A merger can be a time-consuming and laborious endeavor. Before business parties spend the bulk of the time and incur the bulk of the transaction costs that are necessary to consummate a deal, it is usually prudent to ensure that they have a general understanding of the key terms on which their efforts will be based. A well-drafted letter of intent, or term sheet, is essential to achieving this understanding.

The letter of intent summarizes the central terms of the deal. These terms usually include some or all of the following: legal parties to the transaction; price; form of consideration to be paid by the buyer (e.g., cash, stock, debt, or some combination of the three); legal structure of the transaction (e.g., stock purchase, asset purchase, statutory merger); general description of assets purchased and liabilities assumed or excluded (if asset deal); expected tax consequences; key personnel issues; important technology matters; regulatory requirements (e.g., antitrust approval, SEC filing requirements); certain contingencies (e.g., due diligence investigations, board and shareholder approvals); any escrow arrangement and holdback of a portion of the consideration; and a handful of other terms.

The letter of intent is usually not the final, binding merger agreement between the parties. Instead it provides a roadmap for the parties to negotiate, draft, and sign a more detailed, definitive merger agreement that will serve as the binding contract for the deal.

However, it’s common for the letter of intent to nonetheless contain a few binding terms. For example, the buyer may seek a binding “no-shop” provision which prohibits a seller under certain circumstances from negotiating with other prospective buyers during a limited period of time while the current buyer attempts to get the deal done. The seller may in return seek a fiduciary carveout to ensure that its board of directors can comply with its fiduciary obligations when considering the sale of the business. Other terms may be binding such as expiration date of the letter and selection of the state law that will govern the binding terms.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 1: Introduction

Mergers & Acquisitions Primer | Part 2: Overview of the acquisition process

Mergers & Acquisitions Primer | Part 3: Nondisclosure Agreement

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Most businesses should enter into a tailored nondisclosure agreement (NDA) before sharing confidential information and entering into substantive merger discussions. The seller usually is the party who has the most at stake since the seller usually provides the most information about its business.

However, in some cases, it is equally important for the seller to obtain certain confidential information about the buyer. For example, in cases where the buyer is a privately-held company and is offering its own stock or long term debt as part of the consideration, the seller will want to obtain confidential information about the buyer’s business. In these cases, the seller is essentially making an investment decision to buy stock or debt of the buyer in exchange for the seller’s business.

A tailored NDA will define confidential information for the parties (with appropriate carveouts), restrict the use and dissemination of confidential information, govern what happens to shared confidential information upon any termination of the merger discussions, address any applicable export compliance matters, and contain disclaimers, injunctive relief provisions, and other terms appropriate for this type of NDA.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 1: Introduction

Mergers & Acquisitions Primer | Part 2: Overview of the acquisition process

Mergers & Acquisitions Primer | Part 4: Letter of Intent

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Federal and state laws govern the issuance and sale of securities by a business. If the instrument being issued or sold is not a “security”, the securities laws do not apply. A key question, then, is whether an instrument that a company is issuing or selling is a security. Both federal and state laws define a “security” and those definitions largely overlap. The definitions are lengthy and include numerous types of instruments, but in this Securities Law Primer we’ll identify some of the most common types.

A security includes those types of equity instruments which are commonly understood to be securities, such as common stock and preferred stock. A security also includes notes, bonds, and any instrument that is convertible into a security, such as an option to buy a share of common stock (i.e., a stock option), a warrant to purchase a share of preferred stock, and a promissory note that is convertible into stock.

A security encompasses any agreement to sell a security. For example, an owner of corporation sends a simple letter to a prospective employee that states, “Come work for my company and in one year I’ll sell you 20% of the company.” The prospective employee accepts. That letter is itself a security because it includes the right to buy an equity interest in the business.

Finally, federal and state laws include catch-all definitions. Under both federal and California law, an arrangement is a security if it is classified as an “investment contract”. Under California law, an arrangement is also a security if it meets a “risk capital test”. Several factors are analyzed to determine whether an arrangement satisfies the investment contract or risk capital tests, but essentially, these tests are met if a person gives money to another person for use in a venture or enterprise and any return or growth in the value of those funds are dependent primarily on the efforts of someone other than the person who gave the money.

The broad scope of what constitutes a security is intended, in the words of a seminal Supreme Court case, “to meet the countless and variable schemes devised by those who seek the use of the money of others.” (SEC v. W. J. Howey Co., 1946)

A common question is the extent to which interests in partnerships and limited liability companies constitute securities. The answer generally depends on whether the particular interest is accompanied by management responsibility of the business. Thus, a general partnership interest is typically not a security because the interest holder is usually responsible for the operations of the business (along with other general partners). On the other hand, a limited partnership interest is most always a security because limited partners do not have management responsibility in the partnership. An interest in a member-managed LLC, where all members in fact participate in the management of the business, is treated like a general partnership interest and generally is not a security. Whereas, an interest held by a non-manager in a manager-managed LLC is treated like a limited partnership interest and is usually a security.

Other posts in this series (more to come):

Securities Law Primer | Part 1: Applicability of securities laws

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Buyers and sellers of companies find one another through a variety of means. Frequently, executives at companies already know many of the businesses in the industry and can identify candidates with a few phone calls. Investment bankers and business brokers often are employed to find candidates. And sometimes a merger partner is identified when a business receives an unsolicited phone call from the prospective partner.

In the initial discussions, merger partners discuss overall interest in buying or selling, the strategic and technological fit, price, and a few other high-level matters. Basic information may be shared, such as financial statements, bookings, and app user adoption rates. Prudent businesses negotiate and execute nondisclosure agreements before sharing any confidential information.

If the interest of the parties is high enough to proceed, a written term sheet or letter of intent is usually the next step, along with the sharing of more information. The letter of intent will outline the key terms of the deal and frequently is not binding on the parties (at least for certain business terms).

In most cases, the buyer also undertakes a comprehensive due diligence investigation of the seller. If, during this investigation, no information is uncovered that impedes the deal or causes either party to walk away, the parties proceed to negotiate and sign a definitive acquisition agreement. If there are ancillary agreements that are part of the deal (employment agreements, escrow agreements, etc.), these are frequently negotiated and drafted as well.

Once the acquisition agreement is executed, the deal is not yet completed in many cases. Acquisition agreements frequently have delayed closings built into the structure of the deal. This delay is necessary to ensure certain conditions are satisfied prior to the transfer of the seller’s business. These conditions include obtaining approvals from the parties’ shareholders, government agencies, and certain parties with whom the buyer or seller have contracted. When these conditions are satisfied, the closing of the acquisition can occur. At the closing, the buyer delivers the consideration, any required ancillary agreements are signed, and legal title to the seller’s business passes to the buyer.

Finally, the parties integrate their companies to achieve the business purpose for the deal, taking into account their respective human resources, IT infrastructures, sales channels, accounting and financial systems, lines of businesses, and so on.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 1: Introduction

Mergers & Acquisitions Primer | Part 3: Nondisclosure Agreement

Mergers & Acquisitions Primer | Part 4: Letter of Intent

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