Getting closure: deal certainty in an uncertain market
June 2014 | SPECIAL REPORT: MERGERS & ACQUISITIONS
Financier Worldwide Magazine
Closing the deal requires a combination of skills: legal, commercial, organisational, relationship-building; plus the sheer, bloody-minded, ability to push a transaction across the line. Equally important for buyers and sellers, the global financial crisis has led many companies to re-focus on their core strategies and decide to exit selected markets. Achieving deal certainty therefore has an added strategic premium, particularly when the reasons for exiting the market limit the choice of buyer or make it difficult to realise the remaining value in the business. This article considers some of the ways in which to maximise deal certainty in potentially tricky commercial and legal environments.
Deal certainty is boosted even before commencing negotiations or putting together an info memo, by paying close attention to preparing the business for sale. Pre-sale homework is vital to provide a defence against issues which a bidder may raise during the sales process. We often talk about a vendor’s due diligence exercise to get to the bottom of any lingering regulatory, legal or commercial issues, but that has to be accompanied by taking action to resolve those issues. Restructuring some or all of the assets proposed to be sold or deciding how to package up the business to attract the right bidder, is essential. However, time pressures, the impact on operating the business and the risk of information leakage may mean that these steps have to be cut short, in which case sellers need to form a realistic view of how much, in terms of price and negotiation position, these issues are worth to them – and to a buyer.
Getting to ‘yes’
Before you get to close a deal, you need to get to sign one. One decision to be made early on in planning an exit is whether to start with an auction process. Auction processes can test whether there is appetite for the sale at all, create a genuine competition between interested parties, or act as a foil to a dominant bidder and you hope that these characteristics improve the commercial terms of the sale. In terms of deal certainty, however, a competitive bid situation keeps buyers incentivised to close the deal as well, fearing that someone else will do so if they do not. For the competitive process to be effective, the seller – in practice, often the seller’s financial adviser – needs to impose discipline on bidders from the start. One key aspect of this is striking a balance between providing bidders with sufficient information to whet their appetites, allow a reasonably informed preliminary due diligence and attract serious bids; but without sharing information (too early in the process) that would be commercially damaging to the seller or the target business. Maintaining competitive tension as far into the process as possible will maximise deal certainty; mismanagement of the auction process will reduce it.
Another tool for assessing how serious bidders are about the transaction is for the seller to provide a sale and purchase agreement for bidders to mark-up. Whilst it isn’t unusual for a seller’s draft to be included in the auction process, sellers seeking to manage deal certainty should consider taking control of the first draft whatever the sale process. The process of thinking through the key deal document is instructive and allows sellers to take strategic positions for the forthcoming discussions and identify any non-negotiables at an early stage. Communicating those positions to bidders/buyers clearly and consistently throughout the process helps to reduce surprises, set the tone for the negotiation and improve your chances of signing a deal. In addition, that first mark-up provides a timely insight into how closely a (potential) buyer has been listening, how willing they are to invest time and effort in the process, and their attitude to risk allocation and other price-sensitive issues.
Downsides to a competitive bid process include the inevitable time and expenditure involved: dealing with many bidders (some serious, others not) multiplies the internal and external costs involved and the delays increase the risk of information leaking into the marketplace with potentially damaging effects on value. One key to managing these negative aspects is carefully applied criteria from which the seller determines which bidder behaviours, negotiating tactics and – ultimately – commercial terms, will disqualify a bidder from continued participation. Evaluating which bidders you can trust usually requires the insight of a merchant bank and good information is more valuable than legal remedies; however, the basics should also be taken care of so that confidentiality and other preliminary agreements with bidders are with credible and well-resourced entities and written in clear and enforceable terms.
Ultimately, bidders will want exclusive rights to negotiate the transaction for a period of time and will not be prepared to spend more time and money, themselves, on the process without that assurance. Sellers’ ability to keep more than one bidder in play taxes the ingenuity of most negotiators and finding ways to incentivise the buyer when exclusive negotiations have commenced is important. A break-fee is one way to maintain the pressure on the buyer, but a break-fee must not be so large as to be unconscionable or entirely disproportionate to the loss suffered by the seller. However, since buyer and seller haven’t struck a deal yet, it is hard to justify a break-fee under English law that would be commercially painful to all buyers and the break-fee is likely to reflect the seller’s costs (which could be considerable) but not its loss of opportunity. There are some clever solutions to this conundrum, but beware of trying to create the same structure under civil law jurisdictions which say that a break-fee is enforceable only to remember later that it is subject to judicial discretion as to its amount.
Having achieved exclusivity – either directly or via a process of elimination – the next key issue for a seller is keeping that buyer in the negotiation until a binding contract can be agreed. Any exclusivity period should be short, based on clear objectives and entered into when the deal terms are sufficiently advanced that those objectives are achievable. A seller will generally want to move quickly to signing, but that becomes particularly important where the target is distressed or market conditions are deteriorating. The need to advance negotiations rapidly must be balanced against ensuring that the prospective buyer completes adequate due diligence prior to signing, so as to minimise the risk of the buyer seeking to renegotiate the deal in the period between signing and completion. In this regard the need for speed erodes value and deal certainty, although hard work in the pre-sales process can deliver a smoother path to signing.
Whilst a well-written, balanced SPA is in the best interest of both parties, the seller benefits most from managing completion risk through drafting the conditions in an SPA precisely and in detail. Including generic or catch-all conditions will get you to signing faster, but makes it easy for buyers to argue that the conditions are not satisfied, allowing them to either terminate the transaction or renegotiate. In addition, having a detailed action plan and timetable for satisfaction of those conditions and carefully setting out the nature and scope of each party’s obligations in relation to them will improve your chances of reaching completion. One of the most hotly contested conditions will be whether the buyer should be relieved of the obligation to complete if there is a material adverse change and how that gets defined. Managing MAC risks in emerging market transactions is particularly challenging where political and macroeconomic changes are a concern. If forced to include a MAC clause, the seller must ensure that it is not just drafted narrowly but also accurately.
The crafting of the completion process is often something that seems to have little commercial value, but provides potential loopholes for buyers that want to get out of transactions or seek leverage to recut the deal. In any transaction where buyer, seller and target are not in the same jurisdiction, the parties improve certainty of completion by sorting out in advance the steps, sequence and documentation required. In addition, there will inevitably be third parties to manage, such as notaries, brokers, lenders and registrars, not to mention the banks sending and receiving the consideration, which may be in other time zones to the principal completion process. In situations where there is a relative lack of trust between the parties or a completion process where title transfers before payment is made, you may need to create an effective escrow mechanism which operates without reliance on the buyer’s consent. While these are all normal issues which arise in any transaction, they assume additional significance where a seller is exiting in difficult circumstances.
Despite the care taken in negotiation and drafting of the SPA, the completion process and its lead-up will always test the relationship between principals, particularly where a seller is selling distressed assets, selling due to deteriorating market conditions or selling in an emerging market – or any combination of these circumstances. A seller may need to recognise and respond to the fact that the deal that gets signed might not be, despite the team’s best efforts, the deal that closes in the end. A buyer’s ability or desire to pay the agreed price may have changed, for good reasons or otherwise. Sellers need to be prepared for the renegotiation, manage internal expectations pro-actively and empower strong negotiators to take the final, sometimes painful, decisions. Success, however that is measured, depends on many factors, including how strong the personal relationships are between key team members on both sides.
Finally, when the crunch comes, there will be a small army involved in closing the deal and the people (often the lawyers) responsible for the process management will have to demonstrate degrees of stamina and commitment usually only found in a boxing ring. Preparation and organisation are critical to ensuring that when the opportunity comes to complete, it can be seized before another change blows the deal off course. Skill sets of creativity and commercial awareness take second place for a while to concentration on document production, signing formalities and solving the innumerable little problems that would otherwise stall the completion. From the secretaries to the partner, it takes determination and grit.
From a seller’s point of view, in a difficult market the key to maximising deal certainty is preparing thoroughly, negotiating precise agreements and removing factors that would open doorways to renegotiation. All these techniques need to work together as a seamless whole to reduce completion risk to a minimum.
Charez Golvala is a partner and Alexandra Neovius is a senior associate at Chadbourne & Parke (London) LLP. Mr Golvala can be contacted on +44 (0)20 7337 8020 or by email: email@example.com. Ms Neovius can be contacted on +44 (0)20 7337 8050 or by email: firstname.lastname@example.org.
© Financier Worldwide
Charez Golvala and Alexandra Neovius
Chadbourne & Parke (London) LLP