Positioning the Company for an Exit - Chapman - Mar 14

POSITIONING THE COMPANY FOR AN EXIT:

A Primer on IPOs and Mergers and Acquisitions

SANTA CLARA UNIVERSITY SCHOOL OF LAW

March 18, 2014James C. ChapmanPartner, Bingham McCutchen LLP

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Outlook for 2014• Deal activity expected to be solid in

2014 — 63 percent of respondents in KPMG study expect to make an acquisition in 2014 • Companies hold large amounts of

cash 

• Interest rates remain at historic lows — Availability of cheap credit 

• Pent up demand — 2012 and 2013 were disappointing years

• Opportunities in emerging markets

• Strong equity markets

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Factors Motivating Today’s Deals• Being opportunistic 

• Expand customer base

• Expand geographic reach

• Enter new markets

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Important Factors for Success

• Well-executed integration plan 

• Correct valuation/deal price 

• Effective due diligence 

• Positive economic conditions

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Most Active Industries

• Technology 

• Telecom and Media 

• Healthcare 

• Pharmaceuticals and Life Sciences

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Advising the Client

Who is the client?

How do you advise an early stage company regarding an M&A or IPO strategy?

• Build to sell

• Build a good company and they will come

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The M&A Process:Preparing the Business for Sale• Remove assets which seller wishes to retain or which

may be objectionable to the buyer including condominiums or vacation homes, automobiles, or other company owned items

• Ensure that the financial and corporate records are in good order

• Seller should have up-to-date minutes of the meetings of the board of directors and a validly-elected board of directors

• Settle lawsuits or terminate unfavorable contracts before the seller's adversaries see the potential sale as added leverage

• Thoroughly clean and organize the premises

• Ensure that all shares of stock required to be issued have been issued and that all verbal agreements regarding future ownership are either honored or terminated in writing

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• Develop a comprehensive list of all of the seller's assets

• Create a list of all necessary governmental permits

• Document all loans to or from shareholders and employees

• Review the development of the company's technology to determine that no others have any ownership rights

• Compiling a list of the company's patents, trademarks and copyrights

• Compile information regarding the company's product and/or service warranties and warranty claims

• Compile information regarding the presence, use, storage and disposal of hazardous materials

The M&A Process:Preparing the Business for Sale

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Letters of Intent

Determine if the parties can agree on the structure and business points of a transaction prior to spending substantial amounts of time, energy and money conducting due diligence and preparing formal documentation.

• Provide a summary of the proposed business arrangement

• Fix a timetable for completing the transaction (which can be particularly helpful in complex transactions)

• Identify the various contracts included in the transaction such as employment or consulting agreements, license agreements or severance arrangements

• Identify conditions to closing the transaction such as obtaining financing and buyers due diligence review

• Measure of commitment

• Psychological effect on future negotiations

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Under California law, the parties are bound by a letter of intent if they intend to be bound.

Texaco Inc. v. Pennzoil — The court upheld a jury verdict of $10 billion against Texaco. A short description of this case illustrates the pitfall of neglecting this issue.

Letters of Intent ‒ Enforceability

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• Price

• Structure

• Target Closing

Letters of Intent ‒ Key Issues

• Employees

• Confidentiality

• Exclusivity

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Due Diligence

• Financial

• Tax 

• Legal 

• Human Resources

• Intellectual Property

• Environmental

• Other

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Deal Structures

• Asset Purchase

• Stock Purchase 

• Merger

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Challenging Issues

• Consideration• Cash

• Notes — Seller financing 

• Stock

• Earnout — Appear in 38 percent of deals

• Representations• 23 percent — Actual Knowledge

• 73 percent — Constructive Knowledge (68 percent in 2008 / 61 percent in 2006)

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• Indemnification• Triggering events — Breach of

representations, failure of performance

• Basket  

• Basket as a percentage of the deal value

• Cap on Indemnity —  Cap amounts as a percentage of deal value

• Survival

• Escrow — Holdbacks

Challenging Issues

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Common Mistakes by Sellers• Sellers fail to prepare themselves

for the time and emotional commitment required.

• Sellers fail to adequately prepare the business for sale.

• Sellers treat buyers as friends.

• Sellers convince themselves that the transaction is completed when it has only just begun.

• Sellers fail to develop a negotiation strategy prior to beginning negotiations.

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• Sellers believe that buyer’s attorneys are acting independently

• Sellers are not prepared for due diligence and respond poorly

• Sellers work on joint projects with the buyer prior to closing

• Sellers run out of cash during the negotiations

• Sellers cut corners

Common Mistakes by Sellers

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What is an IPO?

The process of offering the securities of a private company, generally common stock, for sale to the general public for the first time.

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Advising the Client — IPO

• How do you advise an early stage company regarding an IPO strategy?

• The decision to conduct an IPO is monumental.• Early in the company’s life, no corner may be

cut

• It forever changes the way a company does business — before and after the IPO

• It may give the company access to deeper sources of capital than a private company

• The IPO process is expensive and time consuming

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“Going public is like standing in front of an X-Ray machine forever. You are completely exposed. Everything about the business is in the public domain and in front of the competition.” 

— Anonymous CEO

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Trends in IPOs

• 2013 was a banner year — 82 VC-backed companies raised $11.25 billion

• 2013 biggest year for internet IPOs since 2000 (Twitter raised $1.82 billion)

• Institutional investors are more receptive — IPOs as a class traded up 64 percent through the end of the year

• 2012 IPOs — Average tech IPO is up 170 percent from the offering price  

• Pipeline is robust 

• Companies are preparing earlier

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Factors Affecting the IPO Market

• Economic conditions — Economic growth is a key determinant of strength of the capital markets 

• Capital market conditions — Need stable robust capital markets

• Geopolitical factors — European debt crisis; Iran/Arab spring

• Regulatory environment — Favorable vs. hostile 

• Venture capital pipeline — Pool of IPO candidates impacted by trends in venture capital

• Private equity impact — PE firms seek to divest companies through the IPO process

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Profile of Successful IPO Candidates• Outstanding management — Every company going IPO needs

experienced and talented management with high integrity, a vision for the future, tremendous energy and courage and proven ability to execute

• Market differentiation — A superior product, technology or service in a large growing market

• Substantial revenues — At least $50–$75 million in annual revenue

• Revenue growth — Consistent and strong revenue growth of 25 percent or more annually

• Profitability — Track record of earnings and ability to grow or protect profit margins

• Market capitalization — Potential market capitalization of $500 million to facilitate the development of a robust trading market

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IPO Process• Prepare the company for the process — 6–12

months before IPO 

• Interview and select underwriter — Quiet period begins

• Clean-up financial statements — Resolve any accounting issues

• Audit prior years’ financial statements• Prepare for due diligence process• Fill any holes in the management team

• Conduct due diligence — Led by the underwriter and its legal counsel

• Prepare registration statement — Usually on Form S-1 Company legal counsel

• Prepare FINRA filing — UW legal counsel

• Prepare Blue Sky filings — Company legal counsel

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IPO Process• File Registration Statement with the SEC

• SEC and FINRA will comment on registration statement

• Respond to comments

• Road Show — 20 days before effective date of registration statement

• Respond to final SEC comments and get them resolved

• Update financial statements to respond to SEC comments

• File pricing amendment 1–10 days before effective date

• Auditor delivers audit opinion/comfort letter 

• Underwriting syndicate is formed

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• Due diligence completed

• Execute underwriting agreement — On offering day 

• Print final registration statement and prospectus 

• SEC declares offering effective

• FINRA declares no objection 

• Provide stock certificates 5–7 days after launch

• Collect proceeds 

• Deliver documents and legal opinions — Company counsel

• Auditor delivers bring-down comfort letter

IPO Process

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Key Players in an IPO• Company — Management, especially CEO and CFO 

• Legal counsel for the company 

• Lead underwriter

• Underwriter’s legal counsel 

• Company independent auditor 

• Advisory accountant

• Financial printer 

• SEC  

• FINRA 

• State securities regulators

• Stock exchange — NYSE, NASDAQ

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James C. Chapman, Partner Bingham McCutchen LLP

Jim is a corporate and securities lawyer focusing on start-up and emerging publicly traded and privately held companies looking to expand domestically and internationally and the venture capitalists, private equity groups and angels that invest in them. He has been involved in approximately 250 mergers, acquisitions and finance transactions and is the author of approximately 50 articles on issues related to raising venture capital, mergers and acquisitions, start-ups, doing business in China and other topics. Jim has been recognized by Legal 500 as one of the best lawyers in the U.S. for mergers and acquisitions, and was named one of the Top 25 Clean Tech Lawyers in California by the Daily Journal.

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