Mergers & Acquisitions: Not a Spectator Sport
Mergers and acquisitions can be like a competitive sporting match. In most cases, there are two sides, each of which seeks to "win."
Mergers and acquisitions can be like a competitive sporting match. In most cases, there are two sides, each of which seeks to “win.” Generally, it is a voluntary endeavor with both parties wishing to “play.” Each party has likely scoped out the other and has what it believes to be a winning strategy. Each side will typically have a star participant (pitcher, center or quarterback) which, on the legal side of the endeavor, is usually lead transaction counsel. Each side will also have its support players.
The life of the M&A transaction also has its ups and downs, much like a competitive sporting event. The unfolding of the transaction can be influenced by surprise factors. In a sporting match, those might be injuries to key players or a mid-game change in the weather. The corollary in the transaction environment could be due diligence surprises, such as uncovering an environmental problem; the unexpected loss of a key customer or supplier; or other factors such as what occurred in the late summer of 2007, when a dramatic change in the sub-prime lending arena impacted liquidity and the capital markets. Once the M&A transaction or the game is over, it is not uncommon for someone to play “Monday-morning quarterback.”
However, unlike a real sporting event, where a spectator can sit on the sidelines and watch the match unfold with impunity, taking that approach can prove to be unfortunate for the responsible executive of a company involved in an M&A transaction.
After the key executives ink the letter of intent (LOI), there is sometimes the temptation to simply “let the lawyers handle the details.” The responsible executive often wishes to return to his normal duties and tasks, which include responding to the needs of others within his organization, particularly when those needs have been set aside while negotiating the LOI. And, of course, the vast majority of executives are routinely pulled in multiple directions simultaneously, so after the diversion of negotiating the LOI, there is a profound desire to get back to business. The process of negotiating the framework of the transaction can also lead to a fatigue factor being present, especially if the front-end effort involves substantial travel or extraordinary working hours. Due to these factors, the post-LOI work is sometimes viewed as nothing more than “papering the transaction,” and not worthy of the responsible executive’s significant investment of time, other than to be kept updated or consulted on the most important of matters.
Nothing could be further from the truth.
“The Devil is in the Details”
This overworked phrase is nevertheless particularly applicable in an M&A transaction. Attention to the details of the transaction is critical in order to maximize the opportunities available in the transaction, as well as to minimize the risk of unfavorable outcomes.
The LOI phase of a transaction sets forth only the general framework of the deal. Both significant opportunities and material risks can first appear during the preparation and negotiation of the definitive agreements, in one or more of the following places:
- representations and warranties
- conditions to closing
- post-closing covenants
- purchase price adjustments
- prerequisites to indemnification rights and obligations
- conditions to the release of escrowed funds
- earn-out provisions
No matter how thorough and experienced one’s legal counsel may be, it is the responsible executive who likely will have superior knowledge of how the subject business enterprise actually functions on a day-to-day basis. That superior knowledge must be brought to bear in evaluating the practical efficacy of each of the above provisions.
Definitive transaction documents can, in one sense, be thought of as a machine, with the facts and circumstances of how the subject enterprise functions being the raw materials fed into the machine. If the machine works properly, then it generates the desired output — be it avoiding (or at least minimizing) liability to the enterprise, imposition of potential liability on the other party when that is desired, or realization of expected earn-outs.
No matter how thorough and experienced one’s legal counsel may be, it is the responsible
executive who likely will have superior knowledge of how the subject business enterprise actually functions on a day-to-day basis*.
Just as the failure of a small part can lead to the malfunction of an entire machine, so, too, can the errant word or phrase, although innocuous on its surface, cause an unintended result when applied to the post-closing facts of the transaction.
Master the Devil
To master the devil is to be engaged in a transaction on an active basis. It is legal counsel’s responsibility to draft legally sufficient documents, which also properly address all relevant facts known to transaction counsel and reasonable hypothetical outcomes from those facts. However, the responsible executive is in the best position to address the following question: “How well does this work in a “live” setting in the enterprise on a day-to-day basis?”
In order for the responsible executive to fulfill this vital role, it is critical that he carefully read the draft documents submitted by counsel and understand what those draft documents say. He should pay particular attention to definitions, as a definition can make a material difference in how a provision is applied. This may not be apparent by reading a provision and giving a capitalized term (which by convention means that it is a defined term) the everyday lay definition. It bears repeating: the responsible executive should understand what each document says. In this regard, this author admits to a drafting bias. While transaction documents are drafted by lawyers, they must be read and understood (and lived with) by executives who are generally not trained in the law. Accordingly, if the responsible executive does not understand a provision, he should insist on clarification from counsel (which may include redrafting the provision) until the responsible executive understands the provision and how it works within the framework of the overall transaction and the subject enterprise. The responsible executive needs to focus on the details even though it would be more pleasant to ignore them and hit only the high spots of the document. Only then can the responsible executive ensure that either (A) he understands the provision and is comfortable that it will work properly with regard to how the enterprise actually operates, or (B) he understands the provision but this is NOT how things work in the real life, day-to-day operation of the enterprise, and therefore a revision is necessary.
And, of course, the responsible executive should ask himself whether the draft document from legal counsel effects the expectations desired by the responsible executive and his organization.
Maximize the Efficiency of Transaction Counsel
M&A transactions are expensive endeavors in terms of the legal fees that are generated. Done correctly, an M&A transaction must be viewed as a process, not an event. American football has four quarters. Similarly, an M&A transaction has a process that must unfold.
The responsible executive can help a great deal in keeping this process as efficient as possible by remaining engaged in the process. Drafts received from transaction counsel should be reviewed promptly. Attorneys are like passenger jets. Revenue isn’t generated by leaving the aircraft sitting in the hangar. If the responsible executive allows a significant period of time to pass between receiving the draft and responding to transaction counsel, it is likely that his attorney will attend to other major matters in the interim. While that in and of itself is not a bad thing, it does mean that transaction counsel will need to spend additional time to review file notes and previous drafts in order to refresh his memory with regard to the transaction at such time as comments are received.
Efficiency can also be enhanced by the responsible executive providing thorough comments. Transaction counsel really does wish to know what the client thinks about the draft documents. Incomplete comments, or comments received piecemeal, can often lead to an unnecessary increase in the overall number of drafts of the documents needed to bring the transaction to an execution-ready status. Additional transaction costs often result. In addition, thorough comments increase the likelihood that material matters are determined and resolved sooner than later in the transaction process, generally resulting in a more efficient and less costly process.
Empower the Responsible Executive
If the responsible executive is not a member of senior management, then senior management should empower the responsible executive within the enterprise. Such empowerment is necessary so that the responsible executive enjoys the cooperation and assistance of company personnel as needed to address operational matters relevant to the preparation of the transaction documents. Failure to so empower him can lead not only to time delays, but also to the possible failure to address important points if information the responsible executive needs from his organization is not provided in a timely and complete manner.
A Critical Link
There is a reason why coaches are on the field as opposed to guiding a game from the skybox. Although the skybox can often be a more comfortable place to be, the responsible executive, like the coach, can be most effective being an active participant in the transaction. He is a key player in the primary objective of any M&A transaction: maximizing the value of the transaction to the enterprise.