In this episode, hosts Brad and Michael share the story of a failed M&A deal between an entrepreneur and a potential buyer. Their already rocky relationship worsened when one party repeatedly withheld information during the due diligence phase. Learn how dishonesty can derail negotiations and lead to the collapse of your deal. Tune in for insights into what went wrong and how you can maintain trust for a successful sale.
Listen to the full episode using the player below, or by visiting one of the links below. Contact ByrdAdatto if you have any questions or would like to learn more.
Transcript
*The below transcript has been edited for readability.
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences, creating simplicity in 3, 2, 1.
Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host Brad Adatto with my co-host, Michael Byrd.
Michael: As a business and health care law firm, we meet a lot of interesting people and learn their amazing stories. This season, we’re entering the most sophisticated season of a business. Our theme this season is Buying and Selling a Business.
Brad: That’s awesome. And as we know, that’s just one of the seasons. What are the other seasons?
Michael: Well, we have the building season – starting a business, the operating season – running a business, the scaling season – growing a business, and here we are in the buying and selling season.
Brad: Very good. Michael. Now Michael, what’s the worst injury you ever had? And it can be a sports injury and no, typing does not count as a sport.
Michael: Well, that’s a pivot. Actually, I’ve [01:00:00] been pretty miraculously healthy. I’m feeling grateful all of a sudden, Brad. I mean, I’ve had tennis elbow issues and typical shoulder strains and muscle pulls that come with being old.
Brad: He admitted that. You hear that Kennedy?
Michael: I have not had to have surgery or any broken bones. Well, I guess unless you count my pinky. What about you?
Brad: Well, up until recently, I think the worst injury came my freshman year in football. Now picture this Brad, a hundred pounds soaking wet, solid five foot, just five foot football machine.
Michael: You said picture this. I can picture the five feet tall. Not a hundred pounds though.
Brad: I just walked right into that one, didn’t I? Alright, so we’re playing this JV football team and the other team had a bunch of juniors that didn’t make their varsity team.
Michael: Oh, so that probably was a pretty strong JV team.
Brad: [00:02:00] They were, yeah, and right when I’m about to tackle one of their biggest guys and guess what happens? He runs right over me like a speed bump and knocks me out cold.
Michael: Oh, did you see stars?
Brad: Yeah. It was more like comets and meteor showers. And I woke up, my freshman coach was just standing over me, asked me if I was okay, and I said I was. So, the good news was I played the rest of the game, because back then no one knew when you got your bell rung you weren’t supposed to keep playing.
Michael: That does beg the question. Did y’all have helmets back then?
Brad: Yes. And we didn’t wear leather helmets like you did when you played football,
Michael: But you’re forgetting I’m a tennis player.So what injury do you wish never happened?
Brad: I think I would say up until recently, if you asked me that question, I would’ve said right before my senior year of soccer, I twisted my ankle pretty good, didn’t practice, and basically my entire senior year I played on that and it just never seemed to heal itself. However, as you know, recently [00:03:00] I did get the fun news of tearing my rotator cuff and I wish I could say I was doing something amazing, like saving someone by climbing up a building or something. But no, I was just doing weightlifting and did something that 50 year olds apparently are not supposed to do. So what about you, what injury do you wish you never had happened?
Michael: I guess the most annoying injury I had was back in 2018 because we were taking, for us, a big trip to Hawaii. It was like the week before the trip and it was a Sunday and I was out throwing the football with Aiden, my son, and just randomly caught the ball funny and it broke my pinky finger for the third time. Every time it’s happened, catching a football, you’d think I’ve learned the lesson to stick with tennis. But it took over a year for the finger to stop hurting. I would just – there’s nothing you can do, but then I would re-break it, just doing the randomest things. [00:04:00] And so, it was very annoying.
Brad: I’m super surprised you didn’t get rushed to the ER to protect your state qualified typing fingers. That’s interesting, Michael. All right, Michael.
Michael: I had to adapt.
Brad: Yeah. Good for you. Good for you, taped it up, get back in there.
Michael: Yeah, exactly.
Brad: Yeah, just that’s like a dark fast again. I keep picturing us in the nursing homes reminding us of the glory days with our grandkids, and they roll their eyes and we’re like, “Back in my day, I wrestled a 300 pound lineman and lost.”
Michael: Yeah. I actually have a tennis story that every time I say it, it makes me sound like Uncle Rico from Napoleon Dynamite – if you want your movie reference for the day – I know how ridiculous it sounds. I picture myself as Uncle Rico every time I start saying it, and yet I find myself still telling it sometimes. But I’m assuming Brad, that injury talk doesn’t have to do with today’s story.
Brad: Most likely not Michael. but I want to share this wild [00:05:00] M&A deal. we were involved in recently.
Michael: Okay, Brad. First this is a show where we’re supposed to share stories with our audience.
Brad: Good point.
Michael: So let’s not skip over the term M&A. So audience M&A, it’s a fancy-er word than buying and selling season. We said we’re in the sophisticated season. M&A stands for Mergers and Acquisitions and it’s essentially the buying and selling of a business. Merger is a legal type of way to accomplish a business coming together with another business. And an acquisition is probably more intuitive. It’s a buyer buys a business from a seller. Of course, there’s a couple of different ways that can be done as well.
Brad: Well done, Michael. Good job of dealing with our vocabulary word there. So we had our client Mr. Fletcher Reede, a serial entrepreneur who was looking to sell his company. [00:06:00] The buyer, Dr. Audrey is a well-known physician who had previously a rocky relationship with Mr. Reede. The parties had worked together in a prior arrangement. At the end of the last deal, the buyer had, the buyer being Dr. Audrey, had a rather kind of hostile disposition to Mr. Reede.
Michael: So you’re seeming to break the pattern you’ve been on recently of naming your characters off of whatever we’ve been talking about in our opening. So they have a reason, I’m sure you have a reason for these names. They sound random, and yet I’m a little afraid to ask. So I’m going to move on for a moment. So it sounds like a soap opera already before it even gets started, just with the very beginning introduction you have on that. So, did these issues happen right away, like in the initial letter of intent phase?
Brad: [00:07:00] No because of their past relationship, even though it was a little rocky, Mr. Reede and Dr. Audrey, they actually got through the LOI phase pretty rapidly.
Michael: So let’s pause for a moment and just, I know we’ve covered this in multiple episodes, but revisit quickly the five phases of an M&A deal. So at a high level, we’ve talked about the LOI phase, the letter of intent phase that this sets the tone. This is usually has some elements that are binding, some elements that are non-binding, but it is the parameters or framework for what the deal’s going to look like. And then you have due diligence. That’s where everybody looks into making sure that what they think they’re getting is what they’re actually going to get to be comfortable with the deal. Then you get into, or the lawyers get really busy that legal documents or the definitive agreements. And then you get to a point where it’s time to close the closing phase, and then you usually there’s some cleanup the post-closing phase is what we call it. [00:08:00]
Brad: Well done. Great context, Michael. Well, this distrust actually started during the due diligence phase, or the rekindling, I guess of it where the buyer gets to examine the businesses with like a magnifying glass, checking out every asset, liability, possible skeletons in the closet, or as I like to say, that moment where they go through your underwear drawer to figure out what’s really going on with your business.
Michael: Due diligence is where secrets come to die. We’ve talked about it a lot in prior episodes, but it’s a pretty intense process where you’re looking, as you said, the underwear drawer moment. You’re looking at every nook and cranny to figure out where the problems are with the business, or to make sure there’s no problems with the business.
Brad: So Mr. Reede had built an ancillary company that worked with doctor’s offices to assist him with wound care and other medical processes.
Michael: Okay. Well, you just kind of dropped a little bomb out there that we need a little more [00:09:00] context. So first, when we talk about the word ancillary company, it’s a common term of art in health care. So, you have this idea where a medical practice often has a business, and then you hear of them having ancillary businesses, and they’re usually related businesses that are not quite the main purpose of their medical practice. And so, wound care, which you just mentioned, is a growing and complicated area of law. There are some kind of holes in the reimbursement system, or I don’t know if opportunities in the reimbursement system right now that’s drawing a ton of people, good players and not good players into wound care.
Brad: Well said, sir. Now during this due diligence phase, Dr. Audrey started to request the standard documents having a better understanding of how Mr. Reede ran the business and Mr. Reede’s relationship with other [00:10:00] medical providers that he was providing services to.
Michael: Okay. That sounds reasonable.
Brad: Yeah. And based on our conversations with Mr. Reede, these documents he provided, we detailed all the services he rendered by other medical providers. Dr. Audrey counsel would also ask us for more details. We would have to look back and forth. There’s a lot of back and forth during this process of getting information to Dr. Audrey’s counsel, them reviewing it and sitting down and obviously reviewing it with him.
Michael: Okay. Brad, this is sounding kind of boring now. Where are you going with this story?
Brad: You know what, in reality, Michael, due diligence phase can seem boring to the clients and apparently also to podcasting. It’s because you’re also trading a lot of information and it’s needing to explain inconsistencies maybe in the data or something that’s missing that they think should be there.
Michael: Okay. Well, I hope you have a plan that’s not, involves singing and dancing to make this story about a [00:11:00] boring topic more interesting. Does the story get better?
Brad: I don’t know if it gets better. Better’s a strong word. Let’s just see. Well, I’ll let you be the judge. What if I told you that Mr. Reede kept feeding us half-truth? It was like a game. Every time we presented information to the buyer, they discovered some new tidbits that the data was completely contradicting what we were telling them.
Michael: So I’m going to say this back. Your client was feeding you half-truths.
Brad: Yes.
Michael: Let me guess. The buyer wasn’t exactly thrilled by this.
Brad: Yeah. That’s putting it a little bit mildly. They started treating me like an unreliable narrator in a mystery novel.
Michael: They’re smart.
Brad: Strike that. Strike that right now. I mean, one time I was told that they had no prior billing at all with this one particular company. We’re like, oh yeah, we’ll tell that to counsel. There’s no prior billing. And then boom, the buyer discovers that they had billed just two weeks prior. I’m like, you said no prior billing, [00:12:00] and now they’re discovering that you were billing out to that company.
Michael: Well, nothing screams trustworthy, like a sudden inconsistent discovery in the middle of a deal. I hope you weren’t caught too off guard.
Brad: I think I aged a decade every time I open an email. I mean, Mr. Reede, and as you can tell, I can’t get much older than this. You know, Mr. Reede, he just kept going over stuff and glossing over certain red flags that Dr. Audrey’s counsel would raise with us. It felt like each time we’d have to pull more information from Mr. Reede was like attempting for him. He was like, he was trying to hide an elephant under a rug and hope that nobody noticed it.
Michael: Well, news alert, I think both of us have just gotten into a new level of self-awareness. We both called ourselves old during this episode.
Brad: I was old, because of him I age.
Michael: Yes. Well, I’m debating what’s worse; dealing with a dishonest client, a bad attorney on the other side, or a dishonest opposing party. This story seems to have the dishonest client element to it.
Brad: Yeah. All three are bad. [00:13:00] I agree with you on that, but for us, it was like playing a whack-a-mole with half-truths. I kept telling Mr. Reede, “If you’re going to go to market, you’ve got to spill it all – the good, the bad, and the really ugly stuff.”
Michael: And how did he respond?
Brad: We learned that he was secretly billing The Death Star.
Michael: Got so far into the episode and you had to come in with your Star Wars reference. What really happened, Brad?
Brad: Honestly, Michael, it was like death by a thousand paper cuts – nothing outrageously or catastrophic. There’s just so many contradictions and somewhat cover ups that…
Michael: White lies…
Brad: Maybe what he thought were white lies. Dr. Audrey’s lawyers finally hit the brakes. They couldn’t trust any part of the deal anymore. And quite frankly, it was hard for us to even figure out if we actually understood the truth as we were trying to explain it to buyer’s counsel.
Michael: So with all this noise in the background, how was the actual deal itself progressing?
Brad: Painfully slow, as Dr. Audrey’s counsel had already [00:14:00] started doing the deal docs and each new discovery required new disclosures and schedules, and the reps and warranties [14:07] had to be updated, so the flow of the deal was kind of being messed up and further because Dr. Audrey was in the same industry, Dr. Audrey was getting additional information to his counsel that Mr. Reede was not sharing with us. So it was like, word on the street A, B, and C, and all of a sudden it came back to us and it didn’t look good in the negotiations because we had to keep backpedaling our prior comments that Mr. Reede had shared with us, which ended up being not exactly correct.
Michael: It sounds like death of a thousand paper cuts, or maybe a bad TV movie. Well, let’s go into commercial and when we return, we can talk about the legal implications of trying to hide your secrets during due diligence.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, with my co-host, Michael Byrd. Now Michael, this season our theme is Buying and Selling a Business, and we’re talking about real stories that pop up in this wonderful season.
Michael: Well, let’s do a quick recap. So we have Mr. Reede, which is your client. Correct me if I miss anything along the way.
Brad: That’s correct.
Michael: And then we have Dr. Audrey who is the buyer or potential buyer in a deal from Mr. Reede’s business. And they had a past together that wasn’t necessarily great – lead friction. [00:16:00] And so they started in a deal that had already been kind of moving along because of their past history, and you started looking like a fool because your client would tell you one thing, and then as you shared it with the other side, they would turn out that that was untrue. And so, it was one, we’ll call it a half-truth – we were being nice, lie after another, that probably didn’t feel like a lie, but in any event, it seems that our client, Mr. Reede, was hiding some secrets and hoping that he could kind of navigate this deal without those coming out.
Brad: Yeah.
Michael: Before we jump back into the story, let’s take a step back because it’s complicated when you have a client situation like this, let’s talk about the attorney-client relationship.
Brad: Now, Michael, is that like having a secret [00:17:00] club where there’s a handshake or something like that?
Michael: It’s a bit more formal than that, the attorney-client relationship is essentially a bond of trust between a lawyer and their client. In fact, us as attorneys, owe what’s called a fiduciary duty to our clients. It’s the highest level of trust. And we have all these rules that go with our license on how we’re supposed to treat our clients. And the flip side is, there has to be a mutually trusting relationship. It’s crucial because it allows clients to be completely honest with their attorneys, without fearing that their secrets will be spilled like coffee on a Monday morning.
Brad: Oh, that sounds terrible. That sounds very serious. So if I’m a client and I just kind of go into my attorney’s office can I tell like all my embarrassing stories to them?
Michael: Yes. You might save some of them like your dance [00:18:00] moves or some of those other things for happy hour.
Brad: Wait, I said embarrassing. My dance moves are amazing.
Michael: Yes. In all seriousness, Brad, you should feel free to share relevant details about your matter. The attorney is legally bound to keep your secrets because of the attorney-client privilege.
Brad: Well that is a relief. Let me give you an example. What if my secret involved, I don’t know, being the culprit behind writing reviews about a podcast that needs more Brad and less Michael. Is that attorney-client privilege? Is that protected?
Michael: Interesting hypothetical. If you disclose it to your lawyer, they have to keep that secret. Even if that sounds like a horrible idea, they have to keep that secret. The privilege cannot be disclosed without your permission. So unless you’re planning to disclose something like this, I don’t know, on a podcast while you’re on the podcast, your secret should be safe. [00:19:00]
Brad: Okay, but why is this whole confidentiality thing so important? I mean, besides keeping me out of trouble with my co-host, allegedly, if I had done these things…
Michael: Theoretically, yes.
Brad: Theoretically.
Michael: Well, I mean, think about it in terms of the story here. I mean, there was clearly some information there that if the clients can be open and honest, it helps you as the attorney provide the best possible advice. I mean, think about having help on a deal like this and someone like Mr. Reede’s probably thinking, I want to get the deal done and I don’t want the terms to be affected, so I’m going to leak little information and half-truths as I can to try to control the scenario of how everything’s happening. But that completely misses the mark of the function of why you have an attorney. [00:21:00] I mean, you are there to lead them through the entire process and guide them. And so if you, as the attorney have the information, then you kind of know, okay, we can go door A, door B, or door C. Now, they may not be as seemingly optimal as if you didn’t have that bad information, but that bad information’s going to come out in some way and hurt you.
Brad: So what I’m hearing, if, if I’m listening to you, this sounds essential and there’s no secret handshake needed. That’s good to know. Just trust and some good legal advice, right?
Michael: You said it back correctly, Brad, though a secret handshake would definitely add some flare to the legal profession.
Brad: Note to self, develop secret handshake. Got it.
Michael: Yeah. I don’t think it’d be good for ByrdAdatto branding if you did that, Brad, [00:21:00] because I’m picturing a Star Trek-like secret handshake.
Brad: Okay. Hold on. Deleting note. Delete, delete, delete.
Michael: Fair. Good, good way to listen. Well, so let’s go back to Mr. Reede. What happened with that sale?
Brad: You know, in the end, believe it or not, it was not one misrepresentation actually that killed the deal. It was discovered that Ms. Reede may have exaggerated some additional connections with other medical providers and we couldn’t prove it. Dr. Audrey’s counsel just came back to us and he basically killed the deal.
Michael: Well, how does it, and I’ll put it in quotes, “basically kill the deal”, what does that mean?
Brad: It’s a good point. Well, when the numbers didn’t add up and with all these other prior corrections, the buyer basically felt like the actual value of the deal was pennies on the dollars to what they were going to pay for it. And as such, because they didn’t trust the data, they came back with an updated purchase price that was hundreds of thousands [00:22:00] of dollars less as to what the initial LOI had.
Michael: I get it. So I am assuming that Mr. Reede did not want to sell for that price.
Brad: Exactly. It killed the deal.
Michael: Well, let’s pause for a minute and talk about it in the context of an M&A deal, what are the tactics that can be used to kill the deal? Now, there’s the straightforward…
Brad: And just to be clear, we don’t want tactics to do that. We don’t want to find ways to kill deals.
Michael: No, no, no but what are the tactics that can be used to kill a deal? So one way a deal can be killed is a straight termination of a letter of intent. That’s what probably most people would expect, someone that’s just open direct communication, this isn’t working. As you just alluded to, one is the ability to change the purchase price after due diligence. And you might, if one, were trying to kill the deal, do this knowing that that substantial [00:23:00] impact of the price is going to make the other side walk away. So you’re like daring the other side to break up with you basically. And you can do the same thing with another material term after due diligence. So again, it’s the indirect, you change the terms and try to make them be the one that breaks up. And then the other thing that we see happen pretty commonly in private equity deals is that all of a sudden it’s just crickets. And oh, we’ve got a bunch of other closings happening right now, and you’re next on the list and we’ll get to it. And it just drags and drags until it quietly dies due to kind of deal fatigue.
Brad: No, all good points. Next time hopefully the client will understand honestly. Honestly might not get you everywhere, but it keeps you from going nowhere. You know, Mr. Reede is now in the process of cleaning up his internal documentation, his paperwork. [00:24:00] He’s got an accountant involved, so hopefully next time he tries to sell, he won’t look like a light liar.
Michael: Oh! Brad with his movie thing. I just got it, Brad. Was Mr. Reede Jim Carrey’s character in a movie?
Brad: Yes! Gold Star for Michael. Put it up there Kennedy. Jim Carrey did play a character, Fletcher Reede as an ace lawyer in the courtroom, but his dishonesty and his, let’s just say the way he acted, ruined his relationship with his wife Audrey and the movie was called Liar Liar.
Michael: Look at you, Brad, getting the movie in on me. Well, here we are, wrapping up towards the end. Tell me what final thoughts you have.
Brad: Yeah, let’s remember that the entire reason you hire an attorney in an M&A deal is so that the attorney can help provide the expertise needed to navigate. Look, these are complex transactions [00:25:00] and they’re there to help protect your interests. By fully disclosing all of the relevant information and factors, it will enable your attorney to conduct a comprehensive due diligence, identify potential risks, and most importantly, craft strategies to mitigate any future liabilities that you have post-closing. These transparencies help in drafting these agreements, and then obviously, hopefully avoiding costly mistakes down the road. And more importantly, unlike this deal, having a smoother transaction throughout the entire process. And ultimately, an informed attorney can actually better safeguard your interests and hopefully not have a deal die like this one did or protect you on, like I said, in those post-closing obligations.
Michael: Cool. Well, kind of my wrap up thoughts, Brad. One thing we haven’t talked about is the other downside to lying during due diligence. What happens if he would’ve actually gotten away with it? [00:26:00]Let’s just play this out and he feeds you half-truths, you know no different, you don’t learn of anything, the buyer’s not really dotting i’s and crossing t’s, and you get all the way to closing and you sell your business. Well, this actually is your worst case – his worst case scenario because the legal repercussions are massive. So let’s start with this. In the legal documents, there’s tons of representations and warranties that the seller has to say, these things are true about my business.
Brad: That’s correct.
Michael: And if he doesn’t tell his attorney the truth, then you don’t know to either negotiate those or list them in the disclosure schedules, which is kind of like your – these representations are true except for what I’ve disclosed on this schedule. [00:27:00] And that’s where you could do your work of helping him say, this information is on the table. So now you have a situation where there’s these reps and warranties out there, and in the documents there may be financial penalties, there could be holdbacks, there could be other earnouts that are penalized from that. And then, there can even be liability directly for first breach of contract, and even worse for fraud. And so you see stories in the news of big deals, billion dollar deals where they’re getting sued afterwards because the seller didn’t disclose adequate information or withheld information that threatens the entire transaction and they’re in this bet the business type lawsuits that drag on for years. And so, Mr. Reede may have thought [00:28:00] he was getting away with something, but it was way worse… would’ve been way worse than my broken pinky.
Brad: Yes. That sounds like it could have been.
Michael: Yes.
Brad: Well, good. Well, Michael, guess what? Next Wednesday we’ll be back with series regular and our partner, Jay Reyero, who will be talking to us about when someone wants to yell out during an M&A deal, “show me the money.” Thanks again for joining us today. And remember, if you like this episode, please subscribe, make sure to give us a five star rating and share with your friends.
Michael: You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com.
Outro: ByrdAdatto is providing this podcast as a public service. This podcast is for educational purposes only. This podcast does not constitute legal advice, nor does it establish an attorney-client relationship. Reference to any specific product or entity does not constitute an endorsement or recommendation by ByrdAdatto. The views expressed by guests are their own, and their appearance on the program does not imply an endorsement of them [00:29:00] or any entity they represent. Please consult with an attorney on your legal issues.
