Sales Personnel Contracts, Sword or Shield for M&A Valuation

Determining a company’s acquisition/merger value requires an intensive due diligence process. Attorney Gregg Metzger discusses salesforce contracts which, especially for life science companies, cannot be overlooked.

A company’s acquisition/merger value is directly proportional to its expected net revenue streams, which ultimately, depend upon its sales. Of course, how companies go about procuring sales and achieving market share growth varies from industry to industry. In certain trades, territorial sales productivity and market share depend upon the skillset, diligence and/or customer account relationships of territorialized sales personnel. In some of those industries-such as the life sciences for example-sales and market share are so sales personnel intensive that the recruitment and hiring of competing sales personnel within territories is a common practice.

Companies within sales personnel intensive industries thus tend to be vigilant about binding existing and new members of their salesforce to contracts that feature protective covenants, such as: (1) Post-Termination restrictive covenants, particularly non-compete and non-solicitation covenants, (2) Nondisclosure covenants, and (3) “Term-of-Years” covenants. Salesperson contracts that incorporate some or all of these protective covenants are indispensable to maximizing the stability and predictability of the revenue streams. For this reason, when assessing the acquisition/merger value of a life science company, the prospective acquirer, merger partner, investor or lender should engage legal counsel to survey the targets salesperson contracts and meticulously evaluate them under the hypothetical assumption that the prospective transaction occurs.

Choice-of-Law

The first threshold determinations to be made at the outset of any contract evaluation are what substantive law will (or most likely will) govern the contract’s enforceability and enforcement. Generally, enforcement of contracts, including salesperson contracts, is a matter of state law.

Salesperson contracts typically contain a choice-of-law provision, which dictates which state’s law governs. If a contract does not expressly state what law governs, the choice-of-law rules of the forum where enforcement is sought usually determine governing law. Hence, in the absence of a contractual choice-of-law provision in a company’s salesperson contracts, there is increased risk that the law of more than one state can apply, reducing predictability.    

Forum Selection

The second threshold determination to be made at the outset of any contract evaluation is in what forum (or fora) an action relating to the contract will be (or most likely will be) litigated and adjudicated.

Contracts typically contain a forum selection provision, which dictates the forum in which disputes relating to the contract may be litigated. The contractually selected forum could profoundly impact the contract’s protective utility-both legally and practically. Further, the accessibility of the courts in the selected forum also impacts, as a practical matter, the contract’s protective utility because it affects how difficult it will be for the company to seek and obtain judicial relief. For example, procedural and administrative facilitators or barriers to securing a temporary restraining order or preliminary injunction in connection with enforcement of a restrictive covenant can significantly vary from state to state.

Another type of forum selection provision sometimes found in agreements dictates that disputes will be resolved in arbitration, as opposed to court and can further dictate the locus of the arbitration proceeding. The variety of potential arbitration provisions is subject for another article. For purposes of this article, an evaluator of contracts containing an arbitration provision should determine whether or not arbitration will be preferred for the successor entity, bearing in mind that arbitration provisions not only are enforceable by the salesperson, but potentially also by non-parties, such as a new employer, who might prefer to arbitrate an agreement-related dispute against the company. Further, an evaluator of salesperson contracts should be mindful that arbitration is not suited for enforcement of restrictive covenants, which typically require court-issued injunctive relief to provide the intended protective benefit.  

Transferability and Non-transferability

It is also critical to determine whether a company’s contracts are legally transferable to the successor entity, which never should be presumed. Salesperson contracts are of a personal nature. Hence, depending upon the governing law, such contracts are not necessarily assignable without the salesperson’s express consent. This limitation on assignability can result in a successor entity without enforceable rights and protections under the contracts that were in effect, and contributed to the company’s value, pre-transaction.

In assessing transferability, an evaluator should apply an additional layer of scrutiny to contracts that are independent distributorship agreements. While directly employed sales representatives are almost always bound only to one company at a time, independently-contracted sales representatives could have simultaneous distributorship relationships with multiple unaffiliated non-conflicting companies. The prospective merger or acquisition transaction could spawn a new entity that conflicts with another company with which an independently-contracted sales representative has an independent distributorship agreement. Such resultant conflict can invalidate the post-transactional transfer of some or all of the successor entity’s contracts involving independently-contracted representatives.

Protective Adequacy

A. Post-Termination Restrictive Covenants

Non-Compete and Non-Solicitation Covenants: To be meaningful, a company’s post-termination restrictive covenants, particularly non-compete and non-solicitation provisions, should be crafted with the realities of the industry in mind. The scope and duration of a company’s post-termination restrictive covenants must be adequate, as a practical matter, to protect the company’s legitimate business interests, especially goodwill in a sales personnel intensive industry. Thus, companies sometimes deem it necessary to have their post-termination restrictive covenants prohibit their sales representatives, for some period of time after termination (one year, for example), not only from selling competing products within their former sales territory, but also from promoting any products, including even non-competing products, on behalf of any new company that competes in any way with the subject company. Whether or not such a post-termination restriction of that scope is enforceable remains a question.

It is particularly salient for a contract evaluator to understand that restrictive covenants were likely devised over time to suit the company given the realities of the industry, and thus such scope and duration should be meticulously noted to avoid potentially detrimental post-transactional contractual changes.          

Non-Disclosure Covenants: An evaluator should look for covenants within a company’s salesperson contracts that will adequately protect the successor entity from misappropriation of trade secrets or of other potentially useful confidential business information. 

B. Term-of Years Covenants

Term-of-years (“TOY”) covenants are sometimes used in sales personnel intensive industries. TOY covenants are generally too broad in effect to be enforceable via injunction. They are nonetheless enforceable in an action for damages in the event of breach. Such an action may be brought against a company that prematurely terminates, against a sales representative who prematurely resigns and/or against a non-party who induces such a premature resignation, such as a new employer. Such liability exposure tends to deter early departures by sales representatives, thus supplementing the protective effect of post-termination restrictive covenants (which are enforceable via injunction). 

Although TOYs are double-edged swords for a company (as the company is mutually bound), TOYs can help stabilize a company’s salesforce and thus the predictability of its sales revenue streams and market share. At a given point in time, a higher average amount of time remaining under a company’s TOYs tends to make a projection of its sales revenue streams and market share more reliable. Hence, the average amount of time remaining under a company’s TOYs should be part of an evaluator’s assessment.  

Conclusion

In a sales personnel intensive industry, a legal survey and evaluation of a company’s salesperson contracts is a potentially crucial part of the process by which a prospective acquirer, merger partner, investor or lender assesses the company’s acquisition/merger value. Such an evaluation should help with decision-making, and might even become a factor in negotiations, whether used as a sword or a shield.    

Gregg Metzger is Partner at Feldman Gale.