In the Jaspan Schlesinger LLP Corporate/Commercial Transactions Practice Group, I advise clients in many mid-cap mergers and acquisitions transactions. The Group represents both buyers and sellers in these exit/change of control transactions.
Last year, I moderated a five-part mergers and acquisitions Boot Camp webinar series. Each of the five installments of that Boot Camp focused on a different aspect of M&A transactions. My favorite installment addressed a transaction’s process generally.
During last year’s Boot Camp series, it came to my attention that many of my panelists experienced (and continue to experience) a similar pitfall in mid-cap, sell side representation.
The typical business in this situation is owned by family members who are looking to exit the business and seek a liquidity event. The buyers in these types of transactions tend to be savvy financial buyers or sophisticated larger strategic buyers engaged in the same line of the target’s business. Although the sell side clients may have received some advice with respect to valuation, they may embark on negotiating a letter of intent for the transaction without involving counsel (and sometimes without involving their accountant or tax advisor).
As a result, many times sellers present counsel with a term sheet that has already been negotiated with a mandate to execute the deal. The following topics flesh out a small sampling of some of the pitfalls for not involving counsel (and other advisors) sooner in the process:
- Tax Planning – The structure of the exit transaction matters. Depending upon the form of the target entity and deal structure, there can be surprising taxation consequences to the sell side where buy side structured the transaction in a way that works for the buyer. In fact, sometimes the buy side is surprised after doing initial diligence. Investigating the tax planning up front can avoid unnecessary transaction costs and surprises down the line.
- Confidentiality – Closely-held businesses should be careful not to let potential acquirers (or their representatives) become privy to confidential formation regarding the target business absent certain protections. Sellers should make sure they get an appropriate non-disclosure agreement signed in advance of disclosure and, when doing so, including an appropriate covenant preventing the buy side from soliciting key service providers (and, potentially, soliciting suppliers or vendors to the detriment of the target business). Even if a confidentiality agreement has been signed, sellers should consider to what extent and when key information about the target business (the “secret sauce,” or identifying and providing data concerning key customers and key suppliers) should be disclosed. Note, when a seller hires a financial advisor the seller should also have the financial advisor sign a confidentiality agreement. Financial advisor confidentiality agreements tend to be less fulsome than those agreements between a seller and a prospective buyer. However, sellers should not rely on the financial advisor’s form without consulting counsel. Many times, the financial advisor’s form confidentiality agreement does not adequately protect the seller.
- Manner of Payment – Although price may have been negotiated, many sellers involved in the letter of intent stage fail to negotiate the specifics of payment. Will there be a (and how much is the) holdback or escrow to support indemnification obligations? Is the amount due all cash at closing (or is there a seller note or performance payment)? Does buyer need third-party financing? Will there be closing date adjustments based on “net debt” or “net working capital”?
- Closing Conditions – Many mid-cap sellers fail to assess at this stage the extent to which third-party consents are required to close the transaction (whether that third-party is a regulatory agency or a material customer or vendor). In addition, the buyer may very well need to secure employment arrangements and or post- closing transition services from key personnel. The material terms of those arrangements should be addressed in the letter of intent as well, especially if an executive shareholder selling into the deal is to be employed post-closing. Recently, we were engaged by a sophisticated executive shareholder who, with our help following our recommendation, negotiated the broad terms of his post-closing employment into the initial letter of intent. Armed with that letter of intent provision, the executive shareholder was easily able to rebut the buyer’s first draft of his employment agreement which provided that he could be terminated any time after closing with severance far less than the compensation of his agreed upon term of employment as set forth in the letter of intent.
Sure, any lawyer’s blog will generally caution prospective clients to “be sure to consult me as early as possible”. In this case, the moral of the story also applies to consulting tax advisers. I am not recommending that sellers negotiate a full-blown letter of intent or memorandum of understanding. In fact, I recall one transaction (representing a publicly traded company as the buyer) that was purchasing a mid-cap distribution business owned by a single shareholder. That selling shareholder was extremely nervous about the transaction and exhibited seller’s remorse at every turn of the deal process. We ended up with a fully negotiated letter of intent spanning over 20 pages. That letter of intent provided for almost every facet of a fully negotiated definitive purchase agreement (including terms of survival of each type of representation and warranty). There, all parties would have been better served by a different tact. That deal became incrementally more expensive and took longer to close than necessary. Good transactional counsel can help a seller navigate the letter of intent process on an effective and efficient basis.
A closely held family business seeking a liquidity event should be wary of some of the deal points identified in this article and yes…..seek out transactional counsel and tax advisors SOONER rather than later.