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Mergers and acquisitions: quarterbacking the deal

Tech companies looking to merger and acquisition (M&A) deals as an exit strategy need to keep their eye on the ball and choose the right quarterback. That’s the collective wisdom of Northern New England brokers, investment counselors and veterans of acquisitions.

“If you just focus on the exit, you’re dead,” said Rich Napolitano, former CEO of Acton, Mass.-based Pirus Networks and now vice president of Sun Microsystems’ Data Services Products. “An effective strategy is not about running down the field staring at the goalpost; it’s about blocking and tackling.”

Investors, employees, and acquirer Sun Microsystems welcomed the recent $165 million sale of Pirus Networks, said Napolitano, who advised, “The way you sell something is not to sell it. Companies are not sold; they’re bought.” Achieving a mutually rewarding merger or acquisition is the result of a mature relationship nurtured over time.

In the current environment, tech companies need to develop an exit strategy that makes sense and maximizes product value to accomplish a transaction that satisfies company goals. Chris Dahl, partner in the Boston, Mass.-based firm of Lucash, Gesmer & Updegrove LLP, urged companies to identify their value proposition, be it their technology, cash from VCs attractive to someone else, or something else. Sellers can prevent buyers from driving up a purchase price adjustment by honestly acknowledging what they’re selling, said Michael Droof, shareholder, Sheehan Phinney Bass & Green, P.A., Concord, N.H.

How information is exchanged between the parties in a deal is “a very important procedural dance,” said Tony Perkins, shareholder with Bernstein, Shur, Sawyer, & Nelson P.A. in Portland, Maine. “Start stepping on people’s toes and they don’t want to dance anymore.” Jesse Devitte, managing director of Borealis Ventures in Hanover, N.H., stressed beginning the integration phrase during the acquisition phase — especially people and their respective company cultures — as key to a successful acquisition. Droof advised companies to realistically assess their chances of making a deal close before signing a letter of intent. If they can’t, they emerge as damaged goods.

Perkins recommended knowing what to say before the buyer asks. For example, intellectual property never signed over to the company may be the only unfinished business but the buyer will see it as the tip of the iceberg.

“The two most likely culprits” that cause a merger or acquisition to stall or fail, said Dahl, are “bad surprises unearthed by the buyer, usually in the due diligence process, and tax and other economic issues ignored or misunderstood when settling upon a price, and that change the value proposition when discovered.” Other factors include creditor, customer, or vendor problems, reductions in volume, pricing changes, litigation, contractual arrangements with a third party requiring consent to assignment or consent to change and letting business advisors drive the deal.

Sometimes surprises are out of the seller’s control, such as when Autodesk had a CEO change that had nothing to do with seller Softdesk or the deal, but which put off the deal. However, “when Autodesk bought us later on, we went public and our valuation was much higher,” said Drew Ogden, legal counsel at Softdesk and now a partner in Concord, N.H.-based Henniker River Group. Ogden characterized his firm as a business development firm that works in exchange for a success fee or equity during what usually amounts to a three-year period of helping companies prepare their exit strategy. 

The seller has to understand how the deal must be put together for it to work, and get lawyers involved before rather than after settling on a price, only to learn too late that the tax effect will reduce the perceived net value. Like a good quarterback, the M&A lawyer develops strategy and executes the plan to dramatically affect the outcome of the deal.

Droof cited four primary responsibilities of the M&A lawyer: 1) structuring the transaction and advising the client as to the most advantageous tax and liability structure for the deal; 2) helping the client negotiate the terms of  a preliminary agreement such as a letter of intent and definitive purchase and sale agreement; 3) bringing that agreement to closure by ensuring its language and obtaining the certifications, signatures and consents of key employees and third-party and/or regulators; and 4) dealing with indemnity claims after closing.

Legal expertise is especially necessary for acquirers who accept stock as payment. Securities laws dictate that stock in small or medium-sized companies be issued as private placement rather than as a public offering, and generally restrict its resale for a period of two years unless the Securities and Exchange Commission (SEC) allows a resale exemption under Rule 144.

Unlike publicly traded shares, buyers can’t liquidate private company shares to lessen risk, according to Martin Eisenstein, partner, Brann & Isaacson, Lewiston, Maine.

However, if the deal is structured properly, he added, buyers can defer the tax into the future when shares are actually sold. Sellers need to consider whether shares will be restricted by vesting, whether they’re getting shares fully earned and not subject to forfeiture in the future, and that shares will be taxed as capital gains and not ordinary income.

Although Eisenstein cited earnings before interest, taxes, depreciation and amortization (EBITDA) as a big factor behind the decrease in M&A deals, and at the end of the third week of November 2002 www.mergerstat.com showed deal flow value down from $615,971.3 in 2001 to $407,414.6 in 2002, Jesse Devitte thinks the market for software company M&A is about to heat up.

Devitte reasons that bigger software companies who have had to drastically cut their R&D budgets still need new and updated products and technology for their customers, so they buy smaller software companies feeling the pinch of a slow economy and more flexible than ever before on price. Tech companies would do well to prepare themselves.

[sidebar] Preparing the playing field

A tech company looking to be acquired needs to:

  • Stay one step ahead of underwriters by performing due diligence on itself as well as its clients, collecting, managing and updating information in advance of acquisition.
  • Thoroughly examine company assets to understand the true balance sheet and income statement.
  • Resolve outstanding legal issues and blemishes like back taxes.
  • Tie together representations and warranties regarding the accuracy of financial records as stated in the purchase contract.
  • Assess and make current the articles of incorporation, operating agreements, annual reports, votes of officers authorizing action items, list of shareholders and shares subject to vesting.
  • Clear the stock ledger and any related shareholders’ agreements.
  • Get key employee agreements with independent or subcontractors in clear and concise writing as to the impact of the relationship on the business.
  • Safeguard the potent bargaining tool of intellectual property with appropriate trademark, copyright, or patent filings; and nondisclosure, nonsolicitation, noncompetition and assignment of invention agreements.
  • Know the legality of transferring outside licensed intellectual property to assets or company stock in a sale.
  • Have business-specific (not boilerplate) license agreements in place.
  • Document key customer and supplier relationships in writing.
  • Provide incentive packages to maintain loyalty among key employees whose departure could affect the value of the purchase price.
  • Talk to investment counselors and bankers, business brokers, industry godfathers, and people involved in tech industry purchase and sales to get the word out to the right audience.

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