During due diligence, you may uncover deal-changing issues, or what I like to call “red bucket items.” Identifying these risks doesn’t necessarily mean you walk away from a deal, but you will need to negotiate new terms with the seller.
Among the ways to protect yourself as the buyer when you find major issues:
1. Ask the seller to fix the problem and continue on good faith.
For example, if you find there is broken equipment in the seller’s plant, insist that the equipment be fixed before the deal closes
2. Require indemnification so the seller is legally bound to cover the costs if the problem materializes.
Let’s say the plant equipment is very old and likely to break soon. In this scenario, the seller would be required to pay for repairs should that occur.
3. Institute holdbacks, where a certain portion of the payment price is withheld to cover the specific issue of concern.
If the broken equipment costs $100,000 to replace you would withhold this amount from the purchase price, guaranteeing resolution before making full payment. You only pay the seller once the problem is fixed.
4. Request that funds be held in escrow to cover the problem and other potential contingencies.
With an escrow account, a percentage of the purchase price is held in a separate third-party account. It is paid to the seller a certain amount of time after closing to make sure all the seller’s claims are true. This serves as a “risk shield” for the buyer.
5. Offer less money for the business.
Sometimes uncovering “deal changers” means the value of the business changes. As a buyer, taking on some risks can mean paying less for the company.
Negotiating “red bucket items” is one of those tougher tasks which may merit involving your third-party adviser. He or she can protect the relationship between buyer and seller, acting as a “marriage counselor” while investigating and developing possible solutions to present to the seller.
*This post was adapted from David Braun’s Successful Acquisitions, available at Amazon.com