Mergers and Acquisitions (M&A) in simple terms is the process by which one party buys — whether in whole or in part — someone else’s business. Although M&A can be simply defined, the process is anything but easy. There are dozens of legal implications, seemingly innocuous clauses that can sneak up on even the most careful entrepreneur, and potentially significant sums of money to be made or lost.
This field guide is a five part series and will discuss in detail the five phases of M&A:
Part Four – Closing
Congratulations! You have almost made it to the end of the mergers and acquisitions process. If everything has gone well so far, chances are closing will too. But it’s not as simple as just signing some documents and wiring funds — there are many important steps and details involved with closing.
There are two general structures used in closing an M&A transaction: (1) sign and close; or (2) sign then close. Although they sound similar, they differ dramatically in terms of timing and the steps and procedures involved. And given the differences, which heavily influence certain terms and provisions of the purchase agreement, the closing structure should be determined early on in the negotiation process.
Sign and Close
In a sign and close transaction, all of the definitive agreements and instruments, including the purchase agreement itself, are executed by both parties effectively at the same time and closing occurs simultaneously with signing. This structure can have benefits to each party in that it eliminates certain transaction risks that could occur during the intervening period between signing and then closing at a later date.
For example, the target business could suffer significant damage from some unforeseen event that occurs during a period between signing and closing. However, under a sign and close deal, if an unforeseen event occurs prior to closing, it is easier for either party to walk away since no signing has taken place. The parties are also not left to determine who should bear the risk or be obligated to spend additional resources possibly disputing the extent of the damage to the target business. Yet, the sign and close structure does have risk in that absent some other binding agreement or provisions in a letter of intent containing an exclusivity or no-shop clause, each party faces the risk the other party can walk away at any moment up until the actual signing and closing moment after spending significant resources working to close the deal.
Sign then Close
The sign and then close structure is the more traditional of the two for numerous reasons. Many deals have matters that must be addressed and completed before closing can even occur but most parties want to have the purchase agreement in place before proceeding. These matters typically include seeking and obtaining consents approving the assignment of contracts and leases and member or shareholder approval to close the deal. Obtaining financing is often another matter that may take a good deal of time and resources necessitating the period between signing and closing. The satisfactory resolution of these matters will become conditions to closing.
Because of the existence of a time period between signing and closing, more time and resources will be devoted to negotiating pre-closing covenants and conditions, and other important provisions in the purchase agreement. Many of these pre-closing covenants are intended to maintain the status quo of the target business during this period. They may restrict the target business from incurring additional debt, making material changes in personnel or compensation and bonuses, as well as require the seller to continue to operate the business in accordance with past practices, including maintaining normal levels of inventory and supplies. This time before closing also affords the buyer more time to conduct due diligence on the target business.
Execution of Documents
When it comes to actually signing the definitive agreements, many might imagine a large group of people sitting around a table, signing voluminous legal documents in blue ink surrounded by their respective legal and financial advisors. That’s rarely the case today. Most of the time, each party signs the documents wherever they are located and then exchanges signature pages through email between their respective legal counsels who assemble with the fully executed documents.
In the case of a sign and close, obviously this would all occur on or around the effective date of closing. But for most transactions using the sign and then close structure where the purchase agreement has already been signed, the process entails execution of the ancillary documents and instruments referenced in the executed purchase agreement. Quite often, in the days or weeks leading up to the anticipated closing date, the parties will begin executing the signature pages of the ancillary documents and instruments for delivery to their legal counsel. Once all of the executed signatures pages are assembled, each party’s legal counsel will exchange the signatures with an agreement that the signature pages are to be held in escrow and will not be released until confirmed by email and/or a during closing call on the day of closing. The primary purpose of executing the documents in advance is to avoid delaying closing because the parties are trying to chase down missing signatures. Imagine the time it would take to obtain the signatures of 75 shareholders needed to approve a transaction who may be located all over the world. Therefore, having all signatures early allows the parties to focus on outstanding conditions to closing and ensure all other matters are in order.
Closing: The Final Step?
In the days leading up to closing, regardless of structure, the parties’ respective legal counsel, accountants, and financial advisors work feverishly running through the closing checklists to tie up loose ends and getting everything ready for closing, including scheduling the all-important wire transfers. In some cases, the originally anticipated closing date may be extended by the parties due to an outstanding issue or final approval not yet obtained. In most deals, the parties conduct a closing call to officially close the deal where their respective key personnel and advisors review and discuss particular details to confirm that all conditions to closing have been met. For example, have you received the approval from a landlord to assign the lease to a new party? Or, if the entity you are acquiring has a special state license (e.g., as an ambulatory surgery center), you should be aware that the license may be personally issued either to an individual owner or in the name of the entity. Depending on the type of license, to transfer the license you may need approval from a state agency, often called a change of ownership (“CHOW”). The CHOW might require pre-approval, or a post notice to the applicable state agency after closing. Once the parties determine that everything is in order, they agree to officially close. Following the call, the parties’ respective legal counsel send confirming emails of the closing and release signatures, the purchaser initiates the scheduled wire(s), and the parties celebrate.
After going through so much effort, many people expect the closing process to be nothing more than a few signatures, a pat on the back, and then everything is complete. But as illustrated above, that’s not the case. Closing can be a challenging and sometimes frantic period to navigate.
In Part Five of this series we will discuss the final phase of M&A – post-closing. If you have any questions or if you would like to learn more about the M&A process, email us at email@example.com.