Classification: Deal Driver
Negotiation Time: Minimal
Transaction Costs: Insignificant
Major Impact: Deal Value and Risk Management
Conduct of Business Prior to Closing
What is This? The Buyer’s due diligence investigation and, ultimately, its decision to buy the Business assume that the Business will continue to operate as it has in the past until the Closing Date (i.e. while the Seller is still in charge). Here, the Seller promises not to make any major changes to the Business without the Buyer’s consent.
The Middle Ground: This covenant requires the Seller to conduct the Business consistently with how it has been conducted in the past and to use reasonable best efforts to maintain the Business’s operations and relationships prior to the Closing. In addition to those general directives, the Seller agrees not to deviate from certain practices without the Buyer’s consent, such as paying debts and taxes when due and performing its duties under the Assigned Contracts.
Purpose: The Buyer bases its valuation of the Business in part on how it has been conducted by the Seller in the past. The best way to protect that value is to ensure that the Business is operated the same way between the signing and Closing as it was in the past. Without this provision, the Buyer would be stuck with the risk stemming from some fundamental change in the Business that occurs after the Buyer signs the Agreement. With it, that risk is shifted to the Seller, who is in the best position to prevent those changes from taking place.
Buyer Preference: Here, the Buyer may want to include a comprehensive list of both the actions the Seller is required to take prior to the Closing and those it is forbidden from taking. If the Buyer is financing the acquisition, the list should also include anything the Seller must do in order for the Buyer to obtain financing. For maximum protection, the Buyer can require consent on all material operational decisions, but there are two important limits on such a requirement. From a practical standpoint, the Buyer may not have the time or expertise to make those decisions, and it would be best served by letting the Seller continue ordinary operation of the Business. From a legal standpoint, if the Buyer and Seller operate in the same industry they must be careful to avoid violating antitrust law by consolidating control before they obtain the proper approval (if governmental approval is required).
Seller Preference: The Seller wants as few restrictions listed here as possible so that it does not inadvertently violate the Agreement. It also wants language in the covenant that allows it to back out of a particular duty if the Buyer consents, with the Buyer’s consent governed by a standard of reasonableness (e.g. the Buyer cannot unreasonably withhold or delay consent). The Seller may also try to mitigate some of the Buyer’s requested restrictions by narrowing their applicability where it makes sense to do so. Both parties want to avoid antitrust issues, so they may include a “No Control of Other Party’s Business” clause if the list included here is particularly comprehensive and/or restrictive.
Differences in a Stock Sale Transaction Structure: None.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.