The purpose of this guide is to save you time, money and aggravation. Mergers, acquisitions, finance and similar transactions are not “business as usual,” they are “extraordinary transactions.”Obtaining experienced legal representation appropriate to the transaction can make the difference between a smashing success and an abject failure. Herein, you will find a summary of the role of a lawyer, some basic tips on selecting the right lawyer, and a summary description of the services that a lawyer typically performs in representing a client who is a party to an extraordinary transaction.
Lawyers, first and foremost, represent their clients’ interests. In most transactions involving the sale or finance of a company, there are at least two parties who have their own legal representation. Although all lawyers practicing in the United States are licensed by at least one state, there is a broad array of different types of law. In the context of mergers and acquisitions, a party may require representation familiar with the legal aspects of taxes, securities, bankruptcy, corporate formalities and shareholder rights, antitrust, real estate, employee rights and benefits, environmental regulations, intellectual property, commercial contracts and any number of other specific areas. Each lawyer will conduct diligence with respect to the company in question and will then advise their client of any risks attendant to the transaction or to their client’s business following the transaction. Each party’s lawyer will assist their client to negotiate and arrive at the most favorable structure and terms for the transaction and to document those terms. The lawyers also manage the process of obtaining third-party consents and government approvals, making required governmental filings, arranging for third-party services (like escrow agents and title insurance) and organizing and executing the closing of the transactions so that all of the documentation is properly executed and delivered to each party. Depending on the transaction, a party’s lawyer may also provide a legal opinion as to certain aspects of the transaction.
What You Need to Know
The selection of legal representation with the appropriate specialization is critical to achieving your objectives. When selecting legal representation for the purchase or sale of a company or significant business unit, you should consider the following factors:
1. Seek extraordinary counsel for your extraordinary transaction. You may have a wonderful relationship with a lawyer who has served you as outside counsel and trusted advisor for as long as you can remember. Even so, before signing them on to represent you in an extraordinary transaction, be certain that they have the required expertise and resources.
(a) More often than not, the lawyer who has provided excellent counsel for all manner of general business issues, contract negotiation, litigation management, etc., has little or no experience with anything but the smallest of merger/acquisition transactions. No doubt, the institutional knowledge possessed by that trusted advisor will be very useful and there is a role for them in the transaction process. That should not, however, be in structuring and negotiation of the transaction.
(b) Similarly, you will need legal representation with resources (man power) appropriate to the transaction. For most middle market transactions, the legal team should be no less than an experienced partner and a reasonably senior associate, together with an experienced paralegal, each experienced in corporate and commercial transactions, and the constellation of legal subject matter experts (tax, environmental, real estate, etc).
2. Your company may not be ready. If you are selling a company, you will need to present every aspect of the company for all would-be buyers to evaluate. There are many technical legal matters that may or may not have made a difference to the company’s operations that you must now address. Failure to address these items (or at least to recognize them) ahead of time can cost you time and money and potentially result in litigation. Even as a buyer, you need an understanding of how your existing organization’s structure functions and how you want to fit in the new acquisition. Moreover, if you are planning on issuing securities to the sellers as consideration, unless you are a public company, you should expect that the sellers would want to take a close look at your company before they will close a transaction. The right legal representation will guide you through the right moves to make before you go looking for your transaction partner.
3. Things that matter and things that don’t. Just like any other service-based professionals, lawyers will pitch their own combination of expertise, price and brand name prestige in an attempt to earn your engagement. When selecting an attorney to represent you in the purchase or sale of a company, keep in mind the following:
(a) Bigger may or may not mean better. There are plenty of giant, international law firms that will be happy to charge you top dollar to guide you through a transaction. These firms have very specific expertise and lots of man-power at their disposal. If you are doing a transaction with over a billion dollars of enterprise value, your transaction involves purchase of operations in ten different countries, you transaction will undergo scrutiny under a somewhat esoteric set of regulatory guidelines (insurance, banking, mining, etc.), or your transaction requires a particularly complicated structure, then paying the big firm bill might be a good idea. For most middle market transactions, however, representation by smaller to mid-size firms will be far less expensive and may be of a higher quality as well.
(b) The sector in which a company does business usually has little to no impact on the legal requirements of the transaction. Experienced merger and acquisition counsel can adapt to the basic legal requirements of most sectors and industries. Exceptions are industries with highly specific and complex regulatory compliance issues, and companies with products and services so technical as to require legal representation with a science background to understand the nuances of the company’s product (and even that is not usually a problem for reasonably experienced attorneys with access to subject matter experts).
4. Your lawyer is probably not your investment banker. Although some lawyers may use their connections to help you find a transaction partner, most do not have their pulse on the current market conditions and pricing. Moreover, lawyers are almost never set up to conduct an auction process or a green field search for the right acquisition target. Middle market companies will almost always find an investment banker to be a value added part of their team.
5. Don’t hire the “C” team if they pitched you the “A” team. This is a particular problem for the middle market business. Most of the larger law firms are built with a pyramid structure involving few partners at the top and lots of junior associates at the bottom. The bigger the firm, the bigger the fees generated by the transaction need to be in order to keep the attention of that top partner that you spoke to in the pitch meeting. Although the junior to mid-level associate who may lead your deal is very “smart,” there is no substitute for experience. Your transaction may not go as smoothly as you hoped, and your fees may ultimately be significantly higher.
Process, Responsibilities, Deliverables
The legal services required for most transactions run a varied path from initial structure through post-closing matters. Typically, your counsel will perform the following services; in more or less the following order:
1. Preparation for a transaction. For a sell side transaction, or a buy side transaction in which securities will be included in the purchase consideration, a little attention at the start of the process can prevent big (and costly) problems later. The target/issuer should be clean for diligence and optimized for tax purposes. Counsel should verify that the company has taken reasonable actions to minimize potential issues relating to (i) the company’s governing documents and records; (ii) litigation; (iii) assignment of material contracts; (iv) labor and employment issues that may arise in the context of a transaction; (v) ownership of intellectual property; (vi) real property, including environmental matters; and (vi) any other matters material to the company’s operations, assets and liabilities.
2. The Letter of Intent (Memorandum of Understanding). A letter of intent (“LOI”), also called a memorandum of understanding, is usually (unless it is solely to start discussion) an agreement between the parties. An LOI usually does not bind the parties other than with respect to certain specified terms. Terms common to most LOIs in the merger and acquisition context include:
(a) Structure of the transaction: which may involve a merger (purchase of all of the target company’s outstanding equity), an acquisition (purchase of some or all of the target’s assets/liabilities) or one of several combinations of the two. Creating a transaction structure also includes the choice of the most appropriate forms of organization (e.g. corporation, limited liability company, partnership, etc.). Transaction structure can be very complex and will depend in part on (i) desired tax effect; (ii) level of difficulty in transferring material contracts, and governmental authorizations; (iii) requirement and amount of difficulty of obtaining shareholder consents; (iv) buyer’s strategy for integrating the target into its organizational structure; and (v) many other factors that may be unique to the transaction in question.
(b) Consideration for the transaction: which is the compensation that the buyer provides to the seller, may include: (i) cash; (ii) equity of the buyer (including preferred equity, warrants and debt convertible to equity); (iii) license(s) to use intellectual property; and (iv) debt, which may be secured.
(c) Procedure and timing of payment: which may include: (i) an earn out; (ii) payment in installments, which may be conditional; (iii) and a hold back in escrow to satisfy the seller’s post transaction indemnity obligations.
(d) Diligence procedures according to which one or both of the parties may conduct diligence to ascertain if they actually want to complete the transaction described in the LOI.
(e) Contingencies to closing the transaction, which may include: (i) buyer’s ability to obtain financing; (ii) either or both parties’ ability to obtain required authorization from shareholders and/or a board of directors; (iii) obtaining necessary government approvals; (iv) completion and satisfaction with due diligence investigations; (v) agreement by seller’s key personnel to not compete with, and/or continue working with the buyer for some time period following the closing of the transaction; (vi) completion of other transactions (which may be with third parties); (v) other terms a party desires to include to avoid surprising the other party during the agreement negotiation process; and (vi) other standard contingencies to be “negotiated in good faith by the parties.”
(f) Expected representations and warranties of the parties often left to be “negotiated in good faith by the parties.”
(g) Terms of indemnification, which may include: (i) the specifics of which parties must indemnify which other parties (ii) the conditions required to trigger indemnification obligations; (iii) whether an indemnifying party may control the defense from a third-party claim; (iv) the amount of any hold-back of consideration; (v) the conditions required to trigger payment of the held-back consideration to a party (often a time schedule for payment to seller) and (vi) the amounts of any threshold or cap to the amount of funds subject to indemnification.
(h) A “no shop” provision that specifies a time period during which the seller may only negotiate with the buyer for the sale of the target company or assets.
(i) A confidentiality provision, which may be unilateral or mutual, that obligates the parties to prevent the disclosure or improper use of each other’s “Confidential Information.”
Often the terms of an LOI are non-binding (exceptions being the “no shop” and confidentiality provisions). IT IS A GIANT MISTAKE, however, to delay engaging competent legal counsel until after execution of the LOI. The LOI is the blueprint for the transaction. Once signed, a party rightfully expects that the terms of the transaction will reflect the terms of the LOI. Counsel engaged after execution of the LOI may find that the terms of the LOI will: (i) increase transaction costs; (ii) create unexpected losses; (iii) result in missed opportunities; or that the terms in the LOI would result in an illegal or commercially impossible result. In these situations, counsel (and their client) will have to now push for renegotiation of established major terms. That renegotiation will invariably cost more time and money and may seriously reduce negotiation leverage. It also may kill the deal.
3. Diligence. Upon execution of the LOI, counsel for the Buyer will send counsel for the Seller a diligence request letter. These letters can be very long and are often overly broad. Each of Buyer’s and Seller’s counsel will review all of the available material information about the target’s assets, liabilities, historical operations and near-term prospects. Buyer will use the information from the review to determine whether to pursue, renegotiate or abandon the transaction. Each counsel will rely on the information to negotiate the final terms of the transaction; and will also advise their client of any possible unintended consequences that may result from the transaction. Complete disclosure of all material information is the surest way to avoid post-transaction litigation between the parties.
4. The Purchase Agreement. A completed purchase agreement will include: (i) a description of the target’s equity or assets being purchased and the purchase consideration; (ii) mechanics for the exchange of consideration; (iii) representations, warranties and covenants; (iv) obligations of the parties’ during the period between agreement execution and closing; (v) documents or conditions required prior to the closing; (v) post closing obligations of the parties; and (vi) tax elections, dispute resolution, and standard “boiler plate” items.
5. Drafting and negotiation. Using the LOI, the parties’ respective counsels negotiate and draft the purchase agreement and other required documents. As part of the process, counsels address material matters discovered through the diligence process. Counsel will review the key documents with their client to obtain information and discuss the legal effect of the language in the documents. Counsel will also provide guidance as to sticking points in the negotiation, including matters discovered through the diligence process, and provide potential solutions.
6. Execution and closing. Upon conclusion of the drafting process, the parties execute and become bound by the purchase agreement. Counsel now works with their client to satisfy any conditions precedent to the closing. Depending on the transaction, the parties may each need to: (i) take required organizational actions including obtaining approval from their equity holders and governing bodies; and (ii) obtain third-party and governmental consents and approvals; (iii) negotiate the terms of any ancillary agreements (e.g. shareholder agreements, employment/consulting agreements, license agreements, etc.); and (iv) draft and review any number of ancillary closing documents (officer certificates, legal opinions, government filings, etc.). Additionally, if required, Buyer’s counsel will also negotiate and draft documents required accomplishing Buyer’s finance of the purchase consideration. When all parties (buyer, seller, financiers and other third-parties) have approved the form of all of the documents applicable to them and all other conditions to the closing are completed or waived, the parties’ counsels run the closing, overseeing the complete execution and delivery of documents in the correct sequence, the exchange of the company/assets for the purchase consideration.
7. Post closing matters. Following closing, one of the parties’ counsels will organize, bind and distribute full sets of executed closing documents. Counsel will also make any required government filings and assist in the drafting of any press release. After the immediate post closing matters are complete, counsel will continue to advise their client with respect to long term matters (e.g. release of held-back purchase consideration, calculation and payment of earn-outs, etc.) and application of the deal documents to real world circumstances (litigation avoidance).
As a final note, nothing (outside of litigation) is worse than spending hundreds of thousands of dollars on a deal that should never have been attempted. Sometimes, the biggest value add from the timely engagement of the right lawyer is identification of deal killing issues before a client becomes committed to an ill fated transaction. A good lawyer will be very clear about whether an issue will not be able to be resolved. Your lawyer should be a problem solver, but not a “yes man.” With the right team, a lawyer can keep the transaction process moving through the various stages described above. Don’t forget to invite them to the closing dinner.
Authored by Josh Lawler, Partner