Articles Posted in Mergers & Acquisitions

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Acquiring a financially troubled company, whether in San Jose, Palo Alto, or New York often requires consideration of the bankruptcy process. If the seller is already in bankruptcy, the buyer must convince the bankruptcy court that it represents the best source of funds to repay existing creditors. If the bankrupt company has attractive technology, there may be other buyers, and the court will typically award that company to the buyer who will pay the most money.

If the seller is not yet in bankruptcy, the parties may decide to purchase the company through a bankruptcy proceeding. If planned properly, the bankruptcy process can provide the buyer with a number of advantages. First, the seller’s assets are purchased free of any liens or other claims (although courts continue to wrestle with allowing subsequent successor liability claims). Second, because the assets are purchased “as-is,” sale documentation is typically shorter than for sales outside of bankruptcy, and stockholder approval is not required.

Planning for purchasing a company through a bankruptcy involves entering into arrangements with the selling company’s creditors and other stakeholders before the bankruptcy filing. As part of these arrangements, a reorganization plan and acquisition agreement may be prepared and agreed to prior to the filing. Once the appropriate pieces are in place, the seller will file for bankruptcy and include the pre-agreed reorganization plan in its bankruptcy documentation. The sale can be completed in a few months barring no other suitors or other unforeseen impediments. Bankruptcy counsel is necessary for both parties to properly shepherd the transaction through the proceedings, and corporate counsel is critical to insure that documentation is accurate and necessary corporate formalities are followed.

Financially troubled companies often provide the opportunity for others to purchase businesses at a relatively lower cost. Reaping the advantages successfully requires balancing the needs of all the business’s stakeholders.

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Technology start-up companies in Silicon Valley exist in a highly dynamic environment, where survival can be crushed by competition from a kid in a garage or a fund partner refusing further investment. As a last gasp, some companies may try to be acquired. Companies which have had to take refuge from their creditors may be able to sell their business through bankruptcy proceedings.

When compared to a standard sale of a business, sales of financially troubled companies require the professional advisors to manage a number of different stakeholders to successfully close a transaction. More so than in standard transactions, professional advisors play an important role in helping a transaction proceed smoothly. Under certain circumstances, their fees may be paid by the buyer or the bankrupt estate.

Most acquisitions of financially troubled companies are structured as an asset purchase. This prevents the acquirer from having to automatically assume liabilities that it doesn’t want. The existing creditors are then left with satisfying their claims out of the proceeds from the sale. Most companies, however, need the products or services of its creditor vendors to survive. In the case of technology companies, these vendors often include technology and hardware suppliers who are core to the company’s business. Irritated suppliers may not want to deal with the company even after its acquisition. Creditors and stockholders of the company may have claims against the company’s board of directors if a company is sold for less than the reasonably equivalent value of its assets. At the same time, key employees of the company, aware of the company’s financial stress, may be looking for alternate opportunities. The importance of these stakeholders, and how they are managed as part of the acquisition, is at the heart of any purchase of a financially troubled company.

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In my last segment, I mentioned a recent deal involving a Northern California company structured as a stock sale. Having tax advisors assist at the early stages helped keep the transaction on track. The next major issue was allocating the risk of business liabilities between the buyer and the seller.

Like any stock purchase transaction, liabilities of the seller stay with the business. This is often a significant disincentive to the buyer, because it must hold an entity that cannot escape its past liabilities. Two mechanisms are commonly used to alleviate the buyer’s risk.

First, a working capital cushion may be created to provide a source of funds to pay the ongoing debts of the business. The amount of the cushion is agreed in the purchase documentation. A portion of the purchase price is then held back at the closing in an escrow. The amount of net assets as of the closing is determined through a post closing audit, and the held back amounts are distributed following the audit to the buyer or seller depending on any difference between the agreed amount and the amount determined under audit.

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In a recent acquisition that I handled for a company in Santa Cruz, the buyer decided to purchase, with cash, the stock of the company rather than its assets. Acquisitions through stock or equity purchases are a common method of buying a company. From an administrative standpoint, equity purchase acquisitions are one of the easiest deal structures to implement.

In an equity purchase acquisition, a company is bought by purchasing all of the ownership interests of that company. If the company is a corporation, a buyer purchases all of the company’s shares of stock from the company’s stockholders. If the company is a limited liability company or partnership, a buyer purchases all the ownership interests of the company from its members, in the case of a limited liability company, or its partners, in the case of a partnership. This discussion will focus on a stock purchase, although the basic issues outlined here are the same when dealing with a limited liability company or partnership.

The administrative benefit of a stock purchase transaction is that ownership changes simply by transferring all of the company’s shares. Contrast this with an asset purchase structure, where each desk, chair and personal computer must be accounted for and sold to the buyer.

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Because acquisition transactions in Silicon Valley move very quickly, it is a good idea to understand the basics of deal structure. Every approach contains trade-offs among a number of different factors, including ease of closing, tax impact, risk preferences, third party involvement, and regulatory issues. This post examines the asset purchase structure.

Asset purchase agreements are used when the buyer does not want to assume any liabilities of the seller, except for those specifically outlined in the agreement (and those from which applicable law does not permit the buyer to escape). This structure is typically used for small owner-operator businesses, such as restaurants, retail establishments, and small service or manufacturing businesses. It can also be used where actual, or a fear of, residual liabilities exist, such as with businesses performing hazardous operations.

In addition to their liability-limiting feature, asset purchase transactions can provide tax benefits to the buyer. For example, some of the assets purchased in the transaction can be depreciated over time.

The tax impact may of the transaction, however, require attention and negotiation. Assets which are not intended for resale may be subject to sales tax. Although the seller is liable for any sales tax in California, parties often negotiate and apportion this liability in sale documentation. Because different types of assets and obligations create different tax obligations, parties are required to agree to an allocation of the assets purchased to particular classes and report the allocations to the taxing authorities.

Special tasks face buyers purchasing a restaurant or a company which principally sells merchandise from stock. In these cases, a buyer, in cooperation with the seller, will make a “bulk sales” notice. If the buyer fails to do so, the buyer may be liable for claims of the purchased company, even if the buyer merely purchased the company’s assets.

Assets can be purchased with cash or stock. If stock is used, securities laws must be complied with, which can increase expense and time to close a sale. If a mixture of cash and stock is used, tax impacts might arise in corporate transactions depending on the relative proportion of each component.

Asset transactions create administrative burdens. All assets must be listed and accounted for. This often requires taking a physical inventory and making adjustments if the inventory predates the closing. If the business has valuable contracts, the contracts need to be reviewed to determine if they can be assigned to the buyer. If not, the other party to the contract may need to consent to the assignment, a potentially time consuming and frustrating process.

Because only assets are being purchased, employees of the purchased business may have to be terminated. Any employees with accrued vacation will have to be paid that vacation. The buyer will then have the option to hire those employees back, or bring in its own employees. For companies with a large number of employees which expect to close facilities after the acquisition, federal and California law may require advance notification to affected employees.

Asset deals provide the best liability limitation for buyers. However, their complexity may render them unwieldy for larger transactions and their use should be explored prior to committing to any sale.

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Finding a buyer for the sale of a business is a lot like dating. Your prospects and your ultimate happiness increases with the number of people you meet. Whether you cruise the bars in San Jose, or schmooze partners at a trade show in San Francisco, building interest in your company is a critical step in finding buyers.

One of the key tools used in building business acquisition interest is a set of documentation often referred to as a “book”. The book will describe the business, the industry, and the potential for growth. It may also include financial statements, projections, and risk factors.

The content of the book must be considered carefully. Financial projections should be accompanied by appropriate disclaimers, and competitive and other risks to the business post-sale should be outlined. If the sales transaction is in the high tens of millions of dollars, language stating that an acquisition could reduce competition or permit other forms of market dominance should be avoided.

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In Part 1 of this entry, I discussed the importance of a business owner choosing the right professional advisors to assist in the sale of the company, whether in San Jose or Palo Alto, and some of the different types of experts.

Although there is overlap, advisors that assist with businesses having a substantial sales price are investment bankers that specialize in mergers and acquisitions. These professionals often help in cleaning up a company’s operations, provide pre-acquisition strategic guidance, act as chief negotiators in the sales transaction, and provide advice and formal opinions concerning deal valuation.

Compensation is a key issue in any agreement with an advisor. Compensation can involve payment of an initial fee, such as where acquisition solicitation materials are prepared, to a commission, such as where the broker takes an active role in negotiations that are successfully closed. Brokers and investment bankers will typically request a non-refundable engagement fee and a success fee. The latter can take many forms. One form provides for a set amount, plus a percentage commission based on the transaction value. Another form provides for a commission percentage which changes with the transaction value, often providing higher percentage commissions for higher values to encourage the advisor to be more aggressive in its pricing negotiations. Exceptions or adjustments to the fee structure are often made for introductions or transactions then in process which were not sourced with the assistance of the professional. Most advisor contracts contain a “tail”, which allows the advisor to collect a success fee for transactions occurring within a certain period, typically 12 – 18 months after the advisory relationship ends. Sometimes the tail can be limited to transactions for which the introduction was made by the advisor.

Advisors can go a long way toward guiding a company and its stakeholders through a successful transaction. Management, however, can’t expect that the advisor will take care of everything involved, and must be prepared to contribute extensively toward the transaction’s success.

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Every business owner at one time or another wants to sell their Silicon Valley business and move from Los Altos, Mountain View or San Jose to Tahoe or Tahiti. Being bogged down in daily operations doesn’t leave a lot of time for an owner to make the necessary contacts to build interest in their company. Owners wish they could just have someone else sell their business.

There are a number of professional advisors that can assist in the sale of a company. Like fundraising, however, management cannot simply pass to someone else a function this important. One of the key reasons for management involvement is that a business buyer is typically found through the company’s own contacts.

As with any advisor, choosing the right professional to advise on potential acquirers and transaction terms is a combination of validation by your network, expertise, and your own personal comfort with the individual with whom you will be working.

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Any large business transaction, particularly a merger or acquisition, requires a well-coordinated team for success. Assembling your team early on makes a large difference between success and failure, whether you are in San Jose, California or Sydney, Australia.

The most critical advisors are your attorney and your accountant. If you are a business owner and you don’t have an attorney or an accountant advising your company, you need to get one now. Although either professional can “parachute in” to assist your company in the event of a sale, their advice to you will be much more efficient and effective if they have direct and long term experience with your company. Failing to have ongoing advice in legal, tax, and financial matters will likely result in the need for remedial work and higher expense in closing a business sale.

Finding a suitable attorney will likely be your first task in assembling your business team. As with any advisor, you should use your referral network to find a professional that is appropriate to your business. You should only choose someone who you believe can act as a trusted, strategic advisor in planning, growing, and selling your business, rather than someone who can merely produce documents. An attorney who you allow to attend your board and/or shareholder meetings and generally become familiar with your business will be able to advise you on building the proper foundation for an ultimate sale of your business. He or she will also be able to tailor their advice to the realities of your business and your own risk preferences.

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What should you do to get your company documentation ready for a potential merger or acquisition? Consult your lawyer. First, he or she will assist the company in getting its basic corporate minute book updated. Important transactions, such as those involving company stock or stock options, appointment or election of directors and officers, and substantial transactions should all be properly documented. The company’s stock book and capitalization table should be reviewed for accuracy, particularly if there are multiple owners. If the company has gone through equity financings or debt financings, closing binders containing the material documents in each of these transactions will need to be made available.

Second, your lawyer should review existing documentation for legal traps. The minefield that poorly prepared documentation presents is extensive, but a few examples can help illustrate the problem. Companies early on may not be able to afford employees, so they will use independent contractors to help create their basic technology. If the company does not have a signed agreement from the non-employee inventor assigning all rights to the company, the inventor, not the company, owns the technology. If the same company has licensed its technology under a purchase order that provides for a transfer of title, then the company now may not own its own technology because it just transferred to the customer title to its technology. Of course, because it didn’t get an assignment from the inventor in the first place, it may not have been legally able to transfer the technology to the customer, so the company may now be in breach. Situations like this do not typically advance closing dates.

Another legal trap exists in confidentiality terms, common to many contracts. These provisions prevent you from disclosing important information you receive from the other party. Often, this information includes the contract itself. As a result, you’ll need to get permission from the other party to disclose the contract. When you ask the other party to disclose, they will want to know who the recipient will be. At that point, you’ll need to disclose the name of the acquirer, and likely the fact that your company is being sold. The fact that you are being sold may not make the other party to your contract very happy. All of this requires you to make sure you know where you are under confidentiality, and to have a strategy where the disclosure requires delicate handling.

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