In June this year Atlassian Corporation Plc, the NASDAQ-listed tech unicorn valued at US$31 billion, took the highly unusual step of publicly releasing its preferred terms for future corporate transactions. The “Term Sheet” sets out the key terms and conditions upon which Atlassian will look to acquire other software companies going forward – declaring Atlassian’s position, upfront, in relation to some of the most heavily negotiated items in a typical corporate acquisition.
Atlassian boasts a consistent record of significant corporate acquisitions, securing ownership of Cenqua (2007), BitBucket (2010), HipChat (2012), Trello (2017), OpsGenie (2018), AgileCraft (2019) and others for combined acquisition value of more than US$1 billion.
In a sense, one shouldn’t be surprised at such a manoeuvre being made by a company as innovative and commercially progressive as Atlassian. The company has a strong reputation for implementing cultural shifts ahead of market norms, including a recent overhaul of its performance review process to reward culture contributors over technical performers.
Nevertheless immediate questions come to mind: why has Atlassian taken this step and what are pros and cons in doing so?
What does the Atlassian Term Sheet say?
The Term Sheet covers off the usual big-ticket items that are applicable to almost all corporate mergers and acquisitions (M&A) such as the:
- purchase price (and any adjustments thereto);
- transaction documents that will be required;
- due diligence exercise to be undertaken by the buyer;
- non-compete restrictions that will apply to key individuals; and
- confidentiality and exclusivity arrangements.
On these items Atlassian’s position in the Term Sheet is quite conventional. However the Term Sheet provides greater insight into the following:
- Indemnities – Atlassian puts forward a very strong position regarding indemnities; in that all shareholders of the target company (including the holders of vested equity that will be cashed out at completion) will be required to indemnify Atlassian against any loss or damage it incurs resulting from a breach of representation, warranty or covenant under the sale agreement. This approach will be viewed as aggressive in some jurisdictions, including the UK, where an indemnity basis for damages is not the norm for domestic deals, but is increasingly accepted where there is a US buyer. In addition, it may cause particular concern in the private equity context, where UK private equity or institutional shareholders would typically resist the giving of warranties or indemnities outright (other than in relation to title to their own shares and their capacity to sign).
- Escrow amount – by reference to the purchase price, Atlassian offers sellers the option of (a) 5% escrow held for 15 months or (b) 1% escrow if the seller takes out warranty and indemnity (W&I) insurance to cover the remaining 4%.
- W&I insurance – all W&I insurance policy costs are to be borne by the seller – noting that if the warranties are being given on an indemnity basis (i.e. US style) for a UK deal, the insurance premium will be higher.
- Limitations on claims – the Term Sheet contains a detailed matrix of the limitations that will apply to claims under the sale agreement including: the type of claim; whether or not the tipping basket (which is set at 0.5% of the purchase price) applies; the liability cap amount; and the time period beyond which the ability to make a claim will expire. In keeping with M&A trends in the US, the Term Sheet distinguishes between “general” and “fundamental” representations (i.e. warranties in UK parlance). The liability cap for breach of a general representation is tied to the seller’s pro rata share of the escrow amount – whereas breach of a fundamental representation is tied to the seller’s pro rata share of the purchase price. Additionally the survival period for breach of fundamental representations is much longer (at least 6 years) than for breach of general representations (set at 15 months). This aspect of the Term Sheet alone is very likely to save time and cost at the negotiating table, particularly as fundamental representations aren’t extended to include IP, which many technology buyers push for.
- Rollover of part of the consideration – Separate from any share option pool, the Term Sheet envisages that “Core Employees” (likely to be management personnel) will reinvest a certain percentage of their sale proceeds into shares in Atlassian (known as rollover shares). Such rollover shares vest progressively over time starting with the first anniversary of completing the deal. This means that management will only see the economic value in those shares progressively, with accelerated vesting upon cessation of employment for certain good reasons. The Term Sheet is buyer-friendly in certain respects, but these provisions tend to be some of the most heavily negotiated in many buyout deals. Management would usually expect the rollover shares to have the same economic profile as the mainstream share class; and for the leaver provisions not to apply. In other words, vesting and leaver provisions would be reserved purely for any other shares received (e.g. under share options), known as sweet equity shares – but not apply to the rollover shares. Conversely, buyers (in this case Atlassian) typically want to ensure that management are incentivised to stay with the company post-sale.
- Employee termination – employee termination costs and payments will be deducted from the purchase price, even if termination is instigated by Atlassian.
On balance the Term Sheet is buyer-friendly, which is not surprising, but it is right to say that a fairness theme runs through the document. In briefing notes that accompanied the Term Sheet’s release, Atlassian signal their willingness to concede on issues that do not bear downside for the buyer going to value.
For example, Atlassian’s commitment to an escrow amount of 1% or 5% is grounded in historical deal analysis conducted by the company which indicates that the typical portion of the purchase price withheld by a buyer did not reflect the commercial risk they were assuming – and if the average indemnity claim was not even coming close to the escrow amount withheld then why not lower the amount from the outset.
Why take this step?
For one thing, Atlassian’s Term Sheet provides clarity.
Of course the Term Sheet is not exhaustive and there are key commercial questions left unanswered, including the depth of due diligence and the warranty package required from the seller. However with the Term Sheet to hand, potential sellers are under no illusions as to Atlassian’s expectations and have been given a very clear picture of what a corporate acquisition by Atlassian will look like.
One example of this is the ‘closing’ provision, which states that “in no event would the Closing occur during the last month of any Atlassian financial quarter” – a clear cut statement which allows all parties (and their professional advisers) to forward plan.
By releasing the Term Sheet Atlassian are promoting speed and efficiency in the M&A environment. With the exception of risk, deal timing (and the propensity for drawn-out negotiations and delay) is arguably the greatest bugbear for parties to a corporate transaction. Atlassian has sent a clear signal to the market that its priority is to cut down the number and impact of legal gremlins that inevitably find their way into transaction documents during the course of negotiations.
Atlassian has stated that fast-tracking early stage negotiations will, from the buy-side perspective, allow more time to prepare and assimilate the target company into the buyer’s existing business operations. This may be viewed by some as a lofty ideal, but surely any method by which corporate deal-making can be streamlined in a cost-effective and timely manner is worthy of consideration.
Given Atlassian’s prominence in the enterprise software market, the release of the Term Sheet imprints a set of benchmark terms for future acquisitions in this industry – all the while showcasing Atlassian’s appetite for further M&A activity.
What is a term sheet worth?
No matter the jurisdiction a “term sheet”, “heads of terms” or “memorandum of understanding” is typically non-binding – and while the ebb and flow of a corporate transaction will see departures from the term sheet it is common for the parties to gaze back and point to the term sheet as a negotiating tool.
We also know that the cold hard terms of the transaction are only one aspect of the M&A thought process. Other factors will weigh on the mind of buyers and seller, not least of all price – and a more lucrative offer, albeit on less favourable terms, will always merit consideration (if not favouritism). Nevertheless the term sheet establishes a framework for the deal and can often be used to ‘butter-up’ one or more of the parties to particular commercial terms which, if introduced later in the process, would cause backlash, a loss of goodwill and extended negotiations.
A thoughtful and tailored term sheet can set the tone for an entire transaction and focus the energy of principals and their advisers on the commercial points that matter most to buyer and seller.
Is it risky to make your intentions known?
Atlassian have stated that their Term Sheet constitutes a blueprint for all of the company’s software acquisitions going forward. This is bold commitment and although there are no legal ramifications if Atlassian were to step away from the contents of the Term Sheet such a move would clearly have a negative reputational impact. No doubt a significant body of thought by Atlassian management and its legal advisers went into the decision to publicise this document.
With this document to hand, the door is open for competitors to engage in one-upmanship, offering slightly improved terms to target companies. If Atlassian is offering the target 5% escrow held for 15 months then why not provide the same but at 4.5% or for only 12 months? Of course this tactic only goes so far and as mentioned above other factors, such as price, come into play.
Private M&A transactions, where the target company is not listed on a public stock exchange, will always unfold at the behest of the parties involved and there is no cookie-cutter approach that can be adopted from one deal to the next. Nevertheless release of the Term Sheet is a bold step that highlights Atlassian’s credentials as serial player in the M&A landscape. Any party of the size and gravitas of Atlassian is going to be in the driver’s seat from day one, however by publicising its approach to future transactions Atlassian has declared that it will prioritise efficiency and collaboration over excessive legal protections.