Acquisition Financing Commitment Papers

By: Linda Curtis and Andrew Cheng, Gibson, Dunn & Crutcher LLP.

Acquisition Financing: Buyer and Seller General Perspectives

It is understandable that before lenders will agree to lend millions, and sometimes billions, of dollars to fund an acquisition, they require satisfaction of certain closing conditions. Some of these conditions are standard and uncontroversial, such as the requirement that the closing of the acquisition occurs upon funding of the loans, or the requirement to deliver customary closing certificates evidencing the ability of the borrower to consummate the business acquisition and the financing transaction. Some of these conditions may be highly contentious and subject to extensive negotiation, such as a condition that a certain maximum leverage ratio for the combined company not be exceeded, or that the buyer and seller have a minimum amount of combined EBITDA (earnings before interest, taxes, depreciation, and amortization.) Consequently, acquisitions that are funded through debt financings are necessarily more complex than those with consideration consisting of equity securities issued by the buyer or the buyer’s cash on hand. This is due to the risk that all conditions to closing under the acquisition agreement may be satisfied at a time when the conditions to the loans that will fund the acquisition are not.

Given this risk, it is now standard practice for an acquisition financed by debt to give the seller an opportunity to review and comment on the buyer’s binding commitment from its lenders. This binding commitment is set forth in a commitment letter which, among other things, describes in considerable detail the structure of the financing, the terms of the financing, and, perhaps most importantly, the conditions that will need to be satisfied before the lenders are required to fund. See Section 7 of the form Commitment Letter (Fully Underwritten Commitment) and Exhibit D to Commitment Letter — Conditions Annex.

For a seller, revealing that it has agreed to be sold can be disruptive to its business operations. Such an announcement may (1) unsettle existing customers, (2) provide an opening to competitors, (3) cause employees to depart or to consider departing, and (4) in the case of a seller that is a public company, be very likely to lead to securities law claims. Moreover, the seller’s senior management will have expended much time and money (including professional advisors’ fees) to even reach a deal in the first place.

Therefore, it makes sense that one of the most important concerns of a seller in an acquisition is the certainty that the acquisition agreement, once signed, will result in a deal that actually closes. Thus, a seller will carefully scrutinize and try to limit not only the closing conditions set forth in the acquisition agreement but also any express or de facto closing conditions in the commitment letter. Consequently, to the extent that a seller has the ability to pick between or among multiple bids, those bidders proposing transactions that provide more deal certainty, such as not being dependent on third-party financing to consummate the closing or being able to provide commitment letters that contain minimal closing conditions, will have a significant advantage.

For the most part, a buyer is just as interested in deal certainty as the seller. Just like the seller, the buyer will have incurred much time, effort, and cost in trying to reach a deal and presumably would not be considering such an acquisition unless there were compelling business reasons to do so. Furthermore, a buyer knows that to the extent it proposes terms with conditionality or contemplates financing the deal with a commitment that includes significant conditionality, it is not likely to even get the deal in the first place.

However, the buyer’s willingness to close the transaction will be based on certain assumptions regarding the state of the seller’s business at closing. For instance, the buyer’s business case could be contingent upon:

• Certain key customer contracts continuing with the business post-closing
• The seller continuing to have the right to use material intellectual property
• Perhaps most fundamentally, the seller’s business not suffering a material adverse change between signing and closing

The closing conditions in the acquisition agreement allow the buyer to ensure that it preserves the rationale for the acquisition.

Similar to the closing conditions required by the lenders in a commitment letter, the closing conditions in an acquisition will range from standard and uncontroversial, such as certain fundamental representations and warranties of the seller having to be true and correct and a material adverse change to the seller not having occurred (although the actual definition of what a material adverse change is will be hotly contested), to those the seller will contest vigorously. In the current market for public deals, for example, as discussed in the next paragraph, any direct financing condition to the buyer’s obligation to consummate the purchase likely will not be acceptable to the seller.

Moreover, a buyer who is relying on debt financing to close an acquisition also risks a scenario where the closing conditions to the acquisition agreement are satisfied but the closing conditions in the commitment letter are not. Depending on the terms of the acquisition agreement, such an occurrence could subject the buyer to a significant monetary penalty or litigation. One way to address this risk is to include a closing condition in the acquisition agreement that the financing be consummated. However, the inclusion of such a financing condition will undoubtedly be refused by the seller, is currently not a market term, and is not likely to become a market term in the foreseeable future. A buyer will thus seek to match the closing conditions in the acquisition agreement to the funding conditions in the commitment letter so that if the buyer needs to close the acquisition under the financing agreement, the lenders will have to fund under the commitment letter.

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