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Using more refined closing terms to avoid disputes | M&A Conference at the University of Chicago

Using more refined closing terms to avoid disputes | M&A Conference at the University of Chicago
Oct
2018

Corporate development and general counsel face a myriad of challenges in matching contractual language to deal intentions.  The structure of earnout provisions, the use of the locked box working capital mechanism, and the application of transactional insurance were discussed in detail during the M&A Conference at the University of Chicago.

Moderator Christen Morand, Partner in Ernst & Young’s Forensic & Integrity Services practice, whose practice deals with a broad range of post-close disputes, started the discussion with a look at innovative methods for structuring earnouts. 

Patrick Belville, who served as Associate General Counsel, M&A, of Cardinal Health (now in private practice as a Partner at Jones Day), expressed caution about earnouts, alluding to how today’s price dispute can lead to tomorrow’s litigation.  Belville did explain how the use of capped earnouts can be a deal incentive.

Aaron Friedman, Director of Corporate Development, Mergers & Acquisitions and Venture Investing at Walgreens Boots Alliance, said that his team tends to focus more on the working capital mechanism, but noted that they have had some success in short-term earnouts for smaller acquisitions.  “As you blend businesses together, earnouts are harder,” Friedman added.

Jason Lilly, Vice President of Strategy & Corporate Development at Neogen, said that his company defines earnouts in the Letter of Intent, adding that most are based purely on revenue. 

Furthermore, these earn-outs are derived from gross margins and defined clearly in spreadsheets, subject to audited financials.  “As long as the numbers are coming through there, the sellers are happy; money helps lubricate happiness,” Lilly noted.

Belville added that earnout considerations should start with integration considerations; what one will do with a business post-closing, which should include a careful assessment of cost structure and cost of product.

“Go as short as you can, capped, with as clear a set of benchmarks as you can get,” Belville advised, reminding that it is difficult to cover all contingencies in such agreements.

Morand also asked about the timing of earnouts. 

Lilly said two years is typical; three years the maximum, with the percentage payout declining over time. Friedman stressed maintaining flexibility and warned, “It’s not as much in the control of the seller as they might think.”

The panel also discussed intricacies of the locked box working capital mechanism and its calculation, including the value of doing sample calculations to show how cash, debt, and working capital are agreed to ensure the benefits of a fixed price deal.

While acknowledging the use of reps and warranties insurance, Belville suggested that “Everything you can get out through working capital the better.”

Video: 
Earn-out Provisions Closing Condition Deal Terms Deal Structuring Locked Box Closing Mechanism Transaction Insurance
By Ms. Christen Morand

Christen Morand is a Partner and Certified Public Accountant in Ernst & Young’s Forensic & Integrity Services practice and is based in Chicago. She provides alternative dispute resolution services and litigation support services on a variety of matters including post-transaction disputes, purchase price disputes, working capital adjustments, analysis and resolution of earn-out provisions and expert testimony. She is a frequent speaker on accounting M&A topics, mitigating M&A disputes, and analysis of M&A contractual language.

View all articles by Ms. Christen Morand
By Mr. Aaron Friedman

Aaron Friedman is Director of Corporate Development, Mergers & Acquisitions and Venture Investing at Walgreens Boots Alliance. He is responsible for evaluating and executing strategic acquisition and venture investing opportunities. He collaborates with the executive, finance, and business unit leadership at Walgreens Boots Alliance in deal analysis, valuation, negotiation and structuring to support a broad range of strategic initiatives.

 

View all articles by Mr. Aaron Friedman
By Patrick S. Belville

Patrick Belville served as Associate General Counsel, M&A, of Cardinal Health before becoming a Partner at Jones Day. His practice includes domestic and cross-border mergers and acquisitions, private equity and venture capital transactions, restructurings, recapitalizations, joint ventures, strategic alliances, and corporate governance.

 

View all articles by Patrick S. Belville
By Jason Lilly

Jason Lilly is Vice President of Strategy & Corporate Development at Neogen. He oversees all aspects of the corporation’s strategy and corporate development activities, including acquisitions, technology partnerships/licensing, IP management, contract administration, and has oversight of Neogen’s global Agrigenomic business.

 

View all articles by Jason Lilly

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