Harvey Jay Cohen
513-977-8144
harvey.cohen@dinslaw.com
US M&A FOR INDIAN COMPANIES: KEY TERMS' PITFALLS AND ROADBLOCKS
ALFA International
November 13, 2008, Mumbai, India
HARVEY JAY COHEN
Dinsmore & Shohl, LLP
I.
II.
Introduction
A.
International vs. Domestic M&A
i.
Domestic M&A deals often now have foreign subsidiaries, licensors, vendors or customers
involved
B.
Due Diligence in any alliance or JV, domestic or international
C.
Pitfalls in indemnity clauses, representations and warranties, liability exclusions and caps, etc.,
transcend M&A agreements and apply to numerous types of agreements
Big Picture
A.
Buyer vs. Seller
i.
Buyer: Pay less up front, pay the remainder as late as possible vs. Seller: earn as much up
front as possible and leave as little payment as possible for later
ii.
Buyer: Hold Seller’s feet to the fire, preserve cumulative practical remedies and retain
holdbacks or escrows as sources of easy recovery for lengthy periods vs. Seller: restrict
recovery, make it difficult to obtain remedies and remain on the hook for as short a time as
possible (Seller sleeps well at night)
iii.
A trained experienced Buyer team has an informational and deal management advantage
(borne of repeat practice)
B.
Locating best Broker/Investment Banker
i.
Competitive process after research in the applicable industry
ii.
Focus on details as to earning a percentage of specified payments (coordinating timing of
payments to broker with payments to Sellers)
iii.
Are brokers really needed and do they truly add value?
iv.
Does the broker add value by its numerous contacts in the relevant industry segment or its
private equity contacts?
C.
Competitive bids from Buyers deliver:
i.
Higher gross purchase price with better payment structures
ii.
Better terms on indemnity, escrow % and duration, personal liability, etc.
iii.
More limited representations and warranties
iv.
A #2 Buyer in the wings for the Seller (if the #1 Buyer withdraws) = leverage! Are you
willing to walk away?
v.
Redlined Agreements should be submitted with bids vs. Letters of Intent (Buyers prefer this
fuzzy LOI method and to lock up the parties with fewer specifics)
a.
Do the redlines lock in the parties too much providing little later flexibility as more
is learned through additional diligence and the delivery of draft schedules?
vi.
Buyers often intend to change terms from the LOI after it is signed (deadlines) (lock up)
D.
Need a seasoned team with repeat M&A experience (Buyer advantage) (Management, Finance,
Accounting, HR, Benefits, R&D, Sales and Marketing, Logistics, Supply Chain, Manufacturing)
i.
Seller needs a detail oriented gopher
ii.
Centralized management of process with discipline, tasks, reports, due dates, etc.
iii.
Public companies' NDA, internal insider trading/confidentiality
iv.
The Team is a Center of Excellence with external legal, financial and accounting support.
The Team should drive the process. The CEO makes "gating" decisions, the Board ratifies
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E.
F.
III.
Focus on integration and key personnel from the inception
Business strategy should be agreed up front so deal momentum does not ultimately drive the deal
instead of pre-agreed principles
i.
Can deal principles such as "Must Haves," "Negotiables" and "Gives" be reduced to a
memorandum EARLY in the transaction?
ii.
Management Gate - does the deal serve the strategy or not? - Are the basic
assumptions/principles met?
a.
Fit? Culture? Technology? Products? Branding? Synergies? Dis-synergies Channel conflict? Margins? Growth area? Geography? Relationships?
b.
Risk Factors ? Negatives ? Killer Issues ? Organizational Capacity?
iii.
Deep dive on targets before deal comes about
iv.
Rapid vetting of new concepts, deals
v.
Predict Buyer and Seller “Must Haves” vs. “Negotiables”
vi.
What are boundaries /walk away principles? Are you willing to walk away?
vii.
Don't shake hands until you know it's a go
viii.
Choose an early time for a joint integration team
ix.
The loyalty of Seller Management switches pre-closing - BEWARE. Seller management can
kill a sale. Restrict informational flow. Some Sellers hold out bonuses for closing (and
thereafter). From other entities? Disclosure?
Due Diligence
A.
Data Room hard copy Due Diligence vs. an E-room with passwords. Track Buyers, Buyer’s
personnel and their focus while in the e-room
B.
Note recent changes in ownership, client mix, accounting policies or Seller's industry?
C.
Focus on litigation and liens-early and often
i.
Consents (leases, key customer agreements, software etc.). Focus early on:
a.
Assignment
b.
Merger, change in control, operation of law provisions
c.
The presence of "Or otherwise" in above provision may require consents
D.
Does Seller have the votes - both sides need to know early. Is there dissention? Are there veto or
supermajority rights? Target shareholder commitment is key. All selling shareholders sign L0I?
Agreement?
E.
Do Seller Shareholders trust each other? Seller representative rights restricted or broad?
F.
Failure to qualify in States
G.
Tax and ERISA filing failures are typical
H.
Is the Seller equity all settled? Were past equity sales properly closed? Early capitalization?
I.
Are creditors being paid on time? Possibility of injunctions? Need to give comfort to Seller
creditors?
J.
Visit key customers, suppliers, commitment/fit
K.
Accounting (expense vs. capitalization vs. EBITDA multiple) (Operating vs. capital leases)
L.
Recent financial statements/sales trends
M.
Bad inventory, count, valuation, depreciation. When fix value?
N.
Postponement of capital expenditures/investment in the business?
O.
Accounts Receivable/guarantee? Reserves? How long? Escrow?
P.
Revenue recognition. EBITDA pumping.
Q.
Interview even lowest employees. Plant visit(s)
R.
Ongoing Seller affiliate guarantees post closing? Removal of Seller guarantees? One affiliate for
another?
S.
Buyer financing truly lined up for a timely closing?
T.
Depreciation policies
U.
Vehicle titles found? Transfer. If voluminous, use a vehicle title nominee agreement (one agreement
for all titles).
V.
Hidden sales taxes on closing? Personal property sales tax (e.g. Kentucky)? Vehicles?
W.
COBRA? State Mini-Cobra?
X.
Tail Insurance needed because of claims-made insurance policies?
Y.
Copies of Contracts? Oral? Are there 30-day outs anyway? Has Seller agreed to customers' Ts&Cs?
Copies?
Z.
Expiration of contracts/renewals/renegotiation pre-closing
AA.
Secure supply of inputs at predictable prices?
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BB.
CC.
DD.
IV.
Are independent contractors or sales reps really employees?
Phase I of Seller? Survey? New studies? Do Early
Environmental Remediation issue - Who approves third party? Conduct during remediation
(maintaining the property)? Remediate to the satisfaction of Buyer?
EE.
Is key IP registered? Expiring? Does Buyer truly receive and understand key IP/trade
secrets/processes?
FF.
Lost customers or customers with negative trends
GG.
Look Seller in the eye - are there any other issues we need to know about?
HH.
Seller - document due diligence materials delivered to Buyer to reduce potential Buyer claims in the
future; Regardless of sand bagging clause.
M&A Agreements
A.
Should the following details be included in the Letter of Intent? Tactical question with typical answer
of "no". The most important terms remain up in the air
B.
Basket - The Seller's #1 issue.
i.
Once basket of post closing liability is exceeded, is the Seller's liability from first dollar or
only the amount in excess of the basket?
ii.
Basket: < .60% is better for Seller. <1% can be market.
a.
Basket
ABA Deal Points Study 2007 (ABA) = 143 publicly - reported transactions in 2006 with private targets, with
reps surviving closing, etc.
UCLA M&A First Monday Forum (UCLA) = '02, '03, '04 mid market deals involving the same broker.
Harris & Williams & Co. brokers (Harris Williams)
NY Law firm study of its deal sample (NY Law Firm)
b.
Basket % of purchase price?
i.
ABA - Deductible: .53% of price if Deductible, .50% of price if
First Dollar, .5-1% of price 28%, <.5% of price 62%. Deductible
basket % dropping since last ABA study.
ii.
UCLA - .80% of price if Deductible, .6% of price if First Dollar.
c.
Exceptions to basket?
i.
ABA - Taxes 42%, Fraud 55%, Authority 47%, Capitalization 52%.
Exceptions % rising since the last ABA study.
d.
% of purchase price?
i.
ABA - Deductible: .53% of price if Deductible, .50% of price if First
Dollar, .5-1% of price 28%, <.5% of price 62%. Deductible basket %
dropping since last ABA study.
ii.
UCLA - .80% of price if Deductible, .6% of price if First Dollar.
e.
Deductible?"
i.
ABA - 36% First Dollar, 54% Deductible.
ii.
UCLA - 70% Deductible.
f.
Double Materiality - keep MAE qualifiers in reps and warranties; but remove them
for indemnification if there is a non-tipping basket.
i.
ABA - 78% Not expressly disregarded.
iii.
Should not apply to breaches of covenants
iv.
High baskets and/or baskets that are Deductibles beget more exceptions
C.
Personal signatures of shareholder(s) - Joint and several liability is a key issue because if the
acquisition agreement provides only joint liability (or worse, with shareholders Proportionally Liable),
the Buyer must pursue each shareholder. Non-active Shareholders issues? Cap on signature liability?
D.
Escrow percentage?
i.
<15% is Market. 2-10% is good for a Seller. ABA 75% of cash deals have escrows.
i.
ABA: 3-5% 13%, 5-7% 12%, 7-10% 14%, 10% 21%, 10-15% 6%,
20-25% 3%.
ii.
UCLA 7% average.
iii.
Harris Williams 3% average.
iv.
NY Law Firm 9% average.
ii.
Escrow duration? Release ½ at ½ the duration?
i.
UCLA 18 mos. average.
iii.
Who gets interest?
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iv.
E.
F.
G.
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Is escrow also a pool for net working capital, tax, accounts receivable issues? Specific
Indemnity issues addressed by an escrow? Cap such that if the shortfall on any of these
items is over $X, the shareholders must replenish escrow. Sometimes need multiple separate
escrows
v.
Must escrow total be exhausted before pursue shareholders? Escrow primary but not sole
source?
Representations and Warranties
i.
Duration: Match - with Escrow length. 6 months - 3 years. Compromise on 12 or 18
months?
i.
ABA - 26% at 12 mos., 34% at 18 mos., 16% at 24 mos., 5% > 24
mos.
ii. UCLA 21 mos. average '02-'04.
ii.
Exceptions:
a.
Environmental - from extra years to statute of limitations
b.
Tax - statute of limitations
c.
ERISA - statute of limitations
d.
Product Liability - extra years if a concern (insured with occurrence - based
insurance?). Exceptions or insurance?
e.
Organization, Authority, Shares, Capitalization, Title, Enforceability: forever?
f.
Exceptions (% higher since last ABA study):
i.
ABA - 19% Title, 67% Taxes, 37% Fraud, 37% Environmental, 39%
Employee Benefits, 37% Organization, 54% Authority, 59%
Capitalization.
iii.
Signing Shareholders sleep better after periods run, but would still remain at risk for these
exceptions.
iv.
No Undisclosed Liabilities Rep
a.
93% ABA deals
v.
GAAP rep vs. solely Fair Presentation Rep without reference to GAAP
a.
ABA 75% without GAAP
vi.
Don't represent that financial statements or accounting procedures are GAAP unless they are,
i.e. unaudited financials will NOT satisfy GAAP and typically omit year end adjustments and
footnotes, among other things. Many "procedures" are not “GAAP”
vii.
A Seller cannot represent that its other contracting party to a contract is not in default, has
authorization, and that the agreement is enforceable as to this other party
viii.
Full Disclosure Rep
a.
52% ABA deals. Of these, 74% without Knowledge qualifier.
ix.
Representation and Warranty Insurance
a.
Expense
b.
Insurer due diligence on valuation, basket, cap, etc.
Liability Cap - Same exceptions as to survival period of representations and warranties (plus fraud if
not listed as an exception)?
i.
Low caps beget more exceptions
a.
ABA - 88% yes but less than purchase price, 7% equal to purchase price.
b.
ABA < 10% deal value 26%, 10% deal value 21%, 10-15% deal value 17%, 1525% deal value 17%, 25-50% deal value 5%, > 50% deal value 5%, 100% deal
value 9%. Mean 16%
c.
UCLA '02 - '04, 12-36% of deal value. Higher % caps for smaller deals.
d.
NY Law Firm 15% average.
e.
Harris & Williams 8.1% average.
f.
Exceptions?
i.
ABA - Taxes 40%, Fraud 64%, Authority 43%, Capitalization 46%.
Indemnification
i.
Taxes > reserves? Do taxes straddle tax/fiscal year ends, etc.
ii.
A Seller indemnity for “acts or omissions”, or a catch all representation of "no undisclosed
liabilities," can negate all the haggling over representations and warranties
iii.
Credit Seller indemnity payment for insurance recovery? ABA 63%.
iv.
Credit Seller indemnity payment for the after-tax value of the loss? ABA 31%.
4
a.
V.
Why subject recovery to Buyer's then existing (NOLs, etc.) tax situation and ability
to take deductions?
v.
Buyer required to mitigate losses? ABA only 22%.
vi.
Who appoints lawyers? Who controls litigation? If the Seller assumes control, can it afford
the litigation and can it pay an adverse judgment? The Seller cannot assume defense if an
injunction is brought
vii.
The Indemnitor cannot settle, agree to injunctions or accept provisions to the detriment of the
indemnified party without consent
viii.
Is indemnification the sole and exclusive remedy?
a.
ABA - 77% exclusive remedy.
ix.
Specific indemnity spelled out for items on disclosure schedule that may result in liability
x.
Asset sale bifurcation of liability based on closing date
H.
Definition of Knowledge: of whom? After inquiry? Actual knowledge of others? Affidavit for the
benefit of Seller by Seller Knowledge parties who will be employed by Buyer? Be specific.
i.
Define Knowledge/parties?
a.
ABA (last study) - 52% contemplated inquiry/investigation
b.
ABA (last study) - 84% defined a group of Seller officers, etc.
I.
Need to limit contract disclosure/listing if they are numerous
J.
Material Adverse Effect/Change - include the word "prospects"? Case law on Buyers failing to close
over a MAC clause, see Tyson vs. IBP, Guidant vs. J&J, etc.
i.
Definition of Material Adverse Effect?
a.
ABA (last study) - only 23% exclude "prospects"
b.
ABA (last study) - 65% with General Economic Conditions carve out
c.
ABA (last study) - 59% with Industry Conditions carve out
K.
Accounting Principles should be agreed and attached for any Net Working Capital Adjustment, audits
L.
Right of Buyer to set-off against any other payments, post closing, i.e. salaries of shareholders,
payments for non-competes, payments for leases, payments for working capital, etc? How to relate to
Sole Remedy Clause?
M.
Claims made policies require Tail Insurance at the Seller's cost
N.
Condition precedent as to employment agreements, non competes, leases, options, consents, etc. if
they are important aspects of the deal
O.
Releases by Selling Shareholders of Selling Company and each other. The Buyer should not be
dragged in
P.
Power of Attorney benefiting Buyer to cash Seller's Accounts Receivable
Q.
Allocation of purchase price left for the last minute - this mistake can hold up closings over goodwill,
etc.
R.
Assuming very specific accrued liabilities
S.
Bank signature cards. Letters to customers and accounts receivable. Resignations. Press Releases.
A Closing Date Reconciliation Statement is a good practice
T.
Earn outs. Tiers correct? Can the earnings truly be segregated and counted? Can the Buyer run sales
through an affiliate? Will the Buyer transfer sales to the purchased entity? Cap the payments? Does
the Buyer wish to shut down part of the business or a product line? Will later acquisitions be folded
in? Sale of business for which an earn out is still due?
U.
Option Pool to New Management.
V.
Sandbag provisions: Buyer can or cannot seek indemnity for facts it knew pre-closing? Seller should
document all information given Buyer.
i.
ABA (last study) - 5% anti sandbagging clause.
ii.
ABA (last study) - 56% pro sandbagging clause.
W.
Legal Opinion (non tax).
i.
ABA - 30% not required.
X.
Waiver of Jury Trial: ABA 50%.
Y.
Arbitration: ABA 31%.
Conclusion - Bargaining advantage and attention to detail (advantage to experience).
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Profile
Harvey Jay Cohen, Partner
Cincinnati, OH
(513) 977-8144 | Phone
(513) 977-8423 | Fax
Harvey Jay Cohen is a Partner in the Corporate Department and Chair of the International Practice Group. Harvey engages in a business and
corporate law practice that includes the representation of non U.S.-owned entities; software, Internet, computer, development, ASP, B-2B, outsourcing and high-tech agreements of all types; acquisitions and mergers; international business transactions, including joint ventures,
foreign subsidiaries and entities, European, Mexican, Indian, and Chinese transactions; alliance, licensing, distribution, and agency agreements;
general corporate counseling; executive compensation agreements; and private equity and venture capital transactions. He frequently lectures in
the U.S. and abroad on high technology, domestic, and international joint ventures, mergers and acquisitions, and other transactions for
international organizations and business groups.
EDUCATION
J.D., University of Cincinnati College of Law (Order of the Coif, 1987)
M.A., International Affairs, Columbia University (1986)
Masters Studies, University of Yaounde, Cameroon (1983)
A.B., Georgetown University (cum laude, 1982)
Undergraduate Studies, University of Sussex School of African and Asian Studies, Brighton, England (1980)
BAR ADMISSIONS
Ohio
SELECTED PROFESSIONAL & CIVIC ORGANIZATIONS
European-American Chamber of Commerce, President
Greater Cincinnati Chamber of Commerce, Foreign Investment Attraction Team and International Trade Council
ALFA® International, Co-Chair of International Law Practice Group
Ohio Commodores (Trade Promotion Organization), Governor appointed member
International Bar Association, Business Organizations, Closely Held Companies and Technology Committees
Northern Kentucky International Trade Association, past Board Member
Ohio State Bar Association, Corporate Counsel Committee; International Law Committee, past Chair
Southern Ohio District Export Council, Board Member
Kentucky District Export Council, past Board Member
University of Cincinnati College of Law, past Lecturer, International Business Transactions
Art Academy of Cincinnati, Attorney to the Board
United Way, Neighborhood Services Field of Service, past Co-Chair, Division Leadership Council
Travelers Aid International, past President
Cincinnati Bar Association, International Law Committee, past Chair; Corporate and Securities Law Committee, past Vice Chair
Congregation B'nai Tzedek, President of the Board and past Treasurer
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