Joint Article By: Ed Batts, Matthew Gemello and Mark Seneca
Originally publicly released on June 20, 2019
Earlier this week, Atlassian published its form acquisition letter of intent under the banner of The M&A Process is Broken: It’s outdated, inefficient and combative.
Atlassian developed and published the LOI in an effort to eliminate time-and-expense of negotiating issues that, based on its experience and research, rarely come into play following the deal closing. By reducing such adversarial positioning, Atlassian hopes to increase collective focus on realizing the larger commercial, product and/or talent synergies that underpin the basis for the deal in the first instance.
In our experience, the M&A market already has prescribed a fairly narrow range of key deal terms and arriving at a finalized term sheet is not often an agonizing process. Due diligence, on the other hand, can be particularly burdensome for founders, but the larger goals of the exercise typically extend to post-closing integration as well as risk mitigation. While streamlining the M&A process is a sound objective, we question whether the Atlassian term sheet will provide the necessary comfort to the average corporate buyer, particularly given facts and circumstances of individual companies which can vary significantly from deal-to-deal. Deal points of this nature and magnitude are judgment calls for buyers often driven by larger institutional perspectives on risk tolerance and compliance and a one-size-fits-all approach may not be practical given a particular buyer’s commercial realities. In particular we note:
- Reducing caps on sellers’ post-closing liability to 5% and making those caps more inclusive (i.e., eliminating special business representations and warranties relating to IP, privacy and other hot-button topics) may be challenging for many strategic buyers. For example, regulators are devoting extra scrutiny to data privacy, as evidenced by the General Data Protection Regulation (GDPR) in Europe, California’s Consumer Privacy Act (CCPA) which takes effect in January (see: https://ccpa.orrick.com/) and Nevada’s leaping to the front in the U.S. implement a similar opt-out construct on October 1, 2019. A 5% total recourse cap, particularly for target companies with large consumer facing activities or that transact in large amounts of consumer data, may not be sufficient.
- The Atlassian term sheet provides for representation and warranty insurance for any deal over $50 million in value – while remaining with an escrow construct for deals under that threshold. The proposed 5% escrow cap is roughly ½ of the 10% ‘market’ lower boundary; on the other hand, the model term sheet’s 15 month survival period for representations and warranties is longer than the 12 month ‘market’ lower boundary.
- While there is increased use of RWI by strategic buyers, RWI may not be the right remedy/protection for certain larger transactions for particular buyers. On one hand, RWI actually generally gives longer periods of protection than conventional holdback/escrow indemnification constructs; however on the other hand, it excludes from coverage any issue that is deemed ‘known’ by a buyer at the time of a deal. Moreover, given current premiums, many buyers are seeking coverage significantly in excess of 4% of the overall transaction value and either splitting the policy cost or absorbing it, rather than forcing the cost on seller to pay.
- The Atlassian term sheet appears to not contemplate crediting the target company for cash-on-hand at closing, but does deduct transaction expenses and any change of control payments – whether or not paid. These positions are not equitable for target companies, particularly those who generate cash or have contingent contractual obligations that may not actually become due and payable. Financial true-ups for cash, debt and/or working capital are useful for transactions with periods between signing and closing, such as those that exceed the applicable antitrust filing thresholds (for the U.S., any transaction worth over $90 million in 2019).
- Retention initiatives may be better addressed through broad-based approaches rather than selective hold-backs/rollovers for certain key executives.
As a result, we expect that the Atlassian model term sheet will serve as a useful basis for continued debate on the merits of various approaches, but that many of its principle tenets will continue to be the subject of case-by-case analysis. Strategic buyers in the current M&A market continue to appear to be willing to offer purchase prices that generally exceed that of more conservative financial buyers, but also expect risk protection for pre-closing issues.