Valuation and Deal Structures

Valuation and Deal Structures

"Value and the Legal Stuff"

Presented by:

Bill GillilandNovember 27, 2014

OutlineValue

• Due Diligence $

• Transaction Type $

• Representations and Warranties $

• Indemnification Provisions $

• Conditions to Closing $

• Material Adverse Change $

• Working Capital Adjustment $

• Collectability of Claims $

• Holdback/Escrow $

• Earnouts $

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Due Diligence

• Value/risk assessment

• Business issues guide legal due diligence

• Legal and business due diligence coordinated

• Legal due diligence informs business transaction

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Value Issues Guide Legal Due Diligence

• Value drivers

• Value assumptions

• Risk assessment

• Sell Side

• eliminate risks

• clarify risks

4

Value Drivers of the Target Business/Acquiror

• Further refinement and focus to legal due diligence exercise

• Where is the value that will be paid for

• underpinnings of value

• What assumptions going to value are being made by acquiror

• assess reliability of assumptions

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Value Drivers of the Target Business/Acquiror

• Asset type – determines relevant issues going to value

• functioning plant/enforceable contracts

• Liability type – determines relevant issues going to value

• tax issues re structure

• Type of business – risks

• Importance of a legal issue depends on business issues

• loan covenants more important where company in financial difficulties?

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Types of Due Diligence – Functional Types

• Market/commercial due diligence

• Legal due diligence

• Financial due diligence

• Accounting due diligence

• Operational due diligence

• Environmental due diligence

• Tax due diligence

• Regulatory due diligence

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Types of Due Diligence – Purposive Types

• Target focused – risks/issues regarding what is being acquired

• existence of loan agreement

• Transactional due diligence – risks/issues regarding getting the deal

done

• loan agreement requires consent of bank for transaction

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Shares vs. Assets

• Liabilities – treatment is different

• choice of liabilities

• residual liabilities issue

• Identity of vendor – collectability issue

• Tax considerations

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Representations and Warranties

• Determined by what can and cannot be said in the circumstances

OR

• "Risk allocation" mechanism

• "Joint and several" vs. "several"

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Representations and Warranties

• Support value assumptions

• Support value drivers

• Risks identified can be covered off with representations and warranties

• risk allocation

• especially risks relating to key value assumptions

• Qualifiers – potential "value slippage" – knowledge, materiality

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"Key" Representations and Warranties

• Title

• shares

• company assets

• Outstanding shares/other securities and rights to acquire shares

• Financial statements

• No material adverse change

• Litigation

• Taxes

• Material contracts

• Third party consents/approvals

• No breach/conflicts

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Understand Areas of Non-Risk

• Due diligence allows risk assessment and impacts "requirement" for representations and warranties

• areas of non-risk

• Due diligence can be a substitute for representations and warranties

• competitive bid/auction situations

• allows assessment of need for representations and warranties

• Effective due diligence can help get the deal

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Indemnification Provisions

• Thresholds

• individual claims

• aggregate claims

• Deductibles

• Caps

• Risks impact indemnity limitations

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Indemnification Provisions

• "No claims may be asserted by the Purchaser or the Purchaser's Representatives under indemnity unless and until the aggregate of the Losses of the Purchaser and its Representatives collectively, in respect of such Claims exceeds <> Dollars ($<>) in the aggregate, in which event the amount of all such Loss including such <> Dollar ($<>) amount may be asserted."

• Does each individual claim need to exceed a specified threshold?

• Potential "value slippage" or "value retention"

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Indemnity Caps

• Limit on claims

• Trend towards significantly less than purchase price

• Significant percentage of deals significantly less than 50% of purchase

price

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Share Purchase - Conditions to Closing

• Matters required to complete the "deal"

• Take account of transactional due diligence

• Transaction/value shaping

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Conditions to Closing

• Third party consents/approvals

• contractual/other stakeholders

• regulatory/governmental

• "hell or high water"

• Debt elimination

• Financing

• Employee issues

• No material adverse change

• Representations and warranties true and correct at closing (usually with materiality qualifier)

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Conditions to Support/Preserve Value

• Non-Compete Agreements

• non-solicit agreements

• Employment Agreements

• consulting agreements

• key employees

• long or short term

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Conditions to Support/Preserve Value

• Transitional Services Agreements

• integration issues – communication systems, other systems

• preservation of value

• facilitate the transfer of the value being purchased

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Material Adverse Change Conditions

• No Material Adverse Change in respect of PCo shall have occurred

after the date hereof and prior to the Effective Date

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Material Adverse Change Conditions"Material Adverse Change" or "Material Adverse Effect" means, with respect to any Person, any fact or state of facts, circumstance, change, effect, occurrence or event which:

(a) either individually is or in the aggregate are, or individually or in the aggregate would reasonably be expected to be, material and adverse to the business, operations, results of operations, properties, assets, liabilities, obligations (whether absolute, accrued, conditional or otherwise) or condition (financial or otherwise) of such Person and its Subsidiaries, on a consolidated basis, except to the extent of any fact or state of facts, circumstance, change, effect, occurrence or event resulting from or arising in connection with:

(i) any change in Canadian GAAP or changes in regulatory accounting requirements applicable to the oil and gas, oil sands and oil shale exploration, development and production businesses, the petrochemicals industry, and the business of refining, marketing and distributing petroleum products (the "O&G Business");

(ii) any change in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic , business, regulatory, or market conditions or in national or global financial or capital markets;

(iii) any change generally affecting the O&G Business;

(iv) any natural disaster;

(v) any decline in crude oil or natural gas prices on a current or forward basis;

(vi) any actions taken (or omitted by to be taken) at the written request of other Party hereto; or

(vii) any action taken by the Person or any of its Subsidiaries that is required pursuant to this Agreement (excluding any obligation to act in the ordinary course of business, but including any steps taken pursuant to Section 5.3(a) to obtain any required regulatory approvals),

provided, however, that with respect to clauses (i), (ii), (iii) and (iv) such matter does not have a materially disproportionate effect on the Person and its Subsidiaries, taken as a whole, relative to comparable entities operating in the O&G Business, and references in certain sections of this Agreement to dollar amounts are not intended to be, and shall not be deemed to be, illustrative or interpretative for purposes of determining whether a "Material Adverse Change" or a "Material Adverse Effect" has occurred; or

(b) either individually or in the aggregate prevents, or individually or in aggregate would reasonably be expected to prevent, the Person from performing its material obligations under this Agreement in any material respect;

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Three Elements:

• General definition of what it is

• Exceptions – matters with respect to which parties assume the risk and

impact on value

• Limitations on the exceptions

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Working Capital Adjustments

• "Your watch/My watch"

• Capturing pre-closing results of business

• Financial Statements

• Need accounting advice

• Buyer traditionally prepares post-closing calculations

• Seller should be comfortable with methodology specified in Agreement

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Collectability of Claims

• P&S Agreements – vendor/purchaser

• Merger Agreements – target/purchaser

• Parties and Post-Closing Positions

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Hold Back/Escrow of Purchase Price

• Considerations

• Supports value of representations and warranties

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Considerations for Escrow/Holdback Provisions

• Considerations

• Exclusive remedy? - rare

• Amount of escrow - significant majority of deals less than 10% of

purchase price

• For what? - indemnity claims and/or purchase price adjustments

• Consider R&W Insurance as alternative

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Earnouts

• An earnout is a risk-allocation mechanism used in an acquisition

transaction where a portion of the purchase price is deferred and is

calculated based on the performance of the acquired business over a

specified time period following the closing

• Increased use of earnouts in private M&A

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Why an Earnout?

• Valuation Gap

• Financing

• Incentive-Based Compensation

• Startups

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Earnouts - Items to Consider

• Defining the business that will "earn out"

• existing/expansions

• integration

• The performance measure

• revenue

• net income

• EBITDA

• non-financial

• The accounting standard

• accounting principles

• practices

• assumptions

• inter-company/non-recurring

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Earnouts - Items to Consider

• The payout timing and the earnout period

• instalments / %

• caps

• Post-closing control and support of the "earning out business"

• approval rights/ restrictive covenants

• affirmative support/level of efforts

• Tax considerations

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Questions and Answers

Bill Gilliland

[email protected]

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The preceding presentation contains examples of the kinds of issues companies dealing with Corporate law could face. If you are faced with one of these issues, please retain professional assistance as each situation is unique.