When it comes to M&A, it's imperative to get through the process with the right team in place. We're digging into legal counsel and M&A transactions for tech enabled services firms, and where's the best place for a lawyer when it comes to deal and the critical things to consider.
Here's what we cover in this episode of Shoot the Moon:
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Mike Harvath 00:02
Hello and welcome to this week's Shoot the Moon podcast broadcasting live in direct from revenue rocket world headquarters. If you know if you tune in regularly revenue rocket is the world's premier and many growth strategy advisor for tech enabled services companies. With me today are my partners, Ryan Barnett and Matt lockhart. Welcome, gentleman.
Matt Lockhart 00:25
Hey, Mike. Good to be with you. Good to be with you, Ryan. We are we are really coming up to the end of summer here, which is sort of bittersweet. We've been in Minnesota. Here. Summers are too short. Now on the flip side, summers can be a tough time to get things done. And so I think we're pretty excited because we we've kind of we feel some momentum growing in the market overall. Right? And specifically in the m&a marketplace. So kind of excited to come out of summer too what's going on Ryan?
Ryan Barnett 01:04
Yeah, I agree with you. It's it's been great to have some great conversations lately and helping it service leaders either grow their business or navigate the trepid waters of m&a. Today, today, we're digging into a topic here on really looking at legal counsel and m&a transactions for tech enabled services firms, and really trying to understand where's the best place for a lawyer and, and legal counsel, when it comes to deal and something kind of critical things to consider. It's imperative to get through the process with the right team in place. And, Mike, I'd love for you to get us all on here.
Mike Harvath 01:47
Really well. I think like anything, m&a, you need to have a quality, qualified, experienced lawyer working on your behalf that knows m&a In the IT services space, that is an absolute requirement, if you're going to get through this sort of with a minimum amount of with a maximum amount of speed, and a minimum amount of fees, as well as, you know, avoiding things that might even cost you money in the transaction. So, you know, there's great legal advisors out there that have done a lot of deals and tech enabled services companies that do nothing but m&a. And I would certainly encourage you to focus there, they usually get started just to kind of give a framework here, you know, by taking an NDA that's been established by a buyer. And, you know, working through the definitive agreement. I would my personal opinion, is that you don't really need your lawyer to review an NDA or an LOI because those documents as much as an NDA is legally binding it just, you know, it's an agreement about non disclosure, I think you guys have probably signed enough NDA is to figure that one out on your own. And loi is are simply that letters of intent, they only outline the intent, they never outline everything that's in the transaction. They are non binding, think what's important to notice. If you have a non legally binding agreement, why would you hire a lawyer to help you negotiate it? In many ways, it's like documenting a handshake. You are documenting your intent in that document very similar to how you might document your intent and an email. And I think once you get to the point where you have an agreement on intent, you'll then want to involve a lawyer for sure. And the development of the legally binding agreement that will stand the test of time and within its four corners, have all of the legal aspects contained for the deal.
Ryan Barnett 04:06
I think that's a great start getting us going here, Mike. Man, I'd love to kind of hear your opinion here on we've worked with generalists, m&a, or department generalist lawyers. We've worked with M&A Focus lawyers, we've worked with IT services lawyers. Now, what's the importance of a lawyer to have domain expertise when it comes to transactions?
Matt Lockhart 04:35
Great question, Ryan. So me and by way of a bit of background. My father was a lawyer. And well, my brother's a lawyer. My sister's a lawyer, my brother in law's a lawyer. Two of my uncle's are lawyers. Three of my cousins are lawyers, right. And of that group, there is one in one of those lawyers that I would do business with in an m&a transaction. Right. And he's done a lot of them he's very experienced with in transactional law. Right. And so, to your point that there's a there are many different lawyers with many different facets, right. The first most important thing is is do they have an experience in transactional law? Now, to your question, how important is it that they have domain experience? Well, you know, if you're selling your landscaping business, I think it's probably less important that they have a bunch of domain experience about the landscaping business still important that they are transactional lawyers, but less important that they have domain experience. If you are selling your tech enabled services business, well, then the importance goes up. Right? And because there's just more complexities in place, that are going to have an impact on the definitive purchase agreement, right? Ya know, what would be an example of that? Well, the amount of money necessary, it to be held back in escrow for reps and warranties, right. A non domain experienced lawyer may not be in a position to adequately represent what is correct in the form of reps and warranties. So that's just one, you know, sort of example. So I do think that and, you know, for our listeners, I betcha there's not a bunch of owners of landscaping businesses. So for our listeners, yes. important that your counsel has some level of experience, you know, within the space. And, you know, we've worked with the good, the bad and the different. Right. And happy to provide recommendations and and referrals to those lawyers who do have domain specific experience.
Ryan Barnett 07:31
Yeah, I didn't realize you had a family full of lawyers must make some interesting holiday parties, for sure.
Matt Lockhart 07:39
Be real boring. I'll tell you how. I discovered that I wasn't going to be a lawyer when I was about 10 years old, when the rest of my family was talking about case law. Thankfully, they did that, or else I wouldn't be here today, I guess.
Ryan Barnett 08:00
Yeah, true. True. No love the origin story. Mike, I'd love to hear your thoughts on on by there's certain things that a generalist they look at, compared to a it specific thing, where, you know, what are what are common things that we see in the tech enabled services business? That may not be common in a quote unquote, generalist business? I'm thinking of something like perhaps a sign and close or even working catching up patients.
Mike Harvath 08:33
Yeah, you bring up a good one. One is certainly that it is common practice in our industry to do a simultaneous sign and close of the purchase agreement. It is exactly the opposite. In other industries, like if you're acquiring a restaurant, or a convenience store, it is very common to do a separate signing clause, meaning you sign the agreement, and then still do diligence, pursuant to a built in remedy, like inventorying things in a restaurant, for example, or in a convenience store. That last step of current inventory analysis to determine its value for balance sheet reconciliation happens after the close and those industries, but in our industry, that's not how it's typically done. I wouldn't say it's never done. But I would say it's very rare to have a separate signing flows in our industry, because we're dealing with people and it's predominantly a human capital type business, and that requires a different motion than what's required and more of a physical asset heavy business. Likewise, when you think about how working capital gets calculated, gets impacted by inventory and asset heavy businesses. or it's not in service related businesses. It is common practice in our industry to either have reps and warrants insurance, or to provide a whole back for the seller, its purchase price, you're going to get it. But it fortifies your representations and warranties in the business to confirm that what you've said about your books and the business and your intellectual property in your contracts. And all that is accurate. And if it's found out to be close, close, that it was not accurate or misrepresented, that there is some remedy to begin an investigation about, you know, maybe a seller's malfeasance in that situation. And so, there is generally always a hold back, for example, and then also, you know, it's very common, there's not a material difference between an asset deal and a stock deal in a services business. from a tax perspective, that's typically the biggest impact as it relates to step up accelerated depreciation based on the buyer. But that's only for physical assets. And so most services businesses have very little physical assets, maybe some office furniture, a few computers, but a lion shell of their the lion's share of their business value is actually goodwill. And because of that there's not a material difference between an asset deal and stock deal for a seller. And there is a material difference for a buyer. Now, if you're a lawyer who has a lot of experience in selling asset heavy businesses, like manufacturing companies, and grocery stores, and you know, companies that have a lot of physical plant and the plant and equipment, you would always advise your seller client to do a stock deal, because you're going to get preferred preferred tax treatment. So, you know, that's just some examples of where you need a domain expert to give you the right advice, or they will give you that lawyer could give you the absolutely the wrong advice, pursuant to their experience in other industries.
Ryan Barnett 12:22
Great advice. I think that really helps to understand there, there certainly going to be a few differences. And those are critical to know, upfront. Otherwise, it feels like a surprise at the end. Matt, good luck to you worked a lot with with lawyers and the timing of legal documents lately. What's your advice on perhaps the process here? And I'll put it in context of oftentimes you will see a definitive agreement released, there might be some red lines back and forth. There might be kind of a lawyer doing thing on one side or other side. Where's the role of that M&A advisor and how you work with legal counsel through that process? And the timing around some of those documents?
Matt Lockhart 13:11
Sure, yeah. So it it's an it's an art rather than a science? Well, I should say it's an art and a science maybe. So the science is, is is clarifying what legal documents are going to be in place, right. Obviously, a definitive agreement via an asset, you know, purchase agreement or a stock purchase agreement. For whom, at our employment agreement going to be in place, if there is a role of equity is there, what are the what are the appropriate Buy Sell agreements? Are there other tagalong agreements could be lease agreements, you know, et cetera, et cetera, that need to be in place. So that's a little bit kind of more the science of saying, alright, what all has to be in place legally, for both sides and to complete a transaction, the art is, is really the when the start to push for appropriate agreements, you know, clearly applicable due diligence by the buyer needs to be done. Right. And in, you know, last episode, we talked about a quality of earnings, right and and, in some cases or quality of earnings is absolutely appropriate and unnecessary. And it's sort of a gate if you will, that a transaction is going to be completed. Well, if that's the case, you probably don't want to engage your legal counsel and start trading documents until Well, that quality of earnings report is done, or that there has been, it may not be officially stamped. But everybody is saying, okay, the quality of earnings is not a problem, you know, et cetera, et cetera, then we do think that is the earlier the better, right to start to get legal engaged once material due diligence is completed. And a couple of reasons for that one. Remove any surprise, right? Out of the legal process. Right. Okay. Because once the, at least the framework of the legal documents is in place, then you can understand okay, right. You know, this is, this should be a pretty standard, you know, legal process, even though you know, there's some things that can't be determined, hold back escrow, or working the exact working capital amount, right, those are going to come later. But let's get the big things out of the way, right. And in the legal document, and a piece of advice that that we always do is that it is super important to get the to get the representative legal counsels talking to each other. And we facilitate this right out of the gate, right? And is that you know, and you go in with this mentality, a positive mentality that the transaction is going to close, right, and everyone wants the transaction to close. And so you set that tone right out of the gate. And you also set the tone that we are not going to have a delayed legal process. Where, you know, you're going to have multiple Red Line terms of a document without communicating, what is the resolution between any areas of disagreement, right? Because it's always easier for the lawyers to talk through those resolutions, as opposed to redlining back and forth to come to an agreement. So, you know, that's part of the art. As soon as material due diligence is done, facilitate getting the lawyers talking, make sure they understand that it is everyone's intent to complete the transaction, ie lawyers don't fight right for every nook and cranny and don't delay the process and facilitate the transaction to a close. Yeah,
Ryan Barnett 17:50
Great advice. Great advice. I've had Michael turnover review for the kind of the last question here. But know what's the role of an m&a advisor in dealing with legal counsel?
Mike Harvath 18:03
Thanks, Ryan. So an M&A advisor really focuses on negotiating the big picture, Deal. Deal structure, what we often call a business negotiation. Lawyers are focused on the legal negotiation. Lawyers love to get into business negotiation, because frankly, sometimes the legal negotiation is kind of boring and fairly black and white when push comes to shove. So a lot of lawyers want to wade into the business negotiation. And it's our job as an M&A advisor to keep them sort of where their expertise lies, and where you really need them focus, which is in the legal negotiation and and making sure they get the language right based on the business intent, the m&a advisors role to make sure the business intent is in alignment. And that that works. So I think in many ways we become the, we shepherd the deal through as an M&A advisor. We keep the lawyers on point, we make sure we all move to a logical close, within 90 days typically takes about 90 days, you get from loi to close and we manage that schedule. So with that, I will tie a ribbon on it for this week's podcast. encourage you all to tune in next week, we'll be unpacking more relevant points around m&a and growth strategy for tech enabled services companies. Enjoy your late summer and early fall and make it a great week. Thanks.