Importance of exclusivity/ No Shop Provisions in a M&A transaction

Introduction

  1. M&A as a process is a costly and time consuming activity that involves third party consultants, investment bankers and attorneys. Hence the buyer and seller in the transaction would prefer to have a preliminarily agreement in place at the starting of the transaction on how the deal will be negotiated and proceed further.
  2. Once the buyer receives the detailed CIM(Confidential information memorandum) document of the seller, the buyer performs a target evaluation of business operations along with the preliminary valuation of the target business based on the financial information shared by the seller in the CIM.
  3. Once the buyer is convinced about the strategic rationale of the proposed deal along with synergy alignment, it shares a non binding indicative offer/bid to the seller in a Term sheet or Letter of intent to the seller.If the seller conducts an auction process for the deal where more than one buyers are involved in evaluating the deal, then the seller will choose the best possible offer from the available options.Once the seller agrees to the purchase price and on the deal structure, the seller invites the buyer to conduct a detailed due diligence of its operations.
  4. It is be to known that till this time, the seller has more bargaining power over the buyer on choosing the best offer.

Inclusion of No Shop provisions in Term Sheet

  1. The term sheet in addition to the deal structure and the final purchase price also include the confidentiality and exclusivity clauses.These provisions are binding and enforceable.
  2. The no shop provisions are generally more prominent in middle market private M&A transactions. The exclusivity provisions are generally demanded by the buyer.The no shop provision clauses state that the seller shall give exclusive access to the seller financial and business data for the buyer to conduct detailed due diligence on the target business operations for the buyer to confirm if its purchase price is in alignment to the value it is looking at.During this time period, the seller shall not be involved in soliciting or negotiating any competing offers from other bidders till the buyer completes performing the due diligence.
  3. The reason why the buyer asks for exclusivity provisions is because the buyer does not want to spend time and money on resources for the deals which is not certain to get closed.In addition, there is also a chance that the seller might get a bigger bid from third parties which shall force the buyer to increase its offer price.The buyer does not want to create a competitive bidding and instead would want to focus all his efforts on due diligence.
  4. The seller on the other hand can reject the buyer demand for exclusivity. This is generally done by the sellers who enjoy a higher leverage or bargaining position due to the attractiveness of their business.
  5. Another scope for negotiation in exclusivity clause is to decide on the time period that the exclusivity shall be adhered to.The seller would like to negotiate for a shorter time period of 2 weeks where as the buyer would like the exclusivity period to be extended till 6 months.The ideal time period should be 60 days.This time period would be enough for the buyer to conduct the due diligence and then confirm back to the seller if it wishes to proceed further or terminate the deal.
  6. The reason the seller would want the exclusivity time period to be as short as possible is because it loses the opportunity to engage with prospective bidders and investors during this time period.There is also no certainty that the buyer will proceed further.Hence in order to compensate this opportunity loss as well as the additional costs that seller has to incur to have its resources ready along with uploading documents in the data room, the seller would request the buyer to provide a refundable deposit which shall be returned if the buyer proceeds further.The negotiations to decide on this fee and also who is responsible for the termination will be extensive and can result in further time delays.Hence this practice is generally not followed in most deals.
  7. Alternatively the seller in order to protect itself shall include milestones covered in the exclusivity clauses which generally states the list of activities to be completed in specific time period.For instance if the exclusivity period is 60 days, then the milestones to be completed within those 60 days needs to be stated like: due diligence should be completed in 20 days, the final offer price based on due diligence report needs to be completed in 30 days etc. This would convince the seller that buyer is committed in closing the deal.Alternatively, if most of the milestones are not achieved, then the seller can terminate the exclusivity clauses early.In some other cases, the buyer would be committed to closing the deal, but would end up taking more time than the timeframe in the exclusivity clause.In these cases, the buyer can extend the exclusivity period at no cost and the seller should agree to the same as it knows that the buyer is acting in good faith in order to close the deal.

Break up fees and other Deal Protection clauses

  1. After the buyer completes conducting due diligence and comes up with a final offer which the seller agrees, then the drafting of definitive agreement would begin.By this time, the exclusivity period ends and the seller can start negotiating with other bidders for higher price.There is also a chance that the seller can proceed with another bidder giving a higher offer and terminate the deal with the current buyer.In order to prevent this situation to happen, the buyer would impose a break up fee on the seller in case the proposed acquisition fails to get consummated and the seller proceeds with another buyer.This break up fee would be around 3-4% of the total purchase price.
  2. For instance when Microsoft acquired LinkedIn, Microsoft proposed a break up fee of $725 million on LinkedIn, if linkedin chooses to be acquired by another bidder.The primary reason for Microsoft to have a breakup fee is to prevent Salesforce to solicit LinkedIn with a higher offer.Inspite of this, Salesforce came up with a higher bid and Linkedin had to inform Microsoft about the offer. So Microsoft had to revise its offer to satisfy the LinkedIn shareholders as shareholders prefer bidders with highest offer price in order to generate maximum returns.

Why Exclusivity clauses is not applicable for Target companies that are public?

  1. No shop provisions is not valid for target companies that are public.The board of public companies have a fiduciary duty towards their shareholders that the final offer price chosen is the best price.Hence post the signing of the deals and before closing, the board can still evaluate offers with higher prices from rival bidders.So even if the target management has signed a no shop provisions with buyer, it shall not be valid.This is generally incorporated by including a fiduciary out clause in Term sheet.

Other Deal Protection clauses for Buyer

  1. The buyer can also try to include other deal protection clauses in the term sheet to prevent rivaling bids from its competitors.
  2. Lock ups – The buyer shall choose to acquire a part of the target company or acquire its assets so that it is in a better advantage when there is a higher bid from its competitors.As the buyer owns a part of the target company, the buyer can resist the rival offer.
  3. Recommendation agreement – The buyer can request the target board to recommend its bid to target shareholders for their approval.This again is subjected to fiduciary responsibilities of board towards its shareholders.

Conclusion

  1. Request for exclusivity provisions by the buyer in the term sheet is common in middle market Private M&A transactions.The reason for having a No shop clause is to indicate that buyer and seller are committed to get the deal closed.So unless there are some serious issues identified in the due diligence by buyer, both the parties should work with an intent to close the deal.
  2. The no shop clause is not valid for public companies as the board of the target company has a fiduciary duty towards choosing the highest price irrespective at which stage the higher bid is coming.
  3. Both the parties can include key clauses like Breakup fee and refundable deposit to mitigate their risks in the event of the buyer/seller not showing intent to close the deal.
  4. The exclusivity clauses form a binding part of the term sheet and can be enforced by either parties in event of the breach by other party.


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