Random thoughts

The guide comes from a deal announced earlier this week, the agreed acquisition of Manatron, a provider of tax software for state and local governments, by an affiliate of Thoma Cressey Bravo, the private equity firm.

The deal is a small one, valued at approximately $66 million, but as you will see there is much we can learn from it. So, let’s dive into the merger agreement.

We start by determining what the agreement states about specific performance. In the Manatron deal, the relevant clause in the merger agreement is in Section 8.8:

The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement. …

So far, so good. This clause is the type that you would normally see in a strategic deal and which provides the seller the power to argue forcefully in a court that the buyer should be required to perform its obligations and complete the deal.

However, in a private equity deal what one clause giveth another clause sometimes takes away (this is what caught United Rentals in its deal with Cerberus). So, the next thing to check is the remedies section in the termination clause. This section often contains a limitation on liability that restricts the scope of specific performance. Here, the relevant sections are 7.2(c) & (d):

(c) If (i) the conditions to Closing … have been satisfied … and (ii) Parent fails to close the transactions contemplated herein … the Company may terminate this Agreement … In the event the Company terminates this Agreement pursuant to the preceding sentence, Parent shall promptly … pay the Company the Parent Termination Fee. …

(d) … The amounts payable pursuant to … Section 7.2(c) constitute liquidated damages and not a penalty and shall be the sole monetary remedy in the event that a Company Termination Fee or a Parent Termination Fee, as applicable, is paid in connection with a termination of this Agreement on the bases specified in Section 7.2(b) or Section 7.2(c). …

So, for those who don’t normally read these agreements the above two provisions essentially provide that if all of the conditions to closing the merger are fulfilled and the buyer fails to complete the transaction, Manatron can terminate the agreement and receive a reverse termination fee. Here the fee is a payment in the amount of $2 million.

However, reading these provisions together with the specific performance clause, if Manatron does not want to terminate the agreement it can specifically enforce the buyer’s obligations to close. So, at this juncture, it looks like a tight agreement, one quite favorable to Manatron. It is also an atypical private equity agreement which often have either a pure reverse termination fee with no specific performance or specific performance only of the buyer’s financing commitment letters.

Here’s the catch. The acquirors here are Manatron Intermediate Holdings, Inc. (Parent), and Manatron Merger Sub, Inc. (Merger Sub). According to the merger agreement, Merger Sub is a shell company and there is no evidence that Parent is not also one. This means that neither company has any assets to collect upon other than the par value of their shares, probably no more than $100 at best.

It is for these reasons that a private equity merger agreement must be reviewed with the fund guarantee and the debt and equity commitment letters. The fund guarantee is the private equity fund’s commitment to stand by any reverse termination fee and pay it from their fund. The commitment letters are the agreements by which Parent and Merger Sub secure the funds necessary to consummate the transaction. Without these letters, the merger agreement is largely unenforceable by the seller.

Here, do a search of the Manatron merger agreement. There is no mention of a fund guarantee or an equity commitment letter. The only terms of relevance are in the Parent and Merger Sub representations. In Section 4.5 the two entities represent that:

Parent has delivered to the Company a true and correct copy of the commitment letter, dated January 14, 2008, by and among Wells Fargo Foothill, LLC and Thoma Cressey Bravo, Inc., pursuant to which the lenders party thereto has committed, subject to the terms and conditions set forth therein, to provide or cause to be provided debt financing of up to $40,000,000 in connection with the Merger (the “Debt Financing Letter” and the financing contemplated thereby, the “Debt Financing”).

The section on financing in 5.13 also only mentions only a debt commitment letter. According to the merger agreement, Manatron has 5,110,374 shares and 851,300 options outstanding and the unvested options included in the latter figure are accelerated in the merger. So, just to purchase the outstanding shares alone the buyer requires approximately $61 million (the per share purchase price is $12 per share).

From their last quarterly earnings report, Manatron only has about $9 million in cash and marketable securities on hand, and the merger agreement requires Manatron to use part of that to pay off its debt prior to closing.

This is all just plain odd. The deal appears to be short at least $15 million. The absence of any mention of an equity commitment letter makes it seem as if there is no equity commitment letter to cover this amount as again would be typical.

This creates two problems. First, the debt commitment letter (which wasn’t disclosed) likely requires an equity infusion as a condition to the lender providing financing. So, if all of the above is true, Manatron’s specific performance right is meaningless because Wells Fargo, the financing bank, can simply refuse to fund if Thoma Cressy refuses to make up the remainder of the required equity funding. Again, though, there appears to be no equity commitment letter to force Thoma Cressy to do so.

The second problem is that if indeed Parent and Merger Sub are true shells, as is typically the case, and there exists no fund guarantee, then the reverse termination fee is a mirage. There are no assets to collect. Thoma Cressy has a costless option on Manatron.

I want to believe in my heart that all of these assumptions are merely that, Manatron simply did not disclose these documents, and the documents will eventually be disclosed in Manatron’s proxy statement. But if they do not exist Manatron has signed a true option to buy the company with no recompense. The board of Manatron has left the company in quite a vulnerable position.

There’s another lesson here. Given the quirks of these agreements, sellers should retain experienced private equity law firms to represent them in these transactions. Manatron’s counsel on this deal, Warner Norcross & Judd, is an excellent Michigan firm, but how many private equity deals have they done recently?

This is the second recently announced deal, Waste Industries being the other, where experienced buyer private equity counsel may have gotten the better of local counsel inexperienced in these types of transactions.

Lesson over.

Coda: The news release for the Manatron deal had the following statement: “The completion of the transaction is not subject to any financing contingency.” Sigh.

–Steven M. Davidoff