This article titled “Strategic Moves in M&A: Seller’s Blueprint” has been written by Mridul Sinha, Dharmashastra National Law University Jabalpur
Introduction
Sell-side participants in M&A transactions often neglect or underestimate certain fundamental issues. Overlooking these aspects can lead to adverse consequences for sellers, such as receiving a lower purchase price than anticipated, unknowingly assuming avoidable liabilities, or encountering structural obstacles and ramifications. Sellers are advised to proactively address and mitigate these issues to safeguard their interests and optimize the outcomes of the transaction. M&A process is a complex affair; therefore, these issues must be kept in mind for the easy flow of the further transaction.[1]
Deal Advisors Involvement
The fundamental aspect which is important to be considered by the sellers is the involvement of the deal advisors very initially or in the process right from the very outset when we’re in a position to reflect our hand shake deal into a Term Sheet or agree to a structure and that’s the time, we must consult the deal advisors who are proficient in these works.[2]
Often, the initial phases of M&A transactions, like drafting the Term Sheet, are handled by in-house teams who may not have much experience in such deals. If we agree to a specific structure without consulting experts, it could create problems later. Getting advisors involved early is crucial to avoid potential issues and ensure we don’t have to change course unexpectedly after realizing there might be complications. It’s important to have our advisors on board from the start to prevent unwanted issues with the other party.[3]
Essentiality of Term Sheet
The Term Sheet is a very crucial part of an M&A transaction and the major mistake made by sellers is either making it a very long-winded document, instituting binding provisions and agreeing to certain provisions like to undertake liabilities of fund issue, specific warranties and structures without thinking it through with their advisors and later on trying to change it which will throw a spanner in the works.[4]
So, a Term Sheet should be broad in nature having a basic understanding of what structure is preferred. For example, if a seller desires an asset sale, it is required to spell out certain provisions like that of confidentiality as the seller will have to expose our confidential data during the diligence process. The Term Sheet should include a confidentiality protection clause to safeguard sensitive information. This clause is essential for preventing the solicitation of the seller’s employees, ensuring a non-Solicitation provision is in place. This measure is crucial to prevent the buyer from recruiting employees during the diligence phase. Additionally, specifying a governing law strengthens the enforceability of these provisions.[5]
If the sellers want the buyers to cover costs in case they decide to leave without a valid reason, this “Break Free” arrangement should be agreed upon and binding. On the other hand, the buyer should have the exclusive right to negotiate with the seller, and this exclusivity provision is typically binding. However, certain aspects, especially those not thoroughly considered, can be left non-binding until detailed agreements are finalized.[6]
Due Diligence in M&A
In an M&A transaction, due diligence is a crucial but often underestimated aspect, particularly from the sellers’ perspective. In situations like auction deals with numerous bidders, it’s essential for the seller to conduct their own due diligence, referred to as Vendor due diligence. Subsequently, the findings from this diligence should be shared with all potential bidders.[7]
Meanwhile, it’s crucial to set up a virtual data room as we populate it with information. This facilitates a more streamlined process when potential buyers review the report and have inquiries. Access to the data room can be granted to address questions efficiently. This not only saves time but also allows us to proactively resolve any issues identified during the vendor diligence process before the buyer becomes aware of potential deficiencies. In the case of a non-auction deal, it is advisable to conduct a preliminary due diligence on our company.[8]
Identifying and resolving issues in advance is essential to prevent the buyer from leveraging discovered issues to demand extensive warranties, indemnities, or potentially reduce the purchase price. So, it’s always important to do our own diligence before exposing our company’s data and at even from a procedural standpoint we must have a virtual data ongoing systematically organizing data room take help of the lawyers not being haphazard thus helping the whole process and saving time which is such a critical component in an M&A transaction.[9]
Disclosure Letter
The disclosure letter serves as a tool for sellers to qualify the representations and warranties they provide, acting as a means to mitigate liabilities. For instance, if the seller is warranting that it possesses all necessary licenses and approvals, but on the given day, a factory license is pending renewal, the seller is obligated to disclose this information. Failure to make such disclosures could lead to misrepresentation, exposing the seller to potential liabilities and legal consequences.[10]
Given the factual and numerous natures of warranties in transaction documents, it is crucial for the seller to engage relevant teams at an early stage, including the finance and tax teams. This early involvement enables these teams to work through the warranties with legal assistance, deciphering the complex and lengthy statements. Making disclosures in advance is essential. Omitting disclosures would not be in the best interest of the sellers.[11]
Another challenge lies in instilling confidence in the pertinent teams, as this exercise is highly critical. In certain cases, the relevant teams on the seller’s side may be hesitant to identify any issues, fearing it might reflect poorly on their performance. Encouraging them to openly address non-compliance or any issues is vital; it’s essential to emphasize that bringing problems to light and addressing them is an integral part of the process when populating the disclosure letter.[12]
Relevance of BATNA
Another essential consideration for sellers is identifying the Best Alternative to a Negotiated Agreement (BATNA). This becomes crucial because during negotiations and the diligence process, issues may arise that lead the buyer to seek adjustments in the purchase price or changes in the deal structure. In such situations, sellers must have a well-defined understanding of their alternative options and potential structures.[13]
For instance, in the course of a transaction, if the buyer discovers substantial liabilities and prefers not to pursue a share deal, opting instead for an asset deal or proposing a deferred payment structure such as an earn-out, intending to retain a portion of the purchase price for potential identified liabilities, the seller should consider exploring alternative options. This could involve assessing whether there’s another potential buyer willing to pay slightly less but in a lump sum or open to a share deal.[14]
If we figure out that our alternative option is superior to the current one, it’s advisable to consider and pursue that particular deal. On the other hand, if the alternative is not more favorable, we can confidently conclude that the existing terms are the most advantageous available. It’s important to have our BATNA, and while disclosure to the other party may not be required, it equips us with the means to make decisions confidently and with a thorough understanding of our options.[15]
Conclusion
A seller should consider several key factors during an M&A transaction. Begin by seeking advice early in the process. It’s advisable to create a Term Sheet with a focus on critical non-binding elements such as confidentiality, exclusivity, governing law, and specific clauses like break-free and non-solicitation. Efficiently run the due diligence process, generating a vendor diligence report if needed, and enhancing the company’s current state. Craft a comprehensive disclosure letter, starting early to ensure thoroughness and mitigate potential liabilities. Lastly, always have a BATNA—an alternative strategy ready—to compare negotiated terms and evaluate whether an alternate deal may be more advantageous before making a decision.
[1]SYMMETRICAL M&A ADVISORY, https://symmetricaladvisory.com/the-role-of-sell-side-advisors-in-ma-transactions/, (last visited Jan. 01, 2024)
[2]Ibid.
[3] Nicolas Camacho and Vanessa Dager, The Role of Financial Advisers in Merger and Acquisitions, LATINLAWYER, (Jan. 01, 2024, 8:35AM), https://latinlawyer.com/guide/the-guide-mergers-acquisitions/first-edition/article/the-role-of-financial-advisers-in-merger-and-acquisitions#:~:text=An%20experienced%20M%26A%20financial%20adviser%20on%20the%20sell-side,in%20seeking%20the%20highest%20possible%20price%20from%20buyers.
[4]Jake Wengrof, Digging Deep Into the Sell-Side M&A Process, CAPLINKED, (Jan. 2, 2009, 8:46AM), https://www.caplinked.com/blog/sell-side-m-and-a-process/.
[5]Ibid.
[6]Ibid.
[7]Matt Lawver, The Importance of Seller’s Side of Due Diligence, QUANTIVE, (October 22, 2021, 10:20 AM), https://goquantive.com/blog/the-importance-of-sellers-side-of-due-diligence/.
[8]Ibid.
[9]David Harner & Drew Solomon, Sell-Side Due Diligence Report Checklist and Guide for M&A and Other Transactions, EMBARKWITHUS, (November 3, 2021, 12:20 PM), https://blog.embarkwithus.com/sell-side-due-diligence.
[10] Prasenjit Chakravarti and Nitish Goel, Why Disclosure Letters Are Crucial In M&A Deals, VCCIRCLE, (Jan. 2, 2024, 9:00AM), https://www.vccircle.com/why-disclosure-letters-are-crucial-in-m-a-deals.
[11]Ibid.
[12]Ibid.
[13]CFI Team, BATNA, CORPORATE FINANCE INSTITUTE, (Jan. 2, 2023, 9:27AM), https://corporatefinanceinstitute.com/resources/valuation/what-is-batna/.
[14]Ibid.
[15]Himanshu Singh, Best Alternative To a Negotiated Agreement, WALLSTREET OASIS, (Jan. 2, 2024, 11:29 AM)
