Across over 1,000 deals where SRS Acquiom has served as shareholder representative, delays in receiving payment – whether at closing or post-closing – is one of the most common frustrations expressed by shareholders. We’ve seen many reasons why. Here are seven of the most common problems and thoughts about how to prevent them.
- Incomplete and Inaccurate Cap Tables
Problem: Capitalization (or cap) tables show ownership stakes in a target company and provide the necessary information about which of the selling shareholders are entitled to receive payments and in what amounts. The vast majority of cap tables we see are spreadsheets of varying levels of complexity – many of which have errors when we first see them. Problems range from unrecorded share transactions, incorrect vesting schedules, failure to track stock splits and changes in percentage ownership, failure to record convertible note holders to incorrect formulas and data entry or cut/paste errors. Often, updates and fixes to cap tables are made in the final days before closing. In our role as payment administrator, we’ve worked on transactions where there have been as many as four or five versions of the spreadsheet provided to us.
Solution: The solution to this issue is perhaps the simplest one in this article – the cap table should be maintained and updated throughout the life of the company to avoid last-minute, rushed fixes that are prone to error. In addition, when pro rata percentages are subject to change post-closing because of the effect of escrow releases or milestone payments, it is important to clearly identify how the various possible percentage calculations are to be made.
Problem: U.S. Patriot Act requirements (also known as Know Your Customer, or KYC) requirements and anti-money laundering (AML) procedures may delay payment or become a pre-closing hassle, costing time and money and resources. These processes, used by financial institutions to verify the identities of clients and prevent criminal financial activities, have become much more stringent in recent years. Each party to the acquisition agreement (and/or escrow and paying agent agreements) must comply with time-consuming documentation-gathering requests. It can be more difficult if the stockholder is a shell company, investment company or other non-operating entity. When non-U.S. entities are involved, the nature of the requests and the processing time can be more extensive.
Solution: To streamline this process, be aware of these requirements, and get started early to collect the necessary documents to clear your bank’s KYC process. Establish an ongoing relationship with an experienced payments administrator who can explain the requirements and guide you through the process. As a benchmark, with established partners typical turnaround time to open an account and gain clearance on KYC for US residents and entities is about a day. However, specific banks may take an additional 3 to 5 days to complete account opening, particularly when one of the merger parties is a shell entity (such as a merger sub or special purpose acquisition entity) or non-US resident or entity.
Problem: Historically, the common practice in M&A has been for the selling shareholders to return their physical stock certificates to the buyer (or their agent) together with a printed letter of transmittal (LOT). Although this practice continues, there are an increasing number of buyers who no longer require collection of physical certificates and who are embracing online LOTs, thereby completely eliminating the need for paper in this aspect of the merger transaction. Stock certificates are often misplaced and the process of searching through file cabinets or safe deposit boxes, filling out affidavits of loss and potentially paying for a bond wastes time and money. Also, the process of printing, mailing, filling-out, returning and processing a LOT is similarly wasteful.
Solution: Eliminate paper! Start by eliminating the requirement of collecting physical share certificates. See Legal Opinion Paves Way for Paperless Closings. Then, consider an online LOT process to facilitate the payment process at the time of the merger transaction in an expedited manner. These two steps save wasted hours and resources – and significantly speed up the timing of payments from days or weeks to hours.
- Complicated LOTs
Problem: LOTs have been used for years as the means by which shareholders agree to the terms of the merger and submit their payment and tax information for receipt of the merger consideration. LOTs are not written in language that the average shareholder can easily understand. As a result, many shareholders make mistakes or need to call the paying agent for help. On average, this process can take 5 to 7 business days for LOT processing and approval even in the best case – much longer when there are questions.
Solution: Use a simple, more intuitive LOT that fulfills all legal requirements and has been designed expressly to be easy to understand. Even better, do all of this with an online administrator so that shareholders enter information directly, thus ensuring that all fields are correctly completed and simple transcription errors are avoided. As an added benefit, a payments administrator with online capabilities will typically get a LOT approved within 24 – 48 hours.
- Tax Documentation
Problem: Using outdated IRS forms and not having proper tax documentation is a common reason for delayed payments. For example, non-US shareholders in US deals may find their payments delayed or subject to unintended non-resident alien withholding if they have not presented a complete W-8. Timely submission of a complete LOT together with a complete tax form is the key to receiving an expedited payment.
Solution: As a shareholder, be ready to provide current tax forms and don’t assume that a form you used previously (even recently) will be sufficient. Check with the IRS website to make sure all tax documents are up-to-date, and anticipate any additional documents that may be needed to transmit payment for your foreign or domestic deals. If you are uncertain about the tax requirements, consult a tax advisor ahead of the closing of a transaction. Furthermore, payment administrators who retain payment and tax documentation for use across multiple deals can be extremely helpful to save time.
- Payments Treated as Employee Compensation
Problem: The majority of merger transactions include payments to optionholders, restricted shareholders, participants in management carveout plans and/or bonus recipients. These payments are typically characterized as compensation and therefore subject to complicated income and payroll tax withholding rules. If payees do not become employees of the acquiring company, then onboarding them to payroll systems is a costly and time-consuming option. Traditional paying agents do not calculate or remit withholding, leaving it to the merger parties to handle themselves.
Solution: Identify these payments early in the process so that they can be accommodated. If your traditional payments administrator will not handle compensation-based payments, then the simple solution is to find one that provides a comprehensive M&A payments service that pays shareholders, vendors and employees of the target company. Ask the payments administrator whether it can assume the wage base from the target company. This benefits both the employees and the target company by avoiding unnecessary over-payment of certain payroll taxes that are subject to wage caps (e.g., Social Security, FUTA).
- Delays Around Delivery of Joint Instructions
Problem: The majority of escrow agreements, approximately 80% of our deals, require joint written instructions from the buyer and the shareholder representative in order for the escrow agent to release funds to the shareholders. However, merger parties may find themselves frustrated if the other side does not move quickly to execute the requisite instructions. Even on deals with no claims against escrow, tracking down parties without vested interest in receiving funds can be painstaking and time consuming.
Solution: Consider including specific timeframes in the merger or escrow agreement by which the parties must act. For instance, a merger agreement may provide that each of the parties must deliver its signature to joint instructions to release the portion of the escrow not subject to outstanding claims within two business days of the expiration date. The parties could also consider providing for an automatic release of escrow funds by the escrow administrator after some period. In addition to building in contractual terms, preparation and planning for the escrow release is the best way to avoid delay.