Ten days, an earn-out, and no transaction team
A long-standing client, a 60-person engineering business, is buying a competitor for £5.2m, funded by a vendor loan note and an earn-out measured on EBITDA over three years. Completion is in ten days. The client asks your firm to advise on the earn-out mechanics, the deferred tax treatment, and whether the loan note breaches its existing bank covenants. Your firm does the client's audit and tax compliance but has no transaction services or treasury specialists; the last deal of this size anyone here advised on was four years ago and the person who led it has left. A newly qualified manager, Priya, volunteers: she trained at a firm that did deal work, her brother-in-law is the seller's finance director, and she can "read up over the weekend". The client says a specialist firm quoted £45,000 and it cannot wait: "just tell us it's fine."
1. Decide whether to accept, and justify the decision by reference to competence, independence and the client's real interest.
Read the worked answer
Decline the transaction advisory work, and say so on Monday so the client still has ten days to instruct someone else.
The competence question is not whether Priya is clever. It is whether the firm can produce advice that a bank, a seller and ultimately a court would accept as sound on an earn-out definition and a covenant test. Earn-out drafting turns on small words - which EBITDA, adjusted how, on what accounting basis, with what buyer discretion - and covenant testing turns on the precise definitions in a facility the firm has probably never read. Weekend reading does not produce that. The four-year-old precedent led by a departed specialist is not a substitute, because the precedent walks out of the door with the person.
The independence problem is separate and fatal on its own. Priya's brother-in-law is the seller's finance director. On a transaction where the buyer's protection depends on the seller's numbers, that is a close family relationship with a counterparty. A screen is conceivable for an audit, but for transaction advice where one person's judgement would drive the numbers, the appearance alone is disqualifying. Note also that the firm audits this client: advising on a purchase that will sit in next year's consolidated accounts creates a self-review threat that must at least be managed, and is another reason to keep the transaction work outside the firm.
The client's real interest is not "tell us it's fine". It is a deal that closes without a dispute in year two. A confident wrong answer in ten days is the worst outcome available.
2. What can the firm legitimately still do, and how would you frame the referral so the client does not simply go elsewhere and get worse advice?
Read the worked answer
The firm can still be useful, and should be explicit about the boundary between what it will and will not opine on.
Legitimately in scope:
- Continue the audit and tax compliance work, and flag now that the acquisition will change the group structure, the deferred tax position and possibly the audit scope.
- Prepare the client for the specialist conversation: a written list of the questions that must be answered before signing, drawn from the facility agreement and the draft sale and purchase agreement - how EBITDA is defined, who prepares the completion accounts, what happens on a dispute, what the loan note does to the covenant headroom.
- Review the client's own covenant calculation with the client's finance team, as part of the existing relationship, without opining on the loan note's treatment.
- Introduce two or three specialist firms with relevant deal sizes, and say plainly why we are introducing them.
Framing to the client: "We are not the right firm for this piece, and the reason is not modesty - it is that a mistake in an earn-out definition costs far more than the £45,000. Here is what to ask them. Here is what we will pick up afterwards." Give the client a deadline: if they have not instructed someone within 48 hours, the ten days will not work, and they should consider asking for an extension to completion rather than signing unprotected.
3. If the client insists the firm proceed regardless, what would you do, and what would you put in writing?
Read the worked answer
If the client insists, the answer does not change, but the record must. State in writing, addressed to the board and copied to the engagement partner:
- The specific areas the firm is not competent to advise on, and why.
- The specialist quote the client has already obtained, and the fact that the client has chosen not to take it.
- The family relationship between Priya and the seller's finance director, and the firm's conclusion that she cannot work on the matter.
- The client's instruction, in its own words, that the firm proceed anyway and "just tell us it's fine".
- What the firm will and will not sign, and the fact that no assurance will be given on the earn-out or the covenant position.
Then hold the line. What the firm must not do is accept the work quietly, with the risk noted only in an internal email. If the client wants a limited piece of work - for example, a review of the client's own covenant model against the facility definitions, expressly not covering the loan note - that can be scoped, priced and disclaimed. That is a real service with a clear boundary.
If the partners overrule me and accept the full scope, my options are to seek an independent quality review and, if that is refused, to consider whether I can remain associated with the engagement at all. That is a serious step and should be taken with advice, but it is the correct frame: the question is not whether I am uncomfortable, it is whether the firm is putting its name to advice it cannot support.