CLOSING STAGEPart of the Business Transition & Exit Planning 2015 Series

Premiere Date: October 15, 2015

CLOSING STAGE

Practical and entertaining education for business owners and executives, Accredited Investors, and their legal and financial advisors.

For more information, visit www.financialpoisewebinars.com

IMPORTANT NOTE: THE MATERIAL IN THIS PRESENTATION IS FOR GENERAL EDUCATIONAL PURPOSES ONLY. IT SHOULD NOT BE CONSIDERED LEGAL, INVESTMENT, FINANCIAL, OR ANY OTHER TYPE OF PERSONAL ADVICE. YOU SHOULD

CONSULT WITH AN APPROPRIATE PROFESSIONAL ADVISOR TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS.

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MEET THE FACULTY

MODERATOR:Jonathan Friedland

Sugar Felsenthal Grais & Hammer

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PANELISTS: Peter Feinberg, Hoge Fenton Sean Roberts, Huron Capital

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ABOUT THIS EPISODE

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Many corporate M&A deals that start never conclude. Why?

What are the pitfalls that can cause a deal to crater? How do experienced dealmakers navigate them to a successful closing?

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ABOUT THIS SERIES

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Business Transition & Exit Planning is geared toward the junior to mid level professional and the experienced business owner. Its goal is to provide a thorough overview of the legal aspects of buying and selling a business.

Each panel discusses its topic in plain English and in a way that requires the attendee to have no background on the subject. As with all Financial Poise webinars, each episode in the series is designed to be viewed independently of the other episodes: think sitcom rather than soap opera.

EPISODES IN THIS SERIES

EPISODE #1 Business Valuation Explored 4/23/15

EPISODE #2 How to Get a Business Ready for Sale 5/21/15

EPISODE #3 The Marketing Stage of Selling Your Business6/18/15

EPISODE #4 Letter of Intent Stage 9/17/15

EPISODE #5 Closing Stage 10/15/15

EPISODE #6 All about ESOPS 11/19/15

EPISODE #7 Post Sale Topics 12/17/15

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CLOSING STAGE

(Dates below are premier dates; all webinars also available on demand)

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What is a Closing?

What can parties do to maximize the likelihood of getting to a close?

Why is a closing checklist so critical and what are best practices to create one?

When should the Closing be?

What are the biggest risks to a Closing after the definitive agreement is signed?

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FIRST THINGS FIRST- THE LOI or TERM SHEET

1. Purpose• Establish a list of material terms to be agreed upon during the negotiation process

2. Process• Draft term sheets go back and forth between parties• Beware of offer and acceptance issues• Balance needed:

• If too detailed then moving straight to definitive agreements may be better• Ambiguity of terms leads to later disputes with the document drafter taking

“upper hand”

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DRIVERS OF STRUCTURENature of Target

Public Target

PrivateTarget

o Negotiation will focus on reps and warranties, indemnity, and purchase price adjustments

o Less focus on fiduciary out; shareholder approval is commonly obtained shortly after signing

o Negotiation focus on conditions to closing

o No indemnity or purchase price adjustments

o Reps and warranties act as closing conditions

o Heavily “market” driveno Fiduciary out

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DRIVERS OF STRUCTURENature and Timing of Consideration

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NOTES

o Defined valueo Limited liquidityo Credit risk

ACQUIRER STOCK

o Uncertain valueo Uncertain liquidityo Potential tax advantageso Registration rights

CASH

o Defined valueo Certain liquidityo Key issue often timing

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REQUIREMENTS BY TRANSACTION• Stock Purchase Agreements

o All shareholders of target company must sell their shareso Potential to purchase 100% outstanding shares and squeeze-out

remaining shareholders through mergero Remaining shareholders have dissenters/appraisal rights

• Merger Agreementso Does not require approval of 100% of target company shareholderso Non-consenting shareholders may assert dissenters/appraisal rights

• Asset Purchase Agreementso Shareholders of target company must approve saleo No appraisal/dissenters rights in Delaware (but yes in Illinois)

• Appraisal/Dissenters Rightso Allow non-consenting shareholders to seek “fair value” for shareso Court decides what “fair value” is

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Such evidence commonly takes following forms:

In Letter of Intent/Term Sheet, Buyer will specify whether third party debt or equity financing will be required, and often date by which a firm commitment for financing must be obtained

In the Purchase Agreement, Seller may ask Buyer for a rep that Buyer has wherewithal to close transaction and/or a covenant that Buyer will use commercially reasonable efforts to obtain financing

If period of time exists between signing Purchase Agreement and closing transaction, Seller will ask to be kept apprised of status of Buyer’s financing, and Seller may ask for a pre-closing covenant to this effect

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FINANCING• Seller often will ask Buyer for evidence that Buyer has

ability to finance acquisition

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BUYER FINANCING CONDITIONIf Buyer is in strong negotiating position or if credit markets are uncertain, Buyer will customarily obtain a “financing condition”, which is a closing condition in Purchase Agreement that says Buyer does not have to close transaction if Buyer does not obtain third party financing on reasonable terms.

If closing condition is contained in Purchase Agreement, then Buyer’s financing term sheet with bank or other financing source will often be attached to the Purchase Agreement as exhibit and serve as basis for financing terms Buyer must accept

Buyer’s financing source (i.e., bank) will usually perform its own due diligence on Seller’s business to ensure that collateral for loan (i.e., the Seller’s assets) is sound.

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SELLER NOTE

If outside financing is unavailable to Buyer,

parties may negotiate a “Seller note”, which is agreement by Seller to accept part of purchase

price in form of promissory note rather than cash at closing. 

Seller notes also “bridge the gap” in valuation

Seller notes customarily have a term of 1-5 years and constitute 20-50% of purchase price (but

sometimes more)

Seller should remember that Seller note

payments usually are subordinate to other

obligations of company, including financing by

outside parties

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Valuation Determinants

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• Above-average growth outlook

• Recurring revenue streams

• Large universe of potential buyers – consolidating industry

• Highly cyclical• Large CapEx or working

capital requirements• Slow/no growth• Commodity products

• Distinct competitive advantages

• Good management depth• Consistent financial

performance• Scalability• Broad and diversified

customer base

• Uneven financial performance

• Customer concentration• Weak management bench• Lack of transparency

and/or detailed financial reporting

Industry

Company

Positive Influences Negative Influences

A variety of industry and company-specific metrics will be considered by prospective buyers in determining an appropriate valuation for your company.

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BRIDGING THE PRICE GAP- EARNOUTS

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• A pricing mechanism with a portion of the final purchase price contingent upon actual post-sale events defined and measured by contractually established criteria (a.k.a. “Contingent Additional Purchase Price”)

• Key characteristics:• Identified achievement criteria – metrics for calculation• More common in sale of privately-held companies• More frequent in deals with transaction value below $250 million

• Advantages:• Solving Valuation Gaps: Buyer and Seller have different perspectives on

value or outlook for the target, so they agree to tie purchase price to future performance

• Financial Motivation for Sellers to Stay and Successfully Run Business• Alternative Financing: Buyer has insufficient cash for payment of full

purchase price at closing

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RATIONALE FOR EARNOUTS

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Used by Buyers and Sellers to bridge valuation

gaps

•Rewards Seller if projections are achieved•Limits risk of overpayment by Buyer for business that fails to achieve projections

May be particularly useful in the following

situations:

•Volatile industries•Unproven product, technology or contract pipeline•General economic uncertainty•Buyer who seeks alternative financing

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• Method of Risk Allocation and Goal Congruence

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PROTECTIONS BUYERS HAVE AGAINST BREACHING SELLERS

Reps/WarrantiesIndemnificationHoldbacks

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MATERIAL CONTRACTS

Must determine what they areMust determine what consents are needExamples:

Employment agreementsLeasesKey supply agreementsKey customer agreements

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WHAT DOES A BUYER BUY?

AssetsIP SharesCustomersManagement teamSeat on the board

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SPECIAL RISKS/CONCERNS

Labor IssuesEnvironmentalRisk of competition by former employeesIP-heavy companies

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DUE DILIGENCE: DEFINITION

“Due Diligence” generally refers to the investigation,

examination and verification by a multidisciplinary team of the material factual and

legal circumstances of target

By conducting due diligence, Buyer seeks review

information sufficient to enable it to make informed

decision on whether to proceed.

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DUE DILIGENCE How much? Retain advisors? Typical items:

Profit-and-loss statements Detail of adjustments to EBITDA Balance sheets Tax returns List of hard assets (e.g., furniture, fixtures, equipment) List of inventory, analyzed as to usability in the business Commercial property appraisal or lease agreement Material contracts Software and other IP Licenses Aged list of receivables Aged list of payables

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PREPARATION

• Form - tailor to transaction• Deal or industry specific• Allow for follow-up

questions

Diligence Request

List• Background research• Understand purpose of

review• Line up specialists

Prepare

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REPS AND WARRANTIESPurpose

• Risk Allocation and Indemnityo Seller makes a series of reps to Buyer about Seller and its businesso Seller provides indemnity if reps are breachedo Buyer will ask Seller to rep to matters it is not certain ofo Purpose is to allocate risk regarding matters to Seller

o Frequently a matter of argument in negotiations between Buyer and Seller• Closing Condition

o Reps true at signing and at closingo Buyer can walk if reps not true at closingo Closing standard may require reps be true “in all material respects” (strong) or

“in all respects”, except where such breach would not constitute a “Material Adverse Effect” (weak)

• Diligenceo Reps tend to “focus a seller’s mind”o Schedules list exceptions to the reps and help focus diligenceo Schedules may force affirmative disclosures – e.g., contracts, independent

contractors, insurance claims history, etc.

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REPS AND WARRANTIESThe “Knowledge” Qualifier

• A “knowledge” qualifier is intended to shift the risk of the unknown from the Seller to the Buyer

Example: “To the Seller’s knowledge, none of the Seller’s products that are or have been designed, created, developed, assembled, manufactured or sold by Seller is infringing, misappropriating or making any unlawful use of any intellectual property owned by any other person.”

• Be very careful to understand from the parties who bears the risk if an “unknown” becomes “known” during the pre-closing period.

• If it is intended that the Buyer continues to bear the risk, then be sure to add a temporal element to the representation.

Example: “To the Seller’s knowledge as of the date hereof, ...”

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REPS AND WARRANTIESThe “Knowledge” Qualifier

Whose knowledge?

What level of knowledge?

o Every person in the company?

o C-level executives?o Who knows about the

deal?

o Actual knowledge?o Actual knowledge, after due

inquiry?o Knowledge a person would

reasonably be expected to have by virtue of such person’s title, or position with, or duties performed for, the Company?

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COVENANTSTwo Types

Pre-Closing

Post-Closing

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COVENANTSPre-Closing

Operation of the Seller’s Business

“During the pre-closing period, Seller shall conduct its business in the ordinary course and shall not take the following actions...”

Seller’s Perspective:

• Seller needs to ensure that it can operate the business in a manner that will not leave it unduly damaged in the event the deal does not close

Buyer’s Perspective:

• Buyer will want certainty that Seller’s financial and business condition is substantially the same at closing as at signing

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COVENANTSPre-Closing

Access

“The Company will make its facilities and personnel reasonably available to the Buyer during normal business hours.”

Buyer’s Perspective:

• Buyer wants to start integration planning

Seller’s Perspective:

• Seller needs to keep running the Company well to make sure conditions are met

• Seller does not want Buyer to engage in fishing expeditions prior to closing

• Seller does not want Buyer indirectly operating business - through contact with its employees, soon to be Buyer’s employees – until business is actually sold

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COVENANTSPost-Closing

Anti-Trust Regulatory Approvals

“The parties agree to take all actions necessary to obtain all applicable U.S. and approvals in connection with the Merger.”

Buyer’s Perspective:

• Buyer may not be able to find purchaser/acceptable price for business unit if divestiture is required

Seller’s Perspective:

• Immaterial divestitures required by regulators should not give Buyer a “walk” right

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COVENANTSPost-Closing

Tax cooperationAsset transfer cooperation

PublicityNon-compete

Employee mattersOther

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INDEMNITYKey Issues

• Breaches of reps and warranties• Breaches of covenants• Specific indemnity items (e.g., litigation

which has been disclosed by Seller)

Indemnification for what?

• Joint or several• Survival or representations and warranties• Caps (i.e., maximum amount of recovery)• Baskets/Thresholds• Escrow as source of recovery

Limitations

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INDEMNITYSurvival

Survival Periods typically range from 6 months to 36 months, tend to be 12 months to 18 months

Parties should focus on “business realities” when negotiating length of survival period (i.e., how long will it take before Buyer has a sense whether representation has been breached?)Certain representations and warranties may survive until the applicable statute of limitations (e.g., tax, ERISA, environmental)

Other representations typically survive forever (e.g., ownership of the shares, capitalization of Target (in stock deal), authorization of transaction)

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INDEMNITY• Seller will typically try to cap Buyer’s recovery for indemnity claims to a portion

of the purchase price (e.g., the amount of the escrow, fixed dollar amount, % of purchase price, etc.)

• Baskets/Thresholds

• Intended to discourage immaterial claims• Amount typically reflects an agreed upon dollar amount, which is typically

based on a percentage of the purchase price• A proxy for materiality?

• Sole remedy provision

• Fraud carveout• Generally used when Buyer believes Seller may not be able or willing to

meet potential indemnification obligations or Buyer is unwilling to go through the process of collecting from seller

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POST CLOSING TASKS- Net Working Capital Adjustments

• Purchase Price is often adjusted after closing for difference between expected or target net working capital number at closing and actual net working capital number at closing

- Purchase Agreement Obligations

• Net Working Capital Adjustments• Earnout• Indemnification Claims• Post-Closing Covenants• Required Filings and Notices

- Other Post Closing Arrangements

• Transition Agreements• Employee/Consulting Agreement• Escrow Agreements

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MORE ABOUT THE FACULTY

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PETER FEINBERG

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Peter Feinberg has almost 25 years’ experience  representing primarily middle market companies in all aspects and many sectors of merger and acquisition transactions.  Mr. Feinberg has successfully closed well over 100 merger and acquisition transactions, representing buyers and sellers, public and privately held companies, multinational firms, family owned businesses and private equity firms.  He practices in Silicon Valley at Hoge Fenton Jones & Appel, a more than 60 year old, 40+ attorney firm.  He has previously been a partner at Thelen Reid & Priest and Ferrari Ottoboni and has worked in house at NetApp and Clorox.

pdf@hogefenton.com

MORE ABOUT THE FACULTY

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JONATHAN FRIEDLAND

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Jonathan Friedland is a partner with Sugar Felsenthal, where he serves as outside general counsel to a number of closely held businesses and their principals; represents private equity funds and others in their M&A activities; and guides companies and their constituents through financially challenging situations.

Jonathan holds the highest possible rating from Martindale-Hubbell (AV® Preeminent™) and AVVO (10/10), has been repeatedly recognized as an Illinois “Superlawyer” in the areas of Business/Corporate Law and Bankruptcy & Creditor/Debtor Rights, and has received several other similar distinctions.  Jonathan has been profiled, interviewed, and/or quoted in many publications, including Buyouts Magazine; Smart Business Magazine; The M&A Journal; Inside Counsel; LAW360; Business Week.com; The Bankruptcy Strategist; Dow Jones Daily Bankruptcy Review; Bankruptcy Court Decisions; Dow Jones LBO Wire; and The Daily Deal.

Jonathan is lead author of Strategic Alternatives For and Against Distressed Businesses, an 800 page treatise; Commercial Bankruptcy Litigation, a 1500 page treatise; The Investors’ Guide to Alternative Assets, a best-selling e-book; and more than 100 articles on various legal and business topics. He graduated from the State University of New York at Albany, magna cum laude, in 1991 (after three years of study) and from the University of Pennsylvania Law School in 1994, upon which he clerked for a federal judge. He served as Adjunct Professor of Strategic Management at the University of Chicago’s Graduate School of Business for several years and was the 2006 Clayton Center for Entrepreneurial Law Visiting Professor of Business Law at the University of Tennessee College of Law.  Jonathan is also the founder and chairman of DailyDAC, LLC.

jfriedland@sugarfgh.com

MORE ABOUT THE FACULTY

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SEAN ROBERTS

Sean is a Vice President with Huron Capital Partners. He is responsible for sourcing, evaluating and analyzing investments made by the firm.

Prior to joining Huron, Sean was an equity research analyst with Lehman Brothers where he covered public companies in the retail sector. His responsibilities included strategic and financial analysis of retail companies, industry research, and preparation of written reports to convey investment recommendations to institutional investors. Prior to Lehman Brothers, Sean was with Ernst & Young where he performed financial statement audits, primarily in the industrial and financial services industries.

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sroberts@huroncapital.com

Business Transition and Exit Planning.com  (“B-TEP”), owned by Financial Poise, is an online

plain-English educational resource for business owners contemplating, or getting ready, to sell their

businesses.

Visit us on line at http://

www.businesstransitionandexitplanning.com/

www.financialpoisewebinars.com

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IMPORTANT NOTE:

THE MATERIAL IN THIS PRESENTATION IS FOR GENERAL EDUCATIONAL PURPOSES ONLY.

IT SHOULD NOT BE CONSIDERED LEGAL, INVESTMENT, FINANCIAL, OR ANY OTHER TYPE OF ADVICE ON WHICH YOU SHOULD RELY.

YOU SHOULD CONSULT WITH AN APPROPRIATE PROFESSIONAL ADVISOR TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS. 46