We talk a lot about the five phases of an M&A deal: the letter of intent (LOI), due diligence, the definitive agreements, closing, and post-closing. Each of these phases makes up the M&A process, and each serves a very important purpose. In this episode, we share what can happen when you stray away from this process and how to avoid these mistakes.
Listen to the full episode using the player below, or by visiting one of the links below. Below is the episode’s transcript which has been edited for readability. If you have any questions or would like to learn more, email us at firstname.lastname@example.org.
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 another episode of The Legal 123s with ByrdAdatto. I’m your host, Brad Adatto with my co-host Michael Byrd.
Michael: Thanks, Brad. As a business and health care law firm, we meet many interesting people in various stages of their business. This season, we get to focus on the high stakes implications of selling a business. This season’s theme is The Hitchhiker’s Guide to M&A. We’ll be guest heavy and bring in different professionals to offer their experiences and perspectives on M&A.
Brad: And for those of you who are virtually raising your hand, trying to figure out what M&A means, that stands for mergers and acquisitions. Though Michael, this season is guest heavy, there’s a guy who’s gonna be joining us today, he’s not really just a guest anymore. He’s kind of more of a regular [00:01:00] podcaster, even maybe, but, Jay, your partners here. Jay, just welcome back to your second home.
Jay: Yes. Thank you. Thank you for having me. And as you guys might hear, I woke up this morning and I sound a little off, but I promise I feel a lot better than I sound, but I got with Riley, our podcast producer before the show, and she promised me that in post production she was gonna make it so that I sound like James Earl Jones the rest of the episode. All right, so Riley, all right, we’re gonna test this out. Ready? All right. Here we go. Brad, I am your father.
Brad: That’s not bad.
Jay: Good Riley?
Jay: All right, good.
Brad: I like it. Well, Michael, you know, before actually we jump in, I just wanna make sure everyone understands when we talk about mergers acquisitions, we’re actually still talking about simply the buying and selling of businesses or buying and selling of substantially all the assets of business, but Michael, you know, Jay kind of kicked this off and I’m kind of excited. It’s been [00:02:00] too long since we had movie talk on the show.
Michael: I see exactly what’s happening here. First of all, you knew that I would give you a hard time to go movie talk so you brought Jay in at the beginning to go movie talk, and now I’m completely ganged up on, okay. Well, Brad, I guess, I’ve got Riley on short notice to cut you off, but I guess keep going.
Brad: Riley, do not listen to anything that Michael says. You know Michael, a lot of times you make fun of me cause you think I’m living the eighties, but today we’re gonna get more into some more modern movies, and movie talk, we’re gonna go to the nineties. So Michael, have you ever seen the movie Pulp Fiction?
Michael: Well, of course Brad, that’s one of my favorite movies.
Brad: Yes, it’s one of my favorite too. Audience members, since Michael loves context, those who don’t know what we’re talking about, Pulp Fiction is a movie that Quentin Tarantino was the director of and it kind of chronicles a story of these different crime incidents in Los Angeles and following some mob hitman, which is [00:03:00] Samuel Jackson and John Travolta, some boxer named Bruce Willis and a pair of diner bandits Amanda Plummer and Tim Roth. Michael, when you saw the movie, did it just blow your mind from a story and then storytelling perspective?
Michael: Well, yeah first, I have to say, this is one of the most quotable movies ever with some of the most memorable characters so when you started talking about this, instantly I’m thinking about the Wolf, The gimp, Zed, Zeds dead.
Brad: Zeds dead.
Michael: And it’s so forever emblazoned in my brain, but yeah, I mean, of course the storytelling was incredible.
Brad: Yes. Some incredibly great lines that I know we throw out with my friends all the time. I thought was brilliant. Jay, one of the characteristics of this movie that the people love so much, and it’s not the first one to do it, but it really jumpstarted again, was this non-linear narrative, the way the audience gets to experience basically skipping around, while telling a really cool story, but it’s not a solid [00:04:00] from A to B, it jumps from A, B, D, Z, F, Z. So it’s a different experience and you love mummies too. Obviously, we started off with a little Star Wars reference. What is one of your favorite non-linear movies of all time?
Jay: So I’ll go a little bit further in the future there to the year 2000 and one of the first Christopher Nolan movies was Memento. It was one of my favorites and it drops you off right at the end of the story and it works its way bits and pieces all the way up to the actual point of the story. And so it’s a non-linear story. It’s fantastic storytelling. It has black and white and color and they represent different time periods and it’s great. So, Michael, have you ever seen Memento?
Michael: I have not. It sounds way too smart for me. But no, believe it or not, I haven’t seen it. I’ve heard of it and heard that it was a great movie. You guys are talking about kind of these unusual movies with the, [00:05:00] you know, non-linear format. The first movie that pops to mind for me for one of my favorite movies is The Usual Suspects.
Brad: Oh man, Michael, I’m so proud of you. That’s such a classic movie. Actually, my wife, Mike and I, it’s one of our favorite movies too. You know, and other people, when you start talking about great non-linear movies, you start talking, some might throw out Reservoir Dogs. Some people think that’s one of the best ones. Another Quintin Tanner movie. Others talk about classic movies, so I’m gonna go way back in time. Citizen Kane is another one. So no matter, what is the quote, number one non-linear movie all the time, all these are amazing because they’re great stories, great movies, and then you don’t seem to be able to understand where you’re gonna start or end. And for those audience members who are listening who want or love this movie talk, just understand, go to your Blockbusters and rent the movies that we’re talking about.
Michael: Oh, Brad, you truly went back to 1990.
Michael: I’ll confess that you guys successfully [00:06:00] sucked me into the movie talk. That was interesting. I think we are not trying to go so far as to be a movie review show, or at least I would like to keep it from that, Brad.
Brad: Right. Okay.
Michael: So let’s kind of go with Legal talk. I think the listeners that are still with us probably came on to hear something along those lines. So where are you going with this opening banter?
Brad: Well, besides Jay doing his Darth Vader impression before we started, you know, understanding some of those stories that Jay’s gonna share, it reminded me that when a client gets involved in an M&A deal or actually any legal arrangement, they sometimes just wanna jump to the end and they skip around to get there. And that works really well in these movies we were just talking about, but it doesn’t always work really well in legal structures.
Michael: Way to cram that segue in there, Brad?
Brad: You’re welcome. All right. Now before we get into Jay’s story, context man, Mr. Michael, why don’t we just, you know, give a little brief reminder to our audience of what’s going on. Right now we’re talking about the seasons of businesses and really the [00:07:00] focusing on the five phases of M&A deals so just give a quick recap please.
Michael: Yeah, and as we’ve talked in every show, the M&A deal is really a buildup of what’s happened in the various seasons of a business and all businesses are in, you know, what we say are one of four seasons. The building season, the operating season, the scaling season, and then finally the selling, buying and selling season. And so when we get into the buying and selling season, that’s of course primarily what we’re talking about M&A. And we talk about this kind of timeline of an M&A deal, or the five phases of an M&A deal. There’s the, you know, kind of the beginning and that ends with the letter of intent. And then you get into the due diligence, your underwear drawer moment, Brad. And then we get into the definitive agreements, the drafting of legal documents and negotiations of those documents, and then [00:08:00] we pop the champagne and have a closing. And then, you know what people don’t like to hear is there’s a bunch of stuff you have to do post-closing to clean things up.
Brad: Good job, Michael. That’s perfect. We’re so proud of you. Now, Jay, which of these phases are we gonna focus on today?
Jay: I guess technically the closing and post-closing phases today.
Brad: I like your strength in that answer by the way. So every client, you know, the deal, they love to see it just close. They love to hear the deals close and really, really do they care about, well, what happens post-closing. And Michael, you have been a lawyer forever, I think, you know, 1900s is, I think when you got your first doodle.
Michael: When Citizen Kane came out.
Brad: Yeah when Citizen Kane.
Brad: Will you give a little, again, context, for our audience, understanding that, you know, what is, what do we say, closing and post-closing phases. For those who aren’t familiar with it, just kind of give an idea of what that looks like and don’t really talk about your speed typing as you’re talking about closing.
Michael: Oh. [00:09:00] Okay. Well, I guess I’ll stay away, but yeah, the closing, you know, back in the day probably did involve some typing, but unfortunately, that wasn’t able to utilize that skillset for that.
Brad: Yeah, your ink pen.
Michael: You know, in modern times the closing is, you know, kind of the culmination and official finish of a deal. And that’s, generally speaking, documents get released, funds that are involved get transferred, celebration ensues. And so, you know, it’s kind of a very small moment in time relative to the entire phase because it’s all done virtually. And so, you know, you get to a closing date and there’s a mad rush up to that in the days leading up to the closing. And then it happens and then, you know, there’s a little bit of kind of that air of pressure of what now all that work is done and then [00:10:00] you realize that you gotta clean up all the stuff that everyone decided, okay, we’ll do this post close, we’ll do that post-close. And so, you know, there’s a lot of there tends to be a lot of, you know, kind of corporate cleanup that happens after the close and sometimes some compliance related cleanup that wasn’t dealt with and then just some administrative closing binders and that sort of thing.
Brad: Sounds real exciting, that post-closing part. Now, Jay, what story do you have today? I guess that’s gonna kinda line up with what the post-closing and closing aspects of it.
Jay: All right. So, well, today’s story is gonna involve a client and who we’re gonna call today, Skippy. And the story begins on the last day of June when Skippy called me up and said, Hey, I agreed to sell my business and oh, by the way, the deal’s effective July 1st.
Michael: Oh, wow. Well, and first Skippy sounds like such a boyish, innocent name, and yet you just told me about your one day notice [00:11:00] phone call. I have a feeling I’m very wrong about this impression.
Brad: Well, first off, Riley, please save that cause Michael saying that he is wrong is not said enough. So that’s correct. You are wrong. Now Jay, how long have you been working with this client to get this deal done since obviously there’s an LOI phase and due diligence, so what point did you really kind of get in there?
Jay: Yeah. The phone call.
Jay: When I picked up the phone and I heard the news. Last one to the party.
Michael: So this was one of those cases where the client had been negotiating the LOI and the parties were doing the due diligence, but just no involvement of you.
Jay: Yeah, I mean basically, so what I gathered from my conversation is, you know, Skippy and the buyer had formed a general business connection, spent time talking business, nothing very specific. They’d known each other for a while. Maybe at some point they had high level discussions about general ideas of what a sale [00:12:00] or purchase would look like, but I never heard anything and there was nothing formal. So I actually had no idea that a sale was even being contemplated by Skippy until that day when I got the call.
Brad: You know, if this was the red flag season we’d have the ding button going a little crazy throughout the story so far, but we’re gonna move on. Audience members that didn’t understand, these are not good signs on how a deal can progress excessively. So what did you learn about what was going on with the deal, Jay?
Jay: Yeah, so what Skippy told me was that, he and the buyer met that morning and throughout the day they worked out all of the details that you ever needed to work out. All of them. Yeah. They covered everything. And they even signed an MOU outlining everything and signed it and said it was effective July 1st.
Brad: Okay. Well, we’re just throwing out all these slang terms, M&A and other things so, Michael, context wise, Jay just said, what is an MOU?
Michael: Well, first, let me just clarify. Did you mean they signed the MOU on the [00:13:00] day that they called you?
Michael: Oh, okay. So it was the effective the next day. Okay. Well, so an MOU is a memorandum of understanding and it’s closest, you know, akin to a letter of intent. So it usually is, here’s the concept of what we’re agreeing to and so there’s nothing wrong in of itself with signing a memorandum of understanding. It is a little concerning when you get the call and then everything’s over the next day cause that’s usually kind of the tone setting beginning of an M&A deal.
Brad: If we’re going through the five phases, that is phase one, audience members, of many.
Jay: Yeah. So, and I mean, in this case, they were basically treating the MOU as if it was the definitive documents so I said, all right, Skippy, send me the document. Let me take a look at it. Maybe you work some magic. And it’s not what I expect, but of course I get it. It looks like an LOI. It, you know, has some high level [00:14:00] terms, but it did not at all deal with everything that you typically see in definitive agreements. It was just basically a summary of here are some of the things that we’re gonna do, but it didn’t have any of your typical provisions you see in those types of documents.
Brad: All right. Well it sounds like you had a lot of work cut out for you. So what’d you end up doing?
Jay: Well, so I jumped on the phone again with Skippy and, you know, not only to talk about the MOU in general, but I basically spent the entire time explaining the five phases that Michael just went through, trying to, you know, show him technically we’re only in phase one, we haven’t really done anything, and if they expected that, due diligence and the definitive documents phases were gonna be done in less than a day at that point, just not gonna be feasible. And you know, there hadn’t been done any due diligence. No one’s looked at anything, no one’s asked anything. CPAs weren’t brought in. There was just nothing done. And so I was basically just sitting there trying to convey, Hey, this isn’t even close to closing the deal tomorrow. This is just the first step, and let’s [00:15:00] start from there.
Michael: And how did Skippy respond?
Jay: Well, of course at first, you know, he was all gung-ho about the deal being closed and selling the company, so he was resistant, but then, you know, as I kept explaining why there were needs to deal with it in the proper way, you know, and I started asking questions about, okay, what about taxes and credit cards and liabilities that weren’t talked about in the MOU that I knew about, you know, he’s started to come around and understand, okay, I get it and by the end of it, you know, I was asking what if scenarios, and I think it became clear towards the end. Okay, I got it. You know, maybe we don’t need to just expedite this tomorrow.
Michael: Okay. Well, did that help?
Jay: Well, for him, yes. I mean, we left the conversation. I felt great about it and Skippy was like, oh yeah, I get it, totally understand. The problem was the buyers thought, no, this is the deal. We closed it, we signed it yesterday, we worked all day. It’s effective July 1st, we own the business. So to the buyers, no, it was [00:16:00] it, it was a done deal.
Brad: Jay, this is, yeah, I guess, I mean, kind of a straightforward story. Someone sits down with someone, writes a piece of paper, they sell it, but I thought you said we were gonna really focus on the closing and post-closing.
Jay: Yeah. Well, so because the buyer didn’t agree and didn’t really understand that, I mean, we basically were consummating the deal as if it was owned on July 1st, and we were, you know, at the end of the day turning and doing the definitive documents during the post-closing phase. So again, kind of backwards, but, you know, that was the best we could do at that point because everyone was very steadfast. No, this deal closed July 1st.
Michael: It is starting to feel like the Pulp Fiction of M&A deals. So what did you do?
Jay: Well, so we talked about all the missing pieces. We talked about the things that needed to be dealt with. I talked to Skippy a lot about, you know, the risks of, Hey, if we go this route, there’s a lot of risks of things that if we don’t do, it’s [00:17:00] gonna be problematic.
Brad: Well, hopefully that changed something, right?
Jay: Nope. Nope, not at all. They were okay with putting the definitive documents together after the fact, but they weren’t gonna do any due diligence. They had done everything during that meeting. The effective date was still July 1st. They actually wanted the MOU to become part of the agreement somehow because they had negotiated it and they had signed it. And so again, we were, going back to the five phases, we were gonna develop these definitive documents after closing occurred during the post-closing phase.
Michael: Just like they draw it up. So what ended up happening?
Jay: Well, so as you can imagine, we go through the definitive documents and things hadn’t been addressed, things hadn’t been asked or, you know, questioned. And so every time I had a question that wasn’t covered, this would kick off basically new negotiations at this point between Skippy and the buyer. Sometimes it would be a, you know, a quick conversation and I’d get the answer right away. [00:18:00] Other times it would drag on for days because they couldn’t agree and spoiler alert, they didn’t talk about it during that day, but ultimately they wanted the deal just to get papered up so it kept moving forward. And we finally did get the documents all prepared, everything signed off, but, that’s, you know, bigger issues were still to come.
Brad: Yeah. So audience members are probably guessing already the things that weren’t covered by the MOU probably caused some trouble.
Jay: Wow. How could you ever have guessed that from that story? So yeah, about two, three months later and beyond, things started popping up from Skippy’s ownership timeframe, but they were now, you know, coming after on and affecting the buyer and the business. And so, as you can imagine, buyer saying, Hey, Skippy, take care. This is your fault. And Skippy’s like, nuh-uh, it’s yours. You took it. And so it became, you know, discussions and more negotiations and more issues. And you look at the general MOU. Figure out, okay, well what did you guys agree to during that [00:19:00] all-encompassing meeting? And there was nothing there. So it, you know, that was not helpful.
Michael: I’m guessing that most of our audience could see this train wreck coming. That’s impressive. Well, let’s go to break and talk about some of the lessons to be learned from Skippy’s story.
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Brad: Welcome back to the Legal 123s at Byrdadatto. I’m your host, Brad Adatto, with my co-host Michael Byrd and series regular, [00:20:00] Jay Reyero. Still all here. Now, Michael, we just had a heck of a story on Skippy, Huh?
Michael: Yeah, no kidding. Skippy was not the sweet, innocent boy that I popped to mind. Well, maybe he was very naive.
Michael: Here’s the story. Jay gets a phone call on June 30th saying that his client has a deal and they’re closing the next day. As Jay starts to unpack that, he realizes that they did come up with an MOU, which in of itself is not bad. I mean, we’ve had episodes where, you know, there are issues that go with that as well.
Brad: Sure, yeah.
Michael: But it’s not the worst thing. It’s non-binding as they say, and at least you can launch from that.
Michael: And hopefully fix some stuff, but lo and behold, Jay discovered that they view this as the definitive [00:21:00] document. This memorandum of understanding was actually in their minds, the paper that closed the sale of a business. Jay, though he tried his best to explain the five phases of an M&A deal, the buyer in particular wouldn’t be moved. So Skippy went along and they decided to do things backwards and have sold the business and then paper it up after the fact and where we left off was trouble brewing.
Michael: Months later.
Jay: Yeah, I think one of the biggest mistakes here, we talked about at the beginning, non-linear is fantastic for movies, not so much for the M&A process.
Jay: The M&A process, the five phases Michael talked about are there for a reason. They each serve very important purposes. The LOI establishes expectations, the due diligence uncovers hidden issues, the definitive [00:22:00] documents memorialize everything, and the closing is kind of that final chapter of we’re done, and then post closing is let’s clean up the things that we knew about beforehand. So not going through that process and just kind of skipping ahead and starting at the end, really creates massive issues, especially because there was less than 24 hours to have the deal technically done. You can see how that non-linear situation and not understanding the process can really be problematic.
Brad: Yeah, you know, we are blessed to have a lot of entrepreneurs and physicians that we get to work with. They’re super smart individuals and extremely knowledgeable in the field that they’re in, and often the case is that this makes them their own worst enemy because they’re the smartest person in the room. They think they can figure certain things out, which they might. I’ve actually been in a room on a panel where someone said, “You don’t really need an attorney to do this stuff. You can negotiate everything yourself, and there’s no reason to have them”. Maybe that particular doctor was correct, but I’d love to see what happened with the definitive documents. I’d love to see what post-closing obligations they agreed to and whether or not they’re within the margins. So, for the audience members to understand, I’m not saying you have to hire an attorney. You just have to understand that there are so many different phases to a deal that need to be done correctly. You really do want to work with someone that has the knowledge to have done these deals. Audience members, you’re probably going to roll your eyes when you hear me say this, but you know, we always talk about the five 50 rule. This is a perfect example of someone who’s like, “oh, I’ll just do it right now. We’ll get this deal done”. But they did not realize on the back end, that’s going to cause tremendous pain and issues because of a date that they had to meet. The July 1st date within 24 hours of assigning it and so’s a five 50 rule file, you’ll pay $5 up front to do it right, or $50 in the back end. This sounds like it is starting to fall into the [00:24:00] $50 roll.
Michael: Yeah, and just to add on to both of you guys, we kind of talked about the purpose in past episodes of the LOI. That it sets the tone for the transaction and the purpose of the due diligence phase. We’ve had a lot of conversations about that.
Michael: If we just take a step back from each isolated phase and ask, why do we go through these five phases? It really comes down to two things. One is risk management, and two is expectations. You have to get to understand what are the risks with this business, and who’s the one that’s gonna be responsible for that risk. The buyer or the seller? And then getting on the same page on expectations. So many times these M&A deals end in some form of a partnership. They’re going to be working together in some way, and if they’re not aligned as to how that’s gonna work, [00:25:00] there can be trouble ahead.
Jay: Yeah, and I think the other thing that we kind of see too is if you go really fast, you don’t uncover a lot of things that could lead to a delay. There are permits, accreditations, licenses, and contracts that need to be assigned, or you need to apply for new ones, or you have to go to a third-party landlord and request consent. Those things can get out of your control. If we don’t deal with those early on, it can sometimes delay closing by weeks or months. We’ve seen it happen over a significantly long period of time. Everyone’s ready to close the deal, and yet we can’t technically close because there’s someone out there who has to be a part of the process that we didn’t involve early enough. Not going through the process creates the risk that it’s going to happen at some point.
Brad: Yeah, and Riley, you can cut this. Michael had a good point there, and it’s that alignment of expectations is really what that LOI should (or in this case, the MOU). It’s just trying to figure out if we are aligned and what those expectations are. We’ve talked about this in previous episodes. The reason why we discuss the five phases is that there’s a process. You have to understand and trust that process to go through each phase. Each phase is extremely important for the next step. As Jay was alluding to, during each phase, you might learn something new and realize, “Oh wow, who handles this particular obligation? I thought you were going to handle it afterwards.’ Well, let’s figure that out because it’s an important element for the post-closing phase.” Another important point that Jay made, especially in health care deals, is that people often say, “Oh, I want to buy this pharmacy in San Antonio and move it to Houston and just buy the license”. But that’s not how it works. They negotiate and discuss it, only to realize that it’s not an untransferable asset. These are the reasons why, especially in health care deals, it’s important to bring in experts to help you through the process.
Michael: Yeah, and you mentioned earlier, you were being a little bit humble as you like to be, Brad, and you’re like, ‘Oh, you know, I don’t know, I’m not saying you have to have a lawyer for this.’ I kind of am like, well, yeah, actually, for an M&A deal, you have to have a lawyer. That’s like going and operating on yourself instead of having a doctor do it. With less stakes, you’re not gonna die, obviously. But taking your expectations point, Brad, there are so many parts of a business transaction that business people, there’s no way they could know that they even need to talk about it.
Michael: That’s where it gets super complicated and you have to have an expert that can walk you through, kind of like Jay, or what Jay was trying to do after the fact.
Brad: Yes, but all within 22 hours or whatever it was.
Michael: Yes, exactly. You have to know what to talk about to even [00:28:00] get alignment and MOU hits the big points, but isn’t going to hit all the points.
Brad: Yeah. Well, Jay, I guess audience members out there are probably wondering, besides your final thoughts, what happened with Skippy and the buyer?
Jay: Well, I mean, to no one’s surprise, for the next probably 12 to 18 months, these issues that were never addressed during that day-long meeting kept popping up, and it became an issue because at some point, the buyers were fed up with all these random issues that they never knew about popping up. They weren’t going to take care of them, and yet the seller was like, ‘Hey, this is affecting me. I need you to take care of them because you promised threats of litigation.’ There was a lot of fighting; some things were just kind of dealt with, and some things weren’t. It was a mess for, you know, 12 to 18 months before finally, I think some of the stuff pre-Skippy finally kind of stopped.
Brad: Yeah. That makes sense that the five 50 rule probably came into play. Michael, what are your final thoughts?
Michael: I would [00:29:00] highly recommend not going the route of Skippy. You don’t want your Jay to be playing the role of the wolf in your M&A transaction, and you certainly don’t want Brad playing the gimp.
Brad: Well, audience members, hopefully you didn’t throw your earbuds out of your ears, but that is all the time we have today. Next Wednesday, we will continue our journey on the Hitchhiker Guide to M&A. We are going to turn our attention to the impact that the Sensei Plan has on an M&A deal.
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