Merger agreements drive M&A success by defining a complex and time-consuming transaction and minimizing risks. Disputes and confusion are commonplace during negotiations, and the chances of failed M&A deals are as high as 70% to 90%.
Drawing up detailed merger agreements and contracts helps manage the problems and secure the rights of both parties. You’ll include relevant terms and conditions to infuse clarity and ensure that information and asset transfers proceed seamlessly.
Mergers and acquisitions typically involve investing significant amounts of resources in terms of money, sweat equity, and man hours. Dealmakers conduct due diligence and gather all the necessary information about the companies before they move forward.
Their objectives include integrating synergies and transferring intangible and intangible assets and skill sets for long-term growth, stability, and market share. These assets may include real estate, leases, intellectual property, contracts with third parties, and more.
Next, you’ll work out the payment structure for the targeted company in terms of assets, cash, debts, and stock. With so much at stake, outlining the terms at the start of negotiations becomes crucial. Having merger agreements in place helps you accomplish just that.
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What is a Merger Agreement?
A merger agreement is a legal contract that drives the combining of two distinct business entities into a single company. This contract addresses a range of issues, including but not limited to liabilities, legal considerations, taxation, and Intellectual Property (IP).
You’ll also negotiate terms in regard to managing the workforce, assets, and business operations. Not addressing these issues raises the risks for shareholders and the liabilities related to indemnification once the deal is concluded. That’s how merger agreements drive M&A success.
Several factors come into play when drawing up the contract, including the expertise of the attorneys and M&A advisors. You’ll also discuss the pricing structure and terms and conditions both parties agreed on when creating the letter of intent.
The clauses included in the merger agreement will also depend on the sellers having other offers for buying their company. And the leverage both parties have. The level of risks dealmakers are willing to carry with exposure to liabilities, and closing conditions will also feature here.
Both parties are liable by the law to disclose all the details and terms in the merger agreement. Next, the board of directors and shareholders approve the contract before the final acquisition or merger takes place.
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Components of Merger and Acquisition Contracts
To understand how merger agreements drive M&A success, you must first list the essential details that go into them. Here’s a quick overview
- Detailed description of the deal, including the parties participating in the deal and the assets and liabilities being transferred. Names of the key decision-makers, their contact information, and other details are also listed.
- The structure of the merger or acquisition and its mechanics.
- Types of mergers such as reverse triangular, forward triangular, direct, spin-offs, or multi-step.
- Pricing structure including direct stock purchase or tender offers, cash, assumption of debt or liabilities, or buyer securities. You’ll also discuss the terms of transferring Intellectual Property, real estate, or a combination of the assets.
- Mode of payment, currencies involved in the case of cross-border M&A deals, and the timeline for making payments.
- Representations and warranties are statements of fact and declarations from both parties. Dealmakers also outline the risks and liabilities for which they will assume responsibility.
- Covenants are a list of the provisions the dealmakers make before and after the final deal closure.
- Conditions are the actions both parties must take before concluding the deal.
- The termination provisions allocate both parties the right to walk out of the deal. That is, if they find that any of the information is incorrect or inaccurate.
- The compensation parties can exact in case of breaches in the representations and warranties feature in the indemnification section. As a result, there is complete clarity about the nature and quality of the assets discussed in the deal.
- This section discusses the applicable taxes for concluding the deal and how they will be paid out.
- The final section includes any additional terms and conditions necessary to ensure the deal progresses and culminates smoothly.
Drawing Up and Drafting Merger Agreements
Before drawing up the merger agreement, you’ll develop an acquisition strategy and a list of potential companies for takeovers. Next, you’ll conduct a thorough evaluation to determine the financial status of the targeted company. Your legal team can now draw up the merger agreement.
Dealmakers then start with negotiations with the assistance of M&A advisors, legal teams, and other consultants. The due diligence process follows this step, a process that can take time and resources. The entire M&A process, starting from the proposal to the closing, can take several months.
But, once the parties affirm that there are no issues, they can proceed with the final purchase and sale contract. Although you can find merger agreement templates online, it’s always advisable to retain the services of expert legal teams. That’s how you can ensure that all the relevant information is included.
Concluding M&A deals takes several months, so you can expect that the merger agreement will go through extensive editing. As dealmakers go through negotiations and due diligence, they may have to make changes to the contract.
Since the process is time-consuming and involves extensive paperwork, losing track of the objectives of the merger can happen. Having a contract in place keeps teams focused, and that’s how merger agreements drive M&A success.
Having virtual data rooms to store documents is always a smart move. That’s how you can ensure that different teams can access the information they need to get things moving. You’ll also ensure ease in tracking data and seamless participation from the key stakeholders.
Infusing transparency and accessibility in the workflows is crucial for the contract lifecycle to operate without any snags. Also, consider deploying AI tools to assist you through every aspect of the deal.
Including Pricing and Considerations in the Merger Agreement
Typically, the letter of intent included the pricing structure and other considerations for the merger or acquisition. But the merger agreement can also include information like:
- Amount of cash payments to be made upfront for the entire purchase price
- Percentage of payments to be made in buyer stock
- Common or preferred buyer stock
- Redemption and dividend
- Voting rights
- Liquidation preferences
- Registration rights
- Rights and responsibilities of the members of the Board of Directors
- Any restrictions on transferability
- In the case of public companies, the agreement will specify if stock valuation is done at the closing or signing of the M&A deal.
- You’ll include any conditions for valuation in case the stock appreciates or depreciates
- Working capital available in the company’s balance sheet. Dealmakers determine this figure carefully to account for any changes that may occur as the transaction progresses.
As your M&A advisor will recommend, you’ll negotiate the difference between equity and enterprise value. The enterprise value is the figure you calculate on closing after accounting for cash and the company’s indebtedness-free status.
In the case of promissory notes, buyers must negotiate the principal and interest payments. You’ll also account for the secured or unsecured categorization and if a third-party guarantee is needed.
Due diligence will also look into the conditions for default. And if you can accelerate payments if there are any breaches in the note’s terms.
Including Holdbacks or Escrows – How Merger Agreements Drive M&A Success
Merger agreements include the holdback or escrow clause to protect the buyers if the seller backs out of the deal. M&A advisors may also recommend adding a second escrow to secure the buyer from losses after the closing. These losses can occur if the prices drop because of working capital adjustments.
Some M&A deals may also need funds in escrow for litigation and any other contingencies. Typically, the indemnification holdback or escrow is between 5% and 15% of the deal value. Third parties hold the escrow funds for nine to 18 months.
Holdbacks and escrows are not mandatory. For instance, when the M&A transaction is on an as-is basis, there are no post-closing indemnities, eliminating the need for escrows.
Alternatively, buyers and sellers may choose to buy representations and warranty insurance for coverage against indemnification claims after the closing.
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How Breakup Fees Work
Considering the time and resources spent in due diligence and negotiations, buyers may want to secure their investment. Accordingly, they may request that the merger agreement or letter of intent have a breakup fee clause. That happens when the seller has multiple bids from competing buyers.
The average breakup fee ranges from 1% to 3% of the total deal value. This amount covers the costs of the negotiations breaking down. Typically, breakup fees are common in public company takeovers. That’s because shareholders can vote against the deal and prevent it from reaching the final phase.
The board of directors may also support other bids. That is if they think that their pricing structure or terms and conditions are more favorable for the shareholders.
In the case of privately held businesses, agreements usually don’t include breakup fees. That’s because this provision could deter other buyers from making offers in a controlled auction. In present times, since M&A deals are publicly announced, buyers typically request a recovery fee.
Aside from the shareholders and board of directors canceling the deal, other factors can result in the M&A transaction falling through. The seller may reach out to buyers in the open market and invite bids from the public. They may choose to opt out of negotiating with the original buyer.
That’s how merger agreements drive M&A success because they deter unfair actions. However, there can be situations where the due diligence reveals certain facts that make the targeted company unsuitable for purchase. In that case, breakup fees can be a failsafe measure for the buyers.
Reverse Breakup or Reverse Termination Fee
Like buyers, sellers also need assurance that the acquirers will keep their side of the bargain. To do that, they include the reverse termination fee in the merger agreement.
This fee awards security that the buyers are committed to entering into a transaction. Sellers can request this compensation if the buyer is unable to secure the funding to complete the purchase. Or if they are unable to get their shareholder approval for the deal.
M&A transactions typically have a deadline, and dealmakers are expected to complete the purchase by this date. The inability to honor this date can also trigger the seller’s request for a reverse breakup fee.
Since regulatory compliance is crucial for mergers, dealmakers may have to cancel if they’re unable to get approval from the relevant authorities.
Material Adverse Changes (MACs) Clauses
Changes in the economic, statutory, and political spheres and climate conditions can result in M&A deals falling through. To account for such unforeseen events, buyers may want the Material Adverse Changes (MAC) clauses in the merger agreement.
Expensive litigation, natural disasters, war, internal unrest, and massive drops in the stock exchange can also be factors. Uncertain capital markets, financial conditions, and credit outlooks can also result in the deal no longer being viable.
No Shop Clauses in the Merger Agreement
Merger agreements drive M&A success by including the no-shop clause. This provision prevents sellers from soliciting better bids and terms and conditions from third parties. As long as negotiations are underway for the deal, the seller cannot consider other offers.
Although dealmakers can insist on this clause, shareholders can override the negotiations and deals. That’s because they have the final say in whether the purchase will proceed as planned. If bids from other potential buyers are higher than the original proposal, sellers may choose to go with them.
Merger agreements drive M&A success by being powerful tools that determine how the negotiations and due diligence procedures work. This document outlines exactly what the dealmakers can expect from the deal.
While these contracts facilitate the M&A deal, they include provisions under which dealmakers can walk away from the table. Having the deal fall through during negotiations is preferable to the purchase closing, especially when the companies face problems later.
These issues could arise from difficulties in integration, cultural mismatches, employee attrition, and more. The costs for a de-merger can be far more significant than breakup fees, reverse breakup fees, and other contingencies.
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