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Andrew J. ShermanMr. Sherman is a partner in the Washington, D.C. office of Jones Day with over 2,500 lawyers worldwide.
He is the author of 23 books on business growth, capital formation and the leveraging of intellectual property. His eighteenth (18th) book, Road Rules Be the Truck. Not the Squirrel. (http://www.bethetruck.com) is an inspirational book which was published in the Fall of 2008. He has appeared as a guest and a commentator on all of the major television networks as well as CNBC’s “Power Lunch,” CNN’s “Day Watch,” CNNfn’s “For Entrepreneurs Only,” USA Network’s “First Business,” and Bloomberg’s “Small Business Weekly.” He has appeared on numerous regional and local television broadcasts as well as national and local radio interviews for National Public Radio (NPR), Business News Network (BNN), Bloomberg Radio, AP Radio Network, Voice of America, Talk America Radio Network and the USA Radio Network, as a resource on capital formation, entrepreneurship and technology development.
He has served as a top-rated Adjunct Professor in the Masters of Business Administration (MBA) programs at the University of Maryland for 23 years and at Georgetown University for 15 years where he teaches courses on business growth strategy.
He has served as General Counsel to the Young Entrepreneurs’ Organization (YEO) since 1987. In 2003, Fortune magazine named him one of the Top Ten Minds in Entrepreneurship and in February of 2006, Inc. magazine named him one of the all-time champions and supporters of entrepreneurship.
• Due diligence is both an art and a science • Proper due diligence involves:
– Knowing where to look– Knowing what to ask– Knowing what tools to use– Knowing who to ask– Knowing how to test premises/answers– Knowing who should ask– Knowing how to verify
• The “Science” of Due Diligence: – Do your homework– Be prepared and well-organized– Be precise in your requests– Be persistent in your quest for the truth– Don’t accept the first answer as the final
answer– Trust your gut – “if it’s too good to be true …”
• Impact of 9/11/01 Attacks• Impact of Dot.com failures and Enron• The era of Sarbanes-Oxley• Subprime Crisis• The Madoff and Stanford scandals• Overall global recession and financial system woes
Bottom Line:We are in an era where everything and everyone mustbe questioned and answers verified
• Provide information to assess risks and transaction requirements
• Understand the target business completely
• Surface issues early on to identify deal breakers
• Create a platform for a successful transaction
• Note that while buyer should resist the temptation to conduct a hasty "once over" (either to save costs or to appease the seller), at the same time it should avoid "due diligence overkill," keeping in mind that due diligence is not a perfect process
• Mismatch between the documents provided by the seller and the skills of the buyer's review team. It may be the case that the seller has particularly complex financial statements or highly technical reports which must be truly understood by the buyer's due diligence team. Make sure there is a capability fit.
• Poor communication and misunderstandings. The communications should be open and clear between the teams of the buyer and the seller. The process must be well orchestrated.
• Lack of planning and focus in the preparation of the due diligence questionnaires and in the interviews with the seller's team. The focus must be on asking the right questions, not just a lot of questions.
• Inadequate time devoted to tax and financial matters. The buyer's (and seller's) CFO and CPA must play an integral part in the due diligence process in order to gather data on past financial performance and tax reporting, unusual financial events or disturbing trends or inefficiencies.
• The buyer must insist that its team will be treated like welcome guests, not enemies from the IRS!
• In conducting due diligence from a business perspective, you are likely to encounter a variety of financial problems and risk areas when analyzing the target company. These typically include:
– undervaluation of inventories or weakness of backlog/customer orders or lack of loyalty
– overdue tax liabilities
– market trends unfavorable (margin on demand shrinkages/erosion, highly competitive, lack of growth in demand, etc.)
• Before we understand the sources of data for the process of due diligence, it is important to understand certain logistics
• The buyer's lawyer should coordinate the due diligence process so that target receives only one set of diligence requests, rather than repetitive requests from the various advisors (e.g., accountants and bankers).
• Even if accountants or other specialists are also performing due diligence, the buyer's lawyers should be responsible for at least reviewing and cataloguing all items in a data room unless explicitly told to not review certain items.
• The target's lawyers should control the due diligence process at least to the extent that they receive copies of all materials that are forwarded to the buyer. Also, the target's lawyers should conduct their own due diligence review of the target, particularly if they have not historically represented the company, to ensure the accuracy of the representations and warranties and schedules.
• When distributing a due diligence request list, the buyer's lawyer may wish to also distribute the draft representations and warranties so that the target can compile information which is responsive to the diligence request and is necessary to prepare schedules to the acquisition agreement.
• Review Public Information• Due Diligence Request Lists• Site visits/Management Meetings• Industry specific professionals• Experienced peers• Interviews: clients, vendors, competitors• Investigators• Abandoned and Failed Deals
The buyer's acquisition team and its legal counsel gather data to answer the following a variety of key legal questions during the legal phase of due diligence:
1. What legal steps will need to be taken to effectuate the transaction (e.g., director and stockholder approval, share transfer restrictions, restrictive covenants in loan documentation)? Has the appropriate corporate authority been obtained to proceed with the agreement? What key (e.g., FCC, DOJ) third-party consents (e.g., lenders, venture capitalists, landlords, key customers) are required?
2. What antitrust problems, if any, are raised by the transaction? Will filing with the FTC be necessary under the pre-merger notification provisions of the Hart-Scott-Rodino Act?
3. Will the transaction be exempt from registration under applicable federal and state securities loans under the "sale of business" doctrine?
4. What are the significant legal problems or issues now affecting the seller or that are likely to affect the seller in the foreseeable future? Are there any FCPA, DCAA, or other regulatory investigations pending or threatened? What potential adverse tax consequences to the buyer, seller, and their respective shareholders may be triggered by the transaction?
5. What are the potential post-closing risks and obligations of the buyer? To what extent should the seller be held liable for such potential liability? What steps, if any, can be taken to reduce these potential risks or liabilities? What will it cost to implement these steps?
6. What are the impediments to the assignability of key tangible and intangible assets of the seller company that are desired by the buyer, such as real estate, intellectual property, favorable contracts or leases, human resources, or plant and equipment?
7. What are the obligations and responsibilities of the buyer and seller under applicable environmental and hazardous waste laws, such as the Comprehensive Environmental Response Compensation and Liability Act (CERCLA)?
8. What are the obligations and responsibilities of the buyer and seller to the creditors of the seller (e.g., bulk transfer laws under Article 6 of the applicable state's commercial code)?
9. What are the obligations and responsibilities of the buyer and seller under applicable federal and state labor and employment laws (e.g., will the buyer be subject to successor liability under federal labor laws and as a result be obligated to recognize the presence of organized labor and therefore be obligated to negotiate existing collective bargaining agreements)?
10. To what extent will employment, consulting, confidentiality, or noncompetition agreements need to be created or modified in connection with the proposed transaction?
In other words, legal due diligence will focus on the potential legal issues and problems that may serve as impediments to the transaction as well as shed light on how the documents should be structured.
• Assume the deal is done until it is actually closed
• Be afraid to walk away from the deal before it is closed. Remember that the key objective of due diligence is not just to "confirm that the deal makes sense" but rather to determine whether the transaction should proceed at all, recognizing at all times that there may be a need to "jump ship" if the risks or potential liabilities in the transaction greatly exceed what the buyer anticipated.
Thank YouNext M&A Master Class is Dec 8th, 1pm Eastern
Rubber Hits the RoadEnsuring Success in Post-close Integration
The easy part’s done – now make your investment work. Alarmed about post-close integration failure rates? How do you increase your chances of retaining key clients, partners and staff? Where can redundant processes and excess costs be cut? Learn practical tips for building successful post-merger integration program and avoid a deal disaster.
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