Negotiation of Final Documents
As due diligence and integration planning continue, the company engages with representatives of the target company to carry out final negotiations around the terms, conditions and requirements of the transaction. Some of these are informed by the findings of the diligence and planning activities.
This agreement represents the final and legally binding agreement that describes the transaction and details its terms and conditions. Each M&A transaction is governed by a contract (the purchase and sale agreement) between the acquiring and the selling parties. That contract can take the form of an asset-purchase agreement, stock-purchase agreement, tender-offer document or merger agreement. Regardless of form, the contract will contain a number of key sections and clauses that are similar irrespective of the situation, including:
- Found at the beginning of the agreement.
- Used to define all capitalized and referenced terms throughout the remainder of the agreement.
- Examples of definitions requiring close attention to verbiage/structure: Aggregate/purchase consideration, working capital, losses, materials adverse event/effect.
Merger Consideration/Purchase Price
- Section of the agreement where the ultimate price to be paid is defined.
- Includes base price and any adjustments that may be made in terms of debt, working capital, deferred bonuses or other payments, extraordinary payable/receivables.
Working Capital Adjustment
- Under normal circumstances, buyers want to acquire businesses including normalized levels of working capital.
- Typically defined as current assets minus current liabilities and can often exclude cash or other certain extraordinary liabilities such as litigation expenses, non-ordinary course payables/receivables.
Termination and Reverse Termination Fees
- Termination fee: Usually highly negotiated and limited in scope as to when the seller is able to terminate. Market fee is 2% to 4% of the purchase price.
- Reverse termination fee: As with termination fees, this is highly negotiated and is very limited in nature as to when it can be used. Market fee has been 2% to 4% of the purchase price, but has been trending to 5% to 6% given abuse.
Go-Shop, Specific Performance and Hell or High Water Provisions
- Go Shop Clause: Provision in the merger agreement that allows a company a 30-60 day period post-signing to shop around for a superior proposal. Usually put into an agreement where a comprehensive auction process/market check has not been performed prior to signing of the agreement (more so in public company purchases) in order for the Board to have performed its fiduciary duties for the shareholders in obtaining the best price possible.
- Specific Performance Clause: A clause that will require a buyer or seller (more often targeted at buyers) to go through with an agreement if all conditions are satisfied. In the M&A context, if the seller does everything required by the merger agreement, it can force a buyer to purchase the company even if the buyer has no financing lined up, etc.
- Hell or High Water Clause: A clause requirng that a potential buyer does everything in their power to close, including finding alternate sources of financing if the initial one falls through, going above and beyond to get government approvals, etc. The burden is on the buyer to use all means possible to close the deal.
Material Adverse Clause (MAC) or Material Adverse Event/Effect (MAE)
- Gives the buyer, under extreme and unforeseen circumstances, the right to walk away and void a contract without owing a reverse termination fee or being subject to specific performance.
- Generally a MAC/MAE cannot be triggered by overall economic or political changes that affect the entire industry, factors known to the buyer before entering into the merger agreement, changes in law or GAAP etc.
Baskets and Caps
- Baskets: Similar concept to a deductible whereas losses/penalties dont get paid out to the buyer from the seller until a certain threshold is hit. Can be structured similar to a working capital adjustment, where once a threshold is met either the entire full amount is paid (tipping basket) or just the amount over the threshold (non-tipping basket).
- Caps: Once the basket threshold has been hit, the cap is the maximum amount the seller can be responsible for. This can reach the full amount of the purchase price in certain instances.
Reps & Warranties and Indemnity
- Reps and Warranties: Section used to identify what the seller is stating is true and correct about what they delivered to the buyer (factual financial statements, tax situations etc.).
- Indemnity: What the seller is taking full liability for post-closing; can include future tax losses should an event arise concerning something the seller did pre-closing, litigation for pre-closing events, etc.
Escrow and Holdback
- Represents the concept that a certain amount of percentage of the total purchase price is held in a separate account to cover potential losses or penalties that arise post-closing for violations of reps and warranties or other claims.
Other Supplemental Agreements
Transition Services Agreement
- Often, buyers will need a transition period for certain services before they can have the purchased company fully operational on a standalone basis.
- These can include benefits, telephone services, use of names and likeness, payroll, accounting, HR, etc. An agreement is pre-negotiated and signed with the merger agreement, detailing what services the seller will provide post-closing, at what cost and for how long.
Intellectual Property (IP) Agreements
- Relates to the ongoing use of intellectual property that the seller is not including as part of the transaction.
- An IP agreement is essentially a license agreement for the ongoing use of the IP at a set cost.
- Generally, pre-close, the buyer will sign up key employees to long-term contracts.
- Signing of employment agreements can often be a condition to close as well.
Prior to completing the final documents, the company must obtain a final approval. The Transaction Sponsor will typically discuss the due diligence findings, conduct a review of an Integration Plan, confirm the business and synergy cases, and finalize prices and other terms and conditions.
Although all of this activity may sound extraordinary, its necessary for the successful conclusion of an M&A, whether its followed through with or not. As a result, key players and the understanding of the intricacies of such transactions mustnt be overlooked.
The next two parts of the M&A strategy and financing will be on approach followed by execution.
Other articles by Elias:
Grow Your Business Through the M&A Pipeline- part 2 of 4 (article above is part 3)