Negotiating a Merger Agreement

When negotiating a merger and acquisition (M&A) agreement for a private company, it's important to consider a range of issues, including but not limited to:

  • Liability
  • Employment
  • Intellectual property (IP)
  • Tax
  • Legal
  • Business operations

Failure to conduct due diligence about these items during the negotiation period can result in high risk to the shareholders and increase the possibility of indemnification liability after closing.

Factors that determine success in negotiating an M&A agreement include:

  • The skill of your attorney and negotiating team.
  • Whether you're competing against others for the purchase.
  • Whether you are open to risks when it comes to liability exposure and closing conditions.
  • Whether the price and key terms were reached during the letter of intent state.
  • The amount of leverage each party has.

Price and Consideration

Ideally, price and consideration for an M&A contract should be addressed in the letter of intent. Issues to resolve include whether cash upfront will be required for the entire purchase price, whether consideration will consist entirely or in part of buyer stock, if the stock in question is common or preferred, redemption and dividend, liquidation preferences, voting rights, board rights and responsibilities, registration rights, and transferability restrictions. For public companies, think about whether stock will be valued at closing or signing and if you need to take steps to limit downside and upside risks.

For promissory notes, you'll need to negotiate principal and interest payments, whether the note in question is unsecured or secured, if third-party guarantee is required, events that constitute default, and whether payment can be accelerated if the note's terms are breached.

The parties must negotiate between equity and enterprise value. The latter means that price is calculated at closing on a cash and indebtedness-free basis. With the former, the buyer exchanges the seller's cash for its indebtedness.

In some cases, the purchase price will receive a working capital adjustment and you must agree on how this will be determined. The working capital adjustment clause should be drafted carefully to avoid a significant price adjustment at the end of the process.

When earnout is included in consideration, you must negotiate the terms of the earnout including milestones and associated payments, seller protections, and inspection and information rights. Because earnouts are so complicated, they often result in post-closing litigation. For this reason, careful drafting of earnout provisions is essential.

Holdback or Escrow

The holdback or escrow clause protects the buyer from the breach on behalf of the seller. A second escrow may be implemented to protect against a post-closing price decrease because of the working capital adjustment.

Some transactions may require escrow for specific situations such as litigation. In rare cases, no escrow is required, such as when no post-closing indemnities exist on an as-is sale. The amount of holdback for indemnification is usually between 5 and 15 percent and must be held by a third party for nine to 18 months.

Many private equity bid transactions have replaced the escrow system with a provision that requires the buyer or seller to buy representations and warranties insurance to protect against indemnification claims after closing. This is rare among strategic acquirer deals, however.

In M&A agreements involving large companies with many shareholders, a shareholder representative should be present in negotiations to represent their interest. This could be one of the majority shareholders or it could be a professional firm hired for this purpose.

Representations and Warranties

This part of the agreement can cover everything involving the seller's business operations, including but not limited to corporate authorization, contracts, employee matters, compliance, financial statements, liabilities, and asset titles. Intellectual property is also a critical matter, particularly for tech companies.

Representations and warranties serve buyer interests in three main ways. This section confirms the buyer's due diligence research, prevents the buyer from having to complete the acquisition if any representations and warranties are untrue, and may indemnify the buyer from any damages that result from misrepresentation.

Only the selling company should make representations that are included in the contract.

If you need help with a merger agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.