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M&A Nuggets
M&A Nuggets: Be Prepared for Due Diligence, Before You Go to Market Part 3 – Privacy Policies
This is Part 3 of a series on steps business sellers should take to make sure their house is in order before going to market. The Health Insurance Portability and Accountability Act, better known as HIPAA, was enacted in 1996 as one of the first laws to protect the privacy of personal identifiable information. The increase in attempts by cybercriminals to obtain or hold hostage private information, whether through ransomware, phishing attacks or other efforts, has been in part the reason for spurts in the enactment of additional privacy laws to protect personal information. As a result of the greater susceptibility of personal information to attack and the increase in the number of laws designed to protect the information, privacy laws and policies have become one of the due diligence areas most focused on by buyers. To be prepared, sellers must first understand which privacy laws apply to them. In the United States, HIPAA, which is designed to protect healthcare information, is the most significant federal law. At present, there is no overall federal law protecting privacy information in general. However, several States have enacted their own privacy laws, including California, Virginia, Utah, Colorado and Connecticut, and more are on the way. It is important to determine whether these laws apply to your business. A State’s law may apply to your business even though you do not do business in that State. Among the most important overseas laws is the General Data Protection Regulation, known as GDPR, which regulates the information of residents of the European Union. Again, just because your business does not operate in the European Union does not mean that your business is not subject to the GDPR, as that law applies to businesses that collect and process information of European residents. The privacy laws establish policies and standards that must be followed to protect personal information. Once it is understood what laws are applicable to your business, the next step is to determine whether your business has in place the policies and standards that are required, including whether its online privacy policies and terms of use are sufficient. Making sure that your business is in compliance with privacy laws will not only go a long way to protect the personal information of persons who do business with you (your employees, customers and members of the public who visits your website or app), but will provide comfort to potential buyers that you have adequately dealt with this area of high risk. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
September 22, 2022
M&A Nuggets
M&A Nuggets: Be Prepared … for Due Diligence, Before You Seek to Sell Part 1 – Sales Tax
The due diligence process, during which the purchaser requests and analyzes large volumes of information, requires a huge time commitment from the sellers’ personnel. Unknown issues and issues which are known but have not been dealt with in the past, can rear their head during the due diligence process, interrupt the otherwise smooth flow of information exchange and, in turn, cause unnecessary pauses and extensions of the deal. To avoid this, it is wise to address these issues prior to seeking to sell the business. Routine items that are easily buttoned down before negotiations begin include making sure corporate documents are in place, that employment policies are up to date and that intellectual property, such as trademarks, have been properly protected. Other issues are not so routine. This article will focus one of those more unusual, or less thought of, issues – sales tax. The issue is – has the business properly collected, paid and reported all required sales tax. Unfortunately, this issue often arises for the first time during the due diligence process, when the purchaser asks about it. Many states have expanded the application of their sales tax statutes to more and more activities, particularly services, and to more ways that products or services are delivered, particularly on-line and out-of-state sales. Many sellers are surprised to learn during the due diligence process that sales tax had not been properly accounted for. The sales tax number not accounted for, when added to interest and potential penalties owed to state governments, can be a significant number and could result in part of the purchase price being held back at closing. This all can be avoided by conducting a sales tax analysis prior to entering into negotiations. The following questions should be answered: 1) which services and products the company provides are subject to sales tax, 2) are the means by which the company provides the services and products (on-line sales, shipments out-of-state) taxable, and 3) are any of the company’s customers (nonprofits, for example) are exempt from the payment of sales tax. The sales tax analysis can be laborious, given that the laws vary state by state. However, being up to speed on the issue and ensuring that the company is in compliance beforehand can save a lot of time, money and worry during the negotiation process. Look for the next issue – change of control provisions.
July 7, 2022
M&A Nuggets
M&A Nuggets: Transparency
Suppose you are in the process of selling your business, and you are aware of an existing issue or a new issue arises that you believe could have an impact on a purchaser’s view of your company. Should you disclose the matter to the potential purchaser? The answer depends on where you are in the process of the sale. If you are at the preliminary discussion stage with potential purchasers, none of whom have committed to move forward, then disclosure is probably not called for. Prior to having a committed potential purchaser ready to move forward, many of these issues can be dealt with and disposed of. If, however, you are at the stage at which a potential purchaser is fully committed to move forward to acquire your business, then the answer is yes. You should disclose. The kinds of issues to be disclosed include an existing or new lawsuit, a difficult co-owner or key employee, or a provision in a key third party agreement, such as a right of first refusal, that has to be dealt with. Often, the perception of the severity of an issue is greater than reality. Further, purchasers of businesses are accustomed to hiccups along the way. Some of these kinds of matters may not be able to be resolved before closing and therefore a purchaser will have to deal with them after closing. Being transparent and communicating potential major issues to the purchaser early on allows both sides to determine whether to move forward and, if so, how to address the issue. Waiting to disclose a major issue to a purchaser could cause delays, higher expenses to be incurred and possibly the loss of a deal. A benefit of being transparent is that it engenders in the purchaser a sense of goodwill and fair dealing on the part of the seller. Certainly, throughout negotiations in the sale of a business, there are times when it is best to maintain a poker face and not let the purchaser know your reaction to an issue. In the event of a potentially major issue that the purchaser is likely to be concerned about, however, the chips are off the table and transparency is the better practice. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
March 16, 2022
M&A Nuggets
M&A Nuggets: Listen, Listen, Listen
In the first M & A Nugget five years ago, I discussed the importance of “Think Win-Win”, which is Habit 4 in Stephen Covey’s book “The 7 Habits of Highly Effective People”. Habit 5 from that book is “Seek First to Understand, Then to be Understood”. This Habit is equally important in an M & A transaction. While both sides in a transaction often communicate early on what each side wants to achieve, it is important for the buyer and seller to first understand what the objectives and motivations of the other side are. This is crucial at an early stage, to determine whether the merger has the chance to succeed. For example, from the seller’s standpoint, what are the buyer’s short and long term plans for the target company, what is the buyer’s intention with respect to the employees of the target company post-closing, and what does the buyer want out of the owner of the target company post-closing? From the buyer’s perspective, what involvement with the business does the seller’s owner want to have post-closing, is the seller at a stage of life in which the seller desires to participate in an equity rollover and have a second opportunity to share in a future sale of the business, and what are the plans post-closing of the seller’s key management team? Understanding the other side’s answers to these questions goes a long way to help the listener decide whether to proceed and whether it makes sense to make any adjustments in the listener’s thinking about how to proceed with the transaction before and after closing. If the parties decide that it is mutually beneficial to move forward after listening to each other, the detailed negotiations will follow. As the myriad of important legal, operational, financial and tax issues arise, understanding one side’s viewpoint and overall objectives in the transaction is extremely productive in resolving these issues in a way that satisfies both sides. So, remember to listen first, and to then think and respond. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
March 9, 2022
M&A Nuggets
M&A Nuggets: Exclusivity
One important component of the letter of intent for the sale and purchase of a business is the exclusivity paragraph. In that paragraph, the seller agrees to deal only with the interested purchaser for a specified period of time. This exclusivity is important to purchasers, because they will be devoting significant time, resources and money to investigate the seller, conduct due diligence and determine the final terms of the transaction to present to the seller. The exclusivity obligation is therefore almost always a requirement. However, sellers should be wary that the exclusivity paragraph is not too restrictive. The exclusivity language should always contain the period of time the seller agrees to negotiate only with the interested purchaser. That period of time needs to be thoughtfully considered. A seller’s business is not on the market during the exclusivity period. Too long of a period could result in missed opportunities if the deal contemplated by the letter of intent falls apart. Exclusivity periods of ninety days are common. The first drafts of exclusivity paragraphs presented by buyers usually contain a requirement that the seller notify the buyer of any other offers received, the names of the party submitting the offer and the terms of the offer. The problem with this language is that offers are often submitted on a confidential basis. So, while it is not problematic for a seller to notify the other party to the letter of intent that another offer has been received, the name and terms of the offer should be not be disclosed and the exclusivity paragraph should be modified accordingly. The bottom line here is that an exclusivity paragraph in a letter of intent is necessary, but it should be modified to accommodate the needs of the buyer while not unduly restricting the seller. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
February 22, 2022
M&A Nuggets
M&A Nuggets: How Will Your Company Be Valued
Up until the early 2000s, the valuation of a privately held company was determined largely by following the guidelines of a 1959 revenue ruling issued by the Internal Revenue Service, which focused on earnings. A lot has changed and a lot has remained the same since then. How will your company be valued in the market? Presently, the most common valuation methodologies are (1) a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”), and (2) a multiple of gross revenues. The multiple of EBITDA method remains the most commonly used method of valuation. Earnings, or profits, before the deductions for depreciation, interest, taxes and amortization are determined for anywhere from the most recent one year to most recent three year period. The earnings are then adjusted, or smoothed out, to eliminate unusual variances that will not be recurring, such as one-time gains on sales of assets or one-time losses. The average adjusted earnings are then multiplied by a cap factor. The cap factor used ranges widely, depending on the industry. A more recent valuation phenomena, which is now commonly used, is the multiple of revenue method. By this method, gross revenues are simply multiplied by a number. As with the EBITDA method, the range of multiples can vary widely, again, depending on the industry. The revenue multiple method is not for every company. Younger companies with no profits or companies which have very fast growth prospects are often valued using the revenue multiplier method. Not surprisingly, that method is now common for technology companies. Under either the EBITDA or the revenue multiplier methods of valuation, a gem looked at and favored by buyers is recurring revenue, meaning revenue that is expected to continue in the future. Today, most companies that desire to increase value should focus on adding recurring revenue. Before looking for a purchaser for your company, it is important to understand how your company will be valued. The above nugget offers a brief explanation of that. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
February 15, 2022
M&A Nuggets
M&A Nuggets: Laws Triggered by a Merger
As part of due diligence, purchasers investigate whether selling targets are in compliance with the myriad of laws governing a target’s historical business operations. Separate and apart from those laws, are laws that are actually triggered by a merger, that is, that would not apply but for the planned merger. Sellers and purchasers must be aware of these laws to determine whether they apply, and if they do, take steps to comply so that the merger is not delayed or prohibited. Here are four examples of laws triggered by a merger: The WARN Act, which stands for Worker Adjustment and Retraining Notification Act. This law requires employers to provide the United States Department of Labor with at least 60 days’ prior notice of any plant closing or mass layoff. The rule generally applies to employers with at least 100 employees when an event occurs that results in a layoff of at least 50 employees. Some states have their own version of the WARN Act. Any merger transaction that involves a plant closing or a mass layoff needs to be vetted to determine whether the WARN Act applies; The Hart Scott Rodino Act. The purpose of this law is to allow the government a period of time to determine that a merger will not violate anti-trust laws. The Act requires notice to be given to the United States Department of Justice and imposes a 30-day waiting period before a merger of a certain size can occur. Generally, if the merger involves a target with a value greater than $92 million or the purchaser and seller have assets or sales of at least $184 million and $18.4 million, the Hart Scott Rodino rules apply; Bulk Transfer Laws. These are state laws that require a buyer of a business that sells inventory to notify creditors in advance of a business sale. Although the Bulk Transfer laws were uniform across all states, many states have eliminated their Bulk Transfer laws. In states with Bulk Transfer laws, it is common for the parties to a merger transaction to agree to waive compliance with the laws. Tax Elections. Many significant tax issues arise in merger transactions. Some of these tax issues require agreements between the seller and purchaser and timely elections of tax consequences to be filed with the Internal Revenue Service. For example, the manner in which the purchase price is allocated in an asset purchase is usually agreed to and requires a common filing with the Internal Revenue Service. In a stock purchase, there is often an agreement to split the tax year into two short tax years, one tax year beginning on the first day of the year of the sale and ending on the closing date and the second tax year beginning on the day after the closing date and ending on the last day of the year in which the sale occurs. This split tax year agreement also requires a filing with the Internal Revenue Service. It is crucial that the seller and purchaser understand which “triggering” laws apply to a merger, so that timely notice under the laws is given, and that closing will not be delayed because of non-compliance. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
July 28, 2021
M&A Nuggets
M&A Nuggets: The Due Diligence Barrage - How to React
After the letter of intent for the sale and purchase of a business is signed, the potential purchaser will then deliver its due diligence list to the target company. The due diligence list can be voluminous. It is not unusual for a list to contain twenty pages with more than 200 specific requests. The topics covered include many areas, from financial to tax to corporate and operations. The target’s owner may be inclined to attempt to handle the due diligence list on its own. It is crucial, however, that the target’s advisors be brought in upon receipt of the due diligence list. Here is why: Due diligence lists often are a purchaser’s attempt to “shoot for the moon”, requesting details that may not be needed for time periods that may not be needed. In fact, the due diligence list is negotiable. Your advisors can guide you on which items the potential purchaser should be asked to remove from the list; For the reasons discussed below, it is important that an organized system be created by which each request and answer to it is linked. Your advisors can assist you to set up that system; Documents provided in response to the due diligence requests usually contain information that must later be disclosed in the representations and warranties section of the purchase agreement. It is important for your advisors to be able to determine early on what disclosures in the purchase agreement will need to be made; and In that regard, documents to be provided in due diligence may contain a surprise or two, since many of the documents may be old and/or never have been reviewed. For example, in one transaction I handled in 2019, one of the target’s vendor contracts contained a right of first refusal in the vendor to purchase the target. These kinds of surprises need to be learned about and dealt with soon in the sale process. By asking for the assistance of your advisors early on, the due diligence process can be made much more manageable, resulting in a substantial savings of time and money. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
July 21, 2021
M&A Nuggets
M&A Nuggets: Know Your Buyer
Many times, a business seeking to sell is in discussions with the wrong buyer – a mismatch. Negotiating with a mismatched buyer can be a waste of time, money and resources and lead to either the demise of a potential transaction or a transaction taking longer with much greater effort, all of which could have been avoided. It is therefore very important that a seller conduct its own due diligence on potential purchasers. This due diligence should include the following: Checking the background of the owners of the potential purchaser – in conducting this check, treat the owners as you would a job applicant; The potential purchaser’s experience in the M & A arena – has the potential purchaser acquired any businesses? The potential purchaser’s finances – requests should be made for the potential purchaser’s financial statements and for evidence of the source of its purchase price funding; References – ask the potential purchaser for the names and contact information of the owners of other companies that have been acquired and contact those references; NDA – insist that any potential purchaser sign a non-disclosure agreement up front. Any reluctance to do so should be a warning sign; The potential purchaser’s objectives – obtain a clear understanding of the purchaser’s objectives, which can vary greatly depending upon whether the purchaser is strategic or financial; and Time Frame – ask the purchaser for a definite time frame in which it anticipates closing the transaction. A reluctance to state a time frame could indicate that you are dealing with a purchaser which is always exploring but never willing to commit. By following the above suggestions, a seller can go a long way to assure that its purchaser is a match. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
May 28, 2021
