Uncover the critical, often hidden, pitfalls of related-party contracts when selling your lower middle market business. This essential guide explains how agreements with insiders—be they owners, executives, or family members—can unexpectedly jeopardize deal valuations and lead to costly M&A disputes. Learn proactive pre-sale due diligence strategies to identify and manage vital consents, ensuring you safeguard your transaction’s value and secure a successful M&A closing. Perfect for LMM owners, buyers, and their advisors seeking to navigate complex deal landscapes successfully.
M&A Stories
July 9, 2025
Preparing a lower middle market business for sale demands more than just strong financials; it requires a meticulous assessment of the enterprise’s legal and operational health. A robust seller due diligence process, initiated once the decision to sell is contemplated, serves to uncover potential liabilities or vulnerabilities that could diminish a seller’s negotiating leverage or even derail a transaction entirely. Identifying and addressing these issues proactively, before engaging potential buyers, is paramount.
A frequent, yet often underestimated, source of complication in business sales arises from contracts between the target company and entities controlled by its own insiders—be they owners, officers, or directors. This very challenge emerged for the owner of a hydroelectric power generation business recently, whose operating company maintained a power supply agreement with a separate venture, a bitcoin mining business, which was equally owned by the seller’s principal and the seller’s chief executive officer.
When the seller’s enterprise faced significant financial distress, its owner sought to sell the core business. A prospective buyer, committed to optimizing the acquired assets, conditioned its purchase offer on the bitcoin mining entity agreeing to revised power terms at a higher price. While the seller’s owner acknowledged the necessity of this adjustment for the deal, the chief executive, also a fifty-percent owner of the bitcoin venture, refused consent. His cooperation, he indicated, was contingent upon receiving a substantially increased severance payment, well beyond the terms stipulated in his existing employment contract with the seller.
The owner resisted these extraordinary demands, and consequently, the acquisition fell through. The inability to complete the sale ultimately forced the owner to seek bankruptcy protection for the business.
This case serves as a stark reminder to sellers: never underestimate a buyer’s diligence, especially concerning arrangements that are not strictly arm’s-length. While the seller’s owner in this instance may not have initially anticipated the buyer’s specific demand to alter the power contract’s pricing, the underlying principle is universal: buyers will invariably scrutinize and often object to purchasing a business encumbered by terms, particularly those with related parties, that do not align with market standards or their projected returns.
A critical step for any seller, immediately upon deciding to pursue an exit, is to conduct a thorough internal review of all related-party contracts. This means evaluating whether the terms of such agreements—be they real estate leases, service agreements, or supply contracts—are consistent with market rates and industry norms. More importantly, it involves identifying any provisions, such as unusual consent requirements or termination clauses, that could empower an insider to disrupt the sale or extract additional, unforeseen concessions. Had such a comprehensive review been conducted, the seller’s owner could have, prior to commencing negotiations with an external buyer, clearly understood the CEO’s leverage and strategically planned how to address this critical contract, potentially by seeking to normalize its terms, or by developing a clear legal pathway to secure essential consents.
By proactively addressing these potential internal obstacles, sellers can significantly mitigate the risk of litigation, safeguard their negotiating position, and preserve the value of their business for a successful M&A closing.
See: In Re Harris Energy Group, Inc., Case No. 23-21117-kmp (Jointly Administered), Adv. No. 23-2078., 23-2080 United States Bankruptcy Court, E.D. Wisconsin (April 1, 2025).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals..
By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
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