Purchasing a business may be one of the biggest decisions – and investments – a company can make.  It takes a significant amount of time, analysis, effort and monetary resources to complete a transaction and the last thing a buyer would want is to see the value of its investment immediately decrease.  In that vein, we want to highlight three ways M&A (mergers and acquisition) buyers typically seek to protect their investment.  As with our entire Top 3 with Lindsay series, this is not intended to be an all-inclusive list, but rather to highlight some of the critical concerns that buyers should keep in mind as they seek to protect the value of their investment.

• Don’t Pay the Purchase Price all at Once: Instead of paying the purchase price in one lump sum at closing, consider paying overtime (e.g., a portion at closing and the remainder under a promissory note where the balance can be paid in a lump sum at a single later date, or it can be paid in installments over time).  Also, all or some of the purchase price can be contingent on the achievement of certain milestones (e.g., earnouts that may increase based on the company’s performance, meaning the better the company does, the better the purchaser does (as its investment generally is more valuable) and the better the seller does (as generally they would be entitled to these additional payments)).  Along similar lines, a portion of the purchase price can be structured such that it is subject to a holdback in which the purchaser holds a portion of the purchase price aside in case there are any indemnification claims and/or other purchase price adjustments and then releases the balance, if any, after an agreed upon period of time, or an escrow (which is a similar concept, except the funds are held by a third party escrow agent).
• Seek Strong Indemnification Protections: How long do the seller’s representations and warranties survive the closing?  This determines how long you have to make a claim under the agreement for a breach of representation or warranty.  Buyers often seek 24 to 36 months survival periods, with sellers pushing back for shorter periods.  Many buyers also seek to carve certain representations and warranties out of that general survival period and instead have specific representations and warranties survive for a longer period, such as the statute of limitations or indefinitely.

Another common “dance” relating to indemnification relates to “baskets” and “caps.”  If a seller requires a basket for the indemnification, the buyer should be aware that there are generally two types: a tipping basket, which is more buyer-friendly (if  and only if an indemnifiable claim exceeds a threshold amount, the seller is liable back to dollar one for the entire claim) or a deductible, which is more seller-friendly (if an indemnifiable claim exceeds the deductible, the seller is only liable for the amount of the claim in excess of the deductible).  If the seller requests a “cap” (an overall limit for the indemnification), consider whether there are any claims that should be uncapped, such as fraud. Buyers should also consider whether representations and warranties insurance (commonly referred to as R&W insurance) is appropriate for the transaction and, if so, which party should be responsible for the premiums or if they will be split between the parties, the limits thereunder and the exceptions from coverage.

While the word “indemnification” is often used to refer to protection against third party claims, for simplicity here we are using the word to also address the buyer’s claims against the seller.

• Require Restrictive Covenants (if Possible and Permissible): You likely do not want to pay to acquire a business from a seller and then have that seller open up a competing business next door the day after closing.  To help combat that concern, your counsel can discuss with you proposing a non-compete covenant from the seller whereby the seller would agree not to engage in specified activities in a location (e.g., New York) for an agreed upon period of time. Similarly, you likely do not want to acquire a business only to find out that the day after closing the seller is soliciting the company’s clients to move their business elsewhere or enticing the company’s employees to work for someone else.  As to that issue, your counsel can discuss with you requiring a non-solicit and non-hire covenant from the seller.  There are many nuances that are involved in these discussions, including the scope (who should be subject to these restrictions - the seller only or also certain key employees), the length of the restricted periods, any carveouts from the restricted activities, etc.).  There may also be enforceability considerations as federal law, as well as the law in some states, has either banned some of these restrictions or has started to swing the pendulum in that direction.  All of these important and complex restrictions should be discussed with your counsel before being proposed.