Mergers and acquisitions (M&A) can be tricky transactions that frequently entail delicate negotiations between buyer and seller. The negotiations must be choreographed in minute detail to ensure the transaction closes in a timely manner and is a success for both parties. The parties will, after all, be living with one another after the deal is done, hopefully for a long, long time.
Successful negotiations require the buyer and seller to consider a multitude of issues before the deal is even reduced to writing. While each transaction poses its own unique issues and crucial deal points, below are some of the top issues that recur over and over again. They should be decided upon as early as possible in the transaction process. Doing so can be paramount to a successful transaction.
1. The Structure of the Transaction
This issue constitutes the defining element of any M&A transaction. Is the deal going to be structured as a stock purchase, asset sale, or merger? Each type of transaction produces competing considerations between buyer and seller or acquirer and target. The factors that most frequently determine the type of transaction are the tax consequences, transferability of liabilities, stockholder approvals, and any required consents to the transaction by third parties.
Tax consequences will occur with asset sales and stock purchases, but some mergers, reorganizations or recapitalizations can be structured in such a way that a portion of the proceeds from the sale can receive tax deferred treatment. Stock sales may be preferable to the seller because the gain is taxed as capital gain at the shareholder level, not ordinary income. Asset sales may be preferable for buyers because they may step up the tax basis of the assets to fair market value, with the seller paying the corporate tax on the sale. Transfer of liabilities is a key difference between asset sales and stock purchases as well, with a stock purchase typically transferring all liabilities while an asset purchase involves negotiating the acquisition of particular items.
Finally, certain groups may have to consent to the deal, including stockholders, governmental authorities, and third parties with existing contracts. Sometimes the deal can be structured in such a way as to do an end-run around the consent of some of these groups, such as an asset purchase, which can be approved without stockholder input.
2. Payment for the Transaction
How is the deal going to be financed? Parties should know from the outset whether payment will take the form of cash, which is liquid and not as much of a risk to the seller, or equity, which will bring more flexibility to the structure of the deal and may improve the acquiring entity’s debt rating while adding such complications as a potential rejection of the deal by stockholders. With private company transactions the value of the equity is subject to calculating fair market value by some type of formula, and thus could be a sticking point between buyer and seller. Payment structures can be further complicated by transactions that contemplate or confront earn-out provisions, deferred compensation plans and their terms, and escrow accounts subject to certain pre-closing conditions, to name just a few.
3. Representations and Warranties
The deal will ultimately include detailed representations and warranties from the seller or target concerning any number of issues, including capitalization, compliance, authority, taxes, risks of litigation, ownership of intellectual property, and the like. The seller or target will need to review these closely. All disclosure schedules, as well as the exceptions to the list of representations and warranties, should be highly detailed.
Representations and warranties are some of the trickier aspects of any deal, with both parties wanting the other to shoulder more of the burdens of the transaction through these provisions. As a consequence, a significant portion of the negotiations between the respective sides often involves discussions about exactly what representations and warranties will be included in the final transaction documents, and the precise language used to explain each representation and warranty.
Litigation that sometimes follows the consummation of an M&A transaction frequently arises over the specific terms of the representations and warranties and whether they have been materially breached by the party providing them.
4. Indemnification and Joint and Several Liability
As with representations and warranties, indemnification is a thoroughly-negotiated provision in any M&A transaction. One piece of this negotiation is whether to cap certain indemnification claims at the escrow amount. Some deals may cap all claims; others may more selectively cap claims. It is a common practice to create some exceptions to indemnification rights, as in the cases of fraud or intentional misrepresentation.
The parties must consider liability for indemnification among the owners of the seller or target company. Will all stockholders be liable individually for the full amount of potential damages, as in the case of joint and several liability, or will the liability for potential damages be applied only proportionally according to ownership, as in the case of merely several liability? Stockholders will likely balk at the idea of full joint and several liability – where any individual stockholder could be solely responsible for all damages – but this provides more avenues for the acquirer to pursue indemnification should damages arise.
5. Closing Conditions
All deals must include a list of conditions to be met before the parties may close the transaction. These may include conditions such as the absence of pending litigation, stockholder approval (and the threshold for that approval that will ratify the transaction), board approval, legal opinions on the transaction, and the like. These conditions will certainly be a part of the final agreement, but they have a place in the letter of intent as well.
There are a multitude of other considerations in an M&A transaction, but the ones listed here should be addressed early in the process. Understanding the larger issues and familiarizing yourself with the fundamental deal structure are the best ways to begin such a transaction. Towards that end, obtaining the assistance of an experienced and knowledgeable attorney at an early stage is key and will pay dividends in guiding you throughout the transaction process.