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In-House Legal Team's Guide to Preparing for M&A Transactions

The merger and acquisitions (M&A) process requires thorough preparation and collaboration to ensure long-term success. The M&A process can look different depending on the industry, but here’s what that process can look like.

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The merger and acquisitions (M&A) process requires thorough preparation and collaboration to ensure long-term success. One of the most integral — and equally tedious — parts of the process is due diligence: combing through the target company’s contracts, financials, and operations to understand the true value of the acquisition. From the Letter of Intent (LOI) at the beginning of the process, all the way to post-transaction integration, the deal team (legal, finance, and their roster of experts) investigate legal and compliance risk, verify financial health, and assess the cultural fit to ensure that the merger or acquisition is in the buying company’s best interest. The M&A process can look different depending on the industry, but here’s what that process can look like.
UNDERSTANDING M&A TRANSACTIONS Mergers and acquisitions transactions refer to the consolidation of two or more companies and/or their assets into a single entity. The M&A process kicks off when both the buying and selling companies prepare a (typically non-binding) LOI that outlines the basics of the transaction. This is often accompanied by a confidentiality agreement, which is binding. Then, the buyer carries out due diligence to uncover risks and validate the value of the business. If the buyer likes what they find, they negotiate the details and final purchase price of the deal. They finalize the transaction by signing the merger and acquisition agreement and beginning the post-closing and integration process. M&A transactions can take anywhere from a few months to a few years, depending on the industry, company maturity, and compliance with regulation. M&A processes can also vary according to the type of M&A transaction it is.
Though “merger and acquisition” is referred to as a pair, there are different types of transactions that fall under the M&A umbrella. These include:A MERGER OF EQUALS A merger happens when two separate businesses join together as peers using stock purchases under a single brand identity. For example, in 2008, Sirius merged with XM Satellite Radio to become SiriusXM Satellite Radio. ACQUISITION An acquisition, on the other hand, happens when a company purchases another company and acquires its liabilities and assets, often via asset purchases. For example, in 2022, Adobe acquired Figma to “reimagine the future of creativity and productivity.” LEVERAGED BUYOUT (LBO) A leveraged buyout (LBO) occurs when a private equity firm or management team borrows money to acquire a company. One example is PetSmart’s 2014 leveraged buyout, one of the biggest LBOs of its time. MANAGEMENT-LED BUYOUT (MBO) A management-led buyout (MBO) is a type of leveraged buyout in which the management of a company pools together resources to purchase the company. A famous example is Dell’s founder and CEO took Dell private for almost $25 million in 2013.
FORMING THE M&A DEAL TEAM The M&A deal team is responsible for running the transaction. The deal team includes internal collaborators and external advisors that are responsible for executing the M&A transaction. Each M&A deal should have a roster of specialists that advises the organization on structuring the deal, conducting due diligence, completing valuation, and negotiating the best contract for the deal. The deal team often includes tax lawyers, IP experts, M&A attorneys with negotiation experience, investors, accountants, company leadership, finance, and HR. The deal team’s composition will vary based on a few different factors, including the size of your legal team, international elements, and regulatory requirements. COMMUNICATION AND COORDINATION ON THE DEAL TEAM The M&A deal team can be divided into various work streams with specified areas of focus — for example legal, financial, operational, and regulatory — depending on company size, maturity, and industry. Finance, healthcare, and telecommunication are examples of industries in which companies are subject to heavy regulatory compliance, and so their regulatory work stream may be particularly robust. It’s important that these work streams aren’t siloed within the deal team. Efficient communication and coordination are essential to ensuring that critical info and tasks don’t fall through the cracks. For example, if legal learns that the seller’s biggest customer is on year nine of a 10-year agreement, they should share that with finance as it may impact the valuation of the deal. Effective communication ensures that all parties, both external and internal, are on the same page. This lowers the chances of unexpected surprises that detract from the value of the deal.
CONDUCTING DUE DILIGENCE When two or more companies come together, the buyer inherits the risks, liabilities, and assets of the seller. To get the promised value out of a target company, legal teams have to conduct thorough due diligence so that they know exactly what they’re getting. Due diligence helps the buying company look under the proverbial hood to determine the true value of the target company and to assess whether or not their companies are a good fit. During due diligence, legal (or outside counsel) dives into the seller’s contracts, financials, policies, governance, product line, and compliance practices — anything and everything that can provide a comprehensive view of the true state of the selling company. Due diligence validates the selling price and predicts future risk liability. LEGAL, FINANCIAL, AND OPERATIONAL DUE DILIGENCE Legal, financial, and operational work streams are each crucial to getting the full picture of the assets and liabilities the surviving company will inherit. While legal due diligence provides perspective around the legal challenges the target company may be facing, financial due diligence does the same for cash flow and revenue, and operational due diligence looks at company governance and structure. All three pieces work together to paint a picture of the benefits and risks of M&A activity. DUE DILIGENCE CHECKLIST As part of the due diligence process, buyers invite sellers to populate data rooms with the documents needing review.
It can be a lot to keep track of, but here’s a checklist to help you get started collecting the right documents. CONTRACTS Leases Supplier, vendor, contractor contracts Amendments and exhibits Guarantees, loans, credit agreements Licensing agreements Confidentiality agreements and NDAs Customer contracts Employment and non-compete agreements Franchise agreements Partnership agreements Government contracts Settlements FINANCIALS Bank and credit card statements Annual and quarterly financial statements Forecasts and projections Internal controls Audits Debt agreements Accounting practices (GAAP) Revenue recognition issues Cash flow and runway Appropriate EBITDA calculation Net operating losses Revenue leakage
INTELLECTUAL PROPERTY Copyrights, trademarks, and patents Foreign patents Jointly held patents Any copyright infringement Current or pending IP litigation Whose IP do you have license to Who has license to your IP Websites and domains IT, DATA, AND SECURITY Tech stack Hardware and software Data storage, security, and encryption policies and practices Software, technology and IT vendors Historical or current data breaches Historical or current vendor data breaches Data breach litigation IT policies Data collection policies and practices Vendor risk management programs HR AND EMPLOYMENT List of job titles and descriptions Employee contracts Employee manuals Vacation and leave policy Compliance with employment law Sexual harassment liability Organizational chart Historical, current, and pending labor disputes Employee benefits Employee compensation plans Employee turnover rate Accrued vacation time Accrued bonuses
CUSTOMERS AND REVENUE GENERATION Biggest customers Revenue generated from biggest customers Customer retention and churn Customer acquisition costs Customer satisfaction Refund policy Unresolved customer issues Sales pipeline List of product lines Sales win rates Sales compensation plans LITIGATION Filed and pending litigation Settlements Claims against the seller Arbitration and mediation policy POLICIES AND PROCEDURES Business continuity plan Crisis management plan Employee policies ASSETS Equipment Inventory Technology Real estate TAXES State & federal tax returns for the last five years Correspondence with IRS Tax credits received Property taxes (paid and in arrears) Government audits IRS Form 5500 for 401(k) plans
DRAFTING AND NEGOTIATING CONTRACTS The due diligence process confirms the projected value of the company or exposes holes in the legal, financial, operational, or regulatory practices of the target company. The legal team drafts and negotiates the M&A contract based on the findings in the due diligence process. The contract is effectively the representation of the deal structure, each party’s responsibility, risk allocation through representations and warranties, consideration, and final purchase price. Effective drafting and negotiation helps ensure: • The exchange of value is clear • Clear post-closing conditions • Appropriately allocated risks for third-party claims
NEGOTIATING KEY CONTRACTS IN THE M&A PROCESS The key M&A documents are the LOI, NDA, term sheet, and the M&A agreement. Though the LOI usually isn’t binding, companies frequently negotiate which parts are binding and which aren’t, as well as the scope of the confidentiality agreement. This determines how much each party will share and protect their disclosure. Likewise, the representations and warranties are usually the most heavily negotiated terms of the M&A contract, because they assign risk responsibility and outline a timeline for receiving additional documents that fall after the closing of the transaction. Your acquisition agreement ought to reflect responsibilities and next steps from a business continuity perspective. This is another important set of terms that are key to finalizing the transaction. TIPS FOR EFFECTIVE NEGOTIATION When negotiating the M&A deal, here are some things to consider in your negotiation strategy. Know the business objectives — Deadlocks in negotiations happen when parties are overly adversarial. Rather than getting hung up on individual terms, contextualize the negotiations within the business’ objectives and think about the larger vision. Think critically — During M&A negotiations, think in terms of the deal instead of “what you’ve always done.” Each party should negotiate with an eye towards what’s best for the deal and their future partnership. Look for other ways to protect the business — You can’t protect the business from every possible risk. Be flexible as you consider ways to mitigate risks, whether through liability caps, reduction in deal prices or other ways that allow the acquirer to protect the deal and future value of the surviving company.
REGULATORY COMPLIANCE AND APPROVALS M&A transactions in the U.S may be subject to state and federal regulations, and regulators can sometimes slow down or stop the M&A transaction if companies aren’t compliant. In particular, the U.S has become more rigorous in its antitrust scrutiny. In 2022, regulators blocked a proposed merger between Simon and Schuster and Penguin Random House because it would reduce competition in the publishing industry. More recently, a proposed merger between Spirit and JetBlue airlines has also been subject to antitrust review. The Committee on Foreign Investment in the United States (CFIUS) has similarly become slightly more aggressive in blocking transactions that could potentially threaten national security. Additionally, regulators are increasingly turning their attention towards cybersecurity and data protection. With a largely hybrid/ remote workforce, businesses are more vulnerable to cyber threats. As a result, the SEC has instituted cyber safety rules that publicly traded companies must follow. This is in addition to the consumer data privacy laws like GDPR and the cookie laws across the U.S that businesses must comply with. Not every company will face these regulatory risks. Some smaller companies, for example, aren’t subject to government oversight. But businesses in industries like transportation, biotech, and insurance have additional regulations that have to follow.
If companies fail to identify and address regulatory requirements, regulators can shut down or gum up an acquisition. It can be hard to know which regulations apply or how regulators will respond. This is why it’s important to work with an experienced M&A lawyer. If you’re not sure which rules apply, try the following: • Have a pre-emptive conversation with regulators • Give regulators a heads up that the M&A transaction will occur • Research requirements, obligations, or limitations federal regulators might place on an acquisition
MANAGING RISK AND MITIGATION STRATEGIES Every M&A transaction comes with its own set of benefits and risks. The benefits are obvious — growing faster, cutting costs, eliminating competitors — but the risks often require a deeper look. One of the most common ways that companies introduce more risk into the M&A process is by phoning in due diligence. Poor due diligence can cause you to miss key factors in the value and liability of the target company. For example, you might miss crucial details like incomplete exhibits and unsigned amendments, which throws some contract validity into question. Additionally, scanty due diligence can result in representations and warranties that do not appropriately allocate risk. Mediocre due diligence also may not alert you to budding cultural clashes. No matter how lucrative the deal, if the companies aren’t a good cultural fit, the M&A transaction will fail. IMPORTANCE OF POST-TRANSACTION INTEGRATION PLANNING To mitigate these risks, buyers need to be thorough in their due diligence, structuring of the deal, and planning for the integrated future as early as possible. For example, you shouldn’t wait until after the deal has closed to figure out what will happen to the CEO of the target company, what the customer experience will look like after the merger, or what will happen to the employees of both entities post-merger. Thinking this through thoroughly increases the chances of successful post-transaction integration, allowing the buyer to realize the gain or growth they sought to achieve through M&A. Planning for what comes next ensures that the transacting companies are prepared for what’s down the road and get the most value from the deal.
POST-CLOSING ACTIVITIES Closing the M&A deal isn’t just signing a contract. It involves a sequence of events that have to take place to finalize the deal and initiate post-merger integration. Some key post-closing activities are: • Finalizing the purchase price • Reviewing acquisition integration plan • Communicating with customers and employees • Introducing the buyer to their acquired customer base • Generating new organizational documentation (bylaws, articles, tax docs, business formation docs)
POST-CLOSING INTEGRATION CHALLENGES AND STRATEGIES Integration starts at due diligence. Meaningful due diligence should be conducted with an eye towards integration and post-closing matters. While the deal team is responsible for structuring and negotiating the M&A transaction, they probably won’t be responsible for post-closing integration. So it’s important to ensure that the right people are brought in sooner rather than later. Failure to think this through can result in a mass exodus from your company — both clients and employees — lowering the value of the merger and inviting more liability. Legal integration can also be a struggle post-transaction, as contracts from two separate entities have to belong to one single one. You need tools to help you integrate all manners of your business — like a Contract Lifecycle Management (CLM) tool to connect all your contracts with important business systems.
CONCLUSION There are several kinds of M&A transactions, and each requires thorough due diligence and a long-term vision of what the surviving company will look like. Every member of the deal team has an important role to play in completing due diligence, negotiating the deal, and paving the way for a successful transaction, which makes effective communication mission-critical. The in-house legal team needs to collaborate effectively with outside counsel, the roster of experts, and other departments in the organization to effectively escalate decision-making and keep the process moving. Most importantly, there needs to be seamless coordination within the legal team itself, making efficient processes and sophisticated technology supremely helpful. Enterprise Legal Management (ELM) software can get your team organized. With task management tools to prioritize activities and a contract repository to store all your business’ agreements, your team can properly prepare for successful M&A transactions. See how LinkSquares can help you manage your M&A transactions. Request a demo today.