The Anatomy of a Deal
Updated: Apr 28, 2021
This step-by-step animation of the anatomy of a deal courtesy of Allen & Overy
LLP explains in easily understandable terms for non-specialists the stages of a leveraged acquisition and what the roles of the lawyers are on each step of the transaction.
The fast-paced and humorous presentation is probably the best presentation ever produced to explain the various steps required for a successful acquisition of a company by a private equity fund financed by a leveraged finance facility. In simple terms it explains the often complex transactions and the commercial and legal motivations of the parties to a transaction and what the various legal teams and specialists do to bring the deal across the finishing line.
Mergers & Acquisitions
The term 'Mergers & Acquisitions' is often used quite liberally. In fact, a merger and an acquisition are two very different legal concepts. From a legal perspective, a merger is a legal consolidation of two companies into one company, whereas an acquisition is when one company takes ownership of another company's shares (a share deal) or assets (an asset deal). If a party purchases the shares in another company, it becomes the new owner of that company and it is therefore called an acquisition. The purchaser may be another company, a so-called 'trade buyer' that wishes to expand or it may be a company that specialises in buying, improving and then selling companies using investor money and aditional funds borrowed from a bank or a number of banks by way of a syndicated loan. This is what a private equity fund does using acquisition and leveraged finance credit facilities to maximise the return for their investors. The investors will often be so-called institutional investors, meaning pension funds, insurance companies, etc., seeking to expand their investments in a diverse range of asset classes to ensure that e.g. the pension fund contributions are effectively managed to provide a return to finance pensions or insurances. Acquisitions can be classified as 'private' or 'public' acquisitions, depending on whether the company being acquired (also called the 'target company') is listed on a stock exchange or not. If the company is listed on a stock exchange, it is referred to a a publicly listed company and the acquisition is a 'public acquisition'. If the company is not listed on a stock exchange, it is referred to as a 'private acquisition'. Likewise, if a publicly listed company is acquired and delisted from the stock exchange, it is referred to as a "taking private"-transaction. Moreover, an acquisition may be described as being friendly or hostile. In a friendly acquisition, the management, employees and shareholders of the target company sees a benefit for the shareholders in the acquisition. In a hostile take-over, the company's stakeholders consider the acquisition as not being in the best interest of the company as a whole. This is a rare, but surely dramatic course of events.
In some instances, a smaller company may acquire control of a larger or more established company and it may also assume the name of the acquired company after the acquisition. This is referred to as a reverse takeover. In its most pronounced form, this is the stragey employed by so-called special purpose acquisition companies (SPAC) that are formed and listed with the stated intent to acquire other privately-held companies with the proceeds from the subscribers. Another acquisition category is the so-called reverse merger. This is a transaction that can enable a privately-held company to become a publicly-listed company within a relatively short time frame. A reverse merger occurs when a privately-held company with strong finances and growth potential acquires a publicly-listed company, usually a more or less dormant company with no material business or assets. The reverse merger avails the the privately-held company to raise capital as a stock exchange listed company in the capital markets.
However, a merger describes two companies that decide to join forces to move forward as a single new company, rather than being separate companies. Legally, one entity will assume all the rights and obligations of the other entity going forward. It is therefore referred to a the 'surviving entity'. The other company will be dissolved once all rights and obligations have been transferred.
A merger can commercially be classified into five basic categories:
Horizontal Merger: means a merger between two companies that are in direct competition with each other in terms of of both product lines and markets.
Vertical Merger: means a merger between companies that are placed along the same supply chain for the same products or services.
Market-Extension Merger: means a merger between companies in different markets that sell similar products or services that complement each other on the market level.
Product-Extension Merger: means a merger between companies in the same markets that sell different but related products or services that complement each other on the product level.
Conglomerate Merger: means a merger between companies in unrelated business sectors to form a conglomerate.
The documentation needed to execute an M&A transaction will often begin with a non-disclosure agreement (NDA) followed by a non-binding letter of intent (LOI). The next step will require the target to prepare a data room to disclose all relevant information in relation to the target company in a due diligence process involving lawyers, accountants, tax advisers, business experts, management consultants and a number of other professionals from both sides of the deal.
Following the completion of the due diligence process, the purchaser's legal advisers will have drawn-up a due diligence report setting out any perceived legal flaws in the target company and seek to quantify these issues. On that basis, the parties will proceed to agree a sale and purchase agreement (SPA) in the form of a share purchase agreement or an asset purchase agreement depending on the structure of the transaction. The SPA will adress the terms and conditions of the acquisition and any issues discovered during the due diligence process. The SPA will commonly include the following main provisions:
Conditions Precedents (CP), which must be satisfied (or ultimatively waived or deferred by the purchaser) before there is a legal obligation to complete the transaction. The CPs may include regulatory approvals from competition authorities, industry regulators such as the financial supervisory authority, governments, etc.
Representations and Warranties (Reps & Warranties) by the seller with regard to the company, which must be true at both the time of signing (signing date) and the time of closing (closing date). The sellers and the purchasers will seek to draft the representations and warranties with respect to certain qualifiers such as "knowledge" and "reasonableness" setting out the level of knowledge attributed to the seller in terms of guaranteeing a certan set of facts attributed to the target company. If the seller's representations and warranties turn out to be wrong, the acquirer may claim a refund of the purchase price. For that reason, a part of the purchase price may be set aside in an escrow or it may be covered by a specialist M&A insurance. As this will materially affect the resulting price, it is often heavily negotiated by the parties.
Covenants, which govern the conduct of the parties to the transaction, both before the closing (e.g. covenants that restrict the operations of the business between the signing and the closing date) and post-closing (e.g. covenants regarding tax or future competition between the parties).
Termination, which may be set out in a material adverse change clause (MAC) triggered by a deterioation of the target company's business, failure to provide adequate acquisiton finance, or by a failure to satisfy certain CPs or seting out a so-called drop dead clause on or before which the transaction must be completed or the offer will be rescinded by the purchaser. This may also include break costs or break-up fees that may be payable by one party to the other if a termination occurs for certain events.
Post-closing adjustments may still take place with respect to certain provisions of the SPA, most importantly with respect to the the purchase price, including so-called 'earn-out clauses' or deductions. This may occur over a period up to five years in some circumstances. The purchasers may also require that certain key persons must remain with the company for a period after the acquisition to ensure a smooth hand-over and continued operations. This is often referred to as a 'key man clause' and may be combined with certain financial incentives to ensure their motivation is aligned with the target company's operations. For that reason, the seller's fortunes may be closely bound to the fortunes of the target company even after the company has been sold and is managed and operated by the purchasers.
An M&A transaction may be financed in a number of ways. In addition, mergers and acquisitions are usually financed in very different manners. While a merger can be financed by cash, by acquiring or 'issuing paper', i.e. by issuing shares in the surviving entity to the shareholders or by a combination of payments and shares, an acquisition is mostly financed by professional actors by way of acquisition and leveraged finance. For certain large-cap leveraged finance transactions, the credit facility may be combined with high-yield bond products, as well as being markets in vastly different markets with divergent terms due to divergent conditions imposed by local regulators such as the UK FCA, the Danish FSA and the US SEC amongst others. Large-cap leveraged acquisitions are frequently financed through a mixture of high-yield bonds and term loans, with working capital requirements provided through revolving credit facilities entered into concurrently with the SPA. Acquisition finance transactions structured with term loans and revolving credit facilities are typically guaranteed by each of the borrower group's material subsidiaries and secured by the borrower group's material asset and guarantees provided by the relevant guarantors or sponsors, if available. In that context second-lien structures are not uncommon depending on the ticket size and the various lenders involved. High-yield bond financings are more likely to be unsecured, but are sometimes supported by guarantees or secured via a first or a second lien.
This means that the purchaser will negotiate the financing of the acquisition concurrently with the negotiation of the SPA, including the conditions precedents to ensure that the necessary liquidity is available at the right terms and conditions. If there is only one bidder, the purchaser may be in a stronger negotiating position, especially if there is agreed exclusivity or if the process drags out and both parties have invested significant time and efforts in the process, which makes it less likely that they will walk away. When a purchaser submits an offer, it must amongst other things consider strategically whether there are other potential bidders in the process, e.g. in a structured auction. The form of payment could be a decisive factor for the seller to chose one bid over another. With a purchase structured as cash deal, there is no doubt as to the real value of the offer. The more contingent a purchase price is structured, including earn-outs where the purchaser is essentially "feeding the dog with its own tail", the less attractive the offer may be perceived, as it is difficult to quantify definitively. In that regard, it is necessary to ensure that any offer does not run afoul local prohibition against unlawful financial assistance, both at the time of the original acquisition as well as in relation to later refinancings.
For lawyers in general, acquisition and leveraged finance is a riveting practice area due to the complexities of the acquisition process, the cross-border issues, and the applicable regulations which all affect the the structuring and the timing in an intricate net of requirements and interdependent conditionalities to be documented in the transaction documentation. As a legal discipline, it requires the combination of a number of distinct legal specialisms such as merger & acquisition lawyers, banking & finance finance lawyers, capital markets lawyers, tax lawyers, property lawyers, employment lawyers, pension lawyers, intellectual property lawyers, competition lawyers, environmental lawyers, and insurance lawyers among other cross-border and jurisdictional specialists. This creates a rich and nuanced tapestry upon which each transaction is painted.
For more information about M&A, acquisition and leveraged finance, capital markets and legal regulation in Denmark or the United states of America, please contact Michael Carsted Rosenberg, Andreas Tamasauskas or Brad Furber to discuss.
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