a portion of itself. Regardless of the deal structure―i.e. statutory merger, purchase of stock or assets― this classification by target type will have an impact upon a buyer’s understanding of the deal process, negotiations, documentation, terms and, ultimately, the outcome of the deal.
Due diligence is perhaps more important and more difficult in the private seller scenario than in other seller types. Given the typical small number of owners and the relationship between them, it is common for private sellers to lack information as well as formalities in their recordkeeping, financials and documentation on key company constituencies. As a result, buyers should be wary as to the reliability of the information provided. Additionally, private sellers’ financials are usually not audited, and there are usually numerous related-party transactions. Buyers might also find confusion among shareholders as to what property is considered the company’s and what is considered the individual’s.
When dealing with private sellers it is good practice to always inquire the reason to sell and the timing of the decision. If it was made a while ago, then there may be concerns regarding the reliability of their accounting and financials. These might have been manipulated to make the firm more attractive for purchase. This is why representations and warranties are perhaps some of the most negotiated provisions with private seller. Their purpose is to formalize the diligence, condition the closing and create a cause of actions, if they survive closing. Indeed, the survival of representations and warranties as a post-closing contractual protection will serve as an “insurance policy” for buyers if confronted with unreliable information.
Moreover, in the private seller scenario there may be more flexibility to bridge the gap on purchase price issues through negotiations. For instance, as an incentive buyers could propose an earn-out clause if the company meets or exceeds certain expectations after closing. Alternatively, buyers could also consider seller financing and include offset rights against payment to seller as insurance for potential claims.
Finally, with a private target there is a higher degree of certainty of getting deal approval since the buyer is typically negotiating directly with the owner. On the other hand, dealing with an owner may lead to uncertainty as they are more likely to change their minds as negotiations progress. Consequently, it is in the buyers’ best interest to have a formal agreement signed as early as possible.