MODULE 3 UNIT 1

The private M&A transaction process

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Table of contents
1. Introduction 3
2. Overview of the mergers and acquisition process 3
3. Agreement on preferred deal structure 4
4. Preliminary agreements 5
4.1 Confidentiality agreement or non-disclosure agreement 5
4.2 Letter of intent 5
4.2.1 Deal terms to protect buyers and sellers 6
5. Due diligence 6
6. Contract drafting and negotiation 7
6.1 Acquisition agreement 7
6.2 Disclosure letter 8
6.3 Ancillary documents 8
7. Signing and closing 9
8. Conclusion 10
9. Bibliography 10

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Learning outcome:

LO2: Identify the key steps in the M&A process.

1. Introduction
So far in this unit, you have learnt about the three core deal structures used when planning
the transfer of a business or undertaking – asset deals, share deals, and mergers – as well
as the incentives and disincentives regarding their use. This lesson will highlight the key
steps in a private acquisition, including choosing the preferred deal structure; closing
preliminary agreements; completing the due diligence process; drafting contracts; and
negotiating, signing, and closing the deal. Private acquisitions are most commonly
structured as share deals. Therefore, this lesson explores the mergers and acquisition
(M&A) process through the lens of the share deal.

2. Overview of the mergers and acquisition

process
Every deal is different, and so is the exact process dealmakers go through to secure them;
from identifying a potential opportunity for a transaction, to eventually closing the deal.
Nevertheless, whatever the specifics of the deal, the parties almost always go through a
series of key steps. As such, it is worth exploring the process of a typical private acquisition
to better understand the sequencing a dealmaker is most likely to encounter in real life.

Figure 1 illustrates the five key steps in the private acquisition process. The following
sections will explore each step in more detail.

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Figure 1: The key steps of a private M&A transaction.

3. Agreement on preferred deal structure

Once an opportunity for a deal has been identified – whether by the prospective buyer or
the seller – the first step is often a discussion of the possible deal structure. This will
typically involve considering the acquisition methods discussed in the previous set of notes:
share deals, asset deals, and mergers or other merger-like structures.

First, it is important to address the following questions:

• Is a share deal the right way to sell or buy the business?

• Are there reasons to prefer an asset deal?

• Can a merger, or other merger-like structure, be used?

To decide on the best structure, the parties will look at a range of different factors. These
include assessing whether the target business is currently operated as a single, stand-
alone company or whether the business is more complicated. For example, the target
business may be owned by a company that also owns other businesses that are not up
for sale.

The following important questions should be addressed when considering these factors:

• Is there only one seller, or does the target company have a more complicated
shareholder structure?

• What are the tax consequences of a share deal as opposed to an asset deal?

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• Is the deal subject to regulatory approvals, such as competition or anti-trust,

clearance?

• Are there liabilities of the target company that are difficult to identify or quantify?

The preferred deal structure may also depend on how the acquisition will be financed by
the buyer and the type of buyer (e.g. a strategic vs a financial acquirer).

4. Preliminary agreements
Before negotiations between the buyer and the seller can start in earnest, the seller will
almost always require that the prospective buyer sign a confidentiality or non-disclosure
agreement (NDA). The seller will often also request that the buyer sets out its intentions in
a preliminary, non-binding agreement or letter, commonly referred to as a letter of intent
(LOI), heads of terms, or memorandum of understanding (MOU).

4.1 Confidentiality agreement or non-disclosure

agreement
The aim of an NDA is to ensure that information that the buyer obtains during the
acquisition process is only used for the purpose of deciding on whether or not to proceed
with the deal. This is particularly relevant where the seller and the buyer are also
competitors. Here, the seller will be concerned that the buyer could use commercially
sensitive information to gain a competitive advantage if the deal ultimately falls through.
Moreover, the seller (and sometimes the buyer) often wants to ensure that the negotiation
of a potential deal does not become public, as this can affect its relationship with customers
and suppliers who may want to hold off on doing business with the target until its future
becomes clearer. Leaked information about the deal can also affect a company’s
employees, who, for instance may then be more likely to look for alternative employment
opportunities given the uncertainty associated with a possible acquisition.

4.2 Letter of intent

The purpose of an LOI is twofold:

1. It shows that the buyer is serious about the possible acquisition and sets out the
key terms under discussion – most importantly, the preliminary valuation or the
price for the target. There is no point in spending significant time, accruing costs,
or expending effort in the process of preparing a deal if there is no overlap between
each party’s idea of a viable price for the target.

2. It often contains some general statements about the structure of the deal, including
the type of acquisition, the valuation method and pricing mechanism to be used,
and the nature and scope of the due diligence.

Although LOIs are generally explicitly non-binding (they do not create an obligation for
either party to proceed with the transaction), they set out a roadmap for the deal and create

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a reference point for future negotiations. Dealmakers will often find it difficult to change
their minds on the key deal terms summarised in an LOI, unless something unexpected is
uncovered during the due diligence process. These preliminary agreements,
unenforceable as they may be, create a form of moral obligation to stick with the agreed-
upon terms as the parties proceed with their negotiations.

4.2.1 Deal terms to protect buyers and sellers

The letter of intent may include specific terms to protect the respective interests of the
buyer and seller, namely periods of exclusivity, agreed-upon break fees, and statements
about an auction structure:

• Periods of exclusivity: The buyer and seller may agree to a period of exclusivity,
during which the seller will not negotiate the sale of the target business with any
other potential acquirer. From the buyer’s perspective, an acquisition requires
significant investment: the buyer needs to pay for lawyers, financial and business
advisors, and importantly, often devotes valuable management time to assess the
potential acquisition. Such investment is less justifiable if the buyer knows that the
seller may also negotiate with others or even just use the buyer’s interest to entice
another suitor.

• Break fees: The seller may agree to compensate the buyer for the sunk cost of a
failed deal by agreeing on a break fee. This fee refers to a sum payable to the
buyer in the case that the transaction cannot be completed because, for example,
the seller finds another buyer willing to pay more.

• Auction structures: Where the seller wants to solicit offers from a wider range of
potential acquirers, the sale can also be structured as an auction. Here, the seller
makes it clear from the outset that there are many potential buyers. To address
each buyer’s lower likelihood of success due to the number of potential buyers, the
seller often structures the process in a way that minimises the initial investment
buyers need to make to assess the transaction (by having the seller’s advisors
prepare detailed and accessible information for the buyers to use when deciding if
they are interested), before narrowing down the field after an initial round of
indicative bids.

5. Due diligence
Once the preliminary agreements have been finalised, the buyer will almost always
conduct its due diligence in relation to the target. Due diligence in M&A transactions refers
to the process by which the buyer gathers the information it needs about the target
company in order to:

• Decide whether to proceed with the deal;

• Determine the purchase price it is willing to pay; and

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• Scope out the terms it negotiates in the acquisition agreement. Such terms include
the necessary warranties, representations, and indemnities, which are contractual
devices used to guarantee the truth of certain statements made in a contract or
agreement. These terms are explored further in Unit 2.

A key purpose for the buyer is to identify the main risks (whether legal, commercial, or
financial) that the target company is subject to. The buyer will demand that the seller
provides either warranties, or representations, or both, as to the status of the target.
However, the buyer does not want to rely solely on the right to sue the seller for damages
should the warranties or representations prove to be false once it becomes aware of
problems after the acquisition. Suing the seller after acquisition may be difficult in practice,
and, as such, it is best to investigate as many problems and risks as possible before signing
off on a deal.

The exact nature and scope of due diligence depends on the target company, but in a
typical deal, separate teams look at the legal, financial, and commercial affairs of the target
company. The target or the sellers (or both) usually provide documents for this purpose in
a virtual data room (VDR) – an electronic database of documents and other data about the
target company.

In addition, the target company (and the seller) usually make some key personnel, such
as senior managers and technical staff, available for interviews to give the buyer an
opportunity to get a deeper understanding of the target. There is also a process for raising
questions that arise during the due diligence.

6. Contract drafting and negotiation

After – and often during – the due diligence process, the buyer and seller will start
negotiating the acquisition agreement and preparing other documents. This section covers
the acquisition agreement, disclosure letter, and ancillary documents.

The acquisition agreement is the contract that governs the purchase of shares in one
company by another company. The disclosure letter is a document prepared by the seller
that provides the buyer with specific facts and promises regarding the target business in a
private acquisition. In addition to these documents, further ancillary documents may be
used to record different aspects of the business.

6.1 Acquisition agreement

In the case of a share deal, the acquisition agreement is commonly referred to as a share
purchase agreement (SPA). Nowadays, in many jurisdictions, these documents are fairly
standardised, i.e. large parts of the SPA will be boilerplate text that any experienced
dealmaker would expect to find in any acquisition agreement. However, given the
importance of the SPA for the parties, the necessary adaptations of the agreement are
heavily negotiated. This negotiation process is influenced and informed by the due
diligence process. The buyer wants to ensure that any risks identified during the due
diligence process are addressed in the SPA, and the seller wants to make sure that the
allocation of these risks is balanced and reflected in the agreed-upon purchase price.

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It is quite common for the buyer to provide a first draft of the SPA to the seller, setting out
the buyer’s desired structure and risk allocation. This draft is then amended and
commented on (or “marked-up”) by the seller – a process then repeated by both parties
until an agreement is reached. However, where the sale is structured as an auction, the
seller provides a draft SPA to all potential buyers. This not only reduces the up-front
investment each buyer has to make; it also ensures that offers from different buyers are
more readily comparable.

6.2 Disclosure letter

As part of the SPA, the seller often also prepares a disclosure letter. The purpose of the
disclosure letter is to qualify the warranties or representations (or both) given by the seller
in the SPA. In the disclosure letter, the seller sets out the facts and circumstances that it
has disclosed to the buyer during the due diligence process. A disclosure letter may be
necessary because if relevant facts are not disclosed during the due diligence process,
and are subsequently discovered by the buyer, this could give rise to a claim under a
warranty or representation.

For example, the seller may warrant in the SPA that the target has operated in compliance
with all applicable laws and regulations and then disclose against this warranty known
instances in which the target had breached a particular tax law. The buyer would then be
prevented from making any claims based on such a breach. In other words, the buyer will
not be able to bring a claim against the seller that the business has breached that tax law
because the seller has duly disclosed this. Therefore, the warranty in the SPA stating that
the target has complied with all applicable laws excludes this disclosed instance.

While standard in UK transactions, a separate disclosure letter is less common in some

jurisdictions (e.g. Germany and France). Instead, warranties and representations are
typically qualified with information disclosed (or “fairly disclosed”, i.e. disclosed in sufficient
clarity) in the VDR.

6.3 Ancillary documents

Apart from the SPA or other acquisition agreements and (when necessary) the disclosure
letter, the parties may also make use of a range of ancillary documents as part of the deal.

These may include the following documents relating to different aspects of the target
company:

• Agreements addressing specific financing arrangements of the target

company: These agreements are necessary when the seller needs to release the
target company from some liability or to release security.

• Escrow agreements: An escrow agreement is used when part of the purchase

price is to be conditionally held back to ensure, for example, that any post-deal
indemnification claims made by the buyer under the SPA will be satisfied.

• Transitional service agreements: This type of agreement is used when the target
business is an integral part of the seller’s other businesses, and the buyer will need

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to continue using some services provided by the seller, such as distribution or

warehousing services, until it can make alternative arrangements.

• Consultancy agreements with the sellers: A consultancy agreement is

necessary when the sellers’ expertise is needed in the target company to ensure a
smooth transition.

Definition: escrow agreement

An escrow agreement or provision allows for a third party to temporarily hold a sum of
money in an escrow account until a certain condition is fulfilled. In the case of M&A
transactions, this escrow account is a separate account funded by part of the purchase
price that the parties establish on the closing of a transaction.

The escrow provides security for the buyer that there will be resources to pay for the
sellers’ post-closing obligations. For example, the seller may need to use the escrow
account to pay for the post-closing crystallisation of target liabilities or liability arising
from a breach of a representation or warranty. Escrow provisions are covered in further
detail in Unit 3.

7. Signing and closing

Depending on the nature and complexity of the deal, signing the SPA (and any ancillary
agreements) may either immediately give effect to the deal, or there may be some time
between the signing and the completion or closing of the transaction.

While it is generally easier to have the signing and completion happen at the same time,
this is not always possible. There may be legal obstacles in the way of an immediate
completion; for example, delays may occur where the acquisition is subject to approval
from competition authorities or is subject to foreign investment control rules.

It may also be the case that the parties agree that some other steps must be completed
before the deal can become effective. Some of these steps may require consent by third
parties, the transfer of intellectual property rights, or a reorganisation of the target
company, which the seller would not want to action without certainty about the agreed-
upon deal. In these cases, the signing of the SPA will not yet lead to a change in the
ownership of the target company shares (or the target business, in case of an asset deal).
This will only happen once all conditions for the completion or closing have been fulfilled,
at which point a separate meeting will typically take place. At this meeting, the parties will
document the completion and effect the transfer of the shares in the target company (or
the transfer of the ownership of the target business).

Test your knowledge of the private M&A transaction process in the quiz questions that
follow.

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Please note:

At this point in the lesson, you have the opportunity to engage with a practice quiz to
test your understanding of the content. Access this lesson on the Online Campus to
engage with this quiz.

8. Conclusion
This lesson outlined the process of a typical private acquisition through a share deal,
including the decision around the preferred deal structure, preliminary agreements, the due
diligence process, contract drafting and negotiation, and signing and closing.

Unit 2 explores the structure and core components of private M&A contracts and the use
of risk allocation devices as they relate to a typical merger transaction.

9. Bibliography
Choi, A.H. & Triantis, G. 2020. Designing and enforcing preliminary agreements. Texas
Law Review. 98(3):439-488. DOI: http://dx.doi.org/10.2139/ssrn.2977676 [2021,
July 12].

Coates, J.M. 2018. Mergers, acquisitions, and restructuring: types, regulation, and
patterns of practice. In The Oxford handbook of corporate law and governance.
J.N. Gordon & W.G. Ringe, Eds. Oxford: Oxford University Press.

Herington, M., Scott, D. & Donaghey, J. 2013. M&A due diligence: evolution and current
trends. Available: https://uk.practicallaw.thomsonreuters.com/1-547-
7845?transitionType=Default&contextData=(sc.Default) [2021, July 12].

Hwang, C. 2019. Faux contracts. Virginia Law Review. 105(5):1025-1078. Available:

https://www.jstor.org/stable/26842261 [2021, July 12].

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