Brian C. Larsen Hawley Troxell blarsen@hawleytroxell

1. Private Equity M&A Key Deal Terms: Fiduciary Outs, Reverse Break Fees, Seller Remedies, Go-Shop Deals and Post-Closing Indemnity John J. McDonald Kelley Drye & Warren jmcdonald@kelleydrye.com Brian C. Larsen Hawley Troxell blarsen@hawleytroxell.com

2. CURRENT TRENDS IN PRIVATE EQUITY M&A DEALS Pluses • Continued favorable credit markets (the return of covenant lite) and historically low interest rates have enabled higher leverage levels. • Improved consumer confidence. • Strategic investors and private equity firms hold large cash reserves. Many private equity funds are nearing the end of their fund lives and need to deploy capital. • Large inventory of companies owned by private equity firms (nearly 18,000 according to the Private Equity Growth Capital Council) that may seek liquidity due to relatively high valuations. • Healthy stock market performance – the S&P 500 was up nearly 30% in 2013 – gives public companies currency to use for acquisitions.

3. CURRENT TRENDS IN PRIVATE EQUITY M&A DEALS Minuses • Still a fair amount of economic uncertainty in the U.S. and Europe, especially with the start of the “tapering off” of quantitative easing. • Stubbornly high unemployment in the U.S. is keeping corporate America cautious. • Increasing shareholder activism is threatening to force companies to return capital to investors rather than pursue M&Aopportunities. • High share prices and stock market volatility forces companies to be wary of overpaying for acquisitions. • Fear of large scale economic shocks from the “new normal” of geopolitical instability (ex., military coup in Thailand, Russian takeover of Crimea and instability in Egypt)

4. CURRENT TRENDS IN PRIVATE EQUITY M&A DEALS Valuation** • Due to economic growth and the availability of debt, dealmakers expect average EBITDA multiples to rise from 9.2x in 2013 to 10.5x in 2014 and 11.3x in 2015. • More buoyant private equity market is expected to support this increase. Buyout multiples held steady in 2013, but are expected to rise sharply in 2015 by which time EBITDA multiples for PE exits are forecast to return to pre-financial crisis levels. • A strong appetite for dealmaking in the Telecom/Media/Technology (TMT) sector has boosted valuations and this is expected to continue, with EBITDA multiples rising in that sector from 9.5x in 2013 to 11.7x in 2015. • PE exits in 2013 reached their highest levels in 6 years, up to 1,659 for 2013, as compared to 1,503 exits in 2012. *** MergerMarketGlobal M&A Valuation Outlook 2014 report.

5. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE “Fiduciary Outs” • "No-Shop" Provisions - To induce the Buyer to enter into the purchase agreement and commit itself to buy the Target company, the Target company and its stockholders will agree to not sell the Target company to another buyer during the time period between signing and closing. • "Fiduciary Outs” – In acquisitions of publicly-traded companies there is usually a “fiduciary out” exception from no-shop provision: • if Target company receives an unsolicited offer to buy the company at a price that is so superior to the existing deal that it would constitute a breach of the Target company board members’ fiduciary obligations to its stockholders… • Then, Target company can terminate the existing transaction or change its Board’s recommendation to stockholdersto advise against the pending transaction (which will have the same practical effect) and instead sell the Target company to the other buyer. • In,.

6. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Fiduciary Outs (cont.) • Although privately-held company boards also have fiduciary duties to stockholders, fiduciary outs are not commonly seen in acquisitions of privately-held companies. • If “Superior Proposal”, Target company has to notify the original buyer and give it the opportunity to improve its offer so that it is superior to the new offer (a “topping” bid). • Although the Target company’s board will take into account all aspects of the new offer in deciding whether it is superior to the existing offer, price is the predominant consideration (Revlon duties). • Original buyer receives termination fee (usually 2.5-3.5% of transaction consideration) and reimbursement of its transaction-related expenses (usually capped at a specified amount).

7. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Reverse Break Fees • Typically Buyer is obligated to close the acquisition as long as Target company has satisfied its closing conditions. However, some deals allow Buyer to pay a “reverse” termination fee to Target company (essentially a liquidated damages payment) and terminate the transaction. • Has become the norm since the 2008 financial crisis, particularly in deals in which Buyer is a private equity fund, since fund sponsors want to protect themselves from a lawsuit and potentially substantial liability if the necessary debt financing cannot be obtained. • Sometimes Buyer can terminate only if a specified event happens. Less frequently, there is “pure optionality”, in which Buyer can exercise the termination right for any reason.

8. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Reverse Break Fees (cont.) • Most common event enabling Buyer to invoke the reverse break fee termination right is when it can’t obtain the necessary debt financing to be able to consummate the deal. • Other events include inability to obtain regulatory approvals (most commonly antitrust) or key contractual consents. • Parties should specify in the purchase agreement that the “specific performance” provision (under which Target company can force Buyer to close) does not apply if Buyer exercises its right to terminate the transaction and pay the reverse break fee. • Reverse break fees are usually larger than conventional break-up fees (4-5%, as opposed to 2.5-3.5%).

9. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Financing Failure – Remedies for Sellers • Seizure of the debt markets following the 2008 financial crisis resulted in numerous M&A transactions in which Buyer couldn’t obtain the necessary debt financing to be able to consummate the transaction. • Resulting litigation was instructive in helping parties plan what will happen if there is a “financing failure”. • Some M&A transactions, most commonly those with a private equity fund (rather than strategic) buyer, include a “financing contingency” in which Buyer is not obligated to close if it cannot obtain necessary debt financing to be able to consummate the acquisition. • Financing contingency deals usually require Buyer to use “commercially reasonable efforts” or “best efforts” to obtain the debt financing.

10. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Financing Failure – Remedies for Sellers (cont.) • Buyer usually required to obtain “commitment letters” from lenders with of debt financing and take all necessary actions to satisfy the conditions under the commitment letter and obtain the debt financing. • In deals in which there is no financing contingency, but Buyer will need to obtain debt financing to be able to consummate the transaction, it runs the risk of being sued by Target company if it is unable to close because it cannot obtain the necessary debt financing. • In this situation, Buyer will often propose a “reverse break fee” structure (discussed above) to put a cap on its potential liability if the debt financing cannot be obtained. • Liability could otherwise be a very large amount since Target company will likely argue that the broken deal resulted in it being viewed as “damaged goods” in the marketplace.

11. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Go-Shop Deals • Target company boards often conduct "auctions" to protect themselves from fiduciary duties breach claims arising out of accepting a purportedly "inadequate price" for the company. • Investment bank invites potential bidders to conduct due diligence and submit offers and the board then selects the best offer. • Assumption is that price determined through open auction process is "highest and best price" that could be obtained. • However, auctions are time consuming (at least 3-6 months), expensive (the investment banker fees can be 1-5% of transaction proceeds) and, through the due diligence process, sensitive Target company information can be supplied to competitors that, although subject to a non-disclosure agreement, may still be used to the Target company’s disadvantage.

12. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Go-Shop Deals (cont.) • Sometimes, Target company will receive a “preclusive” offer that is so much higher than the existing trading price that it would be unlikely to be exceeded in a competitive auction process. • Buyers making preclusive offers typically do so to avoid protracted auction processes and require Target company to act quickly in accepting the offer. • As a result, “go-shop” deal structure was created. Contrary to the normal “no-shop” structure, in which Target company and its stockholders are precluded from soliciting other offers once the purchase agreement and doing a deal with another buyer once the purchase agreement is signed, Target company is specifically authorized to seek out alternative offers during a specified time period after the purchase agreement is signed. • Go-shop period usually ends once Target company stockholders vote on deal.

13. BEST PRACTICES FOR NEGOTIATING DEAL TERMS—BUYER AND SELLER PERSPECTIVE Go-Shop Deals (cont.) • Existing buyer has “topping rights” with respect to other offers obtained and gets a break-up fee from Target company if deal is terminated the purchase agreement with the original buyer to do a deal with another buyer. • Break-up fee is typically less than a conventional fiduciary out termination right (1.25%-1.75%, as opposed to 2.5-3.5%). • Go-shop deals are somewhat controversial, as skeptics believe that fewer buyers will be willing to break up an existing deal, as compared to participating in a competitive auction, so the go-shop process won’t really act as an effective market check on the pricing of the original deal and ensure that the stockholders receive maximum value. • A widely reported 2014 study supports these criticisms. See: http://dealbook.nytimes.com/2014/05/23/go-shop-go-fish/.

14. POST-CLOSING INDEMNIFICATION Generally • Indemnification payments effectively reduce the purchase price paid by Buyer to Target company stockholders. • As a result, post-closing indemnification provisions are usually among the most heavily negotiated deal terms in M&A transactions in which a privately-held company is being acquired. Not in Public Company Acquisitions • M&A transactions in which a public company is being acquired typically do not include post-closing indemnification because, by way of Target company’s SEC filings, all material information about Target company has been disclosed to Buyer (under threat of securities fraud liability). • Also be a logistical issue with post-closing indemnification in an acquisition of a public company because public companies often have large and diffuse stockholder bases.

15. POST-CLOSING INDEMNIFICATION Scope of Indemnification • Usually covers losses resulting from breaches of reps & warranties and covenants in the purchase agreement. • Often also a “tax indemnity” provision requiring Target company stockholders to compensate Buyer for all pre-closing Target company tax liabilities. • In asset purchase (rather than stock purchase or merger) transactions, Target company usually indemnifies Buyer for any losses from “Excluded Liabilities”. • “Excluded Liabilities” - typically defined as all liabilities associated with the pre-closing operation of the Target company other than accounts payable and other current liabilities included in the closing balance sheet. • Asset purchase structure often used for Target companies with significant historic liabilities that Buyer is unwilling to assume.

16. POST-CLOSING INDEMNIFICATION Duration of Indemnification • Indemnification obligations of Target company stockholders for reps & warranties usually extends for 1-2 years post-closing. • Exceptions are reps & warranties concerning tax, employee benefits and environmental matters (which usually extend until expiration of the underlying statute of limitations). • Also excepted are reps & warranties concerning “fundamental matters” like authority to enter into the purchase agreement and clear title to Target company assets (which usually have no time limit). Who is “On the Hook”? • In stock purchase and merger transactions, Target company stockholders are responsible for providing indemnification to Buyer. • In asset purchase deals, Target company entity provides indemnification, sometimes with stockholder guarantee.

17. POST-CLOSING INDEMNIFICATION Who is “On the Hook”? (cont.) • Each Target company stockholder is usually responsible for its pro rata portion of indemnification amounts. • And solely responsible for indemnification concerning its individual actions (e.g., reps concerning ownership of its shares and breach of its non-compete/non-solicit covenants). Indemnification Deductibles and Thresholds • Sometimes indemnification obligations of Target company stockholders are subject to “deductible” (i.e., Buyer is forced to absorb the first “X dollars” in otherwise indemnifiable losses) (Seller-favorable). • Alternative is “threshold” (i.e., Buyer must wait to make an indemnification claim until it has indemnifiable losses at least equal to the threshold amount, but then receives full compensation for all losses “back to the first dollar”).

18. POST-CLOSING INDEMNIFICATION Indemnification Caps • Target company stockholders’ total possible indemnification liability is usually typically subject to a “cap”, sometimes as low as 10-20% of the purchase price amount or as high as the full purchase price amount. • A Target company stockholder’s indemnification obligation is sometimes capped at the amount of transaction proceeds that it receives in connection with the deal. • Where indemnification escrow fund is Buyer’s “sole remedy” for indemnification (increasingly becoming the norm, particularly in sales of PE/VC-backed companies), it effectively acts as an indemnity cap. Carve-Outs from Deductibles/Thresholds and Caps • Breaches of “fundamental” reps & warranties, covenant breaches, fraud and willful misconduct by Target company usually carved-out. • In asset purchase transactions, “Excluded Liabilities” also carved-out.

19. POST-CLOSING INDEMNIFICATION Escrows and Other Indemnity Payment Methods • Part of the purchase consideration (usually 10-20%) is placed into a escrow account with third party bank for 1-2 yearsafter closing. • If the escrow funds are not Buyer’s “sole remedy” for Target company stockholders’ indemnification obligations, usually Buyer is required to exhaust the escrow funds first, before proceeding against Target company stockholders. • If purchase consideration includes non-cash consideration (e.g., Buyer stock, “Seller notes” or earnout payments), need to specify order of forfeiture to satisfy Buyer indemnification claims (e.g., first Buyer stock, then Seller notes, then earnout). • If Buyer stock is part of transaction consideration, need to specify its value for claim satisfaction purposes (e.g., fixed at closing or “floating” fair market value at time of claim).