What insights does a top M&A attorney have to share about buying and selling businesses?
Spending nearly three decades in California’s dynamic business environment, my guest, attorney Addison Adams, has become known as California’s go-to voice on mergers and acquisitions.
In this episode, he’ll share his M&A expertise, including:
- M&A in California
- Non-Compete Agreements
- Bulk Sale Law
- Reps & Warranties Insurance
- Predictions for Next Year
- And more
Mentioned in this episode:
Patrick Stroth: Hello there. I’m Patrick Stroth, trusted authority in executive and transactional liability and founder of Rubicon M&A Insurance Services, now a proud member of the Liberty Company Insurance Broker Network. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions, and we’re all about one thing here. That’s a clean exit for owners, founders and their investors.
Today, I’m joined by Addison Adams of Adams Corporate Law. Spending nearly three decades in the California dynamic business environment, Addison has become California’s go to voice on mergers and acquisitions. So it’s a real pleasure to have you here today. Addison, welcome to the show.
Addison Adams: Patrick, thank you so much. It’s a real privilege and an honor for me to be on your podcast. Really enjoyed getting to know you the last few months and appreciating your expertise in insurance services. And I’m happy to talk to your listeners and see if there’s any value I can provide in terms of some of the latest trends and the tips and tricks about buying or selling a business in California.
Patrick: Well, before we get into the magical land that is California these days, let’s start with you. What brought you to this point in your career?
Addison: You know, for me, I suppose every young person that goes to school and becomes a lawyer has to take a minute to figure out what kind of lawyer they want to be. And I was exposed to the .com explosion at the end of the 90s, and closing financing after financing with venture capital. And my associates, colleagues, you know, we would close the deal and high five in the hallway. And I just fell in love.
I said, this is what I want to do. I want to help both sides win. I just love corporate deal making. I love closing deals, I want to make sure that the deal is good, even after it’s closed after the high fives are done and the closing dinner has happened. And it just really speaks to me. There’s a sort of a creative process to negotiating and protecting the client, but also looking out for both sides and making sure this is a win-win in the long run.
And what a great way to be a lawyer when you’re operating in that kind of environment. Because so much of the law, someone has been injured and there’s a lawsuit and now there’s damages and it can really be a negative situation. And so I feel really lucky to have found an area of the law that is not negative. It’s positive. I love it.
Patrick: Yeah, I agree. A lot of people think when they think lawyers they think adversarial circumstances. And these are actually more where people are working together. I also agree with you, there’s just a tremendous amount of energy in and around mergers and acquisitions where you have one group of people agree to combine forces with another group of people and together, you know, one plus one equals four.
And it’s always fun being around that kind of energy and just seeing it get on through. And so as we get into Adams Corporate Law, let’s talk about the firm and why you know, you were working on the big Silicon Valley .com deals, you’ve come down now with the lower middle market or even below that in area and scope. Let’s talk about that transition and Adams Corporate Law.
Addison: Oh, sure. So it was a great training ground working on larger deals younger in my career. And what I found is that I love being hands on. I love talking to the owner. I love leading the deals. And I also saw an opportunity that the bigger deals have access to higher hourly rates, lawyers, giant firms, 1000 lawyer law firms. And so I’m serving a sort of an unmet niche with my boutique firm.
We charge lower rates, but we have senior level attorneys that have done this hundreds of times, so we know what we’re doing. And we can do it very efficiently. And so it’s where I found myself a little bit on accident and a little bit on purpose. I just enjoy working with owners, with entrepreneurs, really. We do a lot of the sell side business, and a lot of the smaller size companies. And by smaller I mean under $50 million.
And a lot of our transactions are 5, 10, 15, $20 million dollars. And we’ll go down. There’s no limit. We’ll go all the way down to anyone that you know needs advice. In fact, I get calls every day from people and some people are having a small franchise and it’s you know, they’re selling it for a few $100,000.
And I don’t say no, that’s too small. I say, well, let’s take a minute and let me walk you through, you know, see if I can give you some ideas. Are you aware of the after tax treatment? Have you thought about, you know, you’ve got a services business. Let’s walk that through. And a little bit of that is paying it forward.
A little bit is, you know, once they’ve gotten the basics, they can make a decision whether they want to go forward and buy a few more hours, or a few more, you know, after that. But for the most part, the fun of it is in closing the deal and making sure that the client is happy. You know, 100%, so.
Patrick: I think one of the things that you can dispel right now, for a lot of people who are, you know, don’t have an engagement with 1000 person law firm, they’re very fearful that if we start talking to somebody, we’re gonna get ourselves embedded in a real high expense relationship, and so forth.
I think you can make this real simple for them, where the smaller, the simpler the deal may be, you just give them some pointers on here’s what to look out for. And that gives them enough to move forward. It’s not, you know, a five to six figure engagement, correct?
Addison: Correct. No, that’s right. That’s right. So I have gotten very good at tailoring the level of service to the needs of the client. And a lot of that has to do with the size of the deal. And so, you know, interestingly, in one way of looking at it, and a lot of lawyers actually look at it this way, every deal costs the same amount of time to do it right. You could make that argument. Whether it’s, you know, $100 million, or $1 million.
But the reality is that, first of all, the larger companies are more complicated. They’re usually in multiple states, they have more employees, they just have more going on. And when you’re selling a business or buying a business, it’s a very, as you know, it’s a very granular process. You really need to go through the details.
And so the smaller companies just have fewer details to get through, although you got all the same topics. As far as employee benefit plans, intellectual property, material contracts, environmental risks. Go down the list, they’re usually a lot, a lighter touch, a shorter visit to just check and see if there’s an issue there.
Patrick: Would that be kind of part of your secret sauce, or your superpower that you’re bringing to the table to the lower middle market is, you’re getting to the point very quickly, you know what to look for, and you’re not going to make something that’s fairly simple, more complex. You’re going to get forward so they can get execution forward.
Addison: 100%. So one of the benefits of experience is I am able to move very quickly. As far as reviewing asset purchase agreement, giving feedback on the letter of intent that we’re negotiating, even just running through quick diligence, legal compliance, financial compliance. It’s important, I think, to recognize the benefit of experience, because it gives you context, and it gives you better understanding.
And all the time, and really in any agreement that’s being negotiated. But even more so in selling a business. It’s a combination of identifying potential risks, and then having the judgment to assess whether they are likely or unlikely to develop. Typically, in a sale of a company, there’s a lawyer on both sides. And regardless of what side I’m on, and usually I’m on the sell side, but regardless of which side, I prefer having an experienced M&A attorney on the other side.
And one person you know, a layman might step back and say, oh, well, why would you want another expert M&A attorney on the other side? They might take advantage of the situation, negotiate a term and a better way. And the reason is, because they know what we need to negotiate and they know what we don’t need to negotiate.
And it can just save a tremendous amount of time. If you’re using someone that’s not an expert that hasn’t done this hundreds of times, you find yourself having very odd negotiation conversations where something that just doesn’t affect the deal is being removed from the contract because someone doesn’t understand why it’s there and how it works.
So yeah, so that is part of my secret sauce is just the frequency and the expertise and it just allows me as a lawyer to explain things to my clients in plain English and a simple way, a concise way. Just cut to the chase. You know, there’s a rep and warranty section. It’s the biggest section in the contract. This is the part that is the most tedious. Why is it here? You know, let’s talk it through. It’s a protection for the buyer.
It’s a, you know, but I already went through all this with the due diligence answers. They already have all my contracts. Why do I have to list them again? Well, it’s because they want to make sure there’s nothing missing. That we’ve, you know that to the extent they have to write a check after the closing, because there’s a surprise bill they didn’t know about, they want to be able to point back to what you told them, and say, look, this is why you shouldn’t have to pay for it.
They want the seller to pay for some obligation that wasn’t disclosed. And so if you have a little bit of context and understanding, you know, as well as a familiarity, because these contracts, us lawyers, we all sort of get inspiration, I’ll say from each other. And over the course of decades, that inspiration has shaken out to basically all the contracts look the same. They all have the same sections and cover the same topics.
Patrick: They don’t want to admit it’s a copycat league, but it’s the same in a lot of other businesses. I can imagine one of the greatest benefits if you’ve got a counterpart that’s familiar with mergers and acquisitions on the other side of the table, well what that brings now is everybody understands the two sides have, as you said, context. They also know where they’re coming from.
And they know what’s a priority and what’s not a priority, and they can evaluate those things. And if you don’t have that, one of the worst things can happen is delays. Because one side is fearful that they’re missing something. And there’s fear of the unknown out there. And so you get delay after delay after delay.
And the only analogy I can have instead of postponing Christmas would be if your client is like your child, and they’re waiting for their 10th birthday party, and they’re expecting their birthday party, and it’s coming up and then you say, oh, I’m sorry, it’s not tomorrow, we’re moving it out another week, sorry. And then another delay. And it’s that wear and tear on all the parties involved is you know, something you want to avoid.
And if you’ve got, you know, two sides that are equally matched, then you’re working together, you’re not in that potential fearful, adversarial kind of situation. Now, Addison, as you’re doing these, you know, let’s talk about the California venue. Because that’s, you know, we’re the heart of your practice.
And California for a lot of the grief we’ve been given as Californians about in social media, and politically and economically and all the horror stories there about the challenges of California, you gotta face the fact that it’s one of the most prolific venues for innovators. And it is one where we have millions of companies are here.
We’ve got millions of very highly educated people who can work here. So the workforce is sophisticated. There are tremendous natural resources, there are a lot of positive things. The biggest being innovation in this environment that moves things forward. Okay, so you’re not going to, unlike people who want to move out of California and have nothing to do with it.
In mergers and acquisitions, there’s a lot of really good stuff here. But there’s a catch that you’ve got to kind of be ready for that. What are some of the things that are unique about California that if you’re prepared, they’re not that big a deal?
Addison: Well, it’s a great question. And a lot of people that don’t live and work in California are surprised to find some of the unique, you know, differences here. So one of them is the non compete rules in California. And so this is very common that a buyer wants to make sure the seller won’t compete against their business, against them when they buy their business. And California has a law that says all non-competes against employees are void as a matter of law.
Most states have reasonable restrictions on non-competes. How long it can be, this and that. The geographic area. California, just flat out says you just can’t enforce a non-compete. And the case law on that is expanding into non-solicits as well. Many courts have determined that a non-solicit is a non-compete in disguise. A non-solicit is an anti-poaching rule. You can’t reach out and try to solicit employees from the company.
Patrick: A very big deal. A very big deal.
Addison: Yeah. And there’s actually, the FTC has proposed a national law, changing the rule on non-compete. So that’s been proposed. And there’s definitely you know, you can imagine the employees would prefer to have no non-competes nationwide and the employers, they love enforcing non-competes because it helps keep their people and keep the wages down.
So in an M&A transaction in California, there is an exemption, an exception to that prohibition on non-competes. And that is, the owner of the business can agree to a non-compete as long as it’s reasonable. Usually five years or less and tailored towards protecting the buyer’s business. And so that is regularly used, but it also only extends to who the owners are.
So if you have a retiring founder that owns the whole company, that noncompete is going to be enforceable by California courts. But the key employees and the lower or mid level managers, everyone else, there is no way to impose a non compete on them. And so the workarounds there are enforcing confidentiality agreements, enforcing existing rights to prevent unfair competition through stealing trade secrets, through stealing customer lists, that kind of thing.
But yeah, California has a very pro-employee mobility public policy. They just want workers to be able to work and to not have a contract that prevents them from switching jobs. Yeah, so that’s one thing. Another thing that’s somewhat unique to California is we do have a bulk sale law. And so if there’s a seller that has finished good inventory, and the buyer is buying the company, you have a choice there.
One is you can try to get the benefit of the bulk sale law, or you can choose to waive it. So the bulk sale law is essentially intended to protect creditors of the selling company. And so let’s say you sell your business for $10 million. And the seller, the owner takes the $10 million and leaves town. If there’s a creditor that didn’t get paid that comes out of the woodwork in the next, you know, year or two, they’re going to have a claim against the buyer.
Even if it was an asset sale and a bill of sale. And so California allows you to run a notice in the newspaper that says I’m buying all the assets of this business, if you’re a creditor, here’s the address, you know, send us your bills, and let us know what claim you’re owed. And you can set a cutoff date, like a month out in the future.
And so that bulk sale is an opportunity to give the buyer essentially and the seller a little bit more peace of mind that you know who the creditors are. And any, if you run all the newspapers, and you give out the notice to everyone that is a known creditor, and you don’t get those claims in on time, then you’re protected and the creditor is too late. They missed their chance.
Patrick: That’s a great safeguard. How about that?
Addison: Yeah, so a little unique thing. And some states have something similar, some states don’t. But that’s unique to California, I guess a couple more would be California does have cumulative voting of directors. And so if you are buying a California company, and you do an asset purchase, and the buyer is outside California, then you can avoid this issue.
But if you’re looking to do a stock purchase, and a change of control, and if the selling company, if you’re not buying 100% of the selling company, let’s say you’re buying a majority 60%, cumulative voting is going to give the minority shareholders that are not insignificant, you know, 5, 10% or more the ability to elect themselves onto the board of directors and have a position there.
And so that can be tricky in California. And that can even be tricky when you use an outside, a foreign corporation like Delaware or Nevada or anywhere else. But it’s everything’s in California, then the California courts will often enforce that rule. Even though you’re not a California Corporation. There’s the 2115 is a long arm statute.
So let’s say your Delaware, the Delaware court will if you have the lawsuit in Delaware, then the cumulative voting will not be respected. But if the lawsuit gets filed in California and doesn’t get moved to Delaware, the California judge will say, yeah, this shareholder has a position on the board. So that is another interesting quirk.
And then of course California has high taxes. And so you would think that that would be, it just is what it is, you know what you get. But the, I guess the fun happens, trying to get around that or trying to minimize that. Coming up with clever structures.
And so that’s interesting. And there is such a thing of course, if you’re a multi state company, then you allocate income among different states. And if you’re just in California, then pretty much you’re just going to need to pay your taxes in California.
Patrick: All of these fun nuances that are here, you know, you got to come in eyes wide open and was helpful here. And I really appreciate this. As you just suggested a couple of workarounds that are pretty common sense. And it doesn’t completely derail deals is just if you’re coming in aware of these things, you can then adjust and adapt to make sure that the deal goes forward.
So one of the aspects of mergers and acquisitions that’s really accelerated the pace has been the parties that have been able to transfer a lot of the risks that they’ve had between the buyer and seller, using reps and warranties insurance. And I’m just curious, Addison, you know, don’t take my word for it. Good, bad or indifferent. What’s your experience been with reps and warranties?
Addison: Reps and warranties insurance has been, as you say, absolutely sort of a godsend for companies that are looking to really manage and control their risks. And I think private equity is a great example of that, because private equity is typically driven by MBAs with spreadsheets, and they like projections, and they like to minimize the worst case and the best case that you know, or at least the worst case scenario.
And so reps and warranties insurance is a there’s a cost associated with the premium, but you of course, then you get the coverage in the what if scenario if a covered claim comes up down the road. And so I’ve noticed a couple of things about it. One is that with reps and warranties insurance, the other protections can be minimized and go away. So by the other protections, I mean, a large escrow hold back for indemnity of unknown claims that might come up.
So for example, I’ve seen, you know, 10, 15%, hold backs on purchase price, that might be two years down the road. So the seller is waiting for their money. And so if you have a rep and warranty insurance policy, you get more of your money, basically, usually all of it or close to all of it right at the closing, which is great.
So that’s great. My understanding of reps and warranties insurance is that and you’re the expert here, so I’m sure I’m not telling you anything you don’t know. But up until recently, it’s been more limited to the larger deal sizes. And so, you know, 50 million, 100 million and on up, reps and warranty policies were available. And only lately, have carriers been starting to come up with new products that are workable for smaller deal sizes.
And the last I heard on that was they can drop down to in the neighborhood of a $20 million deal. That kind of thing. Maybe a little smaller. But if you’re at the real, you know, low end, meaning under 20 million, then those deals typically, so far at least, don’t seem to have rep and warranty insurance options available to them
Patrick: That’s perfect timing that you went and raised that because that’s one of the great innovations that has happened is yes, rep and warranty, the traditional policies were reserved for 100 million dollar plus purchase price deals. They’ve come down market to as low as 20 million in some cases. There’s still a very hefty cost that’s involved, but the benefits can offset a lot of costs. So it’s been justified in a lot of those cases.
For deals priced from a million to 20 million. That’s been an area that hasn’t been served and one of the insurance carriers out there, CFC has come forward and said look, why don’t we come and pursue these simpler, less complex lower risk transactions. There are 1000 times as many of those at that level than at the 100 million dollar level.
So we can benefit by getting you know, spread risk, we get a lot of volume, we can charge a price that is lower to respond to the reduced risk. And we avoid areas where you know, we’re not going to go into regulated industries like health care, energy or banking and we’ll cap the transaction value of maybe 30 million.
They predominantly work in the sub $20 million space. But if they’re at that area, all of a sudden, they can do a rep and warranty insurance policy every bit as broad as the traditional buy side policies. And the cost is between $10,000 and $20,000 per million dollars in coverage. So you could see a $5 million add on getting a $2 million, $3 million policy for less than $50,000.
And that’s usually the underwriting costs for traditional buyside policy. So we see that as a great innovation. Particularly for clients in the lower middle market where they want to transfer risk out, they just don’t have a vehicle. Now a vehicle exists. It’s called TLPE, transactional liability private enterprise.
And so it is doing, as you’re doing, it’s serving lower middle market. And we’re very, very excited about that. Now, Addison as we’re coming in now, we’re getting close to you know, looking forward into 2024. What do you see out there in M&A? Either in the lower middle market, or for Adams Corporate Law? What do you predict for the future going on?
Addison: You know, it’s been funny, because for the last three years, I’ve been predicting doom and gloom at any moment. Just everything, you know, we had the pandemic, and now inflation and interest rates going up. And everybody keeps saying, you know, we’re headed for a recession.
And I’m not saying that. It’s been an incredibly busy M&A environment. Some parts of the M&A market this year have slowed down for a little while, but they seem to be picking back up. I have never been busier. And so you know, our firm is just, it’s been, it’s been tough to come up for air. And so we’re hiring by the way, if anyone out there is a senior M&A attorney and looking to make a switch.
So I think that it’s going to keep going well, despite the higher interest rates. Traditionally, of course, higher interest rates means lower valuations on M&A exits, and therefore you have a slowdown, while sellers wait for interest rates to drop and pricing to improve. It seems like we’ve got a weird economy, though, with contradictory indications.
And, you know, employment is strong and growth is strong and hard to say how inflation is doing. It’s, you know, it’s not that bad. Except for in some areas. You know, like anything else, I suppose different industries do better, you know, in different markets. And so, but yeah, I’ve got a number of just manufacturing, distribution type sort of low tech, but highly profitable growing companies that are being bought right now.
And so private equity is out there. Strategics are definitely out there. And people still have motivation to sell. Because, you know, when you’re ready to retire, you know, or you’re ready to just try something else, you’re ready. And so you, you move forward. Well, it’s gonna have to really make a big difference for me to wait five years.
Patrick: I think that what happens is between the pandemic and financial, economic headwinds, and so forth, one thing that doesn’t stop is time. And we have a lot of owners and founders out there that aren’t getting any younger. And so I have a feeling is after the pandemic delay, they’re coming out of that. We can see a lot more movement forward for exits, and there’s a growing market of buyers out there.
And so I think that you know, where buyers can meet willing sellers, and what’s great about California, this is a very, very diverse economy. So there’s all kinds of stuff out here. So I am, you know, coinciding with you is I have a very positive view for the future. Now, Addison, how can our listeners find you?
Addison: So I have a website, it’s called adamscorporatelaw.com. So www.adamscorporatelaw.com. You can also send me an email at Addison@adamscorporatelaw.com. You can also find me on LinkedIn under I think it’s called LinkedIn/in/AddisonAdams. You’ll know you found the right one if it says the lawyer that closes deals.
Patrick: Perfectly said. Well, Addison Adams from Adams Corporate Law, thanks for joining us today.
Addison: My pleasure. Thank you, Patrick.