Insights

This Could Change Everything in M&A
POSTED 1.21.20 M&A

There is a potential game changer in the M&A world, especially for Strategic Acquirers, and Representations and Warranty (R&W) insurance is an integral part. And with this coverage available for transaction sizes of $20M (or even lower) the impact will be widespread.

Tech powerhouse Atlassian, which offers software solutions for workplace collaboration, coding, and more, does a lot of acquisitions. It’s a multi-billion-dollar company, and it buys dozens of smaller companies to expand its services into new areas.

So far, pretty standard.

Most large companies use that leverage to “bully” the smaller business into accepting whatever terms of the deal they put on the table.

But Atlassian has shaken things up… to put it mildly. 

As Tom Kennedy, the company’s chief legal officer, and Chris Hecht, head of corporate development, put it in a statement announcing this bold move:

“The M&A process is broken. It’s outdated, inefficient, and combative. Which is why we’re publishing the Atlassian Term Sheet to fix it.”

Why the New Atlassian Term Sheet Is a Game-Changer

The traditional way to go about M&A deals is to conduct negotiations in which one side wins and the other loses. The larger company will always win.

Commandant #1 in the traditional M&A world is, “Those with leverage tend to use it.”

But…

You win the deal at the sake of losing trust from the those on the Seller’s side. It makes everybody uncomfortable. And it’s counterproductive.

When bringing in a target company, you want them to be your next rock stars that will help you capitalize fully on your new investment. If you’ve beaten them into submission and they have to show up at the office on Monday, it can be quite difficult to really put your heart into your work.

One of the biggest points of contention (and cause for resentment): Why is it standard to have escrows that are 20% to 30% of transaction value? Breaches are typically tiny. Big escrows are unnecessary. Atlassian is saying they will give their targets a choice: either provide a 5% escrow for 15 months or pay for a Buy-Side representations and warranties policy and provide a 1% escrow (this insurance would cover the other 4%). That represents a seismic shift from what well-leveraged Buyers usually do.

After going through plenty of deals where that happened, Atlassian decided to make a radical change and be transparent during the whole M&A process, from the beginning.

With the Atlassian Term Sheet, they’ve shown potential Sellers exactly where they stand on:

  • Closing Date
  • Due Diligence
  • Deal Documents
  • Holdback
  • Proposed Purchase Price
  • Outstanding Equity Awards and Other Equity Rights
  • Employment Offer Letters and Non-Competes
  • Employee Retention Pool
  • Indemnification
  • Escrow
  • Insurance
  • Transaction Expenses

These terms are non-negotiable. A Seller can take it or leave it. And, in many cases, they should take it because if you read through the term sheet, you’ll see that Atlassian – the Buyer – actually assumes a lot more risk according to this term sheet than in a similar, standard M&A deal.

This Seller-friendly stance horrifies M&A attorneys. But Atlassian is fine with it because they know there is not much risk in these deals. There are actually very few breaches in deals post-closing, especially with IP. And if there is a breach, it’s small in the vast majority of cases.

Atlassian is not rolling over. Everything is still contingent on extensive, rigorous diligence.

How R&W Coverage Fits In

R&W Insurance is an instrumental part of this document. The glue that holds it together, in a way. And, the term sheet outlines that the Seller will pay for R&W insurance and D&O Tail insurance.

For R&W coverage, the term sheet states that the Seller will pay for it, including any fees, premiums, taxes, or commissions, for a policy limit of 4% of the Purchase Price. It’s quite affordable, costing less than ½ of 1% of the transaction value.

One of the reasons Atlassian can feel comfortable offering these terms is that if there is a breach, the R&W insurance kicks in. It transfers all the indemnity risk to the insurer. If there are any breaches post-closing, they file a claim and get damages – no need to go after the Seller.

Ever since I first saw R&W insurance back in 2014, I’ve had the opinion that as M&A progresses, this specialized type of coverage will become as standard as title insurance for buying a home. Because of the speed and frequency of M&A deals – which is only increasing – things have to become standardized.

And things are heading that way. PE firms and VCs, as well as Strategic Buyers, are being drawn to this insurance more than ever. There are about 20 insurers offering this coverage today, up significantly from a handful just a few years ago. And there are policies even available for deals under $20M, which is a development in just the last year or so.

There is no good reason not to get this coverage, in most cases.

How Will This Term Sheet Impact M&A in 2020 and Beyond?

I think this is going to soon expand beyond Atlassian.

This could be a potential signal for other Strategic Buyers out there. They know they had better streamline the process. Why are they reinventing the wheel for every deal and grinding the Seller into submission? That attitude is as productive as old school football coaches who wouldn’t let you drink water to toughen you up.

Think of it this way. Forty-niners coach Bill Walsh established a policy of no-contact practice mid-season on. There wasn’t any need. And unlike other teams, his players weren’t beat up for pivotal games late in the year.

The NFL is a copycat league, and other teams soon followed Walsh’s tactic. Corporate America is full of copycats, too. So I think you’ll see them follow suit when they see that the term sheet has made Atlassian very attractive in potential Sellers’ eyes.

With everything, there is a hard way… and a smart way. The Atlassian Term Sheet is the smart way. This is a more efficient and cheaper way to get deals done.

They have an eye on the end result: integrating the acquired company. This company wants peace, love, and happiness in their M&A deals going forward, and they’re not having to take on very much risk to get it.

Be sure to check out the Atlassian Term Sheet in-depth. Then I’d invite you to speak with me, Patrick Stroth, about how Representations and Warranty insurance is a key part of this new way of thinking… and how it can protect you in your next deal. You can reach me at pstroth@rubiconins.com or (415) 806-2356.