When purchasing a company (the “Target”), most institutional buyers (i.e. PE firms, hedge funds, family offices, etc.) are aware that the Target’s customer and vendor agreements can present many issues depending on how the Target attends to those agreements on a day-to-day basis. The Buyer’s counsel will have the opportunity to diligence the Target’s contracts; however, the Buyer’s budget constraints, the Target’s inability to produce documents, or a combination of those, and other factors, can limit a thorough review. As such, Buyers often close deals with the recognition that their new portfolio company may have a few contractual “warts” to address post-closing.
Over the next few posts, we plan on diving deeper into some of those contractual “warts” and what firms can do to “treat” them. Institutional buyers place tremendous efforts into improving the operations of their portfolio companies. Focusing on a portfolio company’s contractual hygiene on a go-forward basis can really complement those efforts and create value.
All that said, the first contractual “wart” up for examination is the Most-Favored Nation (MFN) provision.
An MFN provision is a contract term that prevents a company from giving a customer’s competitors a price that is lower or on better terms than the customer receives. A problematic MFN provision usually shows up in a portfolio company’s customer agreements. The following are a few challenges that MFNs present for institutional buyers:
If the Target is combined with another portfolio company that provides similar goods and services at lower prices or on more favorable terms, the transaction could inadvertently trigger the Target’s MFN terms upon closing. If triggered, an MFN could decrease the anticipated revenue from the Target’s customer (as the pricing for that customer could drop). Depending on the materiality of that customer, the Buyer’s financial projections for that deal may look quite a bit different, and that’s not a fun spot to be in.
The Buyer may have plans to increase the Target’s revenue post-closing through new pricing models or promotional campaigns. MFNs could throw a wrench in those plans, as new pricing models or promotions could trigger changes to the pricing/terms of existing customers. Suddenly, a plan to bring in more business could have the opposite effect.
If a Buyer finds out their new portfolio company is subject to MFN terms, here are a few things they can do to “treat” these contractual “warts:”
Address the Source – MFN provisions can find their way into customer agreements a variety of ways. Sometimes companies lack internal legal resources to thoroughly review their customer and vendor agreements. If that’s the case, promptly engage external counsel that has experience negotiating customer and vendor agreements so they are clean on a go-forward basis. Sometimes sales teams are overly eager to close a deal and commit to an MFN to get the deal done. If that’s the case, internal policies should be instituted to curb such behavior and require the escalation of any MFN provision.
Localize the Impact – Once MFN terms are identified, it is important to contain their impact on a go-forward basis. To the fullest extent possible, keep parts of the business segregated until the MFN is no longer in effect (e.g. consider delaying planned consolidations). Also, depending on the potential impact of an MFN and how long until it expires, it could be worth reopening negotiations with the applicable customer to get rid of the MFN.
If you have any questions or want to discuss ways to improve your portfolio company’s customer and vendor agreements, please feel free to contact us (info@gtxlegal.com) – we’d love to help.
We’ll continue our contractual hygiene journey next time with limitations of liability. Until then, keep those contracts clean!
©2024 GTX Legal
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