They Let It Slip | Behind the Buy [5/8] [306]

Full Podcast Transcript

NASIR: Alright, this is our fifth episode of Behind the Buy where we are covering a transaction from beginning to end with our client buyer, My name is Nasir Pasha.

MATT: And I’m Matt Staub.

NASIR: I think this was interesting because our buyer was jarred on this one. To this point, the ups and downs were pretty — I should say palatable by our client but this one, you could tell even on this phone call, she was a little annoyed.

MATT: Yeah and some of the previous calls, there’s been some minor things that have come up and maybe a little bit more than minor. She’s been relatively fine, but she was definitely concerned about this one and rightfully so, a possible thing that could just kind of blow up everything. I would say this is the most material issue we’ve come across even more so than the whole lease situation.

NASIR: Righ. Without giving anything away because we’re gonna play the call here in a minute, I should set up the premise. We’ve signed the LOI, we’re in this due diligence period and we’re exchanging documents. We’re still basically finishing up and drafting the asset purchase agreement, which is by the way one of her vocab words again. We use that term asset purchase agreement, APA, that’s the actual agreement, the purchase agreement that we’re utilizing and it differentiates between just a regular equity purchase or agreement where we’re actually buying the equity in the business, in this case, an asset purchase for buying the assets. In this process of buying the business, we represent the buyer and the buyer wants to make sure that the business continues as normal. Once the business is purchased, we want to continue with the success that it’s had in the past. So anything that disrupts that is a risk to the transaction. From the sellers perspective, they don’t want to risk any kind of disruption in business, and from the buyers perspective, once they buy the business, they don’t want it all of a sudden to fall apart. I guess that’s the kind of cue up of the call is something happens on this call that risks that from happening.

MATT: You’re exactly right, from looking at both sides of the coin, the seller doesn’t want anything to happen because it could blow up the whole deal, there’s contingencies in place and if those aren’t met, the buyer might back out and then on the buyers side of things, if they go through with the transaction — There’s always going to be issues to deal with at the beginning once the transaction is finalized, but they don’t want anything major that’s going to disrupt the entire operations and possibly things from the get-go.

NASIR: Right and so hopefully, we come up with a solution here. This is a short call, so let’s have it. I think we just have one or two more vocab words to go over and we’ll play it. The first is UCC lien. I feel like we’ve covered that before but just in case, again when there is some kind of lender involved or some third-party financing and someone wants to make sure that their collateral is protected, they could actually file a lien with the respective state and that’s called a UCC lien. UCC meaning Uniform Commercial Code. You don’t need to know too much about that other than it’s if you have a UCC lien on the business and you’re buying a business, you probably want that UCC lien removed before you buy into it. Then the next vocab word is basically assuming an agreement. We use the term assumption of an agreement or assuming an agreement. All that means is that when you’re buying a business whether you’re going to be assigned or assumed or in other words, take over that agreement or that contract after purchasing. Look at it this way, when you’re assuming an agreement, you’re assuming all the rights and liabilities. Rights meaning the rights that you may have, but also the liabilities that go with it as well.

MATT: Exactly. The way to kind of look at it would be — I don’t want to confuse people, but it’s equivalent to an equity purchase in a sense of you’re taking on everything.

NASIR: Right, exactly. Let’s get into the call, it’s a short call, but it’s packed with a lot of content and a lot to discuss. We’ll be back in a minute.

BUYER: Hey guys, thanks for getting on the call.

MATT: No problem.

NASIR: No problem. What’s going on?

BUYER: This seller, I swear he does not know what he’s doing. Apparently, he already told his staff that he’s selling the urgent care, but obviously, we need operations to continue as is until we purchase.

NASIR: Okay, that was a mistake obviously.

MATT: I just don’t see how that would be good for anyone.

BUYER: Exactly, and we can’t have any bad experiences for patients because one bad review or something in that community will literally kill the business.

MATT: Okay, do you know what the reaction may be?

BUYER: I don’t really know that yet, but the main issue now is that one of the main people there is a PA, a physician’s assistant and I’m gathering from different conversations with the seller that she’s pretty integral in their whole day-to-day operations now that he’s moved away.

MATT: Let’s just look at this. In our purchase agreement, we usually have a whole section about continuing the business as is and limiting communications to employees even unless necessary just for that reason, so I’m surprised he would just do that even though we hadn’t signed a deal yet.

BUYER: Like I said, I really don’t think he knows what he’s doing, but the good thing is that I think the seller wants to make sure everyone has a job after the purchase and I told him I can’t guarantee that, but I am willing to make sure that his PA stays and I think that she can really help in the transition. I don’t know what the seller has told anyone so far, but I really want to lock her in now so that when I buy the business, I can keep who I want and go from there, what do you guys think?

NASIR: We can actually make the PA part of the deal. Now, we obviously can’t force anyone to work, just like how we did with the landlord, if she’s willing to sign an employment agreement, we can make a contingent upon closing that she has to sign an employment agreement even making an exhibit part of the deal.

MATT: Right, and keep in mind too that usually an asset purchase agreement, the seller will terminate employees and in some cases, spells out what the buyer is supposed to do after close. For example, it could be something like the buyer’s required to rehire all the employees or usually, it specifies that the buyer has no obligations to rehire any employees.

BUYER: I’ll probably hire everyone who wants to continue in the short term, but I just want a commitment from the PA if that’s possible.

NASIR: We’ll probably still leave it out as a requirement. I don’t want to obligate you to hire anyone besides the PA just in case, during the escrow period, there’s someone that may not be a good fit or what-have-you. We’ll draft an employment agreement and we can actually make it a part of the exhibit of the APA itself, the purchase agreement at closing and that will be required to be signed by the employee or you can leave it open too if you just want to negotiate separately, but I think we should include an APA.

MATT: Yeah and this will ensure he continues to maintain the business. We do have a provision in the purchase agreement that requires him to do so and prevents him from entering into certain material contracts without your consent.

BUYER: Okay that’s good. Let’s make that change and then I think we should be ready to sign soon, right?

NASIR: Yeah I think we have pretty much everything. Matt, this Friday, we should be able to get this to her?

MATT: Yeah.

NASIR: Okay, Friday and then we can send it to you and we can also send it directly to the seller if you want for him to review.

BUYER: Yeah, once you guys are ready, you can just send it directly to him and his broker/friend/whatever he is.

NASIR: Yeah, I forgot he’s still in the picture. We’ll get that out to you.

BUYER: Okay, thank you so much for getting on that so quick and I know it’s late.

NASIR: Yeah, no problem. Matt before we go, do you have anything else?

MATT: Yeah, there was something else. I sent you a list of agreements. We just need to confirm which ones we’re assuming. Right now, it’s just the lease, provider agreements, and an agreement for an EMR software that you want to keep, that’s it, right?

BUYER: Yeah, he’s gonna pay off the equipment lease at closing and make it part of the asset purchase, and it’s just an x-ray machine.

MATT: Okay, great. I’ll make note of that. That will clear up the UCC lien we found, but we have to make sure that the lessor does that on payoff.

BUYER: Okay, great. All right guys, have a great night.

MATT: You too.

NASIR: Welcome back. That was a doozy. Unfortunately, this is what happens. You can’t trust your sellers sometimes and this seller definitely let the cat out of the bag so to speak. Before we get to our commentary though, we do have to thank our sponsor and I can’t stress this enough. This is how we’re able to do what we do. Who’s our sponsor, Matt, if you can kind of elaborate for us?

MATT: This is episode 5, so today’s sponsor is Pasha Law PC, a business law firm that operates in California, Texas, New York, and Illinois.

NASIR: Great, a repeat sponsor, we like that kind of continuation. Pasha law, of course, started in San Diego in 2008, has it been 2008 or so? We of course thank them. We definitely recommend them very highly, but that’s a little biased though, right?

MATT: Slightly, yeah.

NASIR: Just because they’re our sponsor.

MATT: Yeah, that’s true. They paid us to say that, so I guess we have to disclose that.

NASIR: Well I would probably say the same thing if they weren’t our sponsor, but maybe not in the podcast. I wouldn’t put it out there. Even though it was a very short call, this opens up so many issues when you’re buying a business. Most of it has to do with the employment issues. How do you deal with employees when you’re buying a business?

MATT: We sort of hit the ball and prior to the call when we were discussing it, but in general, there could be a slew of different things that could possibly blow up a deal like this but I’d say what happened here or what was contemplated here is probably gonna be one of the more significant things that could because if there’s anything involved with employee morale or especially key employees like the case was here, it’s just going to be bad for both sides because like we said before, the transaction might fall through because the seller can’t live up on their end of the deal. On the flip side, the buyer’s gonna have to deal with a bunch of possibly disgruntled employees, so it’s kind of a lose-lose that needs to be turned around.

NASIR: And I would say even if a buyer or a seller is confident that employees, in general, are not going to be put off by the perspective of being purchased, it’s still pretty much our standard recommendation that you don’t want to tell your employees or employees to find out about the transaction until they need to. Sometimes, you can’t avoid it. For example, if you’re doing a lot of heavy due diligence, part of your due diligence may be interviewing employees but you would put that kind of due diligence as far back as possible. There’s a couple things, one is that from a seller’s perspective, if the transaction doesn’t go through now all the employees know that you’re selling and on the prospect of selling and even if they’re okay with that, you don’t know how people are gonna react. There’s this uncertainty with what’s gonna happen next. Even if they know that their job is gonna be kept or not, maybe they don’t know, maybe they’re all gonna be fired, we don’t know that but even if they feel like they’re gonna be kept, they may have anxiety about, “Who’s the new boss gonna be or how is my job gonna change? Am I gonna have to — I’ve been being able to come late every day. Now, do I have to be on time or strict hours, or I’m gonna have all these new policies that I’m not used to?”

MATT: Unless the employees just absolutely despised the owner, there’s gonna be like you said some anxiety, concern even if it’s a small business where the reason that they’re even to the point where they can sell is because of the employers because you just never know, there’s just an unknown. Unless the buyer was from within, but even in that case, you could know somebody within the company, they might do the purchase, they might be the buyer but you don’t know how they’re gonna run the company, it’s a completely different dynamic.

NASIR: Correct, and in this case, it seems as though it’s a little uncertain and we’ll have to wait until next time to figure out exactly how the employees are gonna be reacting, but we did find out some key information here that there is a key employee in this transaction. This is common in a lot of small businesses, and so it’s not unusual here, but you’ll often find that there’s a key person in someone’s business that without that person, the business would likely fail or without it being adequately transitioned or replaced because in a sense, most people are replaceable, but this person in particular, it seems like based upon what our client was saying and what she got from the seller was that this physician’s assistant is pretty much the backbone of the business. If she has anxiety and if she leaves or she starts looking for another job because she thinks she’s gonna lose hers, then that may disrupt the business and may not be good for both seller and buyer.

MATT: We’ve already hit on this a few times, but it affects both sides. Any key figure is gonna be paramount for closing this transaction because you can expect some attrition maybe with the lower-level employees, but you need those key people because there’s already going to be a learning curve for the outside buyer that’s coming into the fold, but you need someone who’s been in there day in day out and also overseeing people to continue to do that. It’s gonna save you as the new buyer or the new owner so much time and money as well.

NASIR: Absolutely. Let’s go over what are some options with employees when you’re buying a business. The first thing is we need to talk about how employees are treated in an asset purchase agreement because in this transaction we’re dealing with that. If it was an equity purchase, it’s a lot more simple in the sense that you’re stepping in the shoes of the tax ID and so there’s no necessity to change the employees, it’s just status quo so to speak and you can just go on as business as usual unless you want to make some changes. With an asset purchase, it’s a little bit more complicated just because you have an employee that works for one entity and then after the purchase, for another entity. Assuming you want to continue on with the employment. In pretty much every asset purchase agreement, the seller is going to agree to basically fire all their employees at closing. That seems strange and if you communicate it poorly, maybe if you want to pull a Michael Scott and joke around a little bit, you can basically say, “Okay, I have some good news and bad news. The good news is that we’re selling the business. The bad news is that you’re all fired.” But literally, that’s what happens in an asset purchase. The reason is because the new buyer with its new entity is going to, most likely if everyone’s going to be retained, rehire all those employees on day one. Of course in that transition, there’s a lot of different options and different things that can be done.

MATT: And just to be clear on the legal reason why that is for the asset purchases, I guess the entity that all the employees worked for is still gonna exist, but it’s not going to be operational. From a legal standpoint, they have to be hired by this new entity that the buyer has set up, so that’s the only reason that people might get a little bit perturbed by that, but the other option is to stay employed by an entity that’s not even generating any money, I guess that’s up to them.

NASIR: Right, I mean obviously it depends obviously on the reason for them selling the business. If you can imagine going back to this phone call, you can see why this can also add to the anxiety because even if they’re being rehired, that means that there could be a different payroll system, the new employer has to do different policies, all that stuff, like little things like you have to set up auto-pay — or not autopay what is it called an ACH direct deposit with all the new employees again. There’s more paperwork and more logistics that you have to go through and so again the reason why you want to make it as smooth as possible and delay the communication. And if you are going to communicate it, often what you want to do is communicate it together with the seller in the sense like, “Hey, let’s have a meeting with the employees and let’s tell them together we’re selling the business. Hi, I’m the new buyer. We’re gonna try to make this transition as easy as possible, etc.” But sometimes that’s not the case because the other option of hiring the employees is not hiring all the employees and maybe cutting down, terminating or coming with a whole new workforce.

MATT: Yeah and I think that’s what set our client so much in this situation because not only did the seller go rogue and just tell the employees, our client hadn’t even made a final decision on retention for all the different employees. Obviously, there were some that she definitely wanted to keep and needed to keep. She didn’t want that out there before she had even made her decision so you can understand why someone in that situation would not be happy with how things played out.

NASIR: Correct and this is something that is not on the call, I don’t think we recorded this but what we ended up advising her and other others as well is that it’s kind of tough to make those employment decisions right away anyway, and so unless it’s different circumstances, we usually suggest that even if you know you’re overstaffed for example, or even if you know you have some individuals that you think that you may not be a good fit, it’s not the worst idea to just hire them anyway. Give it 30 days, 90 days until you can really evaluate the business and how you’re going. At the same time, if there’s someone that you know is just a bad fit, the best time is probably in that transition because then you don’t have any wrongful-termination issues because as a buyer, you don’t have an obligation to hire somebody. So if the seller is terminating them in course of their sale of their business and you don’t hire them, it’s very hard for an employee to somehow say, “Hey, you didn’t hire me because of some wrongful discrimination case.” Or if you hire them and terminate them later, then they may be able to perceive some kind of wrongful termination that they should have been kept as an employed person at the company.

MATT: Yeah, and I think that’s great advice because like you said, you minimize your exposure from a liability perspective in any sort of wrongful termination case, but also like you said, as long as an employee’s not a completely bad apple, there is some value in keeping them on even if it’s for short term because again, they’re the one that’s worked there and they’re gonna at least have some working knowledge of what they’re supposed to do for their role and I guess they’ve even been there longer than the actual buyer has. There’s typically some value but like you said, if there is someone who you know is not gonna be a good fit or gonna be a problem, the time to do it is I guess day zero, it’s before things even start.

NASIR: Correct, definitely. Those are the couple options, but let’s talk about what we had in this case. Besides the other employees, we kind of focused on this key employee. Let’s say it’s the opposite that it’s not that you want to get rid of somebody, you want to make sure that this key employee stays with you. This call went pretty quick, so I think it’s worth kind of elaborating a little bit. What we did in this case and what we were proposing and hopefully, that’s what our buyer was going to propose to the seller is that okay let’s make the employment of this key employee part of the deal, that part of the deal and the contingency to close is that this key employee has to commit to being employed by the new employer. I think I even made a comment, you can’t force somebody to work and so you could come in, buy the business, the next day the employee leaves and that could still happen even with an employment agreement, but if you get that commitment, start talking to that key personnel, “Hey, I’m buying the business. I want to hire you under these terms. Are you okay with that?” And then you get that buy-in from that key employee and gives you some assurances that on day one, you’re gonna have some transition that is smooth from one day to the next.

MATT: Yeah, I think you mentioned this before, but this should be part of the due diligence stage as well of kind of identifying who those key people are and then discussing with them too the intentions and the expectations moving forward, so I think that was the plan for our client in this situation, it just got bumped up and kind of short notice based on what the seller did. But she scrambled and ultimately I think we came to a resolution that worked for her.

NASIR: And then I would note that this wasn’t applicable because this transaction was in California, but often we also addressed non-competes. The reason you do that is that once an employee is fired or terminated through the asset purchase, a lot of times in other states where you have these non-competes, those non-competes will be triggered. So you have to make sure that number one is that within your agreement, the employee is not violating the non-compete by being hired by you as the buyer, but not only that is that sometimes where you may want these non-competes in there, but the previous seller didn’t have them and so you may want to include them with all the new employees, and that may be part of your on boarding process or may be part of when you hire the employees again or in part of the actual transaction, but it wasn’t applicable because again if anyone doesn’t know, non-competes are pretty much not even tolerated anymore in California. It’s very restricted.

MATT: Right, exactly but yeah it’s definitely consideration outside of the state.

NASIR: And then I think the last thing Matt, that I want to make sure we cover is PTO. This is applicable in California and not every state, but in California, you actually have to pay out your paid time off or vacation pay for your employees at time of termination. Of course, when you’re terminating all your employees of the seller, you actually have to pay that out.

MATT: I’m glad you mentioned that, I think that’s something that goes unnoticed sometimes. It’s one of the last considerations, but depending on the size of the company and the longevity or the tenure of how long employees have worked there, it could be a pretty substantial payout. Of course it’s negotiable with the buyer, but I think it’s one of the last considerations that probably get looked at, but it could be a pretty major factor.

NASIR: Yeah, and usually it’s the seller that forgets that right? You mentioned that it is negotiable so it is not uncommon for a seller to say, “Hey look, I have X number of hours that I need to get pay off.” So either you offer that continuation with the employee to keep those accrued hours or how it usually works is that even if you agree to accrue it is that you offset it from the seller of how much you’re paying them so that the seller can actually pay their employees out at termination. That’s usually how it works, but I’ve seen both ways. The problem with continuing the accrual is that you need that signature or that agreement from the actual employee, you can’t do that automatically.

MATT: Right, because absent them agreeing, they’re gonna be entitled to whatever the number of hours that pay for that, so definitely something that needs to get sorted out. It doesn’t need to get sorted out, but it should be sorted out prior to finalizing everything.

NASIR: That’s right. Let’s see, we talked about the options of hiring, firing certain employees, keeping key employees, handling PTO in that transition, making sure that you keep the employment personnel calm. Usually that’s the sellers job, usually the seller’s the one that has the most interest with that which is why this is unusual and I think that’s why our client basically described the seller not knowing what he’s doing because — I think you commented that’s not in anyone’s interest, but that’s what he did so that’s where we’re at so far, but besides that, we also just mentioned a couple things. We are at this point of the series or at this point of the transaction, we are still compiling the asset purchase agreement. What we’re doing is we’re gathering these documents. We’re seeing which agreements that we want to assume and take over because at an asset purchase, it’s basically piecemeal, it’s like a buffet okay what do I want to take and what is the seller willing to keep themselves so that I don’t have that liability. A few key agreements that we talked about in the beginning of the series like provider agreements and maybe some other vendor agreements that we want to make sure that we retain, and then also we talked about the x-ray machine and these liens that we need to make sure that we identify in the agreement so that it gets all cleared up by the time we want to close.

MATT: Yeah.

NASIR: This is usually the point of the episode where we asked for positive reviews, but I do have an announcement to make on that and it’s not good. This past four or five episodes, we’ve been asking you to leave positive reviews on Spotify. I was just informed that Spotify has no review process, at least we can’t find it. So on behalf of the podcast, on our sponsors, I do apologize.

MATT: I thought this was gonna be more dire than that but I think we could live with that.

NASIR: Well yeah, I don’t like to disappoint, but that doesn’t mean that you can’t leave positive reviews on other platforms right? I think we’ve talked about this. It is a requirement in exchange for listening to this podcast. You agree legally and legally bound to leave a positive review on the other platforms.

MATT: I’ve confirmed that other platforms do allow for leaving reviews so I think we should be squared up there.

NASIR: Okay perfect, very good. Joking aside — first of all it’s not a joke, you have to leave positive reviews. Feel free to also reach out to us. We’re very active on social media, whether it is on Twitter or Facebook or Instagram and you can always email us your comments and questions on this episode or previous episodes or if you just want to say hello, info@legallysoundsmartbusiness.com and of course, thank you so much for listening. We love doing this and I hope you’re enjoying this series.

MATT: Yeah, we really appreciate it.

NASIR: That didn’t sound genuine.

MATT: I stumbled on my words.

NASIR: Exactly, you were hesitant to thank our audience. I guess that’s the difference between you and I. I really do honor our listeners in a way that is just very difficult for you to match.

MATT: Good cop/bad.

NASIR: Either way, thanks for joining us everyone. Tune in next episode where we find out what happened to our buyer after this whole employment issue comes up and also what happens with this key employee. Are we gonna be able to get this key employee locked in and rolling when we purchased this urgent care?

MATT: Yup, keep it sound, keep it smart.