Observations on Atlassian’s Proposed Model Term Sheet

Earlier this week, Atlassian published its form acquisition letter of intent under the banner of The M&A Process is Broken: It’s outdated, inefficient and combative. 

Atlassian shared the LOI with the market in an effort to eliminate time-and-expense of negotiating issues that, based on its experience and research, rarely come into play following the deal closing.  By reducing such adversarial positioning, Atlassian hopes to increase collective focus on realizing the larger commercial, product and/or talent synergies that underpin the proposed deal.

In our experience, the M&A market already has prescribed a fairly narrow range of key deal terms.  Arriving at a finalized term sheet is not often an agonizing process.  Due diligence, in contrast, can be burdensome, particularly for founders, but the larger goals of the exercise typically extend to post-closing integration as well as risk mitigation.  While streamlining the M&A process is a sound objective, we question whether the Atlassian term sheet will provide the necessary comfort to the corporate buyer, particularly given facts and circumstances of individual companies and specific deals.  Deal points are judgment calls for buyers often driven by institutional perspectives on risk tolerance and compliance.  In particular we note:

• Reducing caps on sellers’ post-closing liability to 5% and making those caps more inclusive (i.e., eliminating special business representations and warranties relating to IP, privacy and other hot-button topics) may be challenging for many strategic buyers. For example, regulators are devoting extra scrutiny to data privacy, as evidenced by the General Data Protection Regulation (GDPR) in Europe, California’s Consumer Privacy Act (CCPA), which takes effect in January, and Nevada’s leaping to the front in the United States to implement a similar opt-out construct on October 1, 2019. A 5% total recourse cap, particularly for target companies with large consumer-facing activities or that transact in large amounts of consumer data, may not be sufficient.
• The Atlassian term sheet provides for representation and warranty insurance for any deal over $50 million in value – while remaining with an escrow construct for deals under that threshold. The proposed 5% escrow cap is roughly half of the 10% ‘market’ lower boundary; on the other hand, the model term sheet’s 15-month survival period for representations and warranties is longer than the 12-month ‘market’ lower boundary.
• While there is increased use of RWI by strategic buyers, RWI may not be the right remedy/protection for certain larger transactions. RWI generally gives longer periods of protection than conventional holdback/escrow indemnification constructs; however, it excludes from coverage any issue that is deemed ‘known’ by a buyer at the time of a deal. Moreover, given current premiums, many buyers are seeking coverage significantly in excess of 4% of the overall transaction value and either splitting the policy cost or absorbing it, rather than forcing the cost on sellers to pay.
• The Atlassian term sheet appears to not contemplate crediting the target company for cash-on-hand at closing, but does deduct transaction expenses and any change of control payments – whether or not paid. These positions are not equitable for target companies, particularly those that generate cash or have contingent contractual obligations that may not actually become due and payable. Financial true-ups for cash, debt and/or working capital are useful for transactions with periods between signing and closing, such as those that exceed the applicable antitrust filing thresholds (for the United States, any transaction worth over $90 million in 2019).
• Retention initiatives may be better addressed through broad-based approaches rather than selective hold-backs/rollovers for certain key executives.

We expect that the Atlassian model will serve as a useful basis for continued debate on the merits of various approaches, but that many of its principle tenets will continue to be the subject of case-by-case analysis.  Strategic buyers in the current M&A market continue to appear to be willing to offer purchase prices that generally exceed that of more conservative financial buyers, but also expect risk protection for pre-closing issues.