Can this marriage work? Legal tips for corporate M&A

Dive Brief:

• The range of due diligence the legal team does and how it crafts the letter of intent and nondisclosure agreement at the beginning of a merger or acquisition can help set the stage for how well the process goes, merger specialists said Wednesday at an M&A panel at the Association of Corporate Counsel’s annual meeting. The letter of intent should articulate the parties’ priorities and include their closing conditions and a timeline for the process, said Chris King, a partner at Foley & Lardner. That “will drive a lot of your downstream spend and activities,” he said. The NDA should be as concise and clean as possible, because there’s little to gain from cluttering it with arcane detail or complex clauses to cover various scenarios, he said.
• Due diligence should occur in different areas, from documentary due diligence of a seller’s contracts and other paperwork to management due diligence in which executives explain how they run their business. There should also be a thorough intellectual property review, covering the status of patents, litigation and any legal liabilities. For employee due diligence, it’s important for key leaders to present what they do and to guide the buyers as they tour any critical facilities. The commercial due diligence is also crucial as it will answer your CEO’s primary concern: “Is this company worth buying,” said Julia Shemesh, a longtime M&A lawyer and former deputy general counsel at Crowley Holdings.
• Deals need code names for reference in written communications and those leading the process on each side should assemble a small team of both in-house counsel and executives and specialists from external firms. A lead attorney and other specialist lawyers should be delegated, and you’ll need an IT consultant and a consultant on financials and accounting, according to the panel, which walked through simulated diligence on a hypothetical sale of a bio-pharmaceutical company to a healthcare company.

Dive Insight:

The LOI is an “opening salvo” where the parties “put the big surprises down up front” when there are obvious issues to address, such as a data breach, a patent challenge or an action by a regulator, said King, who specializes in patents. The letter is also a good place to start with an expected value of the deal, typically with a price range, so that everyone is in the same general area before the diligence work begins

In-house counsel are critical for managing the overall coordination of the diligence process and managing the outside counsel’s spending and work scope, said Christopher DiLeo, associate GC for IP at Becton, Dickinson & Co., a medical device maker.

In-house lawyers also generally manage the basic review of a target’s contracts, the regulatory review process for a proposed deal and the internal communications strategy.

Your outside counsel are generally responsible for complex IP issues, regulatory compliance, litigation risks and data and cybersecurity risks, especially if the seller has experienced a breach.

Coordination of diligence is key, DiLeo stressed. 

“You don’t want duplicate work,” he said, noting that the buyer’s outside counsel might assign an IP specialist to the project and the purchasing company’s internal counsel involves another IP lawyer. The two lawyers could reach different conclusions about the seller’s property. “You end up looking like the Keystone Cops,” DiLeo said. “You want to have that unified voice.”

As for the seller’s litigation and liabilities, “that’s something you can handle in-house,” he said. Counsel can start with notes in financial statements, which are a good source of information that a company’s auditors would have disclosed. 

Where do the red flag problem areas arise?

Site visits can uncover some as lawyers and executives get a sense of how a company’s manufacturing, distribution, research and other centers operate, Shemesh said. “From my perspective, it is invaluable to do site visits,” she said.

“You also want to have a good understanding of the company’s relationship with the employees,” King said, coupled with “a basic understanding” of bonus payments and other incentives that are part of the seller’s compensation, and capital spending during the transition.

Management due diligence is another area where problems may turn up, as executives share their business philosophies, practices and any pending or potential litigation.

If there are any buyer concerns about the validity of intellectual property or patent infringement, “we are going to ask for any opinions of counsel” on a particular matter, King said. On the seller’s side, he said, “there is going to be reluctance, and rightfully so, to share that attorney-client work product, especially early in the process.”

Many M&A deals come with material adverse effects provisions to protect buyers if certain events befall a target. Buyers may also seek earn-out provisions to account for business issues, greater indemnifications, a pricing adjustment or for a seller to address a particular problem quickly, King said. 

A buyer – especially in a large deal – may also want representation and warranties insurance for a negotiated period of time to mitigate risk in case of a representation breach by the seller. A third of M&A disputes in North America arise from sellers’ R&W breaches, according to a 2023 American Bar Association article, citing Berkeley Research Group. These policies generally offer easier recovery than getting funds from a seller’s escrow account. And unlike an escrow, they don’t tie up capital.

R&W insurance is still a major aspect of larger deals, usually those over $100 million, but it’s been declining in recent years from its peak, King said. Private equity firms are most likely to seek R&W coverage in deals, Shemesh said.

Amid the push-and-pull over issues a buyer identifies during diligence, a seller should keep in mind the value they offer and the reason their business was successful, said Diane Carman, chief legal officer of Windtree Therapeutics, a Pennsylvania-based biotechnology company. 

The seller’s general message as negotiations intensify? “We have warts, but we’ve been on top of them and we’re addressing them. We have a plan,” Carman said.

At the end of the diligence, when the lawyers have submitted their findings and opinions, management must decide the “deal or no deal” question. If the answer is yes, and a sale is agreed, a new round of transition work begins for the in-house counsel.

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