Private Company M&A
The Deal Doesn’t End at Closing
Mark Vogel
Managing Director
Private Equity and Venture Capital Exits
AGREEMENT AND PLAN OF MERGER
This AGREEMENT AND PLAN OF MERGER (this "Agreement"), dated as of
today, by and among Company A, a Delaware corporation ("Parent"), Company B, a Delaware
corporation and a wholly-owned subsidiary of Parent (“Merger Sub”), Company C, a Delaware
company ("Company"), and _______________________________, as Shareholder Representative
(the ”Shareholder Representative").
RECITALS
WHEREAS, the Board of Directors of Parent has approved, and deems it
advisable and in the best interests of its stockholders to consummate, the merger (the "Merger")
of Merger Sub with and into the Company, upon the terms and subject to the conditions set forth
herein; and
WHEREAS, the Board of Directors of the Company (the "Company Board"),
having carefully considered the long-term prospects and interests of the Company and its
stockholders and determined that the Merger is advisable and that it is in the best interest of its
stockholders to consummate the transactions contemplated hereby, has approved the transactions
contemplated hereby and has resolved to recommend to its stockholders the adoption of this
Agreement, upon the terms and subject to the conditions set forth herein; and
WHEREAS, an irrevocable action by written consent of Company Stockholders
sufficient to adopt this Agreement and to consummate the transactions contemplated hereby in
accordance with the provisions of the Delaware General Corporation Law ("Delaware Law")
Delaware Law and, if applicable, the California Corporations Code (the "Corporations Code
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Post-Closing Challenges
•
•
•
•
•
Post-closing purchase price adjustments
Income and sales tax issues
Indemnification claims
Escrow management
Employee compensation and
management carve-outs
• Earn-outs
• Administration and shareholder communications
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Post-Closing Purchase Price Adjustments
Adjustment Metrics*
No Adjustment
Provision
32%
Includes
Adjustment
Provision
68%
Earnings
0%
Working
Capital
73%
Debt
Assets
Cash
Other
43%
2%
30%
23%
* 42% of the post-closing purchase price adjustments in this Study were based on more than one metric; for example, both a Working
Capital and Debt adjustment, or both a Working Capital and Closing Cash adjustment.
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Avoiding Working Capital Disputes
• Information and Time Disadvantages
• Required Specificity
– Non-cash items
– Taxes
– Accounting principles
• Second Bite at the Apple
• OSI vs. Instrumentarium
– Challenges to principles used should be brought as
indemnification claim
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Tax Obligations and Rights
• Income Taxes
–
–
–
–
–
Treatment of Closing Costs
Disqualifying Dispositions of Options
Final year estimated taxes
NOLs – who gets the benefit
Impact on working capital
• Obligations for tax return preparation
– Buyer should be responsible with shareholder rep
approval
• Sales and use taxes
– Easy for buyers to make claims
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Post-Closing Indemnification
What do Buyers Claim?
Appraisal Rights
Fraud and/or Willful
Misrepresentation
3%
Average Claim Size as Percentage of Escrow
2%
28%
Fees and Costs
Capitalization
6%
Customer Contracts
12%
Financial Statements
Tax
Appraisal Rights
Claims
3%
Fraud and/or
Willful
Unspecified
Misrepresentation **
Claims
6%
1%
Fees and Costs
Claims
3%
8%
23%
Undisclosed Liabilities
12%
4%
Intellectual Property
Regulatory
Breach of Reps &
Warranties Claims
13%
Employee
Broker
NWC/Other PPA *
Claims
8%
Under 1%
* Note: Percentage drops to 5% if two large WC claims eliminated
** Buyers that brought fraud claims in sampling did not specify amounts
of damages.
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Timing of Claims
• 20% of claims received during the last week of the
escrow period
• On average, third-party claims come early, direct
claims come late
• The average time from claim notification to resolution
was 8 months
• Methods of Resolution:
–
–
–
–
44% of claims were settled individually
50% of claims were part of global settlements
6% of claims were eventually withdrawn by the buyer
No claims went to a verdict or arbitration decision (although
several advanced to litigation or arbitration)
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Deterrents to Indemnification Claims
• Are you prepared to mount a defense if needed?
– Establish a meaningful expense escrow
– Select a responsible shareholder rep
– Focus on limitations in contract – caps, baskets, time
limits
• Pre-closing preparation
– Due diligence in order
– Clean up issues before closing
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Escrows/Holdbacks
% of Transaction Value
Escrow/Hol
dback Not
Included
5%
Up
to…
2%
>5% 0%
to…
Express No Survival
0%
1%
12 months
25%
>10
%…
15%
35%
>12 to <18 months
40%
>15
%…
>25
%
0%
14%
10%
>20
%…
Silent
<12 months
>7%
to…
Escrow/Hol
dback
Included
95%
12 to 24 Month Escrow Periods
11%
18 months
>18 to <24 months
40%
0%
24 months
11%
2%
>24 months
2%
2%
These periods apply to representations and warranties generally;
specific representations and warranties are often carved out from
these periods.
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Escrow Releases
• Fighting Frivolous Claims
–
–
–
Define what constitutes a claim (when dormant, accruals, etc.)
Assumption of defense, payment of fees
Expense fund
• Automatic release of the escrow fund – pros and cons
• Don’t run payments through any party other than
Buyer or a Bank
–
–
–
Risk if money were to disappear
Risk if payer is insolvent or bankrupt
Be aware of administrative burden if you agree to make these
payments as the shareholder representative
• Escrow Economics
–
–
–
Pay attention to the fees. The banks will often waive them.
Consider no disbursements under $X. It costs more to send them than the amount.
Tax treatment of interest (if you’re earning any)
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Exposure of the Shareholders Post-Closing
• Is your liability capped at the
escrow amount?
– Risk of clawbacks
• If not, consider tradeoffs
Liability Cap Carve Outs
Capitalization (Rep)
Ownership of Shares…
65%
Due Authority (Rep)
66%
Taxes (Rep)
– More escrow in exchange for a capDue Organization (Rep)
Broker's/Finder's Fees…
– Representation and warranty
Employee…
Environmental (Rep)
insurance
Title to/Sufficiency of…
– Establish a meaningful expense
No Conflicts (Rep)
fund
Intellectual Property (Rep)
– Deter indemnification claims
– Ensure all shareholders are
contributing their pro rata
68%
51%
32%
27%
8%
6%
10%
19%
28%
91%
Fraud
Intentional Breach of…
Breach of…
70%
51%
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Employee Compensation and
Management Carve-outs
• Merger Consideration as Compensation
– Escrow release may be compensation, too.
– Often need to run through Buyer’s payroll
– Taxable at closing or when paid?
– Employment tax issues post-closing
– Make clear who pays matching contributions
• Effect on Working Capital and Taxes
– Expensed or Capitalized?
– Disqualifying Dispositions of ISOs
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Earnouts – What’s the big deal?
Earnout Metrics
Revenue
Earnings/EBITDA
No Earnout
75%
41%
5%
Combo of Above
13%
Milestone Events*
41%
Period of Earnout
<12 months
9%
12 months
9%
12 - 24 months
24 months
Includes Earnout
25%
27%
5%
36 months
9%
36 - 60 months
9%
>60 months
32%
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Mitigation of Earnout Disputes
• Avoid earnouts, if possible
– Most heavily litigated area of M&A
• If this can’t be avoided, have an objective
measurement of triggering event
–
–
–
–
Make it hard to manipulate
Avoid financial measurements, if possible
Keep it as simple as possible
Easy to measure (e.g. Phase II FDA approval is
better than $10M in net revenue)
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Administrative Tasks
• Ensure shareholders have received correct
merger consideration
• Track all dates
– Missing a response deadline – the biggest risk!
• Escrow statement reconciliation
– Banks regularly make mistakes
• Investment oversight
– Circumstances do change over 18-24 months
• Shareholder inquiries
– When, how much, claims status, audit confirmations
• Amendments
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Should You Take on the Role of Shareholder Rep?
• Advantage – control
• Disadvantages
–
–
–
–
–
Time commitment can be overwhelming
Tedious admin work
Limited access to qualified staff and info
Rep can’t focus on core business
You’re usually an island (contrast with serving
on the Board pre-close)
• Issues to be considered by potential Rep
– Acceptable risk?
– D&O – are you covered?
– Conflicts & independence – for whom do you
work?
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...Or Use an Outside Professional?
•
•
•
•
•
•
•
Professional independent management
Diverse expertise
Allows for best use of time
Avoid risk & conflicts
Transparency
Improved shareholder communication
Rep can’t easily quit
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The SRS Process
• Review Documents and Submit Proposal
– Fee based on anticipated amount of work required and perceived risk
– Deal size, no. of shareholders, working capital, earn outs, etc.
– Typically 2-10 basis points on deal size (minimum fee of $35k)
• Submission of limited comments
• Negotiation of engagement agreement including contractual
rights of significant shareholders to oversight and direction
• Execution of merger documents
• Serve as Rep until nothing left to be done
– Everything we do is included in our fee, but not 3rd party expenses
– SRS serves as agent but we always make clear we are NOT a law firm
and do NOT provide legal advice
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SRS at a Glance
• Organized in 2007 to address pain point in M&A deals
– VCs repeatedly complaining about shareholder rep role
• Since formation, over 100 M&A deals with over $10B in value
– More experience than anyone else, even large funds
– Represent over 10k shareholders including 400 of the largest VCs
– Shareholders in 44 countries
Professional
Independent
Experienced
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Representative Clients
Accel Partners
ARCH Venture Partners
August Capital
Austin Ventures
Bessemer Venture Partners
Boulder Ventures
Charles River Ventures
CMEA Ventures
CW Ventures
First Round Capital
Foundation Capital
Granite Ventures
Greylock Partners
H&Q Healthcare Investors
Highland Capital Partners
Institutional Venture Partners
Integra Ventures
Kleiner Perkins Caufield & Byers
Mayfield Fund
Menlo Ventures
Meritech Capital Partners
Mobius Venture Capital
Mohr, Davidow Ventures
Norwest Venture Partners
Oak Investment Partners
Redpoint Ventures
Saints Capital
Sequoia Capital
Silicon Valley Bank
SOFTBANK Capital
Steamboat Ventures
Summit Partners
TPG Capital
Trident Capital
U.S. Venture Partners
Venrock
Versant Venture Management
Worldview Technology Partners
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Representative Transactions
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Contact Information
San Francisco
Silicon Valley
Denver
415.367.9400
650.648.9550
303.648.4085
Mark Vogel
mark.vogel@shareholderrep.com
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