Tight credit markets have dampened dealmaking, but intrepid buyers and sellers are still getting deals done. As the markets soften, buyers are demanding better prices and terms and, to the extent that they are successful, further eroding sell-side value. Among the terms and structures now used to get deals done are post-closing purchase price payments, earnouts, simultaneous acquisitions, rollups, payments in kind and joint ventures. Each has its issues and complications, but with careful lawyering, both buyers and sellers can protect themselves against unintended consequences.
Increasingly, buyers are delaying payment of a portion of the purchase price rather than attempting to secure financing. These delayed payments can take the form of a secured note with an interest component, a delayed payment without interest or security, or something in between. The delay between closing and the deferred payment is typically up to six months but can be longer, particularly for an interest-bearing note. The seller benefits by avoiding the delay associated with extended negotiations between the buyer and lender -- particularly when a distressed seller is involved -- and also avoids the risk that those negotiations will stall, preventing a closing.
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That said, a deferred purchase price payment without an interest
component can be a trap for the unwary seller. The Internal Revenue
Service, which deems delayed payments to be loans from the sellers to
the buyers, will impute interest at the applicable federal rate and tax
the seller on the imputed interest at ordinary income rates, rather
than capital gains rates, as the imputed interest accrues and typically
before the payment is received. Sellers should consider requesting a
true-up to compensate for this tax loss and for the time value of
money. Alternatively, the parties could structure the deferred payment
as an interest-bearing note -- although pushback can be expected from
the buyer to ensure that this structure is actually a provision to keep
the seller whole and not a profit mechanism for the seller.
Earnout provisions, by making the payment of a portion of the
purchase price contingent on the acquired business' meeting negotiated
targets after closing, allow the parties to bridge valuation
differences. Every earnout carries the risk of litigation or
arbitration, but as earnouts represent larger and larger percentages of
the potential total deal value, the risk increases that a
misunderstanding or ambiguity will devolve into formal proceedings. In
a soft market, the parties should consider the risk of further erosion
in the markets and how such erosion will affect the seller's ability to
meet the earnout goals or the buyer's ability to make the earnout
payments. To protect itself, the seller should consider requesting an
accelerated earnout payment upon the occurrence of certain events that
threaten the buyer's ability to make future earnout payments or an
escrow of the deferred payments.
To close a deal, the buyer might acquire assets that do not drive
the transaction for the buyer but the buyer can afford to hold and then
divest. In a soft market, however, the buyer may wish to avoid this
option because of the increased risk that there will be no market for
such a post-closing divestiture. Thus, some sellers are now allowing
two or more buyers, each interested in different parts of the business,
to negotiate simultaneous transactions instead of the consecutive deals
in which a buyer might otherwise engage. In simultaneous acquisitions,
the seller can give representations and warranties to all the buyers;
in the consecutive scenario, the first buyer often must make
representations and warranties on the new and unfamiliar assets, or,
conversely, the downstream buyer must accept the risk of very sparse
representations and warranties with no comfort from the initial seller,
with whom it has no privity of contract. Buyers in a simultaneous
acquisition must engage in a more thorough diligence and require a more
detailed description of the purchased assets, as it is imperative that
the assets be transferred to the correct buyer. Co-buyers may also have
divergent interests -- they might disagree on what issues are critical
and worth raising with the seller. Finally, careful attention should be
paid to the structure of the indemnity and escrow. The escrow amount,
the cap and the basket can be structured as a first-come, first-served
aggregate of the claims of both buyers or, at the other extreme, as
entirely separate amounts pro rata based on each buyer's percentage of
the purchase price. An aggregated cap and basket might pit the buyers
against each other post-closing. If the cap and basket are bifurcated
and the assets of one buyer are subject to indemnifiable claims
exceeding that buyer's pro-rata portion of the indemnification cap, the
buyers may request that the buyer with claims in excess receive the
benefit of the other buyer's underused portion.
Rollups are useful mechanisms for aggregating weaker, regional
companies into a stronger company with a broader footprint. While some
rollups have failed, resulting in well-known bankruptcies, rollups in a
down cycle can allow smaller companies to join together to eliminate
overhead costs and gain negotiating power with respect to their
suppliers. For the individual seller, a rollup can be marred by
ineffective leadership, coordination problems and frustration with the
transition. On the other hand, a rollup can forestall bankruptcy for
struggling individual entities. While the new rolled-up entity
overflows with industry knowledge, an experienced investment banker can
bring professional management skills and an unbiased eye to the issues.
Investment bankers that specialize in rollups are often compensated
with an equity interest in the new entity, but in exchange, they can
help balance the individual needs of the constituent companies against
the imperative to integrate the whole.
Another way that companies are closing deals without accessing cash
on hand or the credit markets is by trading assets for assets or for a
combination of assets and stock. In a recent deal, the parties swapped
a retail division for a wholesale division, creating a retail company
and a wholesale company where there had once been two vertically
integrated companies. The parties were able to close these two
transactions despite the fact that one party had little or no access to
the credit markets. To effect simultaneous transactions, particularly
if the parties have little or no access to cash and credit because one
party is distressed, the stronger party necessarily accepts the market
risk of dealing with the distressed counterparty. Even though the
assets may be of equal value, the credit risk being assumed by the
stronger party may need to be balanced with an escrow of stock, a
secured note or a security interest in the assets. In the alternative,
the lack of recourse against the weaker party could be counterbalanced
if the stronger party is receiving a greater deal value.
A joint venture between motivated parties can allow them to
contribute their strengths to the JV without bogging down the new
entity in each party's liabilities. In transferring the assets, the
parties will need to avoid leaving either party legally insolvent and
therefore possibly subject to a fraudulent transfer claim. By starting
from scratch with a new entity, the parties avoid some of the costs of
a full acquisition. First, the diligence requirements are diminished
because the parties can prevent their liabilities from transferring
with the assets. Second, less documentation is typically required.
Taking points one and two together, the parties to the JV agreement can
save on attorneys' fees and other transaction costs.
The use of the discussed terms or structures, or any combination
thereof, has allowed strategic deals to close at a time when many
transactions are cratering. Each concept brings with it a host of
issues and complications that must be carefully addressed for all the
parties to receive the benefit of their hard-won bargain.
Chelsea A. Grayson, a partner at Jones Day, advises emerging and
established companies, focusing primarily on mergers and acquisitions,
distressed mergers and acquisitions, and private placements of equity
and debt. Mary C. Warner is an associate at Jones Day, where she
focuses on representing established and emerging companies in mergers
and acquisitions, securities transactions and compliance, and corporate
finance.
