Recent years have seen growing academic interest in why mergers and acquisitions fall apart. Projects by Morgan Ricks and Da Lin and Robert Miller have explored, for example, why public company transactions fail to close after signing. In a new article, I pursue a similar question, but shift the focus to private company targets and an earlier stage of a transaction—diligence. Using a set of original interviews with practicing lawyers and in-house business stakeholders (in corporate development roles), I highlight deal killers – the various issues that arise during diligence that are considered to be material risks to deal completion. I also examine the role that lawyers play in ensuring those issues are surfaced as early as possible.

I focus on the diligence phase because it is a buyer’s last opportunity for a so-called “easy out.” While the parties have agreed on a “sticky” and momentum-generating term sheet, it is nonbinding, so the costs of exit are limited. Moreover, diligence drives negotiation of the definitive agreement. Issues uncovered once a buyer and its lawyers roll up their sleeves to look under the target’s hood dictate how representations and warranties, indemnities, and closing conditions are drafted. Those provisions provide critical protection to buyers, but that protection is limited by practicality; after the transaction, buyer and seller become one, so obtaining recourse (absent insurance) beyond a portion of the purchase price set aside in escrow is unlikely. Yet, both academics and practitioners agree that most issues—whether related to intellectual property or other asset ownership, financials, or legal risk—can be resolved through customary risk allocation provisions. The question that drove my research, then, was “what issues cannot be?”

My interviews revealed that deal killers can be roughly sorted into three categories: those that are likely to affect all buyers, those that are deal motivation-dependent, and those that are highly buyer-specific. With respect to the first category, interviewees identified issues such as the seller’s significant noncompliance with laws that carry hefty and unquantifiable penalties, such as employee misclassification or widespread tortious conduct (e.g., violations of environmental protection laws). When the scope of an issue is both large and unascertainable, direct indemnification cannot be guaranteed, and insurance may be unavailable. I place external market factors in this first category, too.

The second category is issues whose severity depends on the buyer’s motivation for the deal. For instance, too many contingent revenues might kill a deal where the target is being pursued for its financials, but may be irrelevant in an acqui-hire, where the value of the transaction is in talent. Similarly, encumbrances on intellectual property assets will kill deals when the buyer plans to commercialize those assets.

Most issues fell in this second category, and of those identified, none dominated conversations more than “people.” Interviewees discussed how buyers will get spooked when it seems that key individuals may not come over, be collaborative, or perform as well as originally believed. These issues are most salient in an acqui-hire, but seem to pervade all deals for which some of the value is tied up in tacit knowledge or know-how (i.e., the information retained in individuals’ brains).

In the last category, I place items that I call “buyer-specific.” These issues have little to do with the buyer’s motivation for the deal, but the issue directly and negatively implicates something within the buyer’s existing assets or operations. For example, the target may have a contract that purports to grant a third party a license to all patents owned by the target “and its future affiliates.” For buyers who have a valuable patent portfolio, that provision is going to be a problem as it will result in them granting a royalty-free license without consent.

Not all issues were easily sorted into these categories (which themselves are somewhat fluid). Interviewees also identified deal killers arising from standard M&A process. For example, several discussed the role of detail in the term sheet, strongly suggesting that the more detailed the term sheet, the more likely the deal was to be completed, regardless of diligence findings. Parties also discussed the role of regulators, which hangs over deals that may require antitrust or foreign investment approvals.

What the proposed taxonomy does highlight, though, is the role that each party (and lawyers) can play in facilitating transactions in the most efficient way possible. The more universally applicable the deal killer is (e.g., in the first category), the greater the burden on the seller’s team to maximize deal efficiency because the seller should not have many other (if any) options. In that case, the seller ought to have an incentive to accept a renegotiation of a term sheet from a buyer, rather than let the buyer walk away. As issues become more idiosyncratic to a given buyer, the onus shifts to the buyer to surface its concern as soon as possible because it has better information about its needs. Additionally, the seller might have other suitors who do not share those needs.

As I describe in the article, the lawyer has much to do with all of this. I’ve previously written about how a seller could get ahead of some deal killers by hiring a lawyer early in its lifecycle to manage problems in advance, rather than wait until it is in the throes of an M&A transaction. In that way, the lawyer contributes to efficient transacting and helps deliver maximum value to stockholders. In the article, I focus on buyer’s counsel. The buyer’s attorney does not just negotiate the deal, it manages the entire M&A process, and there are possible shifts to practice that could be made to enhance deal efficiency. For example, lawyers could push clients towards detailed and comprehensive term sheets. Where key employee retention is fundamental to the deal value, then employment agreements could be moved up in the negotiation timeline, as opposed to pushed towards the end. Diligence request lists could be provided in a staged format so that high-priority information is provided first.

It’s great when lawyers can help preserve efficient deal-making, but they can also add value by facilitating efficient deal-breaking.

Rachel Landy is an assistant professor at Yeshiva University’s Benjamin N. Cardozo School of Law. This post is based on her recent article, “Deal Killers,” available here.