Winston WONG (1 May 2024): Joint Venture Series (Part Two of Three)
In the course of building a business, or an idea, or the worldwide version of a regional operation, one key approach is the inorganic. The three-letter acronym SPA is the legal piece of the acquisition jigsaw. It is surely not the central piece, but nearby. Brokers, private equity, stock markets, due diligence, FRS, integration, post-completion earn-outs, key personnels, employee stock options, non-competes – all pieces that fit together on the way to the conclusion of a successful acquisition.
PART TWO OF THREE
Experience tells us key elements of the Share Purchase Agreement, or SPA for short, are the warranties, disclosure letter, and conditions precedent. This Part Two will focus on the sale consideration, and uncertainties in the course of acquisition.
Sale Consideration
It is easy to overlook the diversity of options available to the buyer. Sale consideration can be in cash, in shares of the future holding company of target company, or some other share consideration, depending on its business structure. Where the target company is part of a larger operation, whether in product mix or operating territory, the shares of the prospective holding company holds the key to fidelity of Target Company’s existing team. The appetite of seller to accept the holding company can be a reveal of one’s confidence in the future business and cash position of Target Company.
The use of options can overcome tax concerns, or ensure allegiance of the wider key employee group. One can also employ the use of profit target, or territory-centric sales revenue-based KPIs in phased consideration pay-outs, or even calculation and re-calculation of sale consideration. This can be juxtaposed with clawbacks, bonuses in crafting the tone for the next two, three years post-acquisition.
In drafting the cash-share composite, it is essential to consider the valuation mechanism of the shares component. Some effort should be put – the mechanism can be defined by reference to the average value of emission of shares over a time period. Which time period, and how long? The use of the last issued share price is advantageous over the use of average emissions, but depends on how often emissions occur. One could utilise adjustments of the last issued value with published indexes.
The payment schedule of phased earn-outs warrants attention. KPIs utilised for earn-outs can be drafted as subject to adjustments, normalisation. These adjustments could take time to complete, especially if they could be subject to negotiations between buyer and seller at the relevant time of earn-out. In this case, earn-outs could be possibly delayed, and substantially, in the case where KPIs are subject to dispute resolution mechanisms like adjudication by a qualified valuer.
The Uncertainty Principle
It is basic tradecraft of a lawyer to engage with uncertainty uncovered in a due diligence investigation. We set out to bolster representations and warranties, word disclosure letters, create conditions to a share purchase. There is vast universe in the labyrinth of language within the pre-completion obligations, completion checklist, warranties, post-completion warranties, general indemnities, definition of “Loss”, “Claimee”, and such as, closing indemnities, tax indemnities, earn-outs, earn-out clawbacks, payment schedule adjustments, valuation dispute resolution options.
Case in point: How do we deal with a jurisdiction with no litigation search possibility? There should be time spent thinking out implications of such a scenario. Some are as follows: Contingent liability for events up to 6 or 12 years prior acquisition. What are these events? This could include criminal prosecution for operational lapses, employee excursional sprees, tax liberties, kickbacks to secure contracts, licensing deficiencies, grossly negligent service. Next, allocate monetary values, probabilities, and assign the relevant section of the SPA to restructure the risk back onto the seller.
Closing
It is certainly not the role of the lawyer to determine whether the end justifies the means, but squarely it is within his aptitude to create the means to a successful acquisition. The completion of an acquisition is not the job well done. It is the smooth plain, uneventful years ensuing that is.
Our Team
Do not hesitate to reach out to the Flint & Battery transactions team. Our team is bolstered by CICERO colleagues and their extensive international experience and capability in the US, Europe, and Asia.