M&A College Course Version 2.1 This document is prepared for general information purposes only. It is provided with the understanding that it is not intended to be legal or professional advice to any particular person or under any particular factual scenario. This document is not intended to be a substitute for professional services.
Chapter 1 Chapter 2 Chapter 3 Motivations & Objectives Steps in the Process Planning & Structural Issues Chapter 7 Chapter 6 Chapter 5 Chapter 4 Purchase Price Documentation Negotiations Projected Timeline Chapter 8 Chapter 9 Chapter 10 Due Diligence Disclosure Schedules Closing
Chapter 1 Motivations and Objectives
MOTIVATIONS SELLER BUYER Financial gain Desire for liquidity Business loses strategic importance Diversification of personal assets Estate planning Health reasons Additional capital requirements Technological changes Defensive measures such as reducing net acquisition costs Lender pressure Requirement for greater management resources Buy versus build strategy Accelerate growth Market share Diversification Geographic expansion Enhance shareholder value Generate attractive returns on investments Acquire undervalued assets Keep up with competition Increase profit through economies of scale/synergies (leverage build-up) Chapter 1: Motivations & Objectives
OBJECTIVES SELLER BUYER Maximize value Minimize execution risk Minimize business disruption Maintain confidentiality Seek acceptable buyer culture Expedite sale process Manage and control process Pay fair price Deal provides fit with overall strategy Maintain financial flexibility Seek acceptable seller culture Control/influence transaction timetable Chapter 1: Motivations & Objectives
Chapter 2 Steps in the Process
INTERMEDIATE STEPS Make decision whether to attempt to sell or purchase Develop strategic rationale for buying or selling Establish confidentiality in the process: assign code name, develop other confidentiality procedures as appropriate Assemble team: special counsel, investment banker, outside auditors, consultants (e.g., environmental reports) Commence corporate cleanup: accounting, legal, and strategic Develop plan for due diligence documentation and prices Formulate deal strategy addressing issues: exclusivity, deal structure, liability issues, valuation, tax ramifications, agreement on negotiating strategy Develop meaningful financial projections Chapter 2: Steps in the Process
INTERMEDIATE STEPS Conduct due diligence Prepare first draft of Purchase Agreement Negotiate Purchase Agreement Prepare disclosure schedules Review disclosure schedules Obtain necessary corporate and regulatory approvals Chapter 2: Steps in the Process
FINAL STEPS Execute Purchase Agreement Obtain required consents and approvals Communicate with employees, customers, and vendors Closing Chapter 2: Steps in the Process
Chapter 3 Planning and Structural Issues
PLANNING ISSUES Obtain a valuation. Most business owners do not know what price their business could sell for in a market transaction. To find out, a business owner should obtain the advice of a consulting firm specializing in business valuations. Have a professional sales package prepared. Selling your business may require a marketing piece or "sales memorandum." A professionally prepared, thoughtful, complete and informative sales memorandum (whether done inside the company or by a paid consultant) will yield the following benefits: It will likely attract a larger potential Buyer pool than would be the case without such a piece. It will shorten the due diligence time required by the Buyer. It will demonstrate to the prospective Buyers that the business is well run and professional. It will discourage "bottom feeding" because it clearly demonstrates that the Seller and its team know what they are doing. Retain experienced professionals early in the process. You will want to develop a relationship with the professionals likely to be engaged in your transaction early on in your quest. These professionals can assist with many of the timing and clean-up aspects of the transaction. Having your team assembled early will also ensure that the deal transitions smoothly from one stage to the next and, ultimately, that you are fully apprised of your options throughout the process. Chapter 3: Planning Issues
STRUCTURAL ISSUES Stock Purchase. In a stock purchase, the acquiring entity contracts with the individual stockholders of the target company for the purchase of the target's securities. If the Buyer wants complete ownership, rather than just ownership of a controlling block of the target's securities, the Buyer may, depending upon applicable state law, need to get all of the target's stockholders to agree to participate in the transaction. P $ Stock A T Chapter 3: Planning Issues
STRUCTURAL ISSUES Asset Purchase. In an asset purchase, the Buyer acquires the target's assets only, and does not purchase any ownership in or accept any liability for the target. Buyers often favor an asset purchase because of, among other reasons, it has the ability to "cherry-pick" the assets it wants while avoiding those it does not want or cannot use and to assume only the liabilities which are expressly contracted for in the acquisition agreement. This transaction allows the Buyer to avoid the risk of assuming unknown or undisclosed liabilities. Statutory Merger. The Buyer could effect a merger of the target into the Buyer's company or into an active or newly-formed subsidiary of the Buyer. In a merger the "target" merges its existence into the "surviving" corporation, and from that point on the surviving company holds all of the assets and assumes all of the liabilities of both constituent corporations. The equity interests of the target are converted into a right to receive whatever consideration is being provided for by the agreement and plan of merger (typically, cash, securities of the surviving corporation or its parent, or a combination of the two). Chapter 3: Planning Issues
OTHER ISSUES TO CONSIDER Liability Issues. The Buyer in an asset transaction will only assume those liabilities specifically identified, while leaving behind all others, including unknown or unmatured liabilities. In a stock sale or merger transaction, on the other hand, the Buyer assumes all liabilities. Contract Issues. Business transfers invariably require that the Buyer succeed to some or all of the target company's contract rights. In the case of the stock sale, there is simply a new owner of the stock. In the case of the merger transaction, the contact rights are assumed by the surviving corporation as a matter of law. In both stock and merger transactions it is important to review the material agreements to determine whether a transaction of that nature will require a consent of the other contracting party. Tax Issues. The tax consequences of a sales transaction are impacted by a number of factors, including the transaction structure ultimately implemented. The tax consequences also are influenced by the status of the corporation as a C corporation or a S corporation. It is important in negotiations for both the Buyer and Seller to understand the other party's tax motivations. The tax issues are complicated and extremely fact specific. As a result, a prospective Seller should consult with its tax advisors early to devise a strategy that will minimize the effect of taxes on the transaction. Chapter 3: Planning Issues
Chapter 4 Projected Timeline
PROJECTED TIMELINE Week 1 Discussions between parties Begin to develop transaction terms with each of the prospective purchasers Week 2 Seller and its team select the appropriate Buyer to pursue Buyer's counsel prepares first draft of the Letter of Intent, or LOI Buyer attempts to obtain exclusivity Buyer tenders LOI to Seller and Seller's team for review Week 3 Parties negotiate LOI Due diligence continues Drafts of LOI exchanged, as necessary Execute LOI Buyer commences, in earnest, search for financing Chapter 4: Timeline
PROJECTED TIMELINE Week 4 Week 5 Week 6 Week 7 Buyer's counsel prepares first draft of definitive documentation Tender definitive documentation Seller's counsel provides first written response to proposed definitive documentation Preparation of Disclosure Schedules begins Buyer's counsel prepares second draft of definitive documentation Seller's counsel reviews second draft and determines whether all hands meeting is necessary Negotiations continue Begin acquisition of necessary consents, waivers, authorizations, etc. Redraft of second proposed definitive documentation provided by Seller's counsel Preparation of Disclosure Schedule continues; move toward finalization of same Drafts of ancillary closing documents exchanged Chapter 4: Timeline
PROJECTED TIMELINE Week 8 Week 9 Week 10 Week 11 Finalize all documents Obtain signatures on necessary preclosing authorizations Execute definitive Purchase Agreement Obtain necessary consents and approvals Prepare for closing, including closing checklists Finalize financing Finalize Disclosure Schedules Pre-closing Closing Chapter 4: Timeline
Chapter 5 Negotiations
NEGOTIATION STRATEGIES Understand the reason behind the issue. The truth is, every issue has the potential of having a real world economic impact on you as a Seller. Understand exactly the reasons behind every issue so that your discussions with the Buyer are sincere and you are in a position to assess accurately the risks you are assuming. Hold off conceding the big points until all of the issues are on the table. By conceding a point early, you lose the ability to pull that concession back later -- at a time, potentially, when you need to give up on something else to make the deal work. Hang on to those issues you could potentially concede to use them as chips later. Be professional. The sale process can, at times, be adversarial. Nevertheless, do not compromise your professionalism. Do not make threats, issue ultimatums, or otherwise act inappropriately. If you cannot concede a point - say so. As a corollary to this point, do not indicate that a point is a deal-breaker if it is not. You must maintain your credibility throughout the entire process in order to strike the best deal. Chapter 5:Negotiations
NEGOTIATION STRATEGIES Use your professionals. Your lawyers and intermediaries should take the lead on all negotiations. In this manner, you can stay out of the fray on particularly problematic issues. In addition, to the extent the issue at hand is one you are willing to concede to, you can step in to "override" your spokesperson. Find a "win-win" where available. Not all issues can be resolved as a win-win. Nevertheless, many, if not most, issues can be resolved between reasonable business people. Experienced counsel and M&A intermediaries should be called upon in these circumstances to figure out a way to make it work. Chapter 5:Negotiations
Chapter 6 Documentation
M&A DOCUMENTS Non-Disclosure Agreement or "NDA." This is generally the first agreement signed by the parties to a tentative transaction. In it, the parties will agree to keep information obtained from the other during the transaction confidential. Occasionally, a Buyer will attempt to slip in an exclusivity or "no-shop" provision into the NDA. These types of provisions should be hotly resisted at this point in the process. To the extent the Seller is willing to negotiate with only one prospective Buyer, it should do so only after having negotiated all of the major points of the transaction. Until you have received an offer that you are completely comfortable with, never give up your right to continue shopping the deal. Letter of intent or "LOI." This is a document usually signed by the parties early on (although, in certain transactions, it may not be used at all) that, in essence, demonstrates that each side is serious about the transaction. Although the substantive deal points are usually non-binding, these documents are useful in causing the parties to focus on "deal-breakers" early, prior to expending significant amounts of money on a transaction that may not close. Chapter 6: Documentation
M&A DOCUMENTS The Purchase Agreement. This is the principal document between the parties and will generally take the form of a Stock Purchase Agreement, Asset Purchase Agreement or Merger Agreement. In it, the parties lay out the rights and obligations of each of them concerning all matters relevant to the sale including (1) what consideration will be paid for the business, (2) what representations the Seller must make about the business, (3) what recourse the Buyer has if the representations turn out to be inaccurate, (4) how and whether the transaction can be terminated prior to closing, and (5) each of the other issues critical to a business transfer. Disclosure Schedule. The Disclosure Schedule is the document prepared by Seller and its counsel that details all of the exceptions and qualifications to the representations requested of it (meaning those matters that are inconsistent with the representations requested). In addition, the Disclosure Schedule will detail all other matters required to be disclosed by the definitive Purchase Agreement. The Disclosure Schedule has no meaning without the Purchase Agreement and therefore must be prepared at the same time as, and negotiated concurrently with, the Purchase Agreement. Chapter 6: Documentation
M&A DOCUMENTS Covenant Not to Compete. This document is quite commonly requested by the Buyer and functions to preclude the Seller from competing with the acquired business post-closing. Agreements of this nature are necessary to ensure that the Buyer receives the full value of the business acquired. It is critical to recognize that there are differences between a noncompetition agreement made in conjunction with a definitive Purchase Agreement and a post-employment restrictive covenant. Among other things, a noncompetition agreement made in conjunction with an acquisition is generally regarded as more likely to be enforced. Employment Agreement. The Buyer commonly requests that upper management from the target company remain on-board after the sale to ensure a smooth transition. In fact, to the extent a Seller is completely unwilling to continue with the business post-sale, some Buyers may pull out of an acquisition altogether. At a minimum, if you are unwilling to remain with the business after the sale, you should expect a decrease in the purchase price unless it is 100% self-sufficient. Chapter 6: Documentation
M&A DOCUMENTS Legal Opinions. A legal opinion is a letter delivered by your counsel to the other side of the transaction providing certain assurances about the Company, the business to be acquired or some action related to the transaction. Legal opinions are not used in every transaction, but when they are, they can present issues for you and your counsel. Escrow Agreement. In many transactions, the Buyer will request a fund from which it can satisfy claims against the Seller post-closing. This is particularly true if there is more than one Seller. One method for accomplishing this is to retain a portion of the purchase price in an escrow account with an independent third party, such as a bank or commercial trust group, following the closing. In this manner, the Buyer can seek recovery that is independent from the solvency of the Seller or the Buyer's ability to locate them for purposes of commencing litigation or enforcing a judgment that may be obtained. Chapter 6: Documentation
M&A DOCUMENTS Indemnification Provisions. The indemnification provisions are the principal mechanism in the Purchase Agreement for monetary risk shifting. It generally provides that if, after the closing, the Buyer suffers damage as a result of (a) a misrepresentation by the Seller, (b) a breach of agreement by the Seller, or (c) otherwise as contemplated in the indemnification provision, the Seller will compensate the Buyer for its loss and thus "make the Buyer whole." Representations and Warranties. The representations and warranties are of critical importance to both the Buyer and the Seller. In essence, they are all of the "guarantees" that the Buyer wants the Seller to make about the business. Seller's representations have three overlapping purposes: (1) Disclosure. They serve as a device to ensure that the Seller is properly disclosing all relevant matters affecting the business to the Buyer before the definitive document is signed; (2) Walk-Away. They serve as a basis on which the Buyer may terminate the transaction and walk away from closing without liability. It is generally argued that if the business is not delivered at closing in the same condition it was promised to the Buyer, it should be permitted to walk away with impunity; (3) Indemnification. They serve as a basis for the Buyer's right to recover after closing should one or more of the representations turn out not to be true. Phrased differently, the representations function as the key mechanism to allocate economic risks between Buyers and Sellers. Chapter 6: Documentation
OTHER ISSUES TO CONSIDER Baskets. The Seller should always attempt to negotiate for a "basket" of losses that must be sustained before the indemnified party can collect. The theory behind such a request is that technical or immaterial breaches should not affect the economics of the transaction. Ceilings/Caps. A ceiling or cap represents the Seller's maximum liability to the Buyer in the transaction. Survival. Representations and indemnification rights should survive long enough for the Buyer to discover problems. One to two years is "typical." Some representations are routinely held open for the applicable statute of limitations period. Certain "fundamental" representations are routinely held open perpetually. Chapter 6: Documentation
Chapter 7 Purchase Price
METHODS OF PAYMENT Payment can be in the form of cash, the buyer's equity securities, assumption of debt, or promissory notes, or a mixture of forms. Each method offers advantages and disadvantages. Paying in cash sounds appealingly simple but makes the seller's gain immediately taxable. Using equity requires that the parties agree on whether to value the stock on a specified date or take the average value over a specified period, often with a maximum and minimum. In addition, if the buyer does not register the shares under the 1933 Act (usually on Form S-4), the seller cannot resell them without a private-placement exemption or the buyer's obligation to register them, whether on demand or on a piggyback basis. To minimize an all-stock deal's tax consequences, use a reverse triangular merger: the buyer merges a newly-formed subsidiary into the target. If the parties decide to use promissory notes, the seller can defer some tax liability by reporting gain on the installment method while the buyer gets a source against which to offset indemnification claims (instead of or in addition to escrowing some of the purchase price). Chapter 7: Purchase Price
ISSUES IN SELLER FINANCING Is the Buyer creditworthy? What is the shortest payout period the business or the Buyer can afford? How should the Note be collateralized? Can you obtain additional collateral (possibly in the form of personal guarantees, additional asset pledges, etc.) beyond the value of the company's assets to ensure against the Buyer running the enterprise into the ground? Chapter 7: Purchase Price
VALUATION A purchase-price adjustment in the acquisition agreement reflects the potential for change in the target's value during the oft-lengthy gap between signing and closing. Measures of value are net working capital, net asset value, and net worth. The agreement must specify which party will prepare the closing-date financial statements and set the deadline for the other party to object. Earnout provisions are typically used when the parties cannot agree on a privately-held target's value. The provision requires the buyer to pay the seller a percentage of the amount, if any, by which some benchmark exceeds a threshold during each of several postclosing years. Standard financial benchmarks are net revenue; net income; cash flow; earnings before interest and taxes; earnings before interest, taxes, depreciation, and amortization; per-share earnings; and net equity. Chapter 7: Purchase Price
Chapter 8 Goals of Due Diligence
GOALS OF DUE DILIGENCE To analyze the strengths and weaknesses of the target business To possibly renegotiate the purchase price or cancel the agreement if the information found is unacceptable to the potential buyer To ferret out any information that can be a risk or liability to the potential buyer and minimize post-closing surprises Chapter 8: Due Diligence
REVIEW & INVESTIGATION Face-to-face visits Facility walk-thru and inspection visits Data room- physical room or a virtual data room on the Internet Continuing to meet/exceed financial projections is critical to ongoing valuation dialogue at this stage Limit surprises Establish and keep momentum Source of documents and information to be the substance of disclosure schedules Chapter 8: Due Diligence
ORGANIZATION & GOOD STANDING The Following is a checklist of information and documents which are typically gathered and reviewed during the due diligence period: Company s Articles of Incorporation, and all amendments thereto Company s Bylaws, and all amendments thereto Company s minute book, including all minutes and resolutions of shareholders and directors, executive committees, and other governing groups Company s organizational chart Company s list of shareholders and number of shares held by each Copies of agreements relating to options, voting trusts, warrants, puts, calls, subscriptions, and convertible securities Chapter 8: Due Diligence
FINANCIAL INFORMATION Audited financial statements for three years, together with Auditor s Reports The most recent unaudited statements, with comparable statements to the prior year Auditor s letters and replies for the past five years The Company s credit report, if available Any projections, capital budgets, and strategic plans Analyst reports, if available A schedule of all indebtedness and contingent liabilities Chapter 8: Due Diligence
FINANCIAL INFORMATION A schedule of inventory A description of the Company s internal control procedures A schedule of accounts receivable A schedule of accounts payable A description of depreciation and amortization methods and changes in accounting methods over the past five years Any analysis of fixed and variable expenses Any analysis of gross margins The Company s general ledger Chapter 8: Due Diligence
PROPERTY Physical Assets Real Estate A schedule of fixed assets and the location thereof All UCC filings All leases of equipment A schedule of sales and purchases of major capital equipment during the last three years A schedule of the Company s business locations Copies of all real estate leases, deeds, mortgages, title policies, surveys, zoning approvals, variances or use permits Chapter 8: Due Diligence
INTELLECTUAL PROPERTY Schedule of domestic and foreign patents and patent applications Schedule of trademark and trade names Schedule of copyrights Description of technical know-how Description of methods used to protect trade secrets and know-how Work for hire agreements Schedule and copies of all consulting agreements, agreements regarding inventions, and licenses or assignments of intellectual property to or from the Company Patent clearance documents Schedule and summary of claims or threatened claims by or against the Company regarding intellectual property Chapter 8: Due Diligence
EMPLOYEES & EMPLOYEE BENEFITS A list of employees including positions, current salaries, salaries and bonuses paid during the last three years, All employment, consulting, nondisclosure, non-solicitation, or noncompetition Resumes of key employees The Company s personnel handbook and a schedule of all employee benefits and holiday, vacation and sick leave policies Copies of collective bargaining agreements (if any) A description of all employee problems within the last three years, including alleged wrongful termination, harassment, and discrimination A description of any labor disputes, requests for arbitration, or grievance procedures currently pending or settled within the past three years Chapter 8: Due Diligence
EMPLOYEES & EMPLOYEE BENEFITS A list and description of benefits of all employee health and welfare insurance policies or self-funded arrangements A description of worker s compensation claim history A description of unemployment insurance claims history Copies of all stock option and stock purchase plans and a schedule of grants thereunder Chapter 8: Due Diligence
LICENSES & PERMITS Copies of an governmental licenses, permits or consent Any correspondence or documents relating to any proceedings of any regulatory agency Chapter 8: Due Diligence
ENVIRONMENTAL ISSUES Environmental audits, if any, for each property owned or leased by the Company A listing of hazardous substances used in the Company s operations A description of the Company s disposal methods A list of environment permits and licensees A list identifying and describing any environmental litigation or investigations A list identifying and describing any known superfund exposure A list identifying and describing any contingent environmental liabilities or continuing indemnification obligations Copies of all correspondence, notices, and files related to the EPA, state, or local regulatory agencies Chapter 8: Due Diligence
TAXES Federal, state, local, and foreign income tax returns for the last three years States sales tax returns for the last three years Any audit and revenue agency reports Any tax settlement documents for the last three years Employment tax filings for three years Excise tax filings for three years Any tax liens Chapter 8: Due Diligence
MATERIAL CONTRACTS A schedule of all subsidiary, partnership, or joint venture relationships and obligations, with copies of all related agreements Copies of all contracts between the Company and any officers, directors, 5% shareholders, or affiliates All loan agreements, bank financing arrangements, lines of credit, or promissory notes to which the Company is a party All security agreements, mortgages, indentures, collateral pledges and similar agreements All guaranties to which the Company is a party Chapter 8: Due Diligence
MATERIAL CONTRACTS Any installment sale agreements Any distribution agreements, sales representative agreements, marketing agreements, and supply agreements Any letters of intent, contracts, and closing transcripts from any mergers, acquisitions Any options and stock purchase agreements involving interests in other companies The Company s standard quote, purchase order, invoice, and warranty forms All nondisclosure or noncompetition agreements to which the Company is a party Chapter 8: Due Diligence
PRODUCT OR SERVICE LINES A list of all existing products or services and product services under development Copies of all correspondence and reports related to any regulatory approvals or disapprovals of any Company products of services A summary of all complaints or warranty claims A summary of results of all tests, evaluations, studies, surveys, and other data regarding existing products or under development Chapter 8: Due Diligence
CUSTOMER INFORMATION Schedule of the Company s twelve largest customers in terms of sales thereto and a description of sales thereto over a period of two years Supply of service agreement Description or copy of the company s purchasing policies Description or copy of the Company s credit policy List and explanation for any major customers lost over the last two years All surveys and market reports relevant to the Company or its products or services Company s current advertising programs, marketing plans and budgets and printed marketing materials Description of the Company s major competitors Chapter 8: Due Diligence
INSURANCE COVERAGE A schedule and copies of the Company s general liability personal and real property, product liability, errors and omissions, key-man, directors and officers, workers compensation, and other insurance A schedule of the Company s insurance claims for past three years Chapter 8: Due Diligence
Chapter 9 Disclosure Schedules
LITIGATION A schedule of all pending litigation A description of any threatened litigation Copies if insurance policies possibly providing coverage as to pending or threatened litigation Documents relating to any injunctions, consent decrees or settlements to which the Company is a party A list of unsatisfied judgments Chapter 9: Disclosure Schedules
DISCLOSURE SCHEDULE What is a Disclosure Schedule? The Disclosure Schedule is the document prepared by the Seller and its counsel that details all of the exceptions and qualifications to the representations requested of it (meaning those matters that are inconsistent with the representations requested). In addition, the Disclosure Schedule will detail all other matters required to be disclosed by the definitive Purchase Agreement. The Disclosure Schedule has no meaning without the Purchase Agreement and therefore must be prepared at the same time as, and negotiated concurrently with, the Purchase Agreement Chapter 9: Disclosure Schedules
POSSIBLE CONTENTS Capitalization and stockholders Affiliate agreements and arrangements Indebtedness and obligations Governmental regulation Financial data Management and Employees Litigation Property Insurance policies Material agreement Chapter 9: Disclosure Schedules
Chapter 10 Closing
CLOSING ISSUES List of documents to be executed List of persons to sign documents Closing date, time, and place Exchange of documents Exchange of consideration Chapter 10: Closing
DOCUMENTS EXCHANGED Certificates Agreements Legal opinions Guarantees Qualifications to do business Written consents Lien searches Earn-out plans Assumed name withdrawals Departure agreements Loan payoffs Cancellation of notes Letters of credit Security agreement Chapter 10: Closing