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 One – The Letter of Intent
- Part Two – Due Diligence
- Part Three – The Definitive Agreements
- Part Four – Closing
- Part Five – Post-Closing
Part Five – Post-Closing
Now you are reaching the end of the M&A process after the parties consummate the transaction. While the bulk of the work has been completed, a number of very important matters typically remain outstanding, other than the administrative tasks of assembling and compiling complete sets of fully executed transaction documents and perhaps chasing down some consents to assignment of contracts not able to be obtained prior to closing.
One of the most immediate items to be addressed during the post-closing period are filings required with various state and federal government departments or agencies. These may include uniform commercial code (UCC) financing or termination statements, or other filings such as amendments to a party’s certificate of incorporation or articles of merger, filed with the appropriate Secretary of State, intellectual property assignments filed with the United States Patent and Trademark Office, applicable state agencies, or the United States Copyright Office, and business license transfers or change of ownership. Last, but certainly not least, press releases may need to be sent.
The next matter typically addressed within 30 to 90 days post-closing are the calculations of the target company’s closing net working capital (“NWC”). As a reminder, the target NWC is a pre-established amount of working capital that the seller agrees will be available on the day of closing to ensure continuity of business operations and there is often a mechanism to adjust the purchase price post-closing if the company’s actual NWC at closing is different than the target NWC. Given the complexities in accounting and fluctuating assets and liabilities, it’s not feasible to determine this at closing so the parties often agree on period after closing for calculation and reconciliation. For example, if the target NWC at closing was $1M, but the purchaser calculates that actual NWC at closing to be $800k, subject to a dispute resolution process if the seller disagrees, there will be a $200k adjustment to the purchase price. Unless the parties addressed payment of the difference through an escrow account established for purchase price adjustments, the seller will be required to pay the purchaser directly.
In addition to the seller’s indemnity obligations for breaches of representations and warranties and other various matters that survive closing, a seller’s other post-closing obligations and covenants often include complying with the protective covenants set out in the definitive agreements such as covenants not to compete, non-solicitation of employees and customers, and non-interference. On the other hand, the purchaser may be required to provide employees benefits the same as or similar to those provided by seller prior to closing or insurance and indemnity for the target company’s outgoing officers and directors.
Finally, another post-closing matter included in a number of M&A transactions but the area with a higher occurrence of disputes, are earnouts. Earnouts are an adjustment mechanism for deals with a contingent purchase price typically involving private equity. For example, a way to offer purchase price based on a higher multiple of earnings is to include an earnout requiring some portion of the purchase price to be contingent on the target company achieving certain growth projections. Within the definitive agreements, the seller and purchaser have identified the targets to be achieved to trigger the earnouts and their amount, defining the metrics and methods for calculating the earnout, the periods over which the earnout is measured and the timing of payment, and any post-closing restrictions on the operation of the business. At the predetermined time periods during the post-closing period, the parties will evaluate actual operations against the defined metrics to determine whether an earnout has been earned by the seller and therefore, owed by the purchaser.
Moving Ahead: After the Deal
Once you complete all post-closing matters, hopefully without any disputes, that wraps up the entire mergers and acquisitions process. The only things left are for the purchaser to move forward successfully running the acquired business and the seller to move forward with whatever new ventures await.
From entering into a solid letter of intent, conducting a thorough due diligence process, and negotiating to get what you need in the definitive agreements, are all critical aspects of the M&A process. If the process is approached with a team of experienced M&A legal and financial advisors and follows a well-developed plan from the start, closing and post-closing should be a relatively smooth process.
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