Negotiating Merger and Acquisition Transactions
Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP
Many entrepreneurs consider selling their businesses at some point, either to enjoy life in retirement or, for serial entrepreneurs, to move on to the next venture. The acquisition agreement is among the most negotiated legal document – and not only in the context of the transaction. It may rank as among the most detailed and contested agreements that an entrepreneur and his or her advisors will ever negotiate. Here are six major areas that will be subject to negotiation.
Scope of the Transaction. The typical buyer will want to designate a specific laundry list of assets to be purchased, but the typical seller will want either to push for a stock sale or modify the asset list by using words such as "exclusively" or "primarily." The seller may want to exclude all or most of the cash-on-hand from the schedule of assets to be transferred. In some cases, the seller may want to license some of the technology rights in lieu of an outright sale or, at the very least, obtain a license back for what has been sold.
Security for the Seller's Takeback Note. When the seller is taking back a note from the buyer for all or part of the consideration, the issue of security for the note is always a key point for negotiation. Naturally, the seller will want non-contingent personal and corporate guaranties from the buyer and anyone else that it can manage to get. The buyer will be reluctant to offer such broad security. Several "creative" compromises have been reached between the parties, including partial or limited guaranties, the acceleration of the note based on post-closing performance, the right to repurchase the assets in the event of a default, the issuance of warrants or preferred stock in the event of default, commercial-lender-like covenants to prevent the buyer from getting into a position in which the buyer is unable to pay the note (such as dividend restrictions, limitations on excessive salaries, etc.) or contingent consulting agreements in the event of a default.
Who's On the Line for the Financial Statements. The financial statements provided by the seller to the buyer in connection with the due diligence and prior to closing are often a hotly contested item. The timing and scope of the financial statements, as well as the standard to which they will be held, is at issue. The buyer and the buyer's team may prefer a "hot-off-the-press" and recently completed audited set of financials from a major accounting firm, and the seller will want to serve up a "best-efforts," un-audited, and uncertified guesstimate. Somewhere in between is where most deals wind up, with verbiage such as "of a nature customarily reflected" and "prepared in substantial accordance with GAAP" and "fairly present the financial condition" being bandied about. The scope of the liabilities included on the statements and the names of those who will bear responsibility for unknown or undisclosed liabilities will also be negotiated in the context of this overall discussion.
Playing With the Buzz Words. The Purchase Agreement will be riddled with legal "buzz words" which have material consequences and which will detract, enhance, or even shift liability by and between the buyer and seller. The usage of these terms is typically the source of significant negotiations. Depending on which side of the fence you are on, look out for words or phrases such as the following as tools for negotiation and as phrases.
- "to the best of our knowledge"
- "could possibly"
- "without any independent investigation"
- "except for..."
- "subject to..."
- "reasonably believes..."
- "ordinary course of business"
- "to which we are aware..."
- "would not have a material adverse affect on..."
- "primarily relating to..."
- "substantially all..."
- "might" (instead of "would")
- "other than claims which may be less than $____"
- "have received no written notice of..."
- "have used our best efforts (or commercially reasonable efforts) to ..."
- "endeavor to..."
The Existence and Scope of the Non-Compete. It is only natural for the buyer to expect that the seller will agree to stay out of the business being sold for some reasonable period of time. Depending on the seller's stage of life and post-closing plans, which may include actual retirement, the parties are likely to argue over the scope, duration and geographic focus of the covenant against non-competition. The more difficult issues often arise when a conglomerate is spinning-off a particular division or line of business and the remaining divisions will continue to operate in similar or parallel industries to the business being sold to the buyer. The allocation of the purchase price to a non-compete covenant raises certain tax issues that must be analyzed. These covenants may have only limited enforceability under applicable state laws if their scope or duration is deemed unreasonable or excessive.
Allocation of Risk. The heart and soul of the Purchase Agreement is, in many ways, merely a tool for allocating risk. The buyer will want to hold the seller accountable for any post-closing claim or liability that arose relating to a set of facts that occurred while the seller owned the company or that has occurred as a result of a misrepresentation or material omission by the seller. The seller, on the other hand, wants to bring as much finality to the transaction as possible to allow some degree of sleep at night. When both parties are represented by skilled negotiators, they are likely to reach a middle ground in general, as well as on specific issues of actual or potential liability. The buyer's counsel will want to draft changes, covenants, representations, and warranties which are strong and absolute, and the seller's counsel will seek to insert phrases like "... except insignificant defaults or losses which have not, or are not likely to, at any time before or after the closing, result in a material loss or liability to or against the buyer…" leaving some wiggle room for insignificant or non-material claims. The battleground will be the indemnification provisions and any exceptions, carve-outs or baskets that are created to dilute these provisions.
So there you have it: the six areas that will be subject to negotiation in the course of attempting to sell or merge your company. Familiarize yourself with them, call in your most astute negotiators, and let the dealing begin.