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Advising on private M&A in a cost effective way

Public M&A is often regarded as the pinnacle of M&A advisory.  After all it involves the glamour of buying a public listed company which generally attracts more media interest.  I should know as I used to work at the Takeover Panel and worked on plenty of major public takeovers.  But glamour aside, private M&A can be more painful.  Here is why and some tips on how to make it less painful and expensive.

Why does private M&A cost so much?

Private M&A involves a detailed set of acquisition documents (mainly the Sale and Purchase Agreement, aka SPA) which are individually negotiated.  Large law firms tend to have their own (voluminous) precedent SPA’s which are used as the starting point, and then the lawyers get down to business negotiating the terms.

Then there is the due diligence.  Since lawyers work on hourly rates and involve all the various specialist lawyers in areas such a pensions, intellectual property and so on, before you know it a veritable army of well meaning diligent lawyers are racking up the hours on due diligence and crafting the SPA.  Meanwhile the target company has to respond to the multiple enquiries and the nitty gritty of the legal drafting.

How can the cost and complexity be managed down?

As I don’t have an army of lawyers working for me, I work differently and … that reduces cost for the client.  This is how I do it:

  1. I operate initially like an in-house counsel helping the client negotiate the heads of terms and period of exclusivity.
    1. A good and sufficiently detailed heads of terms can reduce the level of negotiation in the SPA.
    2. An exclusivity creates the space to finalise the deal and a sensible timetable for the deal can avoid a mad scramble to get the deal done.
  2. Once the heads of terms are signed, I generally create a team for the transaction:
    1. I have associates who freelance for me on transactions and their hourly rates are generally lower than their rates when they worked in a major law firm. I also charge significantly less for my time than I used to charge when I was a senior partner in a law firm.
    2. Sometimes, I recommend and bring in a law firm to work alongside me using my network of contacts, especially on larger transactions. Often, I will use a non-London law firm with the right experience.  With my experience, I know how to manage law firms so that the costs don’t get out of hand.
    3. On occasion, I have used barristers on specialist areas of law. Barristers customarily charge lower rates than solicitors at the larger law firms and in esoteric areas of law they are generally better informed.
    4. I generally outsource the tax advice to tax accountants and, with their input, apply that advice to the structuring and drafting.

I’ve negotiated SPA’s for over 30 years.  I’m not saying I have seen it all before.  After all, every deal is different; and the law companies operate in is constantly changing.  But with experience comes judgment and I can generally ensure that focus is directed at what is important rather than treating every issue as if it has equal importance.  I subscribe to Thomson Reuters Practical Law. This is an online resource which provides legal precedents, including SPA drafting tools.  This ensures I have the most up to date legal resource at my finger tips.  All major law firms subscribe to this database.

Here are some sell side tips:

  1. The process of due diligence and disclosure will often reveal that the business being sold is not entirely up to date with all legal and regulatory requirements. It is best to address any issues in advance of the sale process.  Otherwise, the SPA drafting can get quite complex as the buyer starts asking for indemnities and specific drafting to allocate risk.  As a minimum:
    1. Ensure that all key customer and supplier contracts are signed and available;
    2. Identify any contingent liabilities and minimise them as much as possible;
    3. Ensure tax and accounting issues and addressed;
    4. Have a clear record of regulatory compliance.
  2. On large sell side mandates (esp. when the sellers are getting bids from buyers), the seller’s advisers will occasionally prepare a sell-side due diligence report and sell-side SPA. That can be quite effective in dealing with issues, but the downside is that it can front-end cost for the target company/sellers before deal terms are agreed.
  3. Most smaller deals do not take this approach but some of the attributes of the approach can be created by being a well organised seller. For example, a legal audit based on the standard warranties which will be in the SPA can be done in advance and is a cheaper exercise than a full vendor due diligence report.
  4. The on-line data room of key documents can be prepared in advance rather than waiting for the buyer’s due diligence questionnaire. I advocate using a sell-side questionnaire to prepare the data room and then provide that to the buyer when they get access to the data room.  Legal costs can be saved by the target company preparing the data room if it has the resources and it is cheaper if that is not managed by external lawyers.
  5. Often the SPA with detailed warranties is sent to the seller before the due diligence is complete. That can be frustrating for the seller as the process of preparing disclosures against the warranties can seem like a separate and parallel due diligence exercise, esp. as the buyer will insist on specific disclosures against each warranty.  Often these issues can be avoided by the sell-side lawyers reviewing the due diligence materials in the data room and advising on remedial action before the buyer’s lawyers get struck in – see point 3 above.
  6. Generally, the buyer’s lawyers draft the SPA. However, in my experience it can make sense for the seller’s lawyers to draft the operational terms of the SPA based on the heads of terms but leave the warranty schedule to the buyer’s lawyers.

Avoiding liability under warranties

Warranty claims are not that common but I have advised on two transactions where the buyer made successful warranty claims.  Both involved claims in relation to warranties relating to the company’s accounts and the inclusion of supplier rebates which meant the accounts were over-stated.

It is not only crucial to ensure the Annual Accounts are accurate but also to ensure that any warranties on performance since the last Accounts Date are made carefully.  The importance of this is highlighted in the recent case Decision Inc Holdings Proprietary Ltd v Garbett [2023] EWHC 588 (Ch).  In this case:

  1. The sellers warranted that there had been no material adverse change in the turnover, financial position or prospects of the Company since the last Accounts Date. A fairly standard warranty, albeit that most sell-side lawyers will seek to delete the reference to ‘prospects’.
  2. The Court found on the facts that there had been a material advise change in the prospects and damages were awarded based on the difference between the position as warranted and the position based on the actual position.

Warranty insurance is quite common (and relatively cost effective) these days and the sellers can arrange insurance in parallel or even after signing (although it is best to involve the brokers before signing).

Buy-side tips

  1. It is tempting to throw in the kitchen sink and cover every conceivable issue in the SPA. However a well crafted SPA with warranties which cover the key points in a bespoke manner can be more effective than an SPA which is designed like a legal checklist, especially if it follows a sensible due diligence exercise which has revealed the key areas of concern.
  2. The cost benefit of using warranties to carry out a legal audit of the business needs to be carefully considered, especially when most warranty claims arise in relation to Accounts and trading rather than compliance. The buyer needs to set a reasonable materiality threshold and approach the warranties as a genuine risk allocation exercise rather than a second layer of due diligence.
  3. Of course there will be some areas when the business can suffer fines for non-compliance with applicable regulation but this can be addressed by understanding what is important in the business. By way of example, there is little point in having voluminous warranties on environmental property risks if the target business rents office space.

Conclusions

Private M&A is bespoke and one size does not fit all.  On a sale, a streamlined approach is not always in the gift of the sellers.  Unless the sellers are in a particularly strong position, the buyer drives the approach towards the legal documents. On the biggest most complex deals, I sometimes bring in a law firm to work alongside me.