Understand What No Lawyer or Document Can Do For You

I was recently helping a client with a stock purchase in a deal that just felt wrong to me. Each time we asked a question or reviewed a document, it seemed additional issues, questions and concerns arose. Notwithstanding this fact, the investment bankers, company officers and selling stockholders assured us in each instance that there was no problem – usually with the excuse that it was simply bad record-keeping, a lack of attention to detail or a favorable related party transaction that would not adversely affect the company or my client going forward. In fact, they said, it was precisely because of these circumstances that my client had been presented with this amazing investment opportunity. I did not find these explanations to be persuasive or reassuring, even when the sellers agreed to provide a litany of warranties and representations, broad indemnification rights, and other contractual protections.

In this circumstance, I was compelled to explain to my client a very simple fact – while a lawyer can draft an all-encompassing contract in which virtually every possible risk is anticipated and addressed with detailed indemnifications, aggressive remedial provisions, escrows, etc., that does not turn a bad deal into a good one or provide the same level of protection as walking away from a bad deal.

The simple truth is, if your due diligence yields more questions than answers more uncertainty than certainty, and more risks than opportunities – and if you find yourself spending an inordinate amount of time and effort trying to protect yourself from known and unknown legal risks and possible bad behavior or misrepresentations by the other party (versus ordinary course business risks) – no amount of lawyering and no legal document can adequately protect you. In that case, you really only have 2 choices – (1) walk away from the deal, or (2) draft that over-the-top contract with all of the bells, whistles and protections and “hang on for the ride.” And if you opt for alternative 2, understand that a good lawyer and a good contract do not make a good deal.

Nice to Meet You – Let’s Get Married

Only fools rush in.  We’ve all heard that expression many times and probably think we’re far too wise and experienced to be such a fool.  However, you’d be amazed at how often businesses and individuals rush headlong into business relationships or contracts only to find out they should have used more discretion, patience and judgment.  Remember, before you date someone, you usually want to know at least a little bit about them; before you go steady, you want to know a little more; and before you get married, you really want to know them well.

Consider applying some of these dating lessons and clichés to your business and legal relationships and contracts, and you may find you have fewer emotional breakups or (more importantly) fewer bad marriages that end in messy divorces:

  • Ask around (a/k/a, do your due diligence) – learn all you can about a person or company before you engage them, become partners or enter into a long term binding contract.
  • Trust your instincts (a/k/a, if it doesn’t feel right, don’t do it) – unless there’s some compelling reason you have to work with a specific person or company or you have to jump into a deal with both feet, if you’re getting a bad vibe, don’t proceed.
  • Go slowly (a/k/a, – start small) – whenever possible, start with a smaller project or a short term relationship and see how it goes. There’s usually time and there will almost always be more opportunities to work together if the first one goes      well.
  • Build in an escape hatch (a/k/a, don’t put all of your eggs in one basket) – even if you’re ready to hire someone or enter into a contract, make sure you have the ability to terminate or get out of the relationship.
  • See other people (a/k/a, avoid exclusivity) – exclusive relationships are serious commitments and have high risk (and potentially, high reward); take your time.
  • There are more fish in the sea (a/k/a, know when to say when) – ending a bad relationship is always hard – whether personal or business – but when your gut tells you it’s not right, then it probably isn’t. Cut your losses and end the relationship (in the right way, of course).

The bottom line is, business and legal relationships resemble personal relationships – with the same types of risks and rewards.  Look before you leap.

Avoiding Surprises in Transactions – Part 2

Part 1 discussed some general ways to avoid surprises in business transactions.  Here, I’ll apply some of those principles to a hypothetical transaction.

Assume a longstanding attorney-client relationship – communication and trust are well established.  Client plans an acquisition of a competitor.  Here are some key steps to avoid surprises:

  • First – an initial discussion between attorney and client so that the attorney knows as much as possible about the target company and the desired deal terms.  If there are other consultants involved (e.g., accountants, investment bankers, lenders, valuation experts, etc.), they may also participate, since communication among consultants may be just as important as communication between attorney and client. 

This may be the most important step to avoid surprises – every deal is not the same, and all parties must understand this specific deal!  Of course, this will be the attorney’s first opportunity to advise the client as to, e.g., recommended deal structure, risks, potential challenges, etc. – this type of advice should be ongoing throughout the deal.

  • Second – a discussion as to the likely stages and desired timing of the deal, which would typically (but not always) include:
    • NDA;
    • Preliminary Due Diligence;
    • Initial discussions/negotiations between parties as to deal terms (will/should the attorney participate?);
    • Term Sheet or Letter of Intent;
    • In Depth Due Diligence (again, will/should the attorney participate?);
    • Negotiate/Execute Detailed Transaction Documents (attorney and client (other consultants?) should work closely here);
    • Pre-Closing Conditions and Contingencies;
    • Closing; and
    • Post-Closing Conditions and Follow-Up.

This discussion may be initiated by the attorney, but it must be interactive, and tailored to this specific deal.  The key is for attorney and client to understand and expect these stages and to communicate any specific issues or concerns early in the process.

  • Third – the attorney should prepare a transaction outline or checklist, including responsible party, deadlines, status, etc.  This should be continually updated by attorney, client and any other consultants to ensure that everyone knows where the deal is and who’s doing what at any given time.
  • Fourth – throughout the process any challenges, delays, unforeseen developments, etc. must be immediately communicated to the entire team, with an assessment of how they will affect the deal, and hopefully with a plan as to how they will be addressed.

While it may be obvious, the keys to avoiding surprises (and the related costs and consequences) in business transactions are planning and communication from the very beginning and throughout the process.  Challenges will arise, but they should not be unforeseen.

It’s All About Risk-Reward

Anyone who owns or operates a business understands it’s all about risk-reward.  The old adage, “nothing ventured, nothing gained,” is true in business and in life.   The risk-reward analysis also applies to business deals and the underlying contracts – and if your business attorney doesn’t recognize this, you’d better make a change now.

Business transactions, by their nature, involve risk – after all, the safest course of action is almost always to do nothing, or perhaps, to simply do what you’ve always done or what everyone else is doing.  However, while those might be the safest alternatives, they’re rarely the most profitable and are never game-changers for your company.

So, how do businesses and lawyers work together to evaluate potential risks and rewards and reach that delicate balance where the risk level is acceptable and warranted in light of the reward?  I think it comes down to a few key principles:

First, the client identifies and communicates the ultimate objective and how critical it is to achieve that objective – is it “bet the company” important or essential to the company’s survival; or is it simply something you’d like to achieve, but only if the risk is minimal?

  • Next, the client determines and communicates what level of risk is acceptable (this can be measured in dollars, timing, opportunity cost, reputation, etc.).
  • Third, initially and throughout the process, the lawyer informs the client of legal risks of various decisions and courses of action, and the client makes informed decisions.
  • Finally, the client and lawyer work together to achieve the business objective,  seeking to maximize the upside reward and minimize the risk at all stages – from initial discussions with the other party and their counsel, to preliminary negotiations, to drafting the term sheet or letter of intent, to conducting and evaluating due diligence, to executing definitive transaction documents and ultimately closing (or not closing) the deal.

There will be many times in a business deal where the question has to be asked – what is the risk of this approach, and does the potential reward of the deal justify that risk?  These determinations can only be made effectively when there is close communication and a clear meeting of the minds between client and attorney.