In analyzing data from over 500 transactions where Fortis Advisors has served as shareholder representative, we find that many disputes could have been avoided if only the buyer and seller had created proper alignment on all post-closing matters.
For example, many acquisitions include accounts receivables as an asset of the acquired company. Ninety-eight percent of all merger agreements require that the seller represent to the buyer that the financial statements “fairly present” the seller’s financial condition (per Fortis Advisors’ Forsite™ M&A Deal Tool). In addition, many buyers require the acquired company’s shareholders to guaranty ultimate receipt of those receivables. To the extent collections fall short, the buying company may have a claim against the selling shareholders for breach of the fair presentation representation, or may have direct recourse against escrowed purchase funds to the make the buyer whole.
This structure can create a natural misalignment of interests: the buyer has no need to collect on receivables if the buyer can make itself whole through recourse against the escrow. In addition, the buyer may be incentivized to compromise receivables for the benefit of customers to curry early favor post-acquisition. This can be compounded by customers who do not feel loyalty to the buyer, and thus may slow down payments on prior purchases.
This dynamic can be corrected through alignment of interests. Selling shareholders should consider negotiating incentives for the buyer based on subsequent collection of receivables (offset, if possible, by reduced recovery on failure to collect). For example, assume the purchased assets include $1.5 million of receivables with expected collections (after reserves) of $1.2 million. Consider providing the buyer 50% recovery on collection shortfalls (under $1.2 million) in exchange for providing a bonus ($100,000?) once the buyer reaches $1.2 million in collections.
Other structures can accomplish the same result. The key is ensure both the buyer and the selling company’s stockholders are better off if the buyer fully collects on receivables.