by Jin-Kyu Koh, Esq. and Jeffrey A. Belisle, Esq., of Dykema Gossett Law Firm

In an effort to separate fact from fiction for us Midwestern M&A types, we have undertaken a review of the most common deal points for certain Midwest transactions occurring in 2004. Our sample included 30 publicly available acquisition agreements with a deal value of $10 to $300 million (collectively, the “2004 Deals”). For purposes of this study, we’ve defined a “Midwest deal” as one where either the target or acquirer was a Michigan or Illinois company. The 2004 Deals included mergers, asset purchases and stock purchases. Although our review focused on the most common deal points, we also kept tabs on new deal trends inspired by the Sarbanes-Oxley Act of 2002 (“SOA”). Results, in no particular order, are described below.

Indemnification is often one of the most critical and hotly debated deal points – negotiations primarily relating to what, how long, and how much. Interestingly, 33% of deals reviewed did not include indemnification provisions at all (perhaps in part because our review included public/private company transactions which many times do not include such provisions).

Approximately 70% of the 2004 Deals with indemnification provisions provided for the survival of representations and warranties beyond the closing date. The average survival period for the 2004 Deals was approximately 15 months and survival periods ranged from 0 up to 36 months.

Almost half (43%) of the 2004 Deals had survival periods of 12-18 months. Indemnification baskets (excess over a minimum amount recoverable or deductible) or thresholds (all damages recoverable once threshold exceeded) appeared in 80% of the 2004 Deals that provided for indemnification, the slight majority of which (56%) were of the deductible variety. First-dollar thresholds appeared 37% of the time, and the remaining baskets/thresholds were a combination. A combination basket/threshold is one providing for a basket amount that must be exceeded prior to any recovery, and a deductible amount which is something less than the basket. As a percentage of deal value, basket/threshold percentages averaged .58%. The total range varied considerably at < .01% to 2% of deal value.

Indemnification caps provide assurance that total recovery will not exceed a maximum amount (assuming the indemnification provisions are the “sole and exclusive” remedy). Approximately 80% of all deals with indemnification included a cap, the average being 45% of total deal value. Note here that deal value is important in thinking about indemnification caps – generally, as deal value goes up, indemnification caps as a percentage of deal value goes down. Of the 2004 Deals with a deal value in excess of $100 million, the indemnification cap ranged from 7-10% of deal value. For smaller deals (< $100 million), the average cap was 56% of deal value, with many capped at total purchase price. A limited number of the 2004 Deals had no indemnification limit.

As security for potential indemnification obligations, buyers often demand that a portion of the purchase price be placed into an escrow fund. Such funds typically remain in escrow for the representation and warranty survival period and are distributed pursuant to terms of the acquisition agreement or a separate escrow agreement. In certain situations where a buyer is particularly concerned about an aspect of the seller’s business, such buyer may require a “holdback”, where the buyer retains a portion of the purchase price for a certain period of time or until certain conditions are satisfied. As for our sample, 25% of the 2004 Deals with indemnification included an escrow or holdback. While this amount was less than expected, we suspect it’s attributable to the nature of our sample – which mainly included smaller market deals (43% of which had a deal value of less than $50 million). Only one of these smaller market deals provided for an escrow or holdback.

Termination fees are a fairly common deal protection measure. A potential buyer would like to be compensated for being a “stalking horse” and reimbursed for its deal expenses. Such fees are payable by a target to a potential buyer upon certain negotiated termination events. 37% of the 2004 Deals included termination fees, the average being 3.3% of deal value. For all but one deal (which included a hefty 12.5% termination fee), termination fees ranged from .2% to 4.6% of deal value.

A few additional noteworthy deal points reviewed includes the buyer-friendly “10b-5” representation, legal opinion requirements and SOA related representations. The 10b-5, or “full disclosure”, representation is often insisted upon by a buyer to ensure a seller has not left out anything important (even after pages and pages of seller representations). The “full disclosure” representation might read as follows:
“No representation or other statement made by the Sellers in connection with the Transaction contains any untrue statement or omits to state a material fact necessary to make any of them, in light of the circumstances under which it was made, not misleading.”

Based on our review of the 2004 Deals, sellers manage to keep this type of provision out about 53% of the time.

Parties to a deal may ask for legal opinions for a variety of reasons. For example, a specific tax treatment may be sought by the parties and a legal opinion stating a certain tax treatment is proper is often a closing deliverable in these circumstances. Parties may also ask for legal opinions with regard to enforceability of a transaction, authority of a party to enter into a transaction or to assure there will be no conflicts with existing contracts once the deal is consummated. There may also be opinions related to capitalization and compliance with securities laws. Approximately 56% of the 2004 Deals required legal opinions – of these deals, 70% required legal opinions from both parties and 30% only required the seller to deliver a legal opinion. Not surprisingly, there were no deals in our sample where only the buyer was required to deliver a legal opinion. In our view, the requirement of a legal opinion is essentially a cost/benefit analysis. Legal opinions cost money, and in the absence of some critical legal conclusion upon which a deal is based, parties may rely on due diligence and representations to gain comfort.

SOA raised the bar with regard to, among other things, corporate governance, internal controls and executive responsibility. SOA compliance is time consuming and costly, and as a result, a public company that is considering acquiring a private company is well advised to start thinking about SOA early in the process. A fairly significant number (30%) of our sample deals included SOA-related representations. Such representations generally addressed internal controls, disclosure controls and procedures, whistleblower complaints and procedures, retaliation, off-balance sheet items and the existence of material weaknesses. We would anticipate this percentage to trend higher in the future as public company acquirers come to find out how expensive it can be to bring private company targets into SOA compliance post-acquisition.

For additional information on our study results or any other corporate related matters, contact Jin-Kyu Koh at (313) 568-6627 or Jeffrey A. Belisle at (313) 568-5461.

We would also like to recognize Douglas S. Parker, David B. Guenther, Ritu Vig, Jaileah X. Huddleston and Jennifer R.V. Nelson for assistance in the compilation of results cited in this article.