In this episode we're diving into disclosures in M&A. Disclosure schedules are required to be attached to an asset or stock purchase agreement. These are essentially the lists of everything required to be disclosed to the seller prior to the Purchase agreement. On the surface, this task seems easy but in reality, finding every contract you've ever done (and then some) can be harder than you think... Completeness and accuracy is super important so both the buyer and seller are happy. Listen as we help you prepare for disclosures in your next M&A deal.
In every deal we do, we spend a significant amount of time furnishing our clients' data room and ensuring full disclosure on all administrative business functions. The collection and inventory of these items are then transformed into a schedule within the SPA (stock purchase agreement) or APA (asset purchase agreement) known as the “Disclosures”. These items are the source of truth for everything a buyer needs to know and are acknowledging the existence of the items listed. These disclosures are usually referenced within the representations and warranties of the definitive agreements.
Types of things we see in disclosures:
For more information on disclosures and other items impacting your representations and warranties check out our resource section on the revenue rocket website. Or reach out anytime at info@revenuerocket.com
Mike Harvath 00:03
Hello, this is Mike Harvath with this week's Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket headquarters in Bloomington Minnesota. Revenue Rocket is the world's premier m&a and growth strategy advisor for IT services firms. Today with me are my partner's Matt Lockhart and Ryan Barnett. Welcome, gentlemen.
Matt Lockhart 00:28
Good to be here. Thanks, Mike.
Mike Harvath 00:31
Hey, we're talking about disclosure schedules, and how disclosure schedules are an important part of every m&a transaction, protect services companies and kind of what they are and how they play a role and all that stuff. So I'm going to shape kind of a little bit of background on disclosure schedules, and then we can start, you know, having a dialogue about it. First of all, what is the disclosure schedule disclosure schedule is part of a purchase agreement, it has to do with everything that's needed to be disclosed, that's essentially called out in that purchase agreement, whether it's an asset purchase, or stock purchase. And it's a really heavy left for a sales, somebody is selling their business. And most sellers underestimate the amount of time needed to complete a set of disclosures. And no, there's a bunch of them that are, are, you know, pretty easy to disclose, like, you might disclose that there's no litigation pending for your business or, you know, sometimes these are also other disclosures around, you know, have you received notice from a tax authority or not, or whatever, those are disclosures that you would make. They're also very similar to reps and warranties, which we'll talk about in a later podcast. But other disclosure schedules that are really meaningful involve all of your material contracts with your customers need to be able to disclose those and actually attach them to the schedule to be attended to the purchase agreement. thing would be for like any leases you might have for your office, or storage facilities or other operating leases that you might have for equipment, like you know, whether that be for printer, you know, other equipment that you might need to operate in your business or servers. Or, you know, there's other agreements that you have with vendors, it even goes all the way to, you know, specific services you get for like internet access, or might include copies of your banking statements from the most recent period or your financials. And so there's a lot of stuff that you need to disclose that you are going to warrant as accurate as part of a purchase agreement. And generally, when you start peeling the onion back on this, it takes several weeks to a month, frankly, to assemble disclosure schedules properly. Most people don't start thinking about it until they get a purchase agreement negotiated. And then this becomes kind of the long pole in the tent to close. So I'll stop there and turn it over to you to Ryan or Matt for any questions. Yeah,
Ryan Barnett 03:27
sure. Let me jump in Mike. And so when you when you say any material, contract, I mean, how, how is that defined?
Mike Harvath 03:38
materiality is different in every deal. And it depends. So some buyers might insist on every contract being disclosed that every contract is considered material. Others might say Well, in this is a real world example from a project we just closed, where they wanted to disclose the contracts that represented 90% of the revenue, and that you know, in this particular case resulted in about 50 contracts. And then additionally, they will oftentimes on the contracts want to know which ones require up consent or a notice. So that that appropriate level of consent or notice with a customer can be at
Ryan Barnett 04:30
So, so actually, the material the level of the definition material tends to be a negotiation point at between the buyer and the seller. Am I hearing that right?
Mike Harvath 04:40
yeah, and I think all you know by side lawyers are gonna want to see every contract that's what they're gonna ask for. But no, sometimes that's not practical. Depending on the size of your business or the type of customer you service, you might, you might have thousands of contracts that will be very challenging to try Do choline and go through and attach. And some that, frankly, are just not all that important. If they're small, and they were from, you know, they're not active, and they were from two years ago, you know, they're probably not material two years ago or older. If they're larger, and they certainly represent active contracts, we've certainly seen projects where it's only active contracts, or it's all active contracts over a certain size or, in some cases, it's all contracts back five years. Right. So it just, it depends, and you need to negotiate what constitutes materiality.
Ryan Barnett 05:40
Okay, and so in, would you mention this? Is the buyer responsible to declare essentially a blanket statement asking for? I would like, I would like to know all technology issues, or any financial liabilities. But how does a buyer request schedules?
Mike Harvath 06:02
Yes, so so some of those. Yep, it's a disclosure schedule document. And it will ask about those types of things. And you either have to disclose if there is or there isn't this type of issue or this if there is or isn't this type of contract. And if there is a contract that fits into the provision of the disclosure schedules, you have to provide a copy of it. And lawyers are doing their job aren't going to be looking at those contracts to make sure that there isn't any restrictions on the transaction. For example, I alluded to this notice, period or this notice item earlier, you know, notice this kind of a big deal. And need to make sure that, you know, if notice, or consent, in some cases is required that those consents come Now oftentimes, it's a little tricky, because you don't want to go to your biggest customers that might require consent, notifying yourself in the business before the transactions done. So there's usually an opportunity to say, we'll get those consents, you know, either, you know, right near close, like, right, before a day or two or a week before close? Or right after, just depends on the buyers preference?
Ryan Barnett 07:24
And then is to even dig in this a little bit more. So is, is the buyer using a perhaps like a reconciliation sheet of contracts or customer names to to, to pair that up with a contract? Good just trying to get the example? Or I'm just trying to wonder, how does a buyer know what they don't know? And kind of and, yeah, start with that it's been a follow up, as well.
Mike Harvath 07:54
Yeah, as you work through due diligence as the buyer, you're going to get a list of customers or key customers, and you're going to reconcile it against that, we're also going to ask for, you know, those that require notice or consent, you know, you're going to want to understand the nature of the revenue as you're doing your financial analysis, you know, what customers represent, what percentage of the revenue and you know, what's the history been for that customer, so that you can understand the quality of the cash flow. So, you know, it's comes out of an early stage and due diligence or earlier stage and due diligence, and certainly as something that your lawyers will be doing to help you, you know, match up those agreements to make sure they're in good standing. And to make sure that they're, you know, in a position or spot that they can be acquired.
Ryan Barnett 08:46
Okay, and then there's something of a major component, you mentioned months, they could take months of doing this. So who typically is responsible for pulling the data that pulling the data needed for those disclosures?
Mike Harvath 09:03
Well, is a seller oftentimes is someone who's in an administrative function at the seller, could be the owner, you know, the someone who's responsible doesn't want to disclose to their team that they're in the middle of a transaction, but I would tell you in most situations, it administrative role sometimes it's the CFO, sometimes it's a administrator is brought into the inner circle, if you will, on the fact that the business is being sold and that these items are needed for diligence, certainly begin to talk to their lawyers. Their lawyers will be interfacing with the buyers lawyers to make sure that the request and the disclosure schedules one is appropriate. And to that it's accurate. They will work closely with a seller to make sure it's accurate because what you don't want is have a breach in your disclosure schedule. Through mistake made on aka didn't disclose something that you should have disclosed incredibly important that even if it's bad news, or even as perceived bad news like litigation or some other, you know, material impact on the business that is disclosed. And your lawyers will advise you as a seller that you're better off over disclosing than under disclosing or keeping thing from the buyer, because, frankly, if you disclose those, if you certify and attest that those disclosures are complete and accurate, to the best of your knowledge, or maybe just that they're complete and accurate. And they're not. And the buyer finds out about it later, you know, that could be grounds for, you know, material lawsuit. Because you, you know, misrepresented your disclosures. Now, what everybody's afraid of is that you might misrepresent your disclosures by accident, or by omission. And that's where your lawyer can help you with validating that it is complete and accurate to the best of your knowledge as you make the disclosures.
Matt Lockhart 11:20
Hey Ryan, I want to go back to this three months. Now, Mike, it can't really take three months to pull all of the information. But what I'm hearing is, is that you need to get ahead of this. I mean, you really need to be prepared, you need to be you need to prepare with understanding who's got the applicable information, and whether or not they're in the inner circle or not. And if you if those individuals who have the applicant pool information are not in the inner circle, how do you bring them in. So it's not to risk your ongoing operation? You need to get ahead of it with the buyers and buyers council to get an understanding of, you know, the level of information that they're going to look for, start pre negotiating on things like contract value, right, so that you're not going to every Nitin out of minutiae that isn't going to be material. Um, and so it sounds like that preparation process is really that three months and not necessarily the actual combinate, you know, compiling of all the information. Is that right? Or am I off on that?
Mike Harvath 12:44
No, that's absolutely true. I think just call and putting the information together can take weeks, not months, of course. But being prepared, I think it probably opens up a better question, right. But, you know, you want to make sure your records are digitized, you want to make sure that you have access to them, you want to make sure they're complete, you want to make sure that you have complete knowledge of kind of what's going on in the business, particularly if you're, as an owner, kind of work your way out of a job, right, you have a general manager, let's say that's managing the business now comes time for you to sell. Really, really important that you have your finger on the pulse of the business, and that its records are complete and clean and sanitized so that you're not going through an exercise of trying to digitize paper contracts, for example, or trying to go through, you know, big left, as you're working through disclosure schedules. You know, we have seen it in the most complex situations take maybe up to a month, with records that are clean and complete. And some of that has to do with the negotiation associated with what's actually in the disclosures, like, what is the material contract? What is the material vendor contract? Like? Is that your landlord? Is that your landlord? Is there, you know, is there a material contract with an advisor, like revenue rocket? If there is that needs to be disclosed, right, typically, advisors are disclosed as part of disclosure schedules anyway. Because they want to have no ambiguity for as to who's paying the bill. Right. So that's an important thing. And, you know, certainly, I mean, this plays into reps and warrants. I know we've mentioned that we may cover this in a different, a different podcast, but certainly we can touch on that here. You know, representations and warrants again, come back to you know, what you're willing to represent in the business and these are very closely integrated with disclosures and all of that difference between a representation and the disclosure, maybe very nuanced. Disclosures tend to be much more about things that a buyer needs to know about the business to run it moving forward. representations and warrants have to do with you attesting to a fact about the business. So one of those might be that there's no lawsuits pending, right, as a representation, or your warranting that there is no lawsuits, any, you haven't been served regarding a lawsuit, or you don't know about a potential lawsuit, that's an important one, in a reppin war, you may be having a dispute with a former employee or a client or a vendor. And if you don't disclose that, that might be a pending lawsuit, you could be on the hook, if it becomes a lawsuit post close. So you know, there's things in this whole representation and warranty bucket and disclosure scheduled bucket that your lawyer can help you with, and certainly help you make sense of, I wouldn't be afraid of that. It's certainly just something that happens with every project and every sale. You just need to have competent legal advice on how to sort of navigate those waters.
Ryan Barnett 16:24
So Mike, do you have any. Mike or Matt, really, we just worked through a few deals in which there was quite a bit of, of schedules included. And it seemed that, that if this is done, right, it can help admire competence in what the seller has, and what how the business is run. In any deals that you've dealt with lately, you know, can you give an examples of how how these schedules really actually helped? get the deal done and signed and delivered?
Mike Harvath 16:57
Yeah, I mean, I, I would tell you that, you know, certainly, you know, the, oftentimes, particularly the growing business, you know, the terms of the contracts may not have been looked at in detail until you're getting close to close, right. So it gives the buyer a lot of confidence when they begin to look at those contracts, that they're buying, you know, a business that's healthy and prosperous. And so I think in many ways, you know, when you're disclosing things around contracts, there's kind of an aha moment that happens for a buyer that, you know, wow, you have a really sort of interesting, thriving, vibrant business that helps them feel good about the transaction. It sounds a little crazy. But I think, you know, they're certainly that's an example of a disclosure schedule that can really help grease the skids on a deal that you're, you know, well put together from a record keeping perspective, that there are no surprises in the transaction, that all of these records are complete. And you don't make sense. That certainly can help sort of facilitate the kind of move things along and certainly help your side of the negotiation as you move towards close.
Ryan Barnett 18:32
And the flip side, have you seen any deals that are have struggled with disclosure schedules, and or maybe even the timing of schedules and or perhaps underestimated the effort?
Mike Harvath 18:47
Well, yeah, I mean, we've seen deals get in trouble with the disclosures, you know, because their contract, you know, if you're a seller and your contracts are masked, or you're missing a lot of contracts, or you don't have complete record keeping, that can kill a deal. And I think it's important to know that, you know, a buyer is not going to take your word for it, that, you know, everything's great. If there's records that are missing, that's not going to work. Their lawyers are not going to be okay with that. Especially if there's a contract missing that has that would be defined as material or a vendor agreement that's missing, that would be defined as material. You know, if they're a vendor of some sort to you, or your lease, for example, you don't have a copy of your lease, where you're leasing space, probably a problem. Right. So I guess I would, you know, understand very clearly that the hygiene you use around corporate record keeping will make the whole concept of developing schedules much easier and better and certainly fortify your ability to get the deal done. If you have poor record keeping hygiene, one, you shouldn't probably be running your business that way. But you should certainly be thinking long and hard about going to market. Because the likelihood that a buyer is going to accept undue risk, because you can't provide all of the material information in this disclosures. I mean, it's just they're not going to accept that risk, they're not going to accept taking your word for it that this is in place, or that's in place, or that there is no consents required or notices required having to do with some agreement, it has to be actually shown. And so making sure that all that speed work has been done before you would ever consider going to market I think is super important. And it will help you ensure that you get a deal done. It's not something people think about when they decide to sell, or somebody approaches them to sell or buy their business. They don't think about the fact that maybe they haven't been the best at either their accounting rigor or their record keeping rigor. But without that your is going to be very, very difficult to get something transacted.
Matt Lockhart 21:24
I was gonna jump in Ryan, Mike, what's the role of, of what what role do we play as an advisor, versus the role of the buyers and sellers attorneys in the process of, of executing the disclosure schedules?
Mike Harvath 21:47
Yeah, that's a great, great question, Matt. I think, you know, we try to bring some sanity to the discussion, from the business perspective. And we have a discussion oftentimes about what is the risk associated with this disclosure, making it or not making it? And that, what is the practical risk, right, that there will be a problem if something goes sideways if this either disclosed or not disclosed. And lawyers look at it a little differently. In my experience, lawyers look at making sure that whatever the requirement is in the purchase agreement, for the disclosure schedule is complete. And that's different from looking at what is the actual risk of the way the disclosure schedules written for compliance, and doesn't warrant a change in the way it's written. And I brought up this example before where I said, you know, materiality is always something that can be negotiated. You know, what is considered a material contract? Is it something that represents up to a certain percentage of the business as a, as a, from a revenue perspective, or profit perspective? And do you need to disclose every contract or not. And we oftentimes will help in those negotiations to determine what in the legal world is called a carve out, we're carving out a certain number of contracts that are considered material. And that's considered adequate so that people don't get too hung up on all of the making sure, they're checking all the boxes, and even though that might not be very attainable, because it might include four or 5000 contracts, for example. And so our role oftentimes, is to kind of be the I don't want to call it voice of reason. But some of that would come in and say, you know, from a business risk perspective, not a legal risk, because that's lawyers domain, but from a business risk perspective, what is what is the risk associated with either the buyer not having the disclosure? Or the seller not making the disclosure or creating a carve off?
Matt Lockhart 24:11
Yeah, that's great. So you know, I thought, because, ultimately, I mean, this becomes a legal document, right, or attached to the legal document. And so I think that the while we can be the voice of reason, and also lead in a, in a sense, it's the lawyers that that really, you know, have to execute. And, you know, I think, in drawing that out, obviously, I mean, you know, having the right lawyer is something we talk about a lot, who has the experience in this space, and can facilitate, as opposed to making it more burdensome to getting the deal done.
Mike Harvath 24:55
Right
Ryan Barnett 25:03
Yeah, so that's, yeah, that's all the questions I had. Yeah, pass over to you Mike.
Mike Harvath 25:10
Yeah, great. So that will tie a ribbon on it. Next time, we'll continue to pick up the conversation with additional components of growth strategy opportunities and optimization strategies for your business as well as m&a tips and tricks to help you understand the workflow for m&a and hopefully helping you you know, think about how to get those deals done. Thanks and make it a great day.