At Alderwood we have learned to be patient and thoughtful in our approach to GP stakes investing. We won’t acquire a stake in a business unless we are comfortable, amongst other things, with the firm’s culture, its people, and the investment process.
When we reach a commercial agreement to proceed, we don’t just hand the matter over to the lawyers and say “get it done”. Instead, we recognise that negotiating the final terms of a deal and taking it through to Completion is an interactive process which, if not approached correctly, can easily cause tension between the parties and sow seeds of mistrust which risks damaging the fledgling relationship.
Members of the Alderwood team have worked together on numerous asset management transactions over the last twenty years instructing and working with external counsel in the US, Latin America, Europe, the Middle East, Asia (including Japan) and Australia. Over time, we have learned that whilst external counsel play an important role in the acquisition process, if instructed thoughtfully they can also support the development of the relationship between the parties. In this article, we discuss some tips and perspectives and thoughts which we have found to be helpful in executing GP stakes transactions.
It goes without saying that there is no point trying to negotiate deal documents unless and until the detailed commercial terms of the deal have been agreed and due diligence is complete (with no “show-stoppers!”). To do otherwise would be costly and time consuming with no guarantee a deal would be done. It would also likely stress the relationship between the parties at a time when the need to deepen the level of mutual trust is a priority. At Alderwood, we regard ourselves as engaged investors. Our decision to invest is predicated on various things including that the management/investment team are very good at what they do; in fact, that is precisely why we are investing in them. Whilst we require the ability to exercise some oversight of the business, typically through a board seat, appropriate access to senior management and receipt of management information, it is never our intention to interfere in the day-to-day workings of the firm or to unilaterally change things. Instead, it is our aim to support management and to help the business be as good as it can be. This is only possible if the relationship with management is transparent and based upon trust and mutual respect. And a critical time for establishing that relationship is right at the outset as the transactional documents are being settled.
Negotiating the detailed commercial terms is a useful stage because it brings about interaction with the management team and a chance to discuss each party’s expectations about the future of the business and how the relationship will work. Most importantly, the exercise should flush out any “red lines” and require the parties to determine a way through, ultimately, to agreeing terms that will underpin and govern the relationship between the parties going forward.
Asset management is a people business. With little in the way of fixed assets, the real value in the enterprise is in the people and their expertise. Whilst the due diligence stage clearly provides the opportunity to review and assess key parts of the operating business, it can also reveal the way the business is managed, how decisions are made and the culture of the firm, all of which are good indicators as to how the relationship might develop over time.
Ultimately, we have a responsibility to our investors to reflect the protections we have told them we will seek in our agreements with investee managers. To that end it is important that we are open and honest about what we can, and cannot agree to, and what life will look like once we’ve invested. There are often creative and flexible ways to achieve these protections or rights but glossing over these at outset only to have them surface during the legal process is simply counterproductive.
Once the commercial terms are agreed and due diligence is complete the parties will want to close the deal as quickly as possible. The next step is for the parties to secure the help of their respective external counsel to finalise the definitive terms, obtain all necessary approvals and secure an early completion. This makes sense, yet we have learned over many years of investing that even this final stage of papering the agreed commercial terms (in fact, especially this stage) needs just as much meticulous planning and careful thinking as the initial courtship between the parties that led to the agreement of the commercial terms. For example, careful thought is required in both the selection of the right counsel and the instruction of counsel. A failure to approach either of these correctly, could be detrimental to the deal and the parties’ relationship going forward.
When selecting external counsel it is always good to ask “what role do I want my lawyers to perform in this transaction?” and “how can they best help me?” At Alderwood we devote time to ensuring that we have the right counsel for the deal in question. Has our proposed external counsel advised on similar deals in the past? Do they understand the rationale for the transaction and why Alderwood is doing the deal? We spend time briefing them not just about the deal but about Alderwood, our philosophy, behaviours we expect from our advisers and, similarly, tactics we do not wish to see deployed at the negotiating table. We educate our counsel so they are clear about what we expect from our future relationship with the target firm’s management team, how governance (including decision making) should work and how best to resolve disputes should they arise. It is also worth mentioning that the best client/lawyer relationships are typically dependent upon personal chemistry and a willingness to be flexible in the working relationship.
In practice, selection of counsel will invariably occur at an earlier stage as there are clear benefits in having the same lawyers helping with the legal due diligence as well as negotiating final definitive terms.
When instructing external counsel one needs to remember that the proposed transaction represents the starting point in a hopefully long term relationship; it is not ‘just another deal’ to those involved nor should it be seen as a zero sum game. Getting to signing and subsequent Completion needs to be done in such a way that both parties ultimately feel that they have secured a good deal and they look forward to a fruitful partnership going forward.
At this early stage, we encourage the target’s management team to jointly facilitate with us a meeting or call with the selected external counsel from both sides (“Open Meeting”). At this meeting the clients present a united front emphasising to the external counsel the importance of the deal to each party and of them also having a future working relationship based upon transparency and trust. The purpose of the Open Meeting is to encourage the external counsel to do all they can to get their respective clients to Completion feeling happy with the deal and that their relationship with the other party remains in good shape. To reinforce this, the parties discuss with external counsel certain principles that should be adhered to in the process of finalising the transaction.
Having various principles helps align the parties and their lawyers not just to the shared objective of reaching Completion but, more importantly, in the steps to be taken to reach that objective. An early decision to be taken is which party will take the lead on certain tasks? Divide up the responsibilities and decide who will draft the purchase agreement and who will draft the new (or amendments to the existing) shareholders’ agreement (or similar). Similarly, agree who will compile and submit regulatory applications/filings, etc.
Whilst counsel should of course protect their client’s best interests, they should avoid being adversarial or confrontational. This is not a “sale and walk away” situation. Instead, both sides and their counsel should recognise that this is about new partners who will be working closely together going forward and, therefore, falling out over points needs to be avoided. With that in mind, external counsel should avoid trying to “score points”. Sometimes valuable time, cost and goodwill can be eaten up by external counsel flexing their muscles over points that the parties essentially agree on. External counsel will deny this ever happens but we have experienced this on several occasions – a small win here may often cause more detriment in the larger, longer term relationship.
Where difficult, contentious points arise the parties and their counsel should focus on finding a solution. Explain why a matter is important to you but be open to different ways to resolve the issue. Respect the other side’s position in such situations and try and find a solution that works for all parties. There is often a “middle line” between the parties’ respective positions. Avoid posturing and appreciate that each side has an interest to preserve or protect. Try to go to the sensible “middle line” as soon as the matter becomes an issue. As far as possible, don’t hang out for a point that the other side can’t accommodate.
Clients should manage their lawyers and if need be, remind their counsel about what was discussed at the Open Meeting and the purpose of that meeting. Separately, external counsel should also be prepared to manage their clients too and explain and educate where necessary. This might sound an odd thing to say but consider the position for a minute. Assume Alderwood is acquiring a minority stake in an asset management business. Unlike Alderwood, its external counsel and the target firm’s counsel, the target firm’s management may not have done a transaction before. There may be some aspects of the deal that management don’t understand or feel uncomfortable about but which are normal, standard items (e.g. giving reps and warranties as to title, tax indemnities etc.). The target firm’s counsel should help the parties by reassuring their client that such terms are normal. Ultimately, if external counsel can become valued members of the client team, this can only be beneficial for client and law firm going forward (e.g. handling post completion matters, subsequent amendments etc.).
Clients should be aligned in the need to keep their respective counsel focussed on the tasks that need to be dealt with in the lead up to signing and Completion. Ensure that there are regular progress meetings with external counsel with all tasks documented and responsibilities allocated. Hold lawyers (and client representatives, if applicable) to account if items are not getting dealt with or the timeline is slipping. These meetings should have both clients and both sets of counsel represented with all eyes focused on the same data.
At Alderwood we would always require our counsel to provide a cost estimate at outset for budgetary purposes. A fixed fee can be agreed but we have found these often build in contingency which may not be needed and are unlikely to be realistic. Monitor the accruing work-in-progress on a weekly/bi-weekly basis against the estimate and stage of deal reached. When it is time to bill always request the billing guide with all narrative and time entries so one can check that the time being billed reflects actual work done and avoids duplicated time (e.g. several lawyers at same meeting when all not needed etc.).
And, most importantly, if we’ve done this properly, we can enjoy a pleasant completion dinner without all parties glaring at each other!
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