PRE-DEAL LEGAL CONSIDERATIONS
By R. Bradford Malt
Table of Contents
Page*
A.Discussion Outline of Finders’ Agreements1
B.Form of Finders’ Agreement7
C.Discussion Outline of Confidentiality Agreements10
D.Form of Confidentiality Agreement17
E.Discussion Outline for Model Letter of Intent22
F.Form of Letter of Intent for Auction Process27
G.Discussion Outline of Model Diligence Checklist30
H.Form of Diligence Checklist40
I.Discussion Outline of Purchase Price Considerations49
J.Form of Purchase Price Adjustment Provision57
Copyright© 2010 by R. Bradford Malt
All rights reserved.
______
*Refers to number at bottoms of pages.
PRE-DEAL LEGAL CONSIDERATIONS
By R. Bradford Malt
A. DISCUSSION OUTLINE OF FINDERS’ AGREEMENTS
I.Perspective.
A.Context: Finders are active in smaller transactions, especially private, family-owner companies. Investment bankers usually auction larger companies.
B.The model following this outline is written from the point of view of a financial buyer entering into a form finders’ agreement with multiple finders (buyer’s form).
1.The same form could be used by corporate acquirors who are active enough with finders to attempt to impose their own form on a network of finders.
C.An analogous form can be used where a target company engages a finder to locate prospective buyers of its business.
D.A different situation is presented when representing a finder, most of whom have their own standard forms that attempt to maximize the number of circumstances in which a fee is paid.
II.Key Points to Negotiate.
A.Exclusivity.
1.The model agreement contemplates that both the Buyer and the finder will be working with multiple parties.
2.Finders may prefer an exclusive arrangement, especially when representing a target, in which case the period of exclusivity is important.
B.Excluded candidates.
1.A Buyer entering into a finders’ agreement will not want to pay a fee unless the finder provides value.
2.Conversely, a broker entering into a finders’ agreement will take the position that it is entitled to its fee once an introduction is made (or perhaps even a target’s name identified) as long as the transaction subsequently closes.
3.A Seller entering into a finders’ agreement will want the right to exclude undesirable potential acquirors or potential acquirors such as competitors with whom confidential information is too sensitive to be shared.
C.Purchase consideration--the fee calculation should address how the finder’s fee is adjusted in different scenarios.
1.Suppose part of the purchase price is payable over time or only subject to contingencies?
(a)Pay part of the fee over time.
2.Suppose part of the purchase price is payable in notes or other securities (non-cash consideration)?
(a)Fair market value solution--pay FMV of the property at closing in cash.
(b)Or pay part of the fee in kind.
3.Suppose part of the purchase price is escrowed or subsequently returned because of an indemnity claim or otherwise?
(a)Retroactive adjustment to fee and return by finder.
D.Fee schedule.
1.Lehman formula (the “old” standard fee).
(a)5% of the first million dollars of purchase consideration.
(b) 4%ofthe second million dollars.
(c)3% of the third million dollars
(d)2% of the fourth million dollars.
(e)1% above four million dollars.
2.Double Lehman.
(a)The brackets in the first four tiers of the basic fee schedule above are doubled, i.e., 5% of the first two million dollars, 4% of the next two million dollars, etc.
(b)Especially common for small deals.
3.“Stuttering” Lehman.
(a)More generalized version of the Double Lehman, where the brackets are used multiple times (for example, tripled or quadrupled).
4.“Gap” Lehman.
(a)Fills in the gaps between brackets.
5.“New” Lehman.
(a)5% of the first $5 million of purchase consideration.
(b)2½% of the next $10 million of purchase consideration.
(c)1% above $15 million.
6.Minimum fee.
(a)Common for small deals.
7.Escalating fee above expected target price.
8.Finder’s investment opportunity to reinvest part of its fee in the acquisition.
(a)Note tax inefficiency of receiving the fee in cash and investing the after-tax proceeds.
(b)Consider partnership or LLC profit interest alternatives to avoid this inefficiency if finder is “rolling over” part of its fee into equity.
E.Elements of purchase consideration to which the fee schedule may be applied.
1.Cash paid to the Seller.
2.Debt assumed by the Buyer.
3.Other economic benefits: employment payments, non-competition payments, supply payments, licensing payments, etc. to the extent they are in excess of market rates/in the nature of purchase consideration.
4.Leases of retained realty/licenses of assets.
5.Other liabilities assumed by the Buyer (for aggressive finder’s form):
(a)Unfunded pension obligations.
(b)Assumed environmental, product or medical claims or liabilities.
6.Funds necessary to return opening working capital to normal levels.
F.Covered transactions (“triggering events”).
1.Certainly sale of the entire company.
(a)Cover different forms--stock purchase, merger, asset sale, share exchange, etc.
2.How about sale of division or minority assets?
3.Partial sales/recapitalizations?
(a)For instance, suppose the acquiror buys 49% of the target?
4.Resulting business relationships, such as joint ventures, or supplier or vendor relationships?
(a)Watch out for minimum fee provisions in this context.
G.Excluded transactions (for aggressive buyer’s form).
1.Public targets.
2.Investment bank auctions.
3.Targets already being investigated/pursued.
4.No introduction made.
5.No proprietary information provided.
6.Transactions closing after expiration of an agreed amount of time (“tail”period).
H.When fee is earned
1.Ready, willing and able Buyer produced (finder form), versus
2.Only if the transaction closes, regardless of fault (Buyer form).
3.Compromise: “walk away” fee.
I.Payment of expenses to finder.
1.Cap out-of-pocket expenses.
2.Require approval before “reimbursable” outside advisers are hired.
J.Finder indemnity.
1.Indemnity, contribution, exculpation.
2.Negotiate usual issues, including:
(a)Standard of care (delete “finally determined by a court of competent jurisdiction to have resulted primarily from” before the phrase “bad faith or gross negligence”).
(b)Control of defense.
(c)Right to settle.
(d)Limit reimbursable expenses to reasonable out-of-pocket expenses.
K.Protection of seller’s confidential information.
1.See confidentiality outline in these materials, infra.
L.Negotiation of publicity provisions.
1.Right of finder to place post-closing advertisements in financial and other newspapers and journals.
(a)Ability of company to review and approve text.
2.Requirement that press releases identify the finder’s role.
M.Right to terminate agreement.
1.“Tail” for post-termination transactions related to pre-termination introductions.
III.Legal Considerations.
A.Distinction between finder and broker.
1.Sole function of finder is to make an introduction.
2.Broker may play a role in the negotiations.
B.Consider licensing requirements if role goes beyond making introductions (for instance, getting involved in negotiating a transaction).
1.Securities Exchange Act of 1934.
2.State blue sky or other laws.
3.Broker-dealer registration will be onerous for most finders, so finders should take care to limit the scope of their activities.
C.Need for written agreement (Statute of Frauds).
1.New York Statute of Frauds applies to business brokers.
2.Many states do not apply their Statute of Frauds to business brokers.
B. BUYER’S FORM OF FINDERS’ AGREEMENT (NON-EXCLUSIVE)
ThisAgreement, dated as of ______, 200_, is between ______(“Buyer”), having a place of business at ______and ______(“Broker”), having a place of business at ______.
1.Brokerage Services
(a)Broker expects to identify to Buyer one or more companies for evaluation by Buyer as acquisition candidates. Each such company with respect to which Broker provides Buyer proprietary information and arranges an introduction to Buyer is referred to in this Agreement as a “Candidate.”
(b)Broker reserves the right to present acquisition candidates to other parties in addition to Buyer. Buyer reserves the right to identify its own acquisition candidates and to appoint or retain additional agents, brokers, finders or other parties to provide brokerage services with respect to or to solicit or propose companies as acquisition candidates.
2.Broker’s Fee and Basis of Fee
(a)In the event that Buyer acquires a Candidate, then except as otherwise provided in this Agreement, Buyer will cause Broker to be paid a fee (the “Fee”) equal to a portion of the gross acquisition price of the Candidate determined in accordance with the schedule listed at the end of this paragraph. The gross acquisition price is the total consideration paid by Buyer to acquire the Candidate (and not subsequently returned) in any combination of cash, notes, stock or other property, including deferred payments.
5% of the first $1 million
4% of the amount between $1 million and $2 million
3% of the amount between $2 million and $3 million
2% of the amount between $3 million and $4 million
1% of all amounts over $4 million
(b)Any Fee due under this Agreement shall be payable in like kind as the consideration paid to acquire the Candidate, or at Buyer’s election in cash in an amount calculated based on the fair market value of such consideration. If the entire gross sales price is not payable upon consummation of the acquisition, a prorata amount of the Fee will be paid as and when the deferred portion of the gross acquisition price is paid.
(c)Any Fee due to Broker under this Agreement will be reduced by the amount of any other compensation paid or payable to Broker or its affiliates with respect to the Candidate, whether paid or payable by the Candidate or any other person or entity.
(d)Buyer is not obligated to accept any offer of any kind from any party, and may refuse to conclude any agreement or transaction with or without good cause. No Fee or other compensation of any kind will under any circumstances be payable under this Agreement or otherwise if acquisition of a Candidate is not consummated by Buyer for any reason whatsoever, including without limitation the fault or default of Buyer.
3.Previous Activities, Other Brokers, Etc.
Broker agrees that if a Candidate has been identified to Buyer by a third party or if Buyer has been investigating or negotiating with a Candidate prior to the time it is introduced to Buyer by Broker, or if Buyer has become obligated prior to such time to pay another person or entity a fee if it acquires a Candidate, Buyer will have no obligation to pay any Fee to or otherwise compensate Broker with respect to such Candidate. Buyer will use its best efforts to notify Broker within 15business days of receiving the name of any such Candidate submitted by Broker. Unless Buyer agrees otherwise in writing with respect to one or more specific Candidates, no Fee or other compensation of any kind will be payable under this Agreement or otherwise with respect to any Candidate that is publicly traded or as to which, whether before or after introduction of the Candidate by Broker to the Buyer, an investment banker is engaged to solicit buyers.
4.Term
This Agreement shall terminate one year from its date. However, termination of this Agreement shall not affect Broker’s right to a Fee otherwise provided for in this Agreement if Buyer acquires a Candidate that had been introduced to Buyer by Broker prior to such termination, Buyer purchases such Candidate within two years from such termination, and such Fee would have been payable to Broker hereunder had such acquisition occurred prior to such termination.
5.Status of Broker
Broker is an independent contractor, and not an agent of Buyer for any purpose whatsoever. Broker has no authority to, and agrees not to, assume or create any obligation or liability, express or implied, on Buyer’s behalf, or bind Buyer in any manner or to anything whatsoever. Broker agrees to be liable for and to pay its own expenses.
6.Miscellaneous
No provision of this Agreement may be amended, modified or waived orally, but only in a writing signed by a duly authorized officer of Buyer and Broker. This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes all previous agreements and understandings, written or oral, between the parties or their affiliates or agents with respect to the subject matter hereof. The headings in this Agreement are for convenience of reference only, and shall not alter or affect the meaning of any provision. Each party acknowledges that it has not relied upon any representation of the other party, except for any representation made by such party under the express terms of this Agreement, in entering into and undertaking the obligations imposed by this Agreement. This Agreement shall be construed, interpreted and enforced in accordance with the substantive laws of New York. The parties agree that any action brought to resolve any controversy arising under or relating to this Agreement shall be subject to the exclusive jurisdiction of, and may only be brought or maintained in, the state and federal courts of New York, and that any right any party might have to a trial by jury in any such action is hereby irrevocably waived.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above.
BROKER
By:______
A Duly Authorized Officer
BUYER
By:______
A Duly Authorized Officer
C. DISCUSSION OUTLINE OF CONFIDENTIALITY AGREEMENTS
I.Perspective.
A.The model is written from the point of view of an investment banker distributing confidential information to be used in connection with an auction.
B.A similar form can be used by a seller where no investment banker has been retained simply by deleting references to the investment banker or changing them to references to the seller, as appropriate.
C.A target's obligation to conduct a level playing field auction is not violated by the target conditioning its willingness to provide non-public information on entering into confidentiality and standstill agreements. See, e.g.,AllianceGaming vs. Bally (1995 Del. Ch. Lexis 101).
D.Note increasing use of "electronic data rooms," where confidential information is provided on a secured, limited access internet site.
II.Purposes of Confidentiality Agreements.
A.Provide potential bidders with sufficient information regarding the target to enable the bidders to formulate and price a firm offer.
1.Confidentiality agreement may be “bi-lateral” if purchase consideration includes bidder securities.
B.Minimize business risks inherent in releasing confidential information to competitors and others.
1.In a situation where the recipient is a competitor, the disclosing party will need to avoid exchanging competitively sensitive information in order to reduce antitrust risks. See Debra J. Pearlstein and Adam C. Hemlock, Sharing Before the Deal is Done; Information Exchanges and Antitrust, Business Law Today, September/October 2001, at 32.
2.Can also use auction procedures as a safeguard--release highly confidential information only to “finalist” bidders, or only after execution of a purchase and sale agreement.
3.Competitors may not wish to review important technical information of the disclosing party in order to avoid the risk of a claim that the recipient has misused proprietary information.
C.Establish eligibility for confidentiality exception to SEC Regulation FD under the 1934 Act, prohibiting selective disclosure.
1.Otherwise, persons acting on behalf of an issuer may not disclose material, non-public information to certain enumerated persons unless the issuer publicly discloses the information.
(a)Enumerated persons include holders of the issuer’s securities in circumstances where it is reasonably foreseeable that the holder will trade in the securities.
(b)Public dissemination must be simultaneous if the disclosure is intentional.
(c)Communications to a person who owes a duty of confidentiality or who expressly agree to confidentiality are exempt from the public dissemination requirement.
(d)Confidentiality agreement does not need to be written for Regulation FD purposes.
III.Basic Provisions.
A.Covered information.
1.All information concerning the target, irrespective of the form of communication (written, oral, visual, computer, etc.).
2.The fact that a transaction is being contemplated/status of negotiations.
(a)Note need for public acquirors to obtain an exception if disclosure is required by securities laws.
3.Standard exceptions.
(a)Information generally available to the public or in the relevant industry (other than by breach).
(b)Information possessed by recipient prior to disclosure.
(c)Information that subsequently becomes available to recipient on a non-confidential basis.
B.Permitted use of confidential information.
1.Solely to formulate bid.
(a)A prohibition on “using Evaluation Material in any way detrimental” is not appropriate. Your client may, upon reviewing evaluation material, use the information to negotiate special indemnities, change the proposed transaction structure or deal economics or do any of a number of things that are proper, but might be viewed as potentially “detrimental” to the Company or the seller.
2.Keep confidential.
(a)Legally compelled disclosures.
(i)Make sure exception is broad enough so that your client can comply not only with “laws” and “orders” but also with things like subpoenas and warrants.
3.Limit access to “need to know” basis.
4.Share only with advisors who need to know the information for the purpose of evaluating the transaction.
(a)Consider other representatives--bidder must be able to share information with its financing sources if it requires external financing.
(b)Bidder must be able to share information with co-bidders in a club deal.
(c)Bidder must inform its representatives of the confidentiality restrictions.
(d)Bidder is responsible for breach by its representatives.
(e)Or ask representatives to sign confidentiality agreements to create privity with Seller.
C.Losing bidders.
1.Return confidential information.
2.Destroy notes, analyses, compilations, etc. (“derivative material”).
(a)Be sure to cover electronic and other embodiments irrespective of the media type.
D.No representations re confidential information.
1.Representations and warranties (if any) are made only in definitive purchase and sale documentation.
E.Control of process.
1.All contacts with target arranged by investment bank or other external contract.
(a)Allows for better control of the process.
(b)Can reduce risk of unintended commitments or representations.
(c)Allows for consistent message to bidders and better auction process.
(d)Reduces risk of premature disclosure to people outside the deal team.
2.All diligence arranged by investment bank.
3.Target retains flexibility to change the process.
(a)Right to abandon the transaction.
(b)Right to change procedures.
(c)Right to not sell to the highest bidder (i.e., right to select another bidder for any reason, such as certainty or reputation).
4.Disclaim representations and warranties.
IV.Non-Solicitati Provision (Employee Recruitment).
A.Prohibition against solicitation of target company employees protects against the bidder raiding the target of its important human resources (“poaching”).