The butterfly effect of legal debt on your future M&A deal

Speakers

Elliot Cowan (Partner, CMS) and Natasha Bassett (General Counsel, Unbound)

The top three questions or themes explored in this session were…

  1. What is legal debt - short term fixes which cause long term problems which often crystallise upon a fundraising/exit. Repercussions are buyer or investor seeking indemnity protection, price reduction, or in the worst case scenario the deal aborts.
  2. What internal pressures are faced by in-house counsel which result in legal debt arising (i.e. is it simply fee pressure, or is it because in-house counsel don’t want to be the person being seen to be creating issues, etc).
  3. How to approach legal debt – i.e. where there is a problem assessing whether it is material v immaterial, fixable v non-fixable, likely to crystallise v unlikely to crystallise. Where you are faced with legal debt, this should help triage the issues for prioritisation purposes.

The top 3 things that attendees should take away from the session:

  1. Tax issues (i.e. issues re EIS/EMI share options/s431 elections) are rarely fixable. These can be expensive if they go wrong so worth focusing on these.
  2. There are various issues which can be fixed with the cooperation of a third party (say contractors who need to sign an IP assignment in favour of the company, or changing the terms of existing customer contracts).
  3. There are certain issues which buyers/investor will be live to, and worth considering prior to entering into a transaction (such as introducer agreements, whether any employees are really being engaged as contractors, GDPR compliance, errors in the cap table, etc). Always good to pre-empt likely issues on the above

Examples of legal debt from attendees:

  • poor data protection compliance
  • cap table problems (e.g. a founder earns and keeps a high percentage)
  • co-created essential IP (other companies in collaboration- not consultant)
  • options 'promised' but not granted
  • early employee/ investor consent rights for a capital raise
  • quirky' terms in client contracts - non standard terms ('to get the deal done!')
  • mis-classification of contractors' risk
  • perpetual super pro rata
  • GDPR consent related issues (consent from customers not expressly obtained re. onward data sharing)
  • error in the articles (esp. about waterfalls)
  • old share holders agreement that is restricted for future fundraising
  • control of the board is outside the UK
  • problematic clauses in key employee contracts
  • companies house fillings inaccurate on not up to date
  • permanent establishment risk (employees as consultants)
  • domain address not owned
  • historic contracts that leak value/ have onerous payment obligations
  • CSOP not meeting schedule for requirements to be tax efficient
  • introducer agreements
  • miss-use of personal data
  • health tech past engagement with contractors
  • international employees via employer of record
  • unsigned/ unfindable contracts
  • EIS ineligiblity
  • fed all data into an overseas LLM
  • employer of record arrangements not complying with local laws
  • IP assignments poorly drafted
  • T+C of supply
  • copyleft
  • missing POCS showing how shareholders got the IR shares
  • founder expectation to stay/ to leave on exit
  • share buyback not done properly
  • poor risk management framework/oversight
  • rectification of register or members
  • uncertain historical liablility
  • regulatory breaches
  • founder thinks it's still 'theirs' and does not want to 'share' control
  • errors in the company's statutory registers
  • dodgy contracts (badly drafted)

If you want to learn more about this topic, here are some additional resources:

  • Elliot has extensive experience advising on both VC fundraisings and M&A transactions – he’s seen it all throughout his career, and would be happy to act as a sounding board in respect of all legal debt matters. He can be contacted at elliot.cowan@cms-cmno.com or on 020 7067 3467.
  • The Crafty Counsel Community is also a great place to raise any queries you have (which can be done on a no names basis for confidentiality reasons if you prefer)

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