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INITIATING THE M&A DEAL. PREPARING FOR THE DEAL, FINDING A BUYER, CONDUCTING DUE DILIGENCE & FINANCING THE DEAL By James L. Rench, Esq. CURRENT MARKET CONDITIONS. • Challenges of last recession have caused many to take very strategic look at their industry

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initiating the m a deal






James L. Rench, Esq.

current market conditions

• Challenges of last recession have caused many to take very strategic look at their industry

o What are growth prospects of industry?

o What will it take to become or remain competitive in industry?

o How will profits be affected by changing landscape?

• Many are making decision of whether they should be, or could be, a consolidator

• Others are assessing strategic alternatives

• Deal activity will continue to be fueled by

o Ongoing access to capital & financing

o Strengthened balance sheets of strategic buyers

o Increasing private equity activity

• S&P 500 companies have $2 trillion in cash on balance sheets & are increasing acquisition activity

• Private equity firms have $348 billion in capital to invest

• Relatively healthy debt markets with lenders active & competitive in M&A lending

current market conditions cont d

• Current M&A market presents both

opportunities & challenges

o Companies that maintained or improved earnings over last 24 to 36 months can be highly valued in today’s M&A environment

o Strong competition for quality assets as both businesses & private equity continue to seek deals to fuel growth & deploy capital

o General worldwide macro events & general trends in U.S. economy, reflected in volatility of U.S. debt & equity markets, have a direct impact on M&A market activity

o Assuming a relatively stable economy, 2013 & 2014 anticipated to be an active M&A market with attractive valuation multiples

will 2013 see record valuations for middle market business sales
Will 2013 See Record Valuations for Middle Market Business Sales?

On March 5, 2013, John Slater of FOCUS, a nation-wide investment bank, blogged the following (in part):

“Business owners time their exits for many reasons: health, retirement planning, availability or lack of family successors, competition, technology change and many more. Yet overwhelmingly the question we are most often asked as a financial advisor to entrepreneurial companies is “What’s my business worth?” All things being equal, a rational business owner will presumably choose to sell at a point of optimal value for his or her interest in the firm. For the reasons outlined below, we believe that the next eighteen months may see the highest pricing for good middle market companies in the thirty years I have been in the M&A advisory business.

While the M&A market could be derailed by a major decline in the equity markets or further chaos in Washington, we believe that the odds favor a strong market for sales of middle market companies through sometime in 2014. By then a correction will be overdue and the likelihood of a cyclical bear market in equities may become increasingly high. Generally a serious decline in the stock markets leads to a precipitous fall in M&A activity.

The next 12-18 months will almost certainly be a highly favorable period for business exits. If this proves to be a cyclical market top, the next favorable period for businesses owners wishing to sell may not come around before the 2020s. In 2020 today’s sixty-six year old Baby Boomer will be seventy-three and today’s fifty-eight year old will be sixty-five and studying Medicare options.”

initiating the transaction
  • Privately held companies, by their nature, have less perpetuity than their public counterparts
    • Founder/CEO energies & shifts in personal desires
    • Wealth concentration; desire to diversify
    • Competitive landscape & cost of growth
  • Ultimately, business owner is confronted with many important decisions, including
    • How do I monetize value I’ve built in my company for the past 10, 20, 30+ years?
    • What is my company worth?
    • Who are potential buyers (best partner) & what’s the best way to contact them?
    • What are my goals for a transaction & my role post-transaction?
    • Who will help through this process?
initiating the transaction cont d
  • Often once-in-a-lifetime decision
  • Issues are complex & impact many who have contributed to success of enterprise
  • Emotional aspects are real
  • Getting it right is perfect stepping stone to next chapter of life
  • There are no go-to plans or established formulas/rules
    • Assessing client’s situation, objectives, dynamics of company & its industry are critical steps
    • Approach should be tailored to client’s desires
seller s mindset
Seller’s Mindset
  • Owner’s Feelings

• Fear of unknown future

• Fear of losing meaning & purpose

• Fear of being taken advantage of

• Ignorance about “the process”

• Concern for employees

• Will I receive enough proceeds to accomplish my goals? My family’s goals?

seller s mindset1
Seller’s Mindset
  • Dogmatic
  • Can’t get elsewhere the same returns I’m currently receiving from business (may be a reality in 2013)
strategic options consulting
  • Assist clients with understanding liquidity options available to them based on their goals & unique characteristics of company or industry
  • Determine valuation range for their company & potential interest level from buyer/investor/lenders
  • Prepare after-tax proceeds analysis & tax strategies for various options
  • Identify value drivers of the company that could be leveraged in negotiations with buyer/investor/lenders
  • Identify potential red flags that might have an impact on success of a transaction or impact valuation
  • Discuss liquidity event process, timing & probability of a successful transaction
business transition it s a process
Business Transition – It’s a Process
  • Transition process should provide opportunity to recognize strengths, deal with weaknesses & improve operations & bottom line
enhancing business execution strategy elements
Enhancing Business – Execution StrategyElements

How to Professionalize a Business

• Build upon your core strengths (“secret sauce”)

• Define market strategy

• Size box (physical element)

• Tame complexity (process element)

o Ability to manage complexity & scale

o Managing by group theory (product lines, property, values)

• Manage processes, not people (people element)

o Create culture of change

o Process defines organization, not function

o Create standard work

• Successfully apply information technology (IT element)

enterprise value project 24 36 months from planned transaction
Enterprise Value Project(24–36 Months from Planned Transaction)


• Cause owner to “think like a buyer”

o Exhibit track record

o Professionalize

o Attract “quality buyers”

• Use runway to improve EBITDA margins

• Enhance operations – infrastructure

• Demonstrate sustainability

• Highlight transferability

• Situational – each company

mold a strong management team
Mold a Strong Management Team

• Success of company should depend on entire

organization, not a few people

• Loss of one or two key personnel should not

negatively affect company

• Need strong second-in-command & junior-level management

business plan
Business Plan

• Develop business plan–reasonable & attainable assumptions

• Clearly define internal & external growth opportunities

• Identify & explain operation or margin improvements

(investment in technology, improved supplier terms)

• Identify capital expenditures

• Identify capital requirements (internal CF, outside capital)

• Hit your numbers

financial statements
Financial Statements

• Effective financial controls

o Audited or reviewed financial statements

o GAAP internal financial statements

o Dependable accounting department

• Gives sense of security, credibility

• Lowers due diligence costs

• Lowers holdbacks

invest in the future
Invest in the Future

• Putting off needed expenses may not add value

• Review & address operational processes

• Ensure systems & controls are in place

• Invest in technology or equipment

• Give best appearance possible

• Also applies to investment in human capital

o Management

o Other personnel

improve margins profitability
Improve Margins & Profitability

• Eliminate unprofitable products &/or customers

• Examine expenses (excessive, personal/family-related, nonrecurring expenses)

• Review & improve supplier contracts

• Sell divisions or locations if they significantly lower earnings & are not strategic

• Manage working capital

customer concentration
Customer Concentration

• Too much revenue with too few customers can

give appearance that business may be risky

• Improve quality (profitability) & diversification of customers

• Attempt to get sales contracts or agreements

• Be prepared for holdbacks in transaction

balance sheet
Balance Sheet

• Clean up

o Working capital

o Obsolete inventory

o Loans to shareholders

• Will clarify assets & liabilities in transaction

controlled ownership
Controlled Ownership

• Different owners = different objectives

• Beneficial to buy out minority shareholders

• Can ensure smoother transaction & may

increase value

pre due diligence
Pre-Due Diligence

• Litigation

• Corporate records

• Contracts

• Financial records

• Allow time to fix what might impact value


• If selling your company is your exit plan, timing can be single most important factor to consider

• “Buy low, sell high” applies to business sales as well

• Sell on your own terms

• In difficult market, deal structure & partner going

  • forward are critical

• Don’t be a lone ranger

liquidity event process
  • Research, interview and engage accountants and advisors
  • Assemble and review financials
  • Prepare financial analysis (including trends)
  • Recast financial statements
  • Prepare projections
  • Market analysis
  • Identify and research potential buyers  (PE groups, competitors, strategic buyers, others)
  • Identify and research recent transactions in the industry
  • Finalize offering materials
  • Mailing and fulfillment of approved buyers
  • Detailed tracking process
  • Strict confidentiality screening
liquidity event process cont d
  • Coordinate buyer questions and responses
  • Arrange interviews
  • Schedule site visits
  • Manage information exchange
  • Negotiating letters of intent
  • Coordinate competitive bidding process
  • Buyer selection
  • Prepare transaction schedule and deal team contacts
  • Manage due diligence (virtual data room)
  • Prepare transaction documents (Including ownership, acquisition and finance agreements)
  • Handling third-party matters
  • Hart-Scott-Rodino procedure (see Annex A attached to these materials)
  • Closing
liquidity event process cont d1


Prepare for Market 1-3 Mos.

Identify Buyers 1 Mo.

Project Launch 1 Mo.

Manage Inquiries 1 Mo.

Select Buyer 1 Mo.

Due Diligence 1-3 Mos.

Negotiation & Closing 1-2 Mos.



who is on the team

Key members of the deal team:




Legal Counsel

Investment Banker/Financial Advisor

Valuation expert

Tax Advisors

going to market questions
Going to Market…Questions

What business is the seller in?

Why is the seller in that business?

Who are the seller’s customers?

What are the seller’s immediate and long-term objectives?

How will the seller achieve those objectives?

Who is responsible and accountable for what?

Are those roles and responsibilities understood?

How does the seller compare to its competitors?

Through answers to these questions (and many, many more)

  • More likely the seller will attract more buyers
  • More likely the seller will get a higher valuation
financial advisor valuation expert

Benefits of using Financial Advisor:

  • Manage the sale process (Save time)
  • Create competitive bidding (Save money)

Selection criteria:

  • Knowledge of the Market (potential buyers and sources of financing)
  • Knowledge of the Industry
  • Success Rate (percentage of engagements closed)
  • Shared goals & vision

Benefits of Valuation Expert:

  • Objective confirmation of rule of thumb
  • Expertise to defend valuation against objectors
  • Provide fairness opinion (if applicable)

Selection criteria:

  • Financial credentials
  • Industry experience
engagement of financial advisor


Contacts with potential Buyers

  • Pre-screened and pre-approved
  • Before first contact

Retainer fees

  • Non-refundable
  • Credited against success fee

Success Fee

  • Lehman formula (1%-5% based on deal value) no longer market standard
  • Typically 1%-4% with over/under thresholds

Scope of services

  • Sale, investor, joint venture or capital raise
  • Preparation and dissemination of the offering memorandum (the “deal book”)
  • Exclude existing investors and parties with options or known interest
engagement of financial advisor cont d

Term and Termination

  • Fixed term, renewable
  • Terminable at-will upon notice

Tail coverage

  • Typically 6 Mos. to 2 years
  • Only pre-screened and pre-approved buyers
  • Consider excluding any buyer not introduced by advisor


  • Ordinary out-of-pockets, billed monthly
  • Expenses in excess of $x require pre-approval
  • No general overhead or legal fees

Disclaimer of ownership of work product


Confidentiality, non-disclosure

engagement of financial advisor cont d1

Confidentiality/Non-Disclosure Agreement (NDA) to be provided to Recipients of Confidential Information (CI)

  • To be executed by Recipients upon first contact and before receiving any CI
  • Seller’s counsel to approve any Recipient requested revisions to NDA
  • Advisors prefer their “standard form” of NDA – Seller’s counsel should review and propose revisions
  • NDA should expressly cover postings to VDR as CI
  • Disclosure does not waive attorney-client privilege; back-up with joint defense language
  • Recipient should agree to indemnify Seller for breaches of NDA by 3rd parties to whom Recipient discloses CI
  • Recipient should be prohibited from “teaming” with others to make a joint bid
  • Recipient should be prohibited from contacting Seller’s employees without Seller’s consent
  • Provide for return or destruction of CI upon deal termination, including revocation of access to VDR (possible exception for one copy retained by Recipient’s counsel in event of future litigation)
  • Seller does not represent or warrant disclosure materials

Sample NDA with VDR provisions attached as Annex B to these materials

engagement of financial advisor cont d2

Advisor’s Engagement Agreement

  • Advisors prefer their “standard form” of engagement letter – Seller will focus on fee structure in letter - Seller’s counsel should review and propose revisions to benefit Seller
  • Some provisions of engagement deserving careful scrutiny:
    • No contacts without signed NDA and Seller’s consent
    • Seller to have final review & approval of Offering Memorandum and other disclosure materials
    • All postings to VDR to be pre-approved by Seller’s counsel
    • Advisor must be licensed broker-dealer or affiliated with one
    • Exclusivity of engagement to be mutual
    • Carve-out leads provided by Seller or reduce fees for them
    • Define carefully “Transaction” which triggers success fees
    • Define carefully “Consideration” which provides basis for calculating success fees
    • Provide for fees on deferred or contingent payments to be payable if and when paid to Seller
    • Provide a fixed term subject to termination without cause by either party upon notice to the other
engagement of financial advisor cont d3

Advisor’s Engagement Agreement (cont’d.)

  • Define carefully the “tail period” during which Advisor is entitled to fees and the qualifying characteristics of the tail period buyer (e.g., a party referred by Advisor & who signed NDA during the term)
  • Provide for confidentiality and non-warranty of information provided to Advisor
  • Provide for mutual indemnifications (usual standard is gross negligence, bad faith or willful misconduct)
  • Provide for controlling law and venue in Seller’s home jurisdiction

Sample Engagement Letter with Drafting Tips attached as Annex C to these materials

liquidity event options
  • Sale of 100% (or less) to strategic buyer
  • Sale of 100% (or less) to financial buyer (Private Equity Group or Family Office)
    • Majority recap
    • Minority recap
  • Leveraged recap
  • Sale to management team (MBO)
  • ESOPs
strategic buyers
  • Operating companies that provide comparable products & services

Often competitors, suppliers or customers

  • Could also be unrelated to target or its industry

Companies looking to diversify revenue streams

Companies seeking to build upon their business model &/or competencies to enhance earnings or reduce risks

  • Buyer motivations are multifaceted & varied, including
  • Strategic positioning
    • Market share; new channels
    • New products & processes
    • New customers or deeper penetrations
    • Technologies
    • Scale; synergies; earnings enhancements
    • Management skills; corporate know-how
    • Diversification
    • Accelerated growth; seeking higher margins & earnings
strategic buyers cont d
  • Primary advantages
    • Potentially, deep universe of buyers
    • Perspectives of risks & returns among candidate buyers can vary significantly
    • Long-term investment horizons
    • Often lower return hurdles (typically meaning higher valuations)
    • May be motivated to grow in industry with average or below-average prospects
    • Often, can bring deeper management talent
    • Typically, cash/stock buyers with lower transitional demands
  • Issues
    • Confidentiality
    • Tire kickers; data seekers
    • Industry knowledge – double-edged sword
    • Protecting sensitive performance data, IP, know-how
    • Consolidation more prevalent
    • What is current management’s role going forward?
    • Is there a good culture fit?
    • Potential loss of jobs
financial private equity family office buyers
  • Firms with capital & resources that look to buy companies & utilize value-creation strategies
  • Financial buyers can vary significantly
    • Traditional buyout funds
    • Firms with “buy & hold” strategies
    • Firms with existing holdings
    • Generalists vs. industry-specific funds
    • Firms with CEO partners
    • Special situation funds
  • Hold periods often relatively short (generally, three to seven years, although there are many buy & hold firms)
  • Family office (typically longer holding period than traditional private equity fund)
  • Leverage is often deployed to enhance returns
  • Financial buyers may become strategic buyers as they execute their growth strategies (add on acquisition vs. platform acquisition)
  • PEGs have closed roughly 10%-20% of middle market deals in past 10 years
financial private equity family office cont d
  • In general, PEGs have been successful investors in middle market
    • Disciplined buyers (pay for quality; shy from average)
    • Deploy resources to assist growth
  • This success has led to expanding universe of PEGs & large pool of capital to deploy
  • Current overhang is roughly $348 billion
  • Primary advantages of PEG’s
    • Large universe of efficient buyers
    • Hot deals can garner aggressive bidding
    • Equity stakes for incumbent management; noteworthy wealth creation
    • Solid capital resources
    • Pay for excellence
    • Very focused growth agendas
    • Need management teams & infrastructure
financial private equity family office cont d1
  • Issues
    • More need to sell industry attributes; due diligence scrutiny
    • Use of leverage
    • Aggressive growth & earnings enhancements is hard work
    • Must have capable management team
    • Center of influence?
    • Possibility of near-term & medium-term sale
  • Portion of equity is purchased & selling shareholder(s) often retain meaningful stake & continue to operate company
  • Popular for owners who desire to diversify their personal wealth, yet remain active in growing business & recognizing future wealth
  • Majority vs. Minority vs. Leveraged Recaps
majority recapitalizations

Selling majority stake ‒ Advantages

  • Provide liquidity to ownership
  • Retain minority equity position that could potentially double or triple in value in five to 10 years
  • New investors provide capital/resources & will work with management to formulate growth plan & assist in execution
  • Key management remains with company (two- to three- year transition period) with board representation
  • If platform transaction, company typically continues to operate independently


  • New investor now controls company
  • New investor will most likely leverage balance sheet
  • Could experience major restructuring if acquired by portfolio company
minority recapitalizations
  • Sell minority equity stake
    • Advantages
      • Ownership retains control
      • New investor can provide resources (financial & operating)
    • Issues
      • Will most likely see lower enterprise valuation due to minority investment
      • Operate with some leverage
      • Investor will have some minority protections (first right of refusal, preemptive rights, anti-dilution provisions, redemption rights, board representation, etc.)
leveraged recapitalizations
  • Leverage recap (leverage company & pay dividend/buy out shareholders)
    • Advantages
      • Do not give up any equity (potentially minority stake – 25%)
      • Allows for liquidity event to owners without a sale
    • Issues
      • Have to service debt prior to distributions
      • Financial covenants can impact operating flexibility
      • Company more susceptible to macro events—industry or economic events
      • Risk of bankruptcy (possible fraudulent conveyance)
management buy outs mbo s
  • Owners often recognize team’s leadership contributed greatly to his or her wealth creation
  • High-performing teams in solid companies can execute rewarding deals
  • Personal capital investments do not need to be large, but they do need to be meaningful
  • Capital resources (Sr. & Jr. debt & private equity) to facilitate deals for solid, well-managed companies
  • Main element in MBO is control & continuity of management & business operations
  • Equity rewards can be far more rewarding if team controls deal & pursues capital partners in competitive process
management buy outs mbo s1
  • Advantages
    • Reward most meaningful long-term contributors
    • Operating team remains in control of process
    • Company maintains culture & community presence
    • Due diligence issues are rare, as are purchase price modifications
    • Can retain small equity stake in new company
    • Balance sheet integrity can be maintained
  • Issues
    • Lack of strategic value
    • Requires capable team with demonstrated results
    • Team needs to have clear vision & articulate a compelling plan
    • Operate with some leverage
esop s
  • Advantages
    • Retain control & continue to run company (regardless of level of ESOP ownership)
    • Favorable tax treatment
      • Reduce or even eliminate corporate income tax
      • Company repays acquisition debt with pre-tax dollars
      • Interest & principal on acquisition debt is tax deductible
    • Preserve culture, jobs & community
    • Provide stockholder liquidity (over time) tax efficiently
    • Reward key management & long-term employees
    • Uniquely position company for growth via acquisitions
  • Issues
    • Sell company at fair market value; could potentially “leave money on the table”
    • Stockholder liquidity may be realized over time, not immediately
what is private equity
Whatis Private Equity?

Generallyspeaking, privateequity is the useof capitalto invest in privateor non-public companies.

PEG’s are intermediaries between investorsand private


Whoinvests in private equity?

  • PublicPension Funds
  • CorporatePensionFunds HedgeFunds
  • Insurance Companies ,Endowments and Foundations
  • Funds-of-Funds
  • FamilyOffices
  • High-Net-WorthIndividuals
  • SovereignWealth Funds

BasicFund Structure





Limited Partnership Interests (No active Management)

General Partnership/CarriedInterest




key features of pe funds
Key Features of PE Funds

General Partner/Manager Compensation

  • Management Fee (2% of commitments)
  • “Carried Interest” (20% of profits)
  • Subject to “hurdle rate” (8% of profits)

Limited Partners subject to capital commitments

Investment Period for new investments (5-6 years)

Term of Existence (10 years; Additional 1-year extensions;

Subject to early termination in event of “key person(s)” ceasing

to manage the fund)

peg s vs venture capital
PEG’s vs. Venture Capital
  • Venture capital is a type of private equity capital typically invested in start-up and early-stage companies with high-growth potential (PEG’s typically invest in mature companies)
  • VCs take greater risk with the expectation of a few “home runs” to generate returns to investors (PEG’s typically use leverage to generate management fees and returns)
  • VCs take minority positions with provisions to protect their investment, but generally are not actively involved in management (PEG’s typically demand a controlling stake with management control)
  • VCs typically are focused on their primary industry (PEG’s typically are more financially driven)
private equity leverage
Private Equity = Leverage

Use leverage to generate greater returns

Assume: Enterprise Value = $100MM

  • Example #1 (Straight Equity)
  • Investment of Capital = $100MM
  • $120MM Sale = $20MM profit (20%)
  • Example #2 (Equity and Debt)
  • Investment of Capital = $40MM
  • Debt Financing = $60MM
  • $120MM Sale = $60MM profit (150%)

Leverage also allows for use of free cash flow to pay management fees to the fund and make distributions to the investors


BasicLBO Structure







Holding Company


Management Fees






selling to private equity
Selling to Private Equity


- Many players = maximum sale price

- Creative and flexible transaction financing

- Access to capital

- Financial, strategic and operational expertise

- Relationships with bankers, advisors


- May not be familiar with your industry

- Unlike strategic buyer, lack of synergies

- Due diligence may be more involved


- Management continuity is necessary

- Firm exit strategy (5-7 years)

- Leverage

what a pe group wants
What a PE Group Wants

EBITDA (Cash is king, particularly in PE, and purchase price most typically is calculated based upon EBITDA)

Strong growth prospects

Strong management team

Externally prepared financial statements

- Current account receivables and payables

- Clear understanding of non-business expenses

- Support for travel, meals and entertainment

- Rational executive “perks”

Comfort with known liabilities and pending claims

Supportable forecasts and business plans

- Include information on competitors

- Differentiation, advantages over competitors

how do pegs evaluate their investments in businesses they buy
How Do PEGs Evaluate Their Investmentsin Businesses They Buy?
  • Target Returns = Beta Return + Alpha Return

• BETA is market rate returns based on risk

    • (think stock market)

• ALPHA is ability to create above-market rate returns (think beating stock market)

how do pegs evaluate their investments in businesses they buy1
How Do PEGs Evaluate Their Investmentsin Businesses They Buy?
  • Alpha – The value PEGs add by managing, professionalizing & growing the business. This is PEG’s “secret sauce,” aka“investmentthesis”

• PEGs are looking for underdeveloped companies in niche markets that are fragmented

• For this they will aggressively pay top dollar.

  • There are a limited number of companies that provide “Alpha” opportunities
what characteristics are pegs looking for
What Characteristics Are PEGs Looking For?

• Revenue cycle

o Market share

o Defensible niche

o Customer stickiness

o Concentrations

o Trends

o Sustainability

• Management team

o Capabilities

o Motivation

• Management systems

o Information technology

• Valuation

o Reasonable value

o Fair price – future cash flow

what is my company worth
What Is My Company Worth?
  • EBITDA x Multiple
  • Looks simple, but decisions you make every day impact what’s going to happen
it s all about cash
It’s All About Cash
  • Your P + L bottom line =
  • Add back interest expense
  • Add back your taxes
  • Add back your depreciation
  • Add back nonrecurring expenses
  • Add back out-of-period adjustments
  • Subtract nonrecurring revenues
  • Your Adjusted EBITDA
what determines the multiple
What Determines the Multiple?

• Market position

  • Customers
  • Industry
  • Geography
  • Management team
  • Equipment/physical plant
seller s to do list
Seller’s To-Do List
  • Clearly articulate a business strategy
  • Assemble an experienced team
  • Allocate sufficient time and resources
  • Clean house (Seller Due Diligence)
  • Be patient and realistic - A good company will sell at a premium, irrespective of general economic conditions
sell side due diligence
Sell-Side Due Diligence

• Why should seller consider sell-side diligence?

Answer: Sell-side diligence is about helping deal close at appropriate value

seller due diligence
Seller Due Diligence
  • Purpose – Anticipate Buyer’s diligence examination, find

vulnerabilities to remediate or put on best case explanation

  • Corporate & Shareholder Matters
  • Business Information
  • Financial Matters
  • Material Contracts
  • Intellectual Property
  • Employment Matters
  • Legal Matters, Permits, Regulatory Compliance
  • Real Estate, Plant, Property & Equipment Insurance
  • Material Transactions Outside Ordinary Course of Business

Sample Due Diligence Request attached as Annex D to these materials

sell side due diligence2
Sell-Side Due Diligence

• When should I complete sell-side diligence?

• Answer: Pure financial diligence is typically completed concurrently with deal book & distributed to qualified buyers. Work is often done in conjunction with investment bankers

• Advanced planning may be completed for sellers looking to improve their business prior to taking it to market

buyer due diligence
Buyer Due Diligence
  • Purpose – Verify the strategic business case for the acquisition
  • More than identifying legal risks and verifying accuracy of reps and warranties
  • More than document production and review; includes interviews, management presentations and detailed analysis by multi-disciplinary experts
  • Today’s tougher markets and slimmer markets requires deeper dive into financial, legal, structural, operational and cultural attributes of deals
  • Organizational due diligence recognizes difficulties of post-merger integration (most common reason for failure to reach deal goals)
  • Integration plan/team designed to blend operational and cultural character of buyer and seller with periodic reviews of progress
  • Integration focus on employee communication and buy-in
  • Leverage technology – deploy VDR to organize Seller’s information and efficiently provide access, security and control
buyer due diligence cont d
Buyer Due Diligence (Cont’d)

Advantages of VDR:

  • Promotes Seller readiness and review by Seller’s diligence team and counsel before postings “go live” on VDR
  • Professional presentation promotes marketing of deal
  • Multiple parties may access data without knowledge of each other
  • Accelerates diligence process while reducing travel time & expense
  • Allows automatic notice of updates to deal participants
  • Facilitates rapid Q&A exchanges among deal participants
  • Provides online search and audit trail to reduce post-closing disputes
  • Seller can track points of interest to various bidders
  • Eliminates expense of creating, staffing and scheduling access to physical data room
  • VDR can be used for review and secure exchange of deal document drafts
  • VDR can be used as secure post-closing repository for deal documents and escrow processes
buyer due diligence cont d1
Buyer Due Diligence (Cont’d)

Risks to Seller:

  • Disruption of business operations and staff
  • Premature disclosure of confidential information (consider staging disclosures with reaching certain deal milestones)
  • Extreme demands on resource allocation in condensed timeframe
  • Potential compromise of assets and relationships (customers, vendors, staff, regulators, etc.)
  • Potential loss of attorney-client privilege in disclosed information
  • Breach of NDA’s with 3rd parties

Professional responsibility:

  • Counsel should limit responsibility for due diligence (don’t be team leader)
  • Business people should be ultimate responsible party for review and analysis of disclosures and application of business judgment to the multiple inputs derived therefrom
buyer due diligence cont d2
Buyer Due Diligence (Cont’d)

Structuring Buyer’s Due Diligence Request:

  • First, gather and analyze all publicly available information on Seller and the Advisor’s deal book
  • Then focus requests on information necessary to complete the picture of Seller and confirm information of particular importance
  • Buyer should not request information irrelevant to the particular Seller or its market

Management presentations and site visitations:

  • Timing depends on nature of deal
    • Auctions may dictate visits before VDR goes live (avoids disclosure to parties who lose interest after visit)
    • Negotiated deals may benefit from review of VDR materials before visits
    • Plan visits to mitigate workplace disruption and control visitors access to staff
    • Presentations should be scripted by Advisors and delivered by senior management of Seller
    • Presentations and handouts vetted as potential sources of rep and warranty claims
    • Maintain log of Q&A’s and discussions at visitations
    • Consider presence of counsel to guard against inadvertent representations
buyer due diligence cont d3
Buyer Due Diligence (Cont’d)

Buyer’s use of due diligence results:

  • Prepare diligence Memo with findings
  • Buyer’s counsel uses Memo to formulate reps and warranties in acquisition agreement
  • Diligence discoveries may dictate specific terms of acquisition agreement (specific reps and warranties, carve-outs from survival periods, caps and baskets)
  • Memo serves as check on Seller’s disclosure schedules
  • Seller will warrant disclosure schedules but not VDR disclosures
  • Buyer may be charged with its due diligence discoveries i.e., “sandbagging”
  • Deals with signing and deferred closing risk renegotiating disclosure schedules, acquisition agreement terms or purchase price based on diligence discoveries in interim between signing and closing
principal transaction documents
Principal Transaction Documents

Acquisition Agreements

Ownership Agreements

Financing Agreements

acquisition agreements
Acquisition Agreements

Letter of Intent


- Form (Asset, stock or combination)

- Purchase Price


- If Seller Financing, Terms of Subordination

Ownership Agreements

- Equity ownership (including pre-emptive rights)

- Board composition

- Rights, preferences, privileges and restrictions

- Liquidity rights (including registration rights)

Agreements regarding continuing operations

Exclusivity, Confidentiality and publicity

Employment agreements

- Non-competition

- Equity participation (incentive plans, options)


Sample Letter of Intent attached as Annex E to these materials.

letter of intent cont d
Letter of Intent (Cont’d.)
  • LOI = roadmap of deal – Not merely an agreement to agree
  • 1st chance for Seller & Buyer to negotiate terms
  • LOI assures Buyer to proceed with diligence & assures Seller to open access
  • Most provisions non-binding but create moral obligations as leverage for negotiations
  • Chance to anticipate negotiation issues (non-competes, closing conditions, & indemnification caps, baskets survival)
acquisition agreements cont d
Acquisition Agreements (Cont’d)

Purchase Agreement


- Equity contributions

- Working capital adjustments

- Allocation of purchase price

Financing contingencies


Representations and warranties

- Investment purpose

- Solvency


- Employee retention


- Scope, thresholds and caps, joint/several liability

- Contribution agreement among former owners

acquisition agreements cont d1
Acquisition Agreements (Cont’d)

Other agreements and considerations:

Seller Note & Subordination Agreement

Management Agreement

- Fees paid to the fund

Employment agreements

- Good quit/bad quit provisions

- Restrictive covenants, severance

- Release

Incentive and option plans

- Benchmarks for performance plans

- Conversion rights, vesting (death, disability, sale)

- Payment terms, use of shares

- Registration rights (demand, piggyback, follow-on)

-- Expenses of registration

- Rights of transfer

Dispute resolution

- Differ among agreements

Key man & D&O insurance

ownership agreements
Ownership Agreements

Investor Rights/Shareholder Agreement

Equity ownership

- Dividend or distribution policy

- Preferences, anti-dilution

Board Representation (golden rule in effect)

- Reflect percentage ownership

- Appointment and removal procedures

- Process for notice, written consents, veto rights

- Committee selection, scope and responsibility

- Board fees

Advisory board

Defaults and “swamping” rights (Enables changes in control upon certain events; e.g.

breaches in financial covenants, failure to pay management)

Transfer restrictions

- Permitted transfers to family trusts, affiliates

- Right of first refusal, Drag-along/Tag-along

Information disclosure

Buy-sell provisions

acquisition financing
Acquisition Financing

Alternative sources of financing

  • Buyer’s internal sources – cash flow, bank financing, capital infusion
    • Seller financing – Seller note, earn-outs, roll-over Seller equity
    • Bank financing – Line of credit, term facility, SBA backed loans
    • Angel or venture funding - Capital infusion with control complications
    • Growth capital – midway between VC & control buyout; uses redemption rights, preferred equity securities & contractual covenants to effect operational control without majority voting control
    • A recent example of blended financing:

Pittsburgh-based Mylan, Inc. agreed Feb. 27, to buy Strides ArcolabLtd.'sinjectables unit, Agila Specialties Pte. Ltd. for as much as $1.85 billion. Mylan will pay $1.6 billion in cash at closing and potentially up to $250 million in additional cash subject to certain

unspecified conditions that Strides must satisfy. Mylan isn't assuming any debt or acquiring

any of Agila's cash through the deal. It has obtained a commitment letter from Morgan

Stanley for a new $1 billion senior unsecured bridge term loan to help finance the

transaction. Mylan will also use its existing credit lines and cash on hand to fund the buyout.

acquisition financing cont d
Acquisition Financing (Cont’d)

Issues in Seller financing:

  • Credit risk of combined entities post-closing
  • Parent guaranty, restrictions on operations & subordination to Buyer’s creditors
  • Intercreditor agreement between Seller & Buyer’s lenders
  • Subordination of collateral available for other debt
  • Potential set-offs for Seller breach of reps and warranties

Asset Based Lending (ABL’s)

  • Revolving line secured by specific categories of assets (A/R’s, inventory, etc.) with advance rate capped at % of each asset category
  • Advantages of ABL’s
    • Better pricing than cash flow facilities
    • Unpledged assets available for other secured debt
    • Covenants less stringent than cash flow facilities
acquisition financing cont d1
Acquisition Financing (Cont’d)

Disadvantages of ABL’s

  • Rigorous information & inspection requirements
  • Frequent Borrowing Base Certificates to lender
  • Regular appraisals of collateral
  • Field examinations of collateral
  • Cash dominion if “excess availability” falls below certain limits

ABL’s in M&A

  • Seller’s assets may not support advance rate sufficient for closing
  • ABL’s usually employed with complementary forms of financing (term facility, bridge loan or high-yield notes)
acquisition financing cont d2
Acquisition Financing (Cont’d)

Crowdfunding – JOBS Act of 2012

Provides securities registration exemption for online sales of up to $1M every 12 months to unlimited number of investors irrespective of accredited investor status


  • Amount per investor limited on basis of income or net worth
  • Transactions only thru broker or “funding portal” (new category of registered financial intermediary; rules currently being written by FINRA)
  • Broker or funding portal must provide prescribed disclosures
  • Issuer must provide disclosure and information on use of funds
  • Since the passage of the JOBS Act, there has been an uptick in the usage of crowdfunding platforms like Fundable and Indiegogo, which have helped fund all types of small businesses.

Issues with Crowdfunding:

  • Multitude of CF shareholders make subsequent financing rounds more complicated and expensive
  • CF shareholders are not friends & family, thus more prone to be trouble-makers with an agenda
  • Required CF disclosures creates risk of disclosing sensitive information at vulnerable time in business development
  • Routine corporate governance made more complicated and expensive
  • CF shareholders have voting rights & owed fiduciary duties as minority shareholders
acquisition financing cont d3
Acquisition Financing (Cont’d)

The JOBS Act crowdfunding provisions have generated substantial criticism. Below is excerpt from New York Times opinion piece by Steven Rattner, dated March 3, 2013, entitled “A Sneaky Way to Deregulate”:

“Slapping a catchy acronym like the JOBS Act on a piece of legislation makes it more

difficult for politicians to oppose it — and indeed that’s what happened with the Jumpstart

Our Business Startups Act.

Unveiled a year ago by House Republican leaders, the proposal was rushed into law with

large majorities just two months later; its provisions are gradually taking effect.

Its enticing acronym notwithstanding, the JOBS Act has little to do with employment; it’s a

hodgepodge of provisions that together constitute the greatest loosening of securities

regulation in modern history.


No wonder that the Securities and Exchange Commission, whose former chairwoman Mary Schapiro opposed the legislation, has been taking its time writing the regulations to implement these provisions.”