Letter of Intent in Public M&A: Six drafting points on the scope of exclusivity

We will continue our blog on SPAs and private M&A deals next, but in the meanwhile I take a step to the public M&A world and write a few words about exclusivity. This is often a hotly debated issue, but the main principle and aim of the clause are clear.

Let us assume that we have a situation on the table where Company X made an indicative proposal with respect to a potential transaction involving a voluntary tender offer to acquire all of the outstanding shares and equity securities of Company B. In the following Letter of Intent, Company X requires that, during the agreed period (which we can call “restricted period”), Company B “...will not and procures that its affiliates and their respective representatives will not solicit, initiate, or negotiate any approach, offer or indication of interest from or with any third party with respect to any alternative transaction.” Sounds clear so far? Well, for those who are not familiar with the concept of alternative transaction, let me share some thoughts on the concept and what the issues are that should be considered.

First of all, from Company X’s point of view, it is important to define the scope of exclusivity in such a manner that there are no loopholes that Company B can use to circumvent the protection. Therefore, there is typically an exhaustive list of various types of transaction that are restricted, i.e., alternate transactions. From Company B’s point of view this kind of exclusivity needs to be considered carefully not only because of the board’s fiduciary duties may require certain freedom to operate without contractual restrictions, which, as it happens, is a topic outside the scope of this blog, but also to ensure that that the scope is not too wide, unnecessarily restricting the ordinary business of the company.

From Company X’s point of view the definition of an alternate transaction could be, e.g., the following: (a) any transaction concerning the subscription or acquisition of any shares in, or any equity securities of, Company B or any of its affiliated companies, (b) any transaction for the sale by Company B or any of its affiliated companies of all or a significant portion of their respective businesses or assets, (c) granting a licence to any intellectual property rights or assets of Company B or any of its affiliated companies other than in the ordinary course of business and consistent with past practices; or (d) any merger, demerger, formation of a joint venture by Company B or any of its affiliated companies and any transaction having a similar effect.

Second, while we have seen these kind of proposals in the past, we do not consider that these are necessarily business-oriented. Naturally, in point (a) one needs to make a distinction between two cases: one in which the board discusses on the sale of all or majority of the shares in which the control changes, as opposed to a case where an individual shareholder of a listed company trades his or her shares.

Third, in paragraph (c) there is a distinction that should be noted whether the licence is exclusive or non-exclusive. Wide licence to a company’s core IPRs may also be part of an ordinary business and in such case it may not be harmful to give the Company B such rights depending on the field of business as well. If it is outside the scope of ordinary business or exclusive, then there is a potential of value decrease but even then if such deal were to be detrimental to the value of the company, the board naturally would not implement that.

Fourth, in (d) there is a slightly similar issue as above, whether we should expect that there is a change of control. There are many collaboration deals that may be within the ordinary course of business and therefore not even harmful to the offeror.

Fifth, while the concept of alternative transaction is relatively wide, it might be prudent for Company B to consider whether a sentence on ordinary corporate finance transactions and the related security measures should be added. Further, there might be contractual or other rights relating to shares which would also require an express carve-out from the scope. At this point, Company B might not have full visibility as to what arrangements there are affecting the exclusivity and therefore this gives additional comfort to Company B.

Finally as a point number six, in all these types of alternate transactions, one needs to consider whether these reactions should apply to Company B only or Company B’s group as a whole or Company B or its affiliated companies as written above.

As you can see, even a small clause in LOI may be enormously fascinating if you dig deep enough and start playing with different scenarios when finding the optimal drafting. Based on our experience, standard models are used too often without thinking about the particular case in question. 

Hopefully, this will help and looking forward to hearing other comments around exclusivity theme!

Best Regards,

Jan

Some take-aways and personal after-thoughts on competitiveness, financing and platform ecosystems following IBA's Global Entrepreneurship Conference

For various reasons, I have not posted anything here in ages. I have been active otherwise and, for example, have written our firm's M&A and Corporate Finance Update. Anyways, this time I decided to focus on some issues other than ICT agreements or M&A and generally look at the market trends and views from the Nordic point of view. The main topic was discussed at the 5th IBA Global Entrepreneurship Conference "The Nordic model—rising up to the global challenge in Copenhagen" earlier this week.

One of the most interesting discussions was about how in Norway start-ups were able to get funding relatively easily, but the problem was that exits take place too early. After the panel, we actually continued discussions on the topic with my fellow colleagues from Sweden. I do not think that the question about the early exits was approached from the financing point of view. My personal view is that the exit stage usually coincides with hitting the "funding cap". By this I mean a stage when it is difficult for a growth company to get additional funding. Naturally, this stage where this funding cap exists, e.g., from €2 million upwards or something else, just varies slightly depending on the Nordic country in question. So in Finland, the exit stage is reached earlier than in Sweden for example. This would also explain why valuations in M&A context are higher in Sweden than in Finland—the companies in Sweden are developed further before exit as the funding cap is higher. Of course, there are other reasons as well, but it would seem to be quite human a trait that if there is a funding cap, additional growth starts feeling difficult and burdensome and next financing round would seem to require massive efforts and so forth, and therefore you start considering that it might be a good time to exit. Also by that time you might have already achieved enough to cover your personal expenses and paid your home mortgage, so this decision is even easier. On the other hand, it has been said that at least in Norway 2/3 of hirings are done by private firms so these entrepreneurs are also serving a valuable purpose. I would encourage anyone to find solutions to keep entrepreneurs interested in growing their companies even further and postponing this exit stage.

One of the main concerns we should all have is the low level of investments in R&D, especially in this global competitive environment in which we in Europe are lacking behind the US and China. While companies such as Amazon and Google have massively grown during the past few decades, we have not been able to establish quite similar success stories here in Europe. This can also be further be illustrated by looking at the R&D budget figures and activities of FANG (Google, Facebook, Netflix & Amazon):

And here, in this era of large platforms and massive concentrations of data why large platforms prevail and so many companies fail in data sciences? Well, in data sciences area it is not sufficient to have only one of the four described above, but you most likely need all four elements to create a winning strategy. 

Let’s take another topic that was discussed a lot in the conference as an example—GDPR, data protection and data security. This is an important subject but in the context of this blog posting when talking about Nordic firms and their competitive position in the global market, taking into account the insufficient investments in R&D, one can validly ask whether we have made a smart decision to invest such a large sum of resources in the protection of personal data and whether this investment is something that European firm can actually turn as a competitive advantage? One firm mentioned that they have spent approximately €3 million on GDPR compliance here in Europe, and therefore the valid question is whether the company will be able to earn back this investment? How long will it take? Or, if the company had spent, perhaps together with some other firms, the same amount on R&D focusing on the creation novel business models based on advanced data analytics or artificial intelligence, would it be in a better competitive position against its US or Chinese counterparts? In case of GDPR, this decision to invest has already been made so now it would be time not to be scared about the consequences and focus on sanctions and sanction levels, which I understand are interesting at least for lawyers but, instead, to focus on the creation of additional value, ways of turning data protection and privacy and the legislative framework into a competitive advantage for European firms. For Finnish firms, I do find it difficult to compete against these global platforms with our limited resources, but there are so many things to do "on top" of these platforms.

Looking forward to hearing your views on this and, in the meanwhile, have a splendid continuation of your week and greetings to all familiar and new faces at the IBA, we'll see you in Amsterdam next year!

Regards,

Jan