Transcript Slide 1

Mergers and Acquisitions:
A Primer for the Chief Financial Officer
Joint Chapter Meeting of
Financial Executives International
and
National Association of Corporate Directors
California Chamber of Commerce
1215 K Street, Suite 1400
Sacramento, California 95814
April 17, 2012
Michelle Rowe Hallsten
Mark Gould
Shareholder
Greenberg Traurig, LLP
1201 K Street, Suite 1100
Sacramento, California 95814
(916) 442-1111
Partner
Vercor Advisor
11707 Fair Oaks Blvd., Suite 201
Fair Oaks, California 95628
(916) 860-8601
©2012 Michelle Rowe Hallsten and Mark Gould. All Rights Reserved
Mergers & Acquisitions
• 2011 M&A Recap
• 2012 M&A Outlook
• Exit Strategies
• Acquisition Structures
• Types of Buyers
• Directors Duties
• Preparing for Acquisition
• Valuation
• The M&A Process
2
2011 M&A Recap
•
614 deals in California
•
$83.6 billion in aggregate transaction
value
•
Overall, slightly better than 2010, but Q4
2011 significantly lower than Q4 2010 (167
deals with value of $22.6 billion compared
to 125 deals with value of $17.9 billion)
•
Pipeline weak
Press Release - mergermarket – California M&A Round-up for Full Year 2011,
January 23, 2012
3
2012 M&A Outlook
Unfavorable view, driven by uncertainty
•
U.S. and world economy

Government spending

Slow economic growth

Europe
•
U.S. election year
•
U.S. Government policies

New financial regulations

Increased application of antitrust laws

Healthcare

Foreign policy

Taxation
4
2012 M&A Outlook
Unfavorable, despite:
• Cash-rich balance sheets
 Stock buy back vs. acquisition
• Increased corporate debt issuances
 Record low costs of borrowing
 Robust corporate bond market
• Depressed valuations (Buyer’s market)
 Size dependent/public vs. private
• Substantial private equity capital (“dry powder”)
 $477 billion
5
Exit Strategies
• Initial Public Offering
• Employee Stock Ownership Plan
• Cash Dividends/Distributions
• Merger or Other Acquisition
 Primary path to liquidity
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Acquisition Structures
Asset Sale
•
Advantages to buyer
•
Potential disadvantages to seller
Sale of Stock/Equity Interests
•
Direct purchase of equity from owners
•
Risk of “hold out”/ Short form merger
•
Recapitalization – “Second bite of the apple”
 Majority vs Minority
Merger
•
Reverse triangular merger
•
Forward merger
Structure can affect value received by equity holders
7
Acquisition Structures
Matters Influencing Structure
• Federal income tax effect to buyer vs. seller
• State income tax effect to buyer vs. seller
• Does buyer take assets with stepped up or carry
over basis
• Are sellers subject to one tax or double tax
• Contracts and assets that are difficult to transfer
• Sales and transfer taxes
• Exposure for contingent liabilities
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Types of Buyers
Strategic/Synergistic Buyers
• Geographical
• Product or service synergies
• Domestic and foreign buyers
• Industry consolidators
• Public and private
Financial Buyers
• Industry
• Investment
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Types of Buyers
Strategic/Synergistic Buyers
• Competitors and potential competitors
• Potential for higher valuation
• Due diligence concerns
• Post-acquisition role of seller’s management
may not be critical
• No “roll over” of equity required
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Types of Buyers
Financial Buyers (i.e., private equity)
• Typically lower valuation than strategic deal
• Different due diligence concerns
• Portion of consideration typically debt financed
• Post-acquisition role of seller’s management
usually important
• “Roll over” typically required (or desired)
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Types of Buyers
The “Roll over”
• Pre-closing exchange by key members of
management of a portion of their
shares/interest in the target for an interest in
the target/ultimate parent company
• Value of “roll over” can range from 5% to 30%
of total deal consideration
• Retention and financing tool
• No easy way out until next liquidity event
 Put option
 Potential lower valuation
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Types of Buyers
Anatomy of a Private Equity Deal
Deal Price
Fees (Attorneys, Accountants, Investment
Banker, PEG Deal Origination Fee, Etc.)
Estimated @ 5.25% of Deal Price
Total Project
Source of Funds
Leverage (Senior)
Leverage (Junior/Mezzanine)
Seller Fully Subordinated Note
Equity (PEG Funds Under Management)
Rollover Equity ($10MM = 25% Ownership)
TOTAL
$
$
95MM
5MM
$ 100MM
40%
10%
10%
30%
10%
100%
$
40MM
$ 10MM
$ 10MM
$ 30MM
$ 10MM
$ 100MM
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Directors’ Duties
Duties of Directors – Delaware law
•
Relationship to sale process
•
Fiduciary duties

Duty of care
• Fully informed; Reasonable inquiry
• Reasonable reliance on officers and experts

Duty of loyalty
• Conflict of interest (direct or indirect)
• Lack of independence (extraneous influences)
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Directors’ Duties
Business Judgment Rule
•
Presumption that directors were disinterested and acted
on an informed basis, in good faith and in honest belief
that action taken was in the best interests of the
corporation
•
Creates rebuttable presumption, placing burden of proof
on person challenging directors’ decision
•
Protects directors from liability for decision based on
reasonable investigation and made in good faith even if
decision turns out to have negative effect
•
Presumption rebutted if a conflict of interest exists
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Directors’ Duties
Entire Fairness Standard
• Presumption of business judgment rule rebutted
• Directors have burden of proving the “entire fairness” of
the transaction
• Transaction must be product of fair dealing and fair price
• Difficult test to meet
Safe Harbors
• Special committee comprised of independent directors
• Uncoerced approval of majority of disinterested
stockholders
• May resurrect application of business judgment rule
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Directors’ Duties
Revlon Duties
• Generally arise under three circumstances:

Sale of the corporation

Breakup of the corporation in response to an
offer by a bidder

Board’s approval of a transaction results in a
sale or change of control of the corporation
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Directors’ Duties
When Revlon Applies:
• Enhanced scrutiny of the directors’ actions is
applicable
• Directors have burden of demonstrating:
 Adequacy of the decision-making process (including
adequacy of information on which decision was based)
 Reasonableness of the challenged action in light of the
circumstances presented
• Court won’t substitute its judgment – will determine
if directors’ decision was within a range of
reasonableness
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Directors’ Duties
Revlon Duties (continued)
• Require directors to carry out a process
reasonably designed to secure the best price
reasonably available to the stockholders under
the circumstances
• Duty of board is changed from preservation of
corporation as a separate entity, “to the
maximumization of the company’s value at a sale
for the stockholder’s benefit….The director’s role
change[s] from defenders of the corporate
bastion to auctioneers.”
Revlon v. MacAndrews and Forbes Holdings, Inc., 506 A 2d 173, 182 (Del. 1986)
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Directors’ Duties
Revlon Duties (continued)
•
Board not required to merely consider amount of
consideration
•
Other factors may be taken into consideration:

Future value of strategic alliance

Fairness and feasibility of offer

Manner of financing transaction

Potential risks associated with non-consummation of
transaction

Timing of the offer

Identity of bidders

Background and business plans for the corporation

Effect on stockholder’s interests
Paramount Communications, Inc. v. QVC Network, Inc., 637 A 2d 34 (Del. 1994)
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Directors’ Duties
Significance of Revlon Duties
• If directors establish compliance with
Revlon duties, business judgment rule
applies to review of challenged transaction
• If directors do not establish compliance
with Revlon duties, directors must
demonstrate “entire fairness” of the
challenged transaction
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Directors’ Duties
Compliance with Revlon Duties
•
Engage in and document a process
•
Retain an investment banker
•
Prepare for acquisition
•
Obtain fairness opinion/valuation advice
•
Fiduciary “out”
 Public vs. private companies
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Preparing for Acquisition
Key Issues
• Never too early to prepare
• Don’t wait for market to get “hot”
• Know your potential acquirers
• Pay now, or potentially pay a lot more later
• Seller at risk for pre-acquisition conduct of
business before and for a negotiated period of
time after acquisition
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Preparing for Acquisition
Consequences of Not Being Prepared
• Increased dollar amount/duration of
holdback/escrow
• Increased hard deal costs (e.g., attorneys fees)
• Increased soft deal costs
 Distraction of management
 Disruption to business
 Potential impact on earnout
• Reduction/renegotiation of purchase price
• Delayed closing (which increases hard and soft deal
costs)
• Loss of deal
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Preparing for Acquisition
Benefits of Being Prepared
• Maximize value
• Lower transaction costs
• Reduced holdbacks and escrow period
• Faster close
• Minimize disruption to business
• Favorable impression of management
• Creates buyer confidence; less risk of losing
deal
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Preparing for Acquisition
Goals and Expectations
•
Current estimated value vs. desired value
•
Economic needs (e.g., retirement, next phase advancement)
•
Structuring to manage the unexpected
 Future generation, MBO/ESOP, IPO, third party sale / recapitalization
 Individual shareholder goals, issues / dissent …
 Deal structuring - Valuation optimization

Transaction Type, Real Estate, Equipment –
Cap X vs. COG, Industry Pitfalls
Positioning for Buyer Types
•
Looking in unexpected places – Strategic outreach
Factors that increase or decrease value to these
buyer types
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Preparing for Acquisition –
Valuation – What is a company worth?
Depth of
Management
Strength of
Revenue &
Profitability
Customer
Agreements
Fair
Market
Value
• Income Approach
• Market Approach
Proprietary
Products /
Services
Distribution
Channels
• Asset-based Approach
 Liquidation Value
History /
Future
 Book Value
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Preparing for AcquisitionValuation Multiples (Strategic Buyers)
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Preparing for Acquisition –
Valuation Multiples (Financial Buyers)
*1,332 completed transactions by private equity
groups
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Preparing for Acquisition –
Valuation Multiples (Financial Buyers)
*1,332 completed transactions by private equity
groups
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Preparing for Acquisition
Positioning for Maximum Value
• Normalize earnings
• Marketing outreach
• Follow the process
• Deal structure matters
• Focus on the future
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Preparing for Acquisition –
Due Diligence
Key Areas:
• Corporate
 Proceedings of board and stockholders
 Equity records (i.e., stock, options, warrants)
• Regulatory Compliance
 Due diligence is not the time to discover compliance
“issues”
 Compliance audit
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Preparing for Acquisition –
Due Diligence
• Employment
 Wage and hour compliance
 Classification of employees (exempt vs. non-exempt)
 Characterization of service providers (employees vs.
independent contractors)
 ERISA
• Intellectual Property
 IP audit (know and protect your IP)
 Invention assignment/”work for hire” agreements
 Protection of trade secrets
 Hiring practices
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Preparing for Acquisition –
Due Diligence
• Financial
 Internal controls
 Accounting systems
 Audited vs. reviewed statements
 Public company issues
 SOX certifications
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Preparing for Acquisition –
Due Diligence
•
Contracts
 Need to be final, complete and fully executed
 Appoint a “contract czar”
 Compliance
 Avoid contracts/provisions that buyers may not
want
• Restrictions on business
• Noncompetes
• Limited termination rights
• Non-market terms
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Preparing for Acquisition
Retention and Role of Investment Banker
•
Advises on business, industry and valuation matters
•
Manages expectations
•
Prepares CIM and other materials
•
Understands and conducts sale process
•
Creates multiple options
•
Centralizes communications
•
Negotiates business deal

Management stays focused on business

Banker can be the “bad guy”
•
Sustains momentum
•
Issues fairness opinion or valuation advice
•
Isolates emotion/shareholder issues
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Value of Investment Banker –
A Case Study
•
5 yr old medical services company - growing rapidly
•
Base year EBITDA $800K, Projected EBITDA of $4MM - $5MM
•
Clients Valuation Expectation - $15MM to $25MM
•
Received multiple offers:
Offer
Company
Proposal
Progression
Final
1st
Synergistic
$25 million
$50 million
$55 million
2nd
PEG
$29 million
-
$43 million
3rd
PEG
$16-$22 million
-
Not Enough
Summary of Fourth and Final Offer:
•
Timeline – 11 months from engagement
•
Final Purchase Price Achieved - $66.3M
•
Final EBITDA Multiple – 83 x Base Year EBITDA & 13.2 x Projected EBITDA
•
Client’s Satisfaction – Very, Very, Very HAPPY!!!
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Preparing for Acquisition
Investment Banker’s Fee Agreement
• Retainers
 Typically paid up front and monthly
 Credited toward success fee
• Success fee
 Payable for a “covered transaction”
 Based on a percentage of the “transaction value”
 Bonus incentives
• Other key provisions
 Exclusivity
 Fee tail (12 to 24 months is typical)
 Indemnification
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Preparing for Acquisition
Employee Matters
• Protect confidentiality of transaction

Bring certain employees “over the wall”
• Retention of key and other employees
 Determining who is critical to success of deal (e.g., CFO and
CEO), business, integration plan and target’s long-term
prospects
•
Individuals vs. groups of employees
•
Pre- vs. post-closing retention arrangement
 Retention bonuses (CFO, CEO)
 Acceleration of unvested options/restricted stock
 Employment/retention arrangement with buyer
• Sales force – Potential training of future competition
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The M&A Process
Common Pitfalls
• NDAs
• Screening
• Dealing with one buyer at a time
• Offering an asking price
• Lack of control
• Poor definition of sales initiative
• Omitting favorable attributes
• Ignoring value detractors
• Forgetting real value of assets
• Selecting incorrect earnings period
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The M&A Process - Timeline
Pre-Sale Planning Phase – (Months/Years; depending on goals and
expectations)
•
Finalize engagement terms
•
Establish goals and objectives
•
Data accumulation and fact finding
•
Establish marketability and set expectations
Packaging Phase – (30-60 days)
•
Create an executive summary
•
Prepare a confidential business review
•
Develop other documents necessary for effective marketing
•
Establish a centralized location for distribution of documents to qualified
buyers
Marketing Phase – (60-180 days)
•
Finalize marketing approach and plan
•
Obtain confidentiality agreements
•
Marketing outreach
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The M&A Process - Timeline
Buyer Screening – (Concurrent with Marketing Phase 60-180 days)
•
Develop screening criteria
•
Screen and qualify prospective buyers
Negotiation Phase – (30-60 days)
•
Review offers and report
•
Manage key relationships
•
Address critical non-financial issues
•
Coordinate due diligence
Legal Phase – (30-120 days)
•
Work with counsel to develop definitive purchase agreement
Closing and Transition Phase – (Concurrent with Legal Phase 30-120
days)
•
Facilitate close of open issues between parties
•
Advise seller or buyer on strategic planning issues
•
Close the deal
•
Average transaction time ranges from 9 to 14 months
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The M&A Process
Marketing the Company
•
Limited (“soft”) auction
 Identify and solicit smaller number of potential buyers
 Reduced risk of “leak”
 Less potential for damage if process stopped for any
reason
•
Full auction
 Identify and solicit all potential buyers
 Increased risk of “leak”
 Increased risk of collusion among bidders
 Stigma of broken deal/failure to consummate a sale
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The M&A Process
Nondisclosure Agreement
•
Enables buyer to conduct business due diligence in
order to decide whether to make an offer
•
Seller should provide the form of NDA
•
Should cover both use and disclosure of confidential
information
•
Key provisions:
 Nonsolicitation of seller’s employees
 Term (one to two years is customary)
 Avoid expiration date for trade secret information
 Anti-collusion clause
44
The M&A Process
Letter of Intent
• Buyer’s offer to acquire seller
• Buyer prepares LOI
• Contains certain business terms of deal
 “Smoke out” other key deal terms (e.g., amount and
duration of holdback/escrow)
• Binding and non-binding provisions
• Key provisions:
 No-shop/exclusivity
 Due diligence/access to employees
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The M&A Process
Due Diligence
•
Business vs. legal due diligence
•
Organize business due diligence by key elements
•

Financial

Legal

Vendors

Customers

Key processes

Certain employee information
“Timing” of production

Customer identities; key processes; key employees
•
Use of electronic data room
•
Minimize business disruption (“due diligence czar”)
•
Seller’s due diligence investigation of buyer
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The M&A Process
Definitive Agreement - Key Deal Terms
• Purchase price
• Payment of purchase price
 Cash
 Stock or other equity of Buyer
 Promissory note(s)
 Earnout
 Retained ownership in Seller (“roll over” equity)
• Purchase price adjustment provisions
 Working capital; Excess cash
 Clawbacks
•
Representations, warranties and covenants
47
The M&A Process
Key Deal Terms (continued)
• Indemnification
 Survival of representation and warranties
 Limitation of damages
 Thresholds/basket
 Remedies
• Holdback/Escrow
 Amount
 Duration
48
The M&A Process
Key Deal Terms (continued)
• Termination (“walk”) rights
 MAC/MAE clauses
 Other conditions
 Fiduciary out/Break up fee (Seller pays)
• Remedies for breach
 Specific performance
• Full vs. full/conditional vs. limited
 Damages
 Reverse breakup fee (Buyer pays)
49
The M&A Process
Key Deal Terms (continued)
• D&O tail coverage/indemnification agreements
 Length of coverage
• Stockholders’ representative
 Who should serve?
• Employee matters
 Condition of continued employment
 Termination of employees in asset sale
50
The M&A Process
Negotiation of Employment Agreements
• Stockholders and non-stockholders
• Employment agreements should cover earnout
period
• Full disclosure of employment agreement terms to
stockholders
• Purchase price vs. compensation
• Noncompetition and nonsolicitation agreements
• Separate counsel for management
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Greenberg Traurig Overview
 34 locations in the United States, Latin America, Europe, the Middle East and Asia
 Offices in the 10 largest U.S. metropolitan areas and the Top 4 fastest growing states
 350 corporate/securities/M&A attorneys based in GT offices across the globe
• Named M&A Law Firm of the Year
for North America
(Americas Atlas Awards for MidMarket Deals, October 2011)
• Named a “National Tier 1” Law
Firm for Banking and Finance Law,
Corporate Law, Mergers &
Acquisitions, and Securities/Capital
Markets Law
(U.S. News and Best Lawyers,
“Best Law Firms Rankings,”
November 2011)
52
10 North American and 4 International Offices
Investment Banking with Middle Market Focus
• $10MM to $100MM in Revenues
Properly Licensed
Seasoned Multi-Disciplinary M&A Professionals
• Buy-side, Sell-side, Public & Private Transactions
 Passion
 Promise
 Process
 Perseverance
 Professionalism
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