In the area of mergers and acquisitions (M&A), representatives for buyers and sellers are coordinating a delicate dance between the parties to ensure a successful transaction. However, while they choreograph, there are many legal and business considerations that may go overlooked or underappreciated by the buyers and sellers that could have a negative impact on the deal after closing.
Since M&A is the process of bringing the operations and/or assets of two parties together, awareness of the commercial, tax, operational, and legal consequences of the various moving parts of a transaction is key in M&A professionals representing their clients effectively.
While some transactions may take a few weeks and others taking a few years, and valuations ranging from a few hundred thousand dollars to well over a billion dollars, there are many aspects and considerations that are applicable to any magnitude of M&A transaction.
Below, I briefly discuss some of these key legal and business considerations that buyers and sellers, along with their representatives, should pay close attention to at the outset of negotiations. Further, I describe how consideration of both the legal and business aspects together is key to successful M&A transactions.
How to Approach Due Diligence
Arguably the most important part of any M&A transaction, due diligence often gets underappreciated or overlooked due to the fact that it is the cumbersome effort of digging into every minutia of detail and documentation that may affect a transaction. This includes financial matters, customer and vendor relationships, sales and production, management, intellectual property, and much more.
Having a multi-faceted background in engineering, project management, business, and law has given me an pragmatic perspective on how to approach due diligence for M&A transactions. My approach has been molded over the years by extending due diligence beyond just the legal and financial aspects to identify material items that may negatively affect the deal structure. This includes working with operations, technical, finance, land, and other ancillary teams to determine if there are any underlying legal or business concerns that may otherwise go overlooked if not thinking about all aspects of operations. Some examples of these may be inspection records of materials and equipment not being recorded, actual production capacity of equipment and assets versus stated capacity to determine value, and even metes and bounds of claimed property for title research. Often these additional efforts do not result in any negative impacts to the transaction, but from time to time this extra effort results in a major modification in the deal structure.
Accordingly, my first recommendation to any client and representative is to begin due diligence as early as possible by using both a legal and business perspective to mitigate a “kick the can down the road” mentality and coming to the closing table with outstanding questions that could negatively affect the deal for both parties. For instance, many buyers and sellers neglect to review material contracts and whether they contain anti-assignment clauses or require consent. Others neglect to fully define a transition plan for management of the acquired company to ensure smooth operations for a set timeframe. Others neglect to review intellectual property assignments or ownership to determine if there may be infringement exposure.
There is no “one size fits all” approach to due diligence, but defining a predetermined checklist of the most important matters to identify and address early for your client based on the specific deal is key in balancing the legal and business aspects of any M&A transaction.
Choosing a Deal Structure
An M&A representative will often advise buyers and sellers on the advantages and disadvantages of possible deal structures. There are three general types of M&A transactions, asset acquisitions, stock acquisitions, and mergers.
In an asset acquisition, a buyer acquires all or part of the seller’s assets, including equipment, property, intellectual property, etc., and those assumed liabilities specifically assigned in the terms of the transaction. Asset purchases are often more complex than other structures due to the need to identify the assets and liabilities with reasonable certainty being transferred to the buyer. Additionally, asset acquisitions are often more tax-friendly to buyers versus sellers.
In a stock acquisition, a buyer acquires all or part of the seller’s stocks in a company, and with it accepts ownership of the company assets and liabilities alike. It should be noted that if a target company has a large number of stockholders, it may be difficult to execute because each stockholder must enter into the stock purchase agreement.
A merger is a combination of two entities to form one, with the surviving company owning all assets and liabilities of both. There are many forms of merger structures with varied benefits, as well as structures that allow for the merger to take place in one step or two steps.
With these three structures, buyers and sellers have competing legal and business interests and considerations. It is important to recognize and address material issues when negotiating any of these deal structures, but four of the key issues that should be addressed early in any transaction include, transfer of liability, assignment of contracts, member or stockholder approval, working capital adjustments, and tax consequences.
Drafting and Negotiating Contracts and Other Documents
Contract and document drafting and negotiations is where some of M&A representatives cause major issues or delays in a transaction being successful. Candidly, I am a transactions attorney and I admit that I like contracts and documents to be a certain way…my way. However, ego is often a cause of contracts and other documents being delayed or argued over in a way that negatively affects the transaction.
Of course, some edits or alterations may be necessary, or a term may be disputed for good cause, such as governing law, limitation of liability, or the like. However, in my experience many of the common issues with the transactions can be handled when a purely legal focus is coupled with a business focus. For instance, a representative negotiating a document may neglect to discuss the particular risk with their client because they have blinders on and only see the legal considerations of a term rather than analyzing the legal and business considerations together. However, in some cases discussing the legal risks with the client to determine their appetite for such risk if the term is not modified results in the client and representative understanding the business consideration outweighs the legal risk.
Keep in mind that it is the representative’s duty to serve the client in a proper manner, and with the drafting and negotiation of the terms of the specific acquisition, financing agreements, executive employment and transition agreements, and many other documents running concurrently, often up until the closing date, a representative must ensure that simple issues in documents are not holding up closing a deal.
THE GRAYSTONE APPROACH
Kumbaya and Preventing Mountains Out of Molehills
As described above, M&A transactions can be quite complex. Any transaction, whether a merger or acquisition, includes many moving parts and involves business, financial, legal, and other professionals working together with the common goal of completing the deal. Without each member of the buyer’s and seller’s teams properly considering both the legal and business risks concurrently, a deal most certainly will fail.
It is clear to say that no M&A transaction has ever been successful when only one party comes to the table. Getting bids in the door is the first step in any transaction, and getting an agreement in place after a successful bid takes hours upon hours of effort from legal, tax, and other specialists that should not be put to waste due to lack of communication or limited perspective. Negotiations with other companies can be a smooth ride in the right circumstances, but may ultimately fail no matter how smooth it may have been progressing, depending on the sophistication and personalities of the teams on both sides.
Graystone likes to call this the “Kumbaya” of a deal. We believe a transaction is progressing smoothly when there is Kumbaya, or harmony, between the teams, and when that Kumbaya is negatively impacted, whether that be through a disagreement, personality conflict, or the like, that is where our team reassesses the situation to push the teams back to Kumbaya.
Our mentality is that both sides of the transaction want to get a deal done and do not want to make mountains out of molehills that would otherwise delay or terminate the deal. Whether you are a buyer, seller, or representative, it is important to understand every participant’s personality to not let issues get raised that may affect a particular party and the deal in a negative way. Graystone’s approach is that even though every issue that arises in negotiations needs to be addressed explicitly, simple issues, personalities, and disagreements even do not invalidate the value of the transaction, and therefore should be handled in a way that does not distract the parties from coming to terms and maintaining Kumbaya.
If you are looking to sell your company or looking to buy a new one, Graystone has a team of seasoned professionals ready to assist you today. Additionally, Graystone has partnered with top legal, tax, and other professionals to provide our clients access to third party representation and favorable rate structures with these professionals throughout the M&A process.