Are you Deal Fit? - Legal Fitness for M&A and Capital Raising
Are you “Deal Fit”? – Legal fitness for M&A or Capital Raising
I like running. If you have ever been part of the sea of energy that flows through a race, you know one truth by the time you cross the finish line. This truth holds regardless of whether it’s a 5k fun run, a half marathon, or an ultra-marathon trail event. Success, by whatever measure, is mostly about what you’ve done in the weeks and months before the race. Less is determined by what you do on the day itself.
The same can be true for success in Mergers & Acquisitions (M&A) or Capital Raising transactions. Whether you’re selling in an exit, creating a joint venture, or raising capital from venture capital or strategic investors; preparation for a successful deal starts well before you schedule a kick-off meeting with your advisors. From here on let’s just refer to all of these as “Deals”. For the purposes of this discussion, we can generalise.
Over the years, I’ve enjoyed leading the legal effort on countless Deals throughout Australasia, Asia, North America, and EMEA. I have often thought that start-ups, SMEs and high growth businesses with Deals in their future would benefit from a backstage pass to some of those processes. Understanding the obstacles and seeing what works well can help set the course for a smoother future Deal.
This article explores some fundamentals for improving your Deal legal fitness.
Time Kills Deals
The reality is that Deal windows can open and close pretty quickly. When the time comes to do a Deal, you need to be able to move as quickly as your bidders / investors want to move. If you’re discovering the legal skeletons in your corporate closet while preparing a data room or during Q&A with bidders, these issues may be value destructive, or worse; Deal killers.
The more you have to explain problems, the more static there is on the line. Too much static makes bidders nervous and may be used to justify lower valuations, or simply cause the bidder to “hang up” and move on to the next target. Asking the questions below can help you prepare now. Deal or no Deal; you’ll also benefit from getting a better handle on legal risk in your business.
Structure starts with the foundations
You need to be thinking about the future from day one. That doesn’t mean you should be exit obsessed when you start a business, but you do need a structure compatible with growth, raising capital as needed, and ultimately, potential exit. I’m not a financial advisor, but I do suggest you talk to your accountant at the outset to get a basic structure in place. You may not need all the bells and whistles on day one like employee share plans and multiple subsidiaries, but you need the right foundations to build on as the business grows. It can be harder to fix down the line if you consider tax implications of moving assets once they start to accumulate value.
Are you and your co-founders and other shareholders on the same page?
I understand why no-one really wants to focus on what could go wrong at the start of a relationship. But you will minimise damage down the line if you get clarity with your co-founders and other shareholders on key issues like:
· What percentage of the company do you each own?
· What are your roles and responsibilities? (Obviously, this can be pretty fluid in start-up world, but some broad definition is good)
· How are decisions made?
· What decisions require everyone to agree?
· Who decides whether you need more investment?
· What happens when one wants to sell and the other one doesn’t?
· What happens if one wants to invest more and the other one doesn’t?
These are just some of the questions that should be addressed in a good shareholders’ agreement. They are critical questions that need unambiguous answers as you enter into preparation for a Deal. Discord between shareholders can block Deals.
Does the business own its crown jewels?
All businesses have assets that are critical to value. Depending on the nature of the business it could be Intellectual Property (IP), a domain name, customer contracts, key supplier contracts, service contracts, distribution rights, physical assets, land. Whatever it is, you need certainty that the entity that owns the ‘business’ has properly documented ownership or other appropriate contractual rights to those assets.
IP is one category of asset that needs some extra thought and caution. It’s worth checking that all the arrangements with your various service providers actually grant you the IP rights you need. Often services from consultants, agencies, software developers or engineers, content creators and the like may be on their standard contracts. Without the right review, these contracts may not provide the rights you think you’re buying. If there is an IP ownership or licensing gap for key content or systems, it’s worth addressing that well before you enter Deal mode.
Where are my contracts?
It’s still surprising to me that even large, sophisticated organisations often don’t manage and organise their digital environment and information systems with the rigour they apply to other parts of their business. For example, finding the final versions of contracts signed by all parties is the first step to understanding rights and obligations. Without that starting point the rest becomes harder, more time consuming, costly, and uncertain.
You may not need dedicated document management software to get the basics right. Simple, well-understood, consistently implemented procedures governing how documents are named, where they are stored and who is responsible for them will get you most of the benefit. If you start early, you’ll build a consistent culture that is easier to maintain. The longer you wait, the more the sea of disorganised information grows until it becomes unmanageable. This is not just important when a Deal comes along but is also critical to understanding the rights and obligations of your business, keeping an eye on key dates, and giving you a solid basis to efficiently manage your contracts.
Start building the right team
Here’s another sporting analogy for you. You wouldn’t want to meet your teammates just before kick-off. The best teams are a collection of players that trust each other, communicate easily, know their position, and know what their teammates expect of them.
In the same way, start building a good rapport with the lawyers, accountants, corporate finance advisors (or bankers) that you’re going to have with you in the Deal. The more they know about you, your goals, and your business, the more seamless the process and the better the prospects of a successful Deal.
Watch the trailer before you see the movie.
If you’ve got your team sorted, ask them about what you should expect when a Deal rolls around. For example, you might ask:
· What does a timetable look like for different types of Deals?
· What does a diligence request list look like?
· How do you set up and run a data room?
· What sort of resources (internal and external) will you need?
· How much of your time will you need to dedicate?
· How do you manage confidentiality within your employees, customers, and suppliers?
· Are there other preparations unique to your business that you should start now?
Having that frame of reference will be a useful backdrop as you get on with growing your business in the meantime.
Start now and develop a base level of Deal fitness
You don’t want to become so focused on a future Deal that you take your eyes off the road. Running and growing your business comes first, but like all good entrepreneurs you know how to multi-task. Addressing the basics now will help you develop a base level of Deal fitness that could well make the difference when the starting gun goes on your Deal.