You’re halfway through the deal of your dreams. You spent a year searching for a target, beat out other bidders to get it under LOI, you did your QoE, got your lender spun up, and investors are asking where to sign.

Your lawyer calls you to tell you about a legal diligence issue. If you read my last post you immediately ask your lawyer: (1) How much could this cost? (2) What is the % risk this is an issue? (3) What can we do to reduce the risk?

Here are some solutions to reduce the risk of a diligence issue when buyer wants to proceed. I used these solutions representing large private equity deals, but they are equally applicable to SearchFunds, Searchers, and SMB Buyers:

1) Specific Indemnity + Recourse. As soon as you identify the risk, and quantify the $ value of the risk, you can request that sellers provide a specific indemnity – meaning, specifically state in the purchase agreement that they will pay for any losses relating to the diligence issue. However, that promise is only as good as the cocktails seller is drinking in Maui after closing.

In the event of a loss, you need to be able to get your money without chasing the seller. This is done through setting money aside (i) held by a third party in an Escrow, (ii) holding back money in a Holdback (held by buyer), or (iii) offsetting against a promissory note.

2) Pre-Closing Amelioration + Closing Condition. Request that the seller goes out and corrects this issue before closing. Resolving this issue should be a condition precedent to closing (buyer will not have to close if this is not corrected). If you have a deposit, make sure have the right to get it back.

3) Post-Closing Amelioration with Escrow/Holdback. If you want to close the deal and can’t wait for seller to correct it pre-closing, you can create a specific Escrow or Holdback that will be released to seller as soon as this issue is corrected or given the passage of time.

These are the techniques I have used to deal with serious diligence red flags when my client want to get the deal done.

*I am an M&A lawyer, but I'm not your M&A lawyer (unless I am, and if so, call me).