In the world of mergers and acquisitions, there are several ways to structure a transaction. An often strategic option is for the seller to reinvest a portion of the purchase price received in shares of the buyer or its group, called reinvestment.
In practice, this is also known as a "rollover. Sellers often forget that a reinvestment is a transaction in itself, including associated risks.
In this expert contribution, we explain the main differences and risks based on a case study.
Reinvestment case study
TechNexis B.V. (TechNexis), a successful technology company, is sold to the buyer Innoverse B.V. (Innoverse), a larger player in the same industry (these are non-existent companies). As part of the transaction, the shareholder of TechNexis (the seller) is expected to reinvest 15% of the purchase price to be received by it in Innoverse. The purpose of this reinvestment in Innoverse is for the seller to experience greater involvement and gain a financial interest in the further (financial) development of the Innoverse group.
Two transactions
Basically, a reinvestment means that two transactions take place simultaneously: the purchase of shares in the target company (TechNexis) by the buyer (Innoverse) and the purchase of shares by the seller in the buyer. One could view the reinvestment as in part a reverse version of the acquisition by Innoverse. The seller is buyer in this "second" transaction and has an interest not only in a high valuation of TechNexis, but as a future shareholder also in the value development and continuity of Innoverse.
In practice, the seller's purchase of 15% of the shares in Innoverse often does not receive the same careful review as Innoverse's purchase of 100% of the shares of TechNexis.
What the seller needs to know
Valuation of buyer
The buyer's valuation determines the size of the equity stake the seller receives for the portion of the purchase price it reinvests. Thus, it is important for the seller, or its advisers, to perform a financial examination on the buyer's (company's) business to avoid the seller receiving too few shares because of an overvaluation.
Often, information needed for this (financial) investigation is incomplete or supplied too late. We therefore recommend including contractual protection for this at the beginning of negotiations, in the form similar to a ratchet provision in venture capital transactions.
Book review on buyer
As with an investment, when reinvesting, sellers would be wise to conduct a book examination on (the part of) the buyer in order to identify - in addition to financial risks - operational risks and opportunities. Yet this rarely happens; parties often focus primarily on the primary transaction and pay less attention to the "second" transaction.
Herinvesteringsdocumentatie
Reinvestment documents are often standard and applicable to larger groups of managers and reinvestors. As a result, sellers are frequently told that adjustments or negotiations are not possible and can be signed at the crossroads, a "one size fits all" approach. Sellers are pressured by this: if they do not agree to the Reinvestment provisions, the primary transaction may also be affected.
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Conclusion
We recommend discussing and agreeing on the reinvestment documents at an earlier stage of the acquisition (for example, in the term sheet). After all, how will the parties deal with a claim under the purchase agreement in the primary transaction in relation to the Reinvestment? And how will cooperation continue in that case? And are there, for example, arrangements for the protection of minority shareholders and how are proceeds distributed in the event of a (partial) exit. These are important concerns, also in the case of a Reinvestment.
Conclusion: should a reinvestment in an M&A deal be seen as an independent transaction and not just a condition of sale?
The short answer is: yes. It's a transaction in itself, with its own risks, its own valuation, and its own accounting review, if any.
Both buyers and sellers often do not sufficiently realize that a Reinvestment leads to an unusual transaction structure. Both parties must therefore carefully consider how a Reinvestment fits into the broader picture of the primary transaction.
