M&A 101, by Faegre & Benson

I attended an excellent M&A overview by Faegre & Benson last Thursday. The event was organized by the Private Equity Alliance of Minnesota.

The most impressive part of the evening was that Faegre distilled a very complex topic into sixty minutes. It was a 35,000-foot overview of the subject.

There are 6 areas of M&A law. In chronological order, they are:

1. Confidentiality agreements
2. Letters of intent
3. Legal due diligence
4. Deal Structure (most complex, and merits a separate blog posting)
   
5. Definitive Agreement, and
   
6. Indemnification provisions

Here are a few highlights from each of those areas:

1. Confidentiality Agreements. There are actually two distinct CAs: the initial one between the company and its banker, and the subsequent CA between the company and various potential suitors.
   

• The purpose of the CA is to limit the consequences of TargaCo revealing sensitive information. The CA will state what purposes the recipient of the information may use the information for. This is especially important to prevent competitors of TargaCo from acting interested so that they can obtain proprietary accounting numbers from its competitor.
  
• The CA may further require that recipient must destroy the information within a certain amount of time.
  

2. Letter of Intent -- The legal due diligence comes after the business due diligence.

• The lawyers will look at all the "nooks and crannies" of TargaCo's contract and ensure that there is nothing in those contracts that would spoil the benefits of the transaction.
• Especially when TargaCo is a family-owned business there can be unusual terms from previous contracts. Common examples include determining the severity of existing lawsuits, determining what the change in control might trigger (parachute payments, rights of first refusal, or key supplier agreements).
  

3. Transaction Structure

• This can be complicated and confusing.
• To clarify, remember Bruce Engler's clarifying statement that "at the end of the day, the transaction must be either a stock deal or an asset deal."
• To be more thorough, there are two necessary steps for a transaction: 1) the consideration received (stock or assets), and 2) deal structure (reverse or forward triangular).
  

4. Definitive Agreement

• This document "sets in stone" the deal.
  
• It will be either a Stock Purchase Agreement or an Asset Purchase Agreement.
  
• All the information gathered in due diligence and structure strategizing (from accounting and tax standpoints) are brought to bear on this document.
  
• It articulates the purchase price and the composition of that price (cash, stock, debt, seller notes), the reps and warranties, covenants, conditions to closing, and indemnification provisions.
  
• Here are 2 interesting aspects to definitive agreements:

1. The reason why there is often a gap between signing and closing (an Executory Contract) is that, subsequent to signing there remains the need to get financing, third-party consent, or a Hart-Scott-Rodino filing is necessary (when deal size is greater than $70 million).
   
2. Covenants are much different than conditions to closing. A condition to closing, if not met, severs any obligation to fulfill the contract. It is much harsher. A covenant, in contrast, cannot break the fulfillment of the contract.
   

5. Indemnification Provisions

• Indemnification provisions are promises made by both parties in the Definitive Agreement that obligates the party to "make whole" the other party if what they said in the Definitive Agrement isn't true. If a rep/warranty of covenant is breached, the indemnification provision is the ex ante term the parties look toward to resolve their dispute.
  
• The most important term of indemnification is the basket:

1. Baskets set the threshold number when liability will accrue. There are both "deductible" and "dollar one" baskets.
2. In a deductible basket, the guilty party pays every dollar above the basket for the breach. Thus, if there was a $100 deductible basket and $120 in damages, the party would owe $20. Deductible baskets occur 78% of the time that a basket is present.
   
3. In a dollar one basket, the guilty party pays every dollar from "dollar one" once the threshold is crossed. Thus, if there was a $100 dollar one basket and $120 in damages, the party would owe $120. Dollar one baskets occur 22% of the time that a basket is present.