By Richard D. Harroch and Richard V. Smith
In any merger and acquisition (M&A) transaction, the seller’s senior management team is charged with maximizing the price and terms available to the shareholders of the selling company. Taking their direction from the Board of Directors—and with the assistance of the selling company’s legal and financial advisors—the senior management team is instrumental in landing and negotiating a deal that’s in the best interests of the company and its shareholders.
The management team should be aware of the key issues that will arise in attempting to get to a successful completion of an M&A deal.
If they are to continue on with the buyer, the members of the management team will also naturally have a number of questions as to how the buyer will treat the team post-closing with respect to compensation and employment incentive arrangements. Some of these questions will vary if the buyer is a private equity fund versus a strategic buyer. However, in order to avoid a potential conflict of interest claim, members of the management should be sensitive to the issue of when to ask some of their questions.
The following is a list of the key questions that the management team of a seller should consider in connection with a sale of their company.
1. Business Continuation and Strategic Plan Issues
The management team will want to understand the strategic plans the buyer is envisioning for the company, including:
- What is your overall strategic reason for the acquisition?
- How do you plan to support and grow the business?
- How do you plan to integrate the business with your other businesses?
- Do you envision any acquisitions to grow the business?
- What synergies do you see with your existing lines of business?
- How do you like to work with your management teams?
- What existing or new lines of the business do you see as ripe for growth?
- What areas of the business do you envision cutting back or eliminating?
- How long do you plan to hold the business before contemplating reselling it or taking it public?
- What layoffs do you envision, if any?
- What additions to the management team do you envision?
- Will you allow us to speak with the management teams of companies you previously acquired?
2. M&A Deal Issues
Senior members of management teams of selling companies want to obtain an early understanding of the deal dynamics and key issues involved in a potential acquisition. Some of the key questions that management will likely be interested in include:
- What acquisition structure are you contemplating? (Stock acquisition, merger, asset purchase? There will be differing tax consequences)
- What is the range of acquisition price you are considering?
- How do you determine valuation for your acquisitions?
- Are you envisioning any working capital or other adjustments to the purchase price? Debt-free/cash-free deal?
- What will be the consideration? (Cash, stock, note, or earnout?)
- Are you envisioning any escrow or holdback from the purchase price, or will you instead rely on M&A Representations and Warranties Insurance?
- What are the key due diligence steps you will need to undertake?
- How long will you need to complete your due diligence?
- What are the key conditions to closing that you envision?
- What employee interviews do you envision?
- Do you envision any customer calls?
- When do you anticipate issuing a letter of intent?
- How long do you expect it to take between signing a definitive acquisition agreement and closing?
- Will there be any particularly sensitive provisions to our shareholders in your acquisition agreement?
- What will be the key steps for integration post-closing?
- How will our employee workforce be treated? Will comparable compensation and benefits be available to them post-closing?
- Do you have any key intellectual property or technology issues you will be focusing on?
3. Equity Incentive Arrangements
Smart strategic or private equity buyers know they have to put in place equity incentive arrangements for the management team and employees. The key questions management teams will have in this regard include:
- What kind of equity incentive plans do you envision? Stock options? RSUs? Stock appreciation rights? Profits interests? Or something else? How will the plan work?
- If the acquirer is a private equity fund, will the acquirer require a management rollover investment of a portion or all of the equity the management team holds in the selling company? Will the rollover be tax free? Will any of the rolled-over equity be subject to forfeiture?
- In such a rollover, how will the new investment vehicle be governed? What type of rights will the rollover holders have with respect to important actions and transactions which affect their interests in the new investment vehicle?
- If the equity grant consists of stock options, what will be the exercise price? How can this be as low as possible to give more upside to the option holder?
- If there will be stock options, will the holder be able to exercise the options pursuant to a “cashless exercise” and avoid the need to come up with cash to exercise the option?
- What percentage of the fully diluted capitalization of the company will be available for the equity incentive plan? (10% to 15% is typical)
- What specific percentages of the equity incentive plan do you envision being allocated to individual key team members? Which key team members will be allocated equity?
- How will vesting of the equity work? Over what period of time? (Three- or four-year vesting is typical, but performance vesting for a portion may also be built in).
- Will the vesting be accelerated partially or in full on a change of control of the business?
- Will the vesting be accelerated for some or all of the grant on termination of employment of an executive without cause?
- What dilution to the team’s equity could occur over time?
- What tax treatment will be expected for the management team of the equity grant upon a sale? Can it be structured to get capital gains treatment, such as via a profits interest in an LLC?
- How long does the executive have to exercise options after termination of employment? (The typical period is 90 days, but this is negotiable and can vary depending on whether the termination is for cause, not for cause, or voluntary quitting by the executive to accept another job.)
- Are the shares obtained upon exercise of an option subject to repurchase on termination of employment? If so, at what price?
- Are the shares obtained upon exercise of an option subject to a right of first refusal? If so, on what terms?
- How can the executive get liquidity on the equity in the future, without necessarily waiting for an M&A exit? Will the executive have a right to “put” his or her shares at fair market value to the company for purchase, and, if so, when? How will the fair market value purchase price be determined? (The fair market value is often determined by an outside appraiser who is required to ignore any discount on fair market value because of lack of control, liquidity, or transferability for the shares.)
- Will there be “drag-along” provisions forcing the executive to sell his or her shares in a subsequent M&A event? Will those shares be treated fairly along with other shares being sold?
4. Employment Agreement Issues
The buyer may want to put in place an employment agreement for the CEO and some members of the senior management team. From the perspective of such an executive, here are the key issues to be addressed. (It’s beneficial for these executives to request to see the form of employment agreement early, and then have experienced employment counsel review and negotiate the agreement on their behalf.):