In This Issue
INDUSTRY INTEREST
Planning for M&A in 2012? Read Tales from the M&A Trenches
The 126-page third edition of Tales includes several new articles to help dealmakers prepare for common post-closing issues.
INNOVATION
Understanding Escrow Liquidity
Holders of escrow interests can benefit from a new liquidity option. SRS EscrowExchange purchases a small fraction of select escrows.
BEST PRACTICES
Why Your Corporate Documents May Not Work
Company management and investors should review corporate documents, such as options plans and confidentiality agreements, to prepare for the possibility of a merger.
INDUSTRY INTEREST
Planning for M&A in 2012? Read Tales from the M&A Trenches
SRS has released the third edition of Tales from the M&A Trenches: Pre-Closing Practices to Mitigate Post-Closing Risks. Co-authored by SRS Managing Directors, Paul Koenig and Mark Vogel, the book presents issues that can impact parties after M&A transactions close, including potentially problematic deal terms, challenges with financial statements and tax matters, and the complexity surrounding earnouts and disbursements of consideration held back at closing. The newest edition also includes editorial comments from Diane Holt Frankle, partner at Kaye Scholer LLP. As one of the nation's leading M&A attorneys who frequently represents acquirers, Diane provided perspective on the buyer's point of view on many of the issues raised. The 126-page book distills years of SRS experience managing a broad range of post-closing issues into a manual of best practices for acquirers, private company managers, investors and their legal advisors who are negotiating transactions.
Transaction risks continue to loom large for buyers, investors and management teams in recent years, particularly for deals with substantial escrows and earnouts. SRS has successfully managed many transactions through the post-closing process and is uniquely positioned to provide guidance on which issues come up after closing and just how much of an impact losses may have on overall returns. The following examples are just a few of the many topics discussed in Tales:
- Parties should be very precise about the calculation of damages in the merger agreement. In particular, in the case of financial misstatements, buyers and sellers could interpret the impact of the misstatement very differently. Any significant disparity in their assessment of the resulting damages will likely lead to a costly dispute and potential litigation, which both parties would like to avoid.
- Challenges can arise when third-party claims, such as an infringement claim brought by a patent troll, are controlled by someone that is not the party bearing the economic risk of loss. This can result in disputes regarding whether the claim was defended properly.
- Upwards of a third of all deals have issues with proper distributions of merger consideration, which can lead to mistakes, delayed disbursements, and costly cleanup.
Market indicators suggest that there will be an uptick in acquisitions of privately held companies in the next 12 months, and the need for visibility into potential post-closing problems will continue to grow. The newest edition of Tales from the M&A Trenches is an essential resource intended to help dealmakers prepare for future transactions.
The below article, Why Your Corporate Documents May Not Work is one example of the content presented in Tales. The complete book is available on the SRS web site here.
INNOVATION
Understanding Escrow Liquidity
Upon closing, a portion of the purchase price is typically set aside in escrow for purchase price adjustments and indemnification claims that may result in losses. Through SRS EscrowExchange™, former stockholders may have the option to sell their escrow holdings at closing, allowing them to lock in immediate payment and avoid the risk of unpredictable losses and delays. SRS EscrowExchange will only purchase a small fraction of any particular escrow so the stockholder group continues to own the majority of the account. Any transfer of interests is limited solely to a stockholder's transfer of its rights in the residual cash amounts left in the escrow and does not impact the rights of the buyer under the merger agreement. This opportunity was created as a benefit to serve the liquidity and risk-mitigation needs of selling shareholders.
Summary of Important Facts to Consider
- ~85% of escrow amounts on average are eventually released to the former shareholders of the target company.
- 56% of escrows receive claims.
- 23% of deals have claims in the last week of the escrow period.
- Final escrow releases are delayed by claims in 34% of deals, by 9 months on average.
- 14% of escrows receive claims against the entire escrow value
Many escrows are eventually paid out in full to the former stockholders while others are wiped out completely by indemnification claims. Since the remaining balance is typically released a year or two following closing, and because there is meaningful variability around these outcomes, the current value of a typical escrow at the time of closing is likely around 75% of its then current balance, with the discount being attributed to time value of money and general risk of uncertainty. For any particular escrow, the rates at which an escrow interest may sell likely range from $0.75 to $0.10 on the dollar.
Illustration
Assume Stockholder A is eligible to receive up to a total of $100,000 in connection with a merger transaction, $90,000 of which is paid at closing and $10,000 of which is held in escrow. If Stockholder A elected to sell the escrow interest at a 35% discount, they would receive a total of approximately $96,370 near the time of closing (net of transaction expenses). Alternatively, Stockholder A could elect to receive $90,000 near the time of closing and to receive their portion of the remaining balance of the escrow upon its release. This amount could be greater or less than what Stockholder A would have received if it sold its escrow interest now depending on what ultimately happens with the escrow.
SRS EscrowExchange has teamed up with SecondMarket, the leading marketplace for alternative investments, to facilitate an auction process where former stockholders can determine the price at which they are willing to offer to sell their escrow interests should they choose to participate. Participation is purely voluntary.
BEST PRACTICES
Why Your Corporate Documents May Not Work
Many portfolio company charters don't work that well in addressing how money should be split among the shareholders when the company is sold. For example, common shareholders may believe that all contributions to the escrow account should be made pro rata based on gross merger proceeds receivable by all shareholders, while preferred holders may think that any losses from the escrow should come solely from the common if they could otherwise result in the preferred holders getting less than their full liquidation preference. Investors and entrepreneurs should strongly consider discussing issues such as this at the investment stage to avoid having to deal with inter-shareholder controversies when trying to finalize a sale or merger of the company.
At the same time, management and investors should also review other corporate documents, such as options plans and confidentiality agreements executed by key employees, directors and shareholders.
Option Plan Issues
While the provisions of the merger agreement usually address the treatment of company options and warrants, holders of such securities typically do not sign the merger agreement, any related consents or letters of transmittal. In order to address privity of contract issues, the company might consider including language in their warrants, option plan and option grants that states that as a condition to the receipt of the security, the recipient agrees that the instrument will be subject to the terms of any merger agreement or similar transaction the company may enter into, including providing explicit consent to the appointment of a shareholder representative that will be authorized to act on the recipient's behalf with respect to their interest in any escrows or contingent consideration.
Confidentiality Agreements
Companies typically require their staff to execute employee invention and confidentiality agreements. In addition, similar confidentiality agreements may be executed between the company and its directors, consultants and independent contractors. At closing, the beneficiary of this confidentiality obligation becomes the buyer as the new owner of the target company. When a claim arises, we have seen buyers assert that former employees, directors, contractors and shareholders have a duty of confidentiality and cannot discuss the issues and facts arising from the claim with the shareholder representative, counsel or even amongst themselves.
While we believe that employees, directors and shareholders should be able to defend against claims during the claims dispute process through their agents and counsel, companies and investors are advised to review their forms of confidentiality agreements, and may consider adding language to specifically permit disclosure of confidential information to shareholder counsel and the shareholder representative if the company is acquired and a post-closing dispute arises.
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Just Released
Download the Full Book
Tales Announcement
SRS Publishes Third Edition of Tales from the M&A Trenches to Help Dealmakers Mitigate Transaction Risk
Highlights 45 topics based on what goes wrong after mergers close
Read Press Release
Recent Transactions
About SRS
SRS | Shareholder Representative Services is the leading global expert in professionally managing the post-closing process to safeguard selling shareholders' interests in private company M&A transactions. On over 250 deals valued in excess of $25 billion in aggregate, SRS has represented more than 400 venture capital and private equity firms and over 30,000 shareholders in 44 countries. No one has as much knowledge and experience in serving as a shareholder representative and navigating the issues that arise post-closing as SRS.
For more information, visit www.shareholderrep.com
Contact Us
SRS | Shareholder Representative Services
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