In Part 2, we looked at:
- Pre- due diligence
- Due diligence
In this part, we will look at the pre-completion phase.
During the period leading up to completion of the transaction, detailed legal and financial negotiations continue. Deal documentation is revised in detail in order to flesh out and document more fully the headline deal which was agreed in the heads of terms(*).
The lawyers will focus on the precise legal terms and, in particular, the nature and scope of the contractual protections to be afforded to the purchaser (which will include the warranties and indemnities and non-compete undertakings). There will also be negotiations around the limitations to the seller's potential liability in respect of any breach of those contractual provisions.
The negotiations will be informed by what is coming out of the legal due diligence review(*), and those findings will be checked against the seller's disclosure letter(*). The legal process inevitably involves some legal negotiations which can largely be handled by the lawyers who - with the right experience - should know where the "normal" areas of disagreement will arise. However, there will certainly be commercial points to be discussed between the parties and the lawyers need to work together constructively to find those points as soon as possible so the deal principals can find a path through the outstanding points.
Similarly, the finance teams will focus on key financial aspects of the deal and this process will be informed by what is coming out of financial due diligence. Negotiations around the actual price to be paid at closing will commence and this time is often the most intense period of deal-making.
It is often the case that an overall price will have been agreed in the heads of terms, but that price will have been offered on the basis that it does not include cash, has not allowed for any debt, and assuming that the business will be acquired with a "built in" level of normalised working capital(*), such that the purchaser will not immediately be faced with a funding shortfall to be filled from its own reserves (but having paid a full price). The phrase most commonly used is "cash free, debt free and with a level normalised working capital"(*).
There is, however, no strict legal or finance definition of what these items actually include, but the experts and advisers can offer their experience-based opinions. Although cash is usually simply cash in the target business' bank account, the meaning of "debt" is certainly more elastic. Often, the finance experts for the purchaser will look to include as many "debt like" items as possible in the definition in order to bring the actual price to be paid down and the finance experts for the seller will be seeking to keep the "debt like" items down to a minimum in order to avoid the headline price being reduced too far. The seller is looking to avoid a purchaser including the debt equivalent of the kitchen sink.
These negotiations inevitably involve an element of compromise and much will depend on the relative bargaining strength of the parties. Similarly, what the amount of normalised working capital is (and consequently how much is required to be left in the business at completion) will be a matter of opinion and will vary from business to business. Again, analysis and informed negotiation will usually be required before an agreed amount can be struck.
So, you can see that the price which has been "agreed" in the heads of terms (often an enterprise value which will be based on a multiplier of earnings) will often be the subject of intense negotiations. The resulting figure to be paid at completion could be quite different from the headline price. Experienced financial support is invaluable at this stage in a deal to avoid disappointments on either side.
Often, there will be a means for both parties to check what levels of cash, working capital and other assets were acquired at completion, since trading does not stop for even the most important legal processes. The parties will require to agree a contractual mechanic for agreeing adjustments to the price to be paid at completion based on actual levels of cash and actual levels of working capital or net assets, and usually this is done via completion accounts - a process whereby the actual numbers are all checked retrospectively following completion and appropriate adjustments made to "true up" projected figures contained in the deal documentation against actual figures on the day that completion took place.
During the pre-completion period, the deal will need to be managed to make sure that all the plates are spinning and none drop. Often, the management process is undertaken by a combination of the lawyers and the accountants. We would always look to ensure that an updated deal delivery schedule is maintained, such that the status of each legal document or other moving piece in the deal is known and understood by all the parties. Once a deal has momentum, it can be damaging to be derailed by an item or a process that has been left behind by mistake.