M&A – TRANSACTION TRIVIA IN MERGERS & ACQUISITIONS
In this text, I endeavour to showcase some sensitive elements of M&A transactions, which in practice pose a number of difficulties. I point out why it is important not to establish safety guidelines blindly based on the “the more the better” principle. How is the course of an M&A transaction affected by retaining the founder/seller in business? Is it important who gives the transactional assurances? And also, what tools do you use to secure the deferral of the price and what might be associated with it?
Retaining the seller in business after M&A
The mere execution of M&A transactions from the formal side (DD, negotiations, transaction structure, development of the content of assurances, signing all documents) is not all. Why? Ownership changes, apart from obtaining financing and opportunities for development, also entail the risk of creating a turmoil in the company’s current operations. We are talking about the so-called “clash” of the buyer’s vision with the previously employed model of running the company and the difficulties in taking over or changing them.
In practice, finalizing the transaction is not yet a success. It can be undermined for a very simple reason, i.e., if the buyer (new owner) starts to blindly implement their ideas for changing the functioning of the company. However, most buyers know that modifications must be made according to the arranged concept. Otherwise, they can turn the current work organization upside down, and thus inhibit (not strengthen) business development. In our practice, we notice fairly often that buyers offer the current owner to stay in business and cooperate with them under certain conditions. Sometimes permanently, and sometimes for a certain period after closing the deal. In situations where the founder/founders agreed to support the new owner for a certain period of time, business development proceeded more efficiently and smoothly. And the implementation of changes/know-how of the new owner was easier.
It also holds a different advantage. It enables the parties to go through common post-transactional problems more easily. What does it mean in practice?
Security for payment of funds (escrow/deposit)
The founder remaining in business after being taken over by the new owner should make it easier to close the M&A transaction itself. For example, one of the main negotiating points of each party to the transaction is the payment of the price. It is known that there appears a natural conflict here.
From the buyer’s perspective, there are concerns that the seller will not fulfil the assurances and guarantees provided. Or that they will suddenly withdraw from certain obligations or that after the acquisition some problems of the purchased business will come to light.
From the seller’s perspective, there is a concern that if they do not obtain the full price now, they will have problems enforcing it later. Here, there is a common practice of paying the price in tranches released as the individual conditions of the transaction are met. Sometimes it takes years.
Such conflicting needs of the parties are usually reconciled using the so-called escrow account. For smaller transactions, a notarial deposit institution is also used. Here, the first problem always remains the issue of escrow costs (the notary’s deposit is relatively inexpensive) and the criteria for releasing funds, which should be set in as much detail, but also with sufficient objectivity that it is possible to determine without any doubt whether a specific condition has been met or not. These tools alleviate the above-mentioned concerns of the parties.
But coming back to the fact that the founder remained in business after the transaction, it turns out that usually when it happens, there are no escalating conflicts between the parties and the transaction is settled in the agreement of the parties. The conclusion is that from this point of view, one should not be too afraid of the founder in the business after the acquisition. Firstly, it can help to move more easily through the transition period. Secondly, the statistics show that its presence after the transaction guarantees the cooperation of the parties in the implementation of the agreed terms of the M&A transaction, thus ensuring the prosperity of both parties.
More about deferred payment in M&A transactions
Deferring payments for shares/stocks also causes another problem in the long term. This results in the tax on the shares sold being chargeable in a situation where the price for the shares has not yet been paid. It happens that the investor/buyer, for business reasons, must acquire ownership of 100% of shares/stocks immediately. So, there can be no question of any conditionality in the contract transferring them. On the other hand, also for business reasons, if the price is not paid immediately, but is spread over a longer period of time. Then the seller’s problem is that on their side there appears revenue from the whole price, while they receive only part of the funds/price. Such problems can be managed by structuring the transaction appropriately.
Assurances of the legal entity
Another trivium. Often, M&A transaction participants are usually commercial law companies that provide collateral as buyers or sellers. This type of practice, i.e., assurances, guarantees or obligations of legal persons, should each time be bound by provisions and documents enabling their full and trouble-free enforceability.
For example, in order to be protected against “cleaning up” of an entity that provided us with assurances during the transaction, the personal guarantee of the members of the management board is a good way, and preferably the UBO itself, i.e., the ultimate beneficiary of the “target”. Alternatively, you can also use the popular sevens. That is, a statement of a specific person/individuals about submitting themselves to enforcement in the case of a specific event – default. Otherwise, the security provided by a limited liability company may easily turn out to be illusory, difficult to enforce (even due to organizational changes/transformations). In other words, it happens that a small sip of paper makes all the difference. And that’s not the point.
Security in an M&A transaction without excess of form over content
While we are on the subject of safeguards, we observe a tendency to exaggerate and overdo their establishment. This refers to situations where the level of security is inadequate to the transaction. Or situations where a given clause – assurance/guarantee – is backed by several safeguards in parallel.
For example, I handled transactions for several million zlotys and the draft contract with attachments consisted of well over 100 pages! The mere placement of such an offer on the table by the buyer’s lawyers caused a stalemate in the negotiations. In this way, we can easily scare off the counterparty and conclude negotiations at an early stage. The number of documents and their excessive complexity in a situation where it is possible to formulate documentation much simpler (and equally effective and safe) does not bode well for a quick and successful conclusion. In 90% of cases, it will simply overwhelm the other side, blocking the achievement of any compromise. Above all, the instruments guaranteeing the security of transactions should be tailored to the needs and selected sensitively. Sometimes it is sufficient to have one type- and amount-adjusted security for each sensitive transaction circumstance to achieve the effect.
Summary
To sum up, despite the widespread belief that the more clauses and parties to the contract, the better and safer, I would like to point out that in M&A practice it is often excess that gets unhealthy. Here – as everywhere – it is not the volume but the quality of the contract that counts. And from a business point of view, it is worth focusing on simple and effective solutions that will not generate costs disproportionate to the scale of the project. Avoid complicated clauses and multiplication of illusory securities. As a result, they only prolong negotiations, and sometimes – at the end of the day – they will fail to do their part.
Blog edited by dr Anna Maria Panasiuk
Founder and Managing Partner of Panasiuk & Partners, with many years of expertise in wealth management.
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