How to Best Protect a Business Case in an Acquisition

Can you kick off with just a little bit about your role at NCR?

I am on a small team that focuses on executing leadership and organic strategy. I break my job into two categories, which are pipeline management and deal execution. My job around pipeline management is really managing the relationships with bankers and working with leadership members to identify what we want to buy or sell as part of their overall growth strategy.

On the deal execution side, we are focused on internal approval processes, coordinating due diligence, and any type of follow-up for post-closing items.  

What kind of deals have you worked on?

I have some advisory experience as well as some corporate development experience. A couple of those I would highlight is stock acquisition in late 2018, a JetPay acquisition, our D3 acquisition, and Zynstra acquisition. My experience is more on the acquiring side of the deal versus divesting or merger.

What is the hardest thing for you when you are doing these deals? 

It would probably be balancing all of the many items for many processes that are happening at the same time, such as getting internal approvals, managing the diligence process, and managing the negotiations all at once. 

What does the process look like for executing transactions at NCR?

Normally, the deal comes from us. Once the company is identified, we begin negotiations around a mutual non-disclosure agreement. We are interested in having an acquisition discussion, we want to talk about confidential information.

When we execute the mutual non-disclosure agreement, we try to get as much information as possible from the seller, mostly around technical information and financials. Based on that, we build some type of business case around what we can present and what kind of return we can provide for NCR shareholders.

Then we call the investment committee, which is a subset of our leadership team, present our findings, and tell the leadership what we want to do and why.

Once we get approval from them, we begin discussions around a letter of intent, a non-binding letter of intent, and when that is executed, we kick-off the deal, which means hiring outside advisors and the focus moves towards due diligence.

We do weekly check-ins on progress, gather information from the seller, simultaneously working with outside legal advisors on drafting the definitive agreement. Our findings then get presented to the investment committee for them to approve the execution of the definitive agreement. 

Let’s talk about the purpose of each of those legal agreements. What is the purpose of mutual NDA? 

The mutual non-disclosure agreement is necessary for every transaction to protect the information as much as possible. We always try to make it mutual, which helps create a more valuable conversation when we set up management presentations.

Some things that are negotiated are the length of holding the confidential information, as well as the survival period of the actual agreement and non-solicitation of employees or customers.

How about the indicator of interest?

This plays a role in a deal that is being marketed. If a business is not actively being marketed by a broker or a banker, we generally go straight to the letter of intent, and when it is being marketed we have to get an initial read on what we think the value of the business is.

In this case, there will be a range of prices and other high-level terms of how we see the transaction moving forward. This will be non-binding and won’t be negotiated, as it is just a bid.

When staging out the process, sometimes the whole process is outlined in what we call a process letter which the investment banker will provide and will require an IOI, a date, and later, a letter of intent. 

Let’s talk about LOI.

They are similar to IOI, but they have more concrete terms to them, as well as a fixed price. They have certain items that are listed that will be further negotiated during the actual diligence process, but that will be more of an outline for how the negotiation will go.

Things that can be included are the actual price and the exclusivity period, which is the time in which we as the buyer have exclusive rights to learning more about the business and the seller is not reaching to other buyers.

There will be discussions on holdback and escrow accounts or reps and warranties, on how we are financing the transaction, as well as any type of networking capital or completion cash mechanism. These are some of the main items. 

What about the breakup fee? Is that going to be included in the LOI? Is it legally-binding?

Yes, it is going to be included, and if there is one it typically is legally-binding. However, that’s more associated with public transactions. If it is binding, there will be some type of breakup fee. 

This is where the most negotiation happens, on the LOI, right?

I would say that a lot of negotiation occurs at this point, but I wouldn’t say this is where most of it happens. When you actually get to the details of the definitive agreement, you are going to end up negotiating a lot of terms and in a lot more detail.

However, there will be some big points to negotiate at the LOI stage which can include price, what hold-back are we going to aim for, and similar big terms.

What is the thing people go back and forth the most on in an LOI? 

The three main items would be the price, the escrow accounts that are going to be set up and the networking capital mechanism, and how that’s going to be addressed. 

From there, the big main event is going to be a purchase agreement, also known as the definitive agreement. Let’s talk about that. 

The agreement will reference what’s in the letter of intent, but this is actually where all the details are hashed out on those three main items I mentioned, as well as anything else associated with the transaction. They will also have many auxiliary documents to them as well to support the definitive agreement.  

How would a purchase agreement differ between public and private?

In a public transaction, there will be no form of recourse for the buyer, so instead, at the time of close, there is no way for the buyer to come back to the seller and recover any losses if there are any.

You are also going to have different types of agreements, such as a merger agreement or stock purchase agreement, as well as the documentation that needs to go to the public shareholders, which can include tender offering material.

Can you explain the difference between an asset and a stock agreement?

If we are looking at an asset, you are buying the assets of the business. As a buyer, you are going to outline what assets and liabilities you are acquiring and what assets and liabilities you are not acquiring in your purchase agreement.

There are also tax benefits to an asset deal that can be favorable to a buyer. The negative aspect for the seller, however, would be double taxation during an asset deal, one being the tax on selling the assets and another paying the dividend to themselves post the transaction.

On the other hand, the stock is more seller-friendly. In this case, the buyer has to acquire the entire legal entity, all assets, and liabilities associated with it. The benefit is that if there is a net operating loss the seller has, it will come with the business through the shares of the business and there is also no double taxation.

What are representations and warranties in the context of M&A and why are they important?

Representations and warranties precisely describe the state of the business and the circumstance of the transaction to the best of the seller's knowledge. There are legal items called knowledge qualifiers, where sellers represent how much they know about certain facts of the business. These facts are broken into two categories.

The first is fundamental rights, which are the most important, and include the seller's right to sell the shares, capitalization of the business, who owns what and similar items and second is general rights, which include financials, employee benefits, customer and vendor contracts, insurance policies and similar.

There are also intellectual property reps, which protect the intellectual property of what you are buying. 

These reps and warranties, they would omit certain identified risks, right? 

They would disclose certain identified risks. Normally, there is a disclosure letter to disclose things identified as risks, as well as other facts you’d want to expand on, such as financials. 

Now, this is coming from diligence reports. Is it usually a third party or can your internal ones count?

It can be both, depending on what’s identified. I would add that the best practice would be to disclose as much as possible. If you can’t disclose something, ideally there is something in the purchase agreement that is going to protect you as a buyer and the seller is going to want to disclose as much as they can as well, because that protects them. 

How is identification or recovery addressed in a purchase agreement? 

When you identify a tax liability that wasn’t disclosed or known, but the rap indicated that there was no liability in this area, a tax expert needs to identify that liability, calculate the total losses associated with it and inform the corporate development team and a legal team what has happened.

There will be a process in the definitive agreement on how to make a claim on that loss. In terms of recovery, there are a couple of different methods.

The first one is a hold-back, where at the close, a portion of a purchase price gets held back from the seller for a certain period of time and that could be funds for recovery and the second source of recovery could be an escrow account.

There is also warranties insurance, which includes a policy agreement with an insurance company. Sometimes all three methods can be used as a source of recovery. 

Are reps, warranties, and other items subject to different limits of liability?

Generally speaking, they are. Fundamental reps are usually capped at the purchase price, sometimes with no survival period, so they live indefinitely. The buyer should have full rights to reclaim the entire purchase price that was paid when acquiring.

General reps on the other hand are going to be more heavily negotiated in terms of their limits of liability. Tare also IP reps, which generally last longer than general reps.

How can sellers protect themselves from small claims?

There are indemnity baskets set up in the definitive agreement, which means that the claims or losses have to hit a certain amount before a buyer can start making a claim. They normally come in two forms, either a true deductible or a tipping basket. In the first case, the loss itself has to be bigger than the deductible and the transaction will fund that deductible if agreed upon.

Tipping basket is more buyer-friendly, as the buyer will be able to add up all their losses from all claims. Once it hits that total amount for the typing basket, the entire amount is reclaimable by the buyer. 

What’s an example of a usual reason a holdback or an escrow account was set up? 

An example I am seeing more often would be an escrow account set up around data protection rights. Every deal is going to have individual escrow account oriented protections, just in case, if there is a known risk that’s identified.

The buyer will want everything the seller had done in the past to be properly protected post-transaction. You can set one up for potential tax issues, legal issues, litigation and similar issues.

What are the major risks of not properly negotiating indemnity measures in a purchase agreement?

Every transaction that a buyer is going to work on will require a business case to be set up, which revolves around developing a proper strategy and projections associated with the business.

If you are not properly protected from any of the items we have discussed, those are expenses that can directly hit the business case that you didn’t plan for and can materially change the DCF value or how lucrative or diluted the business is. An expense is only going to make it more diluted. 

What are some surprises in some of the deals you worked on?

There are cases where someone not everything is properly disclosed, so you end up being exposed to something you didn’t properly protect yourself from in terms of reps and warranties.

That can happen in terms of a top 10 vendor list, where it turns out that another vendor learns that a big buyer acquired this small business and that they are outside of the top 10 and suddenly they want to raise their fee as being a vendor to a ridiculous amount. This is why it is important to get the strongest rep possible. 

And what are some interesting surprises that come up after the close?

In terms of surprises, most of what I’ve seen post-close would be small claims that come up or something that was improperly disclosed.

Give me advice as somebody that’s selling a company and some tips on how I can protect myself. What are some of the things to think about?

If you are a small business looking to sell, it is important to know that the buyer will take what you are representing very seriously. That means that if your systems are not up to date, you can’t readily pull data to properly represent the business, which is going to be a potential issue during the acquisition process and you are going to be exposed to more risk post-closing if something comes up.

You may want to hire an adviser or an investment banker to help you with that process, otherwise, the process can end up dragging for a very long period of time. 

What’s the craziest thing you have seen in M&A?

The craziest would be some of the emotions that come out during negotiations when you are at a certain point when there is no turning back, but you don’t want to sign up to given terms.

This is somewhat common whenever there’s a lot of money involved and there is a lot of risks associated with completing the transaction. There are cuss words because of the heightened emotions and sometimes you can hear people shouting about something they believe they hadn’t agreed to, especially at the LOI stage.

Ending credits

Thank you for taking the time to explore the world of M&A with our podcast.

Please subscribe for more content and conversations with industry leaders.

If you like our podcast please support us by leaving a five-star review and sharing it.

M&A Science is sponsored by DealRoom, a project management solution for mergers and acquisitions.

See you next time!