1. THE MERGERS
& ACQUISITIONS
HANDBOOK
A Practical Guide to
Negotiated Transactions
First Edition
> DIANE HOLT FRANKLE
STEPHEN A. LANDSMAN
JEFFREY J. GREENE
DLA PIPER
3. O
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5. About DLA Piper
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i
7. About the Editors
DIANE HOLT FRANKLE is a partner in the Silicon Valley, California office
of DLA Piper and Co-Chair of the firm’s global Mergers & Acquisitions Group.
Ms. Frankle specializes in mergers and acquisitions, corporate governance,
and antitakeover counseling. She has represented numerous companies, both
buyers and sellers, in asset deals, stock and cash mergers, tender offers,
management buyouts and other complex acquisitions, and in implementing
defensive strategies. Ms. Frankle is a member of the American Bar Associa-
tion’s Committee on Negotiated Acquisitions and Co-Chairs the Committee’s
Task Force on Public Company Acquisitions. She speaks and writes regularly
in programs for both clients and practicing lawyers on mergers and acquisi-
tions, corporate governance, the fiduciary duties of directors, and federal and
state securities laws. She is listed in the Best Lawyers in America, Who’s Who
Legal: The International Who’s Who of Business Lawyers, Chambers Global
Guide and as one of Northern California’s Super Lawyers, for her mergers and
acquisitions practice. Ms. Frankle received her J.D. magna cum laude from
Georgetown University Law Center in 1979. After law school, she served as
law clerk to Senior District Judge R. Dorsey Watkins, Senior District Judge of
the United State District Court for the District of Maryland from 1979 to 1981.
STEPHEN A. LANDSMAN is a partner in the Chicago office of DLA
Piper and is Co-Chair of the firm’s global Mergers & Acquisitions Group. He
engages in a general corporate, business counselling, and tax practice, with
special emphasis in the area of mergers and acquisitions. Mr. Landsman has
extensive in-depth experience in numerous industries as lead counsel
representing both purchasers and sellers in a wide variety of transactions
including public to public, private to public, private to private, leveraged
recapitalization, divisional or asset sales and joint venture/strategic alliance
transactions. Mr. Landsman has been a speaker on various corporate law
matters and has been the author of several published articles in his field. In
2007 the respected English research firm Chambers & Partners cites
Mr. Landsman in Chambers USA: America’s Leading Lawyers for Business.
He has been designated an Illinois Super Lawyer in both 2005 and 2006 and
is also listed in Who’s Who in America and Who’s Who in American Law.
JEFFREY J. GREENE is a partner in the Shanghai office of DLA Piper.
He concentrates his practice in the areas of cross-border mergers and
acquisitions, corporate and securities law. Mr. Greene regularly advises clients
in a wide variety of mergers, acquisitions and change of control transactions,
and has led cross-border M&A deals in Australia, China, Finland, Germany,
India, South Korea and the United Kingdom, among others. Mr. Greene
frequently presents to practicing attorneys on the areas of mergers and
acquisitions. Before relocating to the firm’s Shanghai office, Mr. Greene prac-
ticed in the firm’s Seattle, Washington office where he was named a “Rising
Star” by Washington Law and Politics magazine from 2001 to 2006.
iii
9. Acknowledgements
Editorial:
Diane Holt Frankle Silicon Valley, California
Steven A. Landsman Chicago, Illinois
Jeffrey J. Greene Shanghai, China
Contributing Authors:
William H. Bromfield Seattle, Washington
Sulee J. Clay Washington, DC
Stephanie M. Decker Shanghai, China
Trenton C. Dykes Seattle, Washington
Francis J. Feeney, Jr. Boston, Massachusetts
Danielle S. Fitzpatrick Seattle, Washington
Diane Holt Frankle Silicon Valley, California
Jeffrey J. Greene Shanghai, China
David M. Hryck New York, New York
Purnima N. King San Francisco, California
Paolo Morante Baltimore, Maryland
Kathryn H. Ness New York, New York
Michelle D. Paterniti Boston, Massachusetts
Thomas B. Reems Washington, DC
Robb Scott San Francisco, California
Jeffrey M. Shohet San Diego, California
Christian Waage San Diego, California
Eric H. Wang Silicon Valley, California
Numerous partners, associates and other colleagues have contributed
to this handbook. Our special thanks to Edward Batts, Joel Ginsberg,
Lawrence Gold, Mark Hoffman, W. Michael Hutchings, Peter Lawrence,
Albert Li, Laura Puckett and David Reitz.
v
10. PLEASE READ THIS DISCLAIMER: This handbook is intended to
provide a general, informational overview to non-lawyers and is not
intended to provide legal advice as to any particular situation. The laws,
regulations and other rules applicable to each specific variation of the deals
discussed in this handbook are complex and subject to change. Experi-
enced counsel should be involved in every aspect of the planning, struc-
turing and negotiation of any M&A transaction, including the drafting and
execution of all transaction documentation.
Without limiting the generality of the preceeding disclaimer, the
discussion of the basic Internal Revenue Service rules and regula-
tions relating to the taxation of business combinations is intended to
be a summary only. Such rules and regulations are extremely complex
and evolving, and by definition are dependent on the specific facts of
each particular case. Participants to business combinations must
consult their tax advisors early and often when structuring M&A
deals.
The views in this handbook are those of the editorial staff and the
contributing authors only and do not necessarily reflect the views of DLA
Piper.
vi
15. Preface
The term mergers and acquisitions, or “M&A”, refers generally to a
number of different types of transactions, including mergers, asset acquisitions
and stock purchases. While there may be some degree of overlap among the
various transaction types, each deal and each deal type is its own unique
animal driven by certain practical and business considerations of the parties.
For example, on the sell-side, a company may look to an M&A deal to
provide liquidity to its founders or because it has reached the limits of its
ability to grow organically. A would-be buyer, on the other hand, may be
motivated by the prospect of acquiring strategic technology, expanding
product offerings, adding distribution channels or increasing market share.
Even under ideal circumstances, an M&A transaction will consume man-
agement resources of both the prospective buyer and would-be seller. Conse-
quently, the parties must have realistic expectations of the timing, structuring,
regulatory and other related considerations. Because every transaction is dif-
ferent, it must be approached from the vantage point of the specific facts and
circumstances at hand. In putting this handbook together, we endeavored to
focus on these practical matters and to use them as a backdrop for our
discussion of the legal considerations associated with doing an M&A deal.
This handbook addresses negotiated transactions only. As such, we do
not consider hostile takeovers or other situations where the would-be buyer
and would-be seller have not come together willingly to attempt to do a deal.
With that said, a negotiated transaction is nevertheless an adversarial pro-
ceeding. While all parties to the deal may be keenly interested in getting the
deal to closing, one should never lose sight of the fact that the parties have
different, competing and, generally speaking, conflicting interests.
While much of the information contained in this handbook regarding both
deal structures and principal deal terms applies to transactions involving both
public and private companies on the buy and sell side, certain structural
considerations and deal terms may be significantly affected by whether the
parties involved are publicly traded or privately held. Reference is made to these
distinctions throughout the book only where relevant to a particular discussion.
Finally, although Federal securities and anti-trust laws may come into
play in certain transactions based on the type of deal consideration or the
nature of the parties, an M&A transaction is for the most part driven by the
laws of the particular state(s) in which the constituents are incorporated or
domiciled. Accordingly, this handbook is intended to be agnostic with
respect to particular state laws. However, because it is generally accepted
among practitioners that Delaware law tends to offer the most comprehen-
sive body of M&A and corporations law, and because a considerable
number of the public companies in the United States are incorporated in
Delaware, Delaware law is sometimes discussed for illustrative purposes.
xi
17. Chapter 1
The Mergers and Acquisitions Process
As we use the term in this handbook, the mergers and acquisitions
(“M&A”) process describes the methods and arrangements by which a
prospective buyer and seller consummate the purchase and sale of a
company. Through this process one party decides to buy and the other
decides to sell at an agreed price and on agreed terms. To make such a
decision, the parties have to reach some level of understanding of under-
lying information. This information almost always includes proprietary infor-
mation which can be obtained only with the consent of the parties.
Moreover, it is the kind of information which the parties will disclose only
after they are relatively confident that a deal will follow. Accordingly, the part
of the process by which the parties exchange information (referred to as
“due diligence”) often parallels to some extent the part of the process by
which the parties arrive at a conceptual price and deal structure (the “letter
of intent” or “term sheet”) and by which the parties finally establish the price,
the allocation of risk and other terms and conditions of the arrangement (the
“definitive agreements”). The overall effort to bring about the transaction is
coordinated with a master checklist (the “time and responsibility checklist”).
This chapter provides an overview of the stages of the acquisition
process with reference to some of the tools that have evolved to manage
each stage. Mergers and acquisitions are generic terms that may refer to a
variety of transactions, including asset purchases, stock purchases, merg-
ers, share exchanges and the like. Except where the context indicates
otherwise, the term “acquisition” is used in the broad sense to encompass
acquisitions and dispositions.
Entering the acquisition process is much like starting a marriage or a
new job or other life altering event in that it involves a major commitment,
and is best embarked upon after carefully considering the long-term goals
of all parties involved. If you make a bad hire or match, you are likely to
regret it for some time, and it is likely to be expensive.
The acquisition process involves a large cast of insiders and consult-
ants, some of whom may have conflicting interests. There are also regu-
latory considerations that are usually routine if addressed in a timely
manner.
There are different kinds of buyers/sellers and different kinds of deals,
and the motivation for doing deals are equally plentiful and varied.
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18. The Mergers & Acquisitions Handbook
A Practical Guide to Negotiated Transactions
Why Buyers Buy and Sellers Sell
Competitive Advantage. Although it is unusual, there are times when a
buyer will acquire a company primarily to keep someone else from buying it.
Strategic Considerations. Strategic buyers are the proverbial crown
princes of buyers because, by definition, they pay more. Generally, a
strategic buyer pays what the company is worth to the buyer rather than
what it is worth on its own.
Cheaper to Buy Than Make. There are buyers for whom buying other
companies is an everyday part of their businesses. These include buyers doing
“roll ups,” which are usually companies operating in an industry that is con-
solidating. Generally, these buyers intend to keep and operate the companies
they buy. On the other hand, private equity funds (formerly referred to as
leveraged buyout funds) and merchant banks typically buy companies with the
intention of reselling them or taking them public within some predetermined
period of time. These professional buyers may be opportunistic or strategic,
depending on the circumstances. Generally, they are experienced buyers with
experienced advisors. Historically, they do not overpay, but they also know
what they are doing and do not waste the seller’s time.
Risk Mitigation. There are times when the best way to resolve or avoid
a lawsuit is to buy the other party.
Elements of Value
It can be fairly inferred from the different kinds of buyers and different
kinds of deals that the parties frequently go into the M&A process with
different goals and expectations. These differences often center around the
elements of value. The deal values of the party with the greatest negotiating
strength generally dictate deal structure.
• Price. In a cash deal, the price dynamic reflects common sense.
Setting aside tax considerations, the higher the price, the better for
the seller and the worse for the buyer. However, where the currency
is the stock of a public company, this may not be true if the deal is
large enough to be noticed by the market. Ironically, if the market
thinks the price is too high (not accretive), the value of the market
price of the stock received as the purchase price will fall after the
transaction. Unless the seller has been able to sell or hedge the stock
before this fall takes place, the seller will end up receiving less total
value because the price was set too high at the outset.
• Tax and accounting consequences. Tax and accounting conse-
quences depend on the deal structure. In an acquisition, the buyer
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19. Chapter 1 - The Mergers and Acquisitions Process
acquires either the seller’s assets or the seller itself. (To make
matters complicated, there is one kind of deal — under Internal
Revenue Code Section 338(h) — in which the buyer acquires the
seller but the transaction is taxed as if the buyer had acquired
assets.) Generally, the buyer pays for what is acquired either with
its stock, cash, or a combination of both.
It is often possible to structure an acquisition as a tax-free reorga-
nization. If the transaction is taxable, the gain may be taxed as either
capital gain rates or ordinary rates. In addition, there are some
potentially scary tax complications, generally depending on how the
seller has been formed and operated. For example, if the seller is an
S corporation that converted from C corporation status, it may have
“built in gain” that will be taxed. Or if the seller has issued stock
options that vest, or bonuses that are earned upon a sale of the
company, the “excess golden parachute” payment punitive excise
tax must be considered. There may also be a punitive excise tax if
stock options were granted at less than fair market value.
The choices here are complicated and often binary (that is, what is
good for one party is likely to be bad for the other). Just as the seller
wants the highest cash price, the seller also wants to pay as little tax
as possible. A tax-free deal sounds like it would be best for the seller,
but cash is always taxed. If the proceeds are to be taxed, the seller
does not want them double-taxed (at the corporate level and again at
the stockholder level) and for this reason would prefer a stock sale
over an asset sale. The seller would also prefer to be taxed at capital
gain rates. If the buyer is a taxpayer and sensitive to tax conse-
quences, the buyer may want a portion of the purchase price paid in
respect of covenants not to compete, which can be expensed more
quickly than purchase price, but which are taxed to the seller at
ordinary income rates. If the seller is more sensitive to impact or
earnings (e.g., a pre-IPO company), it will not want the more rapid
amortization for non-compete payments.
• Liabilities and the Allocation of Risk. If a buyer buys stock, it is buying
the company rather than the company’s assets. The company brings
with it all of the known and unknown liabilities arising from the oper-
ation of the business. The known liabilities are directly addressed, but
most buyers prefer to buy assets in order to avoid, to the extent
possible, the assumption of the seller’s contingent liabilities.
• Liquidity. The seller’s primary motivation for the sale of a successful
company is typically to convert an illiquid asset (the company) into a
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20. The Mergers & Acquisitions Handbook
A Practical Guide to Negotiated Transactions
liquid asset (cash or the buyer’s publicly traded stock). On the other
hand, depending on the circumstances, many buyers using stock to
make acquisitions are concerned about the potential impact of a big
block of stock coming onto the market. As a consequence, if the
acquisition is paid for with stock, the buyer often wants to restrict the
subsequent transfer or hedging of that stock.
The Players
There is a long list of players potentially involved in helping the parties
reconcile the elements of value applicable to their particular type of deal. In
general, the constituencies include some or all of the following:
• Owners. One way or another, the owners/stockholders always get a
voice in the disposition of a company. However, depending on the
form of transaction, the owners may not get a direct voice in the
decision to acquire a company.
• Management. It is unusual to buy or sell a company without the
cooperation of management.
• Employees. If management and the owners are satisfied, employees
as a group generally have only indirect, if any, influence. The excep-
tions are where the employees are unionized, where the buyer and
seller are relying on the employees to perform during a transitional
period, and where a large number of employees will lose their jobs
(requiring compliance with state and federal plant closure laws).
• Third parties.
m Customers
m Lenders
m Creditors
• Advisors.
m Counsel (corporate, tax, regulatory, intellectual property, etc.)
m Investment bankers
m Valuation experts
m Accountants
m Escrow Agents
m Financial Printers
• Regulators.
m Federal Trade Commission. The Hart-Scott-Rodino Act,
administered by the FTC, applies only to large deals
m Securities Exchange Commission and State Securities Reg-
ulators (in the event stock is part of the purchase price or one of
the companies is publicly held)
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21. Chapter 1 - The Mergers and Acquisitions Process
m Internal Revenue Service and State Tax Regulators
m Industry Specific Regulators
Acquisition Process
The big-picture goal of the acquisition process is to manage the players
so as to allow the proposed transaction to be completed on time and on
budget. Of course, this is easier said than done. In practice, a number of tools
and devices have been developed to manage the constituencies as efficiently
and effectively as possible toward the realization of this goal. For example,
the due diligence (fact-finding) process is generally initiated and managed
with a due diligence checklist. These tools and their purposes are as follows:
Acquisition Tools Purpose
Time and Responsibility Manage the overall effort by
Checklist coordinating the constituencies
Due Diligence Checklist Manage the process by which the
parties exchange information
Letter of Intent (‘‘LOI”) or The part of the process by which the
Term Sheet parties arrive at a conceptual price and
deal structure
Definitive Agreement The part of the process by which the
parties finally establish the price,
allocation of risk, and other terms and
conditions of the arrangement
Earn-Out or Price Contingent purchase price
Adjustment
Representations and Allocation of risk as to underlying facts
Warranties and Schedule
of Exceptions
Conditions to Closing Allocation of risk as to supervening facts
Post-Closing Covenants Obligations of the parties after closing
Indemnities Financial consequence of risk allocation
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22. The Mergers & Acquisitions Handbook
A Practical Guide to Negotiated Transactions
Time and Responsibility Checklist
The Time and Responsibility Checklist provides an overview of the
M&A process. It breaks down the deal into component parts. Responsibility
is then assigned and a schedule set for each part.
A typical Time and Responsibility Checklist includes the following:
• a list of each person who will have responsibility for some part of the deal
(generally, the parties listed above in the discussion of constituencies);
• a list of each document or action required to complete the transac-
tion, organized as described below:
m for each, an assignment of responsibility for drafting and
reviewing that document or action;
m for each, a status report; and
m for each, a due date.
Each document or action is further broken down with reference to the
stage of the process, as follows:
• Actions Taken Prior to Signing Definitive Agreement:
m term sheet
m board approvals
m formation of newco (where an acquisition sub is formed)
m business due diligence
m legal due diligence
• Agreements and Documents to be Delivered at Signing, e.g.:
Asset Purchase Agreement (the Exhibits Differ for a Stock
Purchase Agreement and Merger Agreement)
m assumption agreement
m bill of sale and assignment
m buyer’s closing certificate
m contract assignment
m lease assignment
m seller’s closing certificate
m trademark and patent assignment
m stockholder agreement
m offer letters
• Pre-Closing Actions:
Company Stockholder Written Consent
m Information Statement (provides disclosure to stockholders in
connection with soliciting consent to the transaction)
Third Parties Requiring Notice
Third Parties Requiring Consent
Allocation of Cash Consideration
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23. Chapter 1 - The Mergers and Acquisitions Process
• Agreements and Documents to be Delivered at Closing:
General
m Governmental Approvals
m Company Stockholder Approval for Asset Purchase
Deliverables/Actions; Conditions to Closing
m Assumption Agreement
m Bill of Sale and Assignment
m Contract Assignment
m Lease Assignments
m Buyer’s Closing Certificates
m Seller’s Closing Certificates
m Trademark and Patent Assignment
m All Government Consents Obtained
m Third Party Consents
m Offer Letters
m Good Standing Certificates
The closing is the time when all documents, like consents and permits,
must be delivered and proof of any necessary government filings, good standing
certificates and approvals are required. All ancillary agreements and certificates
must also be delivered at the closing. It is obviously “crunch time.”
Leveraging The Process
While M&A transactions come in a variety of shapes and sizes, and
vary from industry to industry, in negotiated transactions, the overall pro-
cess by which the buyer and the seller look to consummate a transaction is
fairly constant. Both the buyer and the seller should have a firm
understanding of the process, as time, money and ultimately the deal itself
may depend on it.
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24. The Mergers & Acquisitions Handbook
A Practical Guide to Negotiated Transactions
8
25. Chapter 2
Letters of Intent & Term Sheets
How does a deal begin? Parties known to one another may from time to
time undertake discussions about a potential tie-up. Often these discus-
sions do not end up amounting to much. However, on some occasions the
parties are serious enough about their discussions to want to memorialize
certain key understandings in writing. Such a writing is generally referred to
as a letter of intent — i.e., the parties’ expressed desire to go forward in
some manner.
The terms “letter of intent,” “term sheet,” “memorandum of understand-
ing” and “heads of terms” are generally synonymous in that they essentially
make reference to the same type of document — i.e., an agreement in
principal by a would-be buyer and would-be seller to further consider the
propriety of doing a deal. In some circumstances, a letter of intent and term
sheet will be combined, with the letter of intent portion setting forth a high-
level discussion of the transaction terms which are then set out with greater
particularity in a term sheet (attached as an exhibit to the letter of intent).
This is really a matter of personal preference as the substance of the
document will be the same regardless of the form in which it is presented.
For purposes of this chapter, the term “LOI” or “letter of intent” is used
broadly to encompass all incarnations of such agreements in principal.
In many deals the first statement of deal terms will be in an LOI or term
sheet; however, in some cases the parties may move from a general
discussion of proposed transaction terms straight to negotiation and doc-
umentation of the definitive acquisition agreement.
While there may be compelling reasons for the parties’ decision to
forego a letter of intent, in complex deals the parties are often better served
by taking the extra time to negotiate an LOI. Among other things, a letter of
intent provides the parties with a structure to their discussions and may set
out the parties’ expectations as to how the deal negotiations will proceed.
Moreover, a well-crafted LOI may streamline drafting and negotiation of the
definitive acquisition agreement and as a result actually reduce transaction
time and expense.
While a letter of intent is not intended to function as the definitive acqui-
sition agreement, to the extent the parties do have an LOI, it should not be so
cursory or high level in nature that the parties move forward without having at
least a general understanding of what the deal terms will ultimately look like.
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26. The Mergers & Acquisitions Handbook
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Letter of Intent Pros and Cons
Parties sometimes resist using letters of intent because, like the
definitive acquisition agreement, the LOI is a negotiated document. Nego-
tiating and drafting an LOI will invariably involve additional front-end time
and expense for the parties. Often the parties are reluctant to want to take
the “bloom off the rose” so to speak by having to undertake tough nego-
tiations when they are just getting to know one another.
Additionally, either party may be reluctant to enter into an LOI for fear of
conceding a particular point that has not been fully vetted. This may be less
of an issue for the buyer because in all likelihood the buyer will have only
undertaken limited, if any, due diligence up to that point and will typically
reserve its rights to modify certain deal terms based on the results of its due
diligence review.
Often the letter of intent will provide for a limited period of exclusive
negotiation between the buyer and seller. This is disadvantageous for the
seller, but it is one of the primary reasons why buyers often insist that the
parties execute an LOI.
Binding or Non-Binding
Generally, an LOI will be non-binding with respect to all but a few
certain provisions. Typically, the binding provisions in an LOI will involve:
• confidentiality obligations of the parties;
• an exclusivity period (i.e., no shop) running to the benefit of the
buyer; and
• the right of the buyer to receive a termination or break-up fee in the
event the seller walks away from the deal.
If the parties have not previously entered into a confidentiality agree-
ment, it would be prudent for them to do so at the time they undertake
negotiation of an LOI. Once an LOI has been executed, the parties’ focus
generally shifts to the due diligence investigation, timing considerations and
negotiation of the definitive acquisition agreement. It is important not to let
the confidentiality agreement slip through the cracks.
Care should be taken to ensure that the LOI is truly non-binding, except
as noted above, and does not inadvertently create a binding “agreement to
negotiate” definitive terms. In some jurisdictions courts have prescribed so-
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27. Chapter 2 - Letters of Intent & Term Sheets
called “magic” language that expressly removes any such implicit duty to
negotiate.
Elements of the Letter of Intent
To some extent, the terms of the LOI will mirror what one would expect
to find in the definitive acquisition agreement, only with less specificity. A
typical LOI will likely address at least the following:
• Assets/Stock — description of the assets (which may simply be
described as “all or substantially all” of the seller’s assets), or capital
stock to be acquired
• Acquisition Consideration — consideration to be paid by the
buyer in respect of the assets or stock of the seller (e.g., cash,
stock, earn-out, etc.)
• Closing Conditions — specifies certain key closing conditions,
such as voting agreements (and proxies), votes/consents required,
required regulatory approvals, and required third party consents
• Closing Date — general timetable for completing the transaction
• Corporate Approvals — whether stockholder consents are
required or whether a stockholder meeting will be called
• Due Diligence — the parties’ respective access to the books and
records of the other party
• Escrow — amount of acquisition consideration to be escrowed or
held-back to backstop indemnification or other post-closing obliga-
tions of the seller
• Governing Law — legal jurisdiction governing the terms of the
transaction, including the LOI
• Representations & Warranties — scope of the seller’s represen-
tations and warranties (Note: because of the abbreviated nature of
the typical LOI, parties often simply provide for “customary” repre-
sentations and warranties, which may set the stage for disagreement
during negotiation of the definitive acquisition agreement)
• Structure — whether the transaction will be structured as a merger,
asset acquisition or stock purchase
• Survival — length of time after closing that the parties’ representa-
tions and warranties will survive
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A more comprehensive LOI might also address other considerations,
including:
• Board Representation — whether the seller would retain any post-
closing representation on the board of the acquired entity
• Employment Agreements — if the buyer is to retain certain key
members of management, the LOI may condition closing of the deal
on the buyer’s ability to negotiate satisfactory employment agree-
ments with such management members
• Fees and Expenses — any special fee arrangements among the
parties
• Options — treatment of outstanding employee stock options upon
consummation of the transaction (Note: terms of the option plan and
applicable option agreements will need to be considered)
• Publicity — whether either party is permitted to announce the trans-
action (typically the parties will agree to keep the LOI and proposed
transaction confidential)
• Registration Rights — buyer’s obligation to register any of its secu-
rities used as acquisition consideration
• Tax Treatment — whether the parties intend for the transaction to
receive a certain tax treatment (i.e., tax free reorganization)
While there may be strategic or tactical considerations for the parties’
decision to forego an LOI, if thoughtfully considered, a letter of intent may
provide the parties an early indicator of whether there is indeed a deal to be
done.
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29. Chapter 3
The Nondisclosure Agreement
The nondisclosure agreement, often referred to as the NDA or con-
fidentiality agreement, is typically one of the first agreements to be entered
into in an M&A transaction. The agreement is designed to protect the
confidentiality of information exchanged in connection with the transaction
and during the course of one party’s due diligence review of the other party.
This chapter outlines a few of the more frequent issues encountered in
negotiating a typical NDA for a merger or acquisition. Generally, the seller
provides the buyer with confidential information. However, as noted above,
the seller may also receive confidential information from the buyer. If the
transaction involves significant equity being issued by the buyer, both
parties may provide confidential information to each other. In such circum-
stances, the concepts discussed below should be considered accordingly.
The NDA is usually prepared by the seller’s counsel or the seller’s
financial advisor. Although the principal focus of the agreement is protecting
confidential information that the seller provides the buyer, the buyer may
also have an interest in maintaining the confidentiality of information pro-
vided during the course of negotiations. For example, the buyer may have
provided confidential information to the seller in order to provide assur-
ances of its ability to pay the consideration for the acquisition. If the buyer is
issuing equity as consideration, the buyer may provide sensitive information
to the seller related to future business plans in order to demonstrate to the
seller that the buyer and the seller make a good business fit, to assure the
seller of its ability to develop the seller’s combined businesses in the future,
or, if the buyer is issuing a substantial percentage of its equity as consid-
eration, to satisfy the seller’s due diligence investigation of the buyer.
If both buyer and seller provide confidential information to each other, a
“mutual” NDA will be needed. If the provision of confidential information is
only contemplated to be from the seller to the buyer, a “unilateral” NDA may
be used. In most instances, however, a mutual NDA will often still be used
because the buyer’s confidential information may be disclosed to the seller
at some point during the discussions, even if it was not originally
contemplated.
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Practical Tip: Tailoring the NDA to the Specific Deal
Parties will often mistakenly start with an NDA that is designed for
providing information to vendors or with a short-form NDA that is not
tailored for M&A transactions. The parties should be careful to avoid
this mistake, because the NDA for an M&A transaction will contain
specific provisions addressing matters not necessarily present in
other situations. For the same reasons, the parties should avoid
the temptation to rely on an NDA previously used by the parties in
a prior commercial arrangement.
Understanding the Scope of Confidential Information
One of the preliminary matters to review in any NDA is the scope of the
definition of “confidential information.” The seller should carefully examine
whether the definition of confidential information sufficiently covers the
information and materials it will provide to the buyer (and, to the extent
applicable, confidential information that may have been provided to the
buyer before the NDA was signed) to ensure that it does not inadvertently
exclude information or materials intended to be confidential. In addition, the
seller should be wary of “residual” clauses that allow the buyer, in its future
products or services, to use confidential information retained in the “mem-
ory” of the buyer’s employees. On the other hand, the buyer typically
attempts to limit the definition of confidential information so that it does
not include information created or discovered by the buyer prior to, or
independent of, the seller.
If the buyer is a close competitor, the seller may have particular
concerns about providing highly sensitive information to the buyer (e.g.,
pricing information, patent information or source code). Similarly, the buyer
may not want to review such highly sensitive information because it might
expose the buyer to future claims of misuse of proprietary information in
violation of the NDA or pose regulatory concerns. Therefore the parties may
want to consider carving out any subset of information that is extremely
confidential to the seller. These items may be better addressed in a sep-
arate NDA containing careful controls and procedures to limit the distribu-
tion and access of information to those advisors or agreed-upon personnel
of the buyer whom the seller reasonably believes will not exploit the infor-
mation commercially.
Another issue that may arise is how to determine whether information
is confidential. The seller may want to remove any onerous legending
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31. Chapter 3 - The Nondisclosure Agreement
requirements that would require the seller to mark written materials “con-
fidential” or to reduce oral statements to writing. The potential pitfall of such
requirements is that the seller may disclose confidential information assum-
ing such information is protected when it is not in fact protected by the NDA
because the seller inadvertently failed to legend the confidential information
or to summarize oral confidential information in writing. The buyer may
agree to waive these requirements, especially since such requirements
often lead to a delay in receipt of due diligence materials due to the seller’s
need to carefully legend each document delivered or desire to limit access
to and control oral diligence discussions.
For evidentiary purposes, the seller should maintain a list or copy of all
the documents provided to the buyer and all persons to whom such doc-
uments were delivered. This will also help the parties to keep track of what
was previously provided so that duplicative requests for information can be
reduced.
Use of Confidential Information
In addition to defining which information is confidential, it is important
that the seller prevent the buyer from using the confidential information
provided by the seller for any purpose other than evaluating the possible
transaction at hand. The seller may want to insist on language in the NDA
stating that the confidential information is to be used solely for the purpose
of evaluating the transaction and that no implied license is being granted to
any of the seller’s intellectual property.
The seller may also want to protect its confidential information by
limiting the distribution of confidential information to a select group of the
buyer’s representatives. The seller may also consider a provision in the
NDA that would allow the seller to hold the buyer liable for any improper use
of confidential information by the buyer’s representatives. Alternatively, if
there are heightened concerns about the sensitivity of the information, the
seller may ask that confidential information be disclosed only to the buyer’s
representatives listed on a separate schedule to the NDA and that such
persons provide an acknowledgement, in writing, that they are bound by the
obligations of the NDA.
Non-Disclosure of Discussions
Both the seller and the buyer often want to keep confidential the fact
that discussions are taking place. Disclosure of such information could
create uncertainty among the seller’s suppliers, customers, vendors, and
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employees, and if the seller is a publicly-traded company, result in a
dramatic change in the seller’s stock price. The buyer typically has con-
cerns about the confidentiality of discussions for similar reasons, and, in
addition, will want to limit the seller from using the buyer’s interest in the
seller to negotiate a potential sale to another party in order to avoid
competitive bidding or to prevent disclosing the buyer’s potential business
strategy to its competitors. However, in an auction context, the seller may
attempt to retain its ability to disclose the fact that the buyer is a bidder, or, to
the extent possible, to disclose the terms of any bid made by the buyer to
other bidding parties. If the buyer needs financing to complete the trans-
action, the buyer may negotiate an exception allowing it to disclose infor-
mation to its financiers.
Practical Tip: What it Means to Not Disclose Discussions
• May not disclose that evaluation materials have been
exchanged
• May not disclose that discussions or negotiations are taking
place
• May not disclose the terms and conditions of such discussions
Legally Required Disclosures
In some situations, the buyer may be legally required to disclose confi-
dential information to third parties in connection with legal proceedings. To
address this scenario, the seller should request either (i) the right to object to
the disclosure of any confidential information, or (ii) at the very least, the ability
to limit or control the scope of any court-ordered disclosure. The seller should
also insist that the buyer and its representatives notify the seller within a certain
period of time of any legal proceedings that would require the disclosure of
confidential information. The notification period should give the seller enough
time to seek injunctive relief or some other protective order from an appropriate
court. The seller may also want to request that the buyer fully cooperate or use
its reasonable best efforts to cooperate with the seller in obtaining such a court
order. If the seller is unable to obtain such equitable relief, the seller will want
language stating that the buyer will only disclose confidential information that is
legally required to be disclosed, in the opinion of its legal counsel.
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Return or Destruction of Materials
It is important to the seller that all written confidential information be
returned or destroyed by the buyer, together with all copies and derivative
materials, if the acquisition is not completed. However, the buyer may prefer
to destroy the confidential information, or certify to the seller that it has
destroyed the confidential information because its representatives may have
made written notes on the documents or incorporated the content of those
documents into internal memoranda or business presentations. If the seller
accepts the buyer’s certification alternative, it should consider requesting that
the buyer list the documents that have been destroyed. Some thought should
be given to the destruction of electronic data on the buyer’s computer hard
drives and servers, as well as the tangible copies of confidential information
that the seller supplied. In some circumstances, the buyer may ask that a
copy of what was received be retained for archival/evidentiary purposes to
protect itself from being accused of using disclosed confidential information.
If this is the case, a copy should be kept by outside counsel only.
Non-Solicitation/Employment
A prospective buyer may seek to interview the seller’s employees as it
“kicks the tires” on its potential acquisition. This raises two concerns for the
seller: (i) it may alert the seller’s employees of a potential acquisition,
making it difficult for the seller to continue its normal course of business,
and (ii) it may result in a situation in which the potential buyer decides to
solicit key employees rather than acquiring the entire company. The seller
should request language in the NDA prohibiting the buyer from soliciting or
hiring the seller’s employees for some period of time (typically 6 months to
2 years, one year being fairly common) and from soliciting or hiring former
employees who may depart within some period of time (typically 3 to
6 months). The buyer may resist this prohibition by arguing that it is a
large entity and that keeping track of the solicitation and hiring activities of
its human resources department will be difficult, if not impossible. As a
result, the buyer may ask to limit this provision to only “key” employees or
employees that the seller identifies during the due diligence process.
Furthermore, the buyer may argue that general solicitations not directed
at the seller’s employees should be carved out because the buyer has no
control over whether the seller’s employees receive or respond to general
solicitations that may appear in newspaper publications or on the Internet.
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Term
The term of the NDA will depend on (i) the strategic value of the
information to the seller, and (ii) how quickly such information may become
obsolete. Some NDAs fail to include a “sunset” provision and are silent as to
the duration of the confidentiality obligations under the NDA. In such cases,
the seller may argue that the confidentiality obligations, especially those
relating to core technology that will not become obsolete, should never
terminate. However, the buyer should attempt to limit the NDA to a specific
period of time (typically 1 to 5 years) because the seller’s proprietary know-
how may become obsolete in several years and the buyer will not want to be
limited by the NDA in making new technological developments. The buyer
may suggest that the NDA terminate upon the earlier of (i) completion of the
transaction or (ii) within a period of time after signing or termination of
negotiations if the transaction fails to close. If the seller is providing software
source code, it should consider asking for a carve-out provision excluding
source code from any time limits on protection.
Practical Tip: Avoiding Inadvertent Termination of the NDA
Generally, a definitive agreement will have a provision that states
that the definitive agreement sets forth the entire understanding of the
parties relating to the subject matter thereof, that it supersedes all
prior understandings, and that all prior agreements are terminated.
Make sure that the NDA is carved out from this provision so that the
NDA is not inadvertently terminated.
Remedies
Another issue to consider in evaluating NDAs is the question of rem-
edies. The seller will want to include some language from the buyer
acknowledging and agreeing that monetary damages are insufficient to
remedy a breach of the NDA and that the seller is entitled to injunctive relief
in addition to any other remedies. The seller may also request that the buyer
pay any legal fees resulting from a breach of the NDA, but a provision
stating that the prevailing party will pay the legal fees may be a more
reasonable compromise.
Choice of Law/Forum
With respect to a one-way NDA, the law and courts of the domicile of
the disclosing party is typically provided for. Where both parties are making
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35. Chapter 3 - The Nondisclosure Agreement
disclosures, this issue is frequently contentious. A possible compromise is
to provide that the law and forum of the domicile of the disclosing party will
control with respect to disputes involving that party’s confidential
information.
While the NDA is typically one of the first agreements to be entered into
in an M&A transaction, it is often the most overlooked. When negotiating
and finalizing the NDA, the parties should carefully weigh the desire to
proceed quickly with a transaction against the importance of assuring that
the NDA adequately protects the parties’ interests. A sample form of a
mutual NDA is attached as Annex 3-A and a checklist of items to look for
when reviewing an NDA is attached as Annex 3-B for your reference.
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20
37. Chapter 4
Legal Due Diligence
In the context of an M&A transaction, the term “due diligence”
describes the process each of the parties undertakes to investigate the
other before a final decision is made whether to proceed. It can be likened to
dating (or maybe an engagement) before marriage. The parties are still
finding out about each other, and either can back out, though that is likely to
be unpleasant for one or both. Usually the buyer assures its investigation is
critical to permit it to decide to spend its cash or issue its securities to buy
the seller. However, a savvy seller will be equally concerned about the buyer
if the consideration is stock in the buyer or there is some strategic com-
bination contemplated.
What Is Due Diligence and When Is It Performed?
Due diligence is not a formality. It is a critical part of any M&A trans-
action because it allows a buyer or a seller to examine the business, legal
and financial affairs of the other to confirm that it is getting what it thought it
was getting. The results should answer two important questions: (i) “Can or
should we do the deal?” and (ii) “On what price/terms do we want to do the
deal?” Due diligence may expose “deal breakers” (e.g., accounting issues,
litigation, regulatory issues, tax issues, third party consent issues, etc.) that
could materially change the anticipated benefits of the deal. At a minimum,
discoveries can change the price/terms of the deal. At the worst, the
discoveries may prevent the deal from getting done at all.
Due diligence findings are also a critical concern in drafting the defin-
itive transaction documents, in particular, the representations, warranties,
covenants and disclosure schedules. Due diligence allows the parties to
allocate the risks as they move forward.
What Are the Objectives of Due Diligence?
The objectives of due diligence vary depending upon:
• whether a party is the buyer or the seller;
• the buyer’s business purpose for the transaction (i.e. does the buyer
plan to integrate operations following the closing, or will it strip down
the seller’s operations to assets); and
• the proposed deal terms, including the type of consideration that the
seller would receive.
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For the buyer (or seller if the transaction contemplates a stock-for-
stock exchange, “merger of equals,” or strategic combination), the objec-
tives of due diligence may include the following, among others:
• accumulating sufficient information to validate the proposed valua-
tion and to justify the business reasons for consummating the deal;
• learning more about the seller’s business and operations;
• uncovering and identifying the current and potential issues, prob-
lems, risks and liabilities posed by the transaction;
• determining whether the seller’s business can effectively be inte-
grated into that of the buyer; and
• identifying unused capacity and determining how such capacity can
be effectively utilized to produce synergies.
For a seller receiving cash consideration in the transaction, its focus
during due diligence will be on (i) what stockholder or third-party consents
are required to consummate the transaction; (ii) corporate, business
records, or contract clean-up issues; (iii) compensation, severance, or
personnel matters; and (iv) arrangements where the consummation of
the transaction would cause an undesirable effect on the seller, such as
an event of default, a right of a third party to terminate a material obligation
of the seller, or a trigger of a source code escrow obligation.
Overview of the Due Diligence Process
Due diligence is routinely time consuming and often complex. However,
the process can be manageable and cost-effective if a party spends time in
advance creating a due diligence plan and forming a due diligence team.
The first step in the due diligence process (after, of course, finding a
deal) is for the parties to enter into an NDA or confidentiality agreement.
This agreement protects the subsequent disclosure of information that will
be provided to a buyer or seller in connection with the due diligence review
of the other party. As discussed in greater detail in Chapter 3 (“The
Nondisclosure Agreement”), a well-designed NDA accomplishes the
following:
• sets the ground rules concerning the disclosure and use of any
provided information;
• defines the scope of the documents and materials that will be
reviewed (for example, certain competitive or sensitive information
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39. Chapter 4 - Legal Due Diligence
may be initially excluded from the process until the parties progress
further in the negotiations, or may be further subject to explicit
screening procedures);
• may include prohibitions on the solicitation of employees and other
“standstill” provisions; and
• addresses the processes and ongoing obligations of the parties
(including the return or destruction of confidential information) in
case the deal falls through during the due diligence stage.
The next step in the due diligence process is assembling a due
diligence team and assisting the individuals who will actually be performing
the due diligence to understand the type of transaction, the context of the
proposed investigation, and the type of company that is being reviewed. By
developing a general understanding of key features of the deal including its
scope, periods of review, and materiality thresholds common for deals of
these types and in the applicable industry, as well as the expected timing of
the transaction, the due diligence team can prioritize its review and struc-
ture the campaign accordingly.
What information does the recipient need or want? In this step, the
parties should broadly identify the scope of the documents they would like
to review and prepare a list of the requested documents and information
(“due diligence request list”). This list, which also creates a mechanism for
identifying and cataloguing both the information requested and the infor-
mation received, is usually very broad in the beginning of the due diligence
process. Upon finalizing the list of initial documents that the reviewing party
would like to receive, the due diligence request list is presented to the other
side, which then begins to compile, copy, and index the requested
materials.
Because due diligence is an evolutionary process, the review of one
document may prompt an additional line of inquiry or a need for additional
documents on the same subject (e.g., supplemental due diligence requests
concerning intellectual property, export, governmental contract, and envi-
ronmental information matters). These supplemental due diligence
requests are common and an important part of the process.
Once the materials have been prepared and organized, the disclosing
party distributes the documents and materials to the reviewing party’s due
diligence team. Historically, this distribution was made in person by deliv-
ering the documents to a “data” or “war” room at the offices of the disclosing
party’s counsel. In such cases, the reviewing party’s due diligence team
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would perform its due diligence review in those offices. More recently,
however, parties have begun to copy and mail (or email) due diligence
documents to the reviewing party’s due diligence team and even post the
materials to secure online data rooms.
Once the diligence materials have been made available, the diligence
teams may spend hours or days reviewing such materials and compiling
appropriate work product to memorialize their findings.
Practical Tip: Online Data Rooms
Online data rooms allow the reviewing party’s due diligence team
to review the documents in the comfort of their own offices, which
generally has the effect of decreasing the cost of the due diligence
review (i.e., there is no need to travel to remote locations to carry out
the review). However, convenience and potential cost reduction must
be balanced against any issues that may result from the broader
dissemination of sensitive information.
Who Is Involved and the Necessity of a Diverse Team of
Experts
Every deal is different, and one of the first priorities in the due diligence
process is to assemble a diverse due diligence team. The team’s collective
expertise should cover the various business, legal, technical, and financial
matters unique to the seller and the deal at hand. This means not only
assembling the appropriate legal team, but making sure that the buyer or
seller has designated the appropriate in-house contacts to address ques-
tions that may arise concerning financial, customer, marketing, technical/
engineering, information technology/infrastructure, or personnel matters.
Although the primary lawyers on the deal will conduct much of the legal
diligence review, there are certain areas that will warrant a legal “special-
ist’s” review. These areas include antitrust, corporate and securities, debt
facilities, environmental, executive compensation and employment, gov-
ernment contracts or regulatory agencies, import and export, intellectual
property, litigation, privacy, real estate and real property, and tax. Each
specialist should have an integral role in creating the contents of the due
diligence request list (or responding to the request list), reviewing material
related to the specialist’s subject matter, and drafting, reviewing and mod-
ifying the portions of the definitive transaction documents relevant to the
specialist. In order to make the due diligence review by a specialist cost-
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41. Chapter 4 - Legal Due Diligence
effective, the specialist should be briefed on the objectives of the parties as
discussed above.
The due diligence process is a collaborative effort and delegating
responsibility will facilitate a more efficient and effective process, thereby
producing a higher quality result and reducing the probability that key issues
will be overlooked or improperly addressed or negotiated.
Practical Tip: Points of Contact
Consider having one point person each for the seller, its counsel,
the buyer, and its counsel, whose task is fielding and responding to all
requests for additional due diligence material or information.
Due Diligence Request List
The due diligence request list (as prepared by the investigating party)
is an important step in formulating the scope of a due diligence review.
Although some may believe that this list is generic or “boilerplate,” a detailed
and targeted request list can make the due diligence process more efficient,
which may also lead to a more thorough and cost-effective review. In
general, a due diligence request will include all material agreements,
stockholder agreements, capitalization records, financial information, cus-
tomer and supplier information and contracts, employee records, and
benefits plans.
Despite the general nature of the types of information that will be
requested, the list itself should be fairly specific, and tailored to the specific
deal. It is better to make a targeted request for specific materials than it is to
make a general request such as, “Provide us with all material information
about the company.” For example, asking for “all charter documents” or “all
financing documents” is not as helpful or efficient as asking for “the
company’s certificate of incorporation, its bylaws, and all amendments
as now in effect” or “all loan agreements, credit facility documents, security
agreements, indentures, bonds, notes, and other evidences of short-term
or long-term indebtedness, and all amendments, as now in effect.” This is
particularly the case with parties that are not experienced in handling due
diligence requests and may not be familiar with the information generally.
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Practical Tip: When a Broad Diligence
Request is Appropriate
A broad diligence request list may be appropriate when:
• the timeline is very tight (for example, a deal involving a public
company in a competitive situation or a situation in which the
risks of a leak are high);
• the disclosing party has a large diligence team to respond to the
entire request;
• the recipient has sufficient resources and personnel to handle
and review the information upon receipt; and
• both parties have committed to completing the diligence pro-
cess efficiently and expeditiously.
Whether the request is global or targeted, generic or detailed, it should
be tailored to the particular provider as much as possible. For example, if
the provider is a public company, its SEC filings should be read before the
request is submitted. This will enable the recipient to identify particular
documents (or potential documents) it might not otherwise be in a position
to ask for specifically.
Although this kind of customization is more difficult when the provider is
a private company, it is not impossible. The recipient will likely have some
specific information about the provider (from firsthand knowledge or infor-
mation from a website); and a modest amount of advance teamwork among
those who have this information can help focus the request.
Practical Tip: When the Disclosing Party is Public
Review SEC filings (e.g., forms 10-K, 10-Q and 8-K) before
preparing a diligence request.
Attached as Annex 4 is an example of what a comprehensive due
diligence request list might look like. Please note that this form is merely a
starting point. However, whether the form is used for a single global request
or staged focused requests, it should provide an itemized list of material
documents that are important in any due diligence review. The form may be
used by provider and recipient alike as an inventory of documents
requested and provided.
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Response to Due Diligence Request List
Once the team has been assembled, the due diligence request list
items have been delegated among team members, and the seller and its
counsel have had the chance to collect and review all of the items
requested, the seller’s counsel typically prepares a formal written response
to the due diligence request list.
In an ideal world, the seller would be able to produce all of the items
requested at once. In practice, however, and in order to keep the due
diligence process moving forward, the seller will usually be unable to
assemble all of the requested information and materials at once. In these
situations, the parties will usually deliver a partial response and will follow
up with additional information as it is assembled. All materials delivered by
the seller should be accompanied by a written response and should be
organized to correspond with the due diligence request list (e.g., a response
that addresses each requested document item-by-item). This will allow the
buyer and seller to more efficiently and effectively locate and review the
desired information and will make subsequent supplements or updates
easier.
Typically, commencement of the due diligence process will require that
a large amount of information be located, reviewed, and produced in a
relatively short period of time. In most cases, the buyer will require that the
seller, and the seller will wish to, keep the potential transaction confidential
and not disclose its existence to the employee base. This reduces the
number of people on the seller’s side available to help in the due diligence
process. As a result, most of the information gathering is done by a handful
of the seller’s personnel, who are oftentimes the high-level executives of the
seller, or the seller’s legal counsel. Some of the information may need to be
collected by or from employees who have yet to be informed of a potential
transaction, and accordingly, production of such items may need to wait
until the likelihood of consummating the transaction is higher.
It is important that no due diligence material is produced to the other
side until counsel to the disclosing party has had the opportunity to screen,
if not complete its review of, and organize, such material. A provider of
information should always memorialize what they send to the other side.
Often, particularly in time-intensive situations, the provider responds to the
due diligence request with an “information dump”, where armfuls of doc-
uments are grabbed from drawers and file cabinets, boxed up, and sent
without first being inventoried.
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Practical Tip: Information Dumps May Have Bad Results
Among the unfortunate results of the “information dump”
approach are
• potential disputes down the road over what was and was not
provided;
• potential inadvertent waivers of the attorney/client
privilege; and
• potential disclosure of sensitive documents.
To minimize the risks of inadvertent disclosure, it is essential to estab-
lish a control mechanism with respect to the review, organization, and
delivery of the documents by the provider and its evaluation by the recipient,
and the creation of an accurate record of the documents so provided. The
most common approach is to designate a single person or a very small
group of people to act as a gatekeeper through which all documents must
flow. In certain situations, this approach may produce internal resistance
because of concerns that such coordination will slow down the review
process.
The due diligence process can be very disruptive to the operations of a
seller. Because the buyer is trying to review a large portion of the seller’s
books and records (and the information may not be readily organized and
available), collection and review can be time-consuming and in turn divert
the attention of company personnel to matters other than the seller’s core
business objectives and operations.
Practical Tip: Source Code Protection and other
Proprietary Information
For protection of source code or other highly confidential propri-
etary information the seller may insist that the parties engage a third-
party/independent organization tasked with evaluating the source
code base or other highly confidential proprietary information rather
than delivering it directly to the buyer.
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Scope and Process of Review
Once documents have been delivered, the reviewing party may wish to
consider imposing some sort of control on the reviewing team as to the
allocation and distribution of the documents. As discussed above, a full-
scale due diligence review — particularly when the provider is a large
company — will involve experts in many disciplines (for example, tax,
accounting, intellectual property, employee benefits, environmental, and
regulatory areas). Within each discipline, more than one reviewer will
probably be necessary. For instance, different people may be needed to
review federal and state tax issues, or patents and copyrights. In order to
control this process and track the documents that are being reviewed by
various team members (in case the documents must be returned or
destroyed), a single individual responsible for each category of requested
information should be established. This procedure helps ensure that there
is a “closed loop” of identified individuals who know about the transaction
and receive the documents for review.
Once an NDA has been signed, the due diligence request has been
submitted, coordination procedures have been put in place on both sides,
and the information has begun to flow, the real due diligence work can
begin: evaluating the information and its relevance to the potential trans-
action. In this part of the process, the due diligence team will begin to review
all the documents and materials provided to date, paying particular atten-
tion to those issues that may impact the proposed terms in the definitive
transaction documents or the likelihood of consummation of the deal.
Much of the diligence review during this process is often performed by
relatively junior team members. As such, it is important for junior team
members to raise potential problems to the more senior members of the
team as quickly as possible. Experience is the key to effectively analyzing
and evaluating the results of a due diligence review. For example, an issue
that may be deemed to be “interesting, but immaterial” to a junior member of
the due diligence team may be extremely material to a more senior person
who has firsthand knowledge of the problems associated with these situ-
ations. In fact, such information may ultimately be linked to another issue
that, together, may be one of the most important issues to the buyer. Thus,
coordination among reviewing team members is critical to success.
An equally important mechanism in the due diligence process is the
exchange of information orally through site visits, interviews with management,
formal presentations, and informal discussions. This part of the due diligence
review is often performed by the acquisition team and other principal employ-
ees or consultants of the reviewing party. Generally, attorneys are not
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A Practical Guide to Negotiated Transactions
significantly involved in this process. In this step, members of management of
the disclosing party may prepare and deliver detailed presentations that give
an overview of the operations, prospects, and finances of the subject company.
The acquisition team will then have the opportunity to talk to these individuals
to “drill down” on the assumptions and statements made in the presentations.
An important fact to remember in these situations is that presentation mate-
rials, statements made in these meetings, handouts, and other materials will
directly affect the scope and substance of the representations and warranties
and the extent of indemnification obligations (if any) in the definitive acquisition
agreement. The buyer’s team will note any inconsistencies and inaccuracies in
these statements and use these facts to shift any risks relating to the state-
ments to the seller and its stockholders under the representations, warranties,
and covenants contained in the definitive agreement.
Results of Review
The results of the due diligence review will ripple through all aspects of
a proposed M&A transaction. A detailed summary of the due diligence
review, often called a due diligence memo, is usually prepared by counsel
as a way to organize, track, and manage which documents have been
reviewed, who reviewed them, and what issues or action items were
identified. The due diligence memo may also become an important tool
for both the business and legal aspects of negotiating the final deal terms.
Once the parties have digested the results of their respective due
diligence investigations, the last step in the due diligence process is making
certain determinations:
• Can or should we do the deal?
• Do we still want to do the deal?
• Is the seller worth the valuation as originally proposed or should there
be a reduction in the purchase price?
• Should an alternative form of consideration or payment be consid-
ered, such as an earn-out?
• To what extent should the scope of the representations and warran-
ties be expanded?
• Is an adjustment to the indemnification and escrow term or amount
necessary?
• Should additional covenants or conditions to closing be added (e.g.,
third-party consents, employee retention targets, required termina-
tions (of contracts, customers, or personnel)?
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47. Chapter 4 - Legal Due Diligence
Practical Tip: Hot Issues in Due Diligence
Following is a list of “hot” issues that may arise during the course
of the diligence investigation, and which may impact the definitive
transaction documents:
• capitalization issues
• nonassignability clauses
• termination/default provisions
• change of control provisions
• employment/severance agreements
• discovery of “hidden” liabilities (i.e., litigation, environmental)
• discovery of provisions that conflict with the transaction or
require consent/waiver
• non-competition or non-solicitation restrictions on the seller
• open source software
• privacy issues
• export control violations
• source code escrow arrangements
• acceleration of stock options
• 280G parachute payments or 409A issues
Assuming the parties wish to move forward with the deal, the due
diligence memo and related documents are invaluable to the buyer in
confirming the contents of the disclosure schedules to the definitive agree-
ment. Moreover, by maintaining an accurate record of all documents dis-
closed pursuant to a due diligence request list, the seller may use this list in
the preparation of the disclosure schedules.
As mentioned above, the due diligence process continues until the
transaction is closed. The parties will continue to request, deliver, and
review information throughout this period. As such, the parties should
recognize that due diligence is an evolving process that will require a
significant time commitment on each of their parts.
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A Practical Guide to Negotiated Transactions
32
49. Chapter 5
Deal Structures
Principal Deal Structures
A business acquisition can take many forms. The optimal structure in
any particular transaction will depend on a number of factors, such as the
nature of the business, assets and liabilities being acquired, the economics
of the business deal, tax considerations, required third-party consents,
securities laws considerations, and similar issues. Determining the optimal
structure for the acquisition is a critical step in every deal and must be
addressed early on in the transaction process, ideally at the term sheet
stage.
The structure may affect the buyer and the seller very differently from
an economic perspective and is therefore often an important part of early
business negotiations. For example, a structure that is tax optimal to the
seller may be less so for the buyer, and vice versa. The structure will also
affect the scope of the due diligence and disclosure process. For example,
structure may impact the scope and nature of the liabilities the buyer will
assume, or the consents required for contract assignment. Setting structure
will be a prerequisite to determining appropriate documentation for the
transaction. Finally, the structure chosen will have a significant impact on
the overall deal process.
The three principal categories of negotiated acquisition structures are
stock purchases, asset acquisitions, and mergers.
Stock Purchase
In a stock purchase, the buyer negotiates directly with the target and its
stockholders to acquire the target’s outstanding shares of capital stock
directly from each of the target’s stockholders. As consideration for the
acquisition of the stockholders’ shares, the buyer may pay cash, its own
capital stock, debt, or other property. As with all acquisition structures,
sometimes a combination of cash, stock, and/or other property may be
used as consideration.
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A Practical Guide to Negotiated Transactions
The following illustrates a typical stock purchase structure:
STOCK PURCHASE
Cash,Stock or
Before:
Other
Consideration
Stockholders
B of
S
Stock of S
S
After:
(if stock consideration)
Former
B Stockholders
of S
Assuming B purchases 100%
of S's stock
S
After the stock purchase has closed, the buyer will own whatever
percentage of the target’s stock is represented by the shares the buyer
acquired. Importantly, the buyer may not acquire 100% ownership if some
stockholders do not sell their shares. After the closing, the target will
continue as it existed prior to the acquisition with respect to the ownership
of its assets and liabilities, its employees and the conduct of its business.
Asset Acquisition
In an asset acquisition, the buyer acquires certain enumerated assets
and liabilities of the seller in exchange for the buyer’s cash, stock, or other
property. The buyer only acquires those assets that are specifically listed in
the asset acquisition agreement and also only acquires those liabilities that
are explicitly assumed. As a result, this structure can provide greater
flexibility for the buyer if it seeks to limit its exposure to undesired or
unknown liabilities or to acquire only those assets that are meaningful to it.
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