Mergers and Acquisitions

Table of contents

1. Copyright
2. About the Authors
3. Preface
4. 1. Merger and Acquisition Overview
   1. Introduction
   2. Central Role of Strategic Planning in the Merger and Acquisition Process
      1. General
      2. Investment Considerations
         1. Strategic Fit
         2. Speed of Implementation
         3. Cost of Implementation
         4. Synergistic Benefits
      3. Impact of Globalization
      4. Enhanced Risk
   3. Types of M&A Activity
      1. General
      2. Mergers versus Acquisitions
      3. Large Public versus Small Private Acquisitions
         1. Strategic Impact
         2. Regulatory Requirements
         3. Stock or Asset Purchases
         4. Leverage of the Parties to the Transaction
         5. Risk Profile of the Transaction
      4. Strategic versus Financial Acquisitions
      5. Portfolio Acquisitions of Holding Companies
      6. Other Characterizations of Acquisitions
      7. Divestitures versus Sales of an Entire Business
   4. Transaction Overviews
      1. General
      2. Acquisition Process
         1. From Process Initiation through Target Qualification
         2. From Valuation through Preliminary Agreement
         3. From Due Diligence to Approval to Proceed to Contract
         4. Contract and Close
         5. Postacquisition Integration
      3. Sales Process
         1. Prenegotiation Preparation
         2. Negotiation
         3. Due Diligence
         4. Contract and Close
      4. Divestiture Process
         1. Divestiture Planning
         2. Transaction Preparation
         3. Transaction Execution
      5. Importance of Proper Planning and Disciplined Implementation
   5. Role of the Financial Manager in Mergers and Acquisitions
      1. General
      2. Coordination
         1. Internal Coordination
         2. Coordination of External Experts
      3. Financial Analysis
         1. Financial Criteria and Metrics
         2. Valuation
      4. Determination of Deal Structure
         1. Assets versus Stock
         2. Earn‐Outs
         3. Working Capital Adjustments
      5. Due Diligence
         1. Establishing Due Diligence Objectives
         2. Managing the Due Diligence Process
         3. Reporting on Results
5. 2. Candidate Search and Qualification
   1. Introduction
      1. Strategic Considerations
      2. Phases of the Acquisition Process
   2. Overview of the Search and Qualification Process
      1. General
      2. Early Identification of an Acquisition Candidate
      3. Importance of Structure and Discipline
      4. Continuous Evaluation
   3. Creation of a Core Acquisition Team
      1. General
      2. Role of the CEO
      3. Need for the Involvement of the CFO
      4. Role of the M&A Attorney
   4. Search Effort
      1. General
      2. Research
      3. Use of the Internet
      4. Networking
      5. Conclusion
   5. Candidate Screening
      1. Basic Criteria
         1. Availability
         2. Strategic Fit
         3. Liabilities
         4. Size
         5. Growth Characteristics
         6. Profitability
         7. Potential Synergies and Efficiencies
      2. Identification
      3. Contact with the Target Company
      4. Confidentiality
      5. Meeting with the Principals of the Target Company
      6. Qualification
      7. Mutual Agreement
   6. Acquisition Charter
      1. Acquisition Charter
      2. XYZ Corporation
      3. February 2007
         1. Targeting Objectives
         2. Profile Data
         3. Acquisition Criteria
6. 3. Valuation and Preliminary Agreement
   1. Introduction
   2. Valuation Overview
      1. Conceptual Framework
      2. Publicly Traded Acquisition Targets
      3. Synergy
         1. Revenue Synergies
         2. Cost Synergies
         3. Impact of Synergies on Purchase Price
      4. Privately Held Acquisition Targets
      5. Valuation Approaches and Methodologies
         1. Income Approach
         2. Asset‐Based Approach
         3. Market Approach
   3. Valuation Modeling
      1. General
      2. Preliminary Information Request
      3. Normalization of Historical Results
      4. Establishing Stand‐alone and Investment Value
      5. Validation of Value by Use of Multiples
      6. Comparing Valuations to Investment Criteria
      7. Use of a Comprehensive Model
   4. Acquirer's Internal Approval to Proceed
   5. Establish a Mutual Understanding of Broad Terms of the Transaction
   6. Documentation of the Broad Terms of the Transaction
      1. General
      2. Content of Letter of Intent
   7. Request for Information to Be Used in Due Diligence
   8. A Survey of Valuation Methodology and Techniques
   9. Valuation Model
      1. Standard of Value
      2. Operational Analysis
      3. Financial Analysis
      4. Valuation Approach
         1. Income Approach
         2. Asset‐Based (Cost) Approach
         3. Market Approach
      5. Valuation Methodology
         1. Capitalization of Earnings
         2. Discounted Earnings Method
         3. Price/Earnings Ratio Method
         4. Dividend‐Paying Capacity Method
         5. Net Asset Method
         6. Excess Earnings (Return on Assets) Treasury Method
         7. Excess Earnings (Return on Assets) Reasonable Rate Method
         8. Guideline Method
         9. Direct Market Data Method
         10. Rule of Thumb and Formula Method
      6. Analysis of Discounts and Premiums
         1. Discount for a Minority Interest
         2. Premiums
         3. Discount for Lack of Marketability
      7. Estimate of Value
   10. Synthesizing the Estimate of Value: Final Comments
   11. Illustration of Letter of Intent
   12. Illustrative Information Request
   13. XYZ Software CO
       1. General
       2. Financial
       3. Human Resources
       4. Legal/Real Estate
       5. Customer Information, Order Entry, and Billing Systems
       6. Shipping/Production
       7. Sales and Marketing
       8. Business Planning and Development
       9. Product/Technology
       10. Miscellaneous Operations
   14. Endnotes
7. 4. Preparing for and Executing Due Diligence
   1. Introduction
   2. Creation of the Due Diligence Team
      1. General
      2. Composition of the Due Diligence Team
      3. Other Considerations
   3. Development of the Due Diligence Program
      1. General
      2. Key Aspects of the Due Diligence Program
   4. Planning Due Diligence
   5. Conducting Due Diligence
      1. Components of the Due Diligence Review
      2. Other Considerations
   6. Reporting on Due Diligence
      1. General
      2. Summary Report
      3. Final Approval Document
   7. Variation on the Theme: Auctions
      1. General
      2. Auction Process
   8. Acquisition Due Diligence Checklist
   9. Business Overview
      1. Company Background and Organization
      2. Review of Proposed Transaction
      3. Management
      4. Related Party Transactions
      5. Labor Force
      6. Product Development and Production
      7. Research and Development
      8. Marketing
      9. Legal and Regulatory Matters
      10. Contracts
      11. Insurance
   10. Financial Review
       1. General
       2. Cash
       3. Accounts Receivable
       4. Miscellaneous Receivables
       5. Inventories
       6. Property, Plant, and Equipment
       7. Prepaid Expenses, Deferred Charges, and Other Assets
       8. Long‐Term Investments
       9. Intangible Assets
       10. Current Liabilities (Other than Income Taxes)
       11. Deferred Revenue
       12. Income Taxes
       13. Long‐Term Debt
       14. Contingent Liabilities
       15. Commitments
       16. Leases, Franchise, and Royalty Agreements
       17. Capital Stock
       18. Income Statement Accounts
       19. Budgeted and Forecasted Data
       20. Systems
   11. Acquisition Candidate Information
   12. Corporate
   13. General
   14. Financial
       1. Current Year and Historical Results
       2. Revenue
       3. Operating Expenses
       4. Balance Sheet Accounts
       5. Other Accounting Matters
   15. Technology
       1. General
   16. Products
       1. General
   17. Marketing and Sales
       1. General
   18. Legal
       1. General
       2. Regulatory Matters
       3. Material Agreements
       4. Facilities
   19. Taxes
   20. Insurance
       1. General
   21. Human Resources
       1. General
       2. Management
       3. Significant Agreements: Nonmanagement
       4. Employees
       5. Demographics
       6. Issues Management
       7. Safety Matters
       8. Development
       9. Employment Costs
       10. Benefit Plans
8. 5. Contract and Close
   1. Introduction
      1. Agreement and Supporting Documents
      2. Simultaneous versus Delayed Close
      3. Contract Negotiations
   2. Elements of the Agreement
      1. Property Transfer and Purchase Price Information
      2. Representations and Warranties
         1. Representations and Warranties Common to Buyer and Seller
         2. Additional Buyer Representations and Warranties
         3. Additional Seller Representations and Warranties
      3. Covenants
      4. Conditions
      5. Indemnification
      6. Schedules to the Agreement
   3. Supporting Documents
      1. Noncompete Agreements
         1. General
         2. Legal Status
         3. Enforcement
         4. Tax Aspects
         5. Other Limitations
         6. Negotiation
      2. Employment/Consulting Agreements
      3. Transition Services Agreement
   4. Illustration of Stock Purchase Agreement
   5. Illustration of Stock Purchase Agreement
   6. Article I Purchase and Sale
   7. Article II Purchase Price and Noncompetition Payment
      1. Cash Payment
      2. Noncompetition Payment
      3. Promissory Note
      4. Security
   8. Article III Representations and Warranties of the Seller and the Company
      1. Organization and Good Standing
      2. Corporate Authority
      3. Capitalization of the Company
      4. No Violation of Obligations
      5. Financial Statements of the Company
      6. Assets
      7. Liabilities
      8. Operations since the Financial Statements
      9. Legal Proceedings
      10. Material Agreements
      11. Employees
      12. Compliance with Law
      13. Environmental Compliance
      14. Tax Returns
      15. Insurance
      16. Complete Disclosure
   9. Article IV Representations and Warranties of Buyer
      1. Organization and Qualification of the Buyer
      2. Corporate Authority
      3. No Violation of Obligations
      4. Financial Statements
      5. Liabilities
      6. Compliance with Law
      7. Legal Proceedings
      8. Liens
      9. Securities Compliance
      10. Complete Disclosure
   10. Article V Information and Confidentiality
       1. Provision of Information Relating to Company
       2. Confidentiality
       3. Provision of Information Relating to Buyer
       4. Contacts with Third Parties
   11. Article VI Consulting and Noncompetition Agreements
       1. Consulting Agreement
       2. Noncompetition Covenant
   12. Article VII Conditions to Closing
       1. Seller's Conditions
       2. Buyer's Conditions
   13. Article VIII Closing
       1. Certificates
       2. Company's Legal Opinion
       3. Endorsement of Stock Certificates
       4. Resignation of Seller
       5. Election of New Officers and Directors
       6. Issuance of New Stock Certificate
       7. Purchase Price
       8. Security for Purchase Price
       9. Consulting Agreement
       10. Noncompetition Covenant
       11. Noncompetition Payment
       12. Other Acts
   14. Article IX Termination
       1. Failure to Close
       2. Failure of Condition
       3. Termination by Agreement
   15. Article X Mutual Indemnification
   16. Article XI Postclosing Operations
       1. Release of Seller
       2. Operations in Ordinary Course
       3. Reports
   17. Article XII General Provisions
       1. Survival of Agreement
       2. Notices
       3. Successors and Assigns
       4. Merger
       5. Governing Law
       6. Obligations to Brokers
       7. Modification or Severance
       8. Captions
   18. Illustration of Assets Purchase Agreement
   19. Illustration of Assets Purchase Agreement
   20. Article I Purchase and Sale of Assets
   21. Article II Purchase Price and Noncompetition Payment
       1. Cash Payment
       2. Noncompetition Payment
       3. Promissory Note
       4. Security
   22. Article III Assumption of Liabilities
   23. Article IV Representations and Warranties of the Shareholder and the Seller
       1. Organization and Good Standing
       2. Corporate Authority
       3. No Violation of Obligations
       4. Financial Statements of the Seller
       5. Assets
       6. Liabilities
       7. Operations Since the Financial Statements
       8. Legal Proceedings
       9. Material Agreements
       10. Employees
       11. Compliance with Law
       12. Environmental Compliance
       13. Tax Returns
       14. Insurance
       15. Complete Disclosure
   24. Article V Representations and Warranties of the Buyer
       1. Organization and Qualification of the Buyer
       2. Corporate Authority
       3. No Violation of Obligations
       4. Financial Statements
       5. Liabilities
       6. Compliance with Law
       7. Legal Proceedings
       8. Liens
       9. Complete Disclosure
   25. Article VI Information and Confidentiality
       1. Provision of Information Relating to Seller
       2. Confidentiality
       3. Provision of Information Relating to Buyer
       4. Contacts with Third Parties
   26. Article VII Consulting and Noncompetition Agreements
       1. Consulting Agreement
       2. Noncompetition Covenant
   27. Article VIII Conditions to Closing
       1. Shareholder's and Seller's Conditions
       2. Buyer's Conditions
   28. Article IX Closing
       1. Certificates
       2. Seller's Legal Opinion
       3. Assignment and Bill of Sale
       4. Assignment of Intangibles and Contracts
       5. Assumption of Assumed Liabilities
       6. Purchase Price
       7. Security Agreement
       8. Noncompetition Covenant
       9. Noncompetition Payment
       10. Corporate Authorization
       11. Tax Allocations
       12. Subordination Agreement
       13. Consulting Agreement
       14. Other Acts
   29. Article X Termination
       1. Failure to Close
       2. Failure of Condition
       3. Termination by Agreement
   30. Article XI Mutual Indemnification
   31. Article XII Postclosing Operations
       1. Release of Shareholder
       2. Operations in Ordinary Course
       3. Reports
   32. Article XIII General Provisions
       1. Survival of Agreement
       2. Notices
       3. Successors and Assigns
       4. Merger
       5. Governing Law
       6. Obligations to Brokers
       7. Modification or Severance
       8. Captions
9. 6. Postacquisition Integration
   1. General
      1. Integration and Synergies
      2. Operational Integration
      3. Importance of Speed of Implementation
   2. Pre–Due Diligence Phase
      1. Integration Leadership
      2. The Team
      3. Preliminary Plan
      4. Cultural Evaluation
   3. Due Diligence Phase
   4. Post–Close Phase
   5. Overview of the Process
   6. Areas of Focus
      1. Human Resources
      2. Facilities
      3. Information Technology
      4. Research and Development and Product Development
      5. Sales
      6. Marketing
      7. Accounting and Reporting Systems
   7. Conclusion
   8. Guidelines for Managers and Executives
   9. Guidelines for Managers and Executives in the Acquiring Firm
   10. Guidelines for Managers and Executives in the Acquired Organization
10. 7. Financing
    1. Introduction
    2. Business Plans and Their Uses
       1. Importance of Projections
       2. Cash Flow Projections
       3. Business Plan as Validation of the Acquisition Rationale
    3. Financing Resources
       1. Use of Internal Assets
       2. Leveraged Transactions
       3. Seller Financing
       4. Equity and Debt Financing
          1. Allocation of Risk
          2. Importance of Equity
          3. Shopping for Debt
          4. Lender Leverage
          5. Guarantees
          6. Subordination
          7. Forms and Types of Equity
          8. Public Offerings
11. 8. Sales and Divestitures
    1. Introduction
    2. Sale of an Entire Business
       1. Acquisitions or Mergers of Public Companies
       2. Acquisitions of Privately Held Businesses
          1. Unsolicited Sales
          2. Preparing a Business for Sale
    3. Divestitures
       1. Strategic Divestitures
       2. Financial Divestitures
       3. Predivestiture Issues and Considerations
          1. Delay
          2. Undercommitment of Resources
          3. Infrastructure Integration
          4. Personnel Issues
          5. Hart‐Scott‐Rodino Act
          6. Conclusion
       4. Divestiture Planning
          1. Approval Document
          2. Retention Plan
          3. Creation of the Divestiture Team
          4. Development of the Divestiture Plan
          5. Development of a Communication Plan
       5. Preparing for the Transaction
          1. Engagement of Broker
          2. Engagement of Accounting Firm
          3. Development of Management Presentations
          4. Development of an Offering Document
          5. Identification of Potential Buyers
          6. Preparation of a Data Room
       6. Execution of the Transaction
          1. Announcement of the Prospective Sale
          2. Solicitation of Initial Bids
          3. Managing Due Diligence
          4. Finalization of the Bid Process
          5. Contract Negotiations and Close
    4. Illustrative Divestiture Timeline
12. 9. Federal Income Taxation of Acquisitions
    1. General
       1. Overview
       2. Ordinary versus Capital Gain or Loss
       3. Nontaxable Transactions
       4. IRS Powers
       5. Buyer‐Seller Conflict
       6. Note of Caution
    2. Taxable Acquisitions
       1. General
       2. Structures of Taxable Asset Acquisitions
       3. Corporate Liquidations
       4. Allocation of Purchase Price in Asset Acquisitions
       5. Gain or Loss of the Seller in Asset Acquisitions
          1. Determining Amount and Character of Gain or Loss
          2. Recapture
          3. Effect on Shareholders of Complete Liquidation after Sale of Assets by a Corporation
       6. Taxable Stock Acquisitions
    3. IRC Section 338
       1. General
       2. Regular Section 338 Election
       3. Section 338(h)(10) Election
    4. Tax‐Free Mergers and Acquisitions
       1. General Concepts and Requirements
       2. Types of Tax‐Free Reorganizations
          1. Type A Reorganization–Statutory Mergers
          2. Type B Reorganizations
             1. Creeping Control
          3. Type C Reorganizations
          4. Type D Reorganizations
             1. Acquisitive Type D Reorganizations
             2. Divisive Type D Reorganization
          5. Hybrid Reorganizations: Triangular Mergers and Reverse Triangular Mergers
             1. Triangular Merger
             2. Reverse Triangular Merger
             3. Continuity Requirement in a Reverse Acquisition
             4. Taking a Corporation Private Qualified as a Reverse Acquisition in Technical Advice Memorandum 9806003
    5. Tax Losses and Tax Credit Carryovers of Acquired Corporations
       1. General
       2. IRC Section 381
       3. IRC Sections 269 and 482
       4. IRC Section 382
          1. General
          2. IRC Section 382 Limitation
       5. IRC Section 383
       6. IRC Section 384
    6. Miscellaneous Tax Considerations
       1. Installment Method of Reporting Gain Not Available to Accrual Method Taxpayers
       2. Expenses of Taxable Acquisitions
       3. Small Business Stock
13. 10. Purchase Accounting
    1. General Principles of Purchase Accounting
    2. Determining the Cost of an Acquisition
       1. General
       2. Stock Issued in Payment of Purchase Price
       3. Direct Costs of Acquisitions Other than Purchase Price
       4. Premium or Discount
       5. Assets Exchanged
       6. Contingent Consideration
       7. Preacquisition Contingencies
       8. Stock Option Exchanges
    3. Recording Assets Acquired and Liabilities Assumed
       1. General
       2. Appraisals
       3. Guidelines for Allocating Acquisition Cost to Individual Assets and Liabilities
          1. General
          2. Marketable Securities
          3. Receivables
          4. Inventories
          5. Plant and Equipment
          6. Intangible Assets
          7. Other Assets
          8. Accounts and Notes Payable
          9. Accrued Liabilities
             1. Pension Costs
             2. Vacation Pay and Compensated Absences
          10. Other Liabilities
              1. Costs to Exit an Activity of an Acquired Company
              2. Involuntary Employee Termination Benefits and Relocation Costs
              3. Disclosure
    4. Purchase Accounting in Special Areas
       1. Inventories
          1. Allocation of Acquisition Cost Including Seller's Profit
          2. Inventory Purchased in Separate Contract
          3. Last‐in, First‐Out Inventory
       2. Leases
          1. Unfavorable Leases
          2. Favorable Leases
          3. Lease Classification
          4. Assumption of a Leveraged Lease as Lessor
       3. Preacquisition Contingencies
       4. Foreign Currency Translation
       5. Minority Interests
       6. Purchased In‐Process R&D Costs
       7. Accounting for Acquired Assets That Are to Be Disposed Of
       8. Intangible Assets and Goodwill at Acquisition Date
       9. Intangible Assets and Goodwill after Acquisition Date
       10. Reporting Units
       11. Effective Dates and Transition for Statements 141 and 142
    5. Income Tax Accounting
       1. General
       2. Deferred Taxes
          1. General
          2. Deferred Taxes in Goodwill Situations
          3. Deferred Taxes in Negative Goodwill Situations
       3. Postacquisition Recognition of Net Operating Loss and Tax Credit Carryforwards
       4. Goodwill
       5. Aggressive Tax Positions
       6. Miscellaneous
          1. Identifiable Intangibles
          2. LIFO Inventories
          3. Tax Rates
       7. Effects of Consolidated Tax Implications
    6. Record Keeping for Purchase Accounting Acquisitions
    7. Financial Reporting of a Purchase Acquisition
    8. Illustrations of Purchase Accounting
       1. Positive Goodwill Situation
       2. Negative Goodwill Situation
14. 11. Securities and Exchange Commission and Other Regulatory Requirements
    1. Overview of Regulatory Environment
    2. Securities Law Requirements upon Merger or Acquisition
       1. Primary Filing Requirements
       2. Private Sale Exemptions
          1. Size of Offer
          2. Relationship to Issuer
          3. Secondary Distribution
       3. Form S‐1 Filings
       4. Form S‐4 Filings
    3. Solicitation and Preparation of Proxies
       1. General
       2. Information Included in Proxy Statements
    4. Tender Offers
       1. General
       2. Purchase of Own Securities
          1. Purchase during a Third‐Party Tender Offer
          2. Other Self‐Tenders
          3. Financial Statement Requirements
       3. Third‐Party Tender Offers
          1. Tender Offer Commencement
          2. Financial Statements of Certain Bidders
    5. SEC Financial Reporting Requirements
       1. Historical Financial Statements of Registrants
       2. Historical Financial Statements of Acquired Entities
       3. Probable Acquisitions
       4. Periods to Be Presented
       5. Acquisitions of Individually Insignificant Subsidiaries
       6. What Constitutes a Business
       7. Stock Exchange Requirements
       8. Pro Forma Financial Statements
          1. Article 11 Presentation of Pro Forma Information
          2. Multiple Presentation for Some Transactions
       9. Unique Situations Involving IPOs
       10. Significant Foreign Equity Investees and Acquired Foreign Businesses of Domestic Issuers
       11. Foreign Private Issuers
       12. SEC Staff Position on Financial Statements of Businesses Acquired or to Be Acquired
    6. Antitrust Regulations
    7. Other Regulations
       1. Blue Sky Laws
       2. ERISA Filings
       3. IRS Rulings
       4. Other Filings
    8. Significant SEC Regulatory and Accounting Pronouncements