Legal Due Diligence Findings
October 16, 2023
by a searcher from University of South Carolina - Darla Moore School of Business in Charleston, SC, USA
I am doing legal due dil on a Seller and found a bunch of DUIs, and arrests for disorderly conduct and similar things. In fact, just earlier this year Seller spend 45 days in jail for these things.
We found the corporation was administratively dissolved and then reinstated this summer. This happens when the corporation fails to file its Annual Report. The lawyer said that this might be a good finding, since it means they settled whatever penalties they had with the State.
The deal is a stock sale, so obviously these are red flags. Would these alone be a deal breaker for most buyers? I'm very tempted to walk away, but a lot has been invested so far into the deal.
from University of Tennessee in Nashville, TN, USA
Substance abuse and Seller integrity are sometimes mutually exclusive and sometimes not. Your discovery certainly raises the risk profile of the business, undermines the perceived integrity of the Seller, and re-emphasizes the importance of thorough, detail-oriented diligence. Quitting is always the easiest option, so deal termination should rightfully be on the table.
Stock sales expose the buyer to the known and unknown liabilities of the Target, unless properly structured contractually and via entities. What first needs to be determined is if the Seller's substance abuse has adversely impacted the operations of the business and/or created any current or future liabilities to the business. The challenge will not be the known issues but the unknown issues. Either via Seller's advisor or directly with the Seller, there needs to be a discussion with the Seller requesting full disclosure related to any on-the-job behaviors that have occurred and may have directly or indirectly adversely impacted customers, employees, vendors, or bystanders. This includes government agencies such as the Secretary of State, Department of Revenue, IRS, etc. The administrative dissolution may be as simple as failing to timely file paperwork or maybe not. Diligence isn't about guessing; it's about finding and understanding the answers to questions that are raised.
Properly disclosing your discovery with the Seller can lead to additional leverage in the SPA negotiations to offer you, as the Buyer, additional protections normally not provided in a stock sale. Your attorney will need to take the lead on this once this and any additional red flags, if identified, are qualitatively and quantitatively assessed. To another poster's point, the business may not need an in-person owner to operate day-to-day. Your diligence should be crafted to answer that question with multiple data inputs, the first being the Seller.
To deal or not to deal, that is the question? Your diligence process and your risk tolerance will determine the answer. Good luck!
from California State University, San Bernardino in Stratton, CO 80836, USA