M&A Deals From a Legal Perspective

Intro

 I'm your host Kison Patel, CEO, and founder of M&A science. Joining me today is Brett Shawn, Senior Vice President, Assistant General Counsel at Warburg Pincus. Today we're gonna talk about how M&A is executed from the legal perspective. 

Would you mind kicking things off with a little background on your M&A experience?

My first job after college was at JPMorgan doing asset-backed securities. After law school, I spent five and a half years doing mostly M&A and some securities and corporate governance work at a firm called Wachtell Lipton. 

And then for the last little over six years, I've been in-house counsel at Warburg Pincus, where I'm one of the in-house M&A lawyers. 

Warburg Pincus is a global private equity firm. Our business is buying and selling pieces of companies. And so each of those is a little M&A deal and I work on those in conjunction with our deal teams and outside counsel.

What's the hardest part of your job?

The hardest part of my job is getting the deal done in a way that is good for everyone. The last 18 months have been like it's a seller's market out there. So things that you didn't think that you would be agreeing to on the buy side, there are plenty of people agreeing to them. 

From a legal precedent perspective, questions that lawyers are always asked is: what's market? Like? What's everyone else doing? The answer should be like, everyone else is jumping off the Brooklyn Bridge. Would you do that? 

You always have to think about it from: What are the appropriate principles? But people are doing things they didn't do before. 

So understanding what the risk really means and whether you can take it, knowing that if you don't take the risk, you're gonna lose the deal, or you could lose the deal. That's difficult because it's sort of something that people haven't done before. 

The other thing that I think gets difficult is, a lot of the deals that we do are minority investments. So we will not control the company. We'll be like 5, 10, 20, you know, 40% holders, and there'll be other people who collectively or an individual are in control of the company. 

So as a fee, how do we think about investing in that company, where we know we're not going to have ultimate decision-making authority? We may have some people on the board, you may have some contractual rights to, our consent is needed to do certain things. 

But we may not have the ability to make all decisions as we would if we were in control of the company. And so that can be difficult, because, like the person is by design not selling control of a company. 

So how do you sort of get the comfort that you think it's a good company now, but you're not going to have as much control over it in the future? 

Can you tell me a little bit more about minority deals? And why do you find them more challenging?

There are sort of like two different general types of minority deals, we see a lot of it. 

One is venture round, which is a company that is owned mostly by institutional investors. The company will raise rounds of private financing. So there'd be like, a seed, an A, B, C, D, and then ultimately IPO, Ds back, whatever. 

And when you invest in one of those rounds, they form documents, people generally use the National Venture Capital Association, corporate is one of the founding members and actually puts out model forms of the documents, they're used in those rounds. 

So those that model documents are something that looks sort of like it is generally a starting point. And so that from a documentation perspective, makes things simpler, but also sort of the way those deals are structured. 

It's a company that is owned by a bunch of other institutional investors. So people that think like us. They know that you want to maximize value for the shareholders. Ultimately, there'll be some sort of liquidity event for the shareholders via a sale or an IPO. 

And that sort of losing control of the company. So even if the individual lead investor series C-round, for instance, maybe they only own 20% of the company, they know that the people that own 70% of the company are people that think like them and are motivated like them. 

And so you have a kind of strength in numbers. So that puts a little bit of pressure off negotiating specific rights for you as a new 20% shareholder. 

There might be areas that are not aligned with the other investors, like if they came in earlier around with a lower valuation, they may be happy doing an IPO or doing the sale at a price that is not great for you as a new investor at a higher valuation. 

So there are specific things like: “don't sell the company for less than 2x for the next three years you might ask for but generally, you can take comfort in the fact that there's a large group of institutional investors that think the same way. 

So that's one type of minority investment, the harder type is the one already behind the founder, or a strategic because then it's really their show and they're letting you in, because they think you add some value, maybe it's capital to help the business. 

Maybe a strategic relationship, maybe it's just somebody smart to talk to about, like, direct new strategic directions, opening into a new market, just having smart people around the boardroom. 

But oftentimes, those people don't want to sell control, they may not want to let you sell the company without their consent. And then you really have to think about, you're making an investment now with a management team that you like, and trust. 

And that's based on the information that you have to date. And it's based on a business plan they've presented to you. But as a fiduciary, for our investors? What sort of protections do you put in place so that you're sure that sort of works out okay. 

If management actually doesn't do a good job, can you replace them like that, which can be extremely sensitive if you're talking to dealing with a founder?  How do you get an exit for our limited partners, if you know, the founder or the strategic doesn't want to sell? 

Are we okay, with just selling our stake? If we want us to sell our stake, how much is someone going to pay for the starting stake versus buying the entire company? These are all, like very difficult questions and trade-offs.

It's fun and challenging from a legal perspective because it's one of those situations where price doesn't always win the day. So if you're a buyer buying the whole company, there'll be an auction. There isn't always an auction, but let's just say there's an auction. 

And the bankers are on the sell side, bankers and lawyers get all the contract markups. And they get all the bids. the contract markups, like some of them will be a little more seller-friendly on conditionality or reps and warranties. 

And there'll be a nice like grid from the lawyers of how the contracts compare. But ultimately, 9 times out of 10 just comes down to price.As a lawyer, like, I don't have much to say there was a price that we bid, off of stuff to say about the legal risks that we take in the contract. 

But ultimately, it comes down to price. In these minority deals, oftentimes, not always, but oftentimes, price is usually very important but it's not just price. It's also governance. How much control are we letting the existing, you know, majority investors keep? 

And then it's on us as lawyers to help guide the business people in terms of not only what's market what other people are going to say, but also just thinking about those risks? 

What should you give up? Like, is it smart to not have a veto over affiliate transactions? The answer is no. 

What sort of exit rights can you have? What, you know, if the other party is worried about us selling at a time you know, they may want to not sell yet, do you let them stay in the company? 

What have you seen that really surprises you in terms of how things have shifted with today's market? 

For a lot of middle-market deals, so you know, say stuffs 500 million TEV, it's become much more common for private equity firms, to larger private equity firms that have funds that are besides they can do this to take debt financing lists themselves. 

So to give a so-called full equity backstop versus traditionally in a private equity deal with a private equity firm lab. 

So in a lot of private equity deals, not all but some of the purchase prices are financed with debt that helps the private equity firm get a higher return on equity because you're putting leverage in the deal. 

Traditionally, some of that financing risk is placed on the target in the sense that while there will be a commitment letter from a, from the debt provider, if the debt doesn't show up to target, all they get is like a termination fee, they can't sue the private equity firm to, like, fill the debt with equity. 

In a lot of middle-market deals, we're seeing both on the sell-side and the buy-side, we see this. You insist upon the private equity firm, equity back's not. 

So debt doesn't show up, the private equity fund has to come out of pocket and pay the entire purchase price of equity. 

It changes how you have to underwrite the deal, and you have to be really certain if you're going to do that, you can raise the debt. 

And that's a business decision that a lot of private equity firms didn't have to make in the past, and now they have to make more and more.

You can always go back and structure that later on right?

It's not really like an efficient use of capital, you're going off from realities. 

Maybe you don't call me, at least we have a credit facility. So but there's still some risk that you're taking.

How's the pandemic overall affected your job? Is it harder or easier?

Everyone's sitting around, like doing nothing else, but deals. So that can make certain aspects easier, you know, like scheduling calls, like I have more calls between like, you know, six, and eight than I ever had before. 

Because there will be times when people will be like, traveling home or whatever, like, going to dinners, and now it's just like calls. So I guess that's, like, easier or harder, depending on how you look at it. 

From a deal perspective, it made everyone much more attuned to Black Swan events because nobody ever thought there would be a pandemic until there was one. 

A few people bought it but like most people didn't think of it until there was one. And now, everyone knows that a draft for a pandemic and a purchase agreement. 

I think people also sort of have a little bit of appreciation for well, what if the next, crazy exogamous event is not a pandemic? Like how do we address those? Address, you know, other sorts of systemic risks. 

And there was an answer for that, there was even an answer for that before COVID, which is, you know, systemic systemic risks that are not specific to the target, those risks are generally placed on the buyer. 

So if you look at a definition of material adverse effect, and the reason that term is relevant, is in a typical M&A deal, the buyer will have to close unless there is something wrong with the target that rises to the level of a material adverse effect.

And the definition of material adverse effect, we usually say, material adverse effect means material adverse effect, just like defined by the courts is like something really bad that lasts for a long time, except the following things are not material adverse effects. 

And it'll say stuff like, general market conditions, movement in the stock market, changes in law, things that you do as buyers, specifically, things like that. 

So general things happening in the market that are not specific to the target are the buyer’s risks, as the buyer knows the market that they're transacting in. And if things change, generally that shouldn't be the target’s risk. 

If you put a pandemic on top of that, it sort of makes sense, like a pandemic is not about one particular company, by definition, its pan, it's everything. So that, should, in theory, be the buyer’s risk. 

And then obviously, as everyone knows, or people who follow some of this litigation know, they're, when that pandemic happened, you know, there were certain industries that were, you know, more impacted. 

And it means that buyers want to get out of those deals that they were signed up to. So they look for ways to, I won't say skirt, but like, other avenues available to them under the contract that allowed them to not close those deals. 

One of the ones that, very famously got pushed on is, there's also a covenant in these agreements, where the target promises to operate in the ordinary course and not to do certain things without the buyer's consent. 

The idea being that the seller has already agreed to a price. So there's some misalignment between seller and buyers operating the business. 

So you want a contractual hook to make sure the seller doesn't, take all the value out of the business until the buyer actually gets a chance to come in there and own it while we're waiting for regulatory approvals and things like that. 

The buyers looked very carefully, and what did the sellers do in response to the pandemic? And if they, you know, shut down all their stores or fired all their people? Well, that's not the ordinary course. 

So you violated that covenant, even though it's not a material adverse effect, to violate the covenant, and if you violate the covenant, you are honored to close. 

So focus on that provision, which I mean, everyone really knew about, we always think about the interim covenant, but it really put a spotlight on it from an M&A practitioners perspective, after the pandemic.

Was that a big thing? Do you think there's a lot of deals where people are looking for either these covenants are sort of the adverse effect clauses to be able to get out of deals? 

The last, like, six, nine months deals that have been signed, since everyone knew about COVID, it hasn't really been that big of an issue. 

The issue was, constrained to certain industries like travel, retail, things like that. You always see the provisions that were developed in response to those events; it's now a kind of market in the agreements. 

But I don't fuss over them as much, because everyone knows what the pandemic means now, at least this pandemic, and like, people guess what, “there's another pandemic that will probably be similar”. 

So you sort of know about this thing, but it doesn't make you think about other stuff that could happen. 

How do you limit risks? What are the risks that you're looking for in a deal?

There are risks that you can address during diligence and then there are risks that you're not going to address during diligence. 

The diligence risks you can address is,you have a thesis about the business that's based on things that the company has told you. So you can do diligence to verify that those things are true. 

They're telling you they have five great contracts with their customers then go and read those contracts. 

There are also things that it's just not humanly possible to do all the diligence. Are their financial statements correct? Or is there someone in the accounting department who doesn't know how to do the financials and is just not doing it properly? 

It’s hard to prove that negative. So you can do some diligence, but you know, that in the few weeks, you have to do your due diligence, you're not going to be able to cover it all. So how do you address that? 

The way that people originally addressed it is you got to wrap and then you get an indemnity. Well, now the market is such that sellers don't want to give indemnities. 

A lot of times, if the indemnity is from the management team, the buyer doesn't really want to be suing their management team either. 

So now there's a rep and warranty insurance that provides that will, in theory, payout if the reps aren't true. So that's one big way to limit that sort of risk. 

There are risks around consummating the deal itself. So when you have financing, that's a question of getting your financing lined up. 

There are also risks around your will to get the approvals that you need for the deal to close? Is there antitrust sensitivity around the deal? If there are ways to mitigate that? 

If you're in an industry that has been in the news, or that’s regulated. The one thing that's important to think about is, what could come around the corner in terms of regulation? 

One thing we often do if we're investing in a regulated industry is not only will we talk to lawyers to tell us if the target complies with the regulations but we often also will hire a consultant, who will talk to key constituencies and understand how those regulations are likely to change? 

Because that may be relevant not only for us but also the future buyer if they're coming into a different regulatory environment that may impact the value of those products, the business.

How do you force majeure clauses that come into play here?

A force majeure clause basically says, if there's some like,an act of God, that's happening, I'm excused from the requirement to perform the contract. 

So in a private M&A deal, so between a single buyer and single seller, those are usually not relevant, because if you think about it, the things that you're required to do under an M&A contract, it's pretty hard to have a force majeure impact on those things. 

When we talk about financing risks, is that just primarily around : we have some general contingencies about getting financing and want to have those in play and just make sure that contracts are sort of our agreement outlays with that in mind? 

There are sort of a couple of dimensions to this. So from a buyer's perspective, the way that a typical private equity deal will be structured, is the buyer will show up with a commitment letter. 

Commitment letter, or some 50-page document that basically says, if you meet these conditions, all will be defined. But it's a term sheet, so in order to actually fund you need to turn it into a long-form agreement. 

And the buyer will have an obligation under the contract with the seller to try and turn it into a use all reasonable best-efforts or something like that, to turn it into a long-form agreement.

And if they're not able to do that, if it doesn't turn into a long-form agreement, and then the buyer won't be forced to or if it doesn't turn into a long-form agreement, or it turns into a long-form agreement, but the bank just doesn't show up, then the buyer can't be forced to close but can be forced to pay or worse, termination fee. 

Everyone always says like, if I have to pay this fee as a sponsor, like I'm getting fired, so nobody wants to pay the fee. So from a buyer perspective, how do they make sure they're not gonna have to pay the fee? 

The thing that they're going to focus on is a good relationship with the banks, they know the bank will show up when it's required to, but also the bank is lending money based on the credit of the target. 

So they need to talk to the target management, they're going to need to get financial statements and other information from the target management and have to sign like KYC information from the target management. 

So as a buyer, you'll get a cooperation covenant from the seller that basically says, please do all these things, but we can get our financing. So we don't have to pay a reverse termination fee. 

And then you flip over to the seller’s perspective, the seller doesn't really want to just get the reverse termination fee either because that's not a good day at the office. 

They just spent  months trying to sell their company, signed on to this other person, and then all of a sudden, they're sitting there with like, 5% fee and they have to go do the whole thing all over again, like the market may have moved like that's not fun. 

So what they'll focus on is a lot of the same stuff. So is there a real bank giving, airtight as possible commitment letter? But they're also going to look at that covenant the buyer has to turn that letter into a long contract. 

Does it say, they have to do everything that they can reasonably do in order to do that? What if that bank goes away? Do they have to use efforts to find a replacement bank? How much worse financing is going to be forced to accept from a replacement bank?

And then also look at that cooperation covenant that I mentioned, to make sure that it's not asking to do anything that it can't actually do. 

Because if it's too strict or asks them to do something they can't do, and then they don't do it, then the seller could be in breach of that cooperation covenant, and then you can't even get that reverse termination pays the debt can not show up. 

And then the buyer is like, well, I don't need anything because actually, you breached the contract. So I don't even have to close. So sorry. So that's sort of what the seller is worried about.

Let's talk about antitrust laws. How do you feel about them? And how are you adjusting for risk around it? 

Particularly as a private equity firm that invests in a variety of industries, we don't usually invest in companies that compete with one another. 

So that means compared to the strategic, generally speaking, the private equity firm will have less antitrust risk to a deal than a strategic will bring, because the strategic usually is not always but oftentimes is buying the competitors. 

Then you have to worry a lot more about, can this deal get through? Are there going to be remedies? How do you allocate the risk of those remedies? 

As a sponsor, it can be a lot easier, because you just don't own anything in the space yet, then it should be easy to get a customer. Obviously, that can get more difficult if you're doing an add-on. 

So because then it's just like a strategic deal. And you are buying the competitors, then you want to think about the same standard things. 

Think about any deal from an antitrust perspective. What is the chance that it gets reviewed? If it gets reviewed? How long does it take? If it gets reviewed? What do remedies look like? Is it something that you can fix relatively painlessly? And then how do you define the amount of pain that the buyer has to take? 

Another way that people handle it is if you think it might be able to be fixed, but the way that you would fix it, nobody would want to do the deal, then there's some fee payable by the buyer. 

If it doesn't happen, is that a fair ask? That's something that often gets negotiated. So those are sort of the ways we think about it.

Often overlooked is in a lot of jurisdictions, there's a joint control test for antitrust filing.

They'll say we and another global private equity firm are each going to come together and buy 50% of a software company that sells software in Texas. 

But all they do is sell software in Texas, from an antitrust perspective, that could technically trigger an antitrust filing in all sorts of other countries, even if there's no nexus to those other countries. 

Because we and the other private equity firms have a bunch of businesses in Europe, let's say. 

And in Europe, there's a rule that if you're acquiring joint control of something with somebody else that has an overlap with you even if the thing that you're acquiring isn't the source of the overlap, that can trigger a filing. 

So it's not something that ever stops a deal. But it can be a timing concern because you have to make the filing and wait. So that can be like an annoyance more than anything else. 

But we take our obligation seriously. So you have to do it. But it can be a timing concern if you're going into joint control with someone.

What are deal jump risks for public companies?

So there's a public company board as a fiduciary duty to get the highest price. 

And so once the deal is put in, there's somebody else that also likes the target and is willing to pay more than, there's a risk that person puts in a bid, and is able to take the deal away from the existing buyer. 

Now, the protection from the buyer’s perspective, at least in the US is you can have a termination fee. So you have a termination fee, and you have a match.

So there's basically like a formulaic process, where the buyer has a right to get information about the topping bid, and is able to match it and has like a fixed period of time to match it and like go back and forth. 

So that can make it difficult for the person who's trying to talk to ultimately get the target to agree with a better deal because the existing buyer, sees all the information that they get, it has sort of like a fair shot to match it.

But ultimately, if the other person is willing to pay more as a lower cost of capital like you can lose the deal. That's life in doing take privates. It can be worse in jurisdictions outside of the US that don't allow the same deal protections. 

So there are other jurisdictions like the UK, where you basically like that termination fee is not allowed. So it's much easier to talk, at least from a financial perspective. So that's something we just deal with if you're playing in public M&A.

How about reps and warranties, retrenchment risk?

The reps and warranties nowadays, the risk of those is on two people. So it's on the sellers, to the extent they're defrauding you. 

If the seller knows it's not true, you can go after them for that. But if they don't know it's not true, usually these days, the reps and warranties don't survive. 

So you're not going to be able to make an indemnity claim against the sellers if they made an honest mistake, but that you can go against a rep margin, if you bought rep and warranty insurance, as long as you as the buyer didn't know it was not true. 

So you have to do your diligence as a buyer to show that you're, he rep and warranty ensure they should be comfortable covering the risks. 

And as long as you've done your diligence and don't know, and there's nothing, no evidence showing that he knew, like you didn't get some email, don't remember opening it or something. Then the insurer should cover it.

The last little thing I noted here was contractual risks. 

Part of the lawyer’s job is looking for things in contracts that business people might not think of. 

So I'll give you an example. Like we were looking at, one of our portfolio companies was looking at an add-on and you know, they were reading through the cost, they were reading through the add ons M&A agreements. 

And one of the M&A agreements where the add-on had sold a piece of itself to a strategic containing non compete and the non compete said, ou add on target shall not compete in this business, and shall not provide services to anyone who competes in the business. 

So this was actually a red flag because it could create potential risk. If our company buys this thing, then that could theoretically infect our company. And could this be more of a stretch, but it is something you'd think about.

If our company was bought by a big strategic, would that non-compete, in effect, the strategic because it says you can't provide services to anyone who's competing.

Well, if there's a strategic competing, and you integrate the target into the strategic is it then providing services to the strategic? 

I don't know, arguably, no. But what if your strategic takes the same view, maybe not, they might have, a lawyer is more paranoid than me could say, I'm not taking that risk. 

So that's like, that's an example of something that lawyers can catch that deal with who may not be thinking about.

Can we talk a little bit about red flags and maybe more of those things that you really look for when you're working on M&A deals?

The biggest red flag is probably, I guess, a few things. If you can't get information that you think is easy to give to you, if people are just being hesitant about giving information, that's a red flag.

If you get inconsistent information, so something tells you one thing with any look at the documents and it's just totally different.And the other thing I would say is just, I mean, there's a lot of times where companies are just like not very informally. 

So you'll just see sloppiness like things that aren't signed records are kept pretty well. And then that creates a question of, well, this thing is messed up, like what else is messed up?

What are some of the things that you've come across that were sort of aha, red flag moments? This could be a whole series of deal surprises.

I've been in a deal where for a few days before signing a very important government regulator sent a notice to the target saying we would like to investigate you, that set up all sorts of alarm bells. And it ended up being fine, there was no issue.

But the fact that you're being investigated for something that could be an issue, you just don't know that can really put a wrench in things. And that particular deal, like it's still a big deal. Cause we did a whole bunch of diligence.

Figured out that it was unlikely to be an issue and then put in place a special indemnity to cover that issue. So, depending on what it is, those sorts of surprises can often be cabined off.

Those are probably the toughest ones because a government investigating something is always something everyone takes very seriously and you don't know how bad it's going to get. It's just not something you want to be on the wrong side of.

What are common mistakes that you see non-lawyers make on deals?

Not being paranoid and pessimistic enough, whatever the other side tells you. There must be some good explanation for it.

They ask for something they're definitely being a hundred percent forthright. And the reason they're giving as to why they want something falling in love with your deal, only seeing the bright side of things.

And you can imagine the opposite of these things is what is missing, like being skeptical. Thinking about things. Assume the other person is just as cutthroat as you as trying to be crafty. 

Think about things from that perspective. Not always assuming someone is a hundred percent forthright. 

And on the flip side, lawyers often over-index those things. If you're on percent pessimistic, but everything you're going to be too risk-averse, you're going to miss good opportunities. If you're too paranoid you may not see things in the proper context.

Yes. There is a risk that some provision, a contract like could be used against you, but is it really practical? I think that would be the case becauseif the other side were to use that they would face these other consequences that we really made it to them.

So it really doesn't make any sense for them to try and use that particular provision, even though technically it's available to them. 

Thinking about things and like too much of an abstract framework is what mistake lawyers can make and not being abstract enough is a mistake that I think non-lawyers make

Can we walk through a deal in terms of working with in-house counsel or in-house counsel's responsibility? Versus when you start working with external lawyers as well, how does that come into play? Like who's doing what? What's the reason why in-house counsel may want to use external?

It depends a lot on the organization and particular in-house counsel. There are places where in-house counsel will do an M&A deal themselves. I think that's not that usual I would say. 

More typical is, and this is the way we do it at Warburg is in-house counsel helps everyone do the deal better, helps the deal team understand and make legal judgments, oftentimes making the legal judgments themselves. 

And then also helps the outside counsel understand what the deal team is trying to do and just helps everyone assess the legal risks better. So there's a sort of situation I mentioned before where outside lawyers incentives not to miss anything. 

So again, I'll send you a diligence memo that has a hundred pages of red flags. Okay. Part of my job is reading that being like, okay, technically, I see why you said this is a red flag but is this really practical? This is a risk.

If it does turn out to be the case, it's not that big of a deal and we can handle it because it's offset by these other factors kind of calibrating and making yourselves comfortable as an organization taking those legal risks, I think is one of the big jobs of in-house counsel.

And then I think it's also sitting on top of all the deals and seeing lots of different things, understanding as an organization, ways that you address similar problems is another big value-added I think that in-house counsel can bring.

So the minority investment example, you are an organization that does a lot of minority investments. 

Oftentimes, as counsel sitting on those will understand all the give and takes that come to a particular outcome when a different deal team sees another one in these situations, they already know the playbook.

Okay. The other side probably thinks about this. Here's the way that we can address it. Here's the risk that will be addressed in this way versus that way.

And then probably the way you use the external counsel really depends on how much coverage you have internally.

I think depending on how detailed you can get in the LOI, oftentimes we'll bring in outside counsel for that. But if you're doing like a very detailed term sheet, bringing in outside counsel. And that varies at someplace to do those sorts of things in-house entirely. 

But I would say most in-house counsel I know, you're more on the consumer than a producer. Other people are grinding the thing out, and then you're looking at it and make adjustments about it and get feedback about it.

Or doing the actual deal, you need someone to. Do they have a lifting and write hundred-page docs? I'm not doing that anymore. So we have outside counsel to do that and I read it and send in my comments about it.

You know, it's different. There's more pressure on getting it right. The boss stops me, but I'm not the one chained to my desk at 2:00 AM anymore.

I'd love to hear your thoughts around PE versus public company deals. What are your thoughts around that in terms of the legal view on putting those deals together?

There are a couple of additional advantages of the buyers. I'll just do the strategic PE buyer and generally will keep the management team because they will have their own management teams back and be attracted to the management team. 

Because they'll know they're going to come in and be, that's a little the back top of a private equity firm would incentivize them to make the best is very valuable.

So that could be lucrative to them personally, the other advantage is private equity firm often don't own that business. So there'll be less closing risks. 

So, those are like the two traditional advantages, and also private equity firms are full of smart investment professionals who are used to sitting on boards and companies that help them grow really well. 

So you're getting that expertise. Now, the company rises to the next level, and then the sort of traditional advantage of the strategic is lower cost of capital synergies. 

So meaning you were paying more than private equity firms are able to pay private equity firms with higher cost capital.

What are cross-fund deals?

Best way to describe the kind of intuition behind it, private equity firm buys a company, grows the company. It's a great investment, but the private equity firm has been in it for let's say six years. And the limited partners that private equity firms want to get liquidity.

So a private equity firm wants to sell it. Not because it's not a good company anymore and not because it's not growing, but just because their existing investors want to get liquidity.

So then what traditionally would happen is a private equity firm would do an auction and would sell it to let's say another private equity firm and none of the private equity firms would grow it. And then you do this like three times or something.

The one question you might ask is well, the first private equity firm owning this thing is like, this is a great company. The only reason you have to sell it is to provide liquidity to our current investors. Why not just buy it with another one of our newer funds? 

It doesn't have investors who need liquidity now because it's a new fund, not a six-year-old fund. Why don't we just sell it? And so that's a cross fund deal now, right? 

Describe that, you might say, wait, private equity firm is like selling it to itself. Does that create a conflict?

The answer is, yes, it does create a conflict. Then you have to think about how you mitigate that conflict. And there's various ways to do that.  There are advisory committees of limited partners that can address conflicts. 

You can bring in a third party to buy the company alongside the new fund. So that provides a third-party mark. So you should show at the existing fund that it's a good investment. You're not buying it on the cheap just to benefit your new fund. You get a fair opinion, things like that.

Why should the target evaluate doing a deal with a PE firm versus a SPAC?

There are advantages to each having what you want. If you want to immediately be a public company and also have the benefit of a professional management team that is respected by the markets. 

Doing a deal with a SPAC or even like a PE backed SPAC can make a lot of sense. However, we do a deal with this SPAC, you're immediately a public company. Basically this SPAC turns into effectively turns into the target, and then there's no longer like a private equity fund invested in you.

So if you're a company that is not interested in immediately being a public company, maybe wants to have access to future capital from someone they know and trust to grow over time.

Then doing a deal with a private equity firm may make more sense because then the private equity firm is invested in you. If you want to do an add-on, you call them up and they're right there in the boardroom with you and they can recommend another check.

So it can be more of a long-term growing relationship. Versus just a route to becoming a public company with a strategic partner.

Do you see SPACs as the longer-term play or somewhat of a current trend?

It's hard to tell it is definitely a current trend. That doesn't mean that it is not a long-term play. Are there going to be as many SPACs as there were in the last six months?

Is that like the steady-state, like the number of SPACs, I guess, no. But is it something that is going to be around for a long time in some form? I would say probably yes.

What's the craziest thing that you've seen in M&A?

The things that stand out in my mind are sort of like in extremist deal situations. So hurricane Sandy, I remember I was like signing multiple deals. My apartment was turned off because lower Manhattan was blacked out.

So I was like couch surfing, friends above 42nd street. Cause that was like where they still have power. On the phone with lawyers and like Kentucky or wherever my deals were signing up deals.

It was kind of cool. I mean, it was crazy. I was charging my phone at work. I mean, it still went to work. Because work actually had power. So it made a lot of sense. It was kind of crazy. And then just, it seemed like big deals always like vacation time.

4th of July for the last few years with rare exceptions and always exciting a deal on 4th of July, you know, I remember I was at my parents' house in the woods and it was over 4th of July. We were like, sign this public deal.

It was multiple calls a day with the project manager, people like going through long checklist. So it was like a total time sink, opposite doing deals. 

So I think zero time and we're in the woods. So there was like no food. So I get in the car and like, drive 15 minutes to the gas station for a sandwich.

It was hard to do because there's so many calls, like who has time to like, leave the house. And that was when I was working at a firm, but those sorts of situations kind of stand out to me.

The other one I remember is like, earthquake. I was on a phone call all of a sudden like the building was shaking and I'm talking to this guy and I was like, Hey, uh, I think there's an earthquake, Oh, that's cool. I kept talking about the deal.

Ending Credits

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You can reach me by my email. It's Kison, kison@dealroom.net. M&A Science is sponsored by Dealroom, a project management solution for mergers and acquisitions. 

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