Category Archives: Mergers & Acquisitions

Fortis Insight: Monitoring the Earn-Out

website here [This insight was written by Bob Holmen for Fortis Advisors.  Additional insights may be found at Fortis Insights]

next page When negotiating an M&A transaction, often the buyer and seller bridge the gap in negotiations over the acquisition price by establishing an earn-out to enable the seller to reap greater rewards if as the seller’s products and services grow under the buyer’s new ownership.  However, after closing, it can be very challenging for the seller to gain insight into the acquired business and asset progress toward achievement of earn-out objectives and milestones.  To address this, sellers are increasingly negotiating post-closing information rights.

click this site We have analyzed data from over 500 transactions where Fortis Advisors has served as shareholder representative, as captured in our Forsite™ M&A Deal Tool.  While 80% of all deals with earn-outs include some form of information rights for the seller, generally those rights are limited to annual written statements—only 26% of deals require more frequent reports, and 30% of deals provide for in-person meetings to review progress toward achievement of contingent payments. In order to enable the selling securityholders to monitor and, where possible, maximize return on earn-outs, the seller should negotiate rights for the shareholder representative to (1) receive meaningful periodic (ideally no less than bi-annual) reports of progress toward achievement of contingent payment, and (2) if possible, require periodic in-person meetings to discuss the progress.  Finally, the shareholder representative should have rights to review buyer records reasonably sufficient to calculate the metrics upon which the contingent payment is based.

Fortis Insight: Eliminating Reliance on Pre-Closing Statements

[This insight was written by Bob Holmen for Fortis Advisors.  Additional insights may be found at Fortis Insights]

It is common practice to include an integration clause in contracts, stating that the contract represents the entire agreement between the parties.  That said, in disputes between parties to M&A transactions, buyers often attempt to establish liability based on pre-closing statements made by the seller as part of the due diligence process.  In response, sellers attempt to add a disclaimer regarding any pre-closing statements; however, based on recent case law, that disclaimer may not be enough to eliminate post-closing liability.

We have looked at data in our Forsite™ M&A Deal Tool from over 500 deals where Fortis Advisors has served as shareholder representative, and determined that in 47% of all M&A transactions, the seller includes a representation that it is not making any other representations other than those set forth in the merger agreement.  Only 25% of merger agreements include a statement from the buyer that it is relying solely on its own investigation and the express representations and warranties set forth in the merger agreement.  Accordingly, in a majority of all merger agreements, neither the seller nor the buyer disclaim extra-agreement reliance, opening the door for post-closing claims based on pre-closing statements made outside of the merger agreement.

The Delaware Court of Chancery recently weighed in on this issue, making it even more difficult for sellers.  In FdG Logistics LLC v. A&R Logistics Holdings, Inc., the Court held that a seller’s representation that it was not making any representations outside of the merger agreement was insufficient to prevent the buyer from bringing a fraud claim based on extra-agreement statements.  Because of the strong public policy considerations on anti-fraud, only the buyer directly including a non-reliance provision will serve to fully integrate the representations and warranties in an agreement and insulate the seller against claims based on pre-closing statements.

While fraud claims at some level can always overcome the language of an agreement (e.g., if the buyer alleges fraud in the inducement, pre-closing statements are critical in determining the merits of the claim), the best practice is to negotiate for the buyer to include a non-reliance statement—a seller’s disclaimer will not be sufficient.

Fortis Insight: Retention of the Attorney-Client Privilege

[This insight was written by Bob Holmen for Fortis Advisors.  Additional insights may be found at Fortis Insights]

Most executives negotiating merger agreements understand that communications with their respective counsels are protected from disclosure under the privilege afforded attorney-client communications.  However, not all executives understand that it is their respective companies which own the privilege rather than the individual executives.  Further, unless expressly stated in the merger agreement, upon consummation of the merger, the buyer now owns and controls the privilege, allowing the buyer to access the privileged information on the merger transaction.

In 2013, the Delaware Court of Chancery confirmed this principal in Great Hill Equity Partners IV LP v. SIG Growth Equity Fund I LLLP, 80 A.3d 155 (Del. Ch. 2013).  The court found that absent express language in the merger agreement excluding attorney-client communications from the transferred assets, the buyer will own the attorney-client communications post-closing.

Since that ruling, we have noticed a sharp increase in the number of merger agreements containing language retaining for the seller all pre-closing attorney-client privileged communications related to the merger transaction.  In mining the data in the Forsite™ M&A Deal Tool, which includes deal points from over 500 recent M&A transactions, we found that in 2013 only 14% of merger agreements included an express retention by the seller of attorney-client communications.  That rapidly climbed to 44% in 2014 and 52% in 2015.

While the buyer may argue against such a retention clause, and the seller may have reasons to not argue for retention, we nonetheless expect the frequency of such retention language to increase as this issue becomes a standard negotiation point in merger transactions.

Fortis Insight: Aligning Buyer & Seller Interests

[This insight was written by Bob Holmen for Fortis Advisors.  Additional insights may be found at Fortis Insights]

In analyzing data from over 500 transactions where Fortis Advisors has served as shareholder representative, we find that many disputes could have been avoided if only the buyer and seller had created proper alignment on all post-closing matters.

For example, many acquisitions include accounts receivables as an asset of the acquired company.  Ninety-eight percent of all merger agreements require that the seller represent to the buyer that the financial statements “fairly present” the seller’s financial condition (per Fortis Advisors’ Forsite™ M&A Deal Tool).  In addition, many buyers require the acquired company’s shareholders to guaranty ultimate receipt of those receivables.  To the extent collections fall short, the buying company may have a claim against the selling shareholders for breach of the fair presentation representation, or may have direct recourse against escrowed purchase funds to the make the buyer whole.

This structure can create a natural misalignment of interests:  the buyer has no need to collect on receivables if the buyer can make itself whole through recourse against the escrow.  In addition, the buyer may be incentivized to compromise receivables for the benefit of customers to curry early favor post-acquisition.  This can be compounded by customers who do not feel loyalty to the buyer, and thus may slow down payments on prior purchases.

This dynamic can be corrected through alignment of interests.  Selling shareholders should consider negotiating incentives for the buyer based on subsequent collection of receivables (offset, if possible, by reduced recovery on failure to collect).  For example, assume the purchased assets include $1.5 million of receivables with expected collections (after reserves) of $1.2 million.  Consider providing the buyer 50% recovery on collection shortfalls (under $1.2 million) in exchange for providing a bonus ($100,000?) once the buyer reaches $1.2 million in collections.

Other structures can accomplish the same result.  The key is ensure both the buyer and the selling company’s stockholders are better off if the buyer fully collects on receivables.