Risk Allocation Between Signing and Closing an M&A Deal

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Don't take my word for it. Check it out for yourself by starting your own free trial@firmroom.com check it out firmroom.com I'm Kisan Patel and you're listening to M and A Science where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals.

Welcome to M and A Science where leading M and A practitioners share lessons learned from their experience. Before we kick off, I want to plug in DRC Evaluation Research Corporation for being so kind to provide the space for us to produce today's podcast. And hey, if you're not familiar with vrc, largest privately held valuation company, if you're looking to work with the best, check out vrc. If you're interested in keeping up with M and a science, visit mascience.com, subscribe to our free newsletter. Every Monday we share highlights from our interviews, invitations to events as we build the greatest community of forward thinking M and A practitioners. Again, that's mascience.com I'm your host Kisan Patel, CEO and founder of M&A Science. Joining me today is brilliant Brett Shahn, Senior Vice President Assistant General Counsel at Warburg Pincus. Warburg Pincus is a leading global growth investor with more than 80 billion in assets under management. Today we're going to talk about risk allocation between signing and closing in an M and A deal. How's it going Brett?

Going great. Great to be with you.

Welcome back.

Thank you.

Can we kick things off with a quick recap on your background?

I've been at Warwick Pancas for just over seven years now. Before that I was at a firm called Wachtel Lipton in New York. Pract, M and A and securities laws. And I'm basically an in house M and a lawyer at work, Pinkus and our business is investing in companies, helping them grow and then selling the investments. The front and the back end of that are M and A transaction. So a lot of what I do on a day to day basis is working on M and A transaction. Very pleased to be with you and talk about this stuff. I guess first I should give the disclaimer. I'm here in my personal capacity. Anything to say is my own view. It does not represent view of Wilbur Pinkus or anybody else.

And you gotta have this level of credibility to be at Warburg Pincus.

It's awesome. I'm very privileged to be working with a whole lot of really smart, driven, nice people.

Now you make me feel like I throw in a safe harbor disclaimer and anybody listen to this. Everything's a forward looking statement. Nothing matters. Don't take anything for any consideration whatsoever in any decision making that you could possibly be contempting on. Does that sound like a good disclaimer?

I don't think we're selling any security. So you might not, but it doesn't matter.

Just in case it comes off that.

We should say, yeah, we are not selling any securities.

All right, there you go.

No NFTs yet, no nothing.

Now that we got that out of the way, let's start from the beginning. What's the difference between signing and closing?

Signing is just when you sign a contract. The contract we're talking about in question is buying a company. Closing is when you actually buy the company. In a lot of transactions that people see in the press, there's a gap between signing and closing. So if you're buying a public company, in all likelihood there will be a fairly substantial gap between signing and closing. There are a couple reasons why the gap exists. The most common reason is regulatory approval. In the US for example, if you do a deal over a certain size formula is kind of complicated. But the sort of back of the envelope over approximately $100 million purchase price that requires an HSR filing. After you make the HSR filing, you have to wait 30 days until you are permitted to close as the buyer. So that is probably the most common source of gap between between signing and closing. The other common source of the gap between signing and closing is a need to get some sort of corporate approval, typically from the target, but sometimes also from the buyer as well. For a public company, for example, that's shareholder approval. And you need to wait because you need to hold a shareholder meeting in order to get that approval. So that's another source of gap between signing and closing. And there could also be reasons for a gap that are more commercial and deal specific. So for example, if there's a very important customer contract, that customer has a termination or a consent, right? Or some bad consequence under the contract that is triggered as a result of the transaction and the buyer doesn't want to go through with the deal. If that customer doesn't consent, the buyer may say, I'm not willing to close, I'm willing to sign maybe, but I'm not willing to close until we get the customer consent. So that can be another source of time between selling, signing and closing.

Would TSAs also fit into the commercial? Specific reasons why you would have a separate signing close.

TSA is something you have generally when you have some sort of a carve out because you're standing up a business and you need services from the seller of the business. If you have the TSA ready to go for everything that's going to be in it, all the services are going to be provided. I don't think there's any apparent reason why the TSA itself should cause there to be a gap, although you could imagine a circumstance where time is needed to do certain operational things to actually separate the business, or time is needed to actually figure out the details of the TSA services and that could be a reason for a gap.

To me it sounds like there's some pros and cons of this. Time is the enemy of M and A, right? Just more time goes by and then you kind of have, wait a minute. If we could game plan a little bit about what we're going to do as soon as closing happens, there's a little bit more of that airtime. I could see that as being a big benefit, but I'd love to hear your perspective on the pros and cons.

Time creates uncertainty. So from the moment you have a meeting of the minds of a buyer and a seller, say we want to do this deal, the more time you have from that to when it actually happens, people could change their minds. And there's a couple reasons why people change their minds. A stereotype that buyers want more flexibility than sellers, although it's not always true. Look at the Elon Musk Twitter thing. Elon Musk signed a deal and the market went down. And now I guess now maybe he's doing the deal again. But for some period of time he thought he was getting a bad deal. He was trying to get at. He was looking for flexibility to call off the deal, basically. And I think part of that is also generalized. Someone once said you learn about 10% of what you're ultimately going to know about a business before you buy it. There's a lot you don't know. And the buyer is at generally an information Disadvantage. So the chance that a buyer finds something out or something happens to the market or something happens to the target company between the time the buyer decides they want to buy the company, when they actually buy the company, there's a decent chance something happens where they may not make the same decision. So I think that's like a common buyer perspective. From the seller's perspective, they're selling the company because they think they're getting a good price. And so generally they want the buyer to be locked up as much as possible. But there are also circumstances where, let's say the market goes up, let's say they find proverbial examples never actually happened gold onto the headquarters, or they find that they didn't fully shock the business and somebody calls them up and says they'll pay twice the price. So in those circumstances, the target may not want to go through the deal. They might want to sell it to somebody else or hold onto it for longer if they in fact found gold on headquarters. I think it's probably a fair generalization to say that buyers want flexibility and sellers want certainty.

That's really interesting and unique and also unique to what role you are in the deal in terms of if you would benefit more or less from having that time in there. So we got these key reasons that happen when we say that in terms of the majority of the deals, they would end up being these private transactions that do sign and close at the same time. Just trying to get a sense of when the volume of deals would start separating sign and close. You know, do you see it like.

At a certain price point, HSR is probably the number one driver for whether there's a gap between signing and closing.

What does HSR stand for, by the way? I forgot to ask you earlier parts.

Scott Rodino, Antitrust Improvement Acts of. I forget the year we'll have to fill in.

They basically file that saying, hey, we're making a pretty bold move here. If you want to check it out, this is your time.

Exactly, exactly. So it's alerting the DOJ and the ftc, the antitrust regulators in the US that we're doing a deal of a certain size. And if you want to look at it, here's the deal. And there's certain documents you have to produce in that filing showing information about your view of market share revenue that the two parties have in the particular industry that is subject of the acquisition. So the agencies can decide whether it's something that poses antitrust risk that they should investigate further. The way it works is they don't give you like a stamp of approval, but they have 30 days to alert you that they want to do a further investigation. So a second request, just like a more in depth investigation that they do, that could result in them assuming to block the deal. So most deals, particularly deals that don't have any overlap between the buyer and the seller, like most private equity deals, will have zero overlap. They sail through. Traditionally they sail through. You don't hear anything from the agencies. And then after that 30 day waiting period is over, you are legally allowed to close. If you just look at most private equity deals over that, I think it's like 102 million. They'll have a gap between signing closing, but it'll be fairly short. This is very important. The other reason you have a gap in signing closing is financing, particularly for private equity buyers. If they're financing the purchase, the mixture of equity and debt. Debt comes from third party lenders. Typically you're signing with just a commitment letter from the lenders and you need time to turn that commitment letter into a long formal credit agreement that you can actually draw on from the lenders. And that's another source of gap between signing and closing because you need the cooperation of the target company in order to get that credit agreement done. And the target is going to say, hey, I'm not going to cooperate with you until I actually get you to sign something that says you're going to buy me. And the buyer signs something with the target that says, yes, I'm going to buy you in 45 days or whatever it is once you give me time and give me cooperation to get my financing in order. And then once the financing shows up, then I'm going to buy you and then the closing can take place. So even if you don't have hsr, there might still be a need or a desire for a gap to signing closing so that the financing can be arranged.

That's a good point. The DOJ on that one you put in this HSR filing, how much detail goes in there? Is it just, hey, we're doing this deal at this purchase price, how much detail do you gotta submit?

This is a good quiz. So I'll caveat this by saying I'm not an HSR expert.

Fair enough.

But my general understanding is it's a description of the deal and it's a bunch of internal documents where you describe the party's view of the deal or how they looked at their view of the deal from a competition perspective. So if you have an investment memo that says we are buying this company because it is a market leader and it has an X percent market share. That document would have to be produced to the agency so they can look at it and figure out what the sort of market impact of the transaction would be.

Oh, interesting. So you have this thesis and you gotta throw some data in there too. Other part that got me was the DOJ finds a little tiff and something got a problem with, they just come out and sue you. Isn't there any room to negotiate this stuff and say let's talk this through, let's. That's what a good lawyer does. We got problem. They don't want things to escalate to a lawsuit. First step is be a good business person and try to negotiate it. From my experience. Yeah, so how does that work in here?

So they're not just going to sue you like immediately because they don't have enough information to sue you. If they sue you, they're going to go in front of a judge and the judge is going to apply the law. And the law places a burden of proof on them to show that there is actually a harm to competition from the transaction. They're not just going to sue you immediately. What they would do is they would launch an investigation. They would issue a second request, demand voluminous volume information and then they would come to you and say, listen, we think this transaction doesn't work from a competitive perspective. You've got, I'll take a silly example like a three person market and number one is buying. Number two, I'm not going to allow a merger to monopoly. If you try and do the deal, I'm going to sue you to block it. Or they would say the more nuanced situation might be you have a retail business. Let's say you have two, like pharmacy chains or supermarket chains. One has all the supermarkets in New York and the other has all the supermarkets in New Jersey. For the most part there's not overlap because you decide what supermarket you go to. You just drive 20 miles, you're not going to drive 200 miles. But there are a bunch of supermarkets like on the New Jersey, New York border where they actually do compete with one another. And so if you have the same person owning all of those, you're going to reduce competition in that little strip of the market. So the agencies might say is you can't combine those. You got to take those stores or some of them and sell them to a third party who is able to run them in a competitive way. Then there would be a negotiation around what are the terms of that sale? Because the agencies are going to want whoever buys those stores to actually be able to be a robust competitor and to preserve the current level of competition in that market. You wouldn't want someone who already owns one of the stores nearby. You're just like creating the same sort of problem. And you wouldn't want just some guy who's never run a grocery store before to buy those stores because he or she's not going to know how to run them. You want like a legitimate operator or someone who has a management team that has experience running grocery stores to be the divestiture buyer and to solve the issue so that the rest of the deal could take place.

How much of that strategy around? Here's those two overlapping. And this is the problem we have where they would recommend splitting that out and then it's okay to do the deal versus hey, we have a problem with it because of this and you're coming back as a respond. What if. Let's propose that we carve out a section of this business, the area that's of conflict, and do the deal that way.

One thing that I've heard from the experts who advise us on this stuff is that the agencies have become much more skeptical of divestiture remedies because they're worried about one of the situations I mentioned where whoever buys the sort of overlapping piece of the business is not really going to be able to operate as well as one of the people who currently owns that overlapping piece piece. Let's say you sell one of the grocery stores to someone who doesn't know what they're doing, that grocery store is just going to go out of business and then you just have one less competing grocery store. You're not preserving the same level of competition as you had before the transaction took place. You're just ending up in the same problem that you were trying to prevent. There's a more aggressive skepticism towards divestiture remedies from the agencies generally these days. I'm sure there's probably situations where they still make sense, but they are. I think you need to think long and hard. If you have a transaction that you think can be solved that way, if it really can be solved that way in the eyes of the agency. Now, as a solution to that problem, one thing that people do or thinking about doing is fix it first, they call it where if you're thinking about doing a deal with a particular counterparty, it's a perfectly fine deal from a competition perspective, except for this one business where you Guys both have the number one or number two, for example, in a concentrated market in one particular sector. And the agencies are going to focus on that. And they may use that as a means of holding up your deal, making it take forever, maybe not approving it. What you could do is you could just go find a buyer for that little piece of your business now and line them up and sell that piece of the business to them. And then you have a much cleaner story to tell the agencies because then you say, hey, we have zero overlap. I just sold this thing. But now we have zero overlap. And you look at some of the stuff that some of the antitrust regulators have said, they sort of recognize this is happening and they don't really love it because it takes away power from them because they would have a say and how that sort of remedy happens. But that is a strategy that I've heard of people using.

You got any friends at the doj? No, I just want to know if I'm working on a deal and need a connection. Just wanted to clarify that. So to recap, we have the big drivers of why you would separate sign and close. Regulatory approval, corporate approval, shareholders, commercial specific items to clear out and finance contingencies. So now I want to get a sense of this announced thing that happens too, because what do you usually see? It's announced right at sign, announced before sign. Would you ever announce after you sign?

Sometimes it depends on what you're trying to achieve and what you're worried about. So I'll just use like an antitrust example. One source of antitrust risk could be whether customers believe that the transaction is anti competitive. The more it's known that the transaction is happening, the higher the risk that there are complaints. So that could cause an announcement, could cause noise in the market that there is some potential antitrust issue. The parties might want it to be known so that they can find out in advance whether there is in fact going to be an issue, whether in fact there's going to be a complaint. It could be like a fact finding exercise. So that's one sort of impact of announcing a transaction. There could also be a seller might be worried about employee retention. If everyone leaves because the transaction is announced, they don't like who the buyer is, does that put pressure on the transaction? The same thing about customers. If customers don't like who the buyer is, does that put pressure on the transaction from the sell side perspective and reduces transaction certainty? Most definitions of material adverse effect, which is the concept that gives the buyer the ability to walk in Those transactions, most of those will carve out effects caused by the announcement of the transaction and effects caused by the identity of the buyer. Those are similar concepts. It should be the buyer's risk if people don't like the buyer. But as we've seen in a bunch of recent cases, regardless of what the contract says, buyer can have a lot of leverage to potentially not close if the business is not doing well and they don't like what's going on in the business.

That's material adverse effect.

Yeah.

And you're talking about the reference of the nature of it and how that would allow somebody to just declare that, hey, here's this material adverse effect. And that's why we're going to change directions.

Sort of a silly example. I'm just going to pick on, like, the Twitter situation. Elon Musk says, gonna buy Twitter. What if all the Twitter employees say, I hate Tesla, I hate Elon Musk, I would never work for this guy. And half the workforce quits and then Twitter stops working and all the advertisers leave and it becomes a failing business.

That's like, good for Elon, but poor for Twitter.

Right. Okay, so if that happened, Elon Musk is gonna say, I don't wanna buy this thing. Half the employees quit, like, because the site's not working anymore. How can you force me to buy this thing? It's now worth half of what it was worth before. Before. Let's say, for example, that is a material adverse effect under the Delaware case law. Material adverse effect needs to be serious. I'm going to misquote the exact legal standard, but basically it's like a very serious defining value that has durational significance, typically measured in years rather than months. If the business is like, irreparably broken or broken in a way that's going to take a long time to fix. That would be like an MAE material adverse. So he would say that the good lawyers representing Twitter would say, elon, look at the terms of the material adverse effect clause. Say that it excludes any effects caused by the mass of the transaction or caused by your identity. Let's say I don't have the clause in front of me, but let's just say it says that. And that would be true. But then he would look at other things in the contract. He would say, there's also a provision in the contract that says you have to operate the ordinary course and you have to use reasonable best efforts to preserve your business, your employees, your customers, et cetera. You have not done that. You had A few people saying they don't like me. But then you didn't make any efforts to retain your people. You just let them all go. And a reasonable person in that situation, trying to preserve their business, would put forth some sort of good faith effort to not have everyone quit, give them a retention package, invite me to come speak to them, tell them that I'm not the devil, whatever. Like they would do that. And the fact that you haven't done that, you have violated your covenant to operate urinary force. And there is a condition in the contract. There is in all US Agreements, more or less, that says I don't have to close if the company is not materially complied with its covenants. That was a covenant and you didn't materially comply with it. Which is basically what he was saying with this information covenant. Which is awesome. A covenant. That's why he was making the argument. That's like a real world thing.

I like how you can real play out both sides. You got the full Jekyll and Hyde effect.

And to be perfectly honest, Elon Musk is not wrong in that hypothetical. How do you let half your employees leave without doing anything about it? It's sort of absurd that they all just leave and you just let it happen.

Just a sidebar. While I was intrigued by that Netflix original, they're doing called Partner Track about a lawyer becoming partner.

Oh, interesting. I haven't seen this. Is it out yet?

No, it's in. It's coming out, I think this summer. And they want to sign a release because they reference M and A Science three times through the series. I don't think they actually use our original language. They just use the logos and stuff. But they're. One of the reference points was around material adverse effect because they were showing like I had a release on the lines and so now I know exactly what that means, which is helpful. I can follow along better going back to announce and sign. I get a sense of that. Or you could do it before you sign. Then it makes sense at sign that, hey, we just signed this agreement and do that knowing announce after sign. Now do you randomly do it in between or.

Or after?

As in we announced that close, even though we had a separate sign and close period.

The different sides get your reasons to be worried about what's the consequence of making a public announcement about the deal. So there's certain deals you need to publicly announce. You need to get shareholder approval, for example. But if you don't need to get shareholder approval, the target may say, I don't want anything that's going to possibly jeopardize this transaction. I don't want your name out there until you're actually closed and don't announce it. For example, Target might say that, and the buyer might say, hey, listen, I'm very happy that I'm about to buy you. We need people to know that this is going to happen so they don't feel shocked and upset that their employer changed, for example, without letting anyone know that. So I actually want to make the announcement. I think it's very situation specific.

Okay, that helps explain. I got nouns, sign, close, a lot of combinations of how those things could play out. What are the usual requirements for closing?

So the usual closing edition regulatory approval. Assuming the regulatory approval is one of the reasons you have a gap in signing and closing. I'm going to say like financing with an asterisk. Because if you look in the condition section, it won't say you need to get financing because there won't be a financing condition. That's what people say, which is technically true. But in the remedies provision, which says what happens if the buyer doesn't close? What can the seller do to the buyer as a consequence of that? So the typical remedy that the seller will want the most, something called specific performance, which means they can force the buyer to actually comply with the terms of the contract, actually buy the company. In a traditional private equity deal and other deals like the Twitter deal, for example, it will be a condition to the seller's ability to get specific performance that the financing shows up. So it is a, I'll call it like a quasi condition that the financing shows up. The other condition will be that the representations and warranties of the target or the seller are true to some level of materiality. When I say level of materiality, meaning if they're not true a little bit, then it doesn't count and the buyer still has to close. And that how much is a little bit versus a lot. That's a negotiated point. Typically for the general business reps, the standard will be material adverse effect. So unless the reps are untrue at a level that is a material adverse effect, the buyer still has to close. Then there'll be certain fundamental reps that are so fundamental that nobody should ever screw them up. It should be easy for the sell and target to give those reps, and it would be disastrous for the buyer if those reps weren't given accurately. Those are thought of as the fundamental reps. They're typically things like the target is duly authorized to enter in the agreement. If you're doing a stock sale, that the person selling you the shares actually owns the shares, that the shares that you're buying actually represent the entire capitalization of the company. That sort of. So those are the reps. And there'll be another condition that says sort of sell side target of the sellers have complied with all the covenants in all material respect. So that's a lower standard than material adverse effect. The material standard is just what would a reasonable person consider to be important. So because it's a lower standard and there's lots of covenants that companies and sellers need to comply with between signing and closing, that can be a source of closing risk from a sell side perspective, like the story we just went through with the Elon Musk hypothetical and shareholder approval. If you need shareholder approval or third.

Party consents, I'm not going to try to recap that. The lawyer is coming out of you and I'm using a lot of brain cells keeping up with you, which is a good thing. That's how I work out my brain every day. I make friends with attorneys. They talk to them once a week. That's your exercise on the regulatory approval. Anything around, little fun facts, things to know about, because we talk about doj. But obviously if you're doing international deals, they got a bunch of different things going on in industry specific. I guess industry specific, you got stuff like that.

There are all sorts of regulatory approvals you might need to worry about based on both the transaction and the industry. So my favorite thing that comes up, say favorite in air quotes is what I'll call joint control antitrust approvals. There are certain jurisdictions that measure whether you need an antitrust approval not by looking at just the buyer and the seller's overlap, but by the overlap of any two parties to the transaction. Where that can show up unexpectedly is let's say you have two global private equity firms that are joining together to buy a company in Texas. Neither of the private equity firms own any business that competes with the target in Texas, but They each own 100 other portfolio companies all around the world. One of the jurisdictions that has joint control test is the European Union. And the European Union is a very complicated test that I was reading about the other day. More specifically, but do not ask me to repeat it because it's very complicated. Remember all the details. But essentially, if those two private equity firms are each acquiring control of a particular business and they each have a certain amount of revenue in the European Union, then the European Union antitrust Approval is required for that transaction, even though the transaction has nothing to do with Europe. It is just to buy a business in taxable. And so that can create a timing issue for that transaction where you got to wait a few months to get the European Commission filing and approval done before you can close. And it's triggered by action of control. It can be complicated because let's say one private equity firm is buying 70%, another one is buying 30%. And then you have to say, what are the rights that 30% buyer is getting? Are they getting a vitro right over the budget, for example? And if they were, then that would probably trigger joint control. And you would have to analyze the revenue of those two private equity firms in Europe and other countries or areas that have these joint control tests and see whether approval is required.

The DOJ doesn't sound so bad anymore.

You know, I'm not going to speak to the regulators. I'm like, I've never heard of a deal getting blocked from one of these things. It's just a timing and hassle impact I got.

So more of the formality of it that ends up being the pain point. Distraction.

Yeah, exactly.

And yeah, it sounds like there's. It's nuanced based on other factors, industry and things of that sort.

So if you're an American doing a deal overseas or overseas person doing a deal in the United States, there could be foreign investment or national security regulatory implications. And those are interesting because they tend to be, I'll say, kind of like potentially more black box depending on what the particular regime is compared to antitrust, and potentially less solvable than less like understandable and predictable than antitrust. If you're from a particular country and you're trying to do an investment in another country that has a foreign investment control regime. So they say, hey, if you're a foreigner and you want to buy a business in this sector, I need to approve it. That's what the rule is. And then are they going to approve it or not? It's like a political question. Are they okay with this jurisdiction buying this type of business in this type of industry? They're going to have all sorts of considering that. You'd have to talk to local council to figure out what are the considerations they apply. And then one of the risks is if they say no and it's just because you're a foreign person, what are you going to do? You can't change your nationality. Maybe you could adjust your governance, but then you still want to do the deal. If you don't have any governance. So that can be potentially more fraught situation. Kind of like national champion business where there could be domestic political pressure against letting an outside foreign investor invest in that particular business.

That's the one. You got to ask somebody if they know somebody, right? As a buyer, how do you protect yourself from risk?

This gets into the interplay between conditions and covenants. And this is like a very legalistic point. But let's say you sign a contract that says, I'm the buyer, you're the seller, I'm going to buy your whenever I get regulatory approval. And then once I get regulatory approval, I'm going to give you $100, you're going to get in your business and it's going to be awesome. And that's all the contract says. Now that sounds okay, right? So the problem is, okay, I've signed the contract and then you got to think about it like literally, what's my obligation? Then I've signed a contract that says when I get regular to approval, I'm going to pay you $100, you give me the business. But that's all it says. Does it say you have to make the filing? Maybe not. It should say that if sell side is a good lawyer, they're going to say make the filing. Okay, fine, I'll make the filing. And the regulator says, you know what, I'm only going to approve you if you agree to sell all your other businesses. The rule in my country is each buyer is only allowed to own one business and you already own five businesses. So you have to sell your other four businesses in order to buy this company. And I'm going to say, what the heck are you talking about? I'm not going to agree to that. See you later. And then we're going to open the contract and you see, what does it say I have to do in order to get regulatory approval? Does it say that I have to use reasonable best efforts to satisfy the conditions to get regular approval? It says that. Then you got to call up your litigators and figure out like, does reasonable best efforts require me to sell my four other precious businesses in order to buy this $100 business? That might be a hard fact pattern to say that reasonable best efforts requires me to do that seems like an absurd thing to require someone to do. But if the sell side is very good lawyers and a lot of leverage and they're able to get what they call a hell or high water covenant from me, then what that covenant will say is I have to make the filing and I have to take all actions necessary or advisable to get approval, including selling any other assets, agreeing to whatever the regulator wants me to do, and basically get approval come hell or high water. Doesn't actually use those words. That's what people call it. So if you had that, then I would say, oh man, this stinks. I actually have to go sell my four other businesses and buy your one business for $100. I signed a contract, so I guess I have to go do that. So that's like the importance of that covenant. And there's a whole bunch of variations between having nothing and that L. RI Water standard that I mentioned. So you could have something. The buyer has to fight really hard and argue with the regulator. Present lots of arguments, but at the end of the day, they don't have to sell anything. They don't have to actually agree to anything. That's called anti hell or high water. You could have something that says reasonable best efforts, which is sort of a fluffy standard and no one's quite sure exactly what it requires you to do. And it creates uncertainty. That can leave room for some compromise. You could have specific guidelines where the buyer can be forced to accept remedies up to a certain amount. You can say sell businesses worth this much revenue, this much ebitda, however you want to frame it. You can say you have to sell this particular business. Someone asks you to. What people worry about in those sorts of more specific guidelines is you can draw like a roadmap for the regulator where they can look at that and say, oh, you're willing to do that? Perfect. That's exactly what I want you to do. Go do that, please. So that's like a potential risk with spelling out the scope of the covenant. 2 Specifically, that's what buyers and sellers do to help allocate the risk of regulatory approval. Signing, closing.

You built a really good case. Why you should have a good lawyer when pursuing any M and A. I think that's my big takeaway there. This gun jumping law thing, can you teach me about that? How does that work? Why people freak out about it.

There are a whole bunch of meetings of gun jumping. Basically, it's like what you would think, don't jump the gun. Don't do something before you are allowed to do it. So like in the securities law world, there's gun jumping and ipo. There's only certain communications you're allowed to make. When you're in an IPO process, you do those communications too early. You're filing the securities laws. So your question was not about securities laws. But I'm just. That's another thing that means that another meaning of the word gun jumping.

You know, as an entrepreneur, you try to get away with what you can get away with. That's the entrepreneur law.

Move fast and break things, so to.

Speak, get away with as much as you can.

So in M and A, if you have what they call suspensory regulatory approvals, meaning you're not allowed to complete the transaction until you get the regulatory approval, generally what that means is if you do something that is completing the transaction, that is considered gun jumping and that's an offense, that's illegal. What does that mean in practice? So it is typical for an M and A agreement to have interim covenants that say that basically protect the buyer from the moral hazard that the seller faces when they've already agreed to sell their company for a certain price. The buyer knows that subject to those conditions I spoke about before, once the regulatory approval or whatever is achieved, they're going to have to close the deal and pay whatever purchase price was freed up front. And so what they want is, they want to make sure that the seller is not just like taking the business and flushing it down the toilet or selling it to someone else, being lazy and not working as hard to preserve the value of the business because they know they've already sold it and they're a lame duck owner or lame duck management team. So to protect against that moral hazard risk, there'll be interim covenants that basically say you're going to operate the business in the ordinary course, consistent with past practice. You're going to use reasonable efforts to preserve your business, and you're not going to do certain enumerated material things without getting my consent. So you're not going to hire a new CEO, you're not going to enter into new material contracts, settle material lawsuits, that sort of thing, and that's generally considered okay. Where you get into trouble is if those interim covenants become too tight. And this is again, I'm not an antitrust lawyer, so don't take this as precise legal advice. But if you had two competitors who are merging, and one of the interim covenants said, before you embark on any new advertising plan for your products that compete with mine, you have to get my approval. I'm pretty confident that is illegal to put in a contract because you're supposed to be competitors until the government says you can merge. And if you're saying that you can't advertise your products without my consent, then you're basically giving A competitor control over the advertising of a competing product. And that is probably a violation of the antitrust laws. And you can imagine more extreme things like I get approval of all your pricing or where you open your store retail business, any new stores near my stores don't do it, I get approval of it. Like those would be examples of gun jumping.

What about when you have a team that is trying to their responsibilities integration of the company and they're trying to plan for that activity and they'll talk about it like be careful not to do X or sort of give too much of this where people are acting on things to trigger a gun jumping law. Where does that context fall into it?

I'm going to reiterate my disclaimer again that I'm not an antitrust lawyer. Like even the example that's gay buck on jumping. Don't hold me to those. Like they're probably. But I don't know, like the M and a lawyers, 8020 understanding of this stuff. What I've been told by very smart antitrust lawyers is you allowed to plan for integration but not actually integrate. So if you want to discuss what you're going to do, which HR system are we going to use, which ERP system are we going to use, which office space are we going to use, how are we going to partition the floors or something like that, like that sort of planning thing is probably okay. Check with your antitrust lawyer. But actually implementing it where you're actually operating as a single enterprise, that is probably not okay. But check with granted trustworthy.

Okay. I don't know if it's even related, but contingencies around customer approval, that needs to happen to closing, how does that work?

I think it depends on a couple of things. So I think it depends on obviously how important the customers. If you have 10,000 customers, nobody cares about this stuff.

That's a contingency. The point is like we have some validation that the customers are generally happy about this happening.

That's right. One thing I would ask as a buyer and as a seller seller is what are the terms of the contracts on their own? Like, let's assume that the contract says that the customer has a termination right on a change of control. Let's just assume it says that. So then you would ask, okay, should we get them to waive that? Should we get their consent? The next question you should ask is what's their termination without a change of control? Because it could be the case that the customer has a termination for convenience. Right. In 30, 60, 90 days. So in that case they could all. Even if you got their consent, they can say, sure, I'll consent. And then the next day they could just send in a notice and say, just kidding, I'm going to terminate. So worry about that both as a buyer and the seller. Like what does it even get you from a buy side perspective, it can still give you validation. Like you said, they're not upset that you now own the business. Still might want that from a buyer's perspective. But if I'm in the sell side, I would say listen, you don't even need this. It's not getting you anything. These are terminable on short notice anyway. I'm not taking the risk. That's your risk. If they don't like you, you're going to live with that risk right after closing anyway.

And then you build out the rules there of like how are you going to validate it, what approach you would have. Because you could have qualitative conversations or sending surveys out.

Exactly. And there's like negative. And this comes up in investment. Again, I'm going to say precise legal things that might have exactly right. Like investment advisors or broker dealers. I forget which is which. But there are. I forget in which case this concept about to mention applies. But there could be a concept of negative consent or positive consent. So affirmative consent means under the terms of the contract they actually have to say yes, I approve versus negative consent is you send them a notice and if they don't respond then it's deemed that they've approved it. So between the buyer and the seller, either from a legal perspective, in certain regulated industries there can be implied terms in the contracts that negative consent might be okay. Or you could negotiate between buyer and seller that you just want notices and then if they complain and that becomes an issue, or the buyer could say no, negative consent doesn't count. I actually want people to come back and say yes, they love me for me to do the deal.

What about delays? When delays happen, how does that go down? Is it all right? We understand why, we'll be patient. This is where you see these deals that don't get done. What are Sprint and T Mobile? Just stuff that just takes forever.

It's a great point. Particularly the antitrust regulators, other regulators getting more aggressive, like they have more work to do and things take more time, more things get investigated. So then, yeah, how do you allocate the risk of time? So there are like a couple of interesting things that happen there. One of the other key terms in an agreement for allocating risk is going to be the drop dead date. But the drop dead date is basically says you hit this date as long as it's not your fault, meaning whoever's trying to terminate, as long as the person is terminating is not their fault that it's taken this long, they can terminate the deal and they no longer have the hell or high water covenant or whatever covenant to actually get the closing to happen. Once you terminate a deal, you tear up the contract more or less, and each party goes on their merry way. So what that date is, is a negotiated point. So you can imagine, for example, if the parties are worried about a protracted antitrust investigation that could take 612 months, they might write in a 3 month drop dead date. So if you hit 3 months, even if the antitrust regulators have started the investigation, forget it. We don't want to spend more than three months trying to get this thing closed. We're going to each go off on a merry way. So that could be a way of allocating risk between the parties, depending on who wants it more. That could be a way of giving the target comfort, for example, that if the deal is taking that long, the chance that it's actually going to close is probably lower than if it had already closed. They may not like being under the thumb of all the interim covenants that I mentioned for longer than, let's say three, four, six months. And so it buys them comfort. They know if they hit that time period, they have an option to get out instead of continuing to be under the thumb of the interim covenants for a deal that made it actually happen. Another way to address that risk from its target seller favorable is you can imagine. I don't know if I've seen this, but I've heard people talk about it, is you can imagine the interim covenants get looser over time. We're okay giving you very tight approval over our material contracts. For example, the first three months back in three months, come on, I got to run my business. Maybe the thresholds for what things you get to approve, they go up so I have more flexibility. So that could be a way of giving the target a little more comfort that they're able to run their business even if the regulatory approval process is taking longer. And then there's economic things you could do. So you could have a ticking fee that if it takes longer, the price goes up. You could have termination fees that go up if the process takes longer. You could have fees like just making this up, like a deposit that somebody pays to extend the outside date. You can imagine where people could have interim deals to keep the process going.

So you got a lot of little reins and angles to keep people on the hook. But also that's interesting how it's all negotiable. If I ever get in that situation, I'm definitely going to call you. What about when we just can't close? There's something I'm just trying to think of. The financial contingency bottomed out. Oh, I had a deal last recession, tides turned and the bank came, pulled all the financing. So we're not going to do this. And at that time there was no way to get it. Then what?

You don't have the money, how's that going to work? Okay, so what would probably happen in that circumstance is you would be making a claim for damages and then you would look at the contract and you would say what are my remedies other than specific performance? So commonly if you have a deal with third party debt financing, there'll be something called a reverse termination fee which basically the buyer says, hey, if I breach the contract or I'm not closing because I don't have the debt and you can't force me to close, then I agree to pay you a termination fee of generally around 4 to 6% of the purchase price as penalty basically or liquidated damages for my failure to close. And that generally is a cap. So the buyer can't be forced to pay more. And it's a deemed liquidated amount. So the buyer can't say oh you're just sold your company to somebody else for twice the price. You don't have any damages. It is just deemed amount that this is the amount that I have to pay if I breach the contract. So that's one way to do it. You could also just not have an RTF and just the seller just has to make a claim for damages. And then there's all sorts of technicalities about like how the deal is structured. Because if you have a merger then the people who are suffering the damage are the shareholders and the company really hasn't actually suffered damages. So maybe the company can get its success expenses, but they might not actually be able to get the benefit of the bargain the shareholders lost unless you include something called Con Ed language. But there's a case that the Con Ed case that basically said in a merger if the shareholders aren't the party to the agreement, then you can't get, the company can't get damages that are about lost premium on the shares, they can only get their own damages which Is like their legal expenses or something. So as a result, you put in language that basically says, no, no, no, the target can get the damages on behalf of the shareholders for the value of their shares. So you would have to look at that as well to see what the actual damages are in that particular circumstance. And then you would have to enforce the damages against the buyer. So if it's a shell company that lost its financing, doesn't have any money, hopefully it has an equity commitment letter from a financial sponsor, so you can enforce that. But that's something else you'd have to look at.

Oh, people suing. A lot of people there. Okay, Brett, you got a little cheat because you already been to this interview and know what the signature close question is. So I want to try a variation of it. What's the craziest thing you've seen in M and A, specifically? What's like, shady stuff you've seen go down between sign and clothes?

It's like only quasi M and A story, but I think it's great. So I was at a party and I met this guy, and he was telling me about his boats. This is like a rich guy. He has, like a boat he, like took to the. He like takes the Hamptons, like a giant boat or something. He upgraded his boat. So we found another boat that he was going to buy that was like a better boat. But in order to free up assets to buy the other boat, he had to sell his current boat. So he's all excited. He has this boat he's going to buy, and he goes and sells his current boat. And then he's like, all right, I got the cash. Give me the other boat. And the guy who was going to give him the other boat sold the boat to somebody else. So he had his financing, but he didn't have his deal. It's sort of like an interesting quirk on the typical problem. Moral of the story is an M and A make sure you have your financing, but also make sure you have your deal. Because that could happen in real life, too. You could have a situation where you raise a bunch of money to do a deal, and then the target has some sort of an ad. It's a public company, your bid gets topped. And the other thing that's crazy that I have seen more like real M and A is somebody signs up a deal where they have to pay a bunch of money and just don't think about the financing. And then they're in a pickle going to people asking for financing to close the deal. So that can also be a crazy situation.

That's a good example. Brett, thank you so much for taking the time. So glad I'm not billable hour rates with you. But even if you were, you definitely earned it. I learned so much from you. So thank you so much for chatting with me today about all the stuff that goes on between Sign and close.

Happy to do it.

Cheers. And here's to the.

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