Lawyers as Value Partners in M&A
Getting your lawyers on board early and getting them on board closely is critical. Obviously, there are early stages of the deal funnel but throughout that entire timeline, there is an appropriate place to bring in your lawyer.
As that deal funnel gets thinner, thinner, and thinner, our involvement becomes more and more critical, and at some point along the way, the lead gets handed off like a baton.
But from the beginning, as a CFO, having your closest and most trusted lawyer there with you helps avoid a lot of potholes along the way.
Especially as you think through specific targets, you may use to execute against your strategy. At that point already, it becomes important.
It's not only flagged legal risks because that's like the narrow view of what we do, and that needs to be absolutely true. But your deal lawyer has been around a lot of deals before and so can help you avoid or at least know what to look at along the way.
And then as you enter into deal negotiation, the more information we have as lawyers about what we're trying to do from a strategic company perspective, the more we understand it, the more we internalize it, and the more intuitive the analysis becomes.
Money and resources are unfortunately not infinite, and you can't focus on everything. So, there's always going to be a trade-off at a certain point in due diligence process in terms and rights and obligations you're negotiating.
The more you know about the why behind the deal, the more I think we can valuably and accurately get to determine the right give and take in this particular scenario. As we sit in pipeline development meetings, we review
- What's interesting out there?
- What targets are we looking at?
- What type of deals could we do?
In the two companies I've been at, the deal lawyers are a pretty active part of that process. More listen mode than dictating at those early stages than when compared to later on.
Shaping the Strategy to Reduce Risks
- What type of deal should we do here?
- What are we trying to achieve?
- And what's the best avenue for achieving that?
- What's our interest in the company? Is it in a specific business area, a specific program?
- Do we want to be buying revenue?
- Are we looking for a technology player?
- Is it a really interesting technology?
- Is there a potential future leader at the company that we think would be critical to running one of our businesses going forward?
As much as I love doing M&A in full control acquisitions, that may not always be what's most important. And what's the best from a risk-reduced perspective and from a cost perspective, the best way to achieve the strategy.
So thinking through how prior significant equity investments, coupled with a significant commercial relationship, have worked. What have we been able to extract and achieve from that in prior context or what a joint venture can do or can't do, again, versus what a full acquisition can do, is important.
All of those are different things that people want to get from M&A deals. You hear that a lot. Those refrains as value drivers in the M&A deals, but which one is it?
Because a few of them could be done by strong commercial relationships partnered with strategic investment. Others could be done by JVs. Others need a full hundred percent control acquisition naturally to really get done.
Seeing what worked and hasn't worked depending on the key things we're trying to get out of the deal, at a high level.
What are we seeking from a transaction, and what are the best levers to pull to get that done? Just being like someone who's kind of a deal geek, super interested, has the experience and is thoughtful, that kind of crosses specialties.
We should be brought in early on, but as the pipeline progresses, as the funnel gets thinner, we become more involved and start taking a leadership role at certain points. Naturally, as that funnel gets thinner, the chances of success or closing a transaction get higher and higher and higher.
While a lot of people you may be working with around the table spend a lot of their time thinking about what's next and what we should be doing? As the lawyers, you get a lot of views, reps, and volume of executing really important deals.
And you get a sense of what works and what doesn't from that sheer volume that maybe other people, focusing more on the opening end of the funnel, don't quite have the benefit of seeing.
Prioritization is the most important area that as a lawyer, you can heavily influence, if not control. We're talking about understanding the value drivers of a deal.
"If you focus on everything, then you're focusing on nothing because not everything can be equally important." - Felipe Heiderich.
Understanding what we're trying to get done will inform all the levers that you can pull both into a merger agreement and in a deal process more broadly about extracting value.
Like in due diligence, you're going to have a ton of contracts uploaded to due diligence. So what is it that we see as the key value driver of this company? Especially in the M&A setting, what is it that we want to get?
- Do we want to buy revenue?
- Is that important for us to get increased sales?
- Is that a key part of the financial driver for this deal?
- How does the customer funnel work?
- What's the contracting?
- What's the business development of the target process?
- What's the contracting process?
- What's in place now?
- What are the term of these contracts? How long are they? How much is left?
- What's the pricing like?
- Do we see this company as getting advantageous pricing?
- Do we think we can get pricing improvements when added to our platform?
Depending on what your finance leads, your sales leads view is on the key customer contracts of the target. Maybe keeping the contract is the most important thing to you. What if it's like a particularly important R&D operation, or they have great software that you want to acquire?
Maybe they have a few customers with change of control provisions, and they will be able to terminate those contracts when you close the deal. But maybe you don't care too much about that.
So you leave the contract review, the customer revenue side, contract review on the side. You focus on IP, patents, the code, and you bring in technical review code review. You bring in your IP team to ensure that the power and potential you think you want to acquire from this R&D or technical engineering organization is really there.
You're not focusing entirely on change of controls and customer contracts and supplier contracts, and you spend all your time on that. You have a pretty thorough-looking due diligence report at the end, but half of the portfolio isn't patentable. You're not going to be able to leverage it afterward, and that's really the thing you are after.
These are kind of like apparent examples, but at the margins, it's going to make it a big difference. Sometimes you'd be surprised at how little communication between the legal team doing the execution and the sales team, finance team, and manufacturing team.
Corporate development, business development lead, and lawyers always have a close relationship. But as lawyers, we try to reach one level beyond that and understand the various functions. What is it that they're looking at because that's all the aspects of the business you're buying.
Working with Functional Leads
Most internal deal teams are structured. There will be a functional lead that the senior manager appoints for each function and as a lawyer, that should be your best friend. You should be talking to those 7, 8, 9, 10 people almost daily during the execution phase of a deal.
Corporate development is my key partners as a deal lawyer. I spend day in and day out with those people, understand their motivations and understand what they're working towards really well at all times.
Once there's a specific deal to execute, even at the early stages where we're just doing some preliminary evaluation, you start working closely with other functions.
What comes to mind is sales, manufacturing, and finance, I think those are the three that almost without exception, I'm running through the big deals I've done recently. And those are three key partners throughout everything I do.
- What are you making?
- How do you make it?
- What are you selling and how do you sell it?
- How do the numbers work?
Is there a particularly talented management team? If so, the HR team is a key partner that you're going to have.
- How do we continue to incentivize the target management team?
- How do we retain them?
- What is already in place?
- What do we have to put extra?
- How do we continue to motivate a dispersed and wide-based workforce?
After we understand how the priorities are, it's diligence.
"You can't know everything about a company, but that doesn't mean you shouldn't try" - Felipe Heiderich.
You really should focus heavily on due diligence. It's the best way to manage and limit risk is by knowing. And by knowing, you can decide
- What do you care about?
- What risks can you assume with certain mitigants?
- What risk can you assume absolutely?
- What risk you just can't take?
But it's really hard to do that without diving in and trying to understand as much as possible about the company.
Mitigating the Risks
The next step after that is how do you mitigate the risk you do know about and how you protect yourself from the unknown risks.
Step one is translating everything you know about the value drivers and what you've learned through your diligence into the representations, warranties, and indemnity schemes in your typical acquisition agreement. That is the first front in the deal document of risk protection.
Some representations and warranties run the gamut of a company's business operations. And that's where you need to figure out what you care about.
Is it the customer contracts? You want to make sure those are short up completely, and you have a valuable indemnity behind it if they aren't what you think they are.
Is it a key supplier or a key manufacturer? Upset that relationship and the company just doesn't work the way you need it to.You need to make sure that you have a valuable indemnity backing that up.
Is it intellectual property or pipeline or R&D? In which case, maybe you can have very loose business side revenues, like warranties where you're going to focus heavily on IP.
As you go through the document, chronologically as it shows up, but also kind of mirrors the chronological progression of a deal. In every aspect of the company and every place in the merger agreement, there are a few levers you can call.
- Interim operating covenants are a big lever you can pull. What can the company can and can't do between signing and closing?
- Closing conditions is another big lever you can pull to ensure you're getting what you need out of the company.
- Acquihires and talented management team. HR, and talent plays are great examples of that. Are there certain people who don't make sense to buy this company without them? If so, make their continued employment a closing condition to the deal.
Getting a Lawyer Late in the Deal Cycle
What you do at that stage is the same process you go through had you been brought in.
It probably skews your risk-benefit analysis because if you force your client or your colleague to walk back something, you're now adding existential deal risk to it. Because one of the tenants of deal-making is your word is bond, you must be trusted. So you have to take that newly introduced risk into your advice.
Otherwise, I would take whatever document that has been memorialized at that point before you were involved and I would run through the same analysis. I'll try to understand where we were coming from.
Why is this the deal we want to do?
Why is this the prospective partner or target?
How do we structure it that way?
"Seek to learn because you'll no longer be there to shape it in the front end. Seek to learn how we got where we are and have an open mind about it. Where you see key risks have an open discussion with your business partner on it. - Felipe Heidrich."
There are probably three levels of risks at that point when you're brought in that late to the game.
- I probably shouldn't have done it that way, but we can overcome it, and we can live with it.
- I think this is an important miss, but there are other ways to get at in the deal document that are absent in this term sheet that is absent in this LOI. That will be a point of emphasis as we're negotiating definitive agreements.
- This is critical; we missed it. We can't do the thing that is agreed to in this LOI. We're going to have to revisit it with the partner. Never take that lightly; that's incredibly serious.
Open discussion, trust your business partner, and say, this is why you need to revisit this. And maybe as you bring in the key relevant functional leads, you may be able to push it back to the second category if there's another way to address this that doesn't involve retrading or backtracking. Every once in a while, you need to reopen an issue.
You can approach it the same way, you just give more and proper weight to the fact that now there's kind of some existential deal risk introduced if you retrade things, but at the same time, you take your advisor role and how your legal risk management role adjust this seriously.
So if there isn't an alternative way to address something that is a significant problem, unfortunately, you may have to just hit that address ahead on and reopen certain points, which is rare.
If you're thoughtful and creative and have good relationships with your functional leads, you'll find a lot of things that can fit into that second bucket.
"Bring the lawyer in early. We are not the "NO police". I want to do a deal just as badly as anyone. So we are here to help together figure out what's the best way to do it and to not do it. - Felipe Heidrich."
Considerations When Drafting a Contract
- Understanding value drivers are the critical baseline aspect. There are so many terms you can put or remove, emphasize, fight for, or give up without knowing what you're trying to achieve. It's impossible to scope even the first draft of a contract appropriately.
- How important is timing to this deal? How fast are we trying to close? That's always going to inform your opening draft.
- Deal Risks
- Are we responding to a process letter?
- Are there going to be other competitive markups?
- Even if it's not a process, do we see a particular interloper risk here? That's going to inform what kind of interim operating covenants you're going to have in there
- What kind of deal control, deal certainty type covenants will you have in there?
- What kind of closing conditions you're going to have in there?
Inter-operating covenants: What actions does the target have to take or is restricted from taking between the time you sign the contract and the time the deal actually closes? So you have an operating version set of covenants, which is really about running the business.
- What type of customers can you sign up which ones can't you?
- What type of contracts can you renew?
- Which ones you can, what type of hiring can you do?
The strategic type of covenants you often see most commonly in a no shop or a go shop or an exclusivity component, which is
- How tightly is this target bound to you?
- Who else can they talk to?
- How can they react to other unsolicited offers?
- What information do they have to give you?
- how much can you know about these competing offers?
- Can you know the identity of who the perspective, new deal, interloper deal jumper is?
- Can you know the price?
- Can you see the offer letter?
Your view on deal risks will inform how much you care about those things.
I have been involved in a few deals that we thought were short up and were then forced to defend a deal either as the target or the acquired number one, let's call it from an interloper. And that's always a wild ride.
Sometimes you see it coming; sometimes, you don't. Sometimes they have a clear price advantage which makes kind of the target's board decision easier, sometimes they don't.
So if you, as the hostile acquirer able to convince the board that a letter of intent is the best thing for their shareholders and to discharge their fiduciary duties, they should accept it, then yes, it becomes the same thing.
And as you hear a lot and now that keeps repeated, among deal practitioners, the exact percentage changes, but like 95% of hostile deals eventually end friendly. So they end with a negotiated agreement at the end. Rarely, the company gets fully acquired in a proxy battle without any negotiated agreement at the end.
Even if that's going to happen in the end, how do you get the leverage to ensure that agreement occurs at the end? You bring in media consultants and PR consultants proxy advisors have a significant influence on a role to play there.
It's a battle of hearts and minds of target shareholders if you're doing a hostile approach.
As the deal lawyer, once the deal closes, I'm not done, but I tend to take a significant step back at that point.
And you get brought in if there are significant issues with the business, with management. Depending on what kind of deal structure you do, there could be some former target shareholder problems, whether that's holdouts or suits. And so, like in those instances, I get brought back in.
I get updates to know how the deal is going because I think that's another important piece of being involved. Post-closing with the business is learning what worked and what didn't work, and that may inform of how you do other deals going forward.
Even if it's smooth or relatively smooth, I like to have periodic updates with the various teams and how leading and heavily involved in that business to understand how's it going. What worked well? Even if you have no significant issues that I have to come in, like a conflict management perspective, what are the bumps along the road or hiccups that did happen?
Know these are common like M&A is buying company. Companies are really complex organizations, so no deal is going to be free of bumps along the way and you're never going to be able to completely prevent them. But again, having that close connection with your business colleagues after the fact can reveal some tidbits here and there that can inform how you do something in the future.
People in one way or another, are the biggest X factor or difficulty predicting. We talk about value drivers and strategic imperative for a particular target and how you can help ensure those are achieved.
You often have management teams and especially incredibly enthusiastic founder operators of a target. They seemed to have all the financial incentives of the world that you structurally set up through retention packages, agreements, and employment agreements.
And from dinners and negotiations with this person, the enthusiasm that this person exudes about their company, you would think, no chance they ever leave.
And then you close and the day after closing, you get whatever notice period is required under the retention agreements or clear waiting period. You see the person waiting for the first significant investor, too and then they're out.
And you go, where was all this enthusiasm that you saw, that I saw months ago or years ago. Where is it now? So I think you can never fully predict how people are going to react.
I's surprising because it's not common, but it does happen, and it's hard to predict just based on structural incentives and someone's attitude during the courting process, if you will.
And the other key surprise is interlopers. Sometimes those come out of the left field, either the fact that there wasn't an interloper or at least the specific one, the identity of the interloper sometimes is unpredictable and throws the entire transaction into chaos, trying to defend the deal.
And that, you have as a lawyer to deal professional, you have a pretty set game plan and schedule and checklist that will get you to closing a deal. And when you bring an interloper in, crumble that and throw it out the window because now you have to react and that's always a bit surprising on your end.
Advice to Lawyers
I can't emphasize enough the idea of thinking like an owner, thinking like a business professional, and putting yourself in your owner's shareholder board's shoes as a lawyer.
Try to understand at every level, from the highest strategic level, all the way down to an operational business level through a risk management level, what is it that we want out of this transaction. And be thoughtful about all the levers you can pull both in the agreement and the process to ensure that happens.
Lawyers and business people, are much closer to each other than they probably each think.
It's bypassing, thinking past functions, thinking past silos, and becoming like putting yourself in the owner's shoes and then using your legal skills and experience to correctly and thoughtfully execute on that.
I think that's much easier said than done, but I can't emphasize enough the importance of that.