The Mergers & Acquisition Process

The Mergers & Acquisition Process

Due Diligence

What happens in due diligence?

Confirmatory Due diligence is typically a 2 to 4 month process. It can start with a formal quality of earnings (Q of E) or amplified financial vetting of your business. This is to ensure the financials we presented were accurately portrayed. Thereafter, a buyer will typically begin clinical, human resources, and legal diligence. Once the information presented is confirmed, the buyer will begin drafting the purchase agreement (PSA). If the information is inaccurate, the buyer may want to adjust the commercial or legal terms of the agreement. All buyers spend time and money to establish confidence in what they are buying. Due Diligence can be very onerous. We establish a Data Room for sharing of information. The majority of the time between an LOI and a close is spent in this process. Intermediates will utilize a Virtual Data Room (VDR) to organize all information and ensure security and confidentiality. This is a secure storage tool, which is administrated by the seller’s representative. Only those parties who are formally invited will have access to the VDR.

What is a Q of E?

Q of E, or Quality of Earnings, is a process involving a CPA doing an audit of the financials. In many cases, our clients are doing cash accounting. The Q of E wants to confirm that the accounting is accurate if converted to an accrual basis accounting. It typically takes 2-3 weeks to conduct. If the findings show that the company has accurate accounting, then we move to the next aspect of diligence. If the accounting is not accurate, falling short of assumptions, then the buyer may ask for an adjusted valuation.

What is a Letter of Intent? (LOI)

A LOI is a Letter of Intent. It captures the vital components of selling your business which include purchase price, exclusivity, working capital, timing to close, holdbacks, governing state of law, confidentiality, reps and warranties, and sometimes other topics.

What is Exclusivity?

Exclusivity is an agreed upon period of time, typically spanning 60-90 days, where the seller agrees to ‘exclusively’ work on selling his/her company to a selected buyer. During this process, we refrain from marketing your business to other buyers.

What is an Indication of Interest? (IOI)

An IOI is an Indication of Interest. It is a less formal way to submit an offer and is used to communicate a buyer’s ‘interest’ in working towards a LOI.

Should anyone on my staff know I’m selling?

We do not encourage you to include your staff in a prospective sale process. The time to inform key staff is closer to the close of the transaction, when we are confident your company will sell. However, if you have key advisors you trust and think can be helpful in the process, it could be advantageous to involve them, especially during due diligence.

Should I review UCC Filings/Liens & Pending Litigation?

Yes! It is vital that you understand any encumbrances on the business. Prior to going to market, we suggest a lien search. Usually this is in the form of wholesale contracts and prior legal action. Buyers will review every aspect of your business before purchase. It makes sense to avoid surprises. (See LOI and Due Diligence.)

What is the difference between an asset sale and a stock sale?

An asset sale is the sale of a company’s tangible and intangible assets. A key attribute of an asset sale is the balance sheet. This may include cash, AR, and debt that remained with the previous owner.

A stock sale is the sale of a company’s shares from the existing shareholders. Stock sales usually allow for a smoother transition at close. However, the buyer must be willing to absorb the past liability of the seller’s company. When considering either of these sales, a buyer and seller may find operational, legal, and tax advantages with one over the other.

What are Reps and Warranties or Special Indemnities?

All Purchase Agreements have Representations and Warranties put forth by seller. If there is a breach the buyer will have certain financial remedies. There are Fundamental Reps and Warranties, like anything that is considered fraud. In this case, the buyer may be entitled to the reimbursement of the entire purchase price. This is highly unlikely. Standard Reps and Warranties are usually for non-compliance issues which may have a M.A.E. (Material Adverse Effect), such as a labor code that is not followed. When considering an offer, a buyer will normally reserve a percentage of the purchase price for a period of time to be a “Hold-back”. If there are any losses due to breach or reps and warranties, these monies are used. It is rare that buyers make a claim and sellers are not paid the Hold Back amount.

What are Material Adverse Effects? (MAEs)

If a buyer walks away from a deal, it is usually due to something that is potentially, or materially, harmful to the business. If a buyer litigates, citing a provision in the Purchase Agreement, there will have to be damages faced by the company to justify the litigation. For example, suing based on an ordinary representation and warranty item would need be due to how it adversely effects the business.

What are Non-Compliance Disclosures?

In the healthcare industry, it is impossible to remain in compliance with all regulations or contractual obligations. It is important to identify non-compliance early in the process and disclose to buyer. Usually this is first done in a conference call. It can also be detailed within the Rep and Warranties of the LOI. Ultimately, these Disclosure schedules will be a larger portion of the Definitive Purchase Agreement.

How is Rollover Equity Treated in a Transaction?

If the seller is part of the future senior management, or would like to invest in the buyer/new company they can choose to Rollover Equity. This is a portion of the purchase price. Keep in mind that this will represent a higher portion of equity, because the buyer is also using debt to finance the acquisition. A seller rolling over equity will usually maintain an executive position (I.e. CEO) and/or or secure a seat on the Board. We also negotiate a role that entails operational and strategic decision-making, which is covered in the operating agreements.

What is a PSA?

The Purchase and Sale Agreement (PSA) is the definitive document, detailing all aspects of the transaction. This document is where the attorneys will do most of their work. It will save time if the most sensitive provisions are negotiated ahead of this phase. These provisions may include non-compete, indemnification cap and representations and warranties.

How many agreements / contracts are involved in the transaction?

Depending on the commercial terms of the deal, there may be as many as 3 separate contracts. There is always a PSA. If the seller is rolling over equity then there will be an operating agreement. If the seller is remaining in an advisory or management capacity, then there will be an employment agreement. Keep in mind, that there can be other agreements within each of these, such as non-compete and certain disclosures.

What other assistance will I have to retain during the process (attorney)?

In all cases, an attorney is required to solidify the purchase agreement, which is the binding document to closing the deal. In some cases, a financial consultant may be required to properly present your company’s financials. It is vital that you select the proper representatives in these categories. We can assist in this selection. It should be stressed that a transaction attorney, in particular, can make or break a deal.