The Legal Team’s Role in M&A

Text Version of the Interview

Legal Team's Role in M&A

If done correctly, we are there from the very beginning. Bring your legal team in as soon as possible if there's any advice I can give to those business development teams. 

We have a solid business development team here, and thankfully, they bring in legal from the beginning. 

My team and I are involved in looking at different targets, thinking if those targets are the right fit. 

And the reason why it's so important to bring legal in as quickly as possible is, my primary role as attorney for the company is to understand the regulatory, legal, and jurisdictional issues and obstacles that may present themselves with any transaction. 

You want those issues highlighted and flagged sooner rather than later. Understanding whatever obstacles lay ahead from the very beginning is key. 

Importance of Strategy 

One of the things I tell my team is if you don't understand why you can't effectively develop the how.

If you don't understand why the transaction is being pursued, how can you develop the appropriate vehicles, agreements, arrangements that advance that goal? 

The business development team must get every function, especially legal, aligned on what the strategy is. Every agreement, every action, every decision has to advance the strategy. 

One of the things that legal can do is to make sure deal fever doesn't consume everybody. 

It happens more often than I can count that a business team executes deals that should never have been executed. So the legal team serves an essential role as being that calm in the storm.

Questioning the team, are we still doing this for the right reasons? Does this decision advance or detract from the goal we have in mind?

How Early Should the Legal Team be Involved

In the beginning, they are even determining the strategy of the company. The words acquisition, divestiture, the joint venture should not come out of anyone's lips until a strategy is formed. 

The transaction follows a strategy, not vice versa. Legal should be involved in the strategy formation because there are some strategies with inherent legal risks.

If you're looking at being acquired by entities in certain countries, there will be a national security risk. Legal for good, bad, or indifferent permeates everything we do. And as a result, it should be part of the strategy discussion from the beginning. 

What you don't want to happen is, the strategy is already baked, and then it lands on the legal's desk, a transaction that advances the strategy but may not be on a sound legal footing. The very beginning legal and business development team should work hand in hand. 

Non Disclosure Agreements

So after the strategy has been formed, we now look at the transaction. The first document one needs to think about is a non-disclosure agreement.

The NDA is necessary if you're the buyer because you don't want the world to know you may be looking at targets. If you're the seller, it's probably even more important because you don't want the whole world to know you're looking at divesting a company or a business line.

Think about the number of 'me' issues that come up when you're selling a business. Your folks may wonder if they're going to have a job next week, your folks may be anxious, whether or not the new company will take care of them as you have. 

These are the types of issues you do not want to inject unnecessary anxiety and angst into your workforce. It affects the bottom line. If people focus on the issues, they're not focused on selling products. They will not make as much money, which will eventually impact your sales price.

Things that are important to include in your NDA

A requirement that the buyer, seller, or outside professionals keep the information quiet as well. It is not uncommon for both the buyer and seller to need external lawyers, external finance, and advisors.

You also want a clear and conspicuous disclaimer on the NDA that says, just because we signed this document doesn't mean we have a deal. It is the beginning of the deal, and your legal team should provide that language for you. 

We have seen case law where an NDA doesn't have the right type of language or goes beyond the confines of an NDA and talks about a partnership or a longstanding relationship. 

And that has gone to litigation where one party claims we've got a deal. So you want to avoid that gray zone, eliminate any ambiguity, and have that conspicuous language. 

Some watch-outs in the NDA

I've seen sellers try to slip in non-solicits in their NDAs. It means you can't hire my employees. Well, if all I'm doing is looking at this target and kicking tires, do I want to assume that responsibility of not hiring employees from that company for two years? 

No, or maybe yes, we should have that discussion because you've now cut off a third of your potential employees, especially if there are only two or three players in that industry.

Exclusivity, if you're in a sales process, you want to be able to talk to as many buyers as possible, to pretty much apply pressure to each and to extract the highest bid. If you agree to exclusivity, then the potential buyer has you now; all the leverage has shifted to that buyer. 

If you're running an auction process or any process, you want to make sure you don't include any type of exclusive prevention. 

Letter of Intent

After you've done the NDA, you've received documents on the target, and you realize that this might be an excellent complement to our business. I want to explore this further. We then issue a non-binding LOI. 

Let me underscore the term non-binding. We haven't negotiated the definitive document yet. First and foremost, conspicuous clear language is non-binding. But here's the difference I've seen between successful buyers and unsuccessful buyers. 

The unsuccessful buyers will put so much weight on the non-binding language that doesn't basically throw together a few paragraphs, throw out a range and submit it to the seller.

The thoughtful, methodical, meticulous buyer will start making its case. It's non-binding to the two scenarios I've just presented. But I can tell you, the one that starts making the case, why this particular buyer is the right fit will go a lot further and will be better received than the buyer who's clearly not putting much thought and effort into it. 

Diligence

Once that's complete, you'll proceed to diligence. And this is where the legal team really jumps in and hopefully earns its paycheck. 

Diligence, in my view, is the most critical aspect of any deal because you are confirming what you think you're buying. 

The strategy must drive diligence. I'll give you a great example. A few years back, we read that Disney bought LucasArts. Why did Disney buy Lucas Art? Was it so they could sell Darth Vader and Chewbacca toys? Was it because Lucas arts may own a few warehouses in Pasadena, California? 

Well, we know the answer to that. They wanted to own Darth Vader. They wanted to own the intellectual property. If I was running that deal, that's where my diligence would focus.

Does Lucas Arts have the right licenses? Do they own a title? Do the assets I feel are most important, are they protected? And am I truly acquiring them through the transaction? 

If Lucas owns a few Buicks and a Fords in their parking lot, I don't care.That doesn't drive my strategy. 

Purchase and Sale Agreement

After diligence, you start developing the purchase and sale agreement. 

As any practitioner knows, more likely than not, your purchase and sale agreement will have language that says whatever was said before, whatever emails went back and forth are meaningless.

Diligence will drive what we call the schedules that will be attached to the purchase and sale agreement to make sure here is what I'm buying. And as importantly, here's what I'm not buying. 

The document needs to make that clear. That's where diligence is key to drive the creation and eventual execution of the document.

When Does Auction Happen?

I've seen it done in all different ways. The most common is, using the auction process, you have to provide a non-binding indication of interest to demonstrate to the buyer I'm interested in this asset and to get to the next round. 

I've also seen it bilateral where, even if you're outside the auction process, to make sure as you're in one of these one-on-one negotiations, are the parties in the same ballpark? Every company is concerned about costs and unnecessarily wasting their folk's time.

I have encouraged our teams. Even in private practice to use letters of intent to lay out the deal in broad strokes. 

So the other side looks at it, soaks on it, and decides, you know what, we're close, and it's worthy of further discussion, or this thing's not going to happen. And we wish you the best of luck.

What to include in an Indication of Interest?

More likely than not, you're submitting that indication of interest very early on in the process. 

You may have preliminary financials, maybe not even audited financials, and a high-level overview of the assets you're looking at. Well, diligence hasn't started in full. So, how are you going to, as the buyer, put a specific price?

And so what one should do and what I strongly recommend is a range. Here's the low end, here's the high end, all subject to additional diligence. And you want to make that very clear in your IOI.

Depending on how many stages in the auction process, mostly it's IOI, diligence, and possibly doing a binding letter of intent. 

Difference Between LOI and Term Sheet? 

I've seen the terminology used interchangeably. A letter of intent is more formal and allows one to begin stating their case as to why I'm a good buyer. 

A term sheet is pretty self-explanatory. It includes the terms. What I typically do and encourage is the term sheet to be incorporated into the overall letter of intent, at least in the broad strokes.

As you get closer to documenting the deal proceeding along the negotiation auction process lifecycle, you'll see more and more terms be fleshed out to make sure it once again, the parties are in the same ballpark. 

Proprietary Deals

With a bilateral type of discussion, get as many details out and as quickly as possible. Get a term sheet out there. 

You don't need to sell yourself at that point, going back to the benefits of a letter of intent, because you're dealing one-on-one across the negotiation table.

I have found there's no point in hiding the ball at that point when you're in bilateral discussions. 

Get it out there, be very transparent. Suppose the other party is willing, fantastic. There is going to be plenty to negotiate. There are going to be plenty of hiccups along the way. So you might as well get all the material issues out there for consideration as quickly as possible. 

Binding vs. Non-Binding LOI

Profound difference. Non-binding is pretty self-explanatory. I get to pull this as quickly as possible, or I may say this stands for one week, two weeks, one month, depending on the diligence process, depending on if you've engaged in exclusivity. 

A lot of times, a binding letter of intent comes in handy if you're going to insist on exclusivity Well, you got to give something in return. If I'm going to forsake all other bidders, I want you, the bidder I'm negotiating with, to put some skin in the game. 

And so, there may be provisions in that letter that are binding. Maybe a deposit, certainly confidentiality, perhaps a fee if you walk away.

And then, of course, if you want an overall binding term sheet, let's get the material terms on a piece of paper. Price, assets, maybe what employees stick around, which ones don't, especially for your smaller companies, where you want the management team to stay on.

Depending on the stage of the deal and people involved in the process, I would pivot from non-binding to the binding.

Legal and Corp Dev Working together

There should be no sunlight between them. And the flip side to that is having a tremendous amount of trust between the two teams because you need to have the trust to have a challenging conversation.

I have found that good lawyers see risk and appreciate the risk. Unfortunately, some lawyers, all they see is a risk, and they want to eliminate risk. Those are not the type of lawyers I want on my team. 

Flip that to the business development team. There are certain business development teams that all they see is a reward, and they don't appreciate or understand the risk. I don't want them on the team either because they will jump at anything and sign anything. 

The great teams care, a legal team that sees the risk and reward, and the business development team that sees it. One prioritized reward over risk, and the other team prioritized risk over reward. And there's that natural tension, and a natural tension is needed.

You need to have balance and that's how the teams can work together to best serve the company's goals. 

Educating Corp Dev on Law 

We've done and have been successful with one of the things we've done is developing a guidebook and training program.

We have been very successful with people joining our business development team, onboarding them and saying 

-here's what indemnification means, 

-here's what a warranty means, 

-here are the issues that you need to watch out for on NDAs and 

-the different checkpoints in the deal cycle and the negotiation cycle. 

We've been successful in onboarding the team in terms of thinking and understanding the documents and nomenclature they will encounter now that they've joined our business development team.

The legal team has an obligation to get familiar with accounting terms and business terms in the same way.

Both parties should train themselves up so they can at least issue spots when needed. 

Level of Expectations from Corp Dev

They should understand the business. They should understand the business that's being acquired and being sold. 

If you don't understand the business you're serving and the clients you're serving, you're not contributing what you need to do to the team.

They should be able to look and review and understand purchase and sell agreements. They should understand what liabilities we're assuming in a purchase deal or what we're shedding in a divestiture.

Do they need to understand every single word? No, but they should be able to issue a spot if they're in a negotiation without us or in an email exchange where legal may not be CC'd. 

They know those red and yellow flags they've been coached up enough to realize, wait for a second, I better not agree to this or disagree with this before I loop in the legal team.

Preserving Value Post-Close? 

Here is something that the legal team and the business development team need to have a thoughtful discussion around. 

If there's a time difference between sign and close if it's not simultaneous. What actions can a seller take between those two points? Can they enter into any contract that they want? Can they depart with very nice golden parachutes? 

The answer is no, because you're not getting the value you assumed. And so you want to discuss how to ensure the business I signed up for is the same business I acquired or divested at closing.

Those types of behavioral and structural considerations should be captured in the agreement. And that's where the legal team plays a pivotal role in memorializing and capturing those obligations. 

Another area where legal plays an incredibly important role are the schedules I talked about. Going back to the document, I represent that you are assuming these litigation matters. I represent you assuming title to this IP and other rights. 

If I list those exceptions, legal should be working with the commercial and business development teams to make sure we're getting what we're paying for or getting what advances our strategy. And it all goes back to what I said earlier.

If the legal team can't read a balance sheet, doesn't understand a bit of the strategy, or the business that's buying or selling, it's not adding value. And the key for any legal team is to add that value. 

Dangers of Deal Fever

Deal fever tends to lead certain companies to assume risk disproportionate to the reward. Most companies that go under frankly are a result of a cycle of bad deal-making. Whether or not you didn't want diligence well enough and assumed environmental or other liabilities that you had no clue you were thinking. 

We saw that many years ago, with the Asbestos litigation, Bayer and Monsanto, that was significant a year or so, or two years back. Always be aware of what you're buying. And as importantly, know what you need to exclude from that acquisition.

On the flip side, if you're trying to shed certain liabilities, you better make sure that those liabilities are explicitly listed in the sales agreement because the worst thing you can do is sell it for a steal. After all, your strategy was to get rid of certain liabilities. 

And because your lawyers did a poor job, you lost good assets, and you're still stuck with the bad ones. 

That's where deal fever had a profound and dangerous impact on companies by muting the discussion that needs to happen, or is this deal advancing our strategy? Is this deal reaching our goals? 

If we mute that discussion, then it's not good for anybody, and it will probably cost a few, possibly thousands, their jobs. 

Building Trust with Clients

The time to build that trust is not in the middle of the deal. That advice applies to in-house as well as outside counsel. You should be building that relationship and instilling that trust when a deal is not happening. 

Build trust every hour of every day. And so when the real decisions have to be made, they're calling you, and they're trusting your view.

Post-mortem 

No deal will ever go right. If anyone promises you that they can navigate you for the perfect deal, they're lying. 

Every deal has its hiccups. Every deal has its mistakes. And so there is an absolute best practice which we follow, which I encourage others to follow, by looking at what we did well and where we can improve next time. 

Legal play a part after every major deal. I call my CEO; I call my CFO, I call my commercial lead. I asked them two simple questions. What did we do well, and where can we improve? I always get answers for both. And I appreciate that feedback. 

Hardest Part of Legal's Job

We are balancing the risk and reward. We're designed and trained from the first day in law school to see risk everywhere. 

While I pride myself in understanding that you can't eliminate risk since our primary function is to partner with the business and bring our acumen and skillset to mitigate risk. 

I probably want to eliminate risk more than our commercial or business development leaders in a perfect world. So it's balancing the different views and the different priorities of every deal.

International Deals

There are certain countries where the party on the other side will sign anything you put in front of them. It doesn't matter if it's completely one-sided for you; they'll sign whatever.

The reason for that is, good luck enforcing it. One of the things a strong legal team will highlight is, yes, we can have the most beautifully drafted document in the world, but if you can't enforce your rights within a document, it's not worth the paper it's printed on. 

if you're looking at investing and entering into certain countries or regions of the world, you also better be aware that your rights are not the same as you would have at a federal courthouse in the United States. That's why it's so important to have the legal team there from the very beginning.

Bringing Local Counsel 

I am a Texas-trained US attorney. So it would be malpractice for me not to reach out to local counsel to understand the legal requirements and the local nuance. Here's what will be acceptable. Here's what's not. Here's what's on their radar screen. Here's what's not. 

Moreover, negotiating in different countries requires a different cultural approach. I've negotiated with lots of parties that are not American and not Texas. But I need to understand what a New York and California attorney wants and the different laws that apply. 

Certainly, if I'm looking outside the US, in China, in India, in Kenya, in countries that I may not be as familiar with, I need to understand, I need to hire very strong local counsel to help me with that.

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