Originally appeared in "Inside The Minds" - Mergers & Acquisitions Best Practices, published by Aspatore Books*
This chapter will focus on the sale of private companies from the seller’s perspective, and those things the seller’s counsel can do to contribute to a good result efficiently achieved.
The essence of the role played by seller’s counsel is to act as the principal manager of the transaction. If an investment banker is involved, this role is shared with the banker. In order to serve in this capacity effectively, it is essential to have the confidence of the board and senior management and to know how to communicate well with both groups.
If your first involvement with the company is in connection with the sale, the initial meetings that are part of an engagement process can be a great opportunity to begin to build that relationship, particularly if you use them to explain your approach to communication, drafting, and negotiations. Anecdotes from prior deals can provide good illustrations. Discussion of issues that might cause concern among buyers can be used to demonstrate your approach to managing a transaction and preparing for potential problems.
Once you are engaged in the transaction, it is a good discipline to prepare a written situation analysis. This should follow discussions with the company organized around a good due diligence checklist. The goal is to identify all the items a thorough buyer’s due diligence might identify as areas for special attention. This preparation can pay significant dividends in running a smooth process and creating maximum confidence in potential buyers that they understand the variables that might affect future performance. Each time a buyer is faced with an issue that is not well understood, they will apply a confidence range to assumptions in their models of future performance that will exert a downward pressure on proposed pricing. The situation analysis should then be used to create an action plan. This plan and its implementation will enable you to deepen your relationships with members of the transaction team.
This same time period should also be used to develop a common set of expectations with the management team regarding transaction timing, resource needs, and likely risk allocation mechanisms. The role of the disclosure schedules in limiting the exposure of the company’s shareholders for breaches of representations and warranties needs to be well understood so adequate resources will be applied to the task. Given the need to operate the business while pursuing the transaction, there will be extraordinary pressure on the management team. The earlier they understand what is required, the more successful they will be in supporting the transaction process.
Working from the diligence checklist, counsel and the management team need to organize a comprehensive set of diligence materials for review by potential bidders. In the past, paper data rooms were the typical way for materials to be made available. Technology has now provided a superior solution. Virtual data sites, which make diligence materials available over the Internet to large numbers of simultaneous users with extensive control and security features, have many advantages over paper-based data rooms. These advantages are particularly pronounced when many bidders are taken into the diligence process, key bidder personnel are located at diverse locations, or a large volume of diligence materials is being made available. There are several commercial products you can compare. The Datasite product of Merrill Corporation and the Intralinks product of RR Donnelly are two good examples.
As the due diligence materials are assembled, it is important to have appropriate specialists in areas such as employee benefits, taxes, environmental regulation, and intellectual property review these materials in order to assist in the preparation of disclosure schedules and to prepare for the follow-up questions of potential buyers. For a transaction involving the sale of a large business or large potential buyers, it is not unheard of for thousands of questions to be submitted to the transaction team. It is also important to establish what third party and governmental consents and filings will be required. If left unattended, these filings and consents can create delay or additional expense or, in the worst case, inability to close or impact on transaction price. In addition to Hart-Scott-Rodino antitrust filings, which are frequently required due to transaction and participant size but rarely a problem, businesses that operate in regulated industries or that involve matters of national sensitivity such as defense technology or services, should be carefully reviewed for such requirements. Inside the Minds
If the seller is going to propose an initial draft of the acquisition agreement, which is typical in a process that involves a broad solicitation of potentially interested parties, there are important decisions to be made about the overall approach taken in the draft. There are two schools of thought on this subject. One is to provide a barebones seller-favorable draft and see what the potential buyers do in response. The other approach is to provide a more comprehensive draft that is closer to where you would expect to end up in a negotiated agreement. The second approach has several advantages. The most important is that it enables you to focus the potential buyers on the items of greatest importance to the seller. The action will take place around terms like the cap on indemnity claims, the size of deductible or basket amounts, the survival of representations and warranties, and the size of any escrow. It is better for the bidders to compete on these terms rather than the scope and qualifications of representations and warranties.
This approach also simplifies the process of comparing the bids and makes the negotiation process more efficient. A form of agreement and plan of merger for initial distribution to bidders that follows this approach is included as Appendix A. For the purposes of this chapter, a broad solicitation of potential buyers will be referred to as an auction without regard to whether a public announcement is made. Such an announcement would be extremely unusual.
The same principles can be applied to specific proposals for key terms. You can propose extremely seller-friendly terms and see how bidders respond or propose terms that are closer to where you would expect to end up. If you assume potential buyers will be well advised about market terms, being excessively aggressive will not result in a more favorable outcome when the dust settles.
The overall goal of achieving a desirable outcome for the seller is most dramatically influenced by the approach to marketing the business. The seller is almost always best served by running an auction with the help of an investment banker. This is true even for transactions that are expected to produce moderate prices. The reasons for this are several. There is nothing quite as effective as competition to produce the highest price and best terms. By definition, the winning bidder has paid more than what other bidders felt the asset was worth. Sometimes, this is due to the business Selling a Private Company: Managing Expectations, Maximizing Results having a unique value to the winning bidder. For example, the ability to realize more cost savings or to increase revenues of related products. Other times, it is just the determination to win that produces the most aggressive proposal. Even the prospect of an auction can be effective. An unsolicited proposal can be turned into a preemptive bid that surpasses the seller’s expectations when a bidder is determined to avoid the uncertainty of an auction.
Running an auction is also the best way for the board to meet its fiduciary obligations to the shareholders to seek the best possible transaction value. In the absence of a full-blown auction, a market check based on comparable transactions and a more focused marketing effort are the best ways to meet these obligations and achieve an appropriate result.
Another characteristic of auctions is that they prevent a bidder from being able to confidently judge the level of competition to acquire the company. The bidder would like to have as much contact as possible with the seller in order to better assess the seller’s expectations and alternatives. Interposing an agent limits that contact until much later in the process, typically after the negotiations have become exclusive and the price has been agreed to.
The method for conducting the auction follows a very uniform pattern. The first step is identification of all of the potentially interested parties followed by the distribution of a short teaser and a form of nondisclosure agreement. Those parties that want to proceed sign the agreement and receive a confidential information memorandum prepared by the banker based on information provided by the company. Preliminary indications of interest with price ranges are solicited and reviewed. Bidders that provide indications that justify further participation are allowed access to detailed diligence materials, participate in management presentations, and are provided a draft agreement to be submitted with proposed revisions and a specific price by a set deadline. Once these materials are submitted, a short period follows during which the bidders who are serious contenders are provided guidance by the investment bankers and encouraged to make improvements in certain areas of their proposals. At the end of this period, the company enters into an agreement with one bidder providing for exclusive negotiations. This agreement identifies the material terms that have already been agreed to and provides that detailed negotiations within the context of those terms shall be conducted in good faith for a specified period. Although the identified terms are not expected to change, it is not unusual for this to happen since diligence investigations may be ongoing and compromises can always implicate otherwise settled terms.
There are many approaches to negotiation. However, there are a few concepts I would like to recommend. They are listening, patience, flexibility, and respect. Even though negotiations also require an ability to be tough and unyielding, when inexperienced negotiators get into trouble, it is usually because they are lacking in these other qualities.
Although it would seem obvious that listening is fundamental to negotiations, many people do not do it well. They are impatient to get their own points across and feel better taking the offensive. This approach interferes with understanding the other parties’ priorities and biases. The result can be lost opportunities to trade points effectively, never hearing the concession that would have been volunteered, or rushing past one that was just offered.
Patience is also a powerful tool in negotiations. Establishing that you are interested in a fair agreement, not simply a fast one, makes clear that you will not rush forward with concessions because the other party does not immediately concede. A willingness to defer an issue can work wonders when it is done the right way. So can a silence. It is surprising how many people are uncomfortable with a pause and will fill that void with more information than is in their interests to share. These approaches taken to an extreme would be clumsy and maddening to your own client. However, in the right measure, they are very effective.
Flexibility in problem solving is also essential. If issues are dealt with primarily as matters of principle, resolution is often difficult to achieve. When the same issues are approached with a view to compromise, the process can move forward. Very often, using a numerical approach by limiting the time horizon for determining whether liability exists or the measure of damages is a good way to arrive at an acceptable compromise. In doing so, you may both move past an issue of principle for the other side Selling a Private Company: Managing Expectations, Maximizing Results and be able to gain a concession on another item of more significance to your client. Another way to demonstrate flexibility is to aggregate open issues and present consolidated solutions that try to address the issues of greatest concern to each side. If you have done a good job of listening, it should be possible to make some astute trades.
Demonstrating respect for the other party to the transaction is also an effective way to make sure your points are considered on the merits. If you acknowledge the sensible parts of their thinking before identifying where you disagree and why, you can build credibility to support your own positions. Negotiation should not be looked at as a way to score points. It is a means for getting everyone ready to sign the same agreement. If your positions are thoughtful, you lay the groundwork for opposing counsel to do the same. Even if counsel does not reciprocate, it is important to remember that in negotiations with clients present, your most important audience is the client across the table. If you establish credibility and a connection with them, you will succeed in representing your client well.
A couple of concluding thoughts on negotiation. They should not be conducted with a uniform delivery. Sometimes, you need to convey determination, at other times, open-mindedness. Messages that are always delivered in the same tone lose part of the message you want your listeners to absorb. Remember that even hardnosed negotiations need to be relieved by humor periodically, and that it is always easiest to agree with someone you like and respect. It is a rare negotiation where raw leverage determines the outcome.
In addition to negotiation, style, and tactics, information about the prior transaction history of a buyer and their counsel can also be very helpful in achieving agreement. If the buyer is a public company, transaction documents from other deals they participated in may be available. Similar information is often available for transactions negotiated by the buyer’s law firm. Understanding how often they have agreed to or taken the same position you are now asserting can be very persuasive if brought into the negotiations in the right way. Whether that is offline or with everyone in the room depends on the personality of the participants and the general tone of the negotiations. However delivered, this information can be very effective. Inside the Minds
The timing and approach to communications with your board of directors is another element of the transaction that needs careful attention. There are several times that interaction with your board is required to run a good process. The first is at the very beginning of the process when the decision is made to initiate the sale process. The second is when the company is deciding to engage an investment banker. Sometimes, these first two steps are combined. The next time is when the preliminary indications of interest are received and then again when the final bids are submitted. If the submitted bids do not permit a decision on which bidder to engage for exclusive negotiations, you should go back to the board when you have sufficient information to make such a recommendation. Finally, when the definitive agreement is in substantially final form, the agreement and the transaction as a whole should come back to the board for final approval.
In connection with each of these steps, appropriate materials should be distributed to the board in advance of the meeting. Since these materials are often lengthy, it is very helpful to prepare charts of key aspects of the material being distributed. These charts facilitate comparison of competitive proposals and are useful tools for organizing the board’s discussions. Highlights can typically be presented in four to eight pages. An example of the format for such a chart is included as Appendix B. It is important to strike an appropriate balance between detail and ease of use. Of course, no written materials are a substitute for thorough board analysis and discussion, which are indispensable to good board process. Investment banking participation in board discussions when initial and final proposals are being reviewed and when the transaction is being approved are also very desirable. Their advice with regard to transaction terms, particularly pricing and how it relates to comparable transactions, is essential input for the board, regardless of whether a fairness opinion has been requested.
Appropriate communications with shareholders, option holders, and other stakeholders are also an important part of good transaction practice. Shareholders should receive an information memorandum describing the transaction that enables them to provide an informed consent to the transaction or to decide to exercise dissenter’s rights. More abbreviated communications with option holders or phantom shareholders are also advisable, even though they do not have voting rights or a direct role in the decision-making process.
Legal issues that arise in the context of acquisitions have a scope that is well beyond this chapter. Appropriate experts should be consulted in all relevant areas. However, I would like to highlight two subjects under Delaware corporate law that have recently developed and that have or may cause a change in transaction process or agreements.
The first of these relates to shareholder approval. Following the Omnicare decision, there is a heightened concern about using voting agreements, irrevocable proxies, and similar devices to provide closing certainty to the buyer prior to formal shareholder approval. The issue is whether such devices can be used without constituting an impermissible "lock-up" of the transaction. One response is to insist on shareholder approval at the time the definitive agreement is executed. If this is not feasible, other responses will provide less closing certainty. For example, voting agreements that are subject to termination in the event of a superior bid or locking up a block of shares that is less than that required to approve the transaction. If none of these alternatives are suitable, the traditional devices can be used with an awareness that they are now more susceptible to challenge.
The second issue relates to the protection provided by material adverse effect closing conditions. In the recent Frontier Oil decision, the Delaware Chancery Court applied the reasoning in the IBP decision to Delaware law. This places the burden of proof on the party asserting a material adverse effect as a basis for terminating a transaction. Meeting that burden in both of these cases was not achieved. The reasons included requirements for dealing exclusively with events that could not be anticipated, that pose a substantial threat to overall earnings potential, and that have long-term impacts. Events that many practitioners would intuitively consider both material and adverse would not qualify under these decisions. In reaction, there is likely to be greater emphasis on providing more objective and detailed standards for defining when a material adverse effect has occurred. This can be achieved by defining specific thresholds for materiality and by defining what later events connected to a known possibility are intended to qualify.
Mergers and acquisitions require the best of lawyers. They are complex, involve highly technical subjects, and require an ability to read and communicate with all parties in circumstances that may be both emotionally charged and tiring. Important judgments have to be made with less-thanperfect information based on an informed intuition of what each party considers its options to be. In the final analysis, it is managing the human dimension that most influences whether you can optimize the results for your client.
Douglas A. Zingale focuses his practice on mergers and acquisitions, private equity, and general corporate representation. He has represented Fortune 500 companies, private equity funds, underwriters, and technology companies in diverse industries. He serves as chairman of the business practice in his firm’s Boston office. His business background includes work as an analyst at Bain Consulting and founding technology companies with fellow MIT alumni. He currently serves on the boards of the Museum of Science in Boston and the MIT Enterprise Forum of Cambridge. His business-oriented approach to transactions has resulted in being recognized by Best Lawyers in America and Super Lawyers of Massachusetts for expertise in mergers and acquisitions, securities, and general corporate advice and having his commentary published on these topics. Mr. Zingale received his undergraduate degree from the Massachusetts Institute of Technology and his law degree, cum laude, from the University of Michigan. Mr. Zingale can be reached at zingaled@gtlaw.com.
Acknowledgement: Mr. Zingale would like to acknowledge the assistance of Roger Lane and DJ Sardella from his office in preparing this chapter and the supporting materials.
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