A company’s value is often tightly bound to its most important commercial contracts—be they supplier deals, license agreements, or critical customer relationships. However, many of these contracts may include “change-of-control” clauses, allowing termination or renegotiation if the business is sold. Failing to secure necessary consents or address these clauses early can undermine the entire transaction’s value. Below, we discuss the significance of these contracts, how to handle potential termination triggers, and strategies to protect the business’s core relationships throughout the M&A process.
Impact on Value
- Long-Term Contracts = Stability
- Revenue Assurance: Multi-year customer deals and exclusive supply agreements can provide predictable cash flow, bolstering the company’s valuation.
- Competitive Edge: A licensing agreement granting unique technology rights or market exclusivity might be a central reason the buyer wants the target in the first place.
- Impact of Contract Loss
- Sudden Revenue Drop: If a key customer contract is voided, the buyer could lose a major revenue stream overnight.
- Damaged Supplier Relationships: Suppliers might use the deal as an opportunity to renegotiate pricing or terms more favorably to themselves.
- Importance of Contract Visibility
- Due Diligence Focus: Buyers typically request a schedule of all material contracts during due diligence; undisclosed contracts or problematic clauses can derail negotiations if discovered late.
- Forward Projections: The buyer’s valuation models often assume continuity of these key agreements.
Termination Triggers via “Change of Control”
- Clause Mechanics
- Definition of Control: Contracts may define “control” in terms of share ownership percentage, board composition, or certain voting rights changing hands.
- Automatic Termination vs. Right to Terminate: Some clauses immediately invalidate a contract upon change of control; others require explicit notice from the counterparty to end the arrangement.
- Standard vs. Bespoke Clauses
- Boilerplate Terms: Many commercial agreements contain generic change-of-control provisions.
- Customized Provisions: High-value or complex contracts may have more elaborate triggers, including partial ownership changes or indirect transfers (e.g., via parent company acquisition).
- Significance for Seller & Buyer
- Seller’s Concern: Ensuring that, after the sale, the target company doesn’t lose crucial contracts (thereby triggering buyer claims for indemnities or price reductions).
- Buyer’s Concern: Avoiding a scenario where the moment they acquire the company, it loses a core customer or license, undermining the deal’s rationale.
Negotiation & Consents
- Identifying Critical Counterparties
- Material Contracts: Prioritize those generating a large percentage of revenue or essential to operations (e.g., exclusive distribution, technology licenses).
- Consent Triggers: Check the threshold for seeking counterparty permission; some might only demand notice, while others require formal consent.
- Consent Timing
- Pre-Signing vs. Pre-Closing: Depending on deal structure and confidentiality needs, you may seek counterparty consent before the SPA is signed or as a condition to closing.
- Coordination with Due Diligence: Ensuring that requests for consent coincide with or follow thorough contract reviews to identify any hidden complexities.
- Leveraging Existing Relationships
- Long-Standing Partnerships: Sellers with strong, positive relationships can often secure quick waivers or consents.
- Incentives & Renewals: Sometimes, offering a more favorable amendment or extension to a contract can encourage the counterparty to waive change-of-control rights.
Practical Tip: If a contract is vital and negotiations with the counterparty are stalled, the buyer may demand an escrow or indemnity to cover potential losses if that contract is eventually lost.
Risk Mitigation During the SPA Process
- Renegotiation or Clarification of Terms
- Proactive Amendments: If a vital contract’s change-of-control clause is ambiguous or highly restrictive, renegotiate the relevant terms in parallel with SPA discussions.
- Eliminate Uncertainty: Clarifying permissible assignments or specifying that ownership changes do not trigger termination can preempt deal complications.
- Warranty & Indemnity Protections
- Seller Warranties: Sellers typically warrant that no contract vital to the business will be terminated by a mere change in ownership.
- Buyer Indemnities or Price Adjustments: Where risk remains high, buyers may seek an indemnity covering losses if a key contract ends post-closing due to change-of-control triggers.
- Transparent Communication
- Seller’s Disclosure Letter: Thoroughly listing all contracts with potential change-of-control triggers and summarizing their status or consent progress.
- Regular Stakeholder Updates: Keeping legal, financial, and business teams aware of any shifting positions from key counterparties during the negotiation.
- Conditions Precedent for Closing
- Essential Consent Condition: The SPA may mandate that certain waivers or consents be obtained before completion. If they’re not secured, the buyer can walk away or renegotiate.
- Fallback Strategies: In some cases, bridging arrangements (like short-term transitional services) mitigate operational disruptions if a contract must be replaced post-close.
Conclusion
Key commercial contracts aren’t just paper agreements; they define the target’s revenue streams, supply chain security, and competitive positioning. Change-of-control clauses within those contracts can abruptly undermine these advantages if not proactively managed. By systematically identifying and analyzing such provisions, negotiating necessary consents, and possibly restructuring agreements in tandem with the SPA, both buyer and seller can safeguard the deal’s core value. Ultimately, clear communication, robust warranties, and a well-handled disclosure process minimize the risk of losing essential contracts and keep the transaction on solid ground.
