Closing Requirements in M&A

Deals rarely conclude with a simple signing. Particularly in the case of public deals, numerous complexities must be addressed before the official transfer of ownership can take place. In this article, we will delve into the crucial closing conditions that must be met during transactions, as well as strategies to safeguard the target company's value during this critical phase.

Closing Conditions

Closing conditions are the requirements that both parties must meet before the deal can be closed. These conditions can be related to regulatory approval, third-party consent, financial performance, and legal compliance. Both the buyer and seller must agree to these conditions and ensure that they are met before closing a deal. Some examples of closing conditions include:

1. Regulatory Approvals: Deals often require approval from government agencies, such as the Federal Trade Commission (FTC), the Securities and Exchange Commission (SEC), and antitrust regulators. These agencies may require the involved parties to provide detailed information about the transaction and its potential impact on competition. Receiving regulatory approval could take several months and is one of the biggest hurdles to overcome when closing deals.?
2. Third-Party Consents: In some cases, transactions may involve third-party contracts, such as supplier contracts, customer contracts, or lease agreements. The involved parties may need to obtain consent from necessary third parties before the deal can be closed.?
3. Financial Performance: Buyers may require a seller to meet certain financial performance metrics, such as revenue or profit margins before a deal can be closed. This ensures that the seller delivers on the promises made during negotiations and that the business performs as expected.
4. Legal Compliance: Buyers and sellers must ensure that they are in compliance with all relevant laws and regulations before closing a deal. This may include obtaining permits or licenses, ensuring that the business is registered in the appropriate jurisdictions, and complying with labor laws.
5. Financial Considerations: If a buyer is doing debt financing, they will need a fully signed purchase agreement to secure the funds from the lenders. This process can take at least 45 days.
6. Corporate Approval: Both parties may need shareholder approval to buy or sell a company.

Risks Between Signing and Closing

In M&A, time is of the essence. The faster a deal is finalized, the better. However, the period between signing and closing is not without risks, as one party can always withdraw from the agreement if they have legitimate grounds to do so. Brett Shawn, Senior Vice President, and Assistant General Counsel at Warburg Pincus LLC outlines some of the most common legal reasons why a party can back out of a deal.

1. Lack of Closing Requirements?

The deal can fall apart if the involved parties fail to obtain the necessary approval.

2. Reps and Warranties?

Parties can withdraw from the agreement if the other party's representations and warranties are proven false. For instance, if a target company is found to be operating illegally, the buyer can choose not to proceed with the transaction.

3. Material Adverse Effects

If there are material adverse effects on a target company between signing and closing, the involved parties are legally allowed to withdraw from the deal. An example would be if a target company experiences a drastic change, such as losing half its workforce, rendering it no longer operational.?

Conversely, suppose a seller discovers a significant new asset, such as gold, on their property. In that case, their business's value could increase astronomically, and they are not obligated to sell at the agreed price.

How to Mitigate Risks

In a contract, interim covenants serve as vital safeguards to protect both parties involved in a transaction. These mutually agreed-upon rules must be followed to ensure a seamless and successful transaction. For instance, the seller must ensure that the buyer takes reasonable steps to meet the closing conditions; otherwise, the buyer may walk away with valuable and sensitive information about the company.

Similarly, the buyer must ensure that the target company is being run properly during the transition period by using covenants. However, be aware of the gun-jumping rule, which prohibits companies from acting as one before closing a deal.

In some cases, a lengthy closing process can harm the target company, so sellers may use a ticking fee to incentivize buyers to finalize a deal quickly. Some deals include a termination fee in the contract to discourage buyers from backing out of the agreement.

Buyers can protect themselves by including a drop-dead date clause in the contract. This clause sets a strict deadline for the transaction, and as long as the buyer is not responsible for the delay, they have the right to terminate the contract if necessary.

Post-Closing Obligations

Even after a deal has been closed, the involved parties may have certain obligations to fulfill. These obligations may be related to reps and warranties made during the negotiation phase, post-closing adjustments to the purchase price, or indemnification for any liabilities that arise after the closing date.

1. Warranties and Representations: A seller may make certain reps and warranties about the business or assets being sold during the negotiation phase. These may include statements about a business's financial performance, legal compliance, or the condition of the assets. If any of these statements are later found to be untrue, the buyer may have the right to seek compensation from the seller.
2. Post-Closing Adjustments: The purchase price may be subject to post-closing adjustments based on certain metrics, such as working capital, net asset value, or the level of indebtedness. These adjustments ensure that the purchase price accurately reflects the value of the business or assets at the time of closing.
3. Indemnification: The involved parties may also agree to indemnify each other for any liabilities that arise after the closing date. This ensures that the buyer is protected against any unforeseen liabilities that may arise from the seller's actions prior to the closing date.

Conclusion

In conclusion, closing requirements in M&A are a critical aspect of the deal-making process. Both parties must ensure that all closing conditions are met, prepare and execute the necessary closing documents, and agree on the closing date.?

Additionally, the parties may have post-closing obligations, such as fulfilling reps and warranties, making post-closing adjustments to the purchase price, and indemnifying each other for any liabilities that arise after the closing date. By carefully planning and executing the closing process, buyers and sellers can ensure a successful and smooth transition of ownership.

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