This document discusses how to prepare a government contractor for sale and maximize its value. It emphasizes the importance of strong internal controls and financial systems. Key points include conducting due diligence on the target's financials, pipeline, technologies, customer relationships and compliance practices. Unique issues for government contractor M&A include transaction structure, organizational conflicts of interest, small business eligibility, security clearances, intellectual property, and compliance with cost accounting standards and GSA schedule requirements. Preparing accurate books and records through sound internal controls helps ensure a healthy business is presented to potential buyers.

1. Preparing Your Government
Contractor for Sale: How to Maximize Value
and the Importance of Internal Controls
Ted Hotz of Pugh CPAs
Todd Overman of Bass Berry and Sims
Oak Ridge Chamber of Commerce
October 13, 2015
VALUE Series
VALUE = Venture, Achieve, Learn, Understand, Evolve

2. Noteworthy 2015 GK M&A
Trends and Transactions
Continued focus on cyber and intelligence and continued growth of
middle market M&A activity with transaction values of $50 to
$200M
Dramatic increase in transformational M&A:
► CSC acquisition of SRA for $2.3B
- Combine SRA into CSC publicly traded spin-off (CSC Government) = largest IT services
provider to federal market with estimated FY15 revenue of over $5.5B
► Lockheed Martin acquisition of Sikorsky for $9B (7/20/15)
► Harris’ $4.8B acquisition of Exelis
Lockheed Martin’s announced sale/spin-off of its IT services
business (federal health IT, FAA traffic control, and commercial
cybersecurity)
All this activity creating concern at DoD?
► Frank Kendall, Undersecretary of Defense for Acquisition, Technology
and Logistics

3. Recent Trends in GK M&A – Deal Terms
Rigorous, but targeted, due diligence
Extensive LOI/Definitive Agreement negotiations
Robust Reps & Warranties and Indemnities
Survival Periods
Use of Earnouts to Bridge Valuation Gaps
Focus on Working Capital/Net Assets

4. What is a Buyer Looking For?
Strong Financials
► EBIDTA
► Revenue
► Debt
Pipeline
► Prime vs. subcontract mix
► IDIQs and other contract vehicles
Unique technologies or capabilities
Intellectual property
Culture of compliance
Customer relationships

5. Issues that are Unique to GK M&A
 Structure of the transaction (stock vs. asset/merger)
• Generally no government consents are required for stock purchase,
whereas novations are required for asset purchases (and mergers)
 Post-closing change of ownership/control notices are common
 Conversions of corporate entities create unique challenges
• Post-closing novation process can be time-consuming
 Special novation issues include:
 Transfer of individual task orders under BPAs or GSA Schedules
 Transfer of proposals during competitive process
 Security clearance and bonding requirements
 Novation requests for mergers when Seller ceases to exist
 Organizational Conflicts of Interest
• Critical for Seller to identify current OCIs and Buyer to identify
potential OCIs during diligence process so that mitigation plan can
be put in place
• Even pre-closing announcement of purchase agreement can cause
government customers to stop issuing task orders

6. Issues that are Unique to GK M&A
 Small business size determination and eligibility issues
 SBA requires re-certification for changes in small business size status post-
closing
 Special considerations apply to 8(a) firms being acquired by non-8(a) firms
 Even a LOI may in some situations be considered to create affiliation
between large business buyer and small business target
 Amount of small business set-aside contracts could impact valuation
decisions (www.usaspending.gov provides visibility into type of contract)
 Facility and personnel security clearances
 DSS notification requirements
 FOCI analysis for Private Equity buyers
 CFIUS filing and approach with foreign buyers
 Intellectual property
 Target’s failure to file invention disclosure reports or to properly mark
technical data can diminish the value of its IP
 Special rules apply to data rights associated with SBIR Program
6

7. ARE YOUR BOOKS READY?
Characteristics of a Healthy Business System for
Government Contractors
(1) Sound Internal Control Environment and Accounting
Framework
Segregation of Duties within Accounting Cycles
Number of Accounting Personnel
Management Override of Controls?
Tone at the Top

8. BUSINESS SYSTEMS AND INTERNAL CONTROLS
Characteristics of a Healthy Business System (Continued)
(2) Appropriate Segregation of Direct vs. Indirect Costs
(3) Identify and Accumulate Direct Costs by Contract
(4) Consistency with the Accumulation and Allocation of Indirect
Costs
(5) Chart of Accounts and Subsidiary Cost Ledger Reconciliations
(6) Timekeeping Systems and Labor Distribution for Cost Allocations

9. BUSINESS SYSTEMS AND INTERNAL CONTROLS
Characteristics of a Healthy Business System (Continued):
(7) Costs Recorded to Contracts on Timely & Consistent Basis
(8) Proper Segregation of Costs Not Allowed by the FAR
(9) Journal Entries Properly Approved and Documented
(10) Billing Reconciliations – Cost Accounts and Contract
Terms
(11) Computer (IT) Controls
(12) Documentation and Monitoring

10. Issues that are Unique to GK M&A
 Compliance with GSA Schedule requirements
 Focused due diligence on compliance with price reductions clause is
warranted due to recent increase in government oversight
 Harmonizing labor rates on multiple GSA Schedules require special
attention post-closing, particularly if consolidating entities.
 Compliance with cost accounting and other IT system
requirements
 Increased DCAA scrutiny is resulting in more frequent negative audit
findings, withholdings and adjustments that need to be evaluated pre-
signing
 Purchase agreement needs to address responsibility for adjustment in
incurred cost rates which may not be finalized for years after closing
 Assess target’s compliance with business systems, IT security, and
Code of Conduct, to the extent applicable
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11. How do I start a sale process?
Create timeline of potential sale and identify milestones
(e.g., contract wins, product development, infrastructure
investments) to achieve to increase value
Engage advisors to prepare business for sale
► Accounting
► Tax
► Legal
Interview and engage investment banker to “go to
market”