Yale Case. By: Kevin Christmas / Kevin D. Grumberg / Jon M. Herzog / Raam S. Jani / Reed F. Leigh / Francesco Salpietro / A. J. Wasserstein
The study provides an in-depth overview of the legal processes and documentation that SF entrepreneurs encounter throughout their journey. It emphasizes that while entrepreneurs need not be lawyers, they must understand the structure, purpose, and importance of these documents to ensure successful navigation of fund formation and acquisition processes. The content is organized into distinct phases, outlining the legal considerations and challenges in each stage.
A. FUND FORMATION DOCUMENTS
These documents establish the foundation of a SF and are integral to attracting investors. Key components include:
1/ Private Placement Memorandum (PPM): Serves as a disclosure document that outlines the investment opportunity, potential risks, and the legal framework for securities issuance. It provides investors with the necessary information to make informed decisions.
2/ Formation documents: Includes certificates of formation, usually filed in Delaware for its business-friendly legal system, and an initial LLC agreement that governs the search fund during its early stage.
3/ Subscription documents: Investors formalize their participation through subscription agreements and accredited investor questionnaires, which ensure compliance with securities regulations and validate the eligibility of participants.
4/ Amended and restated LLC agreement: This agreement governs the economic, governance, and operational terms for the search fund post-investor contributions.
5/ Investor side letters: Non-binding summaries outlining anticipated economic and governance terms, serving as a communication tool for aligning expectations with investors.
B. ACQUISITION PROCESS
This phase represents the core of the entrepreneur’s journey and includes the following steps:
1/ Pre-acquisition documentation:
- Offer letters to interns and associates: Make clear that the intern’s work belongs to the SF.
- Advisory agreements: Establish the relationship between the SF and the finder
- Non-Disclosure Agreements (NDAs): Establish confidentiality terms between the searcher and potential targets.
- Indication of interest and Letters of Intent (LOI): Preliminary documents to define valuation ranges, purchase price, and exclusivity agreements.
- Investor equity support letters: These letters reassure sellers of the search fund’s financial capacity to complete the acquisition.
2/ Due Diligence & Deal structure:
- Financial Due Diligence: Includes quality of earnings reports and other assessments to confirm the target’s financial health.
- Legal Due Diligence: Lawyers investigate intellectual property, tax, labor, environmental, and other potential liabilities to mitigate risks.
- Deal structuring: Decisions between asset acquisitions (preferred for liability protection) and equity purchases (favored by sellers for simplicity) impact the legal and financial implications of the deal.
3/ Purchase and Sale Agreements (PSA)
These definitive agreements are the cornerstone of the acquisition process, detailing all terms of the transaction:
- Representations & Warranties: Statements about the target company’s condition that help allocate risk between buyer and seller.
- Disclosure schedules: Supplements to the agreement that provide detailed lists or exceptions related to the target’s assets, liabilities, or operations.
- Indemnification clauses: Define remedies for breaches of representations or warranties, with provisions like caps, baskets, and survival periods.
- Post-closing covenants: Include non-compete agreements and other obligations to protect the buyer post-acquisition.
4/ Supporting documents
These ancillary agreements are essential for smooth transitions and risk management:
- Seller Note: Defer part of the purchase price, acting as a promise to pay at a later date.
- Employment agreements: Outline terms for retaining key employees, including the seller, during the transition period.
- Escrow agreements: Secure a portion of the purchase price for addressing unforeseen liabilities post-closing.
C. FINANCING
Securing funding for the acquisition involves a mix of equity and debt financing:
1/ Equity documents:
Includes subscription agreements and LLC agreements for governance and investor rights during the post-acquisition phase.
- Preemptive rights notices & subscription agreements: Define the right to purchase their pro rata share of all of the securities offered by the search entity
- Rollover agreements: Allow sellers to retain equity in the business under specific terms.
2/ Debt financing:
- Loan agreements: Define repayment terms, financial covenants, and ongoing compliance obligations.
- Intercreditor agreements: Establish the hierarchy and rights of senior and junior creditors.
Debt financing requires attention to compliance, such as financial reporting and operating restrictions, to ensure the business can sustain its obligations over the loan term.
Conclusion
The article underscores the importance of collaboration between search fund entrepreneurs and their legal counsel. Entrepreneurs must understand the legal framework surrounding search funds to confidently engage in negotiations and ensure compliance with investor and regulatory requirements. By mastering the basics of fund formation, acquisition, and financing documents, entrepreneurs can focus on their primary role: becoming exceptional CEOs and driving the success of their ventures.
This comprehensive understanding equips search fund entrepreneurs with the tools needed to communicate effectively with investors, minimize risks, and navigate the legal complexities of the acquisition process.
Read the full case in: https://yale.app.box.com/s/v0lksshk6htd6frnbhx22whugwamz9gi
