Buying or selling a business can be a complex and emotional process for all involved, so it’s essential to do the proper due diligence with a client before drafting agreements, says Toronto corporate lawyer Sammy Redlick.
“What these deals tend to have in common is they are private company merger and acquisition (M&A) deals,” says Redlick, a partner with Torkin Manes LLP who manages transactions that range in size from $1 million up to $100+million.
“The buyer could be a competitor in the same industry, a private equity-backed buyer, or a private equity fund. The target is usually a private company which is often either owner-operated or owned by a smaller group of shareholders,” he tells AdvocateDaily.com.
Drafting the letter of intent
For buyers and sellers, it all begins with a well-thought-out letter of intent (LOI).
“My recommendation is to have legal counsel involved when drafting and negotiating letters of intent. Frequently these days, you are finding letters of intent with more detail built into them — not only the economic terms but also the legal terms of the deal,” says Redlick. “What is in the letter of intent will, in part, dictate how you draft the purchase and sale agreement.”
The lawyer drafting the agreement has more flexibility in terms of how aggressive they want to approach it if there isn’t an LOI or there is just an indication of the price, but the other terms are missing, he says.
“Part of the discussion that I have with my client is determining how aggressive we want to be in our position with that first draft of the agreement because some people are of the view, ‘Hey, I want to draft an agreement that is fairly one-sided in my favour and leave it to the other side and their counsel to negotiate and mark it up as they see fit,’” says Redlick.
The other side may accept most of your positions, which might leave you in a good situation. However, sometimes, if there are more sophisticated parties and counsel on the other side of the transaction, you could come off looking heavy-handed and unreasonable.
“Some clients say, ‘I don’t want to keep going back and forth — it will take a long time and cost me a lot in legal fees, so just draft something fair and reasonable, and we’ll get to the finish line much faster,’” says Redlick.
“I think a good lawyer is one who has that discussion with a client in the beginning as opposed to just making a judgment call for the client.”
While a client may feel strongly about four or five points, it is essential to know what they are willing to concede on further into the deal process, he says.
“That is absolutely part of the discussion — if you give up all your trading chips too soon, you have nothing left to negotiate,” says Redlick.
Many business owners may be going through an M&A process for the first time, and may not appreciate the amount of work required around reviewing agreements and putting together disclosure schedules and ancillary documents, he says.
“I try to set client expectations early because they often don’t appreciate that the purchase and sale agreement could be 50 plus pages, and sometimes much more than that,” says Redlick. “There’s a great amount of legalese in the document. Part of the process is sitting down and explaining how representations and warranties work, how indemnities work, as well as standard terms such as indemnification caps and thresholds.”
M&A terms are not simple concepts to understand, so Redlick will spend some time helping clients come to grips with their meanings and implications.
“For example, I outline the process and point out that even though we are sending a draft to the other side, you can expect them to push back on points A, B and C because we have taken certain positions, which may not be in line with what you would typically see,” he says. “I explain that the likelihood is that we will land somewhere in the middle. I will have those discussions to set expectations.”
Dovetailing due diligence with the agreement
“It’s imperative when drafting the agreement to make sure that due diligence is done in terms of financial, tax, legal, HR, etc. and that it then dovetails into the representations and warranties you’re getting in the agreement,” says Redlick. “If you’re doing critical due diligence, but it’s then not translating into the reps and warranties of the agreement so that the buyer has legal recourse against the seller following closing due to an inaccuracy or misrepresentation, then a lot of the teeth of the agreement and purpose of the due diligence is lost.”
Post-closing purchase price adjustments
Where legal drafting skills become most relevant is if there is, for example, an earn-out or other type of provision, where some of the purchase price consideration is deferred and dependent on the financial performance of the business after closing, he says.
“That is very important, and any purchase price adjustments, such as a working capital adjustment, those are the types of provisions where there is the most litigation following the closing of an M&A transaction,” says Redlick.
Good grasp of financial statements
It is crucial to ensure the way you are defining financial terms and metrics dovetail with how the business and finance people are doing their analysis, he says.
“At the end of the day, they can work out all the pro forma financial models and spreadsheets they want, but if you draft the agreement and the words don’t match up to their expectations, there is going to be a gap there,” Redlick says. “That is a critical part of drafting, and I think a lawyer who understands financial statements and finance is a huge value add to your legal counsel.”
In a crunch, meet face to face
At a certain point, it becomes time to stop the exchange of documents and have the parties meet together.
“For the sake of efficiency, you have to stop marking up agreements, and put a list together of the outstanding material points and get everyone in a room together and talk,” says Redlick. “It’s a lot easier when you’re hiding behind the computer screen to say no, no, no, than when everyone is in a room together.”