The Digital Media M&A Marketplace:
Thinking about a company sale – some perspectives from legal counsel
Paul McDermott, DLA Piper US LLP MITX Program – March 20, 2007
Copyright © 2007 DLA Piper US LLP
Overview of Private Company M&A Sale Process
• Develop consensus among key managers and key stockholders that potential sale should be pursued (and within what valuation ranges). • Select investment banker, and (negotiate and) enter into engagement letter • Work with investment banker to develop and execute sale and marketing strategy and process • Confidentiality agreements and due diligence • Negotiate and execute LOI (almost always) • Negotiate, draft and sign definitive acquisition agreement and ancillary agreements (e.g. employment agreements) • Close transaction – and now the hard work starts (integration and business success on the new platform)!
Thinking about selling a privately-held business?
• Talk to investment bankers early and often – even before committing to sale process • Don’t delay – it can be a lengthy process (6+ months) • But don’t rush – build/confirm consensus among key managers and stockholders that the sale process should be pursued
• What are intentions of key managers (and key non-management employees, if any) regarding post-sale employment? • Will key stockholders support the deal and at what valuation?
• If seller is venture funded, understanding the liquidation waterfall (liquidation preferences) and blocking/consent rights is critical
• Engage the “right” investment banker
• Market expertise and contacts • Genuine time and attention to your deal • Use the “foxhole” test • Understand scope and terms of engagement letter
Confidentiality Agreements
• To state the obvious – confidentiality is crucial with respect to (1) company confidential and proprietary information and (2) existence of sale process • Concerns about: (1) workforce, (2) customers, (3) competitors and (4) marketplace generally • Absolutely critical to get signed agreements from prospective bidders before confidential information is shared and due diligence is provided • Investment banker will handle, but advisable to review text of proposed confidentiality agreement with legal counsel • No false comfort – breaches often are difficult to discover and even more difficult to prove and redress
Objectives of sale process
• Identify the objectives of your sale process and formulate the sale strategy and process around them
• Maximize proceeds? • Best “fit” / utilize synergies?
• Strategic vs. financial buyers
• Price disparity? • Autonomy and pursuit of existing growth strategy • Focus on financial performance
• Consider whether auction-style process makes sense given objectives and all surrounding circumstances (Q: is your business a “hot property”?)
Due Diligence (and more about confidentiality)
• Early in process, identify key due diligence issues and develop proactive plan to resolve • Some due diligence issues may require considerable negotiations and/or time to fix • Some due diligence issues may affect deal structure/terms • Get internal “clean-up” done early • Particularly if prospective buyer is strategic (possible competitor), consider staged due diligence production (i.e., most sensitive information gets disclosed late in due diligence process) • Utilize “virtual” or “electronic” data rooms • Reduce workforce visibility into diligence process • Tighter control over sensitive documents
Letters of Intent
• Various pro’s and con’s for both sellers and buyers, but usually, parties will negotiate and sign LOI • LOI typically covers:
• Identities of parties to deal • Description of what is being acquired • Key economic terms • Non-economic terms considered essential to deal • No-shop agreement (duration is key negotiated point)
• As typically drafted, LOI is non-binding as to deal terms, but binding as to no shop, expense allocation and other process-related terms • Tactical question: what terms get negotiated at LOI stage and what terms get left for definitive documents?
Basic M&A deal structures -- what drives choice among merger, stock sale and asset sale structures?
• Necessity – sale of division or business line where there is no entity to sell must be an asset sale • Tax considerations – critical to deal structure
• Asset sale structure gives buyer stepped-up basis in acquired assets, but threatens “double” taxation to selling corporation and its stockholders (but NOLs, “S” corp. or LLC status) • Stock sale (or reverse triangular merger) structure gives sellers the opportunity for single level tax at LT capital gains rate • Tax-free reorganization – further constrictions on deal structure
• Liability considerations – asset sale structure enables buyer to leave unwanted/unknown liabilities behind • Transferability of key assets (contracts, etc.) – third-party consent problem often avoided with reverse triangular merger or stock sale (but some contracts could have “change of control” provisions)
Employment/Employee Considerations
• Non-competes and non-solicits almost invariably will be required from seller and key managers/employees
• Buyer has legitimate right and expectation to protect the goodwill of the acquired business • Duration of restrictive covenants can be relatively long in sale of business context
• Which employees will be retained post-closing? • Employment agreements for key managers • Key deal point: how will managers and key employees be incentivized post-closing? • If there is an earn-out, how is earn-out impacted?
Earn-outs
• Often used to bridge disagreement over seller’s valuation (e.g., seller’s business is “growth” story / lack of track record, etc.) • Essentially, additional purchase price is made contingent on the achievement of agreed-upon performance metrics or milestones (which parties see as the value drivers of the business) by the acquired business • Earn-out metrics typically tied to P&L – but where on P&L?
• Sellers prefer revenue-based earn-outs – less likely to be affected by buyer’s decisions affecting the management of the business • Buyers prefer net earnings based earn-outs – reflect true contribution to overall business • Parties frequently agree on earn-out based on EBIT or EBITDA
• The extent of the seller’s ability to control the strategic direction and management of the business during the earn-out period is critical (particularly where earn-out metric is “down” the P&L) • Is earn-out aligned with long-term growth objectives?
Questions and Answers