Conducting Sell-Side Due Diligence in M&A: Maximizing...

Conducting Sell-Side Due Diligence

in M&A: Maximizing Deal Value

and Minimizing Closing Delays

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THURSDAY, JUNE 4, 2015

Presenting a live 90-minute webinar with interactive Q&A

Claudine M. Cohen, Principal, CohnReznick Advisory Group, New York

Karen C. Hermann, Partner, Crowell & Moring, Washington, D.C.

Andrew J. Sherman, Partner, Jones Day, Washington, D.C.

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©Copyright 2015. Andrew J. Sherman. All Rights Reserved.

Part 1:

Goals and Benefits of Sell-Side Due

Diligence: An Overview

Andrew J. Sherman Jones Day

51 Louisiana Avenue, N.W.

Washington, DC 20001

202-879-3686

[email protected]

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©Copyright 2015. Andrew J. Sherman. All Rights Reserved.

Andrew J. Sherman

1500343242

Mr. Sherman is a partner in the Washington, D.C. office of Jones Day with over 2,700 lawyers worldwide.

He is the author of 26 books on business growth, capital formation and the leveraging of intellectual property.

His twenty-second (22rd) book, Harvesting Intangible Assets, Uncover Hidden Revenue in Your Company’s

Intellectual Property, (AMACOM) was published in October of 2011. Other recent titles include the best-selling

Mergers and Acquisitions from A to Z, third edition was published by AMACOM in 2010. He is also the author

of the 2nd edition of the Due Diligence Strategies and Tactics, which was published in the Spring of 2010. His

twenty-third book Essays on Governance, was published June of 2012 and in 2013, he was named by NACD as

one of the Top 100 Leaders in Governance. In 2014, he was included in the global IAM 300, recognizing the

world’s thought leaders in managing intangible assets.

He has appeared as a guest and a commentator on all of the major television networks as well as CNBC’s

“Power Lunch,” CNN’s “Day Watch,” CNNfn’s “For Entrepreneurs Only,” USA Network’s “First Business,”

and Bloomberg’s “Small Business Weekly.” He has appeared on numerous regional and local television

broadcasts as well as national and local radio interviews for National Public Radio (NPR), Business News

Network (BNN), Bloomberg Radio, AP Radio Network, Voice of America, Talk America Radio Network and

the USA Radio Network, as a resource on capital formation, entrepreneurship and technology development.

He has served as a top-rated Adjunct Professor in the Masters of Business Administration (MBA) programs at

the University of Maryland for 26 years and at Georgetown University for 17 years in both the business school

and the law school where he teaches courses on business growth strategy.

He has served as General Counsel to the Entrepreneurs’ Organization (YEO) since 1987. In 2003, Fortune

magazine named him one of the Top Ten Minds in Entrepreneurship and in February of 2006, Inc. magazine

named him one of the all-time champions and supporters of entrepreneurship and business growth.

6

©Copyright 2015. Andrew J. Sherman. All Rights Reserved. 1500343242 7

Current Trends In The

New Era of Due Diligence

©Copyright 2015. Andrew J. Sherman. All Rights Reserved. ©Copyright 2015. Andrew J. Sherman. All Rights Reserved.

Current Trends Affecting Due Diligence Best Practices

• Societal expectations of transparency/age of social

media/millenials

• Impact of shareholder activism and accountability of

company leaders/brands for the success/failure of

transactions

• Depth/breadth/scope of due diligence (post-enron,

mortgage crisis, etc.)

• Cost and timetable impact of the new era of diligence

• Volatility of capital markets and geopolitical shifts

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Current Trends Affecting Due Diligence Best Practices (Cont’d)

• FCPA/regulatory enforcement effects on due

diligence

• Data rooms vs. “face-to-face”/on-site diligence

• IP issues (crown jewels analysis, hidden intangibles,

Black Duck, etc.)

• Cyber-security and data privacy laws and

developments

• Cross-border considerations

• Other trends for discussion???

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The Art & Science

of Due Diligence


Legal and Transactional Goals of Due Diligence

• Identify and mitigate risk

• Test the underlying economic premise of the goals of

the transaction

• Prepare for post-closing integration challenges and

tasks

• Gather key information for drafting R&W’s,

covenants, indemnities, etc.

• Identify “unexpected” opportunities

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What Is “Due Diligence”?

• Due diligence is both an art and a science

• Proper due diligence involves:

Knowing where to look

Knowing what to ask

Knowing what tools to use

Knowing who to ask

Knowing how to test premises/answers

Knowing who should ask

Knowing how to verify

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What Is “Due Diligence”? (Cont’d)

• The “Art” of Due Diligence:

Understanding how to extract key information from a person or situation

Understanding the objectives of the parties and the underlying transaction

Identifying key hurdles and risks

Identifying why information might be falsified or omitted

Targeting the proper sources for disclosure of information

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What Is “Due Diligence”? (Cont’d)

• The “Science” of Due Diligence:

Do your homework

Be prepared and well-organized

Be precise in your requests

Be persistent in your quest for the truth

Don’t accept the first answer as the final answer

Trust your gut – “if it’s too good to be true …”

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Due Diligence Best Practices

• Work as a team, but have a clear quarterback/captain

• Designate a primary point of contact for each party to the transaction

• Conduct regular team meetings to compare notes and coordinate carefully

• The more you know, the better questions you can ask

• Be organized – set timetables and deadlines for deliverables

• Use industry experts early and often

• Use technological tools available to you (search engines, data rooms, etc.)

• Develop penalties/consequences/remedies for non-compliance

• Understand why a party may be trying to hide key facts or circumstances

• Question everything – BE INQUISITIVE!

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Goals and Benefits of

Sell-Side Due Diligence


Overview of the Seller’s Process

• Pre-transactional “mock” due diligence (Identify potential

“turn-off’s” and risks that will defer a potential buyer

and/or adversely affect valuation/ price/deal terms)

• What gets fixed? At what cost? When?

• Financial statement “re-casts” (understanding the actual

performance of the business on a “normalized” basis)

• Preparation of effective and accurate offering

memorandum and management presentations

• Population of the data room (phasing of process; key

participants and who will know what when?)

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Overview of the Seller’s Process (Cont’d)

• Buyer’s counsel are trained to look for problems and

then push hard for document protections/adjustment

to terms – DON’T GIVE THEM ANY MORE

AMMUNITION THAN THEY ALREADY HAVE!

• Study potential post-closing challenges, cost/impact

on buyer, etc.

• Look at internal controls/compliance practices/

accounting systems, etc. (how will a public/large

buyer perceive from an FCPA/Sarbox/etc.

perspective)?

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Due Diligence Is A

Two Way Street


Why do sellers need to conduct “reverse due diligence” on buyers?

• Selecting the right buyer

• Track record for closing deals

• Deal terms (seller financing/creditworthiness, stock

payment/business plan issues, earn-out/

trustworthiness, deferred payments/accounting

integrity

• Perceptions of key customers, channel partners,

supplies, etc.

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Why do sellers need to conduct “reverse due diligence” on buyers? (Cont’d)

• Challenges in removing/replacing seller on loan

guaranty, lease guaranty, related issues

• Channel conflict and OCI issues

• Cultural and compensation impact on employees/

ecosystem

• Post-closing dispute patterns and likelihood of

litigation

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Summary of Sell-Side Due Diligence Tips

• Be well-organized

• Be cooperative

• Be responsive

• Be strategic (what gets shared when to whom?)

• Don’t be defensive

• Think 3 chess moves ahead/”impact” analysis

• Have a key point person for coordination

• Momentum is key

• Know “when to say when” (due diligence disputes are often a precursor to larger problems)

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C O N D U C T I N G S E L L - S I D E D U E

D I L I G E N C E I N M & A

TA B L E O F C O N T E N T S

24

About CohnReznick 25

Transactional Advisory Services 26

Overview of Sell-Side Services 27

Benefits of Sell-Side Services 28

Gathering data room documents 30

Documenting problems 31

Contacts 32

Page

C O H N R E Z N I C K

B Y T H E N U M B E R S

One of the top accounting, tax and advisory firms in the U.S. We offer

solutions to the most complex and challenging business issues facing both

public and private, middle market companies

Blends the deep resources and technical acumen of a large accounting

firm with a hands-on, entrepreneurial service approach that growing

organizations require

Serves clients in numerous industries

International reach via Nexia member firms in more than

100 countries

25

10th LARGEST ACCOUNTING

FIRM

2500+ EMPLOYEES

280+ PARTNERS

26 OFFICES

$500 + MILLION IN ANNUAL

REVENUES

T R A N S A C T I O N A L A D V I S O R Y

S E R V I C E S

26

Serving a broad spectrum of industries, the Transactional

Advisory Service teams are comprised of industry and

subject matter experts who work collaboratively with

other CohnReznick Advisory Group specialty areas as well

as our industry verticals. Our services are designed to (i)

identify value-critical issues that could have adverse

consequences on your transaction, and (ii) provide

buyers and sellers with the intelligence to make informed

risk/reward decisions.

Transactional Advisory Services

Our Transactional Advisory Services

professionals deliver a full range of

services focused on all stages of the

transaction process.

Strategic Advisory Strategic Alternatives

Financing Strategies

M&A Strategies

Recapitalizations

Sell-Side Due Diligence

Financial Due Diligence

Tax Due Diligence

Information Technology and

Operational Due Diligence

Acquisition Integration

Purchase Price Dispute Resolution

With proven experience in complex

situations, unsurpassed technical

guidance, and results-driven strategy,

we deliver unparalleled insight to

maximize value.

O V E R V I E W O F S E L L - S I D E

S E R V I C E S

27

What is Seller Diligence?

Diligence is conducted from a buyers perspective with the goal of increasing buyer

confidence

Sell-side due diligence provides realistic expectations of normalized EBITDA, adds

credibility to data provided to the buyer, reduces the element of surprise during the

sales process and shorten the buyers due diligence process.

Deliverable is a function of the agreed upon scope used as part of the sale process

that has been vetted with seller management for factual accuracy and content

Typically performed as part of an auction, managed sale process, refinancing, etc.

Is paid for by the seller but intended to reduce overall diligence costs by getting

ahead and in front of issues to decrease the chance of unnecessary delays in the

sales process.

B E N E F I T S O F S E L L - S I D E

S E R V I C E S

28

Focuses on issues relevant to even the most scrutinizing purchaser.

Provides in-depth analysis on the financial condition of the seller, and aid sellers in

securing a higher price for their business by adding more control over the sale

process and reducing the sales cycle.

Identifies issues giving the seller an opportunity to fully explain circumstances that

could be perceived as flaws to the prospective buyers.

Determines the true value of their business, assist with purchase agreement structure,

address carve-out and transitional concerns and coordinate data room

composition.

Evaluation of the integrity and sustainability of historical results .

Tax due diligence & structuring, among others.

B E N E F I T S O F S E L L - S I D E

S E R V I C E S

29

Increase the quality of bids and should help to maximize value of the sale.

Reducing potential buyer diligence, there is less of a need to provide exclusivity to

any one buyer.

Set the scope such that buyer focus should be limited to key areas.

Seller will have the opportunity to comment on and screen the deliverable,

providing the opportunity to address issues proactively.

Less time will be required of seller management as the buyers perspective that we

bring will pre-empt much of potential buyer inquiry.

Allows the seller to have greater knowledge and control over the information

presented.

G AT H E R I N G D ATA R O O M

D O C U M E N T S

30

Information request list details financial data and documents available.

Organize and present documents in a systematic manner.

Focuses on information relevant to potential buyers.

Providing financial data and schedules.

D O C U M E N T I N G P R O B L E M S

31

Identify opportunities for the buyer to create & maximize value

Understand the Company’s strategy for procuring, producing, distributing,

marketing, and selling

Assessment of the quality of management & other personnel

Quality of Earnings, quality of working capital, net debt, commitments &

contingencies, cash flow, seasonality, potential exposures (e.g., off balance sheet

liabilities, etc.)

Tax footprint – current structure and whether there are opportunities to capture

value

Analyze whether growth, as projected by Management, appears reasonable

based upon historical performance

CohnReznick LLP

Claudine Cohen, Principal

646-625-5717

[email protected]

www.CohnReznick.com

32

C O N TA C T

Conducting Sell-Side

Due Diligence in M&A

Karen C. Hermann

Goals of the Management Presentation

• Provide additional information to the Buyer to potentially increase the initial offered price.

• Allow the management team to be introduced to the Buyer and to “sell” their vision for the future.

• Obtain information from the Buyer to focus down-selection of potential Buyers.

34

Components of a Management Presentation

• Overview of the management team and the target

• Significant customers / contracts

• Historical financial information

• Pipeline and growth strategy

• Market differentiators

• Threats and challenges

35

Legal Considerations

• While typically drafted by the bankers, the legal team should review for: – Antitrust concerns – Competitively-sensitive information – Inaccurate statements – Guarantees or glaring omissions

• Include appropriate disclaimers. • Limit distribution (and attendance) to persons or

entities covered by an NDA. • Confirm there is strategic alignment among

stakeholders and management team.

36

Confidentiality and Disclosure Considerations • Inevitable that confidential information will be

disclosed: – Nonpublic business information, such as customer and

employee lists. – Information about critical intellectual property. – Competitively-sensitive information, such as pricing, key

competitors or market position.

• The fact that an M&A process is being considered is itself confidential information: – In some cases, an NDA is signed with the investment bank

before the name of the target entity is revealed.

• Use reputable data sites and vendors.

37

Non-Disclosure Agreements

• Critical that the NDA be tailored to the transaction and to the parties.

• Carefully define “Confidential Information” and exceptions.

• Limit further disclosure (to lending sources, for example) or specifically address obligations.

• Buyer may request that the Seller/Target also sign the NDA to prohibit the Seller/Target from disclosing that the Buyer is engaged in the process or any of the terms of the Buyer’s offer.

38

Internal Policies and Procedures

• The internal flow of information should also be carefully managed.

• Disclosure should be limited to the “deal team” and deal team members should understand the confidentiality requirements.

• Consider setting up a password protected or separate document repository.

• Keep the deal team informed on who is or is not on the deal team.

• Hold management presentations and negotiation meetings off-site.

• Limit site tours to after hours. 39

Timing and Limits on Disclosures

• Stage the disclosures: – Do not disclose competitively-sensitive or highly-

confidential information in the initial stages of an auction process:

• Redact customer or supplier names. • Aggregate information where possible. • Disclose employee lists by employee ID only.

– There may be a need to limit some particularly sensitive information until days before or even just after signing.

• Assume that the deal will not go forward, or that this potential buyer will not be the ultimate buyer.

• Consider antitrust implications of disclosures.

40

Karen C. Hermann Crowell & Moring LLP

1001 Pennsylvania Avenue, N.W. Washington, D.C. 20004 [email protected]

(202) 624-2722

www.crowell.com

Crowell & Moring LLP is an international law firm with more than 500 lawyers representing clients in litigation, regulatory, and transactional matters. The firm is internationally recognized for its representation of Fortune

500 companies, emerging companies, and their investors as well as its ongoing commitment to pro bono service, diversity, value-based billing, and legal project management. The firm has offices in Washington, D.C.,

New York, San Francisco, Los Angeles, Orange County, Anchorage, London, and Brussels.

Contact Information

41

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