Preparing for M&A – What Issues to Consider before Deal?

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Long time ago in law school, our partner Jan Lindberg heard a lecture from a professor who was of the opinion that when you are a young lawyer and a client gives you a case, you might have only one valid question to ask him or her, thus arguing that one’s experience is actually measured by the number of valid questions a person is able to ask. The professor continued that when your experience grows, you learn to ask more and more valid questions, and the customers’ answers create even more valid questions leading to endless lengthy discussions. Then, when you go deep enough in your expertise area and also learn business principles from different fields, you start forming opinions, or insight, as you may put it, and truly start creating value for your customers.

This in mind, we often meet companies who are about to start an M&A process and have an interesting target in sight, but almost no experience of M&A deals. They often want information of the process in general and wish to know the right questions to ask before the process even starts from the legal, business, technical and financial point of view. Therefore, we thought it would be helpful to list out some questions from the legal perspective that we believe should be considered at an early stage of the process, or even in the first meeting.

Tech M&A specialities

In technology M&A there are additional twists regarding actual target, are you buying IP portfolio, technology or competence. In each case you focus on different things. In case of competence acquisition, HR plays a leading role and incentives are critical while in the, say, patent portfolio acquisition you focus on geographical scope, validity and exposure -related questions. You could, as an example, be very concerned if there is a license granting too wide patent cross-license to your competitor enabling OEM manufacturing leading to a situation that due to the principle of exhaustion you may loose your position to get additional royalties and the possibility to use such patents for defensive purposes if your competitor raises an infringement claim against you. In case of technology, one need to focus on agreements and how they behave before and after closing of the deal in order to ensure that there are no surprises. We were recently called up to advise in a situation that a firm had divested its significant operations but failed to pay attention to technologies behind the deal resulting a post-closing claim for additional purchases from the technology vendor. This was naturally a precondition for them to grant a permission for the assignment of the agreement. In any case this brief categorisation to three types of tech M&A deals should definitely be kept in mind while asking the first fundamental question below.

What are the three fundamental questions?

Generally we would start with three basic questions:

First, why are you doing the deal (getting rid of competition, synergies, accessing, specific clients, brand, IP rights, market access, other)?

Second, what are the specific risks that might prohibit or restrict you from reaching the fundamental goals?

Third, what is the business rationale for (planning to sell or) planning to pay what you are planning to pay?

The last one is difficult some times for lawyers to ask in particular if the price indication has been on the table already before the lawyers are involved. Further it should be noted that it is not lawyers main task to take stand on this but naturally I personally tend to follow the rule that ”say your opinions on all the aspects of the deal” even though this does not directly concern you. Further, if the pricing does not seem to be correct, it is often that there might be issues in the above points 1) and 2) that you do not fully understand.

More technical questionnaire

The the following list could be worthwhile to go through in a kick-off meeting to get your started:

  • Start with the identification of the parties – potential buyer and sellers. Do these parties exist and do they have any assets or background?
  • Need for non-disclosure agreements? One-sided or mutual? At what point can you present one without feeling embarrassed?
  • Letter of intent or memorandum of understanding – is this needed? Is there negotiation exclusivity? Note that the need and content depend on whether you are the buyer or the seller and whether you want to “lock” the negotiating position – at all.
  • Is the process an auction or a negotiation with a specific named party? What does an auction mean – cost-wise and time-wise?
  • Practical matters like deadlines, contact details of legal and financial advisors, signing rights and proxies? A need for the Board of Directors’ approval? Who has the necessary authorities?
  • Stock exchange releases – who will handle them? A road map is often needed, as disclosure will often have to be made without undue delay.
  • Handling of payments and other closing arrangements – who will handle them and who will agree on the arrangements with banks?
  • Is there a need to engage also foreign legal and financial advisors? Is there a need for the legalization of documents or similar official requirements? As a rule of thumb, advice in the parties’ home jurisdiction(s) and from the country of location of the collateral is often required.
  • Other issues needed to keep the deadlines, like decisions by the competition law authorities, cooperation procedures, preliminary rulings from the tax authorities? How do these affect the closing of the deal?
  • Planned signing and, if needed, closing dates?
  • Due diligence issues: responsible parties and the desired form of the report (descriptive or a findings report)? Is the report intended to be relied upon by the parties financing the said transaction? In the target is a group of companies, which companies are subject to due diligence?
  • Are certain issues excluded from the scope of the due diligence? How is the data room formed and what is the chosen materiality threshold? How are confidentiality issues managed – what should be accessed and by whom?
  • Identifying the target carefully – is it a separate company or a group of companies? This is important also in order to know with whom you can / should discuss.
  • You never know enough of the background, so: in what countires does the target operate? what is the operating model (e.g. subsidiary, branch office, distributor or something else)? What are the most relevant of these all (e.g. in terms of revenue)? Etc.
  • Ownership structures of all entities? Are there options, convertibles or similar that might change the structure?
  • How will the transaction be financed, e.g. shares and/or cash, or is it leveraged transaction?
  • Business sale or share sale?
    • It is important to engage a tax advisor at the early stage of the process, as the structuring may be heavily influenced by tax considerations. Issues affecting the choice include whether the shares are a part of the sellers’ fixed assets, whether capital gains benefit from a tax exemption, whether the seller could otherwise minimize taxes e.g. by using losses from previous years, what the effects on the purchase price are, etc.
    • Are there special rights entitling to shares like options, convertible capital loans, transfer restrictions and similar, which could render a share deal challenging? How could these be handled?
    • Are there special risks, assets or liabilities that should be excluded from the transaction due to which a business transfer would be easier?
  • Is there a need to establish new companies for the purposes of the transaction? Why? Are you planning to merge the acquirer with the target (may be needed due to the “financial assistance” restrictions)?
  • Specific key persons? Management considerations? How do you plan to engage them?
  • Will transitional services be needed after the transaction? E.g. IT, administration, or real estate services?
  • Other tax considerations, e.g. from the purchase price perspective, or future considerations from the buyer’s perspective?
  • Purchase price structure, adjustments and earn-outs? How do you fix the mechanism and the numbers for determining these? The earlier these issues are finalized the better, as mistakes in them may be very challenging to solve after signing the deal.
  • Is the purchase price connected to the refinancing or rearrangement of the target’s financing?
  • Should there be an escrow arrangement?
  • How is the deal financed? cash or debt from banks? Determine, what kind of a balance between creditor and shareholder control is acceptable to you as a buyer.
  • Redemptions, targeted issuances of shares or similar as a part of the purchase price? Do you want the seller to hang on to the company (or as a seller, do you wish to hang on to the company), or would it be better to have just a vendor note from the seller (i.e. deferred purchase price with interest)?
  • What are the most critical business issues – that we know already?
    • Main suppliers and customers?
    • Core assets and intellectual property rights?
    • Litigations?
    • Key persons?
    • Corporate law matters – will there be a trade name change or other similar changes with the trade register? Board composition after closing? Assignment of IP rights as a precondition for the closing?
    • New employment and director agreements – is there a need to make changes, for example, to harmonize them with those of the buyer’s existing employees?
  • Need to arrange cooperation procedures?
  • What kind of a purchase agreement draft is optimal – friendly or aggressive? Who approves the drafts internally?
  • What kind of representations or warranties should be used as a starting point? What are the core issues?
  • What kind of limitations of liability are sought? Claim periods? Basket?
  • Financial standing of the seller(s) – is there a need to consider a parent company guarantee, if applicable?
  • Other specific issues regarding environment, transfer tax, competition law and so forth, that are known at the early stage of the process.

Hopefully, this gives you a head start and let us know if you have questions or comments!

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