Intro to M&A Representations and Warranties

In each M&A transaction, the main contract includes assurances and assertions known as "representations and warranties," often shortened to "reps." These statements cover past, present, and sometimes future facts regarding the status, business, assets, liabilities, properties, condition, operating outcomes, operations, and prospects of the party making the assertions, a group of companies under their control, or a set of assets and liabilities. The reps and warranties section can be extensive, ranging from 15 to 30 pages in a transaction agreement and potentially more when incorporating referenced text from the Definitions section. Negotiating the terms within these representations and warranties typically consumes a significant amount of time and effort in finalizing the deal.

Why do representations and warranties get so much attention?

Disclosure

Initially, they serve as vital disclosures from one party, leveraging their informational advantage, to inform the other party, especially in the case of the seller, regarding the target company or assets. Generally, this information pertains to the target company or assets and is transferred from the seller to the buyer, except in cases where a portion of the purchase price involves buyer stock.

These representations and warranties act as an extension of the due diligence phase, mitigating information imbalances between the parties. Often, during the process of formulating these representations and warranties (alongside the related disclosure schedules), parties uncover significant findings that can substantially impact the deal's overall value proposition.

Walk rights

Secondly, representations and warranties can provide a basis for one party to exit the deal before it's finalized. In most deals where there's a gap between the signing and closing, the main transaction agreement sets forth certain conditions that must be met. These conditions typically require the other party's assertions and guarantees to have been accurate at the start and to remain accurate at the closing. If these conditions aren't met, it usually allows the non-breaching party to cancel the transaction agreements and withdraw from the deal. Thus, these assurances enable ongoing scrutiny of the deal during this interim period and offer protection to a buyer (or a seller receiving shares) from adverse events that might affect the other party or the target company.

Risk-shifting

Thirdly, in conjunction with indemnification rights, representations and warranties function as a mechanism to shift risks—errors in these assertions may entitle one party to receive financial compensation for resulting losses. This concept mainly applies to private M&A transactions, as post-closing indemnities are exceptionally rare in public deals. In private transactions, this aspect of representations and warranties primarily aims to ensure that the seller, rather than the buyer, assumes a significant portion, if not all, of the risk associated with losses stemming from inaccurate statements. This allocation of risk offers the buyer greater certainty, allowing for more accurate deal pricing and better planning for post-closing operations.

During negotiations, parties should keep this risk-shifting aspect in mind. It's not unusual for one party to object to a proposed representation or warranty by stating that it's not entirely accurate or verifiable. In response, a seasoned M&A lawyer might argue that this objection doesn't negate the purpose, emphasizing that the client shouldn't carry the risk. Ultimately, these assertions aren't solely about factual accuracy but also signify which party is responsible for losses arising from specific events or conditions.

Discipline

The final critical role of M&A representations and warranties stems from the preceding functions. The possibility of the opposite party terminating the deal or seeking compensation due to breaches strongly encourages the party making these assurances to ensure their accuracy (or the assurance of their accuracy at the specified time). For instance, if a party asserts representations regarding good standing, authorization, and absence of conflicts, they'll work towards ensuring the entity or the target company is indeed in good standing, possesses the authority for the transaction, and isn't involved in conflicting agreements. Consequently, the aim to avoid the expenses related to a failed deal or breached assurances often positively influences the fundamental aspects of the agreement.

What do representations and warranties say?

The representation and warranty clause covers a wide range of topics, spanning from the legal status of the target company, its compliance with regulations, to the buyer's ability to finance the deal and fulfill obligations in the agreement.

Here's an example of a standard representation regarding the absence of conflicts from the seller:

"Subject to obtaining all required consents, approvals, and authorizations outlined in Section 3.07, the execution, fulfillment, and performance of this Agreement by the Seller will not (a) breach any provisions in the Seller or the Company's Organizational Documents, (b) conflict with or violate any applicable Laws or Government Orders concerning the Seller, the Company, or their assets, properties, or operations, or (c) result in contractual breaches, defaults, termination rights, or the creation of any encumbrances on the Shares or Assets under any agreements involving the Company, except as indicated in Section 3.06(c) of the Disclosure Schedule."

Other reps like this one you may encounter in a typical private company stock purchase agreement would address all or some combination of the following subjects:

organization and good standing
authority and enforceability
capitalization and ownership
subsidiaries
financial statements
books and records
accounts receivable and accounts payable
inventories
absence of undisclosed liabilities
absence of certain changes and events
assets
real property
intellectual property
material contracts
tax matters
employee benefits
employment and labor
environmental, health and safety
compliance with law
legal proceedings
customers and suppliers
product warranties
product liability
insurance
related-party transactions
guarantees
brokers and finders fees and
full disclosure.

The agreement typically includes buyer's reciprocal representations and warranties to the seller. In cases where the buyer pays with shares, their assurances often align closely with those given by the seller because it involves the seller investing in the buyer's securities. However, when cash is the primary payment method, the buyer's representations and warranties are generally more limited.

In transactions without stock consideration, the buyer's representations and warranties typically cover various aspects:

Organization and standing
Authority and enforceability
Avoidance of conflicts
Necessary government approvals
Disclosure of legal proceedings
Intent and purpose behind the investment
Financing arrangements
Details about brokers or finder fees
Independent due diligence and investigation.

What determines which representations and warranties are given in a deal

The precise configuration of representations and warranties in a particular deal is a function of a number of factors in addition to whether part of the purchase price will be paid in buyer shares. These include:

The scope and specifics of representations and warranties in a transaction agreement can vary due to multiple factors:

Transaction structure: Differences arise in representations, such as valid issuance in stock purchases or sufficiency of assets in asset deals.
Public or private deal: Public deals often involve representations regarding SEC filings and compliance, offering added assurance due to federal securities laws and stock exchange standards.
Due diligence depth: Parties conducting thorough due diligence may demand more comprehensive representations from the other side.
Specific issues uncovered: Discoveries during due diligence, like IP disputes or environmental concerns, may lead to enhanced representations in those areas.
Target company's industry: Industry focus varies, with technology deals emphasizing intellectual property and chemical transactions requiring more environmental coverage.
Evolving market practices: Norms change over time, making what was once standard possibly uncommon today.
Past practices and preferences: Previous transaction agreements and individual preferences influence concessions and priorities.
Allocation of post-closing risk: Indemnification terms impact the extent of representations, influencing resistance or acceptance of broad assurances.
Representations and warranties insurance: The presence of insurance can shift risk and influence the contents of representations.
Buyer's strategic options: Detailed seller representations might ease a buyer's decision-making on the deal.
Bargaining power: Competitive situations often favor sellers in resisting extensive representations.
Qualifying definitions: Terms like "knowledge" or "Material Adverse Effect" are critical and affect the frequency and limitations of each representation.
Complexity and cost considerations: Lengthier representations increase drafting time and legal expenses.
Inclusion of broad representations: Comprehensive representations may lead to lesser insistence on specific ones from the buyer's end.
Draft preparation: The initiating party for the agreement draft typically influences the extent of representations; a buyer-prepared draft may feature more extensive seller representations than one prepared by the seller.

Gayatri GuptaJanuary 8, 2024

Nasdaq Compliance

The Nasdaq Stock Market features three tiers of listed companies, namely: (1) The Nasdaq Global Select Market, (2) The Nasdaq Global Market, and (3) The Nasdaq Capital Market. These tiers are characterized by progressively stringent listing requirements, with the Nasdaq Global Select Market setting the highest standards for initial listings and the Nasdaq Capital Market serving as the entry-level tier, particularly suitable for most small-cap issuers.

To list securities on Nasdaq, a company must fulfill minimum listing requirements, encompassing defined criteria related to financial performance, liquidity, and corporate governance. Nasdaq retains extensive discretion in the listing process and reserves the right to reject an application, even if the technical prerequisites are satisfied, if it deems such denial essential to safeguard the interests of investors and the public.

After securing a listing on Nasdaq, a company is obligated to adhere to ongoing listing standards. To initiate the listing process, a company seeking inclusion on Nasdaq must diligently complete and submit a comprehensive listing application to Nasdaq. This application should include specific documents and information as outlined by Nasdaq's requirements.

Typically, the application process spans a duration of four to six weeks. Once the application is submitted, a Nasdaq analyst is designated as the primary liaison with the company. Within two to three weeks of submission, the company can expect to receive an initial comment letter. The comment and review process persists until a decision is reached on the approval or denial of the application. Similar to filing with the SEC, a meticulously prepared Nasdaq application tends to attract fewer comments and facilitates a more streamlined process. Generally, the company's securities counsel assumes a leading role, serving as the primary contact for preparing the application and engaging in communication with Nasdaq.

Similarly to the SEC review process, Nasdaq conducts a thorough examination of publicly accessible information pertaining to a company. This encompasses, but is not limited to, SEC filings, the company's website, management communications and speeches, as well as press releases. The iterative nature of the review process typically doesn't necessitate a formal protocol, and communication is commonly facilitated through email correspondence and phone calls.

Listing Criteria For Nasdaq
For a company to list its securities on Nasdaq, it must satisfy the following criteria:

Specific Initial Requirements:
- Quantitative Standards: Meeting defined thresholds for both quantitative and qualitative factors.
- Qualitative Standards: Fulfilling certain qualitative benchmarks.
Continuing Requirements:
- Quantitative Criteria: Adhering to ongoing quantitative benchmarks.
- Qualitative Criteria: Maintaining specified qualitative standards.

The initial quantitative thresholds are typically set at a higher level than those required for continued listing. This distinction aims to ensure that companies achieve a sufficient level of maturity before being listed. Additionally, Nasdaq imposes rigorous corporate governance standards that listed companies must adhere to throughout their tenure on the exchange.

Before formally submitting a comprehensive listing application, a company has the option to pursue a preliminary listing eligibility review. In this stage, the Listing Qualifications Staff conducts a thorough examination of the company's public filings to assess its compliance with numerical listing requirements. Additionally, the team evaluates the company's adherence to corporate governance requirements outlined in the Marketplace Rules ("Rules"). This preliminary review provides valuable insights into the company's eligibility for listing on Nasdaq before committing to the full application process.

Upon completion of the preliminary review, the Listing Qualifications Staff will make an assessment regarding whether the company meets the numerical listing criteria. Additionally, any corporate governance or regulatory concerns raised during this phase will be considered to determine their impact on the listing approval. It's important to note that while the preliminary review provides insights, final approval necessitates the submission of a formal listing application. This application undergoes a thorough examination by the NASDAQ Listing Qualifications Staff. Furthermore, the final approval process involves satisfactory compliance with specific qualitative reviews. This includes an examination of the regulatory history of the company's officers, directors, and significant shareholders. Meeting these criteria is integral to obtaining the final approval for listing on Nasdaq.

Financial And Liquidity Requirements

    Requirements

    Equity Standard
    Market Value of Listed Standard
    Net Income Standard

    Listing Rules

    5505(a)
and
5505(b)(1)
    5505(a)
and
5505(b)(2)
    5505(a)
and
5505(b)(3)
    
    Stockholders Equity

    	$5 million
    	$4 million
    	$4 million
    
    The market value of publicly held shares

    $15 million
    $15 million
    $
      5 million
    
    Operating History

    	Two years
    N/A
    N/A
    
    The market value of listed securities

    N/A
    $50 million
    N/A
    
    Net income from continuing operations (in the latest fiscal
a year or in two of the last three
fiscal years)

    N/A
    N/A
    $750,000
    
    Publicly held shares

    	1 million
    	1 million
    	1 million
    
    Bid Price

    	$4
    	$4
    	$4)
    
    Closing Price

    	$3
    	$2
    	$43
    
    Corporate Governance

    Yes
    Yes
    Yes
    
    Total Shareholders

    300
    300
    300

Requirements	Equity Standard	Market Value of Listed Standard	Net Income Standard
Listing Rules	5505(a) and 5505(b)(1)	5505(a) and 5505(b)(2)	5505(a) and 5505(b)(3)
Stockholders Equity	$5 million	$4 million	$4 million
The market value of publicly held shares	$15 million	$15 million	$ 5 million
Operating History	Two years	N/A	N/A
The market value of listed securities	N/A	$50 million	N/A
Net income from continuing operations (in the latest fiscal a year or in two of the last three fiscal years)	N/A	N/A	$750,000
Publicly held shares	1 million	1 million	1 million
Bid Price	$4	$4	$4)
Closing Price	$3	$2	$43
Corporate Governance	Yes	Yes	Yes
Total Shareholders	300	300	300

Corporate Governance Requirements

Across all three tiers of the Nasdaq Stock Market, corporate governance requirements remain largely consistent. The categories encompassing corporate governance standards include:

Distribution of Annual or Interim Reports
Independent Directors
Audit Committee
Compensation Committee
Nomination of Directors
Code of Conduct
Annual Meetings
Solicitation of Proxies
Quorum
Conflict of Interest
Shareholder Approval
Voting Rights

These governance elements play a crucial role in ensuring transparency, accountability, and ethical conduct within listed companies, irrespective of the specific tier within the Nasdaq Stock Market.

Companies seeking listing on Nasdaq must adhere to specific corporate governance standards, including the following:

Compensation Committee with Independent Directors:
- The company is required to establish a compensation committee comprised of independent directors.
- The committee must consist of at least two members.
- Rule 5605(d)(2)(A) introduces an additional independence test for compensation committee members.
Responsibility for Executive Compensation:
- The compensation committee is tasked with determining or recommending to the entire board the compensation of the chief executive officer (CEO) and all other executive officers.

These standards are designed to ensure a level of independence and scrutiny in the decision-making processes related to executive compensation within the company.

The Application And Documents

The Nasdaq application package encompasses several key components:

Symbol Reservation Form:
- Used to request the reservation of a specific trading symbol for the company.
Listing Application:
- Requires supplemental documents and details about the company's financials, operations, and other pertinent information.
Listing Agreement:
- A formal agreement outlining the terms and conditions of the listing on Nasdaq.
Corporate Governance Certification:
- A certification affirming the company's commitment to meeting Nasdaq's corporate governance standards.
Initial Application Fee:
- Payable via check or wire transfer, this fee is a prerequisite for initiating the listing process.
Logo Submission Form:
- Used for submitting the company's logo for use in Nasdaq's materials.

These application forms are completed through the Nasdaq website listing center, utilizing the online platform to facilitate the submission of supplemental and supporting documents. It is advisable to thoroughly review all required paperwork in advance, ensuring that the necessary information is readily available before initiating the application process.

Symbol Reservation Form

The symbol reservation form is a concise, one-page electronic form where applicants input information for Nasdaq's consideration. Nasdaq symbols, limited to 1-5 characters, adhere to guidelines established by the Intermarket Symbols Reservation Authority (ISRA). The ISRA system is designed to organize symbols efficiently, prevent duplication, and reduce programming and operational complexities. The ISRA operates within the framework of the NMS Symbology Plan, a plan utilized by Nasdaq.

Key details about the symbol reservation process:

Symbol Choices:
- The form allows applicants to propose three symbol choices in order of preference.
- While Nasdaq generally honors the first choice if available, it retains the authority to assign, rescind, or reassign a trading symbol at its discretion.
ISRA and Nasdaq Authority:
- The ISRA and Nasdaq have overarching authority in managing the assignment of symbols.
Additional Information:
- The form captures essential details about the issuer and the planned public offering.
- Information may include the name of the attorney, lead underwriter (if applicable), CEO and CFO names, yearly revenues, company website, and the sector in which the company operates.

Completion of this symbol reservation form initiates the process of securing a trading symbol on Nasdaq, and it's essential to provide accurate and comprehensive information to facilitate this stage of the listing application.

The Application

The Nasdaq listing application process is comprehensive and varies based on the circumstances surrounding the listing sought. There are twelve distinct listing applications catering to different situations, including changes of control, switches from other exchanges or markets, spin-offs, and initial public offerings (IPOs). Each application, spanning approximately seven pages, collects detailed information about the company, covering areas such as address, contact and billing details, securities attorney and auditor information, transfer agent particulars, and the company's officers and directors. Specific information on the company's securities, including type, par value, and cusip number, is also required.

Furthermore, the application mandates disclosure of legal proceedings involving the company, its officers or directors, or significant shareholders over the past ten years. This encompasses inquiries, investigations, lawsuits, litigation, arbitrations, and other legal and administrative proceedings. Documents supporting the backup and final disposition of these matters must be provided.

Regarding private offerings within the prior six months, including bridge financings, shelf registrations, and Regulation S offerings, the company is required to disclose such activities. Additionally, the application delves into the company's background, posing questions to ensure compliance with seasoning rules.

While Nasdaq retains the right to request relevant supporting documents, specific documents are mandatory based on the application type. For an uplisting from an existing U.S. market, the application must include letters from three market makers confirming their commitment to making a market in the subject securities. Other required documents include a listing agreement, a logo submission form, a corporate governance certification form, regulatory correspondence over the past 12 months, and shareholder confirmation documents. Nasdaq often seeks confirmation from the company's transfer agent regarding the eligibility of the security for the direct registration program (DRS).

During the review of an up listing application, Nasdaq may request additional information, such as a Broadridge share range analysis and NOBO list, a certified shareholder list, details about mitigating any going concerns or opinions, income statement and/or balance sheet projections for the next 12 months, and confirmation of Sarbanes Oxley Section 302 and 906 certifications by the company, among other inquiries related to compliance and financial matters.

The Listing Agreement

The Listing Agreement is a concise document, spanning two pages, serving as a formal affirmation of the company's commitment to adhere to all rules and regulations set forth by the Nasdaq Stock Market. It includes provisions for indemnifying and holding Nasdaq harmless from liability. Notable points in the agreement include:

Compliance Assurance:
- The company explicitly agrees to comply with all rules and regulations stipulated by the Nasdaq Stock Market.
Indemnification Clause:
- The company indemnifies Nasdaq, meaning it undertakes to compensate or reimburse Nasdaq for any losses or damages incurred. This includes harm resulting from third-party trademark infringement claims related to the company's symbol and logo, as well as Nasdaq's use of the same.
Disclaimer of Warranty and Liability:
- The agreement contains a disclaimer of warranty and liability against Nasdaq for trading issues, with the exception of those resulting from gross negligence or willful misconduct.

This agreement establishes a clear framework for the relationship between the listed company and Nasdaq, emphasizing the company's commitment to regulatory compliance while providing indemnification for certain specified matters and delineating the scope of Nasdaq's liability.

Corporate Governance Certification Form

The corporate governance certification form certifies compliance with the governance requirements related to an audit committee, director nomination process, compensation committee, board composition, executive sessions, quorum, and codes of conduct. Where an exemption applies, the form requires specification of the exemption terms. The document specifies the different rules and exceptions in a check-the-box format.

Logo Submission Form

The logo submission form contains the guidelines for the logo and affirms Nasdaq’s rights to use the same. Nasdaq uses company logos in its marketing materials, on the MarketSite Video Wall and Tower, and websites.

Fees

Entry fees are based upon the aggregate number of shares to be listed at the time of initial listing, regardless of class, with a maximum cap of $75,000. Fees are assessed on the entry date in The Nasdaq Capital Market, except for $5,000, representing a non-refundable application fee. This fee must be submitted with the company’s application.

Nasdaq does not charge application or entry fees for any securities transferred from a national securities exchange.

Benefits Of Trading On An Exchange

There are many benefits to trading on an exchange instead of the OTC Markets. The most significant benefits to a business are the ability to attract analyst coverage and institutional investors and the corresponding increase in liquidity that comes with both. Stocks that trade on Nasdaq tend to have a lower bid/offer spread — again encouraging trading volume and liquidity. Exchange-traded securities are exempt from the penny stock definition, allowing more market maker and broker-dealer participation. As further explained below, a broker-dealer cannot recommend a penny stock transaction to its retail clients. Therefore, no analysts, financial advisors, or institutional investors make recommendations for purchases of penny stocks.

As an aside, this is one of the reasons that OTC Markets created the OTCQX market tier, which does not list penny stocks. It is also why the small-cap industry is pushing for a supported valid venture exchange (for further reading.

In today’s world, depositing stock and/or trade-in non-exchange traded securities is increasingly difficult. Despite the congressional efforts and SEC rulemaking in support of small-cap capital formation (for example, the JOBS Act, including the emerging growth company regulations, new Regulation A+ and Title III Crowdfunding and the new FAST Act), through enforcement and investigative proceedings, both the SEC and FINRA continue to apply pressure on broker-dealers, clearing firms and transfer agents to reduce the secondary trading and free flow of penny stocks. For more information on difficulties in depositing stocks.

Further On Penny Stocks

NASDAQ and NYSE MKT traded securities are exempted from the definition of a “penny stock” due to the initial and ongoing listing standards. Penny stock rules focus on broker-dealers’ activity in effectuating trades in penny stocks. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the “Penny Stock Act”) prohibits broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The rules promulgated thereunder, particularly Exchange Act rules 15g-1 through 15g-100 (the “penny stock rules”).

Section 15(h) of the Exchange Act provides that no broker or dealer may effectuate a customer’s purchase or sale of any penny stock unless such broker or dealer.

Approves the customer for the specific penny stock transaction and receives a written agreement to the transaction from the customer.
Furnishes the customer a risk disclosure document describing the risks of investing in penny stocks.
Discloses to the customer the current market quotation, if any, for the penny stock, including the bid and ask prices and the number of shares that apply to such bid and ask prices.
Discloses to the customer the amount of compensation the firm and its broker will receive for the trade.

In addition, after executing the sale, a broker-dealer must send its customer monthly account statements showing the market value of each penny stock held in the customer’s account.

Moreover, brokers and dealers subject to the penny stock rules are subject to additional disclosure requirements outlined in Rules 15g-2 through 15g-9. For my information on penny stocks and the rules affecting broker-dealer activity.

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