M&A is the transfer of control of a corporation. This transfer of control is governed by a contract that is mixture of common contract terminology and specific terms relating to the M&A deal. These contract are shaped by regulators, law firms, finance firms such as investment banks, corporations, and the general business environment. There are specific types of M&A contracts that combine to make a master contract for a particular M&A deal.
This chapter Aims to:
- Review basic contracts in general
- Describe general “deal contracts”
- Describe ways that USA M&A contracts are shaped by ownership and regulation
- Study the content and effect of M&A contracts
Purposes of contracts in general
Purposes of general contract exchanges:
- Help parties come to a fair valuation
- Help parties balance risk preferences by pooling preferences
- Identify potential benefits of an exchange
- Identify specific payment options
Some exchanges do not require a contract because they are simple. For example, when purchasing a hamburger, a contract is not worth the effort due to the simplicity of the offering and the price. Contracts are more useful in complex situations. These contracts are written down to aid memory in the future and communicate the specifics of the exchanges to other parties. Being very specific in the wording of a written contract leads sets the terms of the exchange in stone. This causes both parties to give second thought to the terms and contract and write exactly what they want from the exchange in the contract. If a party is not specific in the wording, they will not receive what they thought they might.
Purposes of M&A Contracts
M&A contracts specify terms of the deal, communicate those terms to third parties, and are also useful for future management of disputes between the two parties. M&A contracts are a necessary component for most M&A deals. M&A investments are often some of the largest that a company ever makes, and each company wants to be sure that they know exactly what assets are being exchanged, how control is being exchanged, and how the deal is being paid for. The following is a summary of often negotiated terms in an M&A contract:
- Intellectual property (copyrights, patents, trademarks, trade secrets)
- Real estate
- Regulatory Licenses (FDA approvals etc.)
- What shares and voting rights are taken from the seller?
- Who are the shares and voting rights given to from the buyer?
- Customer contracts
M&A contracts are sometimes legally required. In order for an M&A transaction to take place, it must be approved by the shareholders, and securities law states that the specific terms of an M&A must be presented to the shareholders before a decision can be made.
Contracts for the different phases of an M&A deal
As stated, a typical M&A contract is a suite of contracts that govern the different phases of an M&A deal. A typical M&A process involves planning the deal, searching for a target, investigating the target, negotiating the terms, processing the terms, and officially closing the deal.
Preliminary contracts conduct how confidential information about each company is shared, and negotiate the bidding process. The following are some preliminary M&A contracts:
- Confidentiality agreement:Outlines how confidential information is shared and restricts or prevents parties from sharing that information with others.
- Exclusivity agreement:Agreement that the buyer will not seek replacement investments for a specified period of time. For example, if Inbev signed an exclusivity agreement when it was looking to buy Anheuser Busch, it couldn’t also offer to buy Boston Beer Company seeking a better price.
- Standstill agreement: An agreement that prevents a buyer from making multiple attempts at taking over a company.
- Letter of Intent: An outline of the terms of the deal between the buyer and the seller before they come to a formalized agreement. These are generally not binding and unenforceable, but serve as a statement of interest from a buyer to a seller.
- Joint Defense Agreement: Allows two companies share confidential information and prevents them from sharing this information with others.
Collateral contracts conducts how deal collateral is adjusted and transferred.
- Non-competition agreement “noncompetes”:A contract stating that an employee is not allowed to enter into direct competition with their employer. This usually means that if the employee decides to leave a firm, that employee may not interact with the clients of his/her old firm. Many times non-competition agreements will void when in a merger/acquisition scenario.
Core M&A contracts gather and summarize all relevant deal information for use by regulators, shareholders, the public and detail who is responsible for each requirement laid out in the contract.
- Support agreement: ?
- Voting agreement: Details the voting right of both parties after the proposed merger/acquisition closes.
- Lock-up option agreement:Prevents the seller from selling a specified number of shares for a stated period of time. This contracts protects the buyer from getting its share diluted.
- Affiliate letter agreement:?
The definitive deal agreement is the summation of all of the above contracts and many more. Given the complexity of an M&A deal, these contracts are useful for specifying the basic terms of the deal including:
- Parties involved in the deal
- Deal structure (mergers, purchases of specific assets, sales of specific assets, sales of specific contract rights etc.)
- Deal Currency (cash, stock, debt etc.)
These terms are often highly negotiated and are subject to significant disputes. As a result, M&A contracts contain many dispute management provisions that attempt to anticipate disputes and come up with a resolution for the dispute before it becomes disruptive to the deal process
The Contents of M&A Contracts
M&A contracts attempt to use a variety of standardized terminology as well as customized terminology. Contracts use many terms that are defined as “market norms” and “deal points” that are set through studies conducted by the American Bar Association. In general, it is important to remember that all M&A contracts are largely similar, but small changes in terminology can cause extreme changes in outcomes for the parties involved.
M&A contracts are organized many different “articles” with each article containing many sections. Typically, articles will be organized in the following manner:
- Parties and recitals
This section serves as a guide for the rest of the document. It highlights the parties involved and defines guiding language on the purpose of the transaction. This article is generally 1% of the words in the entire contract, but can contain important defining information.
- Price, currency, and structure
This section is a detailed description of the core terms in the deal. These terms are subject to extreme negotiation because they define what each party is getting in the deal how much they are going to pay for it. This section often uses complex pricing terms such as:
- Price adjustments are a mechanism used to modify the purchase price in the event of changes in the financial condition of the seller. This provision protects the buyer from paying too much if there is a material change in the health of the seller.
- Earn-outs are a pricing condition in which a seller must earn a specific purchase price. These provisions are used when the buyer and the seller disagree on future financial projections. It protects the buyer from paying too much based upon unreasonable expectations from the seller.
- Cash elections allow the seller to choose the way that the deal is paid for. This protects the seller if the buyer is paying with shares of stock and its stock price falls, then the seller can take a cash election.
- Collars apply to deals that are being paid for with shares of the buyer’s stock. Collars set a price range and a number of shares that the buyer must provide in order for the deal to happen. If the buyers share price falls, a collar may make the buyer provide more shares to come up with the same offer price.
- Ticking fee is an increase in the offer price as the time between signing the deal and closing the deal passes. The ticking fee encourages the buyer to move quickly with the deal process in order to save money on the purchase price and protects the seller from being in a drawn-out negotiation.
- Representations and warranties
Representations are references to deal terms that are expressly stated or implied by one of the parties in the contract. Representations are ~39% of the document are consist of factual statements about the fast or promises about the future for one party and its business. When one party promises to pay for damages or losses in a contract, the piece of the contract that is linked to these losses is linked to the representation section.
- Termination provisions (“outs”)
- Defined terms
- Miscellaneous clauses