Part I: Basic Overview of the Merger and Acquisition Process
A primary goal for many start-ups and new businesses is to eventually sell the company, even if the founders intend to remain with the company. Selling your company can result in a gigantic payday and provide continued vitality for the company going forward. That said, it is critical that owners and entrepreneurs comply with legal requirements and protect their legal interests throughout the sales process to maximize their chances of a positive outcome.
With this blog, I begin a series of blog posts on the most important legal considerations critical considering whether to buy, sell, or merge a business. This first blog is a broad overview of the process involved in a merger or acquisition (often referred to as the “M&A process”). The following is a basic and general look at the six essential steps to successfully completing the M&A process. In future posts, I will take a deeper dive into what each step in this process entails.
Although not a step in the process, it is important to understand the different types of M&A transaction types. First, there are three different transactions structures that nearly all acquisitions follow:
- Asset Purchase. In an asset purchase, the buyer buys all (or part) of the seller’s assets and assumes only the seller’s liabilities expressly agreed to be assumed, except where law causes some liabilities to follow the assets regardless. For example, if the company selling assets owes money to a creditor before the sale of assets, it will continue to owe the money after the sale, but the buyer will not be liable for it. Assets cam be both tangible, such as property and equipment, and intangible, such as intellectual property, brand name/recognition, and goodwill.
- Stock Purchase. The acquisition of a company by stock purchase involves the purchase of all the seller’s shares. A buyer may purchase less than all of a seller’s shares and “squeeze out,” or force a sale by statutory short-form merger the remaining shareholders in order to own 100% of the shares of the company being acquired. Unlike a buyer in an asset sale, a buyer of stock accepts ownership of the company with all of its assets and liabilities. Thus, if the purchased company owed money to a creditor before the sale, the company in the buyer’s hands still owes money after the sale. Important to note, if one is considering buying or selling a sole proprietorship, a partnership, or a limited liability company, this transaction cannot occur through a stock purchase, because none of these entity structures have stock by their very natures.
The purchase of a company by acquiring all of its publicly-traded stock involves a “tender offer” by the buyer. A tender offer is a broad solicitation by a company or a third party to purchase a substantial percentage of a company’s shares or unities for limited time. The offer is at a fixed price usually at a premium over the current market price, and is customarily contingent on shareholders tendering a fixed number of their shares or units. Tender offers are regulated by Federal Securities Law. See 17 C.F.R. Part 240.
- Merger. In a merger, two companies combine to form one upon the issuance of a “merger certificate” by the relevant state. Florida also requires the resulting entity to file articles of merger. See Fla. Stat. §§ 605.0912-1026 on LLC mergers; Fla. Stat. §§ 607.110-11101 on Corporation mergers; and Fla. Stat. §§ 620.8916-8919 of Partnership mergers. The surviving company in a merger assumes all liabilities and receives all assets of the disappearing company. A merger is a creation of law and for this reason can be hard for some to conceptualize. In a stock purchase, the buyer holds stock. In an asset purchase, the buyer holds assets. However, upon a merger, the law deems two entities combined, and all assets of both are owned by the surviving company.
- Engagement Letter of the Financial Advisor
Often, the company to be sold, known as the target of an M&A deal, will engage a financial advisor, such as an investment bank, to guide the company through the M&A process. The advisor can perform a number of roles in the deal, including providing the valuation of the target company, finding potential purchasers for the target, negotiating terms of the deal, and consulting with the target company’s Board of Directors. The first step in the M&A process, thus, is to decide whether the target will hire a financial advisor, who that financial advisor will be, and enter into an engagement letter between the target and its financial advisor, which delineates the responsibilities of the financial advisor through the M&A process and how the financial advisor will be compensated.
- The Non-Disclosure Agreement
Because the M&A process often involves two companies who are competitors in the same industry, delving into non-public aspects of the target company’s business without the assurance of the completion of the deal, targets and acquirers will sign a Non-Disclosure Agreement (“NDA”) preventing either company from using sensitive information about the other to its advantage. An NDA should make clear what type of company information is covered by the NDA, how the companies should share and utilize that information through the course of the deal, and how that information might be shared with third parties such as accountants and outside law firms over the course of the M&A process.
- The Term Sheet or Letter of Intent
Terms sheets or Letters of Intent are two similar types of documents which serve the same essential function: they set out the basic terms of the proposed deal in a non-binding manner. With both types of documents, the information that should be included boils down to what exactly is being acquired and what payment will be provided. For example, are the target’s assets being acquired or is it the whole company being acquired? With regard to consideration, the Term Sheet or Letter of Intent should specify whether cash will be provided and from what source, or stock, and how that stock will be issued.
Terms sheets and Letters of Intent are meant to be non-binding, meaning one party cannot hold the other party accountable in court for their contents, and careful drafting of the documents is critical to ensure the non-binding nature is clear. However, there may be certain provisions, such as confidentiality and exclusivity, which are binding.
- Due Diligence
Arguably, the most important part of the M&A process is the due diligence phase. During the due diligence phase of an M&A process, the acquirer is given access to the target company to examine its business, its procedures, its records, etc. This process often involves the use of outside attorneys and financial advisers retained by the acquirer to conduct the due diligence. The acquirer will be attempting to place a proper valuation on the target company and assess any risks, such as potential litigation risk and questions involving ownership of intellectual property, and determine whether it wants to proceed with the M&A process and on what finalized terms.
- Drafting and Negotiating Definitive Documents
Based on the due diligence findings, the target and the acquirer, along with their financial advisors and attorneys, will then negotiate what will become the binding terms of the purchase agreement, as well as any ancillary agreements such as employment agreements for individuals at the target company and financing agreements related to the purchase. The drafting and negotiating of these documents are often concurrent as both parties go back and forth on terms, and can continue up until closing.
Just like in a real estate purchase transaction, the closing is where the target and acquirer meet to sign the finalized deal documents. At closing, the company ownership will change hands and the payment to the target’s owners will be finalized. The terms and conditions of the operative agreement (i.e., asset purchase agreement, merger agreement, or stock purchase agreement) will vary depending on whether the transaction is structured as a simultaneous signing and closing or as a deferred closing. In a simultaneous signing and closing, the parties sign the documents and close on the deal at the same time. In a deferred closing, the closing occurs sometime after the operative documents are executed.
Further, the parties’ obligations will often not end at the closing. The seller is normally required to enter into a number of covenants restricting its conduct for a defined period of time, such a confidentiality, noncompetition, or nonsolicitation agreement. Depending of the transaction, the buyer may be subject to post-closing obligations, such as a requirement to provide similar employee benefits for a period of time or to provide director and officer insurance and indemnification for outgoing directors and officers of the target company.
As shown above in this very basic explanation, the M&A process can be very complex. All transactions, whether it be a sale or a merger, include many moving parts, and involve different parties with varying ideas and expectations for how the deal will transpire. Without consideration for the legal aspects of the deal discussed above, the deal most certainly will fall through. To ensure your deal stays amicable, occurs smoothly, and results in best deal possible for all parties involved, make sure to follow the rest of this series of blogs on the M&A process. The next blog in this series will delve deeper in to engagement of the financial advisor and the necessary elements of the engagement letter.
By: Kayla A. Haines, Esq., MBA