M&A Escrow Agreements: Negotiation & Drafting …media.straffordpub.com/products/m-and-a-escrow...2015/03/11 · M&A Escrow Agreements: Negotiation & Drafting Strategies CLE Webinar

M&A Escrow Agreements: Negotiation & Drafting Strategies Structuring Contract Terms, Dealing With Escrow Agents, Avoiding Conflicts With Acquisition Agreements

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WEDNESDAY, MARCH 11, 2015

Presenting a live 90-minute webinar with interactive Q&A

George Colindres, Senior Counsel, Perkins Coie, Los Angeles

Paul Koenig, Managing Director, Shareholder Representative Services, San Francisco

Alex Tsarnas, Managing Director - Global Business Development, SRS|Acquiom, New York

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M&A Escrow Agreements: Negotiation & Drafting

Strategies CLE Webinar

George Colindres

Perkins Coie

Senior Counsel

[email protected]

Paul Koenig

SRS Acquiom

Founder, co-CEO

[email protected]

Alex Tsarnas

SRS Acquiom

Managing Director, Global Business Development

[email protected]

Proprietary & Confidential

© 2014 SRS|Acquiom LLC

Page 6



Page 6

I. Current Trends: M&A Escrow Agreements

> Changing Banking Regulations – Impact on Escrows

> With the recent Cigna vs. Audax decision, there may be a trend

towards larger escrows

> No significant changes in the size, duration, prevalence or terms of

typical escrow arrangement

> In competitive bidding situations, buyers might make offers with

smaller/shorter escrows; might buy insurance to fill gap

> R&W insurance and payment in full at closing remain as the exception

> Expense funds are now included on virtually all deals



Page 7



Page 7

Changing Banking Regulations - Impact on Escrows



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Page 8

Changing Banking Regulations - Impact on Escrows

> January 1, 2015: Selection of Investment alternatives for Escrows became

more complex

- New regulations will be phased in during 2015 and 2016

- Escrows last 12-24 months – affects decisions made today

> Money Market Accounts

- Changing liquidity coverage ratio rules make deposits less attractive

> Money Market Funds

- New Floating NAV reporting requirement

- SEC adopted July 23, 2015

- Now affects all MMFs, when historically it didn’t

- Most important change on Oct 14, 2016 (the Effective Date)

- Liquidity fees of up to 2% of the amount of any redemption

> Treasury Funds

- Anticipated supply-demand imbalance

- Subject to same redemption limits and liquidity fees as MMAs/ MMFs



Page 9



Page 9

Private Mergers after Cigna v. Audax

What can buyers do after Cigna v. Audax to address a more limited ability

to bind non-party stockholders?

- Increase escrow coverage

- Focus on obtaining support agreements and/or joinders

- Consider creating “hooks” in merger agreement to the desired stockholder undertakings

- Consider making merger consideration “ascertainable” to a greater degree by limiting

indemnity in time and/or duration

- Depending on degree of risk, buyers might consider more aggressive measures



Page 10



Page 10

I. Current Trends: Claims

> Two-thirds (67%) of expired-escrow deals have material post-closing

issues

- 18% of expired-escrow deals have at least one claim made in the final week of the escrow

period

- 12% of deals with a claim have at least one claim that resulted in litigation or arbitration

- 21% of expired-escrow deals with claims have claims exceeding half of the escrow

> Claims types fall largely into three groups:

- Breach of R&W

- Purchase Price Adjustment

- Fee/costs



Page 11



Page 11

Subset: 2013 deals with escrows/holdbacks*

* 97% of deals included an escrow or holdback for general indemnification purposes. Data does not include special escrows.

Escrows/Holdbacks as a Percentage of Transaction Value

Average Median Minimum Maximum

11.8% 10.0% 2.0% 31.5%



Page 12



Page 12

Transaction value vs. Escrow size (deals over $800MM hidden)

Data set: All deals closing in 2010–2013

* Equity capital investment data provided by S&P Capital IQ™.

Correlations: Transaction Value and Escrow Size

Each point is a deal; linear fit line in blue



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Page 13

Subset: Deals with separate escrows/holdbacks for specifically identified matters*

Deals with special escrows Frequency of special escrow types

* Excluding shareholder representative expense escrows.

** Deals may include more than one special escrow.

Special Escrows

Subset: 2013 deals with special escrow(s) included**



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Page 14

> Median size = $200,000

> Expense fund accounts slightly larger in

deals with earnouts

- 3% of transaction value for deals without an

earnout

- 5% of transaction value (not counting the

potential value of the earnout) for deals with an

earnout

> Expense fund usage

- 42% used some portion of the expense fund

in completed deals

- 20% average amount, when used

Deals including an expense fund Expense fund notes

Data set: all deals

Expense Funds



Page 15



Page 15

Adjustment direction Key figures

Post-Closing Purchase Price Adjustments (“PPAs”)

> 73%: deals with a PPA mechanism

> 46%: deals where the PPA statement was delivered

after the contractual deadline

> 3%: median PPA claim size, as a percentage of a

deal’s total escrow dollars, when buyer-favorable

adjustment

- The average was 10% of escrow, swayed by a number of

large claims

> 33%: average PPA claim reduction due to

negotiation

- The average time to resolve a contested PPA claim was 2.5

months



Page 16



Page 16

Claim subject matter as % of all claims (~700 claims) Subset: breaches of R&W (~ 400 claims)

Data set: claims across all deals (open and completed)

Claim Types and Subject Matter

* Claims pursuant to a post-closing purchase price adjustment mechanism (e.g. working capital).



Page 17



Page 17

Claim size breakdown (median: $140k) Average claim size as % of escrow

Data set: claims across all deals (completed and ongoing)

Claim Sizes Generally



Page 18



Page 18

Claim frequency based on buyer type Claim size based on buyer type

Data set: claims in deals with expired escrows

Claim Activity Based on Buyer Type

* Including deals with no claims.



Page 19



Page 19

Ultimate payouts of general indemnification escrows

Ultimate Payouts

Data set: escrows in completed deals

* * Excludes escrows set aside for special purposes, e.g., working capital adjustments or known issues.



Page 20



Page 20

II. Key Provisions in Escrow Agreements

Terms negotiated between buyer and seller - negotiated at M&A

agreement

> Obligations covered by escrow

- Typically indemnification obligations.

- Sometimes also purchase price adjustments or earn outs.

> Amount of escrowed funds

> Length of escrow period

> Selection of escrow agent

> Responsibility for payment of escrow agents fees

> Who represents the sellers?



Page 21



Page 21


Terms negotiated between buyer and seller - negotiated at escrow

agreement

> Segregated accounts?

> Investment of escrowed funds

> Mechanism for payment of buyer claims

> Timing of release of escrowed funds to seller

> Ownership of escrowed funds for tax purposes

> Removal of escrow agent; selection of replacement escrow agent

> Assignment



Page 22



Page 22


Terms negotiated with escrow agent

> Liens; right to set off

> Indemnification obligations to escrow agent

> Escrow agent’s ability to assign the escrow agreement; resignation of

escrow agent

> Tax reporting

> Jurisdiction and venue



Page 23



Page 23

III. Considerations: Drafting & Negotiating Escrow Agreements

> Addressing Know-Your-Customer (KYC) Requirements Early

> Avoid Improper Lock-up of Escrow Funds

> Ensure Clear Procedures for Release of Escrow Funds

> In Cross-border Transactions, Watch out for FBAR



Page 24



Page 24

Addressing Know Your Customer (KYC) Requirements Early

> Typically each party to escrow agreement must comply with bank’s

KYC

> Can be burdensome and time-consuming

> Compliance departments often issue follow-up requests for more info

> For non-U.S. entities, nature of requests and processing time can be

greater

> Action: proactively clear bank’s KYC process early to avoid last minute

rush that could delay closing



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Page 25

Avoid Improper Lock-up of Escrow Funds

> Clearly define what constitutes a third-party claim

- Do not permit vague concerns about future liabilities (not yet

materialized) to block release of funds.

> Buyer should accrue potential losses on balance sheet

> Specify time limit during which buyer must hear from third party before

claim is deemed dormant



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Page 26

Ensure Clear Procedures for Release of Escrow Funds

> Option 1: Joint written instructions.

- Pro: simplifies matters for escrow agent; simpler to negotiate

- Con: gives buyer leverage to delay releases, whether intentionally or just

being slow

> Option 2: Automatic release of escrow funds by escrow agent at end of

escrow period (less funds set aside for pending claims).

- Pro: funds released without delay

- Con: can prompt escrow agent comments during negotiation

> In any event, clearly define how funds are to be released under each

possible circumstance



Page 27



Page 27

In Cross-border Transactions, Watch Out for FBAR

> Certain accounts domiciled outside U.S. may require compliance with

Report of Foreign Bank and Financial Accounts (FBAR) regulations

> Penalties for non-compliance can be severe

- Forfeiture of up to greater of 50% account value or $100,000

- Possible criminal penalties

> Domicile may not be apparent

- E.g., If escrow fund held at a US bank is actually held in Hong Kong

branch, account may be subject to FBAR



Page 28



Page 28

SRS Acquiom at a Glance

> Continuous innovation in managing post-closing activity in private M&A

- Created professional shareholder representation in 2007

- First online platform for payments administration: Acquiom Clearinghouse

- Patented method applied to first escrow products designed for M&A

> Global leader: 800 deals with $130B in value

- 80K shareholders in 44 countries, including 500 VC and Private Equity funds

- Over 70 professionals

> Three lines of business:

- Shareholder Representation

- Escrow Solutions

- Acquiom Payments Solutions



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Page 29

SRS|Acquiom Data Resources

> 2013 SRS M&A Post-Closing Claims Study

> 2012 SRS Life Sciences M&A Study

> 2014 SRS M&A Deal Terms Study

> Newsletters

Subscribe to receive resources:

srsacquiom.com/newsletters

Currently Available

https://www.srsacquiom.com/newsletters

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M&A Escrow Agreements: Negotiation & Drafting …media.straffordpub.com/products/m-and-a-escrow...2015/03/11 · M&A Escrow Agreements: Negotiation & Drafting Strategies CLE Webinar