Ep. 3: Beyond the Handshake: Why Legal Counsel Matters in AEC M&A

Thinking about buying or selling your AEC firm? Mergers and Acquisitions (M&A) can be a complex process, but with the right guidance, it can also be a strategic move to propel your business forward.

This episode of AEC Unscripted explores the legal aspects of M&A in the AEC industry. Host Jeff Adams sits down with Lawson & Weitzen M&A attorney George Christodoulo, a recognized expert with over 400 deals completed!

In this conversation, you'll learn:

• The critical role of experienced legal counsel on both sides of the deal
• How to navigate common issues that arise during negotiations
• Why clear communication is essential for a smooth M&A process
• The importance of industry-specific expertise in AEC M&A

Listen in and gain valuable insights to ensure your next M&A transaction is a success story.

 🔔 Don't miss out! Subscribe to AEC Unscripted: M&A Edition on your favorite podcast platform. Let's explore the M&A landscape, unlock growth potential, and achieve deal success. Ready to dive deeper? Let's go! 🤝💰 

Transcript

[Intro] 00:00

Welcome to AEC Unscripted: M&A Edition, your go-to podcast for unfiltered conversations and expert analysis, brought to you by Stambaugh Ness.

[Opening Credits]

Jeff Adams 00:27

Welcome to AEC Unscripted. I'm your host, Jeff Adams, the Director of Mergers and Acquisitions at Stambaugh Ness. Today, we're going to be exploring M&A from a legal perspective through the eyes of an attorney. And I'm delighted to have joining me for this episode, a man who needs no introduction to those of you who participate in M&A in the AEC industry.

George Christodoulo. George is a corporate lawyer with Lawson & Weitzen who has spent over 45 years in private practice in Boston. He has extensive experience providing legal services to AEC firms on a national basis. He has an emphasis in ownership transition, mergers and acquisitions, fiduciary duties of directors, and professional licensure and termination of principles. He has completed over 300 transactions among AEC firms in the US and Canada.

Representing both buyers and sellers. George, thank you so much for joining me today.

George Christodoulo 01:33

I appreciate that introduction, Jeff. Thank you very much. And thank you for having me.

Jeff Adams 01:37

So, George, when it comes to M&A, I think it's safe for us to say this is not your first rodeo.

George Christodoulo 01:46

Actually, it isn't. And actually, the 300 is now 400 transactions.

Jeff Adams 01:52

Now 400! I can't believe that. I know I've seen you out there a lot, speaking a lot of different conferences. I've seen you work in different deals, both representing buyers and sellers, and, a matter of fact, I think when I first met you, it was, when we sold the firm I was with, you were engaged.

So, yeah. You've been out there a lot, doing a lot in the industry. So, always great to get to connect with you.

George Christodoulo 02:19

What's happened in the last maybe ten years is the space has gone from 200 - 250 transactions a year, 6 or 8 years ago, to 300 - 350 transactions a year over the last three years, or actually last five years, and now the last three years and the prognosis for 2024 is 400 - 450 transactions.

Jeff Adams 02:48

There's definitely a lot going on in the AEC industry when it comes to M&A, and I don't think we're seeing any end in sight when it comes to that.

George Christodoulo 02:57

No, we're seeing more and more private equity firms join in also.

Jeff Adams 03:02

Absolutely. We actually had a private equity firm on our last episode of the podcast, and we'll have more to come, but George, briefly tell us about your background and how you ended up being a well-known M&A attorney in the AEC industry.

George Christodoulo 03:20

Along with getting a law degree, I got an MBA, it was a special program four years you get two degrees, but you pay for five years tuition. And I joined a medium-sized law firm in Boston. It's a corporate transaction lawyer, and back after a few years in the early 80s, I had a colleague who represented architects and engineers and professional liability defense matters.

And, of course, there was no M&A practice to speak of at the time. He had a client who was engaging in an internal transition and suggested that the employees there get counsel, and I transact that deal. And close that deal. Of course, there was no playbook. So it was a little bit of finding our own way along here.

Then, another matter came up. Then, I was referred another small transaction. And then over the course of the next maybe ten years, I spoke at a PSMJ seminar, and an AEC seminar, and AIA Whitepaper and an AIA Conference an another professional liability conference on the topic of mergers and acquisitions, because the total number of transactions, both internal and external, was, heating up.

So, over a period of time, word got out. I sort of rode the wave of more deals. A book was published in M&A, that I was the author of. Then there was a second book published, and there were more conferences. People were getting mostly strategic to strategics, and then along came some public companies that went across the country buying up firms.

So, the number of transactions was heating up, and many firms were facing the reality that internal transition was very difficult to not only scope out but to implement, turning to mergers, if you will. Some of these were acquisitions. Some of these were mergers. Some of them were defensive coming together. But the number of transactions kept growing and growing and growing, and therefore, now we're at 400 - 450 national deals a year; we probably do 8 to 10% of all those deals right now, 35 to 40 a year, which is a, a large number compared to where we started.

Jeff Adams 06:07

Absolutely. So, George, what would what size deals does your firm work on typically?

George Christodoulo 06:15

The size of deals that we work on is reflective of the size of deals in the space. This year to date, we have done a $75,000 architecture-to-architecture merger, a defensive merger maybe, where two local firms got together. That's sort of on the low side, $150 million on the high side this year. Last year, we did over $200 million.

That's private equity coming in in the third round of buying a firm, that's already been recap twice, and everything in the middle. I would say, as a generalization, we've seen, oh, most of the deals in the 15 or $50 million range because that's what reflective of the size of deals there are allegedly 70,000 firms out there. So it's the biggest firms, second or third.

To recap, those are the ones that get the nine figures, but most firms are in the middle range. First or second recap.

Jeff Adams 07:18

Yeah. Well, that seems to kind of coincide with what we see out there in the industry when it comes to AEC firms where, we know, when we're talking about architects and engineers, there's, depending on who you're asking, around 100,000 or so firms. And I've heard statistics that like 80 to 85% of those have 15 employees or less.

So when you start, yeah, you start looking at that mix and thinking about, okay, who's being sold and going through that. There's a wide array. And as you show, through your numbers that you just put out, you guys cover the gamut.

George Christodoulo 07:57

I would say, as a generalization, the architecture deals are smaller because there are many more smaller architectural firms, though we're starting to see smaller engineering firms, people who have been working on an internal transition at what we'll call an intergenerational transfer. Not intending to sell to a bigger firm, but then getting approached, and the synergistic benefits, the financial benefits, the business acumen benefits, and joining a bigger platform become compelling for the firm. We are not intermediaries; we get involved at some point in the letter of intent process when there is a discussion going.

when there is a discussion going. But there are several firms out there that are just looking to place their investment money, especially the private equity folks that have invested in the space.

Jeff Adams 08:54

Yeah, you bring up a good point there, too, George. And something you just said that I wanted to ask you about. At what point, I get asked this question all the time by sellers in particular. At what point should I engage my M&A attorney? And you just mentioned it somewhere during the letter of intent. Can you just expound upon that a little?

George Christodoulo 09:14

Absolutely. The letter of intent, which usually follows either an approach by a prospective buyer to a prospective seller, an unsolicited approach, or letters of intent, can be solicited by intermediaries working on behalf of the seller. And now we're seeing a third channel, whereas the prospective buyers are literally cold-calling firms and asking if there's any interest in having a preliminary discussion.

But those are what we'll call the discussion phase. The letter of intent, which, of course, is not binding, represents, if you will, a blueprint of the outline of the form of the deal, the compensation in the deal, the employment arrangements post-closing, the integration concepts where you fit, whether your standalone, or you're joining an existing platform.

That is absolutely the stage where we should do get involved and should get involved. Because although the LOI is not binding, most buyers view the LOI once signed as pretty much an agreed-upon outline of the deal. Financially, the form of the deal, which, of course, has tax ramifications for the buyer and the seller. So, we do our best work if we get involved at the LOI stage.

Otherwise, if the LOI has been signed, then you're asking me to mechanically close the deal that I had very little input in negotiating, and what we find in those circumstances is often we have to go back and tweak the LOI because the LOI is not covered. Things like the taxation, or whether this is an asset deal or a stock deal for tax purposes, or the so-called 338(h)(10) deal or F reorg, or is this a merger?

Has anybody thought about the state licensure laws? You can't do this in North Carolina or New York. So the rush to sign an LOI often leads to having to not unwind but do a substantial remake of that LOI to make sure that both the buyer and the seller understand all those concepts. And, of course, the professional licensure aspects, not to mention the tax aspects.

So the money spent upfront before the LOI is signed to bring in a good tax advisor and a good legal advisor on both sides, by the way, on both sides, is money well spent so that when that LOI is signed that the parties have some level of confidence that we've covered most of the structural issues, and then now we deal with getting together and the due diligence and the documentation.

But that's a very important first step. It's a little bit like asking someone to build a building when they didn't have any input in the plans. And it often leads to a much better and smoother process. If little time and effort is spent upfront with the legal teams of both sides and the financial teams of both sides, making sure there are not any major impediments or hurdles to closing the deal as proposed.

Jeff Adams 12:48

Well, your response to that question should sound very familiar to clients that Stambaugh Ness has represented as an intermediary. But that's what we tell them all the time is that while the letter of intent is a non-binding contract, it is the handshake agreement that both buyer and seller are making each other, and we advise them to include in that letter of intent any kind of what I call deal breakers.

You know, those things that really matter to the buyer and seller, get those in the letter of intent because the last thing you want to do is go through the time, the money, expending all the resources you have to during the due diligence process, only to get to the 11th hour to realize this thing is going to fall apart because of something I could have addressed when I was negotiating the letter of intent.

George Christodoulo 13:43

I couldn't agree with you more. Oftentimes, senior owners don't want to stay five years. They're older. They want to stay 2 or 3 years. There's am I a platform topic, meaning: am I the firm going to be the platform, the name, or am I getting folded in? I mean, there are a lot of topics that should be addressed and discussed at the LOI stage because once that LOI is fully vetted inside, it's a much smoother process. And remember, this is not a them and us against each other. We're trying to make a marriage here. We're just trying to help the firms get to their agreement to join together.

Jeff Adams 14:29

George, you mentioned the intermediary term a couple times a while ago and noted you're not an intermediary. I responded a moment ago saying Stambaugh Ness is an intermediary. What's the difference? What's the importance of having an intermediary and an attorney?

George Christodoulo 14:47

Well, we don't do what intermediaries do, and intermediaries, by and large, don't do what we don't. Okay? 

Jeff Adams 15:00

I know that. Let's explain that to the buyers and sellers out there.

George Christodoulo 15:04

An intermediary would go to a seller that is engaged, typically in some kind of an arrangement that has some payments for work and then a success fee. And we'll counsel the seller as to folks in different firms that might be available or might be interested in and run a process, meaning to put together something called the SIM, a confidential informational memorandum that describes the firm, describes what they do, how many people, where they are geographically.

It can run from 10 to 30 pages, depending on the firm. And then some kind of cold teaser, without identifying the firm, is sent out to a number of folks that are vetted. The firm and the intermediary have decided that this group of firms likely will have an interest in at least discussing an acquisition because of the size of the seller, the kind of work they do, where they are geographically, all the above.

And then, there is a process where there's an interaction between the prospective buyers and the seller. They discuss, they talk. Maybe they'll ask for a preliminary IOI, an indication of interest. That's not an LOI, but sort of like you get a feeling for the kind of financial remuneration involved. You get a feeling for where you fit in into the organization of the buyer, etc., And then, from that, discussions ensue, legal comes in, maybe starts to mark up the LOI, which is going to follow the letter of intent with a handful of prospective buyers. And there's an interaction that leads to one, two, three, or 4 or 5, depending upon the number of interested parties engaging in that process, usually whittled down to 2 or 3 if you're a fortunate seller, and then one.

And, the more fulsome the letter of intent is, the more specific it is, and the more likely there will not be any surprises post-signing of the LOI. Signing the letter of intent is very important. The buyer believes they have the deal, and the seller, because there's an exclusivity provision in the letter of intent, is off the market.

That is a very important point because that means that one of the prospective suitors that were interested calls you, the intermediary, and says, hey, we haven't heard back on ABC engineering. The answer has to be, well, ABC Engineering is not in a position to talk to you anymore. So that's code for somebody else has an exclusive arrangement.

And then, of course, those buyers go off somewhere else. Okay. Then, the buyer who signed the LOI goes, well, now they have an exclusive. And, that's when the firms, the buyer and the seller, that have signed the LOI commence the due diligence process and get serious. They're going steady now, and they're hoping to get married soon.

Jeff Adams 18:39

Absolutely. Now I appreciate that, George. Once you get into the process where you're post-LOI now and we're going through negotiations, starting to draft the purchase agreement, employment agreements and all. What's generally the relationship that you see between the attorneys and the intermediaries?

George Christodoulo 19:01

We always want to be working with intermediaries if possible because we're here to close the deal. We're typically not negotiating sensitive points with the buyer or the seller or vice versa. The intermediary is that communication link. We don't want the buyer and the seller facing off face to face on any issue. We want the seller talking to the intermediary with counsel from the lawyers talking to the intermediary or buyer on the other side so that we keep the principals from butting heads.

Jeff Adams 19:43

It's very important. Absolutely.

George Christodoulo 19:45

The back channel, if you will, because lawyers and it depends, it depends who the lawyers are on the other side. And whether it's a buyer or seller that we've done work with so that we know the lawyers. Some of these documents start with a very aggressive approach. Others are more attuned to the marketplace. We can tell you what if restrictive covenants are normal and reasonable in this space, what kind of tax indemnification, okay, etc., etc.

But there has to be a back channel. It's very important to have a back channel. So, we keep the buyer and seller talking Kumbaya. We're getting together and having the professionals, the intermediaries, the tax accountants, the tax advisors, the accounting advisers, and the legal. We're here today. We've gone after the marriage. Okay.

So it's important that they be the source of going back and forth and keeping the the buyer and the seller not facing off on the issues.

Jeff Adams 20:51

Yeah. That's what we tell our clients all the time, George, is that they're the ones going forward. They're the ones that survive post-closing. It's the buyers and the sellers and their relationships of utmost importance. So I generally tell my client, let us play the bad guy. You know, if there's something that needs to be pushed on your behalf, let us be the one to do it.

It's not necessarily important that the other side, like us.

George Christodoulo 21:21

In fact, that's why I'd rather take the heat and let the seller be viewed more positively and have the seller say, well, that's my advisors telling me this.

Jeff Adams 21:34

Absolutely. George, let me ask you this question. You know, as far as the buyer attorney is generally the one who writes the first draft of the purchase agreement based upon the letter of intent that was negotiated. Do you think it's important that the seller, let's say, buyer and seller, is it important that both have an attorney that has experienced an M&A?

I hear that question all the time.

George Christodoulo 22:08

To me, there's no question about it. In fact, I once asked a prolific seller who was going across the country buying firms. We happened to do 2 or 3 deals on the other side as sells counsel. We were actually staying in the same hotel back in the days when we did things in person, and they invited me over for the breakfast; after we went through the Marriott buffet, we were talking, and I said, so what's your greatest challenge when you're at the LOI stage, and you get it signed?

And they said their greatest challenge was that the seller hires accountants, financial advisors, and legal advisors who know nothing about the space. They would much rather butt heads and discuss real topics that are important to both than have folks that are new to the space. A: they talk about topics that are not relevant; B: they're not conversant on the topics that are relevant, and we get off on issues. I will give you a quick example.

The other day, I had a client, and their accountant said, well, this is an asset deal, but you, of course, keep all your receivables. Well, the LOI was just the other way around, and I don't know where that came from. But now we have to work backward. We have to unwind. We have to unwind that advice.

So we would rather talk. In fact, the best deals, the smoothest deals are the ones where the buyers counsel, sellers counsel, the intermediaries, the tax advisors all know each other.

Jeff Adams 23:51

You know, I see confusion. The example you gave there, I see that all the time around networking capital. Who keeps the cash. Who keeps the receivables. Who keeps the will. What happens to the payables. And, you hear all sorts of different answers out there in the industry, people not understand how that works. And so yeah, definitely.

George Christodoulo 24:11

The LOI is so important because that's the time to discuss it. Not in the drafting.

Jeff Adams 24:16

Absolutely, absolutely. But let me ask you one follow-up question on that. So, we're kind of talking along the lines there of is it important that you have attorneys on both sides that are experienced with M&A? What about having your M&A attorney be experienced in AEC? How important is that?

George Christodoulo 24:38

In my mind, it's absolutely critical. There are a few firms across the United States that have various levels of involvement in AEC space. 

When we have a platform company that is a firm that is big enough, a seller that's big enough that, a private equity firm is going to come in and make it their platform. Hence, after that, other firms will be tucked in or rolled into that firm, that platform, and those are the folks that typically are larger law firms, national law firms, and thousand people who are not necessarily conversant in the AEC space.

Those are challenges, challenges because they take positions that just don't work for, and we know what's market here. We've done enough deals. And candidly, they miss stuff. They miss things like professional licensure in New York, North Carolina. They miss sort of topics. And it's not a zero sum game. It's a topic that everyone has to address and solve.

In fact, sometimes, we get called by those law firms to work for them to help them with their licensure. For instance, because professional licensure in the AEC space is, as you know, is very complicated in many states.

Jeff Adams 26:16

Absolutely. Thank you. George I couldn't agree with you more on that, too. Let me ask you this question. Now, kind of shifting gears a little bit, what are some of the more common issues you've seen arise during M&A deal negotiations in the AEC space?

George Christodoulo 26:34

Oh, and we counsel sellers all the time so you can clean up their house, okay. The quality of their financial statements, the quality of their stock ownership books, they promise stock phantom stock to people, but they're not documented. Their shareholder agreement is not complete. Cover mechanics and their compliance with laws. They signed contracts, sellers signed contracts with outrageous indemnification clauses in them because they didn't vet them, and they've got a poor record of professional liability claims.

We had one deal where workplace safety claims were so great that their rating was so bad that the deal stopped right in its tracks. We see the co-mingling of personal expenses of the senior principals of the target firm, cars, entertainment, and boats. I've seen landscapers, boats, stocks, and baseball tickets. And I'm not talking tickets.

I'm talking luxury box for the whole year. Old AR. A failure to run in business like manner, co-mingling of some assets, or the quality of the P&L statement. So, if we get in early enough, we advise our seller clients with their advisors to do their own scrub. In fact, now a lot of sellers are doing their own quality of earnings studies.

They'd rather pay a princely sum to get a quality of earnings done. So they have an idea of what life after signing an LOI might be. They don't want to go sign an LOI, and then, I found out that although the price looks good, the multiples on the earnings are going to be very different because of the due diligence the buyer does.

Jeff Adams 28:43

Yeah, that's definitely an interesting shift that we are seeing where the sell side is coming in and doing their own quality of earnings. And I think it's a great thing for them to do. George, you mentioned, if you get in early enough to help them ready themselves for sales, when is early enough?

George Christodoulo 29:06

Long before. It's when you've got an intermediary, a financial advisor. When that firm goes and gets a good tax advisor, those are different now, one is advising on the deal, the other one is telling you about earnings, real tax, and accounting. And that before you go to market. And that's especially important today because of the number of buyers that are either private equity or private equity-backed firms.

Have turned the focus to not just synergistic services that are being rendered in the right territories around the United States, but also will pay 8.2 times your trailing 12 months EBITDA. Well, everybody thinks that's great until the seller and the buyer can't agree on what that 12 months is like. And we're talking tens of millions of dollars at some point. So to me, the seller who spends the time and the money up front gets a bead on what what the end product is going to be is not disappointed. Having gone through this thinking, I thought I was going to get X, and I got X minus Y. And, I'm also seeing, though, that sellers are getting more sophisticated about about how the deal works.

The deal steps work and are willing to spend some time and money and effort to sort of clean up their house and present to the buyer, if you will. I guess the analogy would be like, you're putting your house on the market, but you can just put a sign for sale, or you might get some professionals come in and stage the house and clean up some of the rotted wood and make sure that there are no showstoppers in the foundation in the roof.

Jeff Adams 31:09

Absolutely. We all understand that from a home-selling viewpoint. Right. And I think it's always a great analogy to put over into the world of M&A because there are a lot of similarities. I think we talk about that. The other analogy you hear a lot is that you referred to earlier as a kind of dating process.

Right. And it's a marriage of two firms is going to happen. So, that whole process of dating, getting to know each other, moving to the next step, and ultimately, marriage is really what you're trying to accomplish.

George Christodoulo 31:40

Yeah, I think that's a great point. I've been talking a lot about objective factors, legal factors, and numerical factors, but I see the really, really attuned buyers spending a lot of time getting the seller leaders excited about what we can do together. Okay, you're not big enough to go after that project, but together we are. Or, you are subcontracting 40% of your prime contract because you don't have those in-house abilities.

We do. So 1 in 1 might make two and a half there.

Jeff Adams 32:18

Yeah, that's what we say here all the time. Yeah, well, we're one plus one equals more than two, right?

George Christodoulo 32:23

Yeah. And I so if I gave the impression that it's not just numeric driven I apologize. It's the, it's the private equity numbers that are coming in that are so compelling that some folks just jump for the number and don't talk about what life after it is going to be, where the things are going to change, or I'm just supposed to go out there and get more work.

Jeff Adams 32:45

Absolutely. I think a lot of times, it's in our human nature just to want to see that number, know what it is, lock in on that. And I try to encourage my clients don't, let's try to delay on that number a little bit because it makes things confusing. Focus on that culture. Make sure you have a great culture fit.

Look for that strategic alignment like you're talking about, where you can have these top-side synergies on the revenue side, where when you put the two firms together, one plus one equals something more than two. Generally, when you find the right fit on those two aspects, money tends to follow.

George Christodoulo 33:27

Absolutely. I find a lot. I think the best buyers are the ones that lead with that discussion of how we can work together and be a better firm and not with, well, let's get in a bidding war. Somebody just bid this much EBITDA. I'll bet this much EBITDA. I won. So I'm. I'm the winner.

Okay. Remember, this is your profession. You joined, you went to school to be a professional. You want to practice your profession. It's okay to take some monetary benefits off the table. It's okay to get rollover stock if that's there. But you still want to go to work every day and practice your profession?

Jeff Adams 34:11

Absolutely. George. How often do you hear of deals or legal issues, let's say, arising post-closing. And what are some of those issues?

George Christodoulo 34:26

Well, luckily, today, with the electronic age and due diligence being electronic, gone are the days when cardboard boxes showed up with lots of documents and people didn't read all of them. I would say there are very few that really have a lack of success or a failure label for them. Sometimes, if the deal is warranted, there's an earn-out, which simply means part of the purchase price is going to be paid based on post-closing performance.

And sometimes that earn-out performance doesn't quite make it. That could lead to disappointment, even though it was written down. Once in a while, I see a personality, not a misfit, but it doesn't work out quite the same. Some a firm sells to a firm that is buying 2 or 3 firms in the same space and putting them together, and each of the three sellers thinks they're going to be the head of the firm.

Well, only one of them is. But I have to tell you, from a legal point of view, we don't see many surprises. You know, professional liability insurance is covered. Covers any professional liability claims. The advent of so-called rapid warranty insurance representations and warranty insurance in many deals means that the buyer and the seller are, together, by an insurance policy that really eliminates, by and large, the likelihood of indemnification claims.

Post-closing falts or incomplete representations by the seller. So, once in a while, there's a tax issue. But the only thing I can tell you that regularly shows up, and I have no idea why it is, is after a closing, there will be some professional liability claim that comes out of the woodwork or something. Okay, but if you buy insurance, that's just a a risk of the profession.

But I will tell you that we've come a long way, and the vetting of due diligence, in the terms and conditions in the insurance, we had D&O insurance: directors and officers insurance, cyber insurance, employment practices insurance, errors and omissions insurance, I mean, fiduciary insurance. So, we knock on wood and have not seen a lot of those claims.

And when they do, they were they were usually anticipated by the use of insurance. So they don't become divested because no buyer wants to walk down the hall and tell their seller, who is now head of some large division of their work, that they have a problem and they're going to have to bring a lawsuit. That is not a good day in the neighborhood.

Jeff Adams 37:33

Yeah, absolutely. When it comes to this, Tail insurance. You know, I've seen where there's the typical, you know, three-year Tail insurance policy that the seller pays for related to their firm that basically covers any claim that arises up to three years post-closing that relates to any work that was done pre-closing.

But then there are also times when you see the buyer say, hey, I'm just going to extend my policy over to you and cover you that way. And I can't remember what that term's called when they do that. Do you have any? Have you seen that, and do you have any thoughts on it? Okay.

George Christodoulo 38:19

Well, first of all, you're right to say that the seller pays for it. But I will tell you, in more than half of the deals now, buyers are offering to pay for some of that insurance. If it's a competitive bid, and I got to find a way to put more money on the table. Okay. I have, and there are challenges.

A typical target would be smaller. So let's say they have the $2,000,000/$5,000,000 or $5,000,000/$10,000,000. $5,000,000 a claim, $10,000,000, whatever. And the deductible of $150,000. $200,000 rolling. Some, some buyers say just come under our policy. Well, the problem is our policy has a $500,000 deductible. Okay. So, they may have three times as much coverage. And then the question becomes who's paying that deductible when the claim comes up. okay. So, we've had a lot of different scenarios there.

Sometimes, the buyer says, no, seller, you keep your policy in place; you buy the three-year Tail. And we're going to insure, as you know, you can't have two insurance policies at the same time. But we can insure it as backup insurance. But that is not to be interpreted as a way around.

It's interpreted getting into two insurance carriers on the phone with some people who understand insurance speak and trying to work out what makes sense, because the first thing you want to do is make sure there's adequate coverage. Secondly, you want to make sure no one's going to get hurt if there is a claim or if you are going to get hurt, we know how much you're going to get hurt. But that is a very sophisticated discussion that, candidly, is really not between the buyer and the seller. It's between the buyer's insurance folks and the seller's insurance folks. And often, we're on that call trying to make sure that the deductibles and the coverage line up appropriately.

Jeff Adams 40:36

Well, and I think you make a great point out there for a seller that when they're looking at the cost-benefit when they have that option of going either way, Tail insurance or rolling over to the buyer's insurance, don't just look at the premium cost, right. There is that deductible piece to consider should a claim arise that needs to be negotiated.

George Christodoulo 40:57

And that's why we tell our seller clients to have a seller's rep account with several hundred thousand bucks in there because the one thing I can assure you is there will be a claim. Okay, I can't tell you why, but there might not be a worthwhile claim. But there will be a claim in the three years, so let's not pretend it's not going to cap.

And let's just understand what the scenario is when it happens.

Jeff Adams 41:23

Absolutely. George, what can I what can a future seller be doing right now from a legal perspective to position their firm for sale?

George Christodoulo 41:35

They can be scrubbing and more and more now, like we have a client that's going to market. And they came to us last year, and they have a myriad number of, not issues, topics. They weren't sure that they were really up to snuff on. They had an offshore company where they worked in some restricted licensure, restricted states. They wanted us to scrub what they had done with their local attorneys, their management services agreements, their shareholder agreement, and they wanted to understand their phantom stock program. They had set up a non-IRS-sanctioned program. There's nothing wrong with that. But they want to understand the tax ramifications. Sometimes, sellers come and say we want to give out bonuses right before the closing to reward our people. And then we brought in an accounting firm to do a so-called 280G analysis because if stockholders get disproportionate bonuses before the closing, there's a legal concept that those could be ordinary income or you can't make them unless the shareholders bless them. So, there are a number of tax licensures. I will tell you licensure still remains problematic. But we do work in North Carolina. Well you're licensed, well we're not licensed there. But we've got a we got a guy there who's licensed. Well that's not that's not going to pass the due diligence, smell test for the buyer. We see where's your S-Corporation election? Well, we've been in S-corp for 20 years. No, where is the S-Corporation election from the IRS? Well, it doesn't exist. You can get it. Except it's better to get it before you go to market than to be asked for it by a bunch of accountants and tax folks on the buy side, who now we're going to say, well, there's a little sloppiness there. We better dig more and more and more.

So it's getting your house in order. It's cleaning up, old receivables, doesn't mean you have to write them off, but just run your business more business like. So a good accountant, a good tax advisor and a good transaction lawyer for pennies on the dollar can help you clean up your presentation before you go to market.

That's important for a couple things. First of all, you clean it up. And secondly, the buyer doesn't get the impression that there's sloppiness because when they get an impression that not everything is just, dotted the I's and cross the T's, they tend to look more now, and they tend to look deeper. They ask for everything.

And today, with electronic due diligence, it's pages and pages and pages. And so we know what they're going to ask. 35% of our work is on the buy side. I can tell you what the questions are. So why don't we do them now when we have time to not fix them but clean them up, whatever that is? These aren't bad issues.

It's just the distractions. And again, back to the house analogy. If the house looks like it's well cared for, then maybe you're less likely to look about the rot under the tiles, okay. So, that's what you should be doing. It's not a lot of money. Financial. Quality. Are you on QuickBooks? Okay. Virtually no firm in this space is GAAP compliant.

Some of the folks don't even understand what GAAP means. That doesn't mean you're going to become GAAP compliant, but it means a good scrub of your financials, revenue recognition is a big deal.

Okay, so spend some time and money with the tax advisor, not just for the folks that do your taxes. I'm talking about a transactional tax advisor.

Get all of that ready. You know, the due diligence barrage is coming. So what I'm saying is get it done ahead of time and be ready for it because that's going to serve the seller well, no matter who the buyer is. And candidly, sellers have enough trouble during the post-LOI stage and dealing with buyer requests, running their firm, meeting about integration, and talking about Kumbaya; after the closing, they don't have a whole lot of extra time to be doing this.

And they have to do this because if you don't, you don't get through this period. Your rep in warranty insurer, your private equity sponsor that's got tons of accountants and MBAs looking at things, they're going to find all these topics, and it's going to delay the closing. It might typically could sour the buyer a bit.

So, if we know what's coming, use your advisors to tell you what's coming and address it now.

Jeff Adams 46:57

Absolutely. And you know, George, you mentioned the whole state advisory issue. I just want to highlight that for a minute because we see that a lot. You know, Stambaugh Ness has multiple arms. And one of those is a State Advisory Group. From time to time, they get engaged on M&A deals post-M&A. We weren't involved in it as an intermediary and going through that process and helping, making sure that the deal was structured in such a way, to ensure those special cases like North Carolina, as you mentioned, were set up appropriately, had the right ownership structure, the right legal name, and we've seen where deals have closed, and projects suddenly come to a screeching halt because they're no longer licensed in that state. And it's a total surprise to the buyers and sellers. Our State Advisory team comes in and helps clean that up. So, there's a lot out there, a lot of things that can happen that people don't realize. You know, I run into people all the time.

And you said pennies on the dollar, talking about the fees that you pay to all your advisors on M&A. I run into sellers all the time, they get sticker shock when they see what M&A consulting fees cost, and they kind of take this mindset of, you know, I could get the same deal myself and save the money.

George Christodoulo 48:23

And we see people that do that. We also see some buyers that are new to the space, especially in the maybe, the financial buyers who sort of shoot, Pooh, Pooh, the licensure stuff and say, well, it's working now, we'll deal with it post-closing. Well, that really works until you get a nice letter or a friendly letter from some licensure board.

And remember, once you have a licensure problem in a state, you have to disclose that licensure issue on every state application in the United States. Thereafter. And if you're the name PE or AIA, your name is on it and you're not a happy camper about that. You haven't committed a crime; you just, and I have been to a disciplinary hearing in New York, okay.

With the engineering board, the board of education. I will tell you, it is not the most pleasant place to be if you're a professional. So it just boggles my mind why people won't clean up matters beforehand. Because they know what's coming down anyway. 

Jeff Adams 49:34

Absolutely. George, is there anything we haven't discussed already that you would just like to share with AEC firm owners, whether buyers or sellers?

George Christodoulo 49:49

I guess I would say that people going into this transaction, particularly on the sell-side service, assuming maybe they've done a small acquisition. They're viewing it as like them against us, but we're trying to make an integrated marriage here. Unfortunately, the legal, accounting, the financial all have to be hurdles.

But we're trying to bring people together. This is their profession. There's no need to make it a zero-sum game. Good buyers say, okay, how can we now address this topic, whether it's licensed, whatever it is. Okay. Some buyers are a little bit more of them and us. Okay. But that's to be expected. And we just got to keep in mind that at the end of the day, all the intermediaries go away.

We don't typically get invited to the first-anniversary party.

Jeff Adams 50:57

That's right.

George Christodoulo 50:58

Okay, okay. We go on to the next deal. Some are gracious enough to have closing, dinners or closing events or send some swag or whatever, but our job is to help you, the seller, you, the buyer, accomplish your goal, which is to grow your the firm through a external transaction and lay the groundwork for a positive integration of that firm.

Or maybe it's going to be a platform company. So it's not them against us. Okay. Recently, somebody asked me, well, what do you do. You get the first draft of the documents and you redline it. I said, well, we don't anymore because when you do that, A, it takes a lot of time, and B, it uses a lot of red ink.

So, we have now gone to here are the 12 major issues. And here's an issues list. And let's have everybody and not the lawyers, not just the lawyers, and not just the tax folks. Let's get everybody on the phone. And let's understand that these are 12 topics that have to be addressed. And if we can address them and resolve them, that doesn't mean and I don't like buyers that say, I'll give on this issue.

We're not giving up on any issue. We're trying to resolve topics.

We're going to be here today and gone tomorrow. People have now taken their professional careers and moved them over to a different firm or a different venue. Okay, there's no going back now. So, the idea is to come together in a meaningful, commercially reasonable, professionally enlightening way. Okay. And most folks want to work another ten years. They're not here to cash out.

No buyer today is going to spend this money and watch somebody leave in two years. Those days are gone. And it with rollover equity, I tell my sellers, you want to be there when the rollover takes place. And that's 3 to 5 years, maybe six. That's when the financial double hit comes from. And that's where you get some fulfillment maybe in growing a bigger firm.

So we just look to counsel folks. We tell people this is commercially reasonable. You might not like it. You might have to sign a non-compete. You don't think you should, but that's the way it works. When somebody write you a check and try to get folks to understand, you know, what's a fair set of parameters to consummate a transaction with.

Jeff Adams 53:45

George, I love the way you talk about the it's not us versus them. It's not a zero-sum game. I love that, especially in this AEC industry where culture really matters. And, you know, that's where that marriage analogy is so applicable. Just like in a marriage, it doesn't behoove either side of the marriage partnership to get to the other side of the wedding and find out a surprise about each other or that someone kind of suppressed the truth on something that's important. That doesn't tend to lead to a happy future marriage. Same thing in M&A when you're talking about buyers and sellers. Full disclosure let people know everything that's important about both the buyer and the seller going through that process. Nobody needs to be surprised on the backside of this.

George Christodoulo 54:41

Absolutely.

Jeff Adams 54:43

So, George, is there anything you would like to say as we close here? Is it just about the Lawson & Weitzen team?

George Christodoulo 54:50

Well, first of all, I appreciate you having us on.

Jeff Adams 54:54

I appreciate you being here.

George Christodoulo 54:55

We're a team of seven folks within a 40-person law firm. And all we do is M&A and internal transition buying and selling. We've been very fortunate to deal with a lot of wonderful people in this space. Architects and engineers, environmental consultants. We get referrals. A lot of times, we get referrals because we try to be seen, act in a businesslike way, and do what you want, which is typically to make something happen between two firms.

We deal with big firms, small firms, big deals, and small deals, as well as the size and shape of the deals we do are reflective really on just what's out there. Yeah, we do a lot of very big ones, but we do a lot of very small ones, too, because there are a lot of very small deals, and the small deals don't mean they get small attention.

They are just as important as big deals. We're not brokers. We work by the hour. We're trying to make things happen for whoever. And we try to take our professional expertise and understand what the goals are and try to help. And, it's very rewarding when we get really nice notes afterwards from sellers and buyers. Thank you for helping us get through this stage. We've made a lot of friends. We get a lot of work from referrals because we've made friends along the way. And most of the deals are well received, and therefore people think of us in a positive way because we were somehow connected to a well received event in their lives. And we treat every deal, you know, fresh, we staff it appropriately, and our goal is to get what you want, which is to make a fair deal in a timely manner with these folks or whoever folks you've chosen. So we really appreciate the opportunity. Talk to you and your fine firm, and we go back a ways.

Jeff Adams 57:12

Well, George, thank you so much, and thanks for tuning in to AEC unscripted, the Mergers and Acquisitions edition. I'm Jeff Adams, and it's been a pleasure guiding you through the legal aspects of M&A in the AEC space. Remember to subscribe and leave us a review wherever you get your podcast. And until next time, keep pushing forward.