DRAFTING AND DOCUMENTATION
DOCUMENTING THE TRANSACTION FROM START TO FINISH
1. Letters of Intent/Term Sheets
a. Purpose:
i. outline key terms of the transactions.
ii. Identify deal breakers early in the process/enhance deal stability
iii. Help avoid misunderstandings during the process
b. Non-Binding
i. Generally non-binding
1. Some binding terms: confidentiality, expenses, noshops/exclusivity;
2. Good faith obligations to negotiate?
a. Courts are split on whether letters of intent or term
sheets create such a duty to negotiate in good faith.
Some courts have held that no duty existed where,
even though there was an express provision to do
so, that provision was not clearly identified as one
of the binding provisions of the term sheet
(see Schwanbeck v. Federal-Mogul Corp., 592
N.E.2d 1289 (Mass. 1992)). Other courts have
found the duty to exist even though it was not
expressly stated in the term sheet but circumstances
supported a finding that the parties intended to be
bound by an agreement to negotiate in good faith
(see In Channel Home Ctrs., Div. of Grace Retail
Corp. v. Grossman, 795 F.2d 291 (3d Cir. 1986)).
b. Remedies for breaches of the duty to negotiate in
good faith are generally limited to money damages,
which are often substantial. Although some cases
have limited recovery to reliance damages (such as,
expenses incurred in the negotiations), most courts
find reliance damages to be insufficient because of
the wrongful actions of the breaching party and
allow recovery of expectation damages (such as,
lost profits from the failed transaction). For
example, in Delaware, courts may award
expectation damages for breach of a duty contained
in a contract to negotiate in good faith if the record
supports a finding that an agreement would have
been reached but for the breaching party’s bad faith
negotiations (see SIGA Technologies, Inc. v.
Pharmathene, Inc., 2013 WL 2303303 (Del. May
24, 2013)).
ii. Binding Term Sheet
1. Beware: the language and terms should be very specific
and detailed (like the definitive agreement).
2. Remedies: Specific performance money damages. What
does the binding term sheet say?
2. Due Diligence
a. Legal, Financial, and Operational Diligence
b. Objectives of Diligence:
i. Confirm buyer’s understanding of what they’re buying
ii. Assure legal title to the asset(s) being purchased
iii. Investigate potential liabilities or risks
iv. Confirm/Assess value of the target business
v. Identify transition/integration issues
vi. Understand operations of the business
vii. Identify impediments, like 3rd party consents and approvals (e.g.,
landlord approval to assign the lease, approvals from government
or licensing authorities, customer/supplier consents to assign
contracts, etc.)
viii. Determine what ancillary documents will be needed.
c. Due Diligence Checklist attached as Exhibit A
3. Structuring the Deal
a. 3 Main Structures:
i. Asset Purchase
ii. Equity/Stock Purchase
iii. Merger
b. Asset
i. Acquire specified assets from the target
ii. Leave behind pre-closing liabilities of the target (avoiding known
and unknown liabilities)
iii. Transitional issues:
1. Third party consents
2. Transitional and administrative issues: (e.g., payroll, sales
tax and licenses, anything tied to EIN or specific entity).
iv. Requires stockholder approval (but what threshold? Majority?
Supermajority? Unanimous?)
c. Stock/Equity
i. Acquire all assets and liabilities (whether known or unknown)
ii. Generally requires all stockholders to consent by selling their
shares.
iii. May result in fewer transitional issues and third party consents
iv. Capital gains treatment for sellers
v. Drastically increases due diligence required to be performed
1. Difficult diligence issues:
a. Taxes (Income, Sales, Employment Withholdings
Taxes).
b. Employment Related Claims
c. Employee Benefits administration
d. Merger
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i. Two Party Mergers (Forward)
ii. Triangular (Forward and Reverse)
1. Triangular merger can insulate the buyer from target’s
liabilities.
iii. Tax
1. Forward and forward-triangular mergers treated as asset
sales (treated as a liquidation of the target)
2. Reverse-triangular merger treated like a stock sale
e. Successor Liability:
i. As a general rule, the buyer of assets does not assume the liabilities
of the seller. However, in certain circumstances, the buyer can be
held responsible for the seller's liabilities if a court determines that
the factors of one of the following exceptions are met:
1. The buyer expressly or impliedly assumes the liabilities.
2. The transaction is deemed a de facto merger under state
law.
3. The transfer was fraudulent or intended to defraud
creditors.
4. The buyer is a mere continuation of the seller.
5. The buyer continues essentially the same operations or
product line of the seller.
ii. In addition, under federal law certain employee pension and
environmental liabilities associated with a business can follow the
business even in an asset acquisition.
iii. Under some state and local tax laws, the buyer may be responsible
for certain of the seller's taxes. Buyers often try to protect
themselves against successor liability, or at least try to minimize
the impact of these liabilities, with comprehensive representations,
warranties and indemnities.
4. What are you Buying/Selling
a. In an Asset sale:
i. Describe and list (in an Exhibit/Schedule) the assets that you are
buying
ii. Explicitly exclude the assets you are not
iii. Explicitly state the liabilities you’re assuming (if any).
5. Price and Payment
a. Forms of Payment
i. Cash
ii. Financing
1. Bank/SBA
a. Limitations on deal terms: Make sure that the SBA
lender knows what’s going on.
i. Sellery carry limits
ii. Transitional employment limited
iii. Buyer must operate
2. Seller Financed
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a. Evidence with Promissory Note
b. Security and priority
c. Beware: Possession is 9/10ths of the law
iii. Property (e.g., Stock)
1. Exchange of Stock or Property
iv. Earnout
1. What is it: mechanism to pay part of the purchase price on
a contingent/conditional basis.
2. When it should be used: Buyer and Seller cannot agree on
the value of the target. Seller’s value is greater than
buyer’s.
a. .
3. Structuring tips:
a. Measuring the Earnout/Setting the Target: Be
specific on how it is measured.
i. Revenue
ii. Customers
iii. EBITDA
iv. Net Income
v. Net Equity
b. Time Periods and Payment Terms
c. Covenants Related to Earnout Period Operation
d. Acceleration of Payment
i. Change in Control
ii. Breach of Operational Covenants
v. Holdbacks: Possession is 9/10ths of the law
1. Notes
a. Security?
i. Assets in Company
ii. Real Property
iii. Guaranty
b. How is paid
i. Balloon payments
2. Escrows
a. 3rd party holding money. Must be delivered at
closing
b. Allocation of Purchase Price
i. allocation is important to the seller because it determines the
amount and character (capital versus ordinary) of any gain or loss
recognized in the transaction.
ii. It is also important to the buyer because it determines, among other
matters, the amount of depreciation and amortization deductions
for certain assets.
c. Purchase Price Adjustments
i. The purchase price may be fixed or subject to adjustment.
ii. A purchase price adjustment is a mechanism used to confirm the
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value of the assets as of the closing date.
iii. A purchase price adjustment increases or decreases
the purchase price after review of specially prepared financial
statements or a review of specific assets, in each case, as of the
closing date.
iv. Common purchase price adjustments are based on:
1. Balance sheet.
2. Profit and loss statements.
3. Valuation of specific assets (for example, inventory or
accounts receivable).
4. Level of cash and debt.
v. Make sure you provide for a review/dispute process in case one
party disagrees with the calculation.
6. Reps/Warranties and Disclosure Schedules
a. Purpose: Representations and warranties are statements of fact and
assurances made by the parties. They are usually the longest part of
the asset purchase agreement and take the most time to negotiate. These
are statements made by the parties which:
i. Disclose material information about the parties and
the assets being sold and the liabilities being assumed.
ii. Allocate risk between the parties.
iii. Serve as the foundation for an indemnification claim in case of a
breach
iv. Impact a party's obligation to close the transaction or right to
terminate the agreement before closing and walk away.
v. The parties are often required to make representations again as a
condition to closing.
b. Ways to Limit Reps Warranties:
i. Materiality: (e.g., Seller is not party to any material legal action)
ii. Knowledge: (e.g., to the knowledge of the Seller)
1. Consider defining who’s knowledge
2. Consider whether there is a duty to inquire or conduct a
reasonable investigation
iii. Time: (From _____ to the Closing Date, there have been none of
the following actions taken)
iv. Scheduled information: reps and warranties can be limited by
references to the disclosure schedules
7. Covenants
a. Pre-Closing
i. Operation of Business; Preservation of Assets/Company
1. Insurance
2. No adverse changes to assets
3. Operate business in ordinary course
4. No incurring debt
5. No capital expenditures
ii. Employees
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1. No terminating key employees
2. Allow access to some or all employees
iii. No Shop
1. No soliciting other bids (fiduciary duties can apply in
public context)
iv. Confidentiality
b. Post-Closing
i. Bulk Sale Laws
1. Beware of state laws that require notices to third party in
connection with the sale of all or substantially all of the
assets
ii. Non-Compete/Non-Solicit
1. Non-Compete in Colorado
a. Reasonable scope, duration, and time period
b. Importance of Blue-Pencil Provision
iii. Consulting and Employment Arrangements
1. Transition consulting/employment
iv. Announcements
v. Confidentiality
8. Sign and Delayed Closing (i.e., when there’s a gap between signing and closing)
a. Needed when:
i. Underwriting for a loan requires a signed agreement
ii. Approval of third parties (e.g., governmental authority, material
contracts to be assigned, etc.)
b. Termination:
i. How can a party get out?
1. Diligence
2. Financing
3. (material) adverse change
4. Sometimes fiduciary reasons
5. Failure to obtain some critical consent
ii. Termination or Break-up fees?
c. Conditions to Closing
i. Common Conditions
1. Diligence
2. Financing
3. Required or desired third party consents/approval
4. No material adverse changes
5. Reps/warranties still true and correct
6. Compliance with pre-closing covenants
9. Indemnification
a. What is it? A post-closing remedy for losses incurred under the purchase
agreement. Losses may arise from
i. Failure to perform covenant
ii. Breach of, or inaccuracy in, a representation or warranty.
iii. Certain liabilities that are allocated to one party or the other (e.g., a
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particular known pending litigation)
b. Procedures
i. How to notify a party of a claim
ii. Who controls third party litigation
iii. Ability to participate in third party litigation
iv. Ability to settle a third party claim with or without consent
v. Mitigation requirements
c. Limitations
i. Caps- setting the maximum aggregate amount of recover.
ii. Thresholds, Baskets, or Deductibles- minimum amount of losses
incurred before claims can be made.
iii. Survival Period- The provision provides an expiration for
indemnification claims made under the representations and
warranties section.
1. Range from 6 months to 3 years
2. Some identified representations may survive for longer
period (e.g., statute of limitations).
a. Fundamental Corporate Matters (Organization,
Authority, and Capitalization)
b. Title to purchased assets
c. Sufficiency of assets
d. Taxes
e. Environmental Matters
f. ERISA
iv. Sandbagging
1. Whether or not indemnification is available to buyer if it
has knowledge before closing (i.e., through diligence)
v. Materiality Scrapes
1. Whether or not losses incurred are qualified by
“materiality” qualifiers in the representations and
warranties section.
d. Funding the Indemnification
i. Escrow
ii. Holdback
10. Miscellaneous Section Considerations
a. Choice of Law
b. Entire Agreement
i. Consider referencing ancillary agreements that are needed to
provide context (e.g., Schedules, Exhibits, etc.).
ii. In the event of a conflict, which document governs?
c. Dispute Resolution
d. Assignment
e. Broker Fees
f. Representative
g. Specific Performance
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