Archive for the ‘Mergers and Acquisitions’ Category

Keeping Company Sale Proceeds: Indemnification-Related Provisions

In the vast majority of sales of privately held emerging companies, the indemnification-related provisions are the most important outside of the purchase price itself—these provisions often determine whether the seller may hold on to the amount paid by the buyer.  I say “indemnification-related” as it is typically not the indemnification provisions themselves that are most important.  Rather, it is the provisions that define and limit the rights to indemnification, determine how damages are calculated, and state when the rights can be exercised.

For example, the upper limit of the amount of indemnification damages that a seller is responsible for in the event that there is an indemnification claim (commonly referred to as the “cap”), is often more important to the seller than the indemnification language itself, which can be written fairly broadly.

While the indemnification-related provisions are important, they are relatively complex and interrelated.  A negotiating “win” in one area for a seller, such as a low cap on the amount of indemnification damages available to a purchaser, can be negated by a negotiating “loss” in another area, such as broad exclusions from the cap.  Because of how these provisions are interrelated, we usually review and negotiate them in their entirety.

Here is an outline of indemnification-related issues that are often negotiated in a company-sale transaction:

  • Survival of representations and duration to make indemnification claims
    • Duration of survival of “fundamental” representations
    • Duration of survival of other representations
    • Time period to make indemnification claims
    • Exclusions from any of the above
  • Sandbagging
    • Anti-sandbagging provisions
    • Pro-sandbagging provisions
    • Silent
    • Nonreliance provisions
  • Indemnification as the exclusive remedy
    • Covering all transaction-related documents
    • Exceptions to the exclusive remedy
  • Cap
    • Amount
    • Exclusions
  • Basket
    • Amount
    • Exclusions
    • Deductible or first dollar
  • Materiality Scrape
    • None
    • Single
      • Breach
      • Damages
    • Double
  • Indemnification damage reduction
    • Tax benefits to buyer
    • Items covered by insurance
    • Buyer obligation to mitigate losses

As indemnification and related provisions are complex and sometimes difficult to understand, they are frequently glossed over by those who do not have the background (or patience) to take the time to understand them.  These provisions, however, can have a significant impact on the financial end result of the sale transaction.  Having a comprehensive negotiating strategy when negotiating indemnification-related provisions is often crucial to a successful sale transaction.

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Company Sale Structure Considerations

In this AlphaTakes video, Matt Storms discusses the common considerations that drive the decision on how to structure a company sale transaction.

Here are the key takeaways from this video:

  1. The most common considerations that affect the transaction structure for the sale of a privately held emerging company are taxes, assignment of contracts, seller shareholder approval, transfer of licenses and permits, ability to exclude certain assets or liabilities, and simplicity.
  2. Which factors are important are often deal specific.
  3. While no transaction structure is right for all deals, an asset sale transaction is used most frequently in privately held emerging company sales.

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AlphaTakes – Structures for a Company Sale Transaction

In this AlphaTakes video, Matt Storms discusses the most common types of deal structures for a company sale transaction.

Here are the key takeaways from this video:

  1. There are a variety of ways to structure a company sale transaction.
  2. The most common types of deal structures are an asset sale, stock sale, and merger.
  3. The most common types of merger structures are a direct merger, a forward triangular merger, and a reverse triangular merger.
  4. Making a sale transaction tax free is often complex.


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A Company Sale NDA is Different

A common misperception is that all Confidential Disclosure and Nondisclosure Agreements (NDAs) are virtually the same. In other words, many people think that it doesn’t matter whether an NDA is for a vendor, customer, employee, strategic, or potential sale transaction—a standard NDA should be sufficient. The truth is, they are and should be different. This is especially true in the company sale context.
Here are some ways that company sale NDAs can be different:

(1) Definition of confidential information

The description of what constitutes confidential information in typical NDAs does not include a number of things that a seller often wants kept confidential in the sale context—most notably, the fact that the seller is considering selling the business or that the buyer and the seller are interested in a sale transaction.

(2) Permitted use of confidential information

A general use restriction seen in “standard” NDAs is often insufficient as a limitation on use of confidential information shared in the company sale context. Moreover, if the buyer is in private equity or is another type of financial sponsor, a limitation on using the confidential information only in connection with the consideration of a potential acquisition of the seller may not be adequate. It often does not limit the disclosure of confidential information to other potential buyers as part of a “clubbing” deal, which sometimes is counter to the seller’s desire to create competition among suitors.

(3) Who the buyer can share the information with

Many NDAs typically restrict disclosure of information by the recipient to those within the recipient’s organization who “need to know” for the stated purpose. Often, in the company sale context, buyers need to also share that information with financing sources, investment bankers, transaction consultants, lawyers, and others.

(4) Non-solicitation of seller’s employees and customers

While it is uncommon to see restrictions on solicitation of a party’s employees and customers in the typical NDA, it is more common to see the matter covered in a company sale NDA as those relationships are more vulnerable in the sale context, especially if the employees and customers know that the seller is interested in selling.

(5) Antitrust requirements

If the buyer is a competitor, provisions and processes should be included that address antitrust concerns.

(6) Seller point person

It is somewhat common to see an individual within the seller’s organization designated as a point person for whom the buyer must work through to obtain confidential information. The intentional procedural bottleneck is designed to ensure that relevant people within the seller’s organization are appropriately briefed, that certain people within the seller’s organization are not contacted by the buyer, and to some extent, keep track of the confidential information that is disclosed.

(7) Seller’s form of NDA

A common issue in many commercial transactions is whose form NDA should be used. In the company sale context, however, use of the seller’s form of NDA is the norm. Also, it is more common to see the NDA in the form of a letter, countersigned by the potential buyer, rather than the standard form of two-party agreement.

Because of some of the unique issues that arise in company sale transactions, sellers should craft the form of NDA they use with those unique issues in mind and not rely on forms or templates used in other contexts.

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Letter of Intent Deal Terms for a Company Sale

Following the nondisclosure agreement, the letter of intent (LOI) is typically the first step in formalizing the company sale process when a company auction process is not involved.  The LOI stage is usually an exciting time for the seller—the seller is full of optimism, there is no deal fatigue, and the new relationship with the buyer has not yet been tested by heated discussions.

The LOI can accomplish a lot.  At a fundamental level, it establishes whether there really is a deal on key issues.  Often times, first time entrepreneurs and those who have not been through a company sale process are willing to proceed with a lengthy “no shop” or “no talk” exclusivity requirement, based only on a non-binding agreement on price.  While purchase price is obviously an important term, it by no means is the only important term.

In most deals, a seller in a company sale process has the most leverage at the LOI stage of negotiations.  The seller has not invested a lot in the deal and it’s the easiest point at which to just say “no” to a request of a buyer.  Rarely, however, do terms get better for the seller after the LOI stage.  On the flip side, buyers will typically take aggressive positions after the diligence process or on the initial draft of the purchase agreement.  They know sellers have committed a lot to the deal and at some point in the process, become committed to making the deal happen for a variety of reasons.  Often, a seller is willing to concede more at a later stage than what the seller would have been willing to do earlier.  As a result, it’s typically a good idea for a seller to get tentative agreement at the LOI stage on key terms that inevitably have to be negotiated.

From a seller’s perspective, here are some of the areas worthy of consideration of including in the LOI:

  • Deal structure, especially if the seller is looking for capital gains treatment
  • Items that affect net proceeds at closing
    • Escrow holdback amount and time period for the escrow, or a statement that there will be no escrow
    • Working capital adjustment amount or a statement that there will be none
    • Earn-out (if any) or a statement that the listed purchase price does not include one
  • Duration of the survival period of seller’s representations and warranties
  • Basket and cap for post-closing liabilities
  • Indemnification cap exclusions
  • Employment requirements of key individuals or at least which individuals or types of individuals the buyer intends to retain, post deal (e.g., 80% of software engineers)
  • Targeted closing date

Buyers will often resist some of the provisions under the guise that, “we don’t know enough information at this point, so we prefer to agree upon those terms after the diligence process.”  The same thing though could be said of the purchase price.  The reason to negotiate the points earlier is that it places the burden on the buyer to change them later.  Once a term is in the LOI, the parties usually tend to feel sort of a “moral” obligation to adhere to those terms.  Buyers frequently need a major diligence finding to justify a modification to a term contained in the LOI, even though those terms are usually nonbinding.

Including more deal points in the LOI also helps to limit surprises later that may surface, such as, “we always require sellers to have no indemnification cap for breaches of representations related to intellectual property.”  Moreover, without touching on the key deal points at an early stage, it’s hard to determine whether the parties have a basic meeting of the minds, even with the assumption that there will be no material surprises in the diligence process.

As with most other things, deciding on the appropriate amount of detail in the LOI is a balance.  On the one hand, it requires including enough detail to help ensure that there really is likely a deal, while also, from the seller’s perspective, taking advantage of the leverage that a seller typically has at the LOI stage.  On the other hand, the seller should not put too much pressure on the buyer at the formative stages in adding too much detail and unnecessarily elongating the time period of the LOI stage.  Striking the right balance is the first step in a successful sale process.

by Matt Storms | Permalink | No Comments


AlphaTakes – Determining the Size of the Stock Option Pool

In this AlphaTakes video, Meechie Pietruczak discusses calculating the number of shares in an emerging technology company’s option pool.

Here are the key takeaways from this video:

  1. Emerging technology companies usually create stock option pools to compensate and incentivize employees, directors, consultants and other independent contractors.
  2. The size of the option pool is typically calculated as a percentage of all capital stock, which is often in the range of 10 to 20%.
  3. The size of the option pool may have a significant impact on the price per share paid by an investor.

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AlphaTakes – Convertible Debt Financing Term Sheets

Convertible debt financings are a common type of bridge financing for emerging technology companies.  In this AlphaTakes video, Matt Storms discusses term sheets for convertible debt financings for an emerging technology company.  He provides a summary of the common key financial and procedural terms that are typically negotiated.

Here are the key takeaways from this video:

    (1)  The convertible debt term sheet for an emerging technology company should be relatively simple and short

    (2)  The key financial term in a convertible debt transaction is typically the size of the discount off the next round’s price or the warrant coverage amount

    (3)  The key procedural terms in a convertible debt transaction typically include the definition of a “Qualified Financing” and the ability to change the transaction documents with less than unanimous approval of the noteholders



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