Monday, April 1, 2019

Frequently negotiated deal terms in M&A transactions

Thanks to the Fort Worth Business Press for publishing my article below, which is available on the FWBP website here.

Frequently negotiated deal terms in M&A transactions

As any experienced merger and acquisition (M&A) professional can attest, some deal points get negotiated in virtually every M&A transaction. Sure, every transaction is unique. But M&A transactions are like love songs; as Randy Travis tells us: “Every one is different and every one’s the same.”
An M&A transaction involves the buyer and the seller entering into a purchase agreement. As part of the purchase agreement, the seller will make a series of representations and warranties about the condition of the seller’s company and its assets.
If those representations and warranties are not true, the buyer may make a claim against the seller for a breach of contract. That’s called seeking indemnification. The purchase agreement may limit the buyer’s ability to seek indemnification claims against the seller.
The tension between the buyer’s desire to know exactly what it is buying (and be protected if the seller’s company does not live up to the buyer’s expectations) and the seller’s desire to limit its exposure to post-closing indemnification liability is the source of many of the frequently negotiated deal points.
Survival Period
How long after the closing should the buyer be able to seek indemnification from the seller for an alleged breach of one or more of the seller’s representations or warranties in the purchase agreement? That time period is called the survival period. As you might expect, sellers would like the survival period to be as short as possible (ideally, none). The buyer wants the survival period to be as long as possible.
Indemnification Basket
After the closing, the seller does not want to hear about every tiny issue that the buyer may have with the company. Often, the buyer and seller will agree that the buyer cannot seek indemnification from the seller for an alleged breach of one or more of the seller’s representations or warranties until the buyer’s damages for such breaches exceed an agreed-upon dollar amount. That’s called an indemnification basket.
Indemnification Cap
Similarly, the seller will seek to have the purchase agreement include a limit on the seller’s maximum exposure for potential indemnification claims from the buyer. That is called an indemnification cap.
Holdbacks/Escrow
The buyer may be concerned that the seller will be unwilling or unable to pay indemnification claims after the closing – or that pursuing such an indemnification claim will be prohibitively expensive. If so, the buyer may seek to have the purchase agreement include a provision that the buyer will hold back a portion of the purchase price for a period of time until the buyer confirms that the seller’s representations and warranties were correct. If the seller agrees not to accept all of the purchase price at the closing, the seller might insist that rather than holding back a portion of the purchase price, that amount should instead be delivered to an independent third party that will hold the funds in escrow.
Qualifiers
While the buyer will want the seller’s representations and warranties to be as broad and unqualified as possible, the seller will prefer for the seller’s representations and warranties to be qualified so they only apply to matters that are “material” or to matters of which the seller has actual “knowledge.”
Sandbagging

What if the buyer knew that the seller’s representations and warranties were not true before the purchase agreement was ever signed or the deal was closed? That’s called “sandbagging.” The seller will seek to include an anti-sandbagging provision in the purchase agreement that provides that the buyer cannot seek indemnification from the seller for representations and warranties that the buyer knew were untrue. The buyer will resist including an anti-sandbagging provision.
Conclusion
There are no right or wrong answers to how any of these issues should be addressed in the purchase agreement – it depends on the relative bargaining power of the buyer and the seller and how willing each side is to fight for its preferred position. Regardless, it is helpful to know the landscape of the issues that will be addressed. And it is helpful to have experience dealing with these issues and with how other buyers and sellers in the market have ultimately reached agreement on these frequently negotiated issues.

Thursday, March 28, 2019

Praise for Acceleration


For anyone interested in corporate and securities law as it relates to startup companies, I would recommend "Acceleration: What All Entrepreneurs Must Know About Startup Law," a new book by Ryan Roberts. Ryan is a longtime friend of mine and an outstanding corporate lawyer.  In fact, his blog, www.startuplawyer.com, was one of the inspirations for this blog.

Ryan does a great job of cutting through the clutter to deliver sound advice in an understandable, entertaining, and informative way. The book is available on Amazon here.  It looks like this:


Sunday, January 20, 2019

Fort Worth Inc. Top Attorney

Thanks to Fort Worth Inc. magazine for including me in their list of Top Attorneys for 2018 (published in their Jan/Feb 2019 issue). I was included in their "annual listing of the best lawyers in town" in the Corporate Finance/Mergers & Acquisitions category.

Thursday, October 4, 2018

SEC Disclosure Update and Simplification

Kudos to the SEC for adopting amendments to update and simplify some of its disclosure requirements that had become "redundant, duplicative, overlapping, outdated, or superseded."

It's unclear if that description of the need for amendments was intended as a joke by the SEC staff or was just a very comprehensive description of the requirements being amended. Regardless, it reminded me of the episode of "Cheers" where Diane expressed concern to Frasier that Frasier had too often voiced suspicions that Sam was trying to woo Diane back. Frasier objects, exclaiming: "Oh, now you're saying that I'm redundant, that I repeat myself, that I say things over and over!"

The amendments, which become effective November 5, 2018, amend numerous disclosure requirements previous required by SEC rules and regulations, including those in Regulation S-K, Regulation S-X, Form S-1, Form S-3, Form 10-K, among many others.

I won't try to summarize the entire 314 page SEC release which is available here, but I did want to highlight my least favorite change. You may have noticed language in SEC filings instructing readers that they may access publicly filed documents at the SEC's Public Reference Room, such as:

"We file reports with the Securities and Exchange Commission ("SEC").  These reports include our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these filings.  The public may read any of these filings at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC  20549 on official business days during the hours of 10 a.m. and 3 p.m." 

Well, no more. The SEC has removed that disclosure requirement. It always brought a smile to my face to imagine a grumpy old man, perhaps wearing a mustache, a bow tie, and a three piece suit, taking a bus to the SEC's office building in Washington D.C. and pounding on the SEC's front door with the end of his cane demanding access to their Public Reference Room so that he could comb through his favorite company's 10-Ks and 10-Qs, only to be kicked out at 3:00 p.m., at which point he would shuffle back to the bus stop. Maybe he'd take a detour for some taffy or a cold sarsaparilla on his way home. How can this gentleman afford to be a direct investor in the US equity markets but he can't pay for a dial-up modem to access the SEC's EDGAR database online?

Wednesday, September 26, 2018

For-Profit Corporation vs. Nonprofit Corporation vs. Social Purpose Corporation vs. Public Benefit Corporation

If you are interested in forming a corporate vehicle for “doing good,” you may have considered forming a for-profit corporation, a nonprofit corporation, a public benefit corporation, or a social purpose corporation.  But which corporate vehicle is right for you and your cause(s) in Texas? I’m going to compare and contrast these corporate forms for you.

For-Profit Corporation:

A for-profit corporation is exactly what it sounds like – it’s in business to make a profit for its shareholders. Thanks to the magic of the "invisible hand” of capitalism, virtually every successful for-profit corporation will end up doing a lot of good things for its customers, vendors, employees, and other stakeholders. But ultimately the board of directors of a for-profit corporations owes fiduciary duties to seek to maximize profits for its shareholders. That’s true even if the board faces a choice that may be right for its shareholders, but may not be in the best interests of the community, the world, or other stakeholders of the corporation.

So if you want to earn a profit for yourself and impact the world in a positive way by providing great products or services, but with no obligation (or opportunity) to consider stakeholders other than the corporation’s shareholders when making business decisions, the for-profit corporation is probably right for you.

For-profit corporations are governed by Chapter 22 of the Texas Business Organizations Code (TBOC).

Nonprofit Corporation:

Being a “nonprofit” corporation does not mean that the corporation may not earn a profit - it just means that all profits earned by the corporation must ultimately flow to a “good cause” and not flow to the benefit of any individual or for-profit corporation.

Nonprofit corporations are governed by Chapter 22 of the TBOC. Section 22.01(5) of the TBOC defines a nonprofit corporation as “a corporation no part of the income of which is distributable to a member, director, or officer of the corporation, except as provided in Section 22.054.”  Section 22.054 of the TBOC permits non-profit corporations to (1) pay reasonable compensation for services provided, (2) confer benefits to its members in conformity with the corporation’s purpose, (3) make distributions to its members upon winding up and termination as otherwise permitted by Chapter 22 of the TBOC, and (4) make distributions of its income to 501(c)(3) organizations under certain circumstances.

So if you just want to “do good” and don’t care about earning any profits for yourself, a nonprofit corporation might be a great option for you.  But if you want to personally share in any of the profits of the corporation as its founder and owner while helping society or the public at the same time, then you might want to consider another type of corporation.

Also, because non-profit corporations may not distribute profits to its members, they often have a more difficult time raising capital – what venture capitalist wants to invest in a corporation with a 0% chance of earning a profit?!  So if you want to attractive investors (not just donations) to your project, the non-profit corporation will not work for you.

Social Purpose Corporation:

In 2013, the Texas legislature adopted the concept of the social purpose corporation in the TBOC. The social purpose corporation sought to bridge the historical divide between for-profit corporations seeking only financial gain for its shareholder or non-profit corporations seeking only to further a social purpose or cause. Why couldn’t a corporation do both? According to the author of the bill that created the social purpose corporation in Texas, the social purpose corporation was adopted in response to a national movement of social entrepreneurship – “a person or entity who uses entrepreneurial principles to affect change in a particular social purpose or cause.”

A new Section 3.007(d) was added to the TBOC, which permits a for-profit corporation to elect to have a social purpose in addition to its for-profit purpose. That Section also permits a for-profit corporation to include a provision in its certificate of formation requiring the corporation’s board of directors and its officers to consider any social purpose of the corporation in discharging their duties.

A new Section 1.002(82-a) was added to the TBOC to define social purposes as “one or more purposes of a for-profit corporation that are specified in the corporation's certificate of formation and consist of promoting one or more positive impacts on society or the environment or of minimizing one or more adverse impacts of the corporation's activities on society or the environment.  Those impacts may include: (A) providing low-income or underserved individuals or communities with beneficial products or services; (B) promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business; (C) preserving the environment; (D) improving human health; (E) promoting the arts, sciences, or advancement of knowledge; (F) increasing the flow of capital to entities with a social purpose; and (G) conferring any particular benefit on society or the environment.”

And new Sections 21.401(c) and (d) were added to the TBOC to explicitly grant the directors and officers of a social purpose corporation the right to consider any social purposes specified in the corporation’s certificate of formation in discharging their duties to the corporation.

As you can see, the social purpose corporation grants the for-profit corporation and its management the right, but not necessarily the obligation, to pursue social purposes while also pursuing a profit for the corporation’s shareholders.  

Public Benefit Corporation:

In 2017, the Texas legislature adopted the concept of the public benefit corporation, which is kind of a social purpose corporation on steroids. Pubic benefit corporations are governed by a newly created Subchapter S of Chapter 21 (For-Profit Corporations) of the TBOC.

The certificate of formation of a public benefit corporation must (1) identify one or more public benefits to be promoted by the corporation, and (2) include a statement that the for-profit corporation has elected to be a public benefit corporation. Section 21.952 of the TBOC defines public benefit as “a positive effect, or a reduction of a negative effect, on one or more categories of persons, entities, communities, or interests, other than shareholders in their capacities as shareholders of the corporation, including effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.”    

The name of a public benefit corporation may include the words “public benefit corporation,” “P.B.C.,” or “PBC." Otherwise, the corporation must notify any potential shareholder of its public benefit corporation status before issuing any shares of stock.

The public benefit corporation provisions of the TBOC also include many provisions that corporation’s might view as onerous. For example, two-thirds of the corporation’s shareholders must approve (1) a merger with a corporation that is not a public benefit corporation, or (2) an amendment to the corporation’s certificate of formation to remove its status as a public benefit corporation. Also, at least every other year, the public benefit corporation must provide its shareholders a statement which must include (A) the corporation’s objectives in promoting the public benefit, (B) standards to measure the corporation’s progress toward such public benefit, (C) objective factual information based on such standards, and (D) an assessment of the corporation’s success in meeting its objectives.

The public benefit corporation really goes all in on the concept of benefiting the public. Section 21.953 of the TBOC requires the public benefit corporation’s board of directors to manage the corporation “in a manner that balances: (1) the shareholders’ pecuniary interests; (2) the best interests of those persons materially affected by the corporation’ s conduct; and (3) the public benefit or benefits specified in the corporation’s certificate of formation.” That’s quite a balancing act for any board.

Conclusion:

While any of these types of corporations may be right for you or your particular situation, I would note that a social purpose corporation (i.e., a for-profit corporation with a social purpose) would seem to give the corporation the maximum amount of freedom achieve both profit and social purposes without many of the requirements and restrictions applicable to the public benefit corporation.

Tuesday, September 18, 2018

NVCA Recognizes Importance of Life Science and Bio-Tech

Life sciences and bio-tech companies continue to have a major impact the venture capital landscape.

The National Venture Capital Association (NVCA) provides model legal forms for venture capital investors and entrepreneurs seeking venture capital. The NVCA model forms are the starting point for many venture capital transactions. In a nod to the growing important of the life sciences industry, the NVCA model forms have recently been updated to become more life-sciences friendly.

As the NVCA's press release from February noted: "For the first time, the documents now incorporate drafting options that are specific to the unique nature of life science transactions."

Examples of new life science focused terms and footnotes in the NVCA Model Legal Forms include the following additions to the NVCA's model Stock Purchase Agreement:
  • Noted that life sciences transactions often include "Milestone Closings" with tranched investments in which investors are expected to make additional contributions to the company (such as upon FDA approval).
  • Added potential penalty provisions applicable to investors who fail to fund Milestone Closings.  
  • Noted that the "Use of Proceeds" section may be more specific for life sciences companies and "may include 'discovery, research and pre-clinical development' of a particular therapeutic." 
  • Noted that for life science transactions, it is common to define "Company Intellectual Property" in greater detail with respect to patent rights, including “patent disclosures and all related continuation, continuation-in-part, divisional, reissue, reexamination, utility model, renewals, extensions, certificate of invention and design patents, patent applications, registrations and applications for registrations.”
  • Proposed more detailed representations and warranties regarding:
    • Intellectual property held or funded by the government or academic or medical institutions;
    • Compliance with HIPPA;
    • Pre-clinical development;
    • Clinical trials; and 
    • FDA approvals.

Thursday, September 6, 2018

Who the Heck Signs Our Stock Certificates?

One of the first things a new corporation must do is issue stock certificates to its founding stockholders (assuming the corporation has not elected to issue uncertificated shares, of course). But who should sign the stock certificates on behalf of the corporation?

To answer that question, the corporation should look first to its Bylaws. For example, I often use a form of Bylaws for Texas corporations which provide that the share certificates should be signed by "the President or a vice president and the Secretary or an assistant secretary."

But what do the underlying corporate statutes provide?

The answer is not as easy to find as you might expect. There is nothing in Title 2 (Corporations) of the Texas Business Organizations Code (TBOC) addressing the issue. Instead, one must look to Title 1 (General Provisions).  Specifically, Section 3.203 of the TBOC provides that a Texas corporation's stock certificates must be signed by "[t]he managerial official or officials of [the corporation] authorized by the [certificate of formation and bylaws]." Section 1.002(52) of the TBOC defines "managerial official" as an officer or a governing person. Section 1.002(37) defines "governing person" as a person serving as part of the "governing authority." Section 1.002(35)(A) defines the "governing authority" of a corporation as its board of directors. Accordingly, a Texas corporation's stock certificate may be signed by any of the corporation's officer(s) or director(s) as authorized in the corporation's certificate of formation and bylaws.  I have never seen a certificate of formation which addressed this issue, though it is a hypothetical possibility. So as a practical matter, that means the issue is governed by the Texas corporation's Bylaws. 

Section 158 of the Delaware General Corporation Law is much easier to navigate. It provides that certificates representing shares of stock in a Delaware corporation must be signed by "2 authorized officers of the corporation."