How Good Contracts Protect You from Bad Haircuts in M&A Transactions

In the context of an M&A event, a “haircut” is generally not a good thing. In fact, a haircut on your company valuation can be a very bad thing, discounting your value to the tune of millions of dollars. And if your contracts contain certain valuation-shrinking clauses, it is exactly what you’ll get.

To avoid unwanted haircuts, forward-thinking legal and sales ops teams are well-advised to do two things: First, review existing revenue contracts to understand where important value-protecting clauses are missing, or value-shrinking clauses are lurking. And second, ensure that the inclusion/exclusion of these clauses is built into your standard contract drafting and negotiation playbook going forward.

Here are some of the clauses you need to watch out for:

1. Non-assignment clauses.

These clauses prevent you from assigning a contract without customer consent, which is not something you want to be running around doing while trying to close a sensitive merger transaction. There may be ways to structure a deal around these, but that in turn could be used as a reason to drive down valuation by an acquirer.

2. Change of control clauses.

Even worse than a simple non-assignment clause is a clause that also deems “change of control” to be an assignment or makes it a termination event for your customer. Once again, a contract that was an important part of your company value is now undermined by the occurrence of an M&A event (which results in a change of control).

3. Early termination clauses.

For multi-year contracts, value is diminished or enhanced by the length of the term. But a five-year contract isn’t really a five-year contract if your customer has the right to terminate without cause. Loose early termination language can shred the value of what appeared to be a lucrative long-term deal.

4. Uncapped indemnity and liability clauses.

For contracts where you have given generous indemnities or assumed uncapped liabilities, the problem is flipped. These are contracts the acquirer may not want to touch. If the potential liability is very large, and the ability to manage the liability is weak, then a single contract can damage your valuation well beyond its own revenue potential.

5. Evergreen product and support warranties.

In the short term, product and support warranties are fine. But in the long term, they can impose a heavy cost on your business, by locking you into (expensive) support for old products that 99% of your customers no longer use. And “wishful” warranties that are virtually impossible to meet in the real world could expose you to months of unpaid work.

There are other clauses to worry about, but fixing these is a good place to start. And if you are going to the trouble of reviewing a portfolio of old contracts, you’ll get a much better ROI by capturing the data into a fully featured contract management system (rather than creating another spreadsheet that nobody can find).

It’s no exaggeration to say that the appearance of bad clauses like the ones mentioned earlier in say 25% of your material revenue contracts could expose you to a 25% haircut on what you thought your company was worth. For an aspiring 100 million dollar company, that’s 25 million good reasons to know where you stand.

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