2021 was ripe with M&A activity, particularly in the fourth quarter, driven by year-end goals and requirements to deploy capital, pent-up demand from 2020, and potential changes to capital gains rates. In Q4 alone I advised our clients on and closed dozens of roll-up acquisitions fueled by such forces. This high volume of activity highlighted many common issues that adversely impact an M&A transaction. As we transition to 2022, I want to flag three critical considerations that came up time and time again in order to help clients who are looking to engage in an M&A transaction this year and beyond.
1. Pick the Right Advisors.
Throughout 2021 I engaged with opposing counsel from all facets of the legal industry—big law, respected regional firms, and solo practitioners. I’ve worked with sophisticated and practical attorneys from each such prong, but also had deals held up by impractical or unreasonable attorneys from each prong as well. The key is picking an advisor who operates, understands, and has practical experience with the task at hand. Just as you would not engage a dermatologist to perform brain surgery, engaging a divorce attorney or litigator to perform M&A services may put you at risk for slow and inefficient negotiations, or worse. Similar goes for your broker and tax advisors.
On a recent deal I encountered an advisor that failed to thoroughly read and understand the documents that were circulated, advised his client based on such incomplete and inaccurate information, and failed to communicate with my team on the issues that arose. This process disrupted the deal, increased time and fees for each side, and left all parties with a sour taste in their mouths. These disruptions were unnecessary as nearly all of the “issues” (a) could have been promptly resolved by a call between the business folks or (b) were, in fact, not issues at all but rather resulted from opposing counsel’s misunderstanding of the documents provided. Ensuring that you engage the correct advisors is critical to an efficient and productive deal cycle.
2. Stay Honest to the Term Sheet.
Although term sheets are generally non-binding, parties to a potential M&A transaction should recognize and understand that getting the term sheet right and staying true to such terms can reduce costs and speed up the closing process. By comparison, ignoring the term sheet or assuming you can “figure out” material points (e.g., purchase price) down the road almost always increases fees and frustration. Nothing aggravates a sophisticated client—or its counsel—more than entering into a negotiated term sheet only to find that the opposing party wants to re-trade material business terms down the line. Parties should engage the appropriate advisors at or prior to the term sheet stage to ensure that the term sheet is acceptable and appropriate.
Many of my transactions require that certain financial metrics – collections, EBITDA, etc. – be met before portions of the purchase price are earned and paid. Notwithstanding that such requirements were clearly set forth in the term sheet, on a recent deal we received markups that effectively removed such financial triggers. In this case, the proposed change was a non-starter and required multiple calls, emails, and revised drafts to move past this problem. Had appropriate care been taken at the term sheet stage to understand and negotiate these business terms, a lot of pain and uncertainty would have been removed from the process.
3. Understand Market Terms.
Moving beyond the negotiation of the purchase price and the execution of the term sheet, there are a myriad of critical business decisions that come up during the negotiation of the definitive agreement. For example, working capital mechanics and targets, escrows or holdbacks, and indemnification caps and baskets. Parties should strive to understand what is “market” prior to circulating comments or issue lists to the draft definitive agreements. It is critical for advisors to properly orient their clients in this regard.
For example, in connection with a roll-up acquisition I was leading last November, we received comments stating that the sole shareholder of a Seller corporation would not agree to backstop the indemnification obligations of the Seller corporation or sign onto the purchase agreement. This request effectively meant that a shell company would be my client’s sole source of recourse in the event we needed to file an indemnification claim and that such sole shareholder would not be bound by traditional M&A restrictive covenants, each of which was a completely out-of-market request. These requests stalled the deal for the weeks and nearly killed it. If the Seller understood how out-of-market the request was, I imagine the proposal would not have been made and each side would have benefited from reduced deal fatigue and expenses.
If you are looking to engage in an M&A transaction in the coming months, I suggest that you review the foregoing and prepare accordingly prior to negotiating and signing a term sheet.
The information in this article is for informational purposes only and does not constitute formal, legal advice. If you have any questions regarding the information contained in this article, please consult with Michael L. Sherlock at [email protected] or any attorney at RM Partners Law LLC for advice about your particular circumstance.