The acquisition agreement will set forth almost all of the legal understandings of the buyer and seller about the transaction. Ideally, it accomplishes four basic goals:
- It sets forth the structure and terms of the transaction
- It discloses all the important legal, and many of the financial aspects of the target, as well as pertinent information about the buyer and seller.
- It obligates both parties to do their best to complete the transaction and obligates the seller not to change the target in any signiciant way before the deal closes.
- It governs what happens if, before or after the closing, the parties discover problems that should have been disclosed either in the agreement or before the closing but were not properly disclosed.
Unlike the typical letter of intent, an acquisition agreement is a legally binding agreement. Once it is signed, a party that fails to consummate the transaction without a legally acceptable excuse can be liable for damages.
The major segments of a typical agreement are as follows:
- General conditions
- The price and mechanics of the transfer
- Representations and warranties of the buyer and seller
- Convenants of the buyer and seller
- Conditions to closing
- Termination procedures and remedies
- Legal miscellany
Companies often need to use external finance to fund an acquisition. This can be in the form of bank debt and/or equity, such as a share issue.
An advisory board is common among smaller companies. It is less formal than the board of directors. It usually consists of people, chosen by the company founders, whose experience, knowledge and influence can benefit the growth and direction of the business. The board will meet periodically but does not have any legal responsibilities in regard to the company.
Alternative assets can be categorized as assets that are nor bonds and neither equities. A part of alternative assets – namely private assets – differ from bonds and equities in their illiquid and unquoted quality, while these features don’t hold for commodity type assets, because they are liquid and quoted publicly. Unlike bonds and equities commodity type assets are physical objects with intrinsic value.
Alternative assets include the following subcategories:
1. private assets:
2. commodity type assets (such as gold, oil, or active currencies)
3. hedge funds
Anything owned by an individual, a business or financial institution that has a present or future value i.e. can be turned into cash. In accounting terms, an asset is something of future economic benefit obtained as a result of previous transactions. Tangible assets can be land and buildings, fixtures and fittings; examples of intangible assets are goodwill, patents and copyrights
The percentage breakdown of an investment portfolio. This shows how the investment is divided among different asset classes. These classes include shares, bonds, property, cash and overseas investments. Institutions structure their allocation to balance risk and ensure they have a diversified portfolio. The asset classes produce a range of returns – for example, bonds provide a low but steady return, equities a higher but riskier return. Cash has a guaranteed return. Effective asset allocation maximises returns while covering liabilities.
A closing is the evnet through which the parties to a transaction conummate that transaction by the execution and delivery of documentation, and, if applicable, the transfer of funds.
The closing process may last for a few hours, or for days or weeks, depending upon how much negotiation is left for the finale and upon the abaility of the parties to satisfy the conditions precedent to closing in a timely manner.
The period immediately prior to the closing is often consumed by final negotiation of the terms and conditions of the operative documents, but this is not always the case. Closings on transactions for which the terms have been negotiated and finalied prior to the closing involve review of documents and confirmation that the conditions precedent to closing have been met, followed by the execution and delivery of documents and, when appropriate, the actual receipt of funding.
Corporate strategy is the pattern of decision making in a company that:
- Shaopes and reveals its objectives, purposes, or goals
- Produces policies and plans for achieving these goals
- Defines the business the company intends to be in and the kind of economic and human organization it seeks to be.
The Covenants section of the acquisition agreement (or “sale and purchase agreement”) defines the obligations of the parties in respect to their conduct during the period between the signing and the closing. For negotiation purposes, the most significant covenant relates to the obligation of the seller to conduct the business in the ordinary course with such exceptions as are agreed upon by the parties between the time of the signing and closing. In the representations and warranties, the seller assures the buyer of the legal characteristics of the target as of the date of the signing of the agreement; in the Covenants section, the seller in essence agrees not do anything to change that picture in any material way, except as necessary in the normal operations of the business.
Any changes other than those that are specifically allowed by the agreement can be made only with the consent of the buyer.
An earnout is a method of compensating a seller based on the future earnings of a company. It is contingent portion of the pruchase price. A common type of earnout provides for additional payments to a seller if the earnings exceed agreed-upon levels.
Earnouts require considerations of various factors: the type of contingent payment (cash or stock), the measurement of performance (operating income, cash flow, net income, or other), the measurement period, maximum limits (if any), and the timing of payments.
The purpose of the indemnification in a contract is to set forth the circumstances under which either party can claim damages or take other remedial action in the event the other party to the agreement has breached a representation or warranty or failed to abide by its covenants.
A letter of intent is a pre-contractual written instrument that defines the respective preliminary understandings of the parties about to engage in contractual negotiations. In most coses, such a letter is not intended to be binding except under very unusual circumstances and then only for certain limited provisions.
The letter of intent crystallizes in writing the basic terms of the transaction, which up to that point have been the subject of oral negotiations between the parties. The letter will set forth the proposed structure of the transaction, the price and how it will be paid, the terms of notes or stock to be conveyed as part of the price, and other important, but general, features of the transaction such as special accounting or tax considerations.
The letter of intent also sets forth the conditions to consummating the transaction including, among others, the need for regulatory approvals and, most importantly, the completion of due diligence and the execution of a mutually satisfactory acquisition agreement.
Most letters of intent specifically stat that the letter does not create a binding obligation to close the transaction.
A leveraged buyout (LBO) is a transaction in which a company’s capital stock or its assets are purchased with borrowed money, causing the company’s new capital structure to be primarily debt.
There are several types of leberaged buyouts:
- Management buyouts (MBOs)
- Employee buyouts (EBOs)
A liquidation preference is one of the essential components of preferred stock and is generally considered to be the second most important deal term in a VC investment (the first being the company’s valuation prior to the investment, commonly referred to as the “pre-money valuation” or “pre”).
Preferred stock, as the name suggests, is preferable because it grants certain key rights to the holders – making it far more valuable than common stock. One of those rights is a liquidation preference.
The word “liquidation” is broadly defined in VC documentation to include not only the actual liquidation of the company (i.e., the disposition of the company’s assets) upon dissolution or bankruptcy, but also the sale of the company (whether via stock, assets or merger) to a third party or a change of control.
Learn more about liquidation preference here.
A private equity firm will often provide finance to enable current operating management to acquire other business they manage. In return, the private equity firm usually receives a stake in the business.
The typical MBO involving an outside financial partner requires at lease three separate but coordinated negotiations:
- the negotiation between management and the financial partners as to the nature of their relationship
- the acquisition negotiation between a team consisting of management and financial partner on the one side and the seller on the other, and
- the negotiation with lenders, in which the financial partner usually plays the lead role but management participates because of its knowledge of the business and its financing needs, and the lenders’ desire to keep management involved.
The representations and warranties reflect the situation as of the date of the signing of the agreement and, together with the exhibits or schedules, are intended to disclose all material legal, and many material financial, aspects of the business to the buyer. The seller also gives assurances that the transaction itself will have adverse effects upon the property to be conveyed. Some of the representations and warranties are not related to the legal condition of the target but serve to provide the buyer with information.
The buyer makes similar representations and warranties about its legal and financial ability to consummate the transaction and certain other limited representations and warranties.
Vertical integration is a strategy mode used to achieve economies in purchasing, sales and distribution. It is composed of two sub-components:
- vertical backward integration and
- vertical forward integration.
Vertical backward integration is buying a current or potential supplier. If combined with the strategy of effecting one or a series of horizontal integration or market extension moves, it can mean increased sales for the acquired supplier entity and increased profits as the company rides down the experience curve.
Vertical forward integration is buying a current or potential customer. Owning your own distribution network is important in many industries in which preventive “freezouts” are common, such as electronic entertainment.