How Private Equity Firms Structure Successful M&A Deals with Jon Dhanawade

Kison: This is the best time in Chicago. Let's kick things off a little bit about your background.

Jon: As you mentioned, I'm a [00:02:30] private equity partner at Mayor Brown here in Chicago, and my practice focuses on, on all the things you mentioned, it's evolved over time, what it means to be a private equity attorney.

Jon: Years and years ago used to be just doing leveraged buyouts. They used to be really popular, different market environments. Over the past couple years, the market has changed. We have a little bit more of the U word uncertainty. And as a result of that, the types of deals and the number of deals that sponsors are looking at have changed.

Jon: A lot of what I spend my time now doing are co-investments, preferred equity investments, LP [00:03:00] investments, back levered structures up top at the fund level. And it's been interesting to be a part of that evolution of investment types that sponsors are interested in.

Kison: I was gonna be excited to have the conversation because you touch a lot of different varieties of deals.

Kison: The adjunct professor, what do you teach?

Jon: I teach a course on private equity transactions at Northwestern. I went to law school at Northwestern, so for me it was a coming home of a kind where I went there many years ago. My background is, I'm a first generation immigrant, so I showed up there. I don't have any lawyers in my family first and foremost.[00:03:30]

Jon: So I showed up and I had this image and maybe I should back up and tell you why I went to law school 'cause I think it all sort of fit in. I'm a bronze level, Indian gold star Indian is someone who's a doctor, which my parents wanted me to be. I very quickly realized I had no science, uh, bone in my body.

Jon: Silver medal is an engineer also not the best at math. And so, you know, I went for sort of a bronze battle. It all started with a mock trial in high school where I had a psychology professor. He started a mock trial team for the first time in my high school. And he said, Hey John, you should come out and do this.

Jon: Now, of [00:04:00] course, I'm not a trial lawyer and I'm not a litigator, but it created that interest in reading and writing and debating and crafting arguments. And that's how I ended up in law school. And I got to Northwestern and the first year of law school is all geared towards litigation. A lot of those classes don't really translate to what transactional lawyers do, and I started to have a feeling that I'd made somewhat of a mistake.

Jon: But the nice thing is in the second and third year, you can start to take corporate classes. And one of the classes I took was an M&A one taught by, at the time, a partner at Kirkland and Ellis. That sort of [00:04:30] got my brain thinking about a different type of practice. And what I wanted to do, and the reason I teach this class now in Northwestern, is I think about how ill prepared I was when I started at a law firm coming outta law school.

Jon: I really lacked a lot of the basic foundational knowledge and skills that are required to be a successful transactional attorney. And my goal and my objective in teaching this class is to say, Hey, if you're interested in private equity transactional work, then hopefully this class sets you up on the right foot.

Jon: So when you join a firm, you know a little bit more than what I did.

Kison: That's actually a good point because [00:05:00] a lot of people I talk to that are getting into a legal program, they are not familiar with any just corporate law in general, specifically M&A, and then it's a good thing to expose 'em to it.

Jon: I remember, by the way, looking at law firm websites when I was thinking about what type of attorney I wanted to be, and I'd look at capital markets finance M&A, and at the time I vividly remember thinking they all sound the same.

Jon: How do you differentiate it as a law student who hasn't been exposed to any of these things? Part of the objective of this course is, hey. Even if you come out outta class thinking, I don't really like it, at least you know, [00:05:30] private equity transactional work isn't for you. So I've at least given you that knowledge coming outta class.

Kison: Hey, if we were to like to break it down real quick, because even in my view, I always think there's like large strategic, right you could work with and private equity, which I don't, I'd be curious to know how you would differentiate those two. And then you have a lot of things that we just described in the intro here where we talked about private credit earlier.

Kison: We have all these other forms. Can we just walk through that quick comparison of like fundamentally how your role differs in those [00:06:00] environments?

Jon: I have the benefit of having started my career doing a bunch of strategic work, public company work and strategic work when I came outta law school, and part of the reason I'm a private equity attorney now is I very quickly after about three years realized that it wasn't for me.

Jon: I just wasn't having fun. And the nature of the beast is you spend a lot of time doing it, you sacrifice a lot of time. Your family, friends and otherwise do the job. So there should be some semblance of joy coming out of it and I realize I just wasn't having fun. I'm writing down private equity's easier.[00:06:30]

Jon: Is that a big difference? Strategic work is a little bit different because number one, there are deals on a strategic side at move quickly, but private equity and comparison across the board, I know it's an overgeneralization, but those deals do move on balance a lot faster than strategic deals. Number two, your clients are really business folks, at least on the strategic deals I worked on that my peers who focus on strategic deals work on.

Jon: You have a host of clients internally at these large companies, some of which are lawyers, some of which are business folks, obviously corporate development individuals. In a PE context, a lot of times the [00:07:00] people who I interface with the most, including funds that have a legal function are deal professionals stated otherwise.

Jon: The people I'm corresponding with are people who are laser focused day in and day out on how to complete an objective. The objective being closing a deal. And what that means is your day-to-day looks very different because you're focused exclusively on items that matter from a commercial standpoint to get the deal done, which is why the deals a lot of times can move relatively quickly compared to their strategic counterparts.

Jon: The other difference, not across the board, but because PE deals can look very different is a [00:07:30] lot of these are private deals. Assuming you're under the HSR threshold, you can move relatively quickly. And documentation can look very different, particularly if you have a simultaneous deal.

Kison: Okay? So in a public company, you have to deal with more people in general because your internal legal team can be pretty robust.

Kison: You have their corp dev team. You're probably dealing with different functions that have their own legal sort of perspective and interest. And then you got like regulatory components. Yes, depending, you gotta file HSA,

Jon: for example, and [00:08:00] that's a key part of it. Public reporting requirements. If it's a public company, I remember early in my career thinking about, okay, we've signed this transaction, we're all exhausted, we've done the deal documentation.

Jon: Then you have to worry about an eight K the next morning and before the markets get going. In a private context, it's not a concern. You get through the deal, you focus on the deal. You may have regulatory approvals along the way, HSR or other regulatory ones, state agencies, but it just looks a bit different.

Kison: Okay. I'm adding reporting private equity, you're more straightforward. You're dealing with deal people. A lot of [00:08:30] 'em, they end up becoming very pragmatic about doing M&A. They have specialized consultants to come in, come out. Okay. That helps to understand the difference. What about these other areas we've talked about, like private credit or some of the other types of transactions you work on?

Kison: What are we missing?

Jon: Private credit has been fascinating. It's absolutely booming, particularly in the past couple of years. Historically, when you think about lending or financing in a transactional context, you have these banks who are lending money to help finance a transaction. What's kind of happened over the past couple years, particularly with the uncertainty [00:09:00] we're seeing in the market is private equity firms have said, Hey, there's money to be made by being a lender.

Jon: And so you have historically what private equity firms saying, let's build out a private credit function. Let's act like banks do. Because they fall within sort of that private capital landscape, they're able to be a little bit more creative. And a lot of times those structures vary and they can be as beneficial as they are from traditional banks and they can also, from a structural standpoint, look very different.

Jon: They just have a lot more flexibility. How do you see the structure as different?

Kison: When I think of banks, I always [00:09:30] think of, I'm probably thinking of referencing more like small business loans, right? That you go there, you get like a five to seven year term loan, it's amortized and you get some fixed interest rate based on, well, they got rid of L-I-B-O-R, what do they call it now?

Kison: Oh, S-O-R-S-O-R. Yeah. Yes. So yeah. So it's whatever plus SOR rate. Yeah. Fixed or floating. How do you compare that with private credit? I haven't done private credit. I've been looking at 'em, right. So far it looks like they're almost more favorable. They're gonna charge you more, but they're all, in some [00:10:00] ways they understand what you're doing, kind of buying something and you're gonna do something with it in three years or so.

Kison: Right? So they set it up as an interest only type of term, and it seemed like they're willing to structure it and make it. Easier to get into. I don't know. You're doing the real paperwork on this. What is like the real difference

Jon: legally, you hit the nail on the head and that's flexibility. The key to all these preferred equity, private credit and other transactions I'm working on is that the possibilities are endless and they're really deal dependent.

Jon: The [00:10:30] fun thing has been that they're pretty bespoke. You don't have a cookie cutter approach that applies to all deals. Here's an example on a back leverage transaction where you have a private credit firm providing a GP with a liquidity solution at the top level fund structure. Those things can look very different from deal to deal, including when they're providing preferred equity.

Jon: Here's an example. Where does a cash sweep come from? Does it come from specific portfolios? All the portfolios? What does a return look like? Is it a multiple of capital invested? Is it some form of interest? Is it both? Is it participating or not? The fun part [00:11:00] for me is that on a deal by deal basis, these deals can look very different and they're pretty bespoke.

Kison: What

Jon: do we

Kison: wanna talk more about? We want to go to talk about the MA deals, because that's a whole topic with someone. Explain all that to me. I wanna talk more about the PE stuff because we've done a lot of interviews on the corporate side, right? I think we sort of described it that there are more counterparties involved.

Kison: I think a big piece of why you end up doing more work on those deals is because so much hinges around how the company's gonna get integrated. Yes. So you're gonna have an HR person in there and they're [00:11:30] like, we're not gonna do an asset deal. Right. We're gonna do a stock deal because we have people in all these different countries and we're not gonna mess around with the HR or deal with visas or any of that stuff.

Kison: And then all of a sudden you got pressure to do that. Wow. The tax person's like, you know, Hey, so like I, I get that there is like a lot of, you know, different interests that you're trying to balance on that. I just didn't hear it. You have more people involved. Like I said, there's just factors like how this company's gonna get integrated that's gonna impact things in general.

Kison: I don't know the private equity [00:12:00] side as much. Can you walk me through? What does that look like? Who are your main stakeholders? What is the big interest and, and how, how do you sort of align strategically with the private equity firm to best serve them?

Jon: It starts with communication, which sounds so simple, but in practice is so hard because when a deal comes in, there's a little bit of inertia built in.

Jon: You start to think about, okay, we have an LOI, we have a deal. How do we structure it? Let's move to paperwork as quickly as possible. There are, of course, timing constraints. What I always try to do is take a step back and think about it. What is the [00:12:30] objective of the transaction? What are we actually trying to do?

Jon: If it's a platform acquisition, meaning a private equity firm is going to go out and acquire a company in a space in which it doesn't otherwise have an investment, or another portfolio company, that's a bit easier. 'cause you're starting from scratch. You're, you have new owners coming in, acquiring a company, and a lot of times you may replace management, but the infrastructure is there.

Jon: What's a lot more interesting at times is when you have add-on transactions, inorganic growth. So you have a portfolio company that's going out and buying another company in an adjacent space [00:13:00] or a supplemental space. And there it looks a lot like a strategic deal. 'cause you have a company with operations, with people, with infrastructure, and it's looking to acquire another company.

Jon: In either case, whether it's a stock deal or an asset deal. The key word is integration. If you're acquiring assets, what does that mean? Okay, you're really, a lot of times it's people, property, leases, contracts. How do you assimilate all of that, if not day one, pretty quickly after acquisition? Ensure that the transaction is in fact synergistic and adds to [00:13:30] growth of the existing company.

Jon: If it's an equity deal where you acquire a company and from a legal standpoint to a standalone company, you still have that same question. How are you over time ensuring that operations work together and mesh together in a way that help you sort of obtain your investment objective in terms of why you looked at that company in the first place?

Jon: And the answer to all of that again, is ensuring that you're communicating with the HR benefits, insurance accounting. Professionals who are both advising on the deal team and who already have that function [00:14:00] internally at the company. And here's an example. When you acquire a company, sometimes when it's an add-on transaction of the kind I require, maybe there's a benefits covenant, which people sometimes gloss over.

Jon: And what the covenant would say is, Hey, buyer, with an X amount of time effort to closing, you will hire all our employees and you'll give them similar benefits to what they currently have. And most buyers will look at and say, okay, some version of that's probably fine. But here's a question. If you have an existing company with existing benefit plans, how do your benefit plans, how do your insurance plans?

Jon: How do they compare to what they have? Are they [00:14:30] different? Are they better? Are they worse? Can you actually comply with that covenant? If the covenant says, Hey, you're gonna hire these people day one, can you actually do that? Can your HR folks onboard? What if it's mid month? What if it's immediately after the payroll cycle?

Jon: Having that communication to ensure that the words on that piece of paper that people are signing actually link up with the reality of the business operations, in my mind is a critical part of, of all of this. So you have platform

Kison: deals. That's a little bit more straightforward early in the thesis of what they're doing, right?

Kison: They buy that transaction. Maybe it's like a [00:15:00] little more straightforward, but once they're doing add-ons, then you're starting to bring a lot of commonalities with the strategies because they gotta integrate the business. Is it as comprehensive as the strategic? When I talk about any of the strategies, I mean there's a big emphasis on integration.

Kison: Yes. Especially if they've done some reps, right? Where PEs aren't as known as integrating as well as starting to change.

Jon: It's sort of interesting you say that because one trend that we didn't talk about that I've seen over the past couple of years, and absolutely right now is last year. So there [00:15:30] was a slight uptick in investments and a slight uptick in exit.

Jon: So we stopped sort of our two year slide. The number of funds that closed was down year over year. But what that means is that LPs aren't getting their money back at a faster clip. Funds are slower to deploy capital that they have in that interim period of uncertainty. They're making some of the investments that we talked about, different forms of alternative investments, let's call it that.

Jon: But the other thing that they're doing is looking internally, portfolio enhancement and portfolio [00:16:00] refinement. There's an enhanced focus on, hey, we have this asset, and right now there may be a mismatch between valuations from the buy and sell side, which is making it such that we're gonna hang on to it for a little bit more time.

Jon: How can we ensure that it continues to grow either at its existing level or at an enhanced level? And part of that is integration. Like how can we ensure that this asset continues to be a creative to overall business, such that even though we're not ex exiting it, now we can

Kison: at a multiple

Jon: in

Kison: the

Jon: future,

Kison: hire consulting firms every B firm.

Kison: Secret weapon [00:16:30] right there. That's right. Can we talk about structure? So if you're like a large strategic, you're just flat out buying these companies a lot of times in cash. Maybe you're putting some kind of earnout in there as well. The bridge evaluation gap on these private equity deals, you got a lot more varieties and I'm just curious what you've seen because I'm looking at small deals right now and I'm looking at, oh, I want the owner to hold some note because it's way cheaper than private capital.

Kison: Hey, earnouts could be great too. You can look at [00:17:00] if you know the right metrics are there. The role of equity seems really interesting because yeah, sure. Why not? You are part owner of this or versus another investor and you're gonna get higher insurance that were aligned on the same objectives of outcome.

Kison: How do you see that in terms of the variety of structures you that good or bad thing?

Jon: That's another aspect of private equity that I find interesting where there are different ways to ensure that the cash portion of the purchase, purchase price that you're paying at closing is not the entirety of purchase price.

Jon: You can slice and dice it any way you want. One means of doing that as an [00:17:30] earnout, a component of purchase price is paid to you in the future, assuming you to sell or hit certain metrics and you mutually agree on what those metrics are. The duration of the earnout can vary. It can be one year, two years, three years.

Jon: It can be contingent on, on a variety of factors. The other two are fascinating. One is a seller note, which I've also seen an increase in or an uptick of, especially in today's current deal environment. And the final one is the most interesting rollover equity. The idea being why don't you have some skin in the game?

Jon: Seller, private equity professionals really focus [00:18:00] on this when you think about it. They're financial investors and the key to any successful investment is the operators that you have for the business. So when you're acquiring a founder owned business, who knows that business better than a person who has operated it for a long time.

Jon: And if you tell that individual, Hey. 20% of the purchase price would others otherwise pay you? Or 30%. Why don't you roll it into the go forward ownership of the business such that when we sell the business at that point in time, you also get a payout, obviously at a multiple, because private equity firms are in the business of making money on your ownership stake [00:18:30] of it.

Jon: That's a great way to incentivize that person to stand shoulder with you as you grow this thing over the next three to seven years. My experience with management rollover has been a powerful tool to ensure that folks have a little bit of, as we commonly call, sweat equity in the business.

Kison: We got these different tools announced, seller note rollover equity.

Kison: This is spice of private equity. I guess I want to come back to the deal structure. What I wanna do is, you talked about mock trials earlier. Let's do a mock deal. Okay? And I wanna blend [00:19:00] in the risk perspective because that's what lawyers are really good at. That's what I learned. You have friends with attorneys who even just go out for drinks, you right know understand your liabilities, risk you're taking of how it progresses on how much alcohol you have and everything.

Kison: We're gonna play that out with the deal. So I wanna understand it changes as you go through different stages, right? So let's make up a deal. Okay? I'm gonna use the data room industry because most people listening to this know that's the low hanging fruit industry. I'm familiar with, and I'm actually looking at a couple deals in the space.

Kison: Let's do [00:19:30] simple math. This is a company I'm looking at. They're doing like 10 million revenues, 2 million ebitda. So it's pretty healthy for a flat business. 'cause most of these data rooms are now, and we're interested in the customer base primarily. We have a really cool buy side platform, if you ever heard of it.

Kison: It's called Deal Room, but we see an opportunity to upsell our product. The thesis is that, hey, this company has 500 customers. Even if we upsell 10% of them to our [00:20:00] product, 'cause it's 40 KACV. That's significant revenue synergies there. There's obviously common backend stuff we could combine and eliminate some costs and draw some efficiency.

Kison: Pretty straightforward thesis. First of all, we're getting an NDA signed. The one thing I'm curious about is even at the NDA stage, we do own a data room business. We have another product called Firm Room, which is like head to head with all the data rooms out there. So as soon as we start looking at NDAs, companies perk up pretty quickly that there's more sensitivity [00:20:30] because it's like direct competition, right?

Kison: How do you start thinking about that as even just negotiating? We can generally talk about it. What NDA, the purpose of it. How do you kind of get that right balance for both parties? For me to do my diligence, to get this offer in, but at the same time, I understand from their perspective and that's not our intention, is to get some intel to compete better with them.

Kison: Walk me through that.

Jon: So your primary objective from the buy side is understanding, number one, the customer relationships that the target has, and number two, bringing those [00:21:00] relationships over. Is that sort of an accurate It is. And

Kison: I wanna strike a line between, we wanna understand it so we know the business of what we're buying, right?

Kison: Like, I wanna know, one, what's their saturation of customers, because there are a few anchors that we gotta look at as big risks, but how diversifies their customers and then. How sticky their customers are. Hey, we're not trying to get a strategy to come coach all your customers. It's just this is part of us valuing your business is really understanding the strength of your customers.

Kison: And there is a piece that we wanna get a sense of when we have a thesis of upselling your [00:21:30] customers to our other product or flagship product, right? We'd wanna least understand the profile. We wanna know which ones are corporate buyers versus investment banks. That all they do is do transactional sales.

Kison: 'cause that's not the winner for us. The ones that we can sell ongoing subscriptions, they're pragmatic about doing M&A. Those are the winners. Is there like a line to draw

Jon: in there? It's sort of interesting because the number one consideration from the target side is exactly what you just mentioned.

Jon: How can we share this information with you, the potential buyer, and ensure that you don't then turn [00:22:00] around and solicit our customers if the deal doesn't happen? And the right balance to strike is number one. Can you limit the number of individuals who are given access to information? From a sell side standpoint, you want to ensure that the buyer is able to conduct a diligence.

Jon: And sometimes what you do is you have a smaller team of individuals on both the buy and sell side who share the information and talk about it and examine the information so you can limit the tool people who have access to the information and are able to examine it on the buy side. That's one. The second is, and [00:22:30] this is probably the easy one, non-solicit of business relationships and executives at the target.

Jon: The worst outcome for the target would be letting you into the hen house, sharing all this information with you. Maybe 3, 4, 5, 6 weeks later, you say, you know what? We're not interested. We don't have conviction about this investment. And then day one, you turn around and start soliciting those customers because you've had the ability to investigate.

Jon: So how do they protect against that? Having some form of a non-solicit in the NDA that says, Hey. We're gonna share this information with you. Maybe we share it with a subset of folks on your side, [00:23:00] maybe just even your attorneys. But for a period of time, if the deal falls apart, you can't then turn around and solicit, number one, our employees, and number two, our relationships.

Jon: The limit

Kison: who's got access to the information, and then a non-solicit, right? Be the key clause that you wanna have in there. That's right. Are there things from a buyer's perspective, I guess buyers like you get in there and just get all the information

Jon: you can. From a buyer standpoint, information's power, the more information you can get.

Jon: From a financial standpoint, the best would be having a one-to-one with a customer. [00:23:30] As you can imagine, most sellers are not gonna be comfortable with that to have some sort of a customer call. Usually those customer calls happen really on the eve of a closing when you're very, very close. But how can you limit that information gap as much as possible?

Jon: Part of that is financials. Part of that is looking at contracts. Part of that is looking at how much revenue they've brought in. Key customers have brought in over time. Is this sort of recurring revenue for how long has it been recurring revenue? What are the contracts you're currently under? Is it just an oral agreement of some kind?

Jon: You'd be shocked how many businesses there are out there where it's a handshake. There's no contractual [00:24:00] agreement. There's nothing that binds that customer to keep coming back for services over time. That's a really bad place to be as a buyer. The acquired business on the basis of the strength of customer relationships have a target, but the contracts number one, are not long lasting.

Jon: Maybe they're on unfavorable terms and you're stuck with those contracts.

Kison: Those are good points on this. NDA, if we're looking a deal outta the country, the jurisdiction's always a big question. How do you sort of compromise that? Is there a standard on that? You know, like if you're a US company looking at something in Europe, where do [00:24:30] decide the jurisdiction?

Jon: That's where it gets tricky, especially when you're looking across jurisdictional deals. That's when you have to ensure that you're engaging counsel in, in appropriate jurisdiction, because number one enforcement can vary too. We think about the clauses themselves, but do they mean anything? Can you actually enforce it?

Jon: Can you rely on the strength of the provision? That's where it gets significantly trickier when you're looking at a business with cross-border operations.

Kison: So that is tricky. What about it? I had one of the NDAs where they wanted to strike out using the [00:25:00] information to create a competing product, right?

Kison: And it's like,

Jon: well, the one thing that I frequently see is what is the use of confidential information? When we think about confidential information, just for simplicity, secret sauce, what makes a target? And the target's gonna say, I'll share all my secret sauce with you. You're only gonna use it to investigate whether or not you wanna do a deal with me, which I think is pretty fair.

Jon: What they don't want to do is share all that with you and then you turn around and use it. They compete with them or otherwise do something that harms your business model. That then becomes the purpose of the use of [00:25:30] the confidential information. What's the real recourse on this stuff?

Kison: Like say, you say, yeah, yeah, yeah.

Kison: You know how people are. There's those people in business that are the shady ones. You signed an NDA, you did this and all of a sudden you created a compete product and obviously you used the information we provided to do that. Is there some real recourse? Do these NDAs stand up? Specific

Jon: performance would be the recourse.

Jon: You go to judge the shit outta 'em, you'd have to sue them and you'd have to say, Hey look, we signed this piece of paper, this paper piece of paper said they wouldn't do this. And then the hard part becomes proving it. While the [00:26:00] facts may have sensibly seem obvious going to court and saying, this person created this product on the basis of information that I gave them and now they're competing with me.

Jon: That gets to be the harder part of it. Now, I will say that reputation means something, especially in this space. So people tend not to for that reason. If you get the reputation of someone who gets the ability to look undercover and then walk away and compete with them and do that a few times, reputationally, it's gonna harm you.

Jon: Okay, so we get NDA signed.

Kison: We start going through I, I sent an initial diligence list, right? Usually like 10, 12 things. I asked [00:26:30] for only 10 to 12. This is why we should work together. I'm doing really small deals, just so you know. The fees are definitely a lot smaller when we look at starting doing smaller deals, but there's always a starting place.

Kison: I feel like that's a, I build a good relationship, get early. So there are small deals that we're looking at, and it's only 10 to 12 items. You don't wanna scare the small business owner away. We typically ask financials and then some of the demographics around the customer base employ employment and the typical things you ask.

Kison: Any lawsuit, stuff like that, right? And we try to understand their [00:27:00] tech stack to know what that's gonna look like. So I will start building a model and start looking at what that's gonna look like so we get a sense of what valuation's gonna be. And we have some management meetings so we can really get some confidence that we're actually gonna work well together.

Kison: And then I get to that point when I wanna start putting an LOI. And so I want you to teach me some real negotiations. And I also wanna understand the risk at the LOI stage too. Because I usually send something that's non-binding. It's like I wanna see if we can at least generally agree on a premise that [00:27:30] we're gonna make this deal happen before we start investing a bunch of time and money into this.

Kison: Okay, so let's say we have the same deal, we got 10 million revenue, 2 million ebitda, and I'm a value-based acquirer here. So I want to keep it pretty simple because I, I feel like what happens is there's flexibility. It's not direct. It's not like, Hey, I'm coming in to buy all the cash. As a smaller company privately held, I wanna preserve as much cash as possible, right?

Kison: Either A, I can go out and I can shop for private credit. If the seller wants all cash [00:28:00] offers, I can shop for private credit and it's gonna be high interest. I won't gonna pay anywhere from 12 to 16% interest. So in that case, I'm gonna be more conservative what I offer. I'm probably gonna offer a Forex ebitda, let's say $8 million.

Kison: Now, if the seller is willing to hold some paper and I'm getting a more favorable interest term, five, 7%. Whatever it is over four or five years, that's very much more favorable. I'm happier with more confidence, [00:28:30] means I'll pay more. Is there some rollover equity component also more favorable or earn out? And then with those things, knowing that this person's bought in with me, I would likely push that up to five X EBITDA and say, okay, I'm willing to spend 10 million.

Kison: Teach me how I should structure things. Do I start off low, then come back with some of these things? Do I sort of offer. Multiple options on the table and be like, Hey, let's choose your adventure here. Do I sit down and really think about what my preference is and push that way? [00:29:00] Do I forecast what their counter move is?

Kison: Because everybody always counters no matter what. Nobody accepts the first offer. Push me like somebody for the first time putting an LOI in. How should I think about really structuring this deal?

Jon: It's sort of interesting because the worst place you can be is having agreed to something at the LOI stage. Notwithstanding the fact that it's non-binding.

Jon: You start to work on documentation, you start doing more diligence. Yeah. That's the normal way you do it. You dig in a bit deeper after you have an L loi

mm-hmm.

Jon: You then realize the business has issues that you hadn't previously identified, which go to price. And then you cut the price. [00:29:30] And I've seen that happen time and again, that's a really tough place to be.

Jon: The number one thing I would say is build in some flexibility in the LOI, you can say that. Here's our valuation subject to certain assumptions and you should lay out those assumptions. Really good PE firms do a nice job of that. Hey, we will pay you X or some multiple of X, or we're valuing your business at X.

Jon: But it's on the basis of this, and that's subject to additional diligence, including accounting, financial and legal. And it sounds a little wishy-washy. It avoids [00:30:00] the harder conversation down the road, which is a seller feeling that you are walking back a deal. That's a much harder thing. And at the end of the day, when you get rid of all sort of the paperwork, you're dealing with people and if someone's lost their trust in you, 'cause they feel like you're backing out of a deal that they thought you had made, it makes executing that deal much, much harder.

Kison: I like that. So here I can start thinking about the terms, which I'm a deal guy, so that's why I probably jump on that right away. I like how you wanna frame it because we're building it around these assumptions that your Q of E is good, you're gonna have some solid quality of [00:30:30] earnings. We're not gonna see some surprises there that there's some revenue that wasn't reported the right way.

Kison: Even

Jon: taking your example where the customers are important and you think you can upsell some of them, it's based on the assumption that based on what you've provided to us so far, this is what the revenue has looked like over the past 12 months or so, or a longer period of time and this is what we expect it to be going in the future.

Jon: And we expect that these three top customers stick around for an amount of time.

Kison: Yeah. Can you gimme an example of that? I've seen that where I've looked at a deal and it was three customers representing 70% of their revenue. [00:31:00] Yeah. Like so then I a hundred percent want to have a contingency that, hey, these customers renew contracts with us.

Jon: No, absolutely. And in businesses where I've worked where the concentration of customers is limited to a handful of customers, the deal is contingent on revised contracts being in place with those customers from an after to closing stated otherwise, before you get to sign executed paperwork that's binding on the buyer.

Jon: From an after to closing, you have to have revised contracts for those customers in place and usually long-term ones to [00:31:30] ensure that investment is worth it.

Kison: Yep, you're good. Protect yourself there.

Jon: Absolutely.

Kison: In this case, if I had a thesis that was assuming, 'cause I was saying, Hey, we're gonna upsell 10%, I would wanna assume that 25% of their customers are corporate clients.

Kison: And they told me that 25% are customers, but I would add that this is subject to the fact that 25% of your customers are corporate clients.

Jon: And you know what? It's interesting if the seller pushes back on it, the national reaction there is to tell me why. Because if they have [00:32:00] said to you, Hey, don't worry, that's true.

Jon: It would be a cause for concern if they're pushing back on something that they'd otherwise identified as being true.

Kison: If there's something in the roadmap, like they had a really cool AI thing they were building and we know we need their CTO locked in and committed, I might have that subject to a retention of your Yes.

Kison: CTO.

Jon: In fact, I was working on a deal earlier today, large companies acquiring a startup and it's an AI based startup, but the key to the acquisition are to people and really [00:32:30] to people. The entire premise is, hey, from an offer to closing for a period of 90 days, a transitional period, these individuals are gonna coach up our folks.

Jon: We've identified 10 people. They're gonna coach them, they're gonna train them to use the AI product that we're acquiring, and the closing won't even happen unless those two individuals enter into longstanding employment agreements and some equity agreements. It's sort of baked into the LOI quite literally, a few hours ago, we sent out the LOI for that deal that I just mentioned.

Kison: Those are common things. I can add my assumptions around what [00:33:00] I expect the finance to look like. Certain things around the customers, certain things around employment retention. That's right. Any other things that you see are pretty common that you'd want to put in there?

Jon: Not all PE firms do this. Two other things are important, I know people don't wanna incur legal fees at the LOI stage, but at least with the relationships I've built with PE firms, they feel comfortable calling me and knowing that, hey, at least John will give us a look over it.

Jon: Ensure that there are no real issues. Two things that popped up. One is structurally, if you're telling someone that you're gonna do an asset deal or an [00:33:30] equity deal, it really behooves you to have a conversation with your attorney to ensure that that's feasible and gives you sort of the end goal that you're trying to achieve.

Jon: And number two, that you're setting that up from an indemnity standpoint or from a seller obligation standpoint that protects you. Those two things can become real sticking points if there's a real tax consequence, a seller later on down the road, or tax consequences even worse to you as a buyer that you hadn't contemplated down the road or you've identified issues that are massive issues, but your LOI says it's, let's say a walkaway deal with no [00:34:00] indemnification, that again, puts you in a fork in the road where you have to have these really tough conversations where the seller said, that's not actually the deal we agreed on a few months ago.

Jon: That's when emotions start to rise. It's better to have some caveats for those things or dig in with the help of your C or your accountants at the LOI stage and you can do it efficiently. And I do it all the time. And I'll give you an example. I was representing a mid-market fund and they have a really well run construction fire alarm business.

Jon: They're looking to expand their footprint across the Midwest and they were [00:34:30] interested in a business based in, in one of the Midwestern states. And they had pushed forward with an LOI pretty fully baked, but they know me by now. And they called me right before they signed. And I looked at it and I said, okay, lemme just look up this company.

Jon: I looked it up and I had an associated run. A few searches. Come to find out, a few years ago, a predecessor to that company had filed for bankruptcy and that had not been disclosed to my client. And then the founder started another business and there's some legacy risks associated with it. And I'm oversimplifying at a high level not to disclose [00:35:00] facts from the deal, but the.

Jon: Fast forward, about a week later, the client, as a result of the issues we identified because of the call that they made to me, said, you know what? This actually changes our investment thesis massively. We're not interested in the deal and I never want to be or have the reputation of someone who doesn't help.

Jon: Lawyers should help facilitate commercial plans and processes. But the firm actually called me after the fact and said, thanks for helping me for making a big mistake. Yeah. It was actually a massive issue. That's a tough one. It's like, yeah, and you don't wanna find that out [00:35:30] 30 days into diligence. I know

Kison: that's like way more expensive and painful

Jon: and I don't blame them because, and none of this had popped up on their end and that's why I'm there.

Jon: And it just gets harder and harder to walk away from the deal. The more right end you get, there's a bit of inertia. You've gone to your investment committee, you have stuck your neck out there. You sold them on an investment thesis, you sold them on a company. You're really excited about it. You've gotten to know the owners.

Jon: You've made all these visits to the site. There's a buzz you created. The idea there is as you start to identify issues, you try to minimize it. It's [00:36:00] human nature to minimize it. 'cause you've built up this idea that we're gonna acquire this company. So sometimes it's a lot easier to say, you know what?

Jon: This is probably not the right move for us. At the early stages, it's increasingly harder. Further down you go.

Kison: I guess there's like a structure component that you may wanna think about. Right? Which the tax perspective, asset stock sale, and then what was the other

Jon: one? Identification obligations, which not all private equity firms do, but some of my favorite clients do, where they take one of two approaches.

Jon: One, they lay out their preferred [00:36:30] indemnification structure in the LOI itself, their pros and cons to that. The pro is you're very clear upfront on what the expectation is. So you don't have that battle

Kison: and the kind, you scare your seller away.

Jon: That's right. And it forces you to have that conversation upfront with a seller.

Jon: You have to strike that balance. It should not look like an indemnification provision in a purchase agreement. That's where people go off the beaten path and it's a bit too much. But the flip side of that is if you tell a seller, particularly a founder owned business, owner of a founder owned business, hey, we're gonna acquire the business.

Jon: And you get to walk [00:37:00] away. You get to go over tire, and you start to do some diligence and you identify some real issues. Let's say it's a car wash business. I've had a few of these go to acquire it, and folks have been dumping chemicals in the backyard for a while. There's some real issues with a business.

Jon: That real issue requires you as a buyer to come out of pocket for some of those losses. That doesn't seem fair, and you want a seller to be on the hook for stuff that they've done historically as it relates to the business before you showed up on the scene. There should be some concept of that in the LO.

Jon: Interesting. Okay. O Otherwise the seller's gonna say you, you told me, look, I'm in my mid sixties and I [00:37:30] thought I was retiring and going to Florida. Now you're telling me of the 2 million you're gonna gimme, you're only gonna gimme 500,000. It doesn't feel like the right deal.

Kison: What about other things?

Kison: I feel like when it comes to the wire, you start Pickering about working capital adjustments and things like that.

Jon: So far we've talked about sort of high level purchase price components, but the real meat and potatoes is the business operating in the way that you've represented to us. And once you start digging on a QR and networking capital and how far back you're looking for the purpose of establishing a peg, those are always tough conversations to have [00:38:00] with people.

Kison: Well this just naturally

Jon: have

Kison: to happen

Jon: later. I feel like otherwise you're

Kison: frontloading way too much and that

Jon: Yes, the way I've seen clients cut it is they agree at the LOI stage that there may be a purchase price adjustment escrow and they just leave it at that like high level. It'll be a reasonable mutually agreed upon purchase price adjustment escrow, and a mutually agreed upon purchase price networking capital target.

Kison: It makes sense.

Jon: I do think the balances not being too into weeds, that you scare away a prospective target not being so high level that you forget to [00:38:30] identify an issue that may become a bigger issue down the road.

Kison: Can we go back to negotiating the deal, like the raw meat terms I gave you. My range four to five x we're kind of between eight and 10 million.

Kison: It's almost like looking at the purchase price, but then there's structure this way and I wanted to use those different tools and we could make it funny just to, I wanna know how you'd use each one. I also wanna learn what's the market kinda range that you typically see. There's obviously cash, which I, you know, if I have cash, I have cash or [00:39:00] how, go get the private credit.

Kison: Little private credit market, just boom, I have that expensive cash to put. And then there's a bucket for the seller note, which is cash later.

Jon: I viewed as cash now and then cash later. Your seller note

Kison: it is cash later, so I'm gonna be paying you over a period of time. Right with interest. Which I like. So it's like you're gonna get that money, you're just gonna get it later.

Kison: And then there's the other bucket, the earnout. Right. Which is similar but different. And maybe we can talk a little bit of the difference between those two, right? Because it is like [00:39:30] payments pay later. But I'm gonna hold you on the hook to certain milestones, which I think don't end up well.

Kison: We'll talk more about that. 'cause I'm curious about your perspective and the role of equity, which it seems like more and more interesting that when I start seeing those as opportunities to, to bring in folks to, to go for the ride to No, absolutely.

Jon: And role of equity to me is, it's sort of interesting because it kind of depends on who the seller is.

Jon: If they're advanced in their career, where they don't contemplate doing what they're doing for much longer. And the concept of not getting [00:40:00] cash at the time that they close and instead getting an instrument of security for which the payment may not be made for 3, 4, 5 or longer years. Obviously you're gonna get liquidated at the time that the private equity sponsor sells to the company in the future.

Jon: That may not be as attractive to someone who's towards the tail end of their career.

Kison: So I, it would probably be more preferred for somebody that I can keep in the business for another three or four years.

Jon: Yes, exactly.

Kison: To come along for the ride. A motivator for you and for them to have that person side by side.

Kison: 'cause if the person is gonna [00:40:30] be out in a year, then it's don't even want them on the cap table because they're not, they're dead weight at that point.

Jon: The consideration there is if they are gonna be out of the cap table and you're giving them a substantial roller of equity stated otherwise you don't wanna pay them a lot of cash, the conversation then becomes, okay, what sort of control rights do they have associated with that equity?

Jon: Do you really want to have a passive owner with substantial consent rights? And that is always a tricky situation to have. And

Kison: then at

Jon: that point, you might as well

Kison: get it. A PE that can actually be a Right. PE could be [00:41:00] more accretive. Yes.

Jon: And I've seen that happen a ton where folks have said, you know what?

Jon: The right way to do this is maybe a club deal. You, we put in 70% into cash, another sponsor comes in for 30%. Maybe that's a better way to do it. And

Kison: then we just give that cash to the seller. Right. Okay. So, you know, if you're in a role of equity, you should, sounds like you should have high confidence that this is just like a PE partner, a real partner that you wanna live with.

Jon: And if it's not, if it's a person who's leaving in a year, one solution is an earnout that you pay them in a year, you know, at the time of contemplated retirement. But it's contingent on hitting some [00:41:30] transitional goals and metrics over the course of that one year.

Kison: So you've seen that earnouts are as short as one year, right.

Kison: Just saying, Hey, I wanna make sure you're doing well, what would be examples of milestones to have? You'd

Jon: set up key transitional metrics. Let's take the data room business. Let's say there's certain tools built into the data room that you're acquiring that you'd like to ensure that your team knows how to properly utilize effectively within six weeks.

Jon: And maybe that's one example. And I'm thinking, actually, I'm thinking of a deal for which I signed an LOI earlier today where the idea was we want [00:42:00] these handful of people on our team to know how to utilize this AI technology within six weeks. Not just use it, but to use it fluently. And of course, the key legal term is in the reasonable discretion of the buyer ability to use this tool and is up to speed in a reasonable discretion of the buyer.

Kison: So we really build on what are those key things that need to happen. Yeah. This case is a one year transition. If we had that more partnership alignment for the long term, hey, we wanted this person for three or four years, then we may stretch that out, right? For a longer period. Yes. And it be based on totally different mi [00:42:30] Other milestones It it would

Jon: have to be,

Kison: it could be integrating technology together.

Kison: It could be revenue type of goals or finding

Jon: someone else. Let's say the person's A CTO helps attract and train their replacement. Maybe that could be. Train a replacement to your reasonable satisfaction.

Kison: I would generally prefer to do a seller note just to make it so straightforward.

Jon: So how do you use seller notes?

Jon: Do you look for as instead of balloon payments, do you lose look for sort of payments at set intervals over time? Is [00:43:00] that how you I'm

Kison: used to, yeah. More of a conventional amortized. Right. I'd want it a little longer. Like a five year old. Yes. But you see everything I've seen on private credit. So interest only with a big balloon payment.

Kison: That's right. That's right. In this market, there's so much money floating around, yeah. Somebody at some point will either redo that debt again and keep it interest payment going forward, or you swap it out for equity.

Jon: I ask, because that's what I'm more commonly used to seeing is some sort of an interest accrual of interest pick, which is picked over time and then a balloon payment [00:43:30] at the end of it.

Jon: That being said, there are exceptions, and I have had deals where a seller note is cash pay. So you, you establish an interval, set intervals and you pay. Now, it's not nearly as common as the first scenario I described, but I have seen that there are real issues there. Does the business have cash to make those payments in the future?

Jon: That being the key concern.

Kison: Oh, so they would have like big chunks of cash that gave Yes. So almost like the buydown of, okay, year one we're gonna pay this. Principal

Jon: payment. Yes. Obviously you'd have to ensure you get a basket in your senior flight and it

Kison: gets, it's tough to even amortize a note now. Like [00:44:00] back in the day when valuations used to make sense, you could do that.

Kison: You could be like, Hey, hold this five year note like right finance, 80% of this and we're, we're good. You're gonna have a great healthy note. You got confidence, I'm gonna pay it. Right. This is a win-win. Nowadays, it's like that's the, then just only at the high interest rate makes more sense to do versus having something that's amortized with the directly the

Jon: seller.

Jon: If I was representing the seller in a circumstance where you do a little bit of reverse diligence, are you confident in the fact that you're gonna get this payout in the future on the time period you expected to get [00:44:30] paid out? Or is it gonna be a situation where that note needs to be restructured or may need to be structured at some point?

Jon: I give 'em a high level of confidence. That's right. And I've had that happen over the past couple years unfortunately too, where portfolio companies are going re undergoing, restructuring out of court restructuring specifically, and in those situations you have to examine the indebtedness of those portfolio companies, some of which are notes, some of which are true traditional third party lenders.

Jon: Those are painful conversations to have. Well, I mean,

Kison: do you look at the

Jon: financials?

Kison: Hey, this is like a two to one debt ratio coverage. It seems like it's pretty [00:45:00] healthy.

Jon: Part of it is also looking at the reputation of a sponsor. Because ultimately, when you think about it, who is the sponsor? Who is acquiring that business and what have their portfolio companies look like and have they been in a situation like this before?

Jon: And if they were, how do they address it? It takes a little bit more diligence on the sell side, but it's an important investigation to undertake.

Kison: You know, so I, I kind of figure out the path we're going based on the scenario of what makes sense in the structure. Obviously I wanna leverage the risk and get the right balance that works for both of us.

Kison: [00:45:30] In terms of the negotiation. How do I make sure I don't do too much or too little, right? I don't want to come in too low, offend a person and they write me off. I don't want to come in and say, Hey, here's my highest and best offer, the five x. The owner holds 40% as a note and they come back and we want six.

Kison: I'm like, no, this is like the best offer I got is sort of a take it or leave it thing. How do I get that right balance so that negotiation goes smoothly? Do I take a person out, get 'em a couple drinks and then [00:46:00] pull the offer out? What's the best way to make that as smooth as possible?

Jon: It's funny because just by happenstance, my career has over the years, moving through various industries over the past couple years, a lot have been into HVAC space, and I only bring that up because there are businesses that are truly people driven for people.

Jon: And the one thing I've seen sponsors, especially the ones I work with, do really well, is focus on the individuals. So before they get to a point in time where they're talking about purchase price and what a consideration looks like, they've really gotten to know the sellers really well. And that is [00:46:30] getting in the same room with them.

Jon: That's going to their place of business, it's getting to know their interests. And by the time the purchase price conversation comes around, you're talking to someone who you know really well. They're your friend. They're your friend. It's a lot harder if you get an offer out of the blue from Joe Schmo.

Jon: He says, Hey, this is the best offer I have. You're probably, it's probably easier to write that person off. Yeah. If, if the offer doesn't fit what you're looking for. But if someone has spent two, three months with you and they've come to your place of employment six or seven times, I'm taking you out to dinner [00:47:00] a few times and you've talked about interest.

Jon: Maybe you've gone to a few games and they've shown real interest in the business and they've shown you that they want to grow the business and they show you why they care about it, and then they give you an offer. That's just a different conversation. The reality is, in any M&A transaction, sellers are gonna want more and the buyers are gonna wanna pay less.

Jon: And I don't think you ever get away from that balance, but the way you balance it out, the best way is getting to know people and, and spending the requisite amount of time with them.

Kison: It's the best advice's tried and true, and it should stay at top of mind as I work on a [00:47:30] company's first deal. It's

Jon: particularly true, I think, for their first deal because it's, I tell this to young associates all the time because you, when you're working on a deal and you're a junior associate disclosure, schedules and diligence or the being of your existence, and sometimes when you're working with founders, you're explaining to people of a full-time job, Hey.

Jon: You have to disclose all this stuff on all these schedules as an exception to the reps or as responsive to the reps. And sometimes associates get annoyed with that. They're like, oh, this is taking longer than it should. I'm up late at night. This person's sending me one-off comments. And I say for a moment, just take a step back and think [00:48:00] this is a seminal moment in this person's life.

Jon: They've worked on this business for sometimes a decade, sometimes longer than a decade. It's been in a family and this is a big payout for them. It's maybe the most important point in their life. Think about it through those lenses and then approach the task on hand. And I think it'll give you a different perspective.

Kison: That's almost the same view as being the counterparty too, right? And building that relationship. But you're so right. It is. I'm looking at two deals and I'm struggling with that. 'cause one deal, I'm going down that path and I'm taking the time to build a relationship proprietary deal. The other one has an [00:48:30] advisor.

Kison: It's not an auction, but it's. Still representing it and they're still soliciting offers and doing like a semi sort of targeted process, which I don't like because they are, they're gatekeeping, they're literally throwing the fence up. They're taking the founder off the C CCC threads and you know, it's like, oh, talk to us and then we'll set up another call with them.

Kison: And it's why this is already a turnoff. This is like hard to, I gotta go through your parents to go on a date type of thing. That's not fun. Right.

Jon: It makes it hard. And it's funny because that brings me to another point, which is [00:49:00] choose your advisors carefully. 'cause when you think about it, your advisory function, whether it's a banker or a lawyer or accountant, is to help facilitate the deal.

Jon: The worst mistake that I've seen and people at my position do is to be abrasive or otherwise be an obstacle to deal getting done. That's not your job. Your job is to advise your client and the overall objective is to get a deal done and you advise your client of the risk and liabilities along the way, of course, but don't get in the way of a deal getting done.

Kison: That's a really good point. Sometimes I communicate with them and I, I think they mean well. I just gotta get them to in, [00:49:30] they need to have six, seven

Jon: visits. It takes time. But that's how mid-market and lower mid market PE firms have been doing it successfully for a very long time. And that's some of the

Kison: deals I need to focus on is the one that I can play a little longer on.

Kison: It's, I got a little bit of that. You've probably seen it. I am just a little impatient and want to get deals done. But it's almost like you wanna grade your relationship to know that you have high confidence in a relationship. Yes. To sort of have that confidence in the foundation of doing the deal. And then the rest of the stuff will actually flow a lot easier.

Kison: And

Jon: that's the key difference between [00:50:00] what you were describing a proprietary deal, which really requires some relationship building over time. You sourced it through a relationship based channel versus an auction processor that's come in here. Who's the highest bidder gonna continually get pushed for best terms and then one person gets picked.

Kison: Yeah.

Jon: What

Kison: would you do in the situation where you have the advisor, they're pushing to get some early terms on the table? I wanna build a relationship they. I wanna know, is this worth investing our time? Because we wanna see the early terms. Right? What would you do in that situation? I'd almost wanna,

Jon: the way I, I might approach it is maybe almost back [00:50:30] into how you arrive at those terms.

Jon: Okay. So they're pushing you for terms, I assume they're economic terms, is what you're referring to. What are you gonna pay us? You sort of level with them. You say, look, I would like to provide you with those terms now, but to do that I need a little bit more information. Some are specific to a target financially and otherwise, which we can be diligent.

Jon: Some of that is getting to know the seller, right? And in the absence of that, I can't get you the information you need. I understand why you need it, but to get there and we have the same objective to get there. I need to be able to do X, Y. That's the way I'd frame it. And frankly, if at that point in time [00:51:00] they, they continue to push back, then that to me is a red flag as a buyer because that advisor is serving exactly what I said as an obstacle

Kison: to getting the deal done.

Jon: Yeah.

Kison: I might be able to go back and say, Hey look, I'm really interested, do the deal, but. There is even a VP of engineering brought up. There's a big cultural difference between an engineering team. It's like I can't really move forward until we really have level of confidence in how that's gonna play out is relationship with management team and the leadership team,

Jon: which is fair.

Jon: And frankly, I would think that a seller where certain employees are gonna get [00:51:30] assimilated into the go forward business would share that same concern. I would hope that they would want that same objective to play out. Cool. Let's talk about diligence.

Kison: One of the pillars of bio led M&A is synchronizing diligence and integration.

Kison: This is the crux of making deals successful, is when you have integration well thought out, really making sure you have a clear executable plan from day one. What are the biggest legal red flags that you look for in diligence? Just to really ensure issues don't become roadblocks [00:52:00] after

Jon: the deal closes.

Jon: The first is, how is the target currently conducting its operations? How are they currently doing the things that they're doing? And two, where it takes a little bit of analysis, how should they be doing it? That's an examination from a purely diligent standpoint. Hey, they're a payment processor, they're subject to these regulations.

Jon: They should be doing X, but they are doing Y. And then of course you give your client the remedial actions that you think need to be taken post-closing. That's where an advisor really adds value. The second piece, just from a deal execution standpoint, [00:52:30] is looking for items whose resolution is outside of your client's control.

Jon: Are there liabilities associated with the business or that have been incurred already? And you don't know what the quantum is that your client's gonna be on the hook for? How do you address those? Are there consents? You mentioned sort of the data room example. Is there a contract that Target data room has with their number one customer that says, in the event of a change of control, that customer gets a terminated contract immediately that's outside of your control.

Jon: How do you manage that [00:53:00] risk? Let's go back to a data room example. Let's say there's a key customer contract that's a 10 year contract. So you're gonna be on the hook, just for example, purposes for nine years post-closing. What are the terms in a contract? What are you gonna be bound by from an offer to closing?

Jon: So what are the shoes of the seller that you're stepping into? Obligations. Yes. You know, so

Kison: like how your business operates, what are all the obligations? What are the obligations your customers have to you? There's a change of control. They can just walk away and say goodbye. Right? You sort of figure out how to [00:53:30] mitigate that risk.

Kison: You got some crazy long-term vendor agreement. You might not know. You might be some licensing, some code somewhere that ping an astronomical amount

Jon: and some of those you walk away from. Real estate is a classic example that everyone gives. So you have a business that has a bunch of leases everywhere, and you have a landlord with a 2,500 square foot spot somewhere in the middle of nowhere who wants to play hardball.

Jon: They want an uptake in rent because the consent's triggered under the lease, but it's not really material to their business. In that situation, maybe as a buyer you say, we'll close over it. The landlord [00:54:00] wants to terminate the lease. So what? It doesn't matter. But if that's the headquarter location or the target you're requiring, that's a totally different consideration.

Jon: Right? Right. If you're counting on using that space for whatever target may do. And you're gonna pay attention to it. Remember having one of those conversations before I had one, it was remarkable. Sometimes when you read these leases, it says, a change of control. Landlord consent required, one of the things that go forward, acquire and needs to provide is proof of financial solvency.

Jon: That they have your resources representing a large PE fund where acquiring this business [00:54:30] out west. And the landlord was like, I don't know what this PE firm is. And we were like, here's a website and see how much assets are in their management. They have a very well established fund. They were like, yeah, that's not good enough for us.

Jon: We need financials. Wow. Ended up being more so of a headache than it should have. And believe it or not, the CFO of the fund had to put together a letter of some kind to get this landlord comfortable for strategic reasons. This location was important, but it was just one of those examples where it was so obvious we were good for the money, but the seller kept pushing.

Jon: And in this particular case, our client said, you know what? It's important enough to us [00:55:00] enough to us. Let's just write something up and, and get it to them.

Kison: How does this work? We're going through this deal, we're going through diligence. You're obviously working on the purchase agreement, right? Like what you just described.

Kison: I can't be in the weeds of all this stuff. I count on ICO and our functional leads. You have a CFO there. We have an HR lead, and then we have some of the department leads. How do I orchestrate all this To pick up on those things that you described so we don't miss something and some of their concerns will get addressed as well.

Jon: It's

Kison: an

Jon: Important question because [00:55:30] frequently what happens is once a deal is in motion, the key is are the right stakeholders getting to look at and apply all some of these things that you're agreeing to in a deal context? The one thing I always ask upfront is, who are the right folks on the buy side who I need to be interfacing with?

Jon: So I always proactively ask the question, ensuring that they have an opportunity to look at the right, not just agreements, but even schedules. We've talked about disclosure schedules, and otherwise ensure that people are getting eyes on it, and have an opportunity to look at it before. The train has left the station, so I always focus on [00:56:00] ensuring that the right people get eyes on it.

Jon: And the second is, so I put the onus on myself. Number one, ask the question and socialize the information. And number two, being available. Your job is not to be in the weeds, but my job is my team has to be really in the weeds and ensure they're corresponding with all the right stakeholders. Make sure they're all talking to you.

Jon: I always ask clients, who's advising you? Setting aside sort of internal stakeholders, who's your benefits advisor? Who's your insurance advisor? If you have one, who's your accounting advisor? I just get all their data points because it's, if I have a question on insurance and how insurance [00:56:30] policies work or benefits, it's just a lot easier for me to pick up the phone and call Joe who's representing you on benefits and say, Hey man, I'm seeing this from a diligent standpoint.

Jon: This have the agreement set up. Does that work? Does that make sense? It's a lot easier for me to have that conversation. Yep. Guess what? By the time I get it to you, it's synchronized in a way that reflects what your advisors as a whole

Kison: think

Jon: is. Earned the right

Kison: answer. Can I just put you in a Slack channel?

Jon: It's funny because we have a team chat. When I started practicing, no one texted or did you know. It was always very formal [00:57:00] and now I have, at least internally, I made it super informal. Text me, send me a slack, send me a team chat, call me on my cell. People are scared to call people. I believe in calling people.

Jon: You have a question. Pick up the phone and call someone. It's the easiest way to do it. Don't send me an email, don't send me a treat. Just call me.

Kison: Yeah, let's keep our paper trail light.

Jon: We're not working on those deals

Kison: yet, but Right. Do the whole deal over phone calls. What are the biggest mistakes people make when it comes to.

Kison: During diligence or even early, teach me the things not to screw up.

Jon: [00:57:30] It again, sounds super simple, but a lack of communication sounds so simple and so trite, but you'd be shocked how many deals happen where the right people are not talking internally on the buy side, and that's when things tend to fall through the cracks.

Jon: If you don't, as an advisor, have the right lens through which you're approaching diligence, you're probably missing what's important from your client's perspective. And here's an example of a target that has 300 customers and you wanna move really quickly on diligence. One question I always ask is, Hey, look, you wanna move quickly on diligence?

Jon: Let's say it's an auction process. You wanna make a bid in [00:58:00] a week, we have access to the data room. You really wanna have a high level of certainty. And of course, hours are finite. What if we look at a list of the top 20 customers over the past four years, we identify the customers who are really important to you.

Jon: What if we really dig down really hard on those customers? Does that work? Simple question. A lot of people just forget it. There's no benefit to you. If I look at all 300 contracts, there's a massive benefit to you if I drill down to the core of the earth on 20 that are important to you. That's just one example.

Jon: So communication. The other thing on the legal side is getting caught [00:58:30] up in inertia. These things are hard when it's two or three in the morning. You're working in an agreement. Maybe you're on calls all day till five. That's when you started drafting stuff, and your human nature is, I just need to get this off.

Jon: I, I need to fire off this email. I need to fire off this document so that I can go to bed, fight that instinct, go a little bit slower. I prefer when people are slower, but they get it right, as opposed to moving really fast and dropping stuff. I would rather tell the client, I'm really sorry. I know we talked about you're gonna have this at 5:00 PM I'm gonna need an hour or two longer to make sure it's right.[00:59:00]

Jon: And I'll get it to you when it's right then to get it to you at 5:00 PM and then have a bunch of comments where we just miss obvious misses. And my clients know me enough to know that when I ask for a little bit more time, it's because at the time that I get you something, it's the end product you're looking for.

Jon: So

Kison: are you trying to save yourself some headaches over here? When I've called you at midnight,

Jon: John, what the hell is this contract? It's funny, and I've developed really good relationships with clients where that's sort of the relationship we have. They'll call me and they'll say, look, this is a hard ask, and we know it's a hard ask, but take the time.

Jon: You need to make sure it's right. [00:59:30] And I'm usually pretty upfront about it. If I had a deal. Over the summer, last summer, July 4th weekend, and nowhere accelerated to where we really wanted to close this thing for business reasons, but we were really far apart, including on fairly early stage diligence because it kind of was sputtering for a period of time.

Jon: And Klein called me and said, Hey, can we close it by X State? And you never want to say no. The idea is to get to yes, but it was July 4th weekend and folks were out. So I had to sit down with them and say, why don't you give me an hour to kind of look at where we are, canvas the landscape, and I'll come back to you with a timeline that I actually think [01:00:00] we can hit.

Jon: More importantly, we can hit it and do the job well. And I came back, it was slightly longer than what they had initially asked for, but the sellers agreed to it because guess what? They themselves weren't gonna be able to sort of match the speed that the buyer wanted and it was done right and everyone was happy.

Jon: Sometimes it's that, and sometimes you know what the flip of, it's true too. There's a real reason to get it done and we all need to suck it up and do it. And that happens too. Get the right people involved in diligence and take

Kison: your time. Don't miss important details. What's the craziest thing you've seen in

Jon: M&A?

Jon: For me, what's always fun is when you're [01:00:30] acquiring a founder owned business and it's been owned by someone, or it's been in your family for a long amount, a period of time, they have something off the side that's also running through the payroll of the business, and I've seen everything from, one was a fried chicken restaurant associated with a business that did absolutely nothing with it.

Jon: Another guy had a large Ferrari collection, another guy had a very Ferrari collection, Ferrari collection. So you see a whole lot of things happening, particularly when you have unaudited businesses. It found our own unaudited businesses. One guy had a large art [01:01:00] collection in his office and we were like, Hey, are you gonna remove it?

Jon: Does it come with a business? These seem like strange questions, but questions that pop up all the time when you're doing these deals with, again, someone who's run this business from the ground up for a very long time. The craziest thing is always when you don't think about a similar story I described, you don't think a deal's gonna happen or it's not happening at the pace that you thought it was gonna happen, and almost overnight it's get it done.

‍