Divestitures from a Legal Perspective

Main differences between an acquisition and a divestiture? 

In an acquisition, the work is really in the front end, and if done well, and efficiently and effectively will lead to a successful transaction. And so when dealing with an acquisition, excuse me, when dealing with a divestiture, you really have to get all your ducks in a row to ensure everything is designed, developed, and really more as importantly or more importantly, presented appropriately. 

Acquisition, a lot of the work is done in the back end. You're doing due diligence. You're looking at the deal. You're looking at the target you want to acquire. As the seller, when you're doing a divestiture, it requires a significant amount of work in the front end. Doing that correctly doing thoughtfully will typically lead to a successful deal.

The Divestiture Process

a.The team needs to understand why we are doing this deal?

• Do we need cash? 
• Does this business no longer advance the overall company strategy? 
• Does this particular site have a lot of legacy liabilities that we wanna shed? 
• Do we want to go in a different direction?

If the entire deal team and especially the legal team, don't understand the why we can't develop the how. No one should be discussing divestitures or frankly, any M&A until you understand the why. 

b. How are you doing a carve-out? 

• Are you selling a legal entity? 
• Are you doing a bilateral deal? 
• Are you doing an auction process? 
• How are you hoping to effectuate the divestiture?

Understanding the how will have a profound impact. All the work you have to do and all the steps you have to take to ensure a successful divestiture, happy to go into all those steps or maybe address to carve out whatever you prefer. 

The Corp dev teams I've worked with are phenomenal, but here's where you do work with the Corp dev team.

c. Identifying what you're actually selling. From a legal perspective, the issues that may arise are based on what you're selling. 

Common Issues to consider:

1. Contractual Issues

If you're selling a legal entity with certain assets owned by that legal entity, there are going to be contractual issues.

There may be a change of control where the contract provides that if the legal entity attached to this contract is sold, the other party can terminate. 

If the real value of the business you're trying to sell is attached to that contract and you can't sell, you can't transfer that contract instead that change of control provision, how much is the business worth? That's a real issue. 

So the legal team will first scrub all the contracts attached to the asset or business being sold to ensure there is no change of control issues. 

2. Employment issues

Do we want to keep some of those employees? Are we fine with those employees being transferred with the business we're trying to sell? How valuable are those employees to the operation of the business? Do we need to put retention agreements in place? 

Do we need to make sure that the management team is working for us as a seller or in the back of the mind, they realize that they're no longer gonna be working with us in a year from now so their loyalties lie elsewhere? 

Are they tied for a year or two to the asset in question? Because the buyer may not know how to run the asset. So they will need those employees to at least run the asset or train their folks and bringing them up to speed. 

Well, if the employees can walk off the site as soon as the deal closes, what value does the asset have? 

3. Tax Issues

Any deal has tax consequences. You always want to clear your proposed transaction with your tax advisor to make sure there are no adverse consequences of going to an equity deal or an asset deal, or some combination thereof. 

4. Debt Instruments

If the business or asset you're looking to sell is collateralized, then your bank will have an interest if you're trying to sell that asset or business. So you need to scrub your debt instruments to make sure you have the ability to actually sell that asset or if you need their consent. 

5. Permits 

How will the acquirer get those permits if the permit is in your name? How will the acquirer have the ability to run those assets on day one? 

6. Licenses

If those assets are dependent on having certain licenses, those licenses are in the seller's name and not the buyer's name, how are those transferred? 

7. Intercompany agreements

You could have two companies or more occupying a larger industrial site or a larger real property site or any type of space, physical or not. How will you share that particular site while there's going to be intercompany agreements? 

This is where a lot of things fall through the cracks, the mundane issues of how to run a site day in, day out that now need to service two companies and two sets of employees serving two different management teams. How are those issues gonna be handled?

8. Regulatory Issues

If you're selling to a strategic buyer, are there gonna be antitrust concerns? Are there gonna be concerns in terms of when they're doing due diligence? Are they getting access to your commercially sensitive information?

Are they getting access to your customer list and other highly sensitive information that if the deal goes sideways, compromises your competitive position 

9. National security issues

A lot of companies produce products that the United States government has an interest in or other governments have an interest in. And do they want those products being sold or managed by an entity from another country that may be hostile to them?

Strategy 

The strategy is to be front and center for every single action, the business development team, and the businesses take.

What is your strategy? What is your end goal? And in terms of business development, as you look at the different business lines, different regions of the world, where in which you do business, different activities, if all of them are not advancing your goals, then you should be taking a serious look at why are you doing that?

Why are you expanding company time and resources on activities, business lines, individuals, and countries that don't advance your goal? And if the answer is you shouldn't be, then at that point, you should be talking about divestiture or shut down.

When does legal get involved? The best practice is from day one.

Because when thinking about divestiture, when thinking about all the strategic actions a company should take, there's a legal consequence to all of that. Whether you like it or not, lawyers have an influence on everything. And you need to be cognizant of the legal ramifications of any action they take.

Build a Team and Setting Up the Data Room

You have to prioritize and you have to be able to work with a team. No one person, especially when talking about a large multibillion-dollar global company, will do it all alone. 

You need to have a team in place that understand the issues and understand what they need to do. And frankly, you need to have a leader who can coordinate all that.

When looking at a large multibillion-dollar transaction between those who are working for the seller and those who may be working for them as an investment banker outside council, 10, 20, 30, 40, 50 people beyond, and a strong project management leader is essential.

Get a team together representing all of those different stakeholders. With a divestiture, it's all about getting the work done right at the beginning. 

You want to put together a data room. It's going to have all the contracts, all the licenses, all the permits, et cetera, that would be of interest to the buyer because the buyer's job is to do the diligence, to make sure what it is bidding can be justified to its shareholders. 

The data room needs to be as thorough as possible and it's easy to use. If you're asking a buyer to bid a hundred thousand, a hundred million, a billion-plus, you need to present that well, that is going to be a first impression for the buyer, like it or not of how well your asset or businesses run.

Teaser and CIM

Whether you are running the sales process or you've engaged in an investment bank to run a sales process, it is typical to send out a teaser. A teaser is a two to three-page document that basically says, look at this asset, look how great this asset is. 

Depending on what communications are required, they will express interest to the investment bank or the seller.

At that point, the potential buyer is asked to sign a non-disclosure agreement and they subsequently receive what is called a CIM, a confidential information memorandum. The CIM is about 50 to a hundred page details about the asset or business in question. 

It has financials, a description of the org chart, a description of the assets, and a thorough way of giving the potential buyer comfort in the asset it's looking to buy. Well, going back to that staging of a house. 

Between the data room, the teaser, and the CIM, that's low-hanging fruit that a seller should get right to ensure all buyers in the process, understand they're dealing with a professional outfit. 

Engaging Investment Banks in a Divestiture

I think every company makes has different criteria of when they engage investment banks. If you really don't have a good feel for the parties that may be interested in the business you're trying to sell, you may go to an investment bank for their knowledge and for them to hold your hand throughout the process. 

You may also look to an investment bank if you're dealing with a very large transaction where their expertise will be invaluable to help you walk through the transaction. Investment bankers know what they're doing. 

A lot of them are fantastic advisors, not only with getting the business or business sold. But in terms of the marketing materials day in, and day out. They know what appeals to potential buyers in different industries and business lines.

The best practice is for the legal team is sitting in on all the pitches by the investment banks. And because in those pitches, the investment banks may promise certain things that if you engage with me we'll give you X, Y, and Z. You want to make sure whatever they promised or represented can be found in the contract.

Preliminary Diligence

Once the management team decides we're going to pursue a sale, a best practice is weekly meetings where the different stakeholders report what is happening and what needs to happen over the next 30 days. 

We've put together a data room and a teaser and the confidential information memorandum.

So the teaser has gone out. We have received interest from a variety of parties. They have signed the non-disclosure agreement, and if they have any objections to the NDA template we've sent out, those will be negotiated by the legal team.

The NDA has been signed and they have received the confidential information memorandum. With that confidential information, the memorandum will be a letter, and the letter will state by X state, we expect your preliminary bid and so it can be a range. 

It can be subject to further diligence, and it can have all these caveats and frankly, it'll be non-binding. If someone is probably sending you a binding bid by that point, either you're in bilateral negotiations or it's a scam. 

At this point in an auction process, they're going to want more than that before making a binding bid.

And whether it's the NDA or the letter I've just described, all that is drafted by legal, and a best practice will be to have those templates ready to go. You have received, you've sent out that request and the date has passed, the due date has passed. 

Post Bid

So now you have all of these potential bids, and it is time to decide which potential bidders will be brought into the second round. What are you looking at? 

• You're gonna be looking at price. 
• You're gonna be looking at liabilities. 
• What liabilities do you think a bidder can assume you will look at? 
• Does the bid have the necessary capitalization to make this acquisition?
• Is the bidder someone with a strong reputation that you would feel comfortable sending your employees to work for? 

Before any of those questions are asked, why are you doing the deal? What was your strategy? Remember everything comes back to the strategy. If you simply need the money, then maybe there's a bias for those bids with the highest amount.

Suppose the driver of the deal is just to shed liabilities; who can assume these liabilities tomorrow, so we have a clean exit. If this driver is to get our employees in a safe spot, who has a good reputation for taking care of employees, especially in the acquisition? Your strategy drives every single step of the way.

Formal Diligence

So you have looked at all your bids, and you've measured those bids against your strategy. And now you've invited maybe four to seven businesses, potential bidders, into your second round. The second round will involve access to your data room. 

It would be best if you also prepared a management presentation for key folks from the business line or from the asset you're trying to sell. It may just simply be a script; they may offer Q&A, but here is your opportunity to demonstrate to the buyer that this is a business you want to buy, and this is a business that justifies top dollar. It is also a potential opportunity for the management team that may be going with the business to demonstrate their value.

So management presentation, site visit, if you're buying a site and possibly with that, a proposed purchase agreement. 

So, let me take a few moments to one, talk about the data room that I mentioned at the beginning and to the purchase agreement. 

Packaging the Data Room

You have now spent six to eight weeks preparing a data room that is staged and packaged well. As you're preparing the data room, you also need to consider who will have access. If your bidders are strategic, more likely than not, they are your competitors. 

You don't want them so early in the process to have access to your customer lists, your pricing schedule, and your commercial Ts and Cs, when contracts with your customers terminate because that will give them an unfair, competitive advantage.

So if you are going to have strategic bidders in the process, one, you should segregate that information, so strategic buyers, so you can tie appropriately decide when to give strategic buyers that access. 

And two, the legal team should develop a clean team agreement. A clean team agreement compels the buyer to designate certain individuals within its organization or outside maybe third-party consultants.

And only those individuals will have access to the competitive sense of the information I just described. They will prepare a summary to aggregate that data and make sure that data is no longer competitively sensitive and more often than not, they will show that summary to the seller. So the seller can also get comfortable that its competitively sensitive information is not going to the buyer.

So that is a best practice for setting up the data room. 

Purchase agreement

The purchase agreement is a huge lift for the legal team as the process is going along with the seller. It is very common for the seller to develop the purchase agreement. And it is a decision of how seller-friendly you want to make the agreement.

Frankly, a lot of it is dictated by the market. If the asset is something you're just desperate to get rid of, then probably a more neutral approach is the best.

If I don't know the why, I can't develop the how, and this is where you need to work. The legal team needs to work very closely with its business development team and the investment bank to decide how much interest will this asset or business generate because that will dictate how the purchase agreement is crafted and what liabilities stay with the seller and what liabilities will go to the buyer. 

As the buyer is marking up the purchase agreement, they will decide which liabilities they want to assume or not? What indemnification rights the seller may have? What limitation damages the seller may have, and really the end, in its layer agreements like the transition services agreements.

This is where the interests of the buyer and seller diverge. The seller wants a clean exit, and the seller wants the greatest amount of cash value and limited indemnification rights as possible. 

And in terms of compensation and how long they'll last, and of course, the seller wants limitation on damages, and the buyer wants the opposite. 

And so that's why the buyer needs to mark up the agreement at a specific date after this. And so, we'll call this round two. The seller will receive a marked-up purchase agreement and a bid letter. 

Purchase agreement (Carve out vs. Divestiture)

The seller in a divestiture wants a clean exit. With a carve-out, you have those ancillary agreements, so your ability to be aggressive is muted. But as the purchaser, you also have different interests in a carve-out. You do not want value being eroded through those ancillary agreements as well because you have decided looking at that asset or business in question is worth X amount of dollars.

You have paid that amount, but if you are now paying a premium via those intercompany agreements or via the TSA, then how you justify that deal to your shareholders is slowly creeping away. 

So the focus in a carve-out, whether you're the purchaser or the seller really needs to be those ancillary agreements.

Your value can increase and decrease after close and for 2, 3, 4, 10, 20-year time period through those ancillary agreements, so they need to be done right and they need to get the attention they deserve. 

Transition Services Agreement  

The TSA reflects a broader question when dealing with carve-out versus divestiture. You're looking to walk away in a divestiture and have a clean exit. So, your pressure points in a divestiture are to get the most consideration and limit your liability across the board.

Those come into play in a carve-out, but in a carve-out, you're still living with the person. Especially if you're carving out an industrial or another type of site, you're still going through the same gate as the buyer. You'll still have to work with them on issues that impact the site, whether it's garbage disposal, parking, traffic issues, or community service events, it runs the gamut.

Your ability to be as aggressive in a carve-out is not as great as it is with a divestiture because you're still living with the other party. And as importantly, whether it's TSA or other ancillary agreements, have you considered all the issues I've mentioned? How two separate businesses will operate and work together within the same geography. 

The legal team with the business, the operation, and the commercial teams need to sit down and go through every single scenario because that is where things fall through the cracks. 

And if one of those carve-out agreements, those intercompany agreements that will help govern the site are forgotten, then whoever has the leverage post-carve-out is going to use that leverage. The best time to address the menu of issues is during the negotiation of the carve-out itself. 

You never want to kick the can on the ancillary agreements because I've seen, more often than not, that comes back to bite you and because the leverage shifts after the deal is done. 

The legal team is drafting the purchase agreement and the TSA. In addition to the purchase agreement, I may send over a suite of ancillary agreements, that address not only transition services, but easements, real estate, operation, permits, and other issues. 

To be quite candid, the purchase agreement is the least of my concerns with a carve-out. Every lawyer in town has a template for the purchase agreement.

And you can find that as much as needed for any particular deal where a lawyer brings the most amount of value in a carve-out is thinking about those ancillary agreements. 

If the other party now has control of the entry and exit, how do our employees get in and out some of the most mundane pedestrian stuff you can think of. If it's not done right, you will see more value erode from the deal than you could possibly imagine if those ancillary agreements are not done properly and thoughtfully.

A good lawyer will be focused on those ancillary arrangements and agreements from day one because in a carve-out that's where the value lies. A transition services agreement will be particular to those services you are willing to provide post-close and the buyer is willing and eager to pay for post-close. 

So that requires far more work and far more teamwork because as the lawyer, I'm not at that site day in, day out, I'm gonna have to reach out to those folks to share it with me. I will depend on them to let me know. 

Do's and Donts of TSA

As a seller, you want to provide as few services as possible and for a short amount of time as possible, it all goes through your strategy. 

More likely than not, your strategy is a clean exit. So you want no TSA if possible and if there a TSA is required, as short as possible. 

Moreover, with drafting any TSA, the mantra I repeat over and over again to anyone on the team is helping me, no good deed goes unpunished. And so you may need to do a TSA to get the deal done, but you should be charging an appropriate amount.

The TSA should not be a giveaway to get the deal done. If you're, dedicating a tremendous amount of your resources, licenses and people to managing the TSA relationship and not getting compensated, you're losing money every minute of every day that TSA goes on. 

The TSA should be for fair value or a markup frankly because you are providing a service and the TSA should also contemplate your goal. If a clean exit is your primary goal, then as short and sweet as possible, 

It all comes down to why are you doing the deal? And that should govern how you package your marketing materials, how you package your data room, and how you package and draft your agreements, including the purchase agreement and including the TSA and other ancillary agreements. The strategy dictates everything.

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