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.

J.R. Ewing -Types Continue to Vex Courts and Corporate Law

Since the dawn of our legal system, courts have had to deal with the problem of the sneaky contracting party (think: J.R. Ewing from tv's "Dallas" - or to cite a more recent example, Rumpelstiltskin from tv's "Once Upon a Time").  You know the type - someone who tricks another party into signing a contract - only after signing the contract does the other party learn further information which, had it been disclosed at the time, the other party never would have agreed to the deal terms in the contract.

On the one hand, courts like to uphold contracts freely entered into by parties which are otherwise legally enforceable.

On the other hand, courts hate to permit contracting parties to get away with fraud or otherwise sneaky behavior.

I've blogged about this issue before here when the Texas Supreme Court tackled the case of the stinky restaurant. In that case, the court came out on the side of the duped tenant whose landlord failed to disclose that the space they were renting smelled like sewer gas.

Two recent corporate law cases decided in Delaware Chancery Court highlight this ongoing tension.

In Prairie Capital III, L.P. v. Double E Holding Corp., the court considered a case in which a company was sold based in large part upon falsified monthly sales information created by the seller. Unfortunately for the buyer, the stock purchase agreement included two key provisions: (1) one in which the buyer confirmed that it was relying exclusively on its own due diligence and the seller's representations and warranties in the agreement itself, and (2) a standard integration provision in which the parties agreed that the stock purchase agreement was the entire agreement of the parties (i.e., there were no oral agreements, side deals, etc.). Fortunately for the buyer, the seller also breached some expressed representations and warranties in the agreement itself, so the buyer's case was able to proceed against the seller on other legal theories.  Nonetheless, the court concluded that so-called extra-contractual misrepresentations by the seller could not be the basis of a fraud claim by the buyer. In the court's view, the buyer had adequately disclaimed reliance on any such extra-contractual statements, even though the buyer did not use any particular "magic words" to do so.

In FdG Logistics LLC, v. A&R Logistics Holdings, Inc. the court considered a case with almost identical facts as the Prairie Capital case but reached the opposite result - the buyer was permitted to pursue fraud claims against the seller. In that case, the seller was alleged to have made extra-contractual misrepresentations (i.e., misrepresentations other than those explicitly set forth in the representations and warranties section of the purchase agreement) in documents provided to the buyer during the due diligence period before the merger agreement was signed. Even though the merger agreement in question included a statement from the seller that it was not making any representations or warranties other than those explicitly set forth in the agreement itself and there was a standard integration (entire agreement) provision, the court ruled that there was not a clear disclaimer of reliance by the buyer in the merger agreement. Without such a clear disclaimer of reliance by the buyer, the buyer's fraud claims could proceed. The court admitted that it was splitting hairs, noting that statement by the seller that it is exclusively making certain representations and a statement by the buyer that it is exclusively relying on such representations seem "like two sides of the same coin." Nonetheless, because courts hate to permit parties to get away with fraud, it will only find an adequate disclaimer of reliance by a victim when such disclaimer is crystal clear.

It is easy to see the tension at work in these types of case. Courts want to allow sophisticated and well represented parties to set the terms of their own deals - and tailor the scope of the relevant representations and warranties upon which the parties relied. That sort of flexibility keeps parties from endlessly claiming to have relied upon all sorts of statements made outside of the contract itself. On the other hand, courts don't like the idea of rewarding those who commit fraud for their dishonesty and underhanded tactics, such as failing to disclose material facts that fall outside the scope of the representations and warranties in the agreement itself but are nonetheless important to the other party.    
                
Takeaways:

The takeaways here are fairly obvious:

• If you are a buyer and you relied upon a particular piece of information received from the seller in making a decision to enter into a transaction, you'll want to have the agreement say so explicitly in the seller's representations and warranties in the agreement itself. Then, you won't have to worry about whether or not the court will tolerate extra-contractual misrepresentation or fraud by the other party in your particular case.
• If you are a seller, and wish to minimize your exposure for alleged extra-contractual misrepresentations, you'll want to include an explicit disclaimer from the buyer of reliance on any other statements from the seller other than those in the agreement itself. And after FdG Logistics, we now know that such disclaimer should be written such that it reads as a statement from the buyer's perspective disclaiming reliance, not just a statement from the seller that it is not making any other representations or warranties.  And even though courts often claim they aren't looking for any particular "magic words," sellers should seek to include the magic words "disclaim reliance" on other statements of the seller or seller's representatives. PUTTING THE DISCLAIMER OF RELIANCE IN BOLD AND ALL CAPS IS ALSO A GOOD IDEA. 

But regardless of how carefully contracts are drafted by the parties, society will always have parties seeking to game the system by complying with the letter but not the spirit of agreements, and courts will have to decide whether to let them get away with those games or not.

The Divisive Merger: A Powerful Tool in Texas

What the heck is a divisive merger?

A divisive merger is a merger involving splitting up one company up into two or more new companies.

It's a potentially powerful tool available to Texas companies under the Texas Business Organizations Code (TBOC).  And it's a tool that is not available in most other states, including Delaware.

The concept of the divisive merger is baked into the definition of the word "Merger" in Section 1.002(55)(A) of the TBOC, which defines "Merger" to include, among other transactions, "the division of a domestic entity [such as a Texas LLC or Texas corporation] into two or more new domestic entities or other organizations or into a surviving domestic entity and one or more new domestic or foreign entities or non-code organizations."

So why is a divisive merger so powerful?

Let's say you and another person own Texas Widgets, Inc., a Texas corporation that does business in two Texas cities - Dallas and Fort Worth.  Now say you wish to split the business in half, with one shareholder taking the Fort Worth operations (which will continue in business as Cowtown Widgets, Inc.) and the other partner taking the Dallas operations (which will continue in business as Big D Widgets, Inc.).  You'll just assign half of the company's assets to one shareholder or the other, right? But wait - what if one or more of the company's leases, permits, licenses, contracts or other instruments setting forth the company's legal rights include non-assignment provisions that prohibit the company from conveying rights from Texas Widgets to Cowtown Widgets or Big D Widgets?  Is the split-off transaction doomed without getting the consent of the company's landlord(s) or other parties?  Maybe not.  Depending upon the exact language prohibiting assignment in the contract or other document, the company may be able to enter into a divisive merger to split up the company's assets without triggering the anti-assignment provisions which would otherwise require the company to obtain another party's consent. If a company merges, technically no assignment has taken place - legally, it is as if the surviving company always owed the asset or other legal rights.

Even if your company is not a Texas entity, you might be able to convert or merge your company into a Texas entity, then take advantage of the divisive merger statute to complete a transaction with similar hurdles to overcome.

And there may be other situations where a divisive merger makes sense - perhaps where taking the time, effort, and expense of conveying individual assets might be unduly costly (such as conveying dozens of working interests in oil and gas properties in numerous counties throughout Texas). A merger might be able to immediately vest title to assets to a newly merged company as a short-cut to individually conveying a series of individual assets.    

Although the divisive merger can be a valuable tool, it can also be a sword used against you by savvy operators.  So when drafting anti-assignment provisions in business contracts, you might consider if the other party might be able to use a divisive merger as an end-run to a anti-assignment provision that permits mergers but not assignments by the other party.

Time to Sell: Five Tips

Thanks to FW inc. ("Greater Fort Worth's Premier Business Magazine") for publishing an article I wrote on preparing to sell your business.  The article is available here.

Talking Two-Step Tender Offer Transaction Techniques for Texas Targets

Are we living in the Golden Age of the two step tender offer acquisition technique?  Probably so - last year, the process got a whole lot easier for buyers seeking to acquire publicly traded M&A targets incorporated in Texas.

What is Two Step Tender Offer?

A buyer seeking to acquire all of a public company (a Target) may either:
(1) propose a one-step merger - which generally must be approved by the Target's shareholders; or
(2) propose a tender offer - in which case the buyer offers to buy at least a majority of the Target's shares (STEP 1); followed by a "squeeze-out" merger in which a successful vote of the Target shareholders is already assured (because that was the minimum number of shares purchased in the tender offer) (STEP 2).

Historic Second Step Merger Thresholds Requirements

Historically, both the Delaware corporate law (Section 253 of the Delaware General Corporation Law (DGCL)) and Texas corporate law (Section 10.006 of the Texas Business Organizations Code (TBOC)) required that the buyer acquire at lease 90% of the Target shares after the tender offer in order to enter into a short-form merger.  Qualifying for short-from merger treatment was important because the short-form merger did not require a vote of the Target shareholders. It was presumed that such a vote would be meaningless because 90% of the shareholders would doubtlessly vote to approve the merger.

Shareholder merger votes cost time and money because state corporate law and SEC proxy voting rules require the preparation or a detailed disclosure document, an SEC review, and distribution of the disclosure document to the Target's shareholders.  

New Second Step Merger Threshold Requirements

Eventually, Delaware realized that a merger vote by the Target's shareholders would be equally meaningless if the buyer acquired at least a majority of the Target shares (or whatever the minimum number of shares otherwise necessary to approve a long-form merger under the DGCL and the corporation's certificate of incorporation).  So in 2013, Delaware adopted a new subsection (h) to Section 251 of the DGCL which permits the buyer to merge with a publicly traded Target (or a Target with more than 2,000 shareholders) following a tender offer under certain conditions.

Effective September 1, 2015, the State of Texas adopted new sub-sections (c), (d) and (e) to Section 21.459 of the TBOC, thereby granting public companies formed in Texas the right to merge without a shareholder vote following a successful tender offer.  The (relatively) new Texas rule is substantially similar to Section 251(h) of the DGCL.

Why do buyers like Two Step Tender Offers?

Simply put, a two step tender offer is a whole lot faster and cheaper than an acquisition via a traditional one-step merger, especially when the buyer is paying cash (rather than stock) to the Target's shareholders. This is because the SEC review process is generally more limited and more expedited for a tender offer than it is for a one-step merger.

According to a recent a survey conducted by the M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee of the Business Law Section of the American Bar Association (ABA), from the announcement of a public M&A deal until the closing of the deal, the average cash tender offer takes 49 days, the average stock tender offer takes 54 days, the average cash merger takes 129, and the average stock merger takes 199 days.  (Thanks to Richard E. Climan, Joel I. Greenberg, and Claudia K. Simon for providing the survey data in a recent webcast sponsored by the ABA).  

What are the requirements to use the Two Step Tender Offer?

In order for a buyer to take advantage of Section 21.459(c) of the TBOC to obtain a shareholder vote waiver following a tender offer, certain conditions must be met, including the following:

1. The Target's certificate of formation cannot prohibit merger without a shareholder vote;
2. The Target's shares must be listed on a national securities exchange or held of record by at least 2,000 shareholders;
3. The plan of merger must expressly: (A)  permit or require the merger to be effected under Section 21.459(c) of the TBOC; and (B) provide that the merger be effected as soon as practicable following the consummation of the tender offer;
4. The tender offer must be for all of the outstanding voting shares of the corporation on the same terms provided in the plan of merger, except that the offer may exclude shares owned by: (A)  the Target corporation; (B) the buyer; (C) any person who owns, directly or indirectly, all of the ownership interests in the buyer; or (D) any direct or indirect wholly owned subsidiary of any of the foregoing persons;
5. The buyer must acquire in the tender offer (together with shares held prior to the tender offer) a number of shares of the Target equal at least the percentage of the shares that, absent Section 21.459(c), would be required to approve the plan of merger under both: (A) the TBOC (generally, two-thirds (2/3) of the shares); and (B) the certificate of formation of the Target;
6. The buyer must merges with or into the Target pursuant to the plan of merger; and
7. Each outstanding share of the Target not purchased in the tender offer must be converted or exchanged in the merger into the same consideration as those selling in the tender offer.

Kudos to the Texas Legislature for following Delaware's lead in modernizing the two step tender offer rules for Texas Targets.

“Take It to the Limit” in your next M&A Deal

Thanks to Fort Worth Business for publishing my M&A article on its website here. In the article, I use Eagles lyrics as a jumping off point to discuss key lessons for folks involved in merger or acquisition transactions.  The best part of writing the article was spending an afternoon listening to Eagles Radio on Pandora to "research" this project.  I hope you have as much fun reading it as I did writing it.

Rest in Peace(ful Easy Feeling), Glenn Frey.

M&A and the Wisdom of Seinfeld - Vol. 2

George Costanza: That's why I'm different. I can sense the slightest human suffering.
Jerry Seinfeld: Are you sensing anything right now?

This is my second blog post in my occasional series on "M&A and the Wisdom of Seinfeld."  You can read my first blog on knowledge qualifiers here.  I'm a big believer in the notion that practically every aspect of our lives has been commented upon in a Seinfeld episode!

The exchange between George and Jerry above is a great example of the importance and utility of materiality qualifiers in an M&A transaction.  Materiality qualifiers help ensure that parties to an M&A transaction aren't unduly damaged by the slightest suffering.  Let me explain.

Let say BigCo wants to acquire TargetCo and the parties enter into an asset purchase agreement (APA) with a purchase price of $50 million. The APA includes numerous representations and warranties by TargetCo, including a representation that TargetCo's financial statements are true and correct in all respects.  Suppose also that one of BigCo's conditions to closing the APA is that all representations and warranties of TargetCo are true and correct in all respects. Finally, let's suppose the indemnification provisions of the APA permit BigCo to sue TargetCo for the breach of any representation or warranty, whether or not BigCo knew about the breach prior to the closing.  

Now assume that after the APA is signed but before the transaction closes BigCo determines that the amount of cash on TargetCo's balance sheet was misstated by $2.37.  Under a strict reading of the APA, BigCo can now weasel out of the deal and refuse to close!  One of TargetCo's representations and warranties was false, so one of the conditions to BigCo closing the deal cannot be satisfied, and BigCo can walk.

Suppose instead that TargetCo had represented and warranted only that its financial statements were true and correct "in all material respects."  Or suppose the closing condition only required representations or warranties to be true and correct in all material respects.  In either case, arguably the $2.37 misstatement would be deemed immaterial in the context of a $50 million transaction, and if BigCo wanted to walk the deal, it would be forced to try to find another reason to do so. 

Likewise, if TargetCo had added a materiality qualifier to the representation and warranty regarding the accuracy of its financial statements, or if the indemnification provisions of the APA included a materiality qualifier, TargetCo could avoid being sued for a breach of the APA as a result of the financial statement error (again, assuming the $2.37 misstatement was indeed immaterial with respect to the transaction).             

M&A and the Wisdom of Seinfeld

George Costanza: "Jerry, just remember, it's not a lie if you believe it." 

Today I'm starting a new feature on this blog called "M&A and the Wisdom of Seinfeld." We'll explore some of my favorite quotes from the greatest sitcom of all time, Seinfeld, and how those quotes provide (perhaps unexpected) insights for lawyers and other professionals involved in merger and acquisition transactions.

George Costanza's advice to Jerry Seinfeld (quoted above) which guides Jerry in attempting to fool a lie detector test is a great example of knowledge qualifiers and how they can be used in an M&A agreement.

Among the most negotiated portion of any M&A transaction agreement is the representations and warranties section. The buyer typically asks the seller to provide a laundry list of promises (i.e., to represent and warrant) that certain facts are true about the seller's company.  For example, the buyer might ask the seller to promise that the seller's company has complied with all applicable environmental laws.  The seller might strike that representation from the initial draft of the M&A agreement arguing: "I'm pretty sure I haven't violated any environmental laws, but what if it turns out that I have - I don't want the buyer to be able to sue me or to walk from the deal if the buyer's due diligence activities identify an environmental issue that I never even knew about."  The buyer might be sympathetic to the seller's concerns, but the buyer wants the seller to disclose any environmental issues known to the seller.  Thus, the parties might compromise by changing the representation to read something like: "To the best of seller's knowledge, the company has complied with all environmental laws."

Notice how George's maxim "It's not a lie if you believe it" comes into play here.  If the seller truly believes that the seller's company has complied with all environmental laws, even if as a matter of fact the seller's company has violated dozens of environmental laws, the seller will not be liable under the knowledge qualified representation at the end of the previous paragraph.

Of course, just because the parties have agreed to include a knowledge qualifier doesn't mean the matter is completely resolved.  The buyer might insist that "knowledge" of the seller should include a duty to reasonably investigate the truth of the underlying representation before the seller can rely upon the knowledge qualifier.  On the other hand, the seller might argue that "knowledge" of the seller should mean only the seller's "actual knowledge," without any duty to investigate. The parties might also argue who's "knowledge" should be deemed to be included in the definition of seller's knowledge.  For example, what if a low level employee of the seller's company knew the company had violated environmental laws, but that employee never reported the violation to the seller's company's officers and/or directors - should the seller be deemed to know about anything any of the seller's company's employees knew or only a handful of the seller's company's most senior executives?

As you can see, there are many issued to be considered and resolved regarding knowledge qualifiers before one can accurately state that "It's not a lie if you believe it."

Buyer Beware: Texas Comptroller Certificate of No Tax Due

If you are buying the assets of a Texas business (but not assuming any of its liabilities), you cannot be held liable for any of the business's liabilities, correct?

Wrong. A potential source of successor liability for the purchaser of a business is Section 111.020 of the Texas Tax Code.

If a business or stock of goods (inventory) of a business is sold, the purchaser will be liable for the seller’s taxes due to the Texas Comptroller’s office (such as sales, excise, use and franchise taxes), unless the purchaser withholds a portion of the purchase price equal to the amount the seller owes to the Texas Comptroller’s office (including, if applicable, any interest or penalties thereon). 

Fortunately, the purchaser of a business may protect itself from successor liability under Section 111.020 of the Texas Tax Code by requesting that the Comptroller issue a certificate stating that no tax is due from the seller.  Surprisingly enough, that certificate is called a "Certificate of No Tax Due"!

The Comptroller must issue the Certificate of No Tax Due (or a statement setting forth the amount of taxes due) within 60 days after receiving the request (or within 60 days of the seller making its records available for audit), but in either event within 90 days after the date of receiving the request.

The Texas Comptroller’s office has a useful guide to Certificates of No Tax Due called “Tax Information:  Buying an Existing Business” which is available here.

Introducing the M&A Broker

What is an m&a broker?  It is a new term recently introduced by the Securities and Exchange Commission (SEC) to describe a business broker who may be involved in private company merger and/or acquisition transactions involving stock without registering as a broker-dealer. This is great news for unregistered business brokers and the small, mid-sized and family owned privately-held companies that they typically represent.

Previously, business brokers were required to be registered with the SEC if they were in the business of effecting transactions in securities, such as the sale of stock.  However, there is no SEC registration requirement to serve as a broker in the sale of assets.  So under the prior law, an unregistered business broker could earn a commission on the sale of 100% of a business’s assets, but could not earn a commission for the sale of 100% of the same business’s stock. Many felt that different treatment for stock deals and assets deals made little sense. The old rules often required buyers and sellers to structure transactions as a sale of assets, even in cases when a sale of stock would make more sense for the buyer and seller from the standpoint of tax, accounting, regulatory or other considerations.

On February 4, 2014, the SEC came to the relief of unregistered business brokers and their clients by issuing a no-action letter creating the m&a broker exemption from SEC broker-dealer registration requirements. A copy of the no-action letter is available here. The m&a broker exemption permits unregistered business brokers to be involved in transactions involving the sale of control stock of a privately-held company to a buyer who will actively control the business.  The transaction may be structured as a merger, acquisition, business sale or business combination.  There is no dollar limit on the size of the private company that may be involved in the transaction.  There are other restrictions on use of this exemption set forth in the no-action letter, including that the broker may not bind either party, provide financing for the transaction or handle funds.

Easing the regulatory burden on business brokers should result in brokers bringing more buyers and sellers to each other’s attention, thereby facilitating the closing of more business transactions, which in turn should result in fairer prices and greater liquidity for business owners seeking to sell their company.      

2013 ABA Deal Points Study

The 2013 Private Target M&A Deal Points Study has been released by the M&A Market Trends Subcommitte of the Mergers & Acquisitions Committee of the Business Law Section of the American Bar Association.  It's available to members of the Business Law Section of the ABA here.

I've blogged about the value of the Deal Points Study before here.  In fact, that has been one of my most popular blog posts based upon number of pageviews.

The 2013 Private Target M&A Deal Points Study reviewed 136 publicly available purchase agreements for acquisitions of private companies by public companies completed in 2012.  The transaction sizes in the study ranged from $17 million to $4.7 billion, with an average transaction size of $305 million and a median transaction size of $150 million.  The study analyzed a few dozen frequently negotiated deal points with a goal of being able to provide some guidance on "what's market."

For example, a few of the study findings are as follows:

• 64% of the purchase agreements in the study included a representation from the target company similar to the SEC's Rule 10b-5, such as: "No representation or warranty or other statement made by [Target] in this Agreement, the Disclosure Letter, any supplement to the Disclosure Letter, the certificates delivered pursuant to this Agreement, or otherwise in connection with the Contemplated Transactions contains any untrue statement of material fact or omits to state a material fact necessary to make the statements in this Agreement or therein, in light of the circumstances in which they were made, not misleading."  That is up dramatically from 32% in the 2008 Deal Points Study.

• 19% of the purchase agreements in the study required a legal opinion from target's counsel.  That's down from the 58% of the deals in 2008 that included such a requirement.

• 83% of the purchase agreements in the study provided that the representations and warranties would survive the closing for a period of between 12 and 18 months.  The most popular survival period length was 18 months (44%).

• 89% of the purchase agreements included caps on indemnification obligations.  Of those agreements with caps, 89% of those agreements included caps at or below 15% of the purchase price.

As always, thanks to the hard-working members of the M&A Market Trends Subcommittee for gathering the valuable information provided by the survey.

How Much Is My Business Worth?

How much can you sell your business for?  Well, that depends on many factors, including historic revenues, profit margins, cash flow, industry trends, customer loyalty, availability of potential buyers and their access to capital, barriers to entry by competitors, and a host of other factors.  If you are serious about selling, you should certainly consult with an experienced business broker-dealer or similar certified professional.  That said, here are a few interesting data points from a recent Dallas Business Journal article (citing BizBuySell.com).  On average, Dallas-Fort Worth small business owners selling their business have an asking price equal to:

• 90% of their annual revenues; and
• 3.28 times their annual cash flow.

The median small business sales price for small business in DFW listed on BizBuySell.com was $223,000. Food for thought.   

Thanks for reading this blog in 2013.  Hope everyone has a healthy and prosperous 2014!

M&A Deals Under Siege

One of my favorite movies is Under Siege, the film in which Steven Segal portrays Casey Ryback, a Navy cook and former Navy Seal forced into action to save a U.S. battleship from a terrorist takeover led by Tommy Lee Jones. As much as I loved that movie, I was shocked to learn that it was actually nominated for two Academy Awards! See http://www.imdb.com/title/tt0105690/awards. 


Anyway, I couldn't help but think of Under Siege when I read the following statistic in The Economist magazine.  96% of M&A transactions over $500 million faced legal challenges in 2011.  That's up from 39% in 2005.  Thus, any party to a significant M&A transaction should expect to be sued.  That's why it is critical that the board of directors of any company undertaking an M&A transaction carefully plan the transaction process to ensure a fair process and a fair price for the target's shareholders.  That planning should include engaging experienced bankers and transaction lawyers to help walk the company through a process that should be expected to be reviewed and second-guessed in a courtroom after the deal is announced.   

ABA's M&A Deal Points Study

The Mergers & Acquisitions Market Trends Subcommittee of the Mergers and Acquisitions Committee of the American Bar Association Business Law Section (I dare you to say that name five times fast!) has released its 2011 Private Target Mergers & Acquisitions Deal Points Study (For Transactions Completed in 2010).  It's available to members of the ABA's M&A Committee here: http://apps.americanbar.org/dch/committee.cfm?com=CL560003.  Dallas's own Wilson Chu co-chairs this project.

The annual Deal Points Study contains a tremendous amount of valuable information for M&A participants regarding deal terms actually negotiated in transactions which are publicly disclosed.  This year's survey looked at 100 acquisitions of private companies by publicly traded buyers with transaction values between $25 million and $960 million which were completed in 2010.

The beauty of the Deal Points Study is that it gives the deal lawyer something tangible to point to when arguing that a particular deal point is (or is not) "market."  For example, let's say the buyer in an M&A transaction is demanding a "full-disclosure" representation and warranty from the seller, which would provide that, in addition to the reps and warranties specifically set forth in the acquisition agreement, the seller must also promise that the seller is not aware of any other material fact about the business that has not been disclosed to the buyer.  The buyer and its counsel will likely argue that such a full-disclosure rep is one they "always" get from sellers and what is typical in the "market."  The seller and its counsel will probably take the opposite position.  A seller armed with the Deal Points Study could point out that 63% of the deals closed in 2010 excluded such a full-disclosure rep.  While that won't end the debate, it's certainly more persuasive than a general comment such as: "That's not what we've been seeing in the market."
   

Is Going Public a viable Exit Strategy?

When I began practicing securities law in the late 1990's, it was the golden era of public offerings.  It seemed anybody with a hot idea and a Silicon Valley address was taking their company public.  That's no longer the case.  The Great Recession has really put a damper on the number of public offerings generally, and initial public offerings in particular.  According to the September issue of Inc. magazine, only 67 companies have gone public so far this year in the United States, 109 went public in 2010, and only 48 went public in 2009.  Accordingly, shareholders of private companies seeking a near-term exit strategy should generally be thinking of a sale in a privately negotiated M&A transaction rather than tapping into the public equity markets. 

More Caddy Shack Quotes

As noted in a prior blog post: (See http://www.northtexasseclawyer.com/2011/08/caddy-shack-m-article-publiched-in.html),
my article identifying M&A guidance from Caddy Shack's Judge Smails has been pretty popular, so I thought my readers might enjoy a few more quotes from everyone's favorite golfing judge.  These quotes were edited out of the article published in the Dallas Business Journal to meet its word count limits, but that doesn't make these quotes any less entertaining. Here they are:

“Well, we're waiting!”

Just as every golfer has felt the frustration of waiting for another golfer to swing their club, every veteran of merger and acquisition transactions has felt the frustration of waiting for the all of the parts of the transaction to come together for a closing.  Typically, many parties are involved in an M&A transaction, including buyers and sellers, lawyers, bankers, accountants, appraisers, title companies, and potentially many others.  The deal may need to be approved by boards of directors, shareholders, creditors, landlords, regulatory authorities, or others.  Thus, you may find yourself waiting on any number of deal participants.  An experienced M&A lawyer prepares a detailed closing checklist, anticipates and addresses potential bottlenecks that might delay closing, politely but persistently reminds other deal participants of their responsibilities, keeps the deal moving forward, and keeps the client informed on the status of the transaction.     

“Oh, Porterhouse, look at the wax build up on these shoes.  I want that wax stripped off there, then I want them creamed and buffed with a fine chamois, and I want them now.  Chop, chop.”

A seller in an M&A transaction should scrub up its business records with the same zeal that Judge Smails expects Porterhouse to apply to shining shoes.  A well represented buyer is going to conduct detailed due diligence review during which the seller’s problems are likely to come to light.  It is much better for the seller, and the seller’s reputation, if any bad news comes from the seller rather than as a result of an audit by the buyer’s accountants or other representatives of the buyer.  The seller will want to put the seller’s best foot forward.  That means business records should be as complete, accurate, and organized as possible.  And of course, the seller can make Judge Smails happy by assuring that its business records are free of wax build up.

“I've sentenced boys younger than you to the gas chamber.  Didn't want to do it.  I felt I owed it to them.”

When things go badly for the target of an acquisition after the closing, the buyer may share Judge Smails’s sense of moral obligation with respect to the seller.  For example, the buyer may refuse to pay the seller the earn-out portion of the purchase price if profits fall short of expectations.  As the buyer learns more about the target company and its operations after the closing, the buyer often becomes aware of breaches of the seller’s representations and warranties.  Like Judge Smails, the buyer may feel it owes it to the seller to sue and seek indemnification from the seller under the purchase agreement.

Judge Smails: “Do you mind, sir. I'm trying to tee off.”

Al Czervik: “I'll bet you a hundred bucks you slice it into the woods.”

Judge Smails: “Gambling is illegal at Bushwood sir, and I never slice.”

Too often, sellers take too little time reviewing the representations and warranties in an M&A purchase agreement because they think their company is “clean” or the target company has “never had a problem.”  Like Judge Smails, sellers think they will never slice.  But guess what?  There is a first time for everything.  And with new management of the target company after the sale, sometimes new problems emerge or old problems are uncovered.  When that happens, the seller will be glad if the seller carefully reviewed the representations and warranties and reasonably limited the representations and warranties with qualifications as to the seller’s knowledge and materiality.  Failure to carefully review the representations and warranties and related disclosure schedules in a purchase agreement can truly be a gamble for the buyer or the seller.    

Caddy Shack M&A Article published in Dallas Business Journal

I have received a lot of positive feedback for an article I wrote which was published in the July 22 issue of the Dallas Business Journal.  It was titled "Acquiring Knowledge: Don't let your M&A deal end up in the rough." Based on the premise that everybody loves quotes from the movie Caddy Shack, the article takes several quotes from Judge Elihue Smails and explains how they apply to merger or acquisition transactions.  In case you missed it, here is a link to the article: http://www.canteyhanger.com/content.php?page=news&newsid=165

Special thanks to the Dallas Business Journal for publishing my work.

Drafting Tip: Indemnified Affiliates or Third Party Beneficiairies?

Can a party be an indemnified affiliate of a contracting party but not a third party beneficiary of that contract?  A recent New York case (Diamond Castle Partners IV PRC, L.P. v. IAC/InterActiveCorp, 2011 N.Y. App. Div. LEXIS 1542 (2011)) highlights an interesting legal drafting issue that comes up often in deal documents. 

Diamond Castle is a private equity fund that formed an acquisition vehicle, Panther, to acquire the equity of another company, PRC, for $286.5 million.  Immediately after the closing, Panther was merged into PRC.  The purchase agreement included two arguably contradictory statements:

(1) The seller, IAC, would indemnify Panther and all of its affiliates for any breaches of the purchase agreement; and

(2) There are no third party beneficiaries of the purchase agreement. 

So when Diamond Castle, an affiliate of Panther, sought indemnification for an alleged breach under the purchase agreement, IAC argued that statement (2) above controlled.  Obviously, Diamond Castle argued that statement (1) controlled.

The New York court agreed with Diamond Castle, reasoning that the only logical reading of the agreement was that affiliates of Panther were intended to be indemnified and that such indemnified parties were therefore not "third parties" for the purposes of statement (2).

Regardless of the results in this particular case, drafters of purchase agreements can remove any ambiguity on this point by more careful drafting.  When drafting agreements, consider including a carve-out to the "no third party beneficiary" provision to specifically except third parties indemnified under other provisions of the agreement.

Special thanks to Jonathan P. Gill, Michael C. Hefter, and Kelly Koscuiszka of Bracewell & Giuliani LLP who brought the Diamond Castle case to my attention.

Representations and Warranties

 "Why do we have to have all these Representations and Warranties?" 

That is a common complaint in merger and acquisition transactions (and other transactions for that matter).  For example, a 75-page purchase and sale agreement might have 30 pages of reps and warranties in which the seller certifies various facts about the seller's company. 

The Seller's reps and warranties serve at least three important functions in a purchase and sale agreement:

(1) They serve a disclosure function.  By asking the seller to rep and warrant facts about the seller's company, the buyer learns valuable information about what may be less-than-perfect about the seller's business.  For example, if the purchase and sale agreement asks the seller to rep and warrant that the seller's company has no pending litigation, the seller would (or at least should) disclose that the seller's company has just been sued by one of its largest customers.

(2) They give the buyer an "out" to avoid closing.  The purchase and sale agreement typically provides that the deal will not close unless all of the seller's reps and warranties are true and correct in all material respects as of the signing date and as of the closing date.  Therefore, if the buyer becomes aware of an inaccurate rep or warranty during its pre-closing due diligence period, the buyer may be able to refuse to close the deal or may be able to demand concessions from the seller prior to the closing.  For example, if the buyer learns before the closing that the seller's company has spilled hazardous materials on one of its properties that was not disclosed by the seller in the purchase and sale agreement, the buyer might request a reduction of the purchase price. 

3) They give the buyer the right to sue the seller.  If the purchase and sale agreement provides that the seller's reps and warranties "survive" the closing, then the buyer can typically sue the seller for breach of contract during such survival period if the buyer can prove that one or more of the seller's reps and warranties was inaccurate as of the closing date. 

Of course, no seller likes to make pages and pages of representations and warranties, but those reps and warranties are typically critical to a buyer to assure the buyer is really getting the company that the buyer expects.