This article is written by Romit Nandan, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.

Who is a stockholder representative?

The foremost impetus to understand the role of a stockholder representative in an M&A deal is by understanding who exactly is a stockholder representative. After the closing of an M&A deal, the old shareholders/owners of the target company move out and hand over the company to the acquirer or the buyer. And while the transaction has culminated, there still might be some disputes or issues that may arise between the old shareholders and the acquirers either due to discoveries that were missed during the pre-closing phase or any claims or issues that may have developed post-closing like unpaid tax notices etc. Often such issues involve discussions and negotiations at great length, and the buyer might just find the necessity to deal with various former shareholders individually a cumbersome process.

Thus, for the sake of convenience, a stockholder or shareholder representative is put in place as a general practice who would be representing as-well-as acting on behalf of the old shareholders to put forth their interests and defend them in any disputes that may arise with the new shareholders/acquirers post-closing. A stockholder representative is a person designated and appointed to act on behalf of the former/seller shareholders to negotiate and deal with crucial matters and disputes post-closing of the M&A deal to safeguard the interests of the selling shareholders. (You can find the sample clause definition of a stockholder representative here). They are appointed by the seller shareholders, but a buyer might also have an interest in who becomes a representative due to concerns over confidentiality and to ensure that the designated person will work professionally with the buyers with efficiency.

Role of the stockholder representative in M&A deals

As mentioned before, a stockholder representative’s major role is in the post-closing phase, generally tasked to be ready to handle disputes and claims before they arise and to ascertain the actual expenses to be borne and the amount to be received by the old shareholders. A well-rounded list of functions that are typically shouldered by a shareholder representative are:

Post-closing communication

A shareholder representative acts as the bridge between the old shareholders and the new owners of the target company. They are the focal point of any and all communication between the two. They keep tabs on the balance of the escrow account, the expenses to be paid, the progress towards the earn-outs and any receivable amount from it and regularly provide this status report to all the old shareholders. Besides communication, they also undertake negotiations on behalf of the old shareholders with the acquirers in regards to the escrow account, expenses, earn-outs etc. 

Negotiating purchase price adjustment

Typically, the time window between when the parties agree on a purchase price and the time when the actual closing takes place, there are certain fluctuations in the assets and liabilities of the target company due to operations on a going concern basis, and thus, after closing, there are certain adjustments made to the purchase price. A shareholder representative is expected to review the financial statements and the working capital calculation prior to the closing and after the closing and negotiate the purchase price adjustment taking into account any seasonal fluctuations or unusual nonrecurring events and growth in business.

Resolving disputes

If any disputes arise between the buyer and the seller post-closing, it is the responsibility of the stockholder representative to advise the old shareholders, strategize the best procedure and overall manage the entire dispute resolution process from inception till the end either amicably or through litigation. 

Minimizing indemnification claims

A stockholder representative also handles any, and all of the indemnifications claims that may be raised by the buyer post-closing and tries to preserve the Escrow Funds as best as he can.

Earn-out management

A stockholder representative also undertakes audits and reviews of relevant accounting and financial data of the target company post-closing to assess the probability of achievement of an earn-out and intimate the progress made so far to the old shareholders.

Tax returns and claims

A stockholder representative also, based on the present taxation scheme, prepares and files tax returns, if any, on behalf of the old shareholders post-closing. If the acquirer has received any tax returns, it is the stockholder representative’s responsibility to ascertain how much and to ensure that the tax return proceeds get to the old shareholders. There are also tax claims which at the time of the deal could not be foreseen, like municipal taxes or sales tax; a stockholder representative will have to weigh the merits of the claim and pay off the claims as needed on behalf of the old shareholders. 

Logistics for distribution of proceeds

A stockholder representative receives any and all proceeds or amounts post-closing from the acquirer on behalf of the old shareholders. And it is the duty of the stockholder representative to distribute these proceeds to the old shareholders as per their share or agreed manner of distribution. The entire process can become difficult if there are several shareholders or a distribution waterfall involved (disproportionate distribution).

Dealing with sandbagging claims

Sandbagging claims are those breaches or claims that the buyer already knew about in pre-closing but nevertheless did not raise it and waited for the closing of the deal and then sought damages. As a stockholder representative, you would be required to undertake a comprehensive background check and technical analysis of the entire deal to find out what the exact facts were and if they were known to the buyer to ascertain if there has been any breach of warranty or representation.

Third-party patent issues

Often the issue with M&A deals for businesses on a going concern basis is that there might be some infringement that might trigger. As a stockholder representative, you would have to work with both the acquirers and the buyer to work around the third party claiming the license of a patent that is now the acquirer’s property. 

Correcting financial misstatements

In an M&A deal, it is very common for certain financial misstatements to go unseen for it to only pop up later after the closing. As a stockholder representative, you would not only have to undertake the correction of the errors in the financial statements and even calculate damages that would be payable for the misstatements.

It is quite evident that a stockholder representative serves a wide and extensive role and shoulder a wide gamut of responsibilities. The above-mentioned functions are a broad spectrum of duties; in any given M&A deal, a stockholder representative may or may not perform all of the above duties, it all depends upon who the stockholder representative is, what are his skills and qualifications and most importantly, what are the terms of the relationship between the shareholders and the stockholder representative. It is good advice that shareholders understand their stockholder representative and engage his services in matters that he or she has the requisite calibre to deal in as any mistake may make the entire scenario leave behind a wounding scar on every shareholder. Thus, it is best to not confine all the post-closing matters to only a stockholder representative and rather engage services of professional litigants, accountants etc., in pair with the stockholder representative. 

Is a stockholder representative mandatory in M&A deals? 

While a stockholder representative is in no way mandatory but due to the growing complexities as well as the consideration involved over the past few years, M&A deals from the last decade have witnessed an astounding increase in claims and disputes post-closing, issues like working-capital adjustment, earn-outs, escrow, indemnification claims etc. All such issues involve long-hours of dialogue and negotiations which would be impossible when there are several shareholders.

Because of this, the buyers usually requires the sellers to designate a person as a stockholder representative to act and negotiate on behalf of the old shareholders in the post-closing matters. It makes the process of communication and negotiation far easier and speedier, as there no longer is the need to round all the shareholders together and then move forward with the negotiations and get their approvals individually. It is this administrative convenience in negotiations and decision-making because of which stockholder representatives are nowadays sought mandatorily by the buyer in any M&A deal.

Do I need a third-party/professional stockholder representative?

Traditionally, the founders or the senior officer like the CEO or the majority investor like a representative from a Venture Capital or private equity firm of the target company used to be appointed as a stockholder representative. 

So, while there seemingly is no requirement to get a third-party as a stockholder representative but today, many parties are engaging their counsels and professional shareholder service providers as the designated representatives. There are few reasons why, as a Seller, one should consider getting a professional:

Limited skills or expertise

As a CEO or an investor, you might lack the needed expertise to deal with the post-closing issues. Often these issues are very technical that requires a professional’s touch to better deal with them. Post-closing witnesses a plethora of highly complex issues (you can learn more about the post-closing issues here) that not just contemplate but also expect dexterity in accounting, taxation, auditing and litigation, to name a few. Any wrong move might have an adverse impact on not just your liability but the liability of your other shareholders as well.

Conflict of interest

There is also a possibility that one may run into a conflict of interest. Often the acquirers ask the founders and other executive officers to stay back in the acquired company as they are the ones who created the company and know it well. So, if you as a founder or senior officer are not only the stockholder representative but also an employee of the acquired company, you may be in an awkward position where you would have to argue on behalf of your former shareholders against your new employer, in such a situation, it is best to hire a third-party professional.

Higher costs

A stockholder representative is required to devote significant a huge chunk of time and effort in dealing with disputes, negotiating the claims, communicating back and forth with the old shareholders and the new owners. Nowadays, post-closings are witnessing an increase in earn-outs and other such revenue offers that lapse from anywhere between one year to more than four years after closing. As a founder, if you become a stockholder representative, you would be exhausting your attention and resources in managing your disputes which could have rather been utilized in your other and new ventures and businesses.

Legal risk

A stockholder representative can be held responsible in case of negligence or mistakes (discussed in detail later); usually, there are notices which the representative fails to reply in 30 days they are deemed to be accepted. In such scenarios, legal action may be taken against the representative. If you, as a CEO or investor, are a stockholder representative, it might work out to your disadvantage as you could be denied employment or to carry out any other transaction if there is any lawsuit pending against you. You might even pass on the risk to your other partners if you are in a partnership.

Thus, as sage advice, a competent third-party professional stockholder representative is recommended. Another very pertinent question to answer is ‘What if my deal is very small, should I still get a Professional Stockholder Representative?’

As discussed above, the main reason why buyers impose the requirement of a stockholder representative is because of the fact that there is a large number of shareholders. And so, one would assume that if your deal is small or doesn’t have that many shareholders, you won’t have to splurge for a professional stockholder representative. But it is irrelevant to assume so because, after all, it is not the number of shareholders that determines the need for a professional stockholder representative but rather the buyers and their disputes that necessitates a professional touch. So, while the requirement of a stockholder representative is driven by the buyer when there are a considerable number of shareholders, the need for a professional stockholder representative is completely separate and not correlated with the number of shareholders that exist.

In fact, the need for a professional stockholder representative is all the more felt when there are few shareholders or the consideration is not that much or both because of two counts. Firstly, a smaller number of shareholders means there is a greater share in the liability or claims in case something goes wrong; the liability or risks involved in a haywire post-closing won’t get diluted amongst a small number of shareholders. Secondly, if the consideration amount is less, it still does not mean that the expenses or claims would be less too; who’s to say that the damages won’t be more than the deal itself if something goes wrong. Moreover, any single claim or dispute raised by the buyer could ensure huge delays in the payback of any earn-outs or escrow to you, the seller! thereby frustrating what would have been a small and quick deal. So, the need to get a professional on board is a deliberate choice based on a multitude of factors that needs to be carefully weighed by the seller.

Advantages of a professional stockholder representative

Better suited

A professional stockholder representative has a greater degree of skill, experience and training to deal with the technicality of post-closing matters and the kind of transactions involved in them. They are far better equipped to deal with them and to get the right people on board to address them whenever needed.

Better devotion

A professional would have far more time and resources to put in the post-closing matters than a seller. The professional does this as a matter of employment and thus can provide better attention to the issues than a seller doing it out of compulsion. 

Long-term availability

With M&A post-closing matters spanning up to 5 years, it is impossible to expect a seller to have that kind of commitment. But a professional has the capability to be available for the entire duration of the post-closing period.

Better communication

With post-closing issues, the potential receipt of revenues are attached in the form of earn-outs or escrow, and it is natural for many former shareholders to have questions regarding the same. A professional who has the knowledge and the time to monitor the progress regularly will be in a better position to answer these queries and also communicate about the likelihood of receiving them better than a seller shareholder acting as a representative.

Authority of a stockholder representative 

It is commonly asked whenever one comprehends hiring a third-party stockholder representative that whether ‘I will lose control of the Decision Making in the Post-Closing or not?’ 

To give a straightforward answer, NO! A shareholder representative will not reduce or take away any of your control or decision-making in the post-closing and probably might improve and give you more control. This can be understood through two instances:

1. Whenever you engage a professional stockholder representative, you only delegate the execution of the ideas to the stockholder representative. As a shareholder, you continue remaining in control; you continue making material decisions as to what is to be done or how it’s to be done.
2. The next thing is that professional stockholder representatives work with the shareholders as an advisor, they advise them on the best course of action thereby giving more choices, and they don’t do anything without the proper authorization or consent of the shareholders.

Thus, it is nothing but a myth that a professional stockholder representative will take away your decision making.

Liability of a stockholder representative 

So, the very next question that would come to your mind is ‘Is the stockholder representative relationship with the shareholders one of principal and agent?’

And it would be right to think that it is one of principal and agent; after all, they act almost identical to any other professional like a lawyer or doctor who is deemed to be agents of their clients. But interestingly, this is not the case for a stockholder representative, at least not per-se; I’ll break it down for you. In a 2014 Massachusetts case of Mercury Systems v. Shareholder Representative Services LLC, a class-action lawsuit was brought against the defendant shareholders in lieu of some claims, and along with the shareholder, the stockholder representative was added as a co-defendant. The court, however, held that a stockholder representative is only appointed as a helping hand in resolving post-closing disputes, they are nowhere engaged to act expressly on behalf of the shareholders on their own authority, and thus there is no principal-agent relationship between them. They are a mere representative only.

If the relationship of a stockholder representative is not that of a principal-agent, what is the liability of a stockholder representative, if any at all. A stockholder representative acts as an advisor and on behalf of the shareholders only as a matter of administrative convenience, and so they do not have any liability in any actions taken by them nor do they share any obligation to act without the authority of the shareholders even if it is for a minuscule matter. Their liability only arises if they do anything with malicious intent or without the authority or knowledge of the shareholders; otherwise, they share no cent in the liability. 

A stockholder representative is for this reason considered a ‘Limited Party’ to the M&A Agreement as they are there only to perform the basic administrative functions. But if the shareholders were to initiate stockholder representative to see through litigation or arbitration or act as an accountant, then their relationship would be as that of their counterpart professional for only that concerning matter only. Thus, as long as the stockholder representative is performing basic administrative and advisory functions like communication, negotiation, status check etc., they are not an agent but a mere Representative and do not have any liability so attached.

Key points to keep in mind while drafting the terms of appointment of a stockholder representative

• Outlining their scope in the main agreement

The first thing to ensure is that the mother agreement or the main M&A Agreement specifically provides a clause that establishes the role of a stockholder representative even if you think you won’t need one. Or, at best, there should be a clause specifically stating that it would be the shareholders that would be deciding and outlining the scope and role of the stockholder representative as an addendum to the M&A Agreement. This would act as a contingency; in the event should you be required to either serve as a stockholder representative or to hire one, their actions would not be bound by the normal clauses of the main agreement that usually apply to third parties that are generally engaged in any M&A deal. Because the scope and powers of a stockholder representative widely differ from the other third parties that are generally engaged like lawyers and merchant bankers, valuers etc. (You can find a few samples of stockholder representative appointment clauses here).

• Matters to be dealt

It is also a good idea to define what matters will the representative be dealing with. The former shareholders should consider this based on the knowledge and proficiency of the representative. Do not give them powers in all matters but rather in only the post-closing matters. The common post-closing matters are investigation, negotiation, dispute resolution, intellectual property, taxation, accounting, employment issues and so forth.

• Defining the power of the stockholder representative in the ambit of the M&A deal

A stockholder representative affects the sellers and its shareholders more than that of the buyers; thus, typically, a buyer would always want that the stockholder representative has the broadest powers. Thus, as a seller, it is important that in terms of the appointment, you curtail their powers and explicitly state that the stockholder representative does not have any power to deal with the buyer alone, that they require the approval of the shareholders in all decisions, that all communications must flow through the representative to all the shareholders and that they cannot materially change the terms of the M&A deal after closing. Otherwise, there is nothing preventing a representative to solely act with the buyer and execute settlements that might have adversity on or may not be the intention of the sellers and are difficult to undo without litigation.

• Proper latitude information sharing

A buyer would not want a stockholder representative to be privy to certain information that it considers confidential. The buyer may also not want the communication to be to all the shareholders as it would make the process cumbersome, and a buyer often wants quick decision making. But without proper communication, the right and proper decisions cannot be taken. So, it is a good idea to negotiate the terms of communication with the buyer and ensure that communication should be to all the shareholders and be limited only if certain information by its nature needs to be communicated to a few shareholders it is intimated to them only and that the entire communication is bound by the terms of confidentiality. It is also important to make all exchanges of information, advice, and any discussions between the former shareholders and the stockholder representative are bound by confidentiality so that the buyer cannot use them against you.

• Extension of representation to all interested parties

Often the post-closing matters are not the sole concern of the former shareholders but also of third parties like former employees, option-holders etc. It is a good idea to ensure that the stockholder representative has the authority to deal with all post-closing matters related to even the concerned third parties to ensure that all matters relating to the escrow, earn-outs etc., are covered within the scope of the representative.

• Indemnification of stockholder representative

Often stockholder representatives engage other persons for advice and sound decision making; it is not uncommon for them to ask for the opinion of a lawyer or an accountant in matters that are best suited to them. If you are a stockholder representative, it is a good idea to also ensure that along with you, any advisory committee that you may refer to is also indemnified and free of incurring any liability.

• Removal of stockholder representative

As a seller, you must clearly retain the absolute power to remove the stockholder representative at any time. In case of death or incapacitation of the representative, a new representative must be designated once more with the approval of the former shareholders. And as a stockholder representative, you must ensure that you have the ability to resign anytime you want. (You can find drafts of more such clauses here.)

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