This article has been written by Brijesh Devi, pursuing the Diploma Programme in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
Mergers and acquisitions are very complex corporate transactions that involve a lot of legalities as well as finance and advisory work. Mergers and acquisitions (M&A) in simple terms can be explained as a unification between a company’s business undertakings by either acquiring or merging with another enterprise’s business activities. Though, both the terms are mostly misunderstood for being the same, they are different concepts in their entirety. An acquisition is a process whereby the acquirer company purchases the majority stake and becomes the new owner of the target company. In a merger, two companies combine to form a new company. Needless to say, these heavy transactions bring in a lot of changes in the managerial and financial structure of the companies. As two different enterprises unite the different cultures of these organizations are also bound to be exchanged with one another. Cultural challenges are one of the biggest hurdles companies face during M&A transactions. However, not everyone’s expectations from the target/old entity can be met. Similarly, not everyone is welcomed in the newly formed organization. Hence to avoid these problems there exists an ‘Exit’ mechanism for top executives of such companies. This article deals with the reasons executives for which executives choose to leave at the time of M&A transactions and legal issues that might come up during their exit. 
Top executives role in M&A transactions
A ‘Top Executive’ of an organization is a person with senior managerial responsibility for the enterprise’s business. They are at the top level in the chain of command in the organizational structure of the company. Top executive positions are also called C-level positions wherein the ‘C’ stands for chief. This is because the top executives are generally the Chief Executive officers (CEO), Chief Financial Officers (CFO), Chief Marketing Officers (CMO), and people with similar posts. However, this position is not only for the ‘COs’. An Executive Director, Vice President of the organization, and other senior-level positions can also be termed as ‘top executives.’ Their day-to-day duties in a company are usually giving guidance to their subordinates, assigning them the work, working with their peers, facilitating the financial goals of the organization, etc.
Role of the top executives during M&A transactions
There are certain roles of senior management in M&A transactions that are very important. Fulfilling these roles is a difficult task and if the senior executives do not take proper care, then the M&A transaction might fail. The roles of the top executives in M&A transactions are a little more complex than their day-to-day roles. Some of them are as follows:
- Going through the business activities of the target/acquirer company
Before making an offer to a company the executives have to go through all the business activities of the target/acquirer companies in a detailed manner so that they get a clear picture as to the exact work of the company & what industries they indulge in & what new markets they might step in if at all a transaction occurs.
- Analyzing the strength & weaknesses of the target/acquirer company
After understanding the business activities of the target/acquirer company the executives have the task to analyze the strength and weaknesses of the organization and also work on a plan to use them to bring the most out of these features should the transaction happen?
- Identifying pros & cons of the deal
Another task of an executive before making/accepting an M&A offer is to identify the pros & cons of the deal if it happens, are the pros worth more than the cons and how is it beneficial to the current organization he is working in.
- Convincing other parties to go ahead with the deal
Once the business activities are understood and strengths & weaknesses, pros & cons are analyzed then it is time for the executives to persuade other parties such as other executives, financial creditors, etc. to go ahead with the deal.
- Helping with negotiations as well as landing the deal
After most of the approvals are given and different transactional considerations are made then the executives lend a helping hand in negotiating the deal. They are mostly accompanied by their counsel or negotiator and they conduct a session with the other party and finalize the financial aspect of the deal.
- Negotiating the incentives of other executives during their exit
When an M&A transaction occurs or is on the verge of happening it is not necessary that all executives are in favor of the deal or that they simply don’t want to be a part of this newly formed organization. An executive therefore must see to it that their fellow executives get the incentives they require and how far are they willing to compromise on it.
Reasons for the exit of top executives in M&A transaction
When a proposal of merger arrives or when a company is on the verge of acquisition not all of the senior employees of the organization will see eye to eye about the transaction. There might be a difference of opinion or some executives might want to exit the organization simply because it doesn’t feel like ‘theirs’ anymore. The most common reasons for Top Executives exit during M&A transaction are as follows:
- Misunderstanding the intentions of the acquirer/proposer
During the initial stages of an M&A transaction when the acquirer or the proposer lays down the agendas for the transaction an executive may not be able to comprehend their intentions and misinterpret them and he might want to exit the organization if such confusion happens.
- Not seeing eye to eye with the other party
The goals of the old organization before its union might be very different from the goals of the acquirer/proposer. In such a scenario’s executives might not continue their role in the newly formed organization as they feel there is no consensus with the merging party.
- Unwillingness to face change or overwhelmed by the growing size of the company
Some executives might be uncomfortable with the change which is brought in by the new organization. Similarly, there is also a chance that they are overwhelmed by the sheer growth of the organization as they did not expect it to grow immensely out of the blue.
- Unsatisfactory earnouts
An earnout is basically a provision wherein the seller of a business gets certain compensation from the buyer. Earnouts are based on the revenue performance of the acquired entity. Agreement concerning profitability and earnout period must be clearly communicated or there might be disputes on this topic during the exit.
- Chasing different goals
There are times where the executives feel they have experienced many things during their tenure and now want to try out different ventures. This sense of fulfillment inspires them to chase different goals and hence they opt-out of management.
- Not in the plans of the new owners
The contracts of some executives are not renewed or even terminated when there is a change in ownership. Their services are no longer needed as the owners might feel there can be control struggles if the executives extend their current stay or the acquiring corporation feels that their existing managerial body might be sufficient to run the target organization as well.
The legal issue relating to exits by top executives during M&A transactions
All transactions have some or the other kind of legal binding to them so that there is no undue advantage taken by any party towards the stakeholders of the organizations. There are various reasons as to why an executive exits the organization during or after the M&A transaction. In such cases, it is the duty of the acquirer to see to it that the legal obligations towards the leaving executives are completed and no disputes are remaining. Ignoring these obligations might bring serious legal action towards the defaulting parties. The key legal issues pertaining to top executives’ exit during M&A transactions can be divided into two situations:
1) The executive wants to leave on his own free will;
2) The executive’s role is terminated by the new managerial body. Legal issues arising out of both situations differ accordingly.
When an executive does not want to stay in the newly formed organization
Legal issues that might crop up when an executive willingly leaves the organization are-
Non-disclosure/ confidentiality
An executive has knowledge about all the operations their organization has undertaken. As a result, he/she has complete access to sensitive information that can be used against the entity. Executives of an organization are bound by the non-disclosure clause in their employment contracts to keep such information confidential. It is necessary to re-evaluate these clauses and check whether the clauses are binding after their tenure in the organization.
Non-compete
One of the major issues an acquirer is not willing to face is when an employee of the target company joins its direct competitors or starts their new venture which brings them in direct competition with their entity. To avoid such conflicts, it becomes essential for the acquirer to see to it that a non-compete clause is enforced during their exit negotiations.
Remuneration/benefits
The employment agreements of senior executives have remuneration, bonus, and similar clauses that allow them to be paid handsomely for their services if their exit is accepted by the organization. It thereby becomes necessary to pay them accordingly and not create any default that might enforce a legal action.
When an executive wants to stay but their role is terminated
Legal issues that might crop up when the role of an executive is terminated against his will are-
Equity incentive compensation
Equity Incentive Plan Agreement is a legal contract between a corporation and its employees to provide the employee with an interest in the corporation. The purpose of an Equity Incentive Plan is to strengthen the financials of the corporation by providing incentive stock options to its employees. An executive of the company may have a large stake in the company. During their exit it is a legal obligation of the company to compensate their equity stake or the concerned employee can file a suit against the management.
Unlawful dismissal
When the employment of a top executive is terminated without sufficient or satisfactory reasons then the executive is said to be unlawfully dismissed. Unlawful dismissal isn’t just limited to the top executive but all employees of the organization. The aggrieved person may seek HR’s response in relation to the reason for their termination. If no efforts are taken to communicate a response then the executive can give a legal notice for breach of contract. Unlawful dismissals are dealt with more rigidly in the US and European countries where such instances can bring in heavy monetary punishments along with loss of brand equity.
Payment of golden parachutes
Golden parachutes are a form of compensation paid to top executives in the event that a public company is sold and these executives lose their jobs or have their responsibilities trimmed. Payment of golden parachutes are triggered in two events:
- A publicly traded company is sold.
- Key executives are terminated without cause.
Employment contract issues
There are a lot of different clauses in an employment agreement relating to the different demands which were agreed as a contingent on the employee’s termination. However, the new managerial body will not be willing to honor every condition agreed by the old management. Such cases can bring in heavy litigation relating to breach of agreement so it is necessary to make sure that the executive is compensated handsomely if there is a certain promise the organization is not planning to fulfill.
Conclusion
M&A brings in a lot of change in regard to the control of the company. Many executives are cut off from the organizations and many may choose to leave by their own free will. The executives aren’t willing to stay in the organizations for various reasons. During their exit, the legal advisors of the companies should look at whether there are any legal obligations pending that might bring legal consequences to their organizations.
References
- https://www.forbes.com/sites/allbusiness/2019/10/23/mergers-and-acquisitions-management-team-questions/?sh=3383462d5f10
- https://www.lexology.com/library/detail.aspx?g=aa477882-1ce7-4583-affc-df7fc93ad780
- https://www.ngs-global.com/images/MA_is_the_New_IPO.pdf
- https://www.mckinsey.com/business-functions/m-and-a/our-insights/talent-retention-and-selection-in-m-and-a
- https://www.allbusiness.com/merger-and-acquisition-transactions-key-lessons-122918-1.html
- https://blog.ipleaders.in/key-managerial-personnel-kmp/
- https://www.bain.com/insights/change-management-in-merger-integration/#:~:text=The%20key%20is%20to%20embed,flow%20throughout%20the%20broader%20organization.
- https://dealroom.net/blog/impact-of-mergers-and-acquisitions-on-employees
- https://www.insperity.com/blog/mergers-acquisitions-keep-employees-leaving/
- http://levinebakerlaw.com/publications/protecting-executive-rights-in-mergers-acquisitions/
- https://www.azalaw.com/blog/if-theres-a-change-of-control-an-executive-needs-options-in-writing/
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