Mergers & Acquisitions

Observations from our Founder and

Managing Director

Is an Acquisition via Merger an Optimum Growth

Strategy?

A company is ready to grow and has determined, after months

of evaluation and internal discussion, that growth by

acquisition is more cost-efficient than organic growth. Is this

really an optimum strategy to scale the firm and build

enterprise value? It very well may be, but it is not without its

challenges. The buyer, or “acquirer,” creates the strategy. The

seller, or “target,” assuming an interest to be acquired on the

“right” terms, has to fully cooperate in the process.

An external M&A advisor for the C-suite team is a value-add

that pays dividends in creating or evaluating the strategy,

reviewing and conducting initial due diligence of the target,

designing the acquisition terms and capital to be utilized (cash,

debt, securities), negotiating the deal points for the conditional

letter of intent, and completing the due diligence of the target

candidate. Once all parties are satisfied, closing the transaction

is the final stage.

Typically, an Advisor Uses a Focused Process of Q&A to

Define and Guide the Strategy:

1. What are the steps to viable growth by acquisition?

2. Who must approve the proposed structure change to

accommodate the acquisition plans?

3. Can the acquirer utilize balance sheet assets or free cash

flow to accommodate the proposed terms of an

acquisition?

4. What does the deal structure for the acquisition look

like?

5. When, in terms of the proposed acquisition, does the

deal become toxic and require termination before

completion?

6. Can the same proposed structure be utilized in multiple

transactions?

7. Can the company access Lines of Commercial Credit

for capital?

8. Does the company intend to issue equity to the sellers?

If so, what equity, with what terms and conditions?

9. How do you determine the value of the “target” to be

acquired?

10. What steps of due diligence are necessary?

11. When is a binding letter of intent created for joint

execution?

12. What is the combination of good will and assets to be

acquired that makes sense for both the seller and the

buyer? Sometimes, depending on the mix, it is possible

for the principals of the target to receive less

consideration but have a larger net after-tax final

settlement.

13. Can and should the transaction be a tax-neutral

acquisition under Section 368 of the IRC?

14. If it is to be a 368(a) acquisition, is the target merged

into a new subsidiary or the parent company?

15. To qualify as a tax-free merger, what is the limit on the

“cash boot” to be distributed to the sellers?

16. How, when, and under what terms do the sellers receive

their enterprise value?

17. Does the acquired branding remain in place after the

acquisition?

18. Are key employees of the seller retained, under what

terms, and for what length of time?

19. Does the buyer acquire the company itself or only its

assets?

20. If the buyer is purchasing both the brand and the assets,

are they combined in the same transaction, or separated

to address potential liability?

21. What reserves must be posted that cannot be released

until after the transaction has “seasoned”? What are the

terms for “seasoning”?

22. Are “clawbacks” built into the acquisition structure for

potential future events?

23. Who receives the accounts receivable (A/R) of the

seller?

24. Are minority passive equity holders in the seller treated

differently than key employees?

25. Is there likely to be any transaction friction from

minority shareholders? How is it mitigated or

neutralized?

These are the preliminary questions that must be addressed by

the acquirer’s team to establish a reality check, before

approaching a target company.

Preparing for an Acquisition Strategy

What must the acquirer prepare in order to proceed with the

acquisition strategy?

1. Documentation Must be Accurate and Current:

Structuring an acquisition requires the buyer to have

current, accurate financial statements of the current

business operations, along with projections for the

P&L, and balance sheet, as well as the cap table before

and after the acquisition. This allows the acquirer to

determine the necessary steps to mitigate downside risk,

and identify potential operating efficiencies that may be

achieved by the post-acquisition entity. Any candidate

that is receiving a promise to be paid in equity of the

acquirer or in installment payments will require a

transparent analysis of the acquirer’s capacity to honor

future commitments.

2. A Non-Binding Letter of Intent Created by an

Experienced M&A Attorney is Required: Both

parties must agree to terms and conditions for a

non-binding Letter of Intent that defines the intentions

of both parties, outlines the proposed terms and

conditions of the acquisition or sale, and specifies the

“binding” covenants that survive the due diligence

period even if the transaction is not completed (such as

confidentiality covenants, NDAs, and

non-circumvention agreements, etc). It must also define

what both parties are required to provide during the due

diligence period, the time periods for each stage of the

due diligence, any breaches and time to cure, potential

regulatory approvals by third parties, and what

penalties, if any, are to be imposed for a non-completed

transaction. Our experience tells us if the terms of a

non-binding Letter of Intent cannot be properly sorted,

no actual acquisition is going to happen.

3. Due Diligence is Not Optional: The seller is typically

subject to a rigorous due diligence review, which

requires every “closet door" to be opened to determine

actual operating margins, current and prospective

customer lists, and to discover and address any

potential risks associated with the seller’s business

operations for potential future liability claims. A

company that puts itself “in play” to be acquired can

and should expect a very thorough vetting process

designed to surface any and all issues or potential issues

impacting the proposed acquisition.

This includes thorough background checks on all

employees in the firm to be acquired, confirmation of

all A/R, written confirmations of contracts and terms in

motion, an audit-level review of the last three years of

operations, tax compliance verification, as well as

confirmation of banking relationships and credit lines.

The primary purpose is to uncover any potential “land

mines” that could create risks the acquirer will be

forced to mitigate, and to perform a reality check on the

forward- looking representations of the target.

4. What is the Proposed Deal Structure? Will the buyer

issue securities, equity and/or debt securities in the

proposed transaction? Will the buyer pay cash and on

what terms? Who obtains the current receivables of the

target? Is there to be an escrowed reserve of a

percentage of the purchase price to accommodate any

uncertainty? Will current employees of the target be

retained and for what period of time, under what terms?

How and why would any condition of the acquisition be

unwound? What damages, if any, in a multi- step

transaction, are to be awarded if either party fails to

perform as agreed? Will state and federal securities

laws and regulations impact the transaction? Are there

any regulatory agencies that require review or approval

of the transaction, pre- or post-closing? Are the

contracts in the portfolio of the target actually

assignable to a new entity, or, if the current target is to

be kept intact as a wholly owned subsidiary, are any of

the contracts subject to cancellation due to a “change in

control”?

Closing

In summary, acquisitions of assets or entire companies occur

with frequency in both up and down economies. Preparing the

buyer to negotiate the prospective acquisition, conduct

comprehensive due diligence on the target, properly define the

desired outcome, complete the acquisition, and cross all

regulatory “t’s” and dot the transaction “i’s” before, during, and

following the acquisition is a financial, legal, and tax discipline

best mid-wived by experienced legal and tax professionals.

We are frequently asked why we only accept retainers to

represent and counsel the acquirer and typically do not

represent sellers. It is simply a personal preference, borne out

of forty years of M&A experience.

A buyer intent on expanding acquisitions to grow the business

footprint via acquisitions typically is prepared to engage in

serious preparation for potential transactions, including

securing the funding necessary for the preparation. As a result,

the likelihood of completed acquisitions is high.

A seller of a business seldom demonstrates the same level of

certainty of making the proposed future transaction work, and

the process of due diligence to prepare a business to be

acquired is more challenging, largely due to the uncertain

nature of finding an acquirer willing to meet the perceived

value of the business enterprise on terms acceptable to the

current owners.

It has been our experience that sellers of a business enterprise,

particularly original founders, frequently hold unrealistic

expectations regarding the value of their own business

enterprise relative to what an acquirer may be willing to pay.

When reality sets in, during good faith- negotiations, the

potential sellers may elect to maintain ownership of the

enterprise, wasting time and capital for all parties involved.

It is only a preference, but a strongly held preference.

— From the Office of the Managing Director