Your SlideShare is downloading. ×
September 2011 Acc Docket  Due Diligence & Your M&A Success Story Fletcher Gottfried
Upcoming SlideShare
Loading in...5

Thanks for flagging this SlideShare!

Oops! An error has occurred.


Saving this for later?

Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime - even offline.

Text the download link to your phone

Standard text messaging rates apply

September 2011 Acc Docket Due Diligence & Your M&A Success Story Fletcher Gottfried


Published on

Tips on executing a successful M&A due diligence plan

Tips on executing a successful M&A due diligence plan

Published in: Economy & Finance, Business

  • Be the first to comment

  • Be the first to like this

No Downloads
Total Views
On Slideshare
From Embeds
Number of Embeds
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

No notes for slide


  • 1. INSIDE: Canadian Briefings September 2011 CONTRACT, COPYRIGHT AND TRADEMARK LAWDue Diligence and M&A / IP in Joint Ventures / Importer Loopholes / Legal Cost Containment In-house Defendants / Wastewater Violations / Legal Hold Workflow
  • 2. &Due Diligence Your M&A Success Story BY FRANK FLETCHER AND KEITH E. GOTTFRIED You are in-house counsel at MidSize Software Corporation, a leading publicly-held developer and marketer of computer software based in California’s Silicon Valley. MidSize has a market capitalization of approximately $300 million. Over the preceding fiscal year, MidSize had almost an equivalent amount of revenue, which means the stock market is valuing MidSize at approximately one times its most recent fiscal year revenue. There is a consensus among management that MidSize’s stock price does not reflect its intrinsic value or its growth prospects. Your CEO has decided that MidSize needs to grow by acquisition. She envisions a “roll-up” strategy where MidSize would acquire relatively small privately-held software companies that can be acquired and integrated quickly, thus expanding MidSize’s annual revenue. ACC Docket 35 September 2011
  • 3. The first target, TargetCo, is a small paid a flat royalty equivalent to 20 percent ofprivately-held venture-backed start-up with the purchase price for each unit of softwareproducts that are complementary to Mid- sold by TargetCo. Next, you receive a letterSize’s offerings. While TargetCo is not cheap, FRANK FLETCHER is the general from an investment banking firm that hadyour CEO believes that as long as TargetCo counsel of Nero AG, a developer of been retained by TargetCo in connection platform-neutral softwarebrings to MidSize the revenue it forecast, or technology for editing and with its efforts to find a buyer but waseven an amount relatively close to that num- managing video, music, photos and subsequently terminated three months later other multimedia, which isber, and given the synergies and earnings headquartered in Karlsbad, and replaced by another investment bankingaccretion that are expected to be generated Germany with subsidiaries in firm. Attached to the letter is an agreement Hangzhou, China; Yokohama,from the acquisition of TargetCo, the acquisi- Japan; and Glendale, California. that requires TargetCo to pay the investmenttion should be a “home run” even if MidSize Fletcher is responsible for all banking firm 3 percent of the aggregate aspects of the company’spays a “full price” for TargetCo. Your CEO, worldwide legal function, including consideration paid for TargetCo in the event mergers and acquisitions, softwarehowever, adds as a caveat that she is assum- licensing, patents, trademarks, that it was sold during the 12 months follow-ing no “landmines” will be uncovered post- antipiracy and litigation. Prior to ing the termination of the agreement, which joining Nero, he was a member ofacquisition. TargetCo has told MidSize that the products and technologies law did in fact occur. You also begin to receiveother companies are lining up to make offers group at Sun Microsystems where notices from collection agencies seeking he served as chief counsel for theso MidSize believes that it needs to move CPU manufacturing, integrated payment on behalf of the target’s vendorsquickly. Your CEO makes an offer which is circuit testing and validation and for invoices that were not paid. That amount global business services groups. Heaccepted by TargetCo. is available at quickly aggregates into millions of dollars Your CEO takes you aside and instructs and explains why TargetCo has as muchyou to get this deal closed as soon as possible cash as it does on its balance sheet. Unfor-so that MidSize can announce the deal and tunately, none of these invoices had beendemonstrate to its investors its commitment recorded as accounts payable, and much KEITH E. GOTTFRIED is a partnerto growth by acquisition. You are told to in the Washington, DC office of of TargetCo’s cash will be needed to payget M&A counsel engaged yesterday and to Blank Rome LLP. He concentrates these invoices. As you begin to consolidate his practice primarily on mergersfocus your efforts on negotiating the acqui- and acquisitions, corporate TargetCo’s trademark portfolio, you discoversition agreement. You ask the CEO about governance, shareholder activism, that although TargetCo’s trademarks are securities regulation, NYSE andforming a due diligence team and adding Nasdaq compliance and general indicated as registered on the software pack-consultants, accountants and other industry corporate matters. Over the course aging, none of the trademarks have been of his career, Gottfried has workedexperts, and the CEO tells you that there is on a number of high-profile mergers registered in the United States, but rather and acquisitions across a broad“no time to waste needlessly kicking tires range of industries and sectors. they are registered only in a few foreignand overlawyering the transaction.” You Prior to rejoining Blank Rome, he countries. Further, one of TargetCo’s prod- was the general counsel of the USeasily meet the CEO’s accelerated schedule Department of Housing and Urban ucts, a virus protection program promotedfor negotiating the acquisition agreement. Development, a position to which as the best in the business, is discovered to he was appointed by PresidentFollowing the approval of the acquisition George W. Bush and unanimously have had a programming flaw that preventsagreement by MidSize’s board, it is executed confirmed by the US Senate. it from detecting computer viruses. While a Previous to that, Gottfried was theby MidSize and TargetCo. The transaction general counsel of Borland patch is quickly developed and made avail- Software Corporation in Cupertino,is structured as a simultaneous signing and California. He is available at able to all customers, it is too late for someclosing so it is consummated upon signing. customers — a virus has already corruptedYour CEO congratulates you on completing their computer network. As a result of thethe acquisition of TargetCo. You are celebrat- virus, tens of millions of dollars in damagesed throughout the company as its “superstar M&A lawyer” are incurred by affected customers. The product liabilityand as the “can do” lawyer who “gets deals done.” When lawsuits are filed in rapid succession across the are in ear shot, the CEO often comments loudly, “there Next, a US Government agency indicates that it believesgoes my favorite lawyer!” TargetCo had been overcharging it for custom software de- Unfortunately, these halcyon days are short-lived, as velopment work, and has filed a debarment action againstyour “stock” is about to crash. Fast-forward 60 days follow- TargetCo to prevent it from doing business with any agencying the acquisition of TargetCo by MidSize. You receive or instrumentality of the US government, one of the largesta letter from one of the major patent troll firms politely customers of both TargetCo and MidSize. You also nowasking you to enter into a patent license since allegedly start to hear rumors of some overseas payments, made toTargetCo’s software infringes on a few of their patents. In facilitate the completion of contracts with several inter-connection with the license, the patent troll is seeking to be national governmental organizations, and your outside ACC Docket 36 September 2011
  • 5. counsel gives you a quick tutorial on the Foreign CorruptPractices Act. Finally, after an extensive review of Tar- The Big Ten Purposes ofgetCo’s schedule for launching new software products or MA Due Diligencereleasing updates to existing products, it is discovered thatthe software development teams are at least six months 1. Accumulate bargaining chips for thebehind schedule, and there will be nothing for TargetCo to negotiation of the acquisition agreement.release for at least the next two fiscal quarters. Numerous 2. Assess possible synergies and cost-HR-related issues begin to percolate at TargetCo, including saving opportunities with otherseverance obligations that were not uncovered during the businesses of the acquirer.course of the due diligence process. At the same time, you 3. Help management decide whetherlearn that assignment of invention agreements cannot be to acquire the target.located for many of TargetCo’s top inventors. 4. Confirm the strategic rationale As more bad news on the acquisition of TargetCo for the transaction.becomes public knowledge, the financial and trade press 5. Justify the proposed purchase no mercy and label the transaction as an ill-timed, 6. Mitigate risk and avoid “landmines.”poorly executed fiasco. The MidSize board is furious over 7. Determine what legal hurdles exist tonot seeing the promised benefits from the acquisition and acquiring the target or operating thenow questions the strategy of growth by acquisition. The business (e.g., existence of a non-board believes that it was not adequately briefed about the competition agreement, restrictions on userisks of acquiring TargetCo. The investors of MidSize are of IP, agreements with regulators, etc.).also angry, and several shareholder suits are filed claiming 8. Determine how to structure the transaction.that the board breached its fiduciary duties in not properly 9. Determine how to document the transaction.evaluating the acquisition of TargetCo. After an initial pe- 10. Plan the post-closing operationriod of denial, your CEO now agrees that the acquisition of and integration of the target.TargetCo is an unequivocal disaster and demands to knowhow you could have allowed her and the board to be so“blindsided.” She makes it clear to you that she is no longera member of your “fan club” and glares coldly at you whenyou pass by her in the hallway. Assembling the MA This scenario may seem familiar to many of you. After Due Diligence Teamall, it is well known that many mergers fail or turn out tobe great disappointments. While there are many reasons 1. Company representatives (e.g., legal,to account for an MA transaction not meeting expecta- corporate development, finance, accounting,tions, a poorly planned and executed due diligence process marketing, product management, tax,is often responsible. There are few aspects of the MA human resources, risk management, etc.)process that are more important — and often not carefully 2. Outside MA counselplanned and appropriately executed — than the due dili- 3. Other legal counsel (e.g., antitrust,gence process. The due diligence process of any acquisition labor/employee benefits, intellectualis a critical, if not the most important, phase of any MA property, tax, environmental, governmenttransaction. While different buyers may have different contracts, litigation, etc.)goals for what they hope to achieve from the due diligence 4. Local/state law counsel (e.g., realphase, generally, this is the time to develop an understand- estate, zoning, state licensing, etc.)ing of what you are buying, justify the proposed purchase 5. Foreign counselprice and the transaction, determine whether there are 6. Accountants (independent auditors,any unusual or unanticipated risks to the acquisition, and an accounting firm’s transactiondetermine whether there are any actual or contingent li- advisory group, tax advisors, etc.)abilities that may be assumed in the acquisition. To put it 7. Consultantssuccinctly, the due diligence phase is the time to identify 8. Investment bankersany “landmines” and to prevent the acquisition from result- 9. Lender’s counseling in disaster. This is also the time to identify issues relat- 10. Private investigative firming to how the transaction will be structured, identify whatadditional provisions will be needed to be included in the ACC Docket 38 September 2011
  • 6. Incomplete e-discovery could leave you all wet. When it’s raining down risk, many e-discovery providers leave you exposed. FTI delivers a comprehensive e-discovery solution that protects you from the complexity of global litigations and investigations—and pricing that won’t soak you with surprises. Be Ready. Be Right. ftitechnology.comFTI TECHNOLOGY | Be Ready. Be Right.© 2010 FTI Consulting, Inc. FTI Technology LLC is a business of FTI Consulting, Inc.
  • 7. 4. Can you identify possible synergies and cost-saving Ten Reasons Why MA opportunities with other businesses of the acquirer? Due Diligence Fails Using due diligence to justify the transaction 1. Failure to prioritize areas of focus 5. Is the due diligence process intended 2. Failure to plan due diligence to confirm a decision that has already 3. Failure to set appropriate materiality thresholds been made to acquire the target? 4. Failure to properly coordinate all members 6. Is management still undecided on of the due diligence team and ensure that whether to acquire the target? there are open lines of communications 7. Will the due diligence process be used to confirm among members that are being used the strategic rationale for the transaction? 5. Failure to efficiently use time afforded by exclusivity agreement or letter of intent Connecting due diligence to the purchase price 6. Failure to quantify due diligence findings in 8. Does the proposed purchase price a way that credibly supports an argument need to be justified? for a purchase price reduction 9. Are you trying to bolster the argument for a 7. Failure to communicate findings from downward adjustment in the purchase price? the due diligence “ground” team to the 10. Is there justification for increasing the proposed folks drafting the acquisition agreement purchase price, particularly if you are involved and other transactional documents in a competitive bidding situation? 8. Failure to “harvest” due diligence findings and leverage them into appropriate revisions to the Mitigating risk and avoiding “landmines” acquisition agreement and related documents 11. Does the acquisition of the target carry 9. Undue reliance on the acquisition with it any unusual risks (e.g., ongoing agreement’s representations and warranties, litigation, customer issues, regulatory and the related disclosure schedules issues, etc.) that need to be evaluated as a substitute for “due diligence” during the due diligence process? 10. Insufficient participation in due diligence 12. If the target is a public company, have you process by acquirer’s senior-level personnel and reviewed the risk factors that are contained in from legal, accounting and financial advisors the target’s annual and quarterly SEC filings? 13. If the target is not a public company, have you reviewed the risk factors that are contained in the annual and quarterly SEC filings of comparabledefinitive agreements, and accumulate bargaining chips to companies and the target’s competitors?be used for negotiating various aspects of the transaction. 14. What are the potential “landmines” to look for? Based on our past MA experiences, and particularly, 15. Have you identified upfront whatreflecting back on due diligence processes that were well the deal breakers are?executed and those that could have been more carefully 16. Have all relevant departments at theplanned, we have prepared a list of questions that should company reviewed and commented onbe considered and addressed sooner rather than later as the list of potential “landmines”?you commence the due diligence process in connection 17. Do the assets on the target’swith an acquisition transaction. balance sheet actually exist? 18. Are the assets on the target’s balanceUnderstand the goals of your due diligence process sheet in good operating condition? 1. Other than the customary goal of risk mitigation, 19. Does the target have any actual or contingent what are the goals of your due diligence process? liabilities that may be assumed in the acquisition, Write them down to avoid confusion. but may not appear on the target’s balance sheet 2. What types of information are you seeking or in the accompanying footnotes thereto? to obtain from the due diligence process? 20. Are all customer contracts binding, and 3. Can the due diligence process provide you do they all relate to the specific amounts with bargaining chips for the negotiation of revenue indicated by the seller? of the acquisition agreement? ACC Docket 40 September 2011
  • 8. The right technologyfor the wrong market? Innovation in itself is no guarantee of success. You need a market that’s prepared to accept that innovation. At Foley Hoag, we can help you fit your technology to its proper market. We offer more than clear and sound legal advice. We offer strategic thinking that helps you realize every advantage. Learn more at Attorney advertising. Prior results do not guarantee a similar outcome.
  • 9. Twenty-Five Items to Enhance the Customary Due Diligence Request List 1. Agreements with professional services providers 13. Settlement agreements, including those related to (e.g., investment banking firms, law firms, litigation, governmental investigations and other past accounting firms, consulting firms, etc.) disputes, and particularly those that provide for the 2. Agreements restricting the target’s right to compete target to have any ongoing obligations or restrictions 3. Agreements restricting the target’s 14. Offer letters and other employment, compensation, right to solicit employees option and incentive agreements that the target is a 4. Agreements that are triggered upon the sale party to or, if not yet executed, that exist in draft form or other change in control of the target 15. Proprietary rights and confidentiality 5. Agreements that are not yet executed agreements with employees 6. Correspondence alleging breaches of agreements 16. Consulting and independent contractor agreements 7. Correspondence threatening a lawsuit 17. Severance agreements with former employees 8. Lawyers’ response letters to auditors 18. Written communications between 9. Agreements in connection with previous MA the target and its stockholders transactions, whether completed, aborted or 19. Samples of all packaging for its products still in progress (e.g., letters of intent, exclusivity that contain legal notices and/or reference agreements, merger agreements, stock purchase to any protected intellectual property, agreements, asset purchase agreements and whether registered or unregistered other business combination agreements) 20. Presentations given by any employee of the target, 10. Agreements with respect to ongoing earn-outs whether to customers, employees, investors, analysts, in connection with past MA transactions trade, and professional associations or other groups 11. Agreements to indemnify third parties, including 21. Press releases issued by the target over those in connection with previous MA transactions the past three years 12. Agreements providing for indemnification 22. Certified copies of the target’s corporate obligations of the target in connection with charter (long-form) past MA transactions that may be deemed to 23. The corporation statute of the continue past any specified durational limits, and target’s state of incorporation in excess of any specified indemnity cap, due to 24. Analyst reports on the target certain specified carve-outs, such as claims for 25. Market research studies that reference the target, intentional misrepresentation, fraud and taxes whether commissioned by the target or another partyPlanning the post-closing operation of the target 26. What corporate approvals are required 21. What information is needed to be gathered to consummate acquisition (e.g., from the due diligence process to plan the board, shareholder, etc.)? post-closing integration of the target? 27. What third-party consents are needed to 22. What additional investment is required post-closing? consummate acquisition (e.g., customers, 23. How much working capital will be required lenders, bondholders, licensors, etc.)? to operate the business post-closing? 28. What permits, licenses and other 24. Which employees will you retain post-closing? governmental authorizations are needed to operate the business going forward?Determining what legal hurdles exist to acquiring thetarget or operating the business Determining how best to structure the transaction 25. What legal hurdles need to be met to acquire 29. What is the optimal corporate structure the target or operate the business (e.g., for the acquisition (e.g., asset purchase, existence of a non-competition agreement, stock purchase, merger, etc.)? restrictions on use of IP, agreements with 30. What tax-planning opportunities exist for the regulators, governmental approvals, etc.)? transaction, such as a 338(h)(10) election? ACC Docket 42 September 2011
  • 10. ACC Extras on… MA Due Diligence ACC Docket • Goals of Due Diligence (July 2009). • Outsource Resource: Outsourcing Challenges During a Merger and Acquisition (Nov. 2009). Article • Mergers and Acquisitions (Fraser Milner Casgrain Presentations LLP) (June 2010). • Technology Issues in Mergers and Acquisitions (Oct. 2010). Education • Avoiding Surprises in MA Transactions (March • Dealing with MA transactions abroad? Join us at ACC’s 2009). 2011 Annual Meeting, October 23-26 in Denver, Colo., and attend session 204 – Hot Issues in International Forms Policies MA. This session will discuss the critical issues • Intellectual Property Due Diligence Request List associated with international MA, including anti- (Oct. 2010). trust law, privacy, and environmental liability. Learn • IP Due Diligence Issues in MA Transactions Checklist more and register today at (Feb. 2010). • Preliminary Due Diligence Checklist (July 2009). ACC has more material on this subject on our website. Visit, where you can browse our resources by practice area or search by keyword.Determining how best to document the transaction Using due diligence as part of your commitment to 31. What ancillary agreements will be needed, best practices in corporate governance such as escrow, transitional services, non- 39. How will you demonstrate that the board of compete, employment, consulting, etc.? directors took reasonable steps to inform itself, to 32. What specific representations and the extent of satisfying its fiduciary duties, of the warranties will be required to be included potential risks associated with the transaction? in the acquisition agreement? 40. What additional data points are needed 33. What special covenants should be contained to convince the board of directors of why in the definitive acquisition agreement they should approve the transaction? (e.g., cooperation, tax, treatment of stock 41. Have either you or your CEO asked the options and restricted stock, etc.)? board of directors whether there are specific 34. Which particular closing documents areas of the due diligence process that (e.g., officer certificates, legal opinions, they are particularly concerned with? releases, etc.) will be required? 42. Have either you or your CEO asked the board of directors how they would like the dueUsing due diligence to support broadening the diligence findings communicated to them?seller’s indemnification obligations 35. Should the seller’s indemnification Paying attention to the clock obligations be broadened? 43. How much time do you think the due 36. Should a portion of the purchase price diligence process will take? be placed in escrow as security for the 44. Have you planned your due diligence seller’s indemnification obligations? using a realistic time table? 37. What types of special indemnification provisions 45. Does the team negotiating the definitive should be included in the acquisition agreement? transaction agreement understand that, from 38. What should be the appropriate cap amount on a timing perspective, they need to remain seller’s indemnification obligations, and how long in sync with the due diligence team? should such indemnification obligations last? ACC Docket 44 September 2011
  • 11. Deciding who should participate as part of your team 51. Are there unique issues of local or state law (e.g., 46. Who from the company will be part of the real estate, zoning, state licensing, etc.) involved due diligence team (e.g., legal, corporate in the acquisition that would suggest that local development, finance, accounting, counsel be represented on the due diligence team? marketing, product management, tax, human 52. Are these assets and/or operations located resources, risk management, etc.)? overseas and require that foreign counsel be 47. Who from your outside law firm will be part of the represented on the due diligence team? due diligence team (e.g., MA counsel, securities 53. Have you verified that your outside counsel counsel — if target is a public company — etc.)? is appropriately staffing the due diligence 48. What legal specialties should be represented on team and not just assigning you relatively the due diligence team (e.g., antitrust, labor/ junior lawyers? Have you received a list of the employee benefits, intellectual property, tax, attorneys that have been assigned to the due environmental, government contracts, etc.)? diligence team? Have you read their bios? 49. Is your MA law firm the right law firm to 54. Will the company’s auditors be represented coordinate due diligence, or does the nature on the due diligence team? of the target’s business require a law firm 55. In addition to the company’s auditors, will with very specific industry experience to any other accounting firms be retained in coordinate the due diligence process? connection the due diligence process (e.g., an 50. In addition to your MA counsel’s law accounting firm’s transaction advisory group)? firm, will other law firms be retained in 56. Are there any anticipated tax issues (e.g., connection with the due diligence process? open tax audits, NOL carryovers, etc.) with respect to the target that would suggest that tax advisors be retained in connection with the due diligence process? Corporate Finance Mergers and Acquisitions Product Liability Defense Energy and Agribusiness Life Sciences Financial Institutions Bankruptcy Commercial Litigation Insurance Recovery Securities Litigation Real Estate Employment and Bene ts Intellectual Property Minneapolis „ Denver „ ACC Docket 45 September 2011
  • 12. 57. Will any consultants be retained for the due Reporting due diligence findings diligence? Who will engage these consultants? 69. How should each member of the due diligence Should they be retained by your law firm so as to team memorialize their due diligence findings? preserve the attorney-client privilege reasons or 70. Should you provide each member of the should they be retained directly to save costs? due diligence team with a template to use 58. Will the company’s investment bankers be to capture their due diligence findings? represented on the due diligence team? 71. What is the most appropriate and optimal method 59. Who will conduct the customer/partner due to memorialize the aggregate due diligence diligence, and when will that due diligence be done? findings (e.g., memo, report, chart, etc.)? 60. Will any of the parties providing financing 72. Should you prepare a separate due diligence for the acquisition of the target be summary or report that focuses only on issues that represented on the due diligence team? have a quantitative impact on valuation of the 61. Is there any need to retain a private investigative target and may affect ultimate purchase price? firm to conduct background checks on the 73. Should you hold regular status update target’s management team, particularly where meetings? How will they be organized? Who the target holds various security clearances; will attend? How will results be presented? the loss of which would have a material adverse effect on the target’s business? Preparing and submitting the due diligence 62. Have you prepared an appropriate form request list of confidentiality agreement up front to be 74. Have you prepared and submitted to the target executed by each professional service firm a comprehensive due diligence request list that involved in the due diligence process? has been appropriately tailored to the target 63. Have you reviewed, and as appropriate, had and the transaction you are pursuing? Is the your outside counsel review and comment due diligence list appropriately tailored to the on the engagement letters and/or retention target’s industry and regulatory environment? agreements for each professional service firm 75. Should each of the “legal specialists,” regulatory involved in the due diligence process? counsel, employee benefits counsel, foreign 64. Should any of the non-legal service providers counsel, etc., prepare separate due diligence participating in the due diligence process be request lists focused on their respective areas? retained by your outside counsel so as to attempt to preserve the attorney-client privilege? Haste makes waste While the due diligence process may not be the most ex-Establishing appropriate reporting channels citing phase of an MA transaction, there are many moreand lines of communication opportunities for the in-house counsel to be the “hero” in 65. Have you established appropriate reporting that phase than the phase where definitive agreements are channels, intervals and deadlines for the due executed. The MA world is littered with deals that have diligence team to forward their findings? gone bad because folks unduly rushed a signing without 66. Have you established and communicated materiality knowing what they were buying, and would be owning and thresholds and what your company, as the acquirer, operating. We hope the questions that we list above will would view as possible “deal breakers”? provide in-house counsel with a useful roadmap for issues 67. Have you scheduled weekly conference calls with that need to be clarified early in planning and conducting due diligence team members to review findings and the due diligence phase of any acquisition. By organizing update all on timing and progress of transaction? an efficient and effective due diligence plan up front, at 68. Do you need to establish a virtual deal room for the end of the process, you will be the “hero” and remain transaction participants to provide updates? prudent in protecting the your company’s interests. Have a comment on this article? Visit ACC’s blog at ACC Docket 46 September 2011