At a recent roundtable event, our corporate team led an informal discussion on the key legal and practical issues arising where you are the buyer in an M&A transaction.

We explored approaching targets and structuring the deal, running an effective legal due diligence process, working through the key milestones to completion and successfully integrating a target post-completion.

Within this article, we have distilled some practical tips for individuals and teams with responsibility for their business’ M&A activities.

Heads of Terms – Approach and deal structure

So, you have identified a target, agreed a price with the sellers. What next?

Probably the first thing you do is agree a Heads of Terms / Term sheet.

There is a fine line between (1) over-engineering a term sheet such that it describes the deal in great detail and (2) ensuring that the parties have agreed enough material terms for the lawyers to draft the key documents to reflect the parties’ agreement in principle.

Below, we have listed some of the key points which we would expect to see in a term sheet

a) Consideration – all cash or cash and shares or potentially shares for shares.

b) Timing of Consideration – this will stipulate if the consideration will be paid on completion or delayed till some specific future date or paid in stages subject to certain events.

c) Timing of share transfers – the term-sheet will stipulate whether all the shares will be transferred on completion or whether some will be subject to a hold back / earn-out and will be transferred at a later date, potentially at a different price.

d) Role of selling shareholders – Sometimes, the buyer may want to retain the selling shareholders for a period of time post sale. This could be via employment agreements / contract for services / incentive plans to keep them motivated.

e) Legally Binding or Not? Generally, the commercial terms in a term-sheet are non-binding, allowing the parties to renegotiate if, for example, the buyer discovers something substantial on due diligence which warrants a reduction in the purchase price. However, certain terms can be binding such as:

• Non-poaching of either parties’ key staff, customers, suppliers.
• Non-compete with the other party’s business within certain key sectors.
• Provision for one party to bear the other’s costs (in certain or potentially all situations) or a clause simply stating that both parties will bear their own costs.

Non-Disclosure Agreement (NDA) / Confidentiality Undertaking

Alongside or perhaps included within the heads of terms/term sheet, you would usually find an NDA or Confidentiality Undertaking. As a buyer, you will expect to be given access to a great deal of non-public information about the seller. Whilst much of this information may be made available to you via a data room, the definition of confidential information goes well beyond any data room access.

Confidential information often includes (but is not limited to) the following:

a) Management accounts / financial analysis

b) Key business contracts

c) Key suppliers

d) Information technology / intellectual property details

e) Details of key employees, i.e. salaries, bonuses, perks etc.

A strong NDA is vital to protect confidential information related to the seller’s business and give them comfort in sharing sensitive information with third parties. Nevertheless, it is not only the seller which needs to be protected. As a buyer, you will be disclosing information about your approach to transactions and potentially also the state of your finances. Again, much of this information is not public and you will want to be protected under the NDA. Key NDA Provisions often include:

a) Mutual or One Way – The protections within an NDA can be limited to one party’s confidential information or that of both parties. Typically, both parties will want to be protected, although the seller usually has more to protect than the buyer.

b) Length of undertaking – How long restrictions on confidential information last is often as long as the information has commercial value, or a specific time limit, typically between 2 and 5 years depending on the nature of the information disclosed.

c) Exclusions – Information in public domain or that is already known to the recipient is often excluded from being considered “confidential information”.

d) Restrictions – To the extent not already addressed in the term sheet, NDA’s often include non-poach provisions to guard against a recipient using confidential information to entice away customers or key employees.

These are just some of the key considerations to have in mind during the early stages of an acquisition. Once you have put your term sheet and NDA in place, your next step as a buyer will be to carry out due diligence on the target business.

Getting the most out of Due Diligence

Understanding the function of legal due diligence is vital to getting the most out of it during an acquisition. There are 3 key aspects: (1) identifying deal critical legal risk; (2) informing decision making, and (3) enabling appropriate risk allocation. Critically, by identifying the roadblocks to actually seeing an acquisition through to completion, a buy side team can work on whether the issue can be mitigated and plan ahead before cost, the timetable and patience become strained.

Some key red flags to look out for in any acquisition are:

• Corporate and Ownership – Inconsistent ownership records and a complicated shareholding history.
• Material Contracts – Notification and approval requirements around change of control, informal contracting arrangements and exclusivity obligations.
• Litigation, Disputes and Investigations – Frequent or repeated disputes, outstanding judgement or settlement obligations and poor complaint procedures.
• Regulatory and Compliance – Historic investigations and enforcement actions; inconsistent compliance monitoring or working within critical infrastructure, the defence sector or Government procurement.
• Employment and Pensions – Misclassification of workers (employee vs contractor), unsettled holiday pay or poorly managed pension arrangements.
• Data Protection and IT (brief but increasingly critical) – Unclear records of data held and poor compliance procedures.

The critical path to making the legal due diligence process easier is to put a good team in place (both internally and externally) to take control of the flow of information and ensure the right people see critical material. Before getting started, considering how comprehensive the due diligence exercise should be and what you consider material can help ensure whoever is undertaking the process knows when to keep asking questions and when to stop. Additionally, making sure the seller uses a structured data room, cross references your questionnaire and does not overload you with unrequested information can keep the process more streamlined. As a helpful funnel, it can be useful to divide information received by those which: (1) affect deal viability, (2) affect valuation of the target, and (3) need to be addressed in post-completion integration.

When properly managed, legal due diligence can be a useful tool to funnel key information to the right parties who can analyse and mitigate risk. Using specialist advisors surgically can ensure you keep their efforts in scope and don’t leave your deal term overburdened with unnecessary information. Due diligence can consume a significant part of any project’s time and budget, so make sure you know what your desired output is and ensure you work closely with your advisors to focus their questions effectively on relevant lines of enquiry.

From heads of terms to completion

Transactions can get stuck for a number of reasons and keeping momentum is essential for getting an acquisition completed efficiently. Here are three key ideas that can help to keep a transaction on track and on time:

• Understand the personal motivations of the parties behind the deal
  By taking the time to map the different stakeholders in a transaction and their drivers early on, you can ensure that negotiations are approached constructively and productively – putting forward solutions that appeal to all parties.
• Understand the documents so you don’t get lost in the minutiae
  Hand in hand with the first point, designing documents to drive progress, not friction, helps ensure that you retain a strong relationship with the sellers/management team before, during and after a transaction. Know your non-negotiables but also know where you can be flexible. Although any transaction can involve an element of horse trading, considering key points in issue and putting forward a packaged solution can bypass some of the friction that inevitably arises when parties become entrenched and begin to focus on winning the point rather than completing the transaction.
• Horizon scan and unblock early
  Identify consents / third parties who could delay things, and tackle them pro-actively. Where you have a cooperative sell side team and a well structured approach to due diligence, push for mitigation strategies around key issues once they are identified. Telegraphing additional protections or potential deal structure changes early on can help motivate sellers towards a pre-completion solution and soften perceptions around how negotiations are being managed.

Taking on board these ideas can help to instruct the right outside counsel and effectively manage your in-house teams, such that a transaction can be completed more efficiently. Increased efficiency means less time wasted, less cost (whether that be external fees or internal management time), and a transaction that invigorates your business rather than exhausts it.

Why so many acquisitions disappoint – and how to do better

The deal has completed. The champagne corks have been popped – and the advisors have moved on to the next project.

But, studies have reported that as many as 90% of acquisitions do not deliver the value which was forecast in the deal model, and which was used to justify the purchase price.

The most common causes are practical, predictable – and preventable.

• Operational teams who will have to deliver the deal value were distant (or absent) from deal teams, so practical implications were not given enough weight:
  • IT integration – systems and data sets being incompatible, and needing time, effort or cost to align.
  • Regulatory – either by acquiring a business in an unfamiliar regulated sector, or increased scale crossing thresholds for more onerous regulation.
  • HR – culture clashes, with people working in parallel, or even in competition with, their new colleagues, to preserve and protect their own fiefdoms.
  • Marketing/PR – not being prepared with a Day One message explaining the rationale to customers, in a way that retains their business.
  • Business Support teams requiring additional resource to deliver the integration and to support the enlarged group.
• Unrealistic expectations as to the synergies and efficiencies which can be implemented in practice. Economic models don’t take account of:
  • reluctance to make unpopular changes at the behest of new owners.
  • human reactions to those changes being implemented – demotivated staff, reduced productivity/quiet quitting, resignation of key talent.
• No-one truly owns the post-acquisition delivery process:
  • failure to monitor actions and outcomes against the business case.
  • lack of accountability for delivery of the plan.

Your chances of a worthwhile commercial outcome will be greatly improved by giving proper attention to these aspects as part of the planning process, before committing to a project or price based on unachievable results. Legal, operational and cultural risks must be tested with the same discipline as financial ones.

In conclusion, planning for and coordinating the flow of information to the right people is critical to a successful outcome. Keeping your deal team lean and using specialists (both internally and externally) surgically can help to avoid an acquisition becoming bloated by excess information sharing and a lack of clear direction. From the beginning, the teams identifying the target, executing the transaction and taking responsibility for integration should be working closely together to identify risks that need mitigation and start planning solutions early.

At Collyer Bristow, we strive to fit seamlessly alongside your deal team, identifying your key motivators for an acquisition and ensuring they are prioritised throughout the process. Whether you need targeted input on transaction documentation or comprehensive support from target identification to integration, we can provide flexible support to meet your requirements.