DealLawyers.com Blog

As you know, there is some debate out there in “deal land” as to the value of requiring the other side’s counsel to provide your client with a legal opinion. At the suggestion of one of our readers we decided this year to start tracking in our Study (see below for the Study parameters) the percentage of times that legal opinions were required in transactions. Our 4th Annual Deal Point Study (hot off the presses and just presented at The University of Texas Law School’s Securities and Business Problems Conference in late February) indicates that legal opinions were required of seller’s counsel in 68% of the transactions we reviewed and required of buyer’s counsel in 49% of those transactions. Are we surprised? Not really, and anyone who tells you that opinions are merely standard operating procedure would appear to be blowing the proverbial anecdotal smoke…

Next year, we plan to slice and dice this legal opinion analysis a little more to gauge, for example, the nature of the consideration paid in the transaction. For example (and just one of many), a recipient of equity as a portion or all of the purchase price might be realistic in insisting that purchaser’s counsel provide a legal opinion. Although, as you think about it, because our study is comprised of public acquirers the purchaser could reasonably argue that any opinion their counsel might give is just expensive window dressing to already fairly extensive public information. Conclusion? None. Still, the unsliced and undiced percentages do appear to indicate that legal opinions are not necessarily SOP.

4th Annual Deal Points Study Parameters: We reviewed acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database).

(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )

Here’s something useful on that (in)famous “rule of thumb” commonly used to price common stock in VC deals (compliments of Bart Jealous of American Appraisal Associates, Inc. bjealous@american-appraisal.com ):

“The below comes Gerry Mehm, the head of our Financial Valuaton Group in our San Francisco office. Let me know if you have any questions.

The Venture Capitalists in Silicon Valley have historically used the 10-to-1 ratio of preferred to common stock values when companies did their first round of financing. That is, money was raised by pricing the A Preferred at $1.00 per share, and options to purchase common stock would be granted to the founders and key employees with a strike price of $0.10 per share. But as the company progressed, the subsequent rounds of preferred stock are typically sold at higher prices ( $2.00, then $5.00, then $10.00, etc.), and the ratio of preferred to common would then be decreased from the 10-to-1 to 5-to-1 to 2-to-1, until the shares all had the same value at the IPO date (equal to the IPO price).

This “rule of thumb” was criticized by the SEC at the height of the high-tech IPO market in 1999. Companies were routinely required to record stock-based compensation expenses in their S-1 filings if they simply employed the rule of thumb. The analysis we performed was based on reviews of the S-1 filed at the time by comparable companies. That is, we pulled data on the capitalization history of the comps, and prepared tables showing the overall money raised, the ratio of values to money raised, and the ratio of preferred to common stock values which the SEC accepted. We then built tables showing how the client’s value would increase as more money is raised and spent on development. It was a “softer” valuation than one for a mature company with public comparables, but at the time it addressed most of the questions raised by auditors and the SEC.

The issue today would be to find good comps who have gone public recently, since the IPO market has been so weak. But I would continue to use this type of analysis rather than simply the rule of thumb you refer to.”

Best regards,
Bart Jealous
Vice President-Principal
American Appraisal Associates, Inc.

OK, all those who’ve faced a sell side ROFR -and like it – raise your hands. My guess is that I won’t see many hands, and you certainly won’t see mine.

All to often, our clients are too willing to give ROFR to buy a business without truly understanding the negative effect it may have on the their ability to maximize value in a sale. I’m really thinking about those “Trojan Horse” ROFRs that innocuously appear in transactions like licensing, supply, outsourcing, or corporate VC-backed deals.

In my experience, ROFRs in the M&A context is a poster child for the Law of Unintended Consequences. Let’s say you want to sell the business that’s subject to a ROFR. So finding a stalking horse isn’t so tough because it’s done all the time in sales under Section 363 of the Bankruptcy Code?

Ive found it’s a little tougher outside of bankruptcy, especially if target’s distressed or not particularly a belle-of-the-ball. To begin with, it just isn’t that easy to find a buyer who’s willing to devote the time, money, and effort to give seller a written binding and unconditional offer – without demanding a huge breakup fee and open-ended expense reimbursement. (Of course, there’s always that famous “hello fee” that buyout funds get for taking a look at a deal).

If you’re under pressure to sell the company and timing’s critical, don’t be surprised if all you can get is an LOI that’s subject to gaping walk rights like due diligence, financing, and even, board and shareholder approval (notwithstanding the fact that buyer may be closely held and you’re dealing with the CEO who controls the vote!).

You next send it off to the holder of that ROFR. Did the lawyer who negotiated the ROFR in the context of that supply agreement bother to add simple things like a short time frame under which the ROFR holder (“ROFR’er”) has to take the deal or that the ROF’er had to match or top all the terms of the offer. Does the match have to be identical or can the ROFR’er play horseshoes? How much of a modification of the stalking horse offer will trigger a new ROFR period? I could go on but it’s only re-living past painful memories.

The worst part is that ROFR’er could “match” the bid but is only interested in driving away the stalking horse so ROFR’er could re-trade the deal as the sole bidder. Is the ROFR’er required by contract or common law to deal in good faith? So many questions, so few answers…

I don’t know about anyone else but if I’m on the potential sell-side, I always resist requests for ROFRs and try to educate the client to watch out for those “Trojan Horses.” If I have to give one, then it’s much better to give a right-of-first-offer. Of course, if I’m on the ROFR’er side, I like the leverage that a ROFR creates so I always think it’s an inifinitely reasonable request that, errrrr, “Ive never seen anyone have a problem with giving.”

In a recent conference call, opposing counsel’s rather unimpressive “negotiating voice” served up a vivid reminder that delivery is almost as critical as the message.

Yep, I’m talking about those tell-tale signs in someone’s voice that telegraphs weaknesses in one’s positions and otherwise emboldens the sharks who smell blood. With so many of our negotiations being conducted over the phone, it reminded me that I must be really careful of how I sound to the other side (in fact, after this particular conference call, I authorized my colleague to shoot me if I ever stuttered like our poor opposing counsel).

In my typical stream-of-consciousness rambling, I thought I’d throw out some “deadly sins” that can turn an otherwise competent deal lawyer into a deal-killer (all of which I’m sure I’m guilty of — many times over):

1. (Intentional) Stuttering and other Mental Stall Tactics. No, I’m not making fun of people who have a real speech impediment. I’m talking about otherwise eloquent lawyers who subconsciously stutter in negotiating sessions. Ever caught yourself saying “I-I-I…” just to buy some time to formulate your thoughts? Sure, you may be nervous or not entirely sure of your position, but why would you want to possibly send a message that’s interpreted by the other side that you’re either (i) unprepared; (ii) – or worse- don’t know what you’re talking about; or (iii) – even worse – have no conviction in your or your client’s position? Even worse are the negotiators who stutter intentionally as a matter of style. I recall a colleague at my old firm who learned his trade from a partner who stuttered because he naturally stuttered. The junior lawyer- who otherwise was very well spoken – switched into his stutter-style whenever he started negotiating with opposing counsel. Little did junior lawyer know that he was probably encouraging the other side to be more aggressive. Have you ever thought: “OK, it doesn’t sound like he’ll stick to that position, let’s just hammer a little more?” Lesson: hesitancy in your voice kills.

Errr, I-I-I will continue – ummm – rambling – ummmm– on this topic –ummmm– next blog. Better yet, if you have any anecdotes to share on this, email me at wilson.chu@haynesboone.com.

Thanks to IRS tax-shelter regs imposed mid-last year, we deal lawyers were begrudgingly modifying confidentiality provisions of most agreements, including acquisition related agreements, exclude certain tax-related matters. Under those regulations, participation in a “confidential transaction” resulted in reporting and record-keeping requirements. To avoid these burdens, parties were being advised to expressly authorize disclosure of tax treatment and tax structure.

GOOD NEWS!! On December 29, 2003, the IRS issued new regulations that significantly change what is considered to be a “confidential transaction” for these purposes. Under the new regulations, the definition of a “confidential transaction” is limited to transactions in which an advisor who is paid a significant fee places a limitation on disclosure of the tax treatment or tax structure of the transaction. Confidentiality obligations that are imposed solely by the parties to a transaction will not cause a transaction to be a “confidential transaction” for purposes of these regulations. There is some uncertainty about how these new rules will be applied to transactions in which a participant is both an advisor and a principal, such as certain financial transactions in which a commercial bank or investment bank is both an advisor and a party to the transaction.

These new regulations are effective for transactions entered into on or after December 29, 2003, and they may also be relied on for transactions entered into on or after January 1, 2003 and before December 29, 2003. Accordingly, the tax confidentiality carve-out language that had become standard in commercial agreements is generally not needed. In addition, the failure to include the language (or the inclusion of ineffective language) in prior agreements should not have any adverse consequences.

Thanks to Vicki Martin, tax partner at Haynes and Boone, for this guest blog.

With the dawn of a new year Wilson and I find ourselves in the middle of preparing the next installment (this year’s being the 4th…my how time flies when you’re reviewing documents) of our annual M&A Deal Points Study. As such, we would like to take this opportunity to solicit suggestions from you as to any particular area(s) you would like for us to review and include as part of this year’s Study. Those familiar with the Study will remember that we examine acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database). For those of you who are not aware of the Study (which we lovingly refer to as the “BS Detector for the M&A Sector”) and would like a complimentary (i.e., FREE) copy, please email Wilson or me (wilson.chu@haynesboone.com or lglasgow@gardere.com ).

We look forward to hearing from you!

Yes, we’re still alive and will resume blogging with reckless (good thing this blog can’t be construed as legal advice – I hope) abandon after the first of the year. I hope everyone is having a great holiday break and I extend our best wishes for a banner, deal-crazy 2004!

This is one of my favorite tidbits on working with foreign counsel. Your local counsel has all the right credentials. His English is excellent; he worked (briefly) for a Wall Street law firm after his LLM from an Ivy League school. So why do you have a funny feeling that the answers he’s giving you just don’t sound right?

More times than I care to remember, after a conversation or even email exchanges with foreign counsel, I still wonder if I have the right answer. I ask a question, foreign counsel gives me an answer. Done, right?

Not quite. Many times, we fall victim to the phenomena of “talking apples and hearing oranges.” It usually goes like this: you ask about an issue “so, how are the apples in Mexico today?” On the other end of the line, foreign counsel says reassuring things like “yes” and “OK” (thereby lulling you into a sense of complacency) and foreign counsel, thinking that you’re asking about oranges, replies “I’m afraid that can’t be done in Mexico.” The problem is that due to a myriad of influences, including, English being foreign counsel’s second or third language, cultural differences, and even bad phone lines, foreign counsel’s answer could be absolutely correct – to the question he understood was being asked, which unfortunately may not be the question you’re asking.

It’s not a pretty sight if you relayed foreign counsel’s advice to the client and later on, someone else on the deal proves that you’re wrong. If the problem is material enough, it may even be a good idea to put your carrier on notice (remember that thing about negligent selection of counsel?).

So, how do you raise the “confidence index” on foreign counsel’s advice, especially if you don’t have the luxury of getting a second opinion? Here are my basic survival tips:

1. Ask the same question several different times – and in several different ways. For non-US counsel, it never hurts, before giving the answer, to repeat the question or say something like “Let me make sure of what you’re asking…”

2. Even if foreign counsel’s English is good, don’t assume that her English is the same as your English. For example, to “table an issue” has opposite meaning depending on what side of the Atlantic you’re on. In American English, to “table” an issue is to remove it from consideration. On the other hand, to the Queen’s English speakers, to “table” an issue mean to present it for consideration. And I wouldn’t make the mistake of thinking that it’s only like that when you’re doing a deal in London. Don’t forget that the Brits’ influence, including that funny English they speak, is prevalent not only in Europe but also former colonies like Singapore, Hong Kong, and India.

If you have a particularly painful – yet in hindsight, funny – story along these lines, email me to be a guest -blogger. The next blog on this subject, I’ll talk about a related but necessarily distinct topic of not taking “no” for an answer.

After a mind-numbing viewing of Charlie’s Angels, I thought I’d spend the next few hours on the plane back from Japan to muse abit about cross-border dealmaking. This will be the first in a series of blogs on this subject.

It’s the Relationship, Stupid! As American lawyers, we’re taught to believe in the written contract as king and as such we must provide for every little contingency under the sun. Voila, the famous 100 page kitchen-sink American acquisition agreement! We also believe that once the contract is inked, the negotiation stops.

In my experience, deal docs from other countries (particularly the civil law jurisdictions) tend to be very skinny. Aside from the fact that lawyers in civil law jurisdictions always tell us that “eet’s all in zee Code,” how can you explain the difference in approach to contracts?

As I’ve learned (the hard way), it all comes down to that fact that in the US, we think the contract is “the deal.” Outside the US, the relationship is “the deal.” The non-US agreements tend to be more framework in nature with the principals comfortable in their ability to work things out as needed. To the distress of American lawyers, once the contract is signed, the real negotiations begin!

So if your client is planning to do a deal outside the US (or a US deal with a non-US company), tell them this: A good agreement cannot fix a bad relationship, but a good relationship can fix a bad agreement.

So relax and do what Asian and European dealmakers have been doing for centuries: wine, dine, and (then) sign…then wine and dine some more.

Dear Deal Guys,

Buyout King Just Trying to Put Food on the Table

********

Dear Buyout King,

We know it’s hard for a proud parent to think this way but your little baby needs SOX appeal. Yes, even though you’ve been running a private company, you’re finally going to have to pay attention to all those SOX client alerts that has been clogging your in-box from every law firm that can spell C-A-S-H-C-O-W.

As you know, the CEOs and CFOs of those potential deep pocket strategic (that’s read: public) buyers have to sign those pesky 302 and 906 certifications that, under SOX, subject them to personal liability and jail time for the accuracy of their public companies’ financials. The prospect of target’s sketchy financials getting morphed into the buyer’s essentially means that CEOs and CFOs may be taking personal responsibility for target’s financial statements and results of operation. It’s no wonder that public company buyers are turning up the due diligence heat on private targets.

For example, if a target’s officer is to become an officer of the public buyer, then buyer wants due diligence on any loans currently in place for that officer (remember, SOX prohibits loans to executives and directors). This is a particular problem for fund-back companies because the buyout guys always want management to have significant skin-in-the-game, which many times means company loans to officers to buy stock. A public buyer must now deal with these loans as it structures comp arrangements for target managers that will stay on.

We could drone on about the SOX parade of horrors but we’ll leave that to others. Just remember that SOX doesn’t have any grace periods for a private target’s un-SOXy things when being acquired by a public company (except the one about 302 certifications not applying to target’s financials filed in an 8-K relating to an acquisition).

So, it may turn out that the most attractive private company acquisition prospects are those who have the their financial and corporate governance house in order so that it can seamlessly fold into SOX compliant public buyers. If you don’t care about silly things like exits (sale or IPO), liquidity (publicly registered debt) or you simply feel “too SOXy for your shirt”, feel free to run your private company like your own little fiefdom with no regard to SOX compliance. On the other hand, if you want to eventually sell or do an IPO, you may have unwittingly whacked your debutante with a big ugly-stick.

(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )