Practical tips for M&A negotiations
Practical tips for M&A negotiations
The negotiation process is a key part of every transaction. In the early stages, discussions concerning the transaction are typically conducted under a non-disclosure agreement (NDA), and the process is business-driven. At this stage, the key players are usually the relevant business representatives on the buyer’s side and, on the seller’s side, the financial adviser or the majority shareholders or the board of directors and executive management, depending on the size and nature of the transaction. Once a high-level mutual understanding has been reached, an indicative offer, or a ‘term sheet’ or similar document is drawn up, which paves the way for the due diligence process to begin.
In parallel with the due diligence process, work also begins on drafting the actual M&A documentation. In addition to the share purchase agreement, this typically comprises several agreements entered into at the same time, which are subordinate to the share purchase agreement. These agreements may include, for example, new directors’ agreements with key personnel of the target company, agreements relating to retention and incentive schemes, and agreements concerning the sellers’ reinvestment.
The early stages of the M&A process are typically straightforward, because once agreement has been reached on the valuation of the target company, it is easier to accept the other terms at a high level, particularly as an indicative offer, term sheet or letter of intent (LOI) is not typically binding, apart from a few specifically listed conditions.
The actual negotiation phase begins when the first ‘long forms’, i.e. the full-scale agreements, are made available for review. Typically, the first drafts are prepared by the buyer, and they contain terms that have not been discussed at an earlier stage of the process, or which have been referred to in the term sheet only in general terms as ‘standard’ or ‘in accordance with market practice’. This is the stage at which a party gains, for the first time, a more comprehensive view of the other party’s position on the terms of the transaction as a whole. It is also at this stage that the first conflict in the transaction process typically arises, for example where the seller considers that the draft agreements provided by the buyer deviate from what the seller believes was previously discussed and recorded in the term sheet.
The process often continues from this point with the seller providing the buyer with a ‘redlined’ version of the transaction agreements, which the seller has amended to reflect its own view of the agreed terms and of what is ‘standard’ and ‘in line with market practice’. This, in turn, may lead to a corresponding negative surprise on the buyer’s side, as the buyer feels that the seller is attempting to renegotiate terms that the buyer considers having already been agreed, or is presenting incorrect views on what is customary or in line with market practice. The end result may be a deterioration of trust between the parties and a shift in the negotiation process from the positive search for solutions during the initial term sheet stage to a negative stance of stubbornly defending one’s own views. This, in turn, may complicate the transaction negotiations and, in the worst case, derail the entire deal.
The content of the transaction agreements is also influenced by the findings of the buyer’s due diligence review, which are incorporated into the share purchase agreement on the basis of review reports prepared by the buyer’s advisers. In the initial drafts of the agreement, the buyer typically reserves the right to propose additional terms or to amend terms already proposed on the basis of due diligence findings, and such additions are therefore often made only after the initial drafts have already been prepared. These findings may, for example, result in the seller granting an extended specific indemnity in favour of the buyer in respect of risks that the buyer is not prepared to accept as falling within the scope of the ordinary limitations of liability. Occasionally, advisers have included in the due diligence report a wide range of findings that may not necessarily be material to the transaction or which, by their nature, fall within the scope of normal business risk. In turn, amid the contract negotiations, the due diligence process, and any financing negotiations relating to the transaction, the buyer may carry such findings over unchanged into the share purchase agreement, thereby increasing the seller’s risk in relation to the target. This can easily lead to the next conflict, as the seller feels that the buyer is attempting to shift an unreasonable amount of risk onto the seller. The end result is a further complicated negotiation process, in which the parties feel that they disagree on almost every issue.
So what could be done to prevent the accumulation of issues that complicate negotiations?
Firstly, it would be advisable for the parties to discuss their expectations and priorities regarding the terms of the transaction in greater detail as early as the term sheet stage. The buyer, for example, may have a specific interest that it wishes to protect particularly well. Sellers, on the other hand, may have differing profiles, which affect the terms they are prepared to commit to. For example, a private equity investor is typically not prepared to enter into commitments that restrict its own freedom of action, such as non-competition and non-solicitation undertakings, or to give seller’s warranties concerning the operational activities of the target company. An individual shareholder who has left the company, on the other hand, is in a fundamentally different position from individual shareholders who act as key personnel within the company and continue in the buyer’s employ after the transaction. It is important to understand that not all terms and conditions necessarily apply as they stand, even to individuals in the same role within the transaction. Identifying and raising these matters at the start of the process helps to prevent the conflict typically arising at an early stage in connection with the parties’ reactions to the initial versions of the agreements.
Secondly, the parties to an agreement should be aware that a contract will never be perfect from either party’s point of view. The increasing use of artificial intelligence has brought with it certain characteristics that reveal a tendency to ‘optimise’ the contract to suit one’s own interests. When both parties act in this way, the result is an endless back-and-forth of redlining, which improves neither the quality of the process nor the final outcome. Instead, it is important for the parties to identify their key interests and terms and to form an understanding of where the acceptable limits lie in relation to them. Often, these terms are precisely those that are resolved at the end of negotiations as a ‘package’, once all other terms have already been agreed. If, on the other hand, these issues could be identified and raised at an earlier stage of the negotiations, one might not even end up in a situation where, after the negotiations, there are typically 3–5 major issues remaining, for which a solution is sought amidst negotiation fatigue. For one reason or another, the parties’ willingness to compromise is often only found at the stage when one or both parties are already prepared to call off the deal because the negotiations have become, in their view, too difficult.
Thirdly, the parties and their advisers should have a deep understanding of the transaction mechanism and the interrelationships between the terms to be agreed. Transaction negotiations often get bogged down on a single technical clause, which at some stage becomes more a matter of principle than a rational issue. At the same time, it is forgotten that no single clause in a share purchase agreement operates in a vacuum but is linked to all the other clauses. For this reason, the best solutions are invariably found by considering the matter from an overall perspective and by understanding how the sets of terms recorded in the agreements operate, serve, and protect the interests that the parties have identified as important to them. All too often, people stand behind the terms, fixating on a single clause and justifying it with market practice or some other general reason, rather than discussing why this particular clause is important and non-negotiable for that party, and why there can be no flexibility on this specific point. If the grounds are genuine, a solution can usually be found within the broader set of terms and conditions, where, in turn, the other party may secure the concession they desire on a matter important to them.
Fourthly, it is worth bearing in mind that no two transactions are exactly the same. A solution that has proved successful in one transaction may not necessarily be so in the next. Therefore, when embarking on a transaction, it is advisable to gain a sufficiently in-depth understanding of the target company right from the start. Particularly on the adviser side of an M&A mandate, advisers often join what might be described as a moving train, without necessarily having any prior familiarity with the target or its owners. Whilst the parties to the transaction usually discuss matters directly with one another at business management level in the early stages, the advisers’ knowledge is based on the limited material provided to them, on the basis of which the transaction documentation is drafted and the due diligence process is initiated. As the level of information improves during the process, it is often found that many issues presented as absolute and crucial may not, in fact, be that important.
Good preparation makes the whole process easier
As a general guideline, one could say that the better the parties have done their homework before signing the term sheet, the more openly the parties’ key interests and priorities regarding the terms of the transaction have been brought to light right from the early stages of the process, and the better the parties understand the significance and interrelationships between the target company and the terms to be agreed, the easier, more pleasant and faster the negotiation process will be for all parties.
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