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Firms should master ins and outs of M&As

Rochester Business Journal
January 28, 2000
Acquisition frenzy was at an all-time high last year, driven by such factors as a booming stock market, low interest rates, renewed aggressiveness of lenders, reduced capital gains, the growth of niche companies with promising technologies, and buyers with plenty of cash and a strong interest in making deals.

The largest dollar volume of company purchases in the country's history-$1.73 trillion-was recorded in 1998. It was an activity level almost 90 percent higher than in 1997, itself a record year.

When the numbers are available for 1999, they should show more of the same. Founders of successful private companies may be thinking that now is the time to sell. But it's a tough decision, and knowing how to seek out or respond to a potential acquisition can mean the difference between success and failure.

Before making a decision to sell, privately owned companies need to understand all the elements that go into a deal, as well as the roles played by investment bankers, finders and deal attorneys.

A letter of intent is typically drawn to outline and resolve the basic deal terms. The letter of intent, although it purports to be non-binding, can be a binding "agreement to agree," thereby creating a lien on the seller's company. Also, once a seller signs a letter of intent, even though it is largely non-binding, the seller's leverage drops dramatically.

Therefore, before signing a letter of intent, sellers should make sure it covers as many critical deal points as possible and that the "no shop" provision is as short as is practical. The "no shop" provision is a binding provision by which the seller agrees not to talk to other prospects for an agreed time period.

The nature, extent and survival period, as well as other limitations on representations and indemnities the seller will be required to make concerning the company's financial and business condition, should be covered in the letter. These topics determine how certain key risks are divided between the parties.

The letter of intent should also contain the price to be paid, assets to be acquired and liabilities to be assumed; method of payment, such as cash, notes, stock of the buyer or a combination of all these; any purchase price adjustment for changes in book value between signing and closing; and the portion, if any, of the purchase price that will be made up of "earnout," determined by future earnings of the company.

Tax planning and deal structure should also be determined. Usually, the biggest issue is whether the transaction will be an asset sale or a stock sale. The after-tax results of the two alternatives are usually much different.

In an asset deal, the allocation of purchase price to the purchased assets should be agreed upon. Other deal points to be covered include the size of any escrow or "hold-back" from the purchase price to secure the representations; any collateral security for installment payments; and any conditions to the buyer's obligations, such as financing and board of directors approval.

If the buyer's publicly traded shares are to be used to purchase the company, the letter of intent should address whether those shares will be registered with the Securities and Exchange Commission for resale. If the buyer is paying with stock but is not yet a public company, the letter of intent should deal with "piggy-back" rights of registration in the event that the buyer later goes public and files a registration statement with the Securities and Exchange Commission. The seller and buyer will also want to consider whether they are to be provided any protection from fluctuation in the market price of the buyer's stock.

The owners and executives of the selling company will want to address in the letter any relevant employment terms and, if applicable, the nature and duration of non-competition provisions.

Confidentiality agreements should be confirmed as a binding obligation whenever a letter of intent is signed. However, confidentiality agreements should not be too heavily relied upon. Breaches of the agreement are difficult to prove. Therefore, it is wise to hold back sensitive information, such as customer data, until an appropriate stage in the negotiations.

The need for an investment banker or other "finder" will depend on many circumstances. A finder's role is normally limited to coming up with prospective buyers, while an investment banker's role is broader, such as helping with sophisticated analysis of other long-term strategic alternatives and valuation. An investment banker's compensation should be structured so that the commission rate increases substantially for purchase prices in excess of the high-end of value.

Initially, a seller should consider who are the most logical buyers and the size of the potential acquiring companies. Next, a seller will want to review, among other things, a buyer's acquisition record, purchase criteria and cash position. The seller should also set a range of realistic valuation of the company.

Any seller engaged in a conversation with a prospective buyer or buyers must consider the potential damage to the company in releasing confidential company information. A seller should weigh the pros and cons of initiating a dialogue with one or two preferred buyers versus a more systematic approach to a wider list of prospects.

The role of the deal attorney is to help the seller anticipate any potential deal problems, such as environmental and tax issues, and to consider in advance the proper approach and timing to discuss those problems with prospective purchasers. The attorney's job is to start the seller off on the "right foot" with a reasonable and reciprocal confidentiality agreement and help the seller understand the deal process. Buyers are typically more experienced and expect sellers to act predictably.

Once the deal starts, the deal attorney is expected to maintain and accelerate the deal momentum. Serious stalls can be fatal. Since cooperation is key to getting the deal done, the seller's attorney needs to set a positive tone with everyone in the deal and keep communications strong.

For the seller, the bottom line in any deal is to preserve "walk-away power," not spend the money until it's "in the bank," keep other potential acquirers in the process as long as possible and be ready to retain ownership if a suitable deal cannot be negotiated.

(Justin P. Doyle is a partner with Nixon Peabody LLP. His partner, Charles Claeys, assisted with this article.)

1/28/00--Rochester Business Journal

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