GENERATING GROWTH, BUILDING CONNECTIONS.
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PRE-LOI
If all seller (or seller representative) representations and proposed adjustments are positive, you should be skeptical about what negative items have not been disclosed. Do your due diligence to vet key representations and pro forma adjustments that seem too good to be true.
A quick screen of the organization type before LOI should indicate whether tax basis step-up will be difficult (or possibly not even possible).
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- Each owner’s role and responsibilities are compared to job titles with similar responsibilities.
- Benchmark compensation by job title, industry, location, size, and other relevant factors.
- Compare owner's compensation as a percentage of revenue to that of similar businesses. The benchmarking data is derived from multiple subscription-based services.
If the company is being purchased for its technology platform, be sure that it has a solid technology foundation to build upon. If the reason is for sales/marketing opportunities and the plan is to “rip and replace” the technology platform, then decide how long you can live with what exists.
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QUESTIONS TO ASK
What happens to an employee benefit plan in an acquisition, and what is the timing of transition?
DISCOVERFor employee retention, many merging companies combine the best benefits of each. During the due diligence process, benefit consultants, brokers, lawyers, and accountants determine disparities between the plans (including coverage and costs) and take steps to integrate them, which may last more than a year beyond the merger or acquisition.
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DILIGENCE PROCESS
QUESTIONS TO ASK
Are there any potential cost savings/synergies or potential incremental costs resulting from changes in cost structure that should be considered in your investment thesis?
DISCOVER- The existence of potential synergies or anticipated post-close cost savings upon integration should be incorporated into the model.
- Any incremental costs or investments that may be required post-close (such as enhancement of finance / accounting or other back-office functions) should also be incorporated into model.
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- Income (federal/state/local)
- Personal property
- Sales & use
- Payroll (including 1099 vs. employee categorization)
The valuation firm should have experience in the valuation of intangible assets and be familiar with the various methodologies used to value intangible assets (e.g., the multi-period excess earnings method or MPEEM, relief from royalty method, discounted cash flow).
- Fixed assets
- Identified intangibles
- Rollover equity
- Other equity instruments
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Getting a year-over-year look at risk assessment and the overall risk-management plan can help. It also helps show how risk is being tracked year over year and provides insight as to whether an organization understands that it has risk and what the organization is doing to fix those problems.
QUESTIONS TO ASK
Why does the buyer need to understand potential outstanding benefit liabilities and any termination provisions?
DISCOVERAny bonus, vacation, pension, or health-and-wellness liabilities or termination provisions should be identified during the diligence phase to avoid delay to timelines for transition plans. In certain instances, changes to employment terms can result in additional compensation or vesting of certain benefits, adding both time and expense to proposed deals.
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DEAL EVALUATION
QUESTIONS TO ASK
Does the adjusted EBITDA as a result of financial due diligence align with the buyer’s investment model?
DISCOVERIf all seller (or seller representative) representations and proposed adjustments are positive, you should be skeptical about what negative items have not been disclosed. Do your due diligence to vet key representations and pro forma adjustments that seem too good to be true.
Be sure to agree on working capital target and calculation mechanism. Also ensure you have contemplated all items to be included in the definition of indebtedness.
QUESTIONS TO ASK
What kind of structure will optimize buyer tax deductibility and associated filings that may need to be made within a specified time period after the transaction?
DISCOVERAsset purchases, F-reorganizations, or having the seller make a 338(h)(10) or 336(e) election will allow the buyer to amortize or depreciate the additional value paid over the basis of the assets. The structure will be dependent upon the type of entity and will be part of the negotiation
Tip: Consider a lookback period for any tax issues that transfer to the buyer.
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There are various types of financial instruments that may be used to assess whether an investment meets the risk & return appetite of the organization as a whole.
EXPERTS WEIGH IN
QUESTIONS TO ASK
What should be considered if there is interest in the target company’s intellectual property?
DISCOVERBe sure you understand what data-loss controls are in place and whether the organization has sensitive, proprietary information properly secured. Don’t be caught blindsided by an employee who downloads confidential information to a USB drive, uploads it to a cloud repository, and takes it for use not approved.
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A sample of items to look at is as follows:
- Talent
- Culture
- Employee benefit plans & liabilities
- Compensation programs
- Employee contracts & policies
- Legal exposure
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CLOSING
EXPERTS WEIGH IN
QUESTIONS TO ASK
Have you considered any impact of your closing date on the working capital target?
DISCOVERTip: Consider closing at month end to minimize accounting/timing issues. Also assess any seasonality trends when assessing your target amounts.
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It is important that the various elections be made timely. In some instances, the IRS allows for relief for late-filed elections; however, in some cases, a private letter ruling may be necessary in order to obtain relief, which can be a costly and time-consuming process.
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- Valuation of intangible assets for financial statement reporting
- Contingent earnouts for purposes of the purchase price allocation and reporting the proper amount of goodwill on the balance sheet
- Favorable / unfavorable leases
- Any debt assumed (rather than incurred) from the seller in the transaction
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Strategy. If technology needs to be replaced, the process must be outlined and sequenced properly. If the technology is staying and integration with other systems needs to happen, the timeline will most likely take longer.
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To retain key employees and minimize disruption, a transition plan should be implemented as soon as possible. A transition team should be formed with members being given key tasks, target due dates, and expectations with clear responsibility. Appropriate communication to employees is often where transition plans achieve the best success.
QUESTIONS TO ASK
What type of transaction is occurring—an asset purchase or a stock purchase?
DISCOVERIn a stock purchase, the acquiring company assumes the responsibility for the plans of the acquired company. In an asset purchase, the acquiring company has more flexibility in deciding which assets to take on. The purchasing company may not acquire the existing employee benefit plans in an asset purchase.
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FIRST 90 DAYS
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Determine appropriate party to complete the returns and ensure proper allocation of costs to pre-transaction and post-transaction. Specify these roles and responsibilities within the purchase agreement.
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The integration plan. Whether you are going to rip and replace or incorporate existing technology, your IT integration plan is most important to avoid major cyber issues in the future.
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