M&A Monday*: Closing Conditions
October 30, 2023
by a professional from Georgetown University in Maryland, USA
I have seen more buyers saved by closing conditions than any other provision.
Last month, I got an urgent call from a client. He had signed a purchase agreement, but his deal had not closed. The key manager was leaving. He said, do we have any way out of the purchase agreement or renegotiate terms? Of course, we had a closing condition, the parties renegotiated. It closed shortly thereafter.
Closing conditions are only applicable to a non-simultaneous sign and close.
In an M&A deal, there are 3 milestones: (1) LOI, (2) Purchase Agreement, and (3) Closing. Usually, the Purchase Agreement is signed at Closing (simultaneous sign and close). In a simultaneous sign and close there are no closing conditions.
Closing conditions are contingencies that must be achieved or waived in order to close. Usually, the closing date is not set and will occur when all closing conditions are met/waived. Closing conditions are included in the LOI and are extremely important. Remember, buyer is not forced to close if conditions are not met. However, if buyer wants to close, it changes the negotiating power to allow buyer to renegotiate (i.e., if no closing condition is triggered, seller can tell buyer to pound sand).
When I draft a LOI, I think about closing conditions applicable to this specific business. Here are some common conditions:
1. The conclusion of due diligence review. This is a controversial condition. It gives buyer the right to back out for any DD issue buyer does not like. This is powerful for buyers. When I represent sellers, I do not accept this.
2. No occurrence of a material adverse effect (MAE). This is always included, but the definition of MAE is hotly contested. If there is a dramatic change in the business, buyer does not have to close.
3. Buyer’s consummation of financing. This is another controversial one. Sellers view this as a financing contingency – because it is. However, from buyer's perspective, if no financing they usually cannot buy the business.
4. Offer letters with key employees. I started including this a couple years ago after seeing too many deals go bad after closing because of misalignment with key employees. This forces buyer to sit down with key employees and level set expectations and seller to retain employees. So important.
5. The receipt of third-party consents. There are lots of consents, including, landlords, licenses, key suppliers, etc. Those consents should be obtained or waived by buyer. Buyer cannot be forced to buy a business if in default of key agreements.
A buyer should ask, what change in the business would prevent me from buying it? That should be a closing condition.
*It still feels strange writing substantive M&A posts while 243 civilians are held in Gaza. But our resilience is our strength. This post is dedicated to 5-year-old Emilia Aloni, kidnapped from her home. She has been held captive for 23 days.
from University of Pennsylvania in Charlotte, NC, USA
As for things like conclusion of due diligence as a condition of closing, this is always the case - buyer can decide not to proceed (so can seller) at any time up to the signing of a purchase agreement; and after signing, the consequences of backing out depend on what the purchase agreement says (not the LOI) - there may be break-up/reverse break-up fees, forfeiture of a deposit, or other things. But as a practical matter, in a private company deal it's unlikely that seller is going to start an expensive, disruptive and time-consuming legal battle trying to force the buyer to complete a deal that buyer no longer wants to do. Sure if it's Twitter and Elon Musk in a $44B deal, that's different.
I agree closing conditions are important; just not following how they would work in an LOI or how some of these you mention would come into play practically - except consents like licenses and regulatory. Thoughts?
from University of Utah in Salt Lake City, UT, USA