9.05.2018

Completing the Deal

Key steps in deal process

In the current market, where it is generally taking parties some time to negotiate deals, we are seeing more heads of agreement being negotiated by clients as the first step in the deal process. While such agreements are normally non-binding (other than confidentiality and exclusivity) they are useful tool as they:

  • set out the commercial agreement to date. This means that parties cannot exercise “selective memory” when negotiating the sale agreement;
  • cover contentious issues such as guarantees, escrows and earn outs so these do not become “deal break” issues later on in the process;
  • set out a timeline and the role of the parties. For example, who drafts the sale agreement and when due diligence will start; and
  • can include an exclusivity period during which time the vendor cannot deal with another purchaser. This gives comfort to the purchaser who will need to put significant resource into the next steps in the deal process.

Our experience indicates that a carefully negotiated heads of agreement greatly increases the chances of a successful deal and makes the next step in the documentation process, drafting and negotiating the sale agreement, considerably smoother.

Prior to launching into formal documentation, a due diligence investigation of the target should be undertaken. This should include both financial and legal issues. It is obviously better to uncover any “skeletons in the closet” at an early stage, rather than when a purchaser is too far down the track. A well defined due diligence scope, which focuses on the key drivers of the target and the purchaser’s aspirations for the target, is key.

The next step is negotiating the sale agreement. As stated above, a heads of agreement which sets out the key commercial terms is useful. However, if there is no heads of agreement in place, our experience is that the parties having at least an informal understanding of how key commercial issues will be dealt with, will make the negotiation and finalisation of the sale agreement a more efficient and cost effective process.

Bridging the price gap

Given that in the current climate valuations are a moving target and earnings are volatile, purchasers and vendors are often not on the “same page” when it comes to talking price. It is therefore important to look at ways to structure deals to ensure that the price expectations of both parties can be met. Common ways of achieving this are earn outs, the vendor retaining part of the equity post acquisition and/or the vendor financing part of the purchase. In any of these scenarios, the vendor takes the risk on the purchaser’s operation of the business post-completion.

Earn outs require the purchaser to pay the vendor an additional amount if the business performs as specified after completion. For example, payment of an earn out will follow the achievement of target earnings. Earn outs enable the parties to complete a transaction where there is a difference of opinion on the value or future prospects of the business. Earn outs can be complex to draft as the parties will want to clarify what changes in the business should or should not impact the target earnings figure e.g. should new head office costs allocated to the acquired company by a purchaser be added back, etc.

While potentially complex, there are a number of advantages for both parties in considering an earn out structure. For example, the vendor has the potential to receive a higher purchase price, while the purchaser ensures that the price they pay for the business is directly linked to post-completion performance.

To consider an earn out, the vendor must be confident in the future performance of the business. In our experience, the best outcome for vendors is where they will continue to have significant influence over the performance in the business going forward, for example, by continuing in an management position.

Another option to help bridge the price gap is vendor finance. This involves the vendor effectively part funding the purchase price by means of a loan to the purchaser (from the sale proceeds the vendor receives for the business). The main issue that we see with vendor loans is that the vendor’s security for its loan will generally be a second ranking general security which ranks behind, and subordinate to, the security of the purchaser’s bank. It is important that the vendor understands, from the outset, that this means that its rights rank behind the purchaser’s bank in all respects. In this scenario, the vendor is obviously taking a gamble on the purchaser’s ability to successfully operate the business going forward so that the vendor’s loan can be repaid in the agreed time frame.

Conclusion

There have been significant changes to deal dynamics in recent times. Our considerable experience in acting for both vendors and purchasers in this changing environment ensures our clients get the best advice on how to get deals done.

Do you need expert legal advice?
Contact the expert team at Hesketh Henry.
Kerry_100x100 1
Media contact - Kerry Browne
Please contact Kerry with any media enquiries and with any questions related to marketing or sponsorships on +64 9 375 8747 or via email.

Related Articles / Insights & Opinion

Don’t Let Your Guard Down
The risks arising from the use of unguarded machinery are well-known to the point of being blindingly obvious.  The measures to ensure the safe operation of machinery are usually straightforward.  W...
19.02.2019 Posted in Health & Safety Law
CONSTRUCTION CONTRACT REFORM: Ten Guidelines the Government could Adopt
“We need to lead by example and if there are things that we can do to take a leadership position with that industry then we should be.” Prime Minister Ardern[1] As 2018 draws to a close a...
21.12.2018 Posted in Construction Law
Nearly there! Only a few days of 2018 left!
Just a quick note from the Hesketh Henry Employment team about what’s on the horizon:
18.12.2018 Posted in Employment Law
When did you last have your Ts & Cs reviewed?
The Commerce Commission recently announced that, after its investigation of jeweller Michael Hill Limited, the company was fined $169K for breaching its obligations in relation to the extended warrant...
13.12.2018 Posted in Corporate & Commercial law
Time for Change (again!)
The winds of change are once again blowing through the employment law landscape.
10.12.2018 Posted in Employment Law
Summer Maritime Update
Welcome to our summer maritime update - November 2018
27.11.2018 Posted in Maritime Law
Employment Litigation Costs: In for a penny, in for a pound?
Vindication is frequently offered as a motivation for litigation.
Send us an enquiry
For expert legal advice, please complete the form below or call us on (09) 375 8700.
  • This field is for validation purposes and should be left unchanged.