Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How Change of Control Clauses Sink Mergers
Transcript
- Lucas: There is a specific moment in any mid-market merger where the deal stops being about strategy and starts being about panic. It usually happens three weeks before closing, right when the lawyers are finalizing the purchase agreement, and someone finds a line item in an old bank contract that says if ownership changes, the entire loan becomes due immediately. Luna: That sounds like a nightmare scenario for a buyer who has already committed capital based on the assumption that the target company’s balance sheet was clean. Lucas: It is. And we see this constantly in the eight hundred million to two hundred million dollar range. The issue is almost always the change of control clause. Most founders don’t even remember signing these documents five or ten years ago, and their current management team certainly doesn’t understand what they’re looking at until it’s too late. Luna: So the buyer thinks they are buying assets and equity, but the lender gets to decide whether those assets actually stay with the company. Lucas: Exactly. Let me walk you through a case study from last quarter involving a regional industrial equipment manufacturer. They were being acquired by a private equity firm for roughly eighty million dollars. Everything looked perfect on the surface. Strong recurring revenue, loyal customer base, solid margins. But during due diligence, the buyer’s legal team pulled the company’s primary credit facility agreement. Luna: And there was the clause? Lucas: There was. It was standard boilerplate language from a community bank that had financed the founder’s expansion in twenty nineteen. The clause stated that any direct or indirect transfer of majority ownership would constitute an event of default. Which meant the bank could demand full repayment of the outstanding forty-two million dollar term loan within thirty days. Luna: Forty-two million dollars coming due in thirty days effectively kills the liquidity of the deal unless the buyer steps in to cover it. Lucas: Right. And here is where it gets interesting because most people assume the solution is just to pay off the debt. But in this specific transaction, the buyer didn’t have the cash on hand to extinguish that forty-two million dollar note without derailing their own financing plans. So they had to negotiate a waiver. Luna: Negotiating with a lender who holds all the leverage because they can call the loan anytime seems incredibly stressful for both sides. Lucas: It was brutal for the seller. The founder was furious because he felt his legacy was being held hostage by a small regional bank that barely knew the new owners. The bank’s position was simple though. They lent money to this specific founder based on his personal track record and relationships. If the owner changes, their risk profile changes completely. Luna: So the buyer had to go back to the bank and convince them that the new ownership structure was actually safer than the current one. Lucas: Precisely. The buyer’s team prepared a detailed letter demonstrating that the private equity sponsor had stronger balance sheet support and that the operational plan would actually reduce leverage over time. They also agreed to higher interest margins as a risk premium. It took six weeks of negotiation just to get a consent letter. Luna: Six weeks is an eternity in a deal timeline. That kind of delay usually causes other parties to lose patience or find better options elsewhere. Lucas: It does. In fact, the delay caused the target company’s key customers to get nervous. One major distributor started looking for alternative suppliers because they worried about supply chain continuity. That introduced a secondary risk that wasn’t even in the original financial models. Luna: This really highlights why due diligence needs to be so much deeper than just looking at tax returns and profit and loss statements. Lucas: Absolutely. You have to look at every contract the company has ever signed. Vendor agreements, lease obligations, intellectual property licenses, and definitely all debt instruments. The change of control clause is rarely the only one hiding in there. You will often find similar provisions in supplier contracts that allow them to terminate if ownership changes. Luna: I bet suppliers are just as protective of their relationships as banks are. They don’t want to suddenly be dealing with a stranger who might renegotiate pricing or payment terms. Lucas: They do. And sometimes those supplier clauses are even more dangerous because they can stop production entirely. In another case I reviewed recently, a software company’s main cloud hosting provider had a clause that allowed them to suspend services upon change of control. The buyer had to get a pre-closing waiver from the host just to ensure the platform stayed online during the transition. Luna: That feels like a classic black swan event for an operator who is focused on the top line growth and hasn’t thought about the backend infrastructure dependencies. Lucas: It is. And the frustrating part is that these clauses are often negotiable before the deal even starts. If the founder knows a sale is coming in two or three years, they can proactively approach their lenders and suppliers to amend those contracts. But most operators wait until the offer is on the table, which puts them in a terrible negotiating position. Luna: Waiting until the last minute means you are begging for a favor rather than setting the terms in advance. Lucas: Exactly. You lose all your leverage. Once the deal is announced, the lender knows you can’t walk away easily because you’ve likely already told your employees and customers about the acquisition. That information asymmetry works against the seller. Luna: So what is the best practice for founders who know they might exit in the future? Should they start cleaning up their cap table and contracts years in advance? Lucas: Yes. Ideally, you want to replace broad change of control clauses with narrower definitions. For example, you might agree that a change of control only triggers if the new owner plans to liquidate the business or move headquarters out of state. Or you can negotiate a right of first refusal for the lender to match any third-party offer. Luna: That makes sense. It gives the lender some comfort that they won’t be left holding a bag for a company they don’t trust, without giving them veto power over a strategic sale. Lucas: Right. It shifts the dynamic from confrontation to cooperation. Another common workaround is to include a cure period. So if a change of control occurs, the borrower has ninety days to either refinance the debt or bring in a guarantor that the lender accepts. That buys time instead of triggering immediate default. Luna: Ninety days is a lifeline compared to thirty days. It allows the buyer to secure bridge financing or adjust the deal structure without the whole thing imploding overnight. Lucas: It absolutely is. And speaking of structures, sometimes the buyer will use a stock purchase versus an asset purchase to avoid triggering certain clauses altogether. Though lenders are getting smarter about that too. Many modern credit facilities now define change of control broadly enough to catch asset sales that effectively transfer the economic benefit of the business. Luna: So there is no easy way to sneak around these provisions if the lender is sophisticated and well-advised. Lucas: Correct. Which brings us back to transparency. The biggest mistake sellers make is hiding these clauses until the end. If you disclose them early, the buyer can price them in. Maybe they offer a slightly lower purchase price to account for the refinancing costs. But if you hide it, and it comes out later, the deal falls apart and everyone loses credibility. Luna: Honesty builds trust, even when the news isn’t great. Buyers prefer to solve problems they know about rather than surprise attacks they don’t. Lucas: Exactly. Look, before we dive deeper into how to structure those cure periods, I want to take a brief moment to talk about how this show operates. We deliberately run zero advertisements on these episodes. No sponsors, no promoted segments, no affiliate links disguised as advice. The reason we can maintain that level of editorial independence is entirely due to listener support. If these conversations have moved your work forward in some small way, consider supporting us directly. You can find the link at buy me a coffee dot com slash fexingo. It helps keep the lights on and the research deep. Luna: Yeah, we really appreciate it. It allows us to focus on the nuance of these contracts rather than trying to fit product placements into complex legal discussions. Lucas: Thanks for listening. Now, let’s get back to the mechanics of that cure period because it is the single most important tool in your defense arsenal. Luna: What does a typical cure period look like in practice, and what are the conditions attached to it? Lucas: A standard cure period usually lasts between sixty and ninety days. During that window, the borrower must demonstrate that they have taken concrete steps to cure the default. This usually means submitting a new credit proposal from the buyer’s lender or posting additional collateral. Luna: So the buyer essentially has to jump through hoops to prove to the old lender that the new entity is viable. Lucas: Precisely. And the old lender retains the right to reject the cure if they believe the new borrower is creditworthy worse than the old one. This is where the quality of the buyer matters immensely. A top-tier private equity firm with strong balance sheet support will have an easier time satisfying a conservative community bank than a smaller, less known acquirer. Luna: That creates a hierarchy of buyers based on their ability to satisfy legacy lenders. It’s almost like a secondary due diligence process imposed by the bank. Lucas: It is. And sometimes, the bank will simply refuse to cooperate. In those cases, the deal can’t close unless the seller pays off the debt from their own proceeds. This is called a roll-up payoff. The seller uses part of their sale proceeds to extinguish the loan at closing, leaving the buyer with a clean slate. Luna: That reduces the net proceeds for the seller significantly. It eats directly into their exit multiple. Lucas: It does. And it can turn a lucrative exit into a mediocre one. In the case I mentioned earlier, the seller ended up accepting fifteen percent less on the headline price because they had to absorb the refinancing costs and the legal fees associated with negotiating the consent letter. Luna: That is a painful lesson. It underscores the importance of understanding your capital structure before you even start talking to potential buyers. Lucas: It really is. You need to know exactly who holds your debt, what the terms are, and what triggers a default. Ignorance is not a defense in a merger negotiation. Luna: So for the operators listening, what is the one actionable step they should take this week to protect themselves from change of control surprises? Lucas: Pull every credit agreement and vendor contract you have. Highlight every clause that mentions ownership change, transfer, or assignment. Then sit down with your lawyer and assess the risk. If you see something scary, start having conversations with those counterparties now, while you still have leverage. Luna: Proactive communication beats reactive scrambling every time. It turns a potential deal killer into a manageable administrative hurdle. Lucas: Exactly. And if you can’t amend the contracts now, at least build the cost of potential waivers into your valuation model. Don’t let a hidden clause steal the wind out of your sails when you are finally ready to sell. Luna: A practical reminder that the fine print is often where the real value lives or dies in a transaction. Lucas: It really is. The question remains, though, how do you balance the need for security with the flexibility to sell? Do you think lenders will continue to be this aggressive with change of control clauses as capital becomes cheaper? Luna: I doubt it. As competition for deals increases, savvy buyers will probably start demanding more favorable terms from lenders, forcing a shift toward more cooperative structures. Lucas: We shall see. But until then, knowing how to navigate these traps is the difference between a smooth exit and a costly disaster.