This Practice Guide provides a general overview of private M+A transactions involving frequently encountered issues. It briefly discusses:
- Types of private M+A transactions
- Advantages and disadvantages of a share sale versus asset sale
- The typical process for a private M+A acquisition
- Elements of a Definitive Agreement
- Negotiating process
- Elements of the Negotiation
Other Practice Guides will elaborate on several of these items in greater detail.
As described in the “Mergers and Acquisitions (Canada) – Overview” Practice Guide, merger and acquisition transactions in some cases involve the acquisition or merger of publicly listed or widely held target companies. Others involve the acquisition of shares or assets of a privately held target company.
While public merger and acquisition transactions more often make headlines, there are more private M+A transactions than public M+A transactions completed every year. This Practice Guide provides a general overview of private M+A transactions.
Types of Private M+A Transactions
Most typically, private M+A transactions are effected pursuant to either an Asset Purchase Agreement between an Acquiror and the target company, pursuant to which the Acquiror agrees to purchase, and the target company agrees to sell, assets (often substantially all of the assets of the target company used in carrying on a specific business (or businesses)), or a Share Purchase Agreement between an Acquiror and the shareholders of a target company, pursuant to which the Acquiror usually agrees to acquire all of the issued and outstanding shares of the target company (although in some cases Acquirors do not acquire 100%, and instead wish that the Vendors retain an interest).
Share Sale Versus Asset Sale – Advantages and Disadvantages
Under an Asset Purchase transaction, the Acquiror typically will only agree to assume and become responsible for certain liabilities and obligations of the target company, and leave the target company with certain “retained liabilities” and obligations which the Acquiror does not wish to assume. In general, Asset Purchase transactions are usually more complicated than Share Purchase transactions, often requiring additional documentation and more governmental or other third party consents, approvals or authorizations. There may also be significant different income tax considerations and consequences. For a further discussion of these matters, see the “Share Sale Versus Asset Sale – Key Considerations” Practice Guide.
Private M+A transactions frequently follow the following general process:
- Initial contact between representatives of the prospective Acquiror and the target company. In some cases this follows a process under which the target company has, usually with the assistance of an independent investment banker or other broker, been “shopping itself around” and contacting persons that have been identified as potential prospective purchasers. In other cases a target company might be approached on an unsolicited basis, for example, by a prospective “strategic” Acquiror seeking to determine if the target company might be willing to be acquired.
- The prospective Acquiror and the target company enter into a Confidentiality Agreement or Non-Disclosure Agreement requiring the parties (e.g., the Acquiror) to keep information obtained confidential.
- The prospective Acquiror conducts initial due diligence investigations. Assuming that this initial due diligence justifies a continuing interest on the part of the Acquiror supporting a purchase price that is mutually beneficial, the parties often will enter into a Letter of Intent (“LOI”) or Term Sheet. The Term Sheet or LOI typically sets out key elements of the proposed Acquisition, including the structure of the Acquisition (share sale versus asset sale) and the proposed purchase price, as well as anticipated timing of the negotiation of a Definitive Agreement and the anticipated Closing Date. Letters of Intent are generally expressly not legally binding, except for a limited number of covenants (e.g., “Exclusivity” covenants restricting the target company from soliciting or responding to other acquisition proposals for a limited time period, and confidentiality restrictions, if not already addressed in a Confidentiality Agreement or NDA).
- Once the LOI is entered into, the Acquiror will continue conducting its due diligence investigations. At the same time, (or, in some cases following a short further additional due diligence period) legal counsel for the parties will draft and negotiate the Definitive Agreement for the transaction.
Once the terms and conditions of the Definitive Agreement have been settled, the parties will then:
- in a “Sign and Close” situation, focus on the process of obtaining required third party consents and approvals; legal counsel will prepare required Closing documentation, and the Definitive Agreement will be executed and delivered on the date of completion (“Closing”) of the transaction, in some cases a week or two after the parties have effectively reached an agreement on most substantive terms of the Definitive Agreement; or
- execute and deliver the Definitive Agreement, following which there is a period of time (an “interim period”) during which required third party consents and approvals are obtained and legal counsel prepare Closing documentation, with Closing occurring following this interim period (again, often two to three weeks after the agreement is executed and delivered), but sometimes longer.
- On Closing, the Purchaser will typically pay the purchase price, or a substantial portion thereof, (subject to possible deferrals of some portion of the purchase price, possible escrow holdbacks or a possible “earn out” additional purchase price) against transfer of the shares or assets.
- Often the purchase price at Closing will be subject to a purchase price adjustment, most typically based on a comparison of the estimated amount of the working capital of the acquired business at the time of Closing compared to a target working capital amount. In addition, in effect, the purchase price may be subject to adjustment if the Purchaser may make claims for breach of representations and warranties, or other amounts claimed pursuant to indemnification provisions in the Definitive Agreement.
- In addition, there is often a post closing working capital adjustment based on a comparison of the estimated working capital amount as at the time of Closing and final determination of the actual working capital as at the time of Closing determined within 60, 90, 120 days (as specified in the Definitive Agreement). Once the amount of the purchase price adjustment is determined, either the Purchaser pays an increased purchase price amount, or the Vendor refunds to the Purchaser a portion of the purchase price.
- A Purchaser may submit claims to the Vendor(s) (usually within a 12 to 24 month period) claiming amounts for breaches of representations and warranties, or other obligations indemnified pursuant to Indemnification provisions in the Definitive Agreement. To the extent that the Definitive Agreement provided for an escrow holdback, the amount claimed may be paid out of the escrow funds, following which, at the end of the escrow period, the balance of the escrow funds are paid to the Vendor(s).
A summary of typical items of content in an Acquisition Agreement for a private M+A acquisition will be addressed in another Practice Guide. Following are a few points:
- Complexity. Definitive Acquisition Agreements can range from fairly short and simple (e.g., where the Purchaser already may be a shareholder and familiar with the business; or the dollar value of the transaction is low) to very long, detailed legal documents.
- Not Standard Form. Definitive Acquisition Agreements are not cookie cutter, standard form, “change the names” precedent documents that are mass produced or readily adaptable from one transaction to the next. Instead they are often heavily negotiated, and provisions, including provisions that parties sometimes seek (or hope) to dismiss as only “boilerplate”, vary from agreement to agreement.
- No Boilerplate. As a general comment, very few, if any, provisions in a typical M+A Acquisition Agreement can be dismissed as “boilerplate” that represent standard or “unimportant” provisions. Instead, almost every provision, including provisions often included at or near the end of a long, complex agreement, should be carefully reviewed by all parties and negotiated as appropriate.
- Buyer and Seller Friendly Drafts. It is very common that legal counsel preparing a draft of an Acquisition Agreement (particularly the first draft) will prepare a draft that is “one-sided” and which more fully reflects their client’s interests than the draft that would be prepared by the other party’s legal counsel (or that the same legal counsel would prepare acting for the other party). This typically results in the counsel for the other party having to respond with their own draft, possibly one sided in their client’s interest, and subsequent exchange of “dueling drafts”. While this process may seem inefficient, and it would instead potentially reduce legal fees on both sides if neither side nor their legal counsel prepared a draft agreement which includes provisions which the drafting legal counsel would not, if acting for the other party, agree to, the process reflects how negotiations are most typically conducted. This generally reflects the fact that, as noted above, Acquisition Agreements are not standard form, and instead typically heavily negotiated, with one sided, Buyer Friendly, or Seller Friendly provisions varying from agreement to agreement depending on a variety of factors, including the relative bargaining power of the parties, the differing desire of the parties to complete the deal, as well as the appetite and willingness of the parties to dispute or compromise on specific terms of the agreement.
Typically parties will directly negotiate key terms of the transaction, including the structure (share sale versus asset sale), Purchase Price, form of consideration (e.g., cash or securities of the Acquiror) whether the entire price is payable on Closing, or whether payment of a portion of the price will be deferred, and anticipated (or hoped for) date of Closing.
Often, the parties’ legal counsel will, with input and guidance from the parties, negotiate other terms and conditions, including:
- Representations and warranties, and qualifications thereto;
- The indemnification provisions;
- The indemnification “Basket” amount;
- The indemnification “Cap”;
- Indemnification “Carve Outs”; and
- Holdbacks and escrows.
As many of these matters relate to provisions intended to provide protection to Purchasers, as a general comment, Purchasers often may more readily appreciate the significance of these matters than Vendors. Both Vendors and Purchasers need to understand that these are matters that likely need to be negotiated, and are not simply “legalese” or “boilerplate”, and generally are not matters that legal counsel, rather than the respective parties, can negotiate and agree upon.
Although legal counsel may agree upon many terms, conditions and provisions of the draft Acquisition Agreement, there will often be a number of issues which must be negotiated directly between the parties. This might occur by way of an “all parties” and advisors face to face meeting, or conference call. Resolution of these issues is often achieved by compromise and trading off resolution of one issue for another, or based on the bargaining power and levels of motivation of the parties to ‘get the deal done’.
Other Practice Guides will expand and elaborate of some of the topics discussed above, including specific terms and conditions frequently negotiated between parties in a private M+A transaction, and issues relating thereto.
Elements of the Negotiation
A summary of the various types of provisions frequently included in, and negotiated under, Acquisition Agreements will be included in a separate Practice Guide. Following is a very brief overview.
- Parties. In determining who should be included as a party to the agreement, the parties will need to consider a number of questions. Should the parties to the agreement (e.g. an Asset Purchase Agreement) include the shareholders of the target company? Should principals of a corporate vendor (or shareholders of a target company in an Asset Purchase transaction) be parties? Should shareholders of the target company have to stand behind the representations and warranties regarding the target company on a Joint and Several liability basis?
- Representations and Warranties. The number and extent of representations and warranties that Vendors are required to give is often subject to negotiation and varies between buyer friendly drafts and seller friendly drafts. Also typically subject to negotiation is the extent to which representations and warranties can include materiality qualifications or knowledge qualifications.
- Covenants. Acquisition Agreements typically include covenants by a party to do something or take certain actions (positive or affirmative covenants) or to not do or permit certain actions (negative or restrictive covenants). In general, covenants are typically negotiated by the parties as largely business, rather than legal matters.
- Conditions. Acquisition Agreements often specify various conditions that must be satisfied (or, some cases, waived by the party for whose benefit the condition is inserted) before the parties are obligated to complete the transaction. This generally includes obtaining required third party consents and approvals, the representations and warranties of the other party being true at Closing, and the other party complying with its covenants to be performed before Closing. In some cases Purchasers may seek to include conditions that are wholly or largely within the Purchaser’s control, such as the Purchaser obtaining financing, or completing due diligence to its satisfaction. These may be resisted by the Vendors on the basis that they may effectively convert a binding mutual agreement to a Purchaser’s option.
- Indemnification. Acquisition Agreements often, but not always, include indemnification provisions. In general, indemnification claims by Purchasers against Vendors are more common than claims by Vendors against Purchasers. As a result, Purchasers and their legal counsel often focus on indemnification provisions to a greater extent than Vendors, and seek to impose buyer friendly indemnification provisions. Vendors should not dismiss indemnification provisions as simply being legal “boiler plate”, or reflecting covenants that “are always included”, neither of which is the case.
- Termination Provisions. In private M+A transactions, typically agreements can be terminated by mutual agreement or by either party if the transaction does not close by an agreed “outside” or “drop dead” date. This date is usually shortly after (e.g. one month, or the end of the month) the anticipated Closing date, but may sometimes be longer, depending on whether there may be third party consents or approvals required.
- General or Miscellaneous Provisions. Acquisition Agreements often involve a variety of other provisions, many of which often are towards the end of the agreement. These should not be dismissed as simply representing legal “boiler plate” and should be considered. For example, does an “Entire Agreement” clause negate provisions of a previously signed Confidentiality or Non-Disclosure Agreement? Does it make sense to have an agreement governed by the laws of a jurisdiction which the Purchaser is more familiar with, rather than the laws governing the target company? Should the Purchaser have any right to assign the agreement?
- Schedules. Acquisition Agreements often include various schedules, including Disclosure Schedules pursuant to which the target company lists items referenced in the agreement, or specifies exceptions or exclusions which qualify representations and warranties. In addition, in many cases copies of the forms of other ancillary agreements to be executed and delivered at Closing will be attached as schedules to the Acquisition Agreement.
- Ancillary Agreements. As noted above, it is not uncommon for Acquisition Agreements to include as schedules, or exhibits, forms of ancillary agreements that are intended by parties to be executed and delivered at Closing. These may include employment or consulting agreements with key employees (e.g. principal shareholders of the target company); non-competition and non-solicitation agreements from principal shareholders of the target company; Escrow Agreements under which a portion of the purchase price that is held back will be held in escrow as a potential source to satisfy indemnification claims of the Purchaser; or post Closing purchase price adjustments that may be in favour of the Purchaser; leases of premises (e.g. when a controlling shareholder may own premises that are being leased by a target company), and in some cases there may be a “Transition Services” agreement under which, the target company may agree to provide specified support or administrative services to the Purchaser in relation to the acquired business post closing. The terms of these agreements should not be overlooked, as it is frequently specified that they must be executed and delivered in the form, or in “substantially” the same form attached, such that there may be limited ability to negotiate changes after execution of the Acquisition Agreement.
A private merger and acquisition transaction is indeed an adversarial process. Typically, Acquisition Agreements are not at all standard form, “off the shelf,” precedent documents. Successful negotiation and completion usually involves a significant commitment on the part of the parties to work through complex issues with their counsel and, where necessary and appropriate, fight for the positions necessary to properly protect their interest.
Typically, both parties to an Acquisition transaction have no difficulty focusing on negotiation of the key terms, such as the purchase price and timing and manner of payments. Unfortunately, many of the toughest negotiations arise in relation to more technical or complicated legal issues. Parties cannot dismiss or overlook these issues and must be prepared to negotiate them as well.