If you’re regularly involved in the process of buying companies or advising clients who are, you know there are plenty of “trip wires and trap doors” to avoid and always something new to learn. And if you’ve never been involved in an acquisition but think you might be soon, you’re undoubtedly hungry to learn what you can to avoid mistakes and negotiate effectively.
One way to develop your deal savvy is to read cases addressing issues faced by buyers in real-world transactions, but I’m guessing you’d rather spend time growing your business than playing lawyer. So let me save you some time by passing along some insight gleaned from a few important cases issued by the Delaware courts.
To put a finer point on it, let me share with you two deal terms that you, as a Buyer, should avoid when negotiating with a Seller. Each of the suggestions below is qualified by one important caveat: you should defer to the advice of your legal counsel because every deal is different and the general advice below may not be appropriate for your situation.
1. Avoid a Binding Agreement to Negotiate in Good Faith.
Do not enter into an express agreement to negotiate specific deal terms in good faith, unless you’re absolutely certain you can live with those deal terms and that any ambiguity in those deal terms can be resolved in a satisfactory way.
So when does this come up? When you’re asked to sign a term sheet, memorandum of understanding, or similar document that (i) summarizes deal terms or attempts to provide a roadmap for future discussion by describing specific deal terms that your Seller thinks have been agreed upon and (ii) lists other deal terms that need to be agreed upon to complete a deal.
And what’s the problem with signing something like that? Here’s the problem: if you sign a term sheet compelling you to negotiate certain deal terms in “good faith,” you could be deemed by a court to have acted in “bad faith” if you propose terms that are “substantially dissimilar” to those contained in the term sheet. That may not always be a problem, but so often a Buyer’s view of what deal terms are optimal will evolve as a result of its post-term sheet due diligence and guidance provided by legal and business advisors. So why bind yourself now to deal terms that may turn out later to be disadvantageous or costly?
If you want your term sheet to be truly non-binding, be sure to state that in writing and add that the term sheet is for discussion purposes only and subject to due diligence and the negotiation and execution of a definitive purchase agreement.
For more on this topic, read SIGA Technologies v. PharmAthene (Del. Dec. 23, 2015).
2. Avoid an Overly Strict or Vague Obligation to Maximize the Seller’s Earnout Payment.
Buyers and Sellers often enter into “earnouts” in their purchase agreements that provide that the Seller will receive (or “earn”) a portion of the purchase price after closing if the acquired business performs at a certain agreed upon level after closing.
Disputes often arise when the business underperforms and the Seller doesn’t receive the earnout payments it was hoping to receive. It’s not unusual in that situation for the Seller to make claims that the Buyer breached the earnout agreement by failing to fulfill some stated or implied duty to maximize the payout to the Seller.
As such, it’s important that you as a Buyer don’t agree to an earnout provision that puts you at a disadvantage should this situation arise.
The earnout provision in the purchase agreement may require the Buyer to use “commercially reasonable efforts” to maximize Seller’s earnout payment; or it may prohibit the Buyer from taking specific actions that would “intentionally” or “knowingly” reduce or limit the amount of Seller’s earnout payment.
If your Seller pushes you to agree to a broad standard like one of those mentioned above, be sure that standard won’t interfere unreasonably with your operation of the business after closing. Once you close on the acquisition, the business is yours and you should have as much freedom as possible to make decisions that maximize the potential success of your business without having to worry about the impact of your decision on the Seller’s earnout payment.
One thing to consider with your legal advisor is whether any ambiguity in the agreed-upon standard can be minimized by agreeing to refrain from taking a list of specific but exclusive actions. If the earnout requires you to take or refrain from taking specific actions, include a statement that no other required or prohibited actions may be implied or imposed by the Seller on the Buyer.
For more information on this topic, read Winshall v. Viacom Int’l Inc., 73 A.3d 38 (Del. 2013);Fortis Advisors LLC v. Dialog Semiconductor PLC, C.A. No. 9522-CB (Del. Ch. Jan. 30, 2015); and Lazard Tech. Partners v. Qinetiq North America Operations LLC, C.A. No. 464, 2014 (Del. Apr. 23, 2015).
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