Mergers & Acquisitions

McDermott Will & Emery has released the Winter 2015 issue of Inside M&A, which focuses on current issues surrounding mergers and acquisitions.  Articles in this issue include:

Recent U.S. Cases Highlight Liability Risks to Executives in Mining, Heavy Industrial Transactions
Historically, corporate executives rarely faced personal or criminal liability resulting from mining or environmental accidents in the United States. Several criminal cases stemming from two recent disasters, however, indicate that the tide may be turning. These disasters, the repercussions of which have been playing out recently in the U.S. criminal courts, should put private equity and strategic investors in the mining and heavy industrials space on alert. Thorough due diligence into a target’s past operations and compliance record is more important than ever before.
Read the full article.

Options for Buying a UK Company with Multiple Selling Shareholders
In the United Kingdom, the issues and considerations involved in the acquisition of a private company with multiple selling shareholders can be complex. Some of the issues that arise in such acquisitions are similar to those that are considered with publicly traded companies, but would not typically be encountered in the acquisition of a private company with few shareholders.
Read the full article.

Merger Control in Africa
Many African countries have enacted competition law legislation in order to improve market conditions and attract investors. These regimes differ from one country to another, depending on the country’s history, culture, economic development, and whether its legal system is based on common law or civil law. While most African competition regimes contain rules addressing anticompetitive practices (such as collusive practices, abuse of dominance and unfair state aid), the legislation does not always provide for a merger control regime.
Read the full article.

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McDermott Will & Emery has released the October 2014 issue of Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries. Articles in this issue include:

Proposed EU Merger Review of Non-Controlling Minority Shareholding Acquisitions: Challenges and Opportunities for Private Equity
A recently proposed plan to reform EU Merger Regulation could expand the scope of transactions subject to prior notification. For the first time, minority shareholding acquisitions that do not lead to a change in control could be subject to prior notification to the European Commission. The proposed expansion of the Merger Regulation’s jurisdiction could significantly impact businesses.
Read the full article.

IPO Market Offers Attractive Exit Alternative for Sponsor-backed Companies
The strong IPO market offers private equity sponsors an attractive alternative to the sale of a portfolio company. However, the IPO process is complex, and must be structured properly at the outset. This article discusses some of the most significant structural considerations sponsors must consider in order to be in the position to obtain the maximum benefit from an IPO.
Read the full article.

McDermott Will & Emery has released the Fall 2014 issue of Inside M&A, which focuses on current issues surrounding mergers and acquisitions.  Articles in this issue include:

Managing Compliance Risks in M&A Transactions
Compliance risk management plays an increasingly important role in mergers and acquisitions transactions.  Appropriate compliance due diligence helps to establish the true value of the target company because successor liability for non-compliance of the target company can jeopardize the whole transaction.  Post-closing compliance initiatives help to reduce the compliance risks significantly.
Read the full article. 

You’ve Acquired a New Qualified Retirement Plan?  Time for a Compliance Check
In connection with a merger or acquisition, an acquiring company may end up assuming sponsorship of a tax-qualified retirement plan that covers employees of the acquired company.  This article provides a brief summary of some key issues that a company should focus on to ensure that the numerous administrative and fiduciary requirements involved in maintaining a qualified retirement plan will continue to be met on an ongoing basis if the plan will continue to be maintained following the acquisition.
Read the full article.  

A Personal Interest in Compliance
All individuals involved in a proposed sale transaction have a personal stake in full federal, state and local legal compliance because of expanding doctrines of personal liability and successorship liability, notwithstanding transaction documents that purport to disclaim assumption of seller’s liabilities.
Read the full article.  

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As those in the search fund community are aware, finding the right investors for a fund is critical to its success.  Equity sources bring more than their capital to the table; the best investors serve as experienced advisers and trusted mentors to search funders as they navigate the acquisition phase and beyond.  As the search fund model has proliferated both within and beyond the United States, today’s search funders may have more potential stops on their “roadshows” than their predecessors.

In seeking their ideal mix of initial investors, several of our recent search fund clients have ventured north of the border to raise a portion of their equity.  For search funds, which are typically structured as U.S. limited liability companies (LLC) with heavily standardized investment documents, taking on Canadian investors in a U.S. search fund has raised some interesting legal and practical issues.  Below are a few gating items for the search funder to consider in deciding whether to open the fund up to investors in Canada and elsewhere:

  • What percentage of your investor base will be from Canada?  The greater your percentage, the more likely it is that the search funder will want to structure the fund to cater to its Canadian investors.
  • What type of tax treatment do your Canadian investors expect?  Search funds generally utilize an LLC as the capitalized entity, which is treated as a partnership for U.S. tax purposes.  However, for Canadian tax purposes, U.S. LLCs are treated as corporations, which are subject to an entity-level tax.  This is a discrepancy that can significantly affect a Canadian investor’s economics.  The search funder may want to explore with his or her attorney whether an alternative structure, such as a limited partnership, is a viable option.
  • Do your investors have a tax presence in the United States, or will this be their only U.S. investment?  Because partnerships are essentially pass-through entities to their partners for tax purposes, investors in a partnership are inherently U.S. taxpayers.  For this reason, many non-U.S. investors prefer to invest in U.S. corporations, whereby the profits and losses of the entity are not passed through to its members.  If this is a particular sensitivity to the search fund’s Canadian investors, then the search funder may consider implementing a structure which will not result in the investor being a U.S. taxpayer.

In evaluating these alternatives, search funders should always be cognizant of how their U.S. investors may be impacted.  The above suggestions are not intended to be one-size-fits-all solutions.  As a practical matter, implementing a non-standard fund structure may affect the fund’s marketability to traditional sources of search fund financing.

Part of a search funder’s ongoing challenge is determining how best to serve its investors.  Experienced counsel can be a valuable resource in tailoring a fund to best accommodate both the search fund and its investors.  If some of those investors are Canadian, then the search funder should be aware of the issues that might affect such financiers’ investment decisions.

Learn how corporate counsel should (and are) adopting new tools and technologies resulting in significant efficiencies in legal project management. Byron Kalogerou, a Corporate partner in McDermott’s Boston office and co-chair of the Legal Project Management Task Force of the M&A Committee of the Business Law Section of the American Bar Association, explains why the “old way” no longer works and how legal project management is being utilized for M&A transactions. 

Read the full article.

McDermott Will & Emery has released the July 2014 issue of Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries.  Articles in this issue include:

Latin American Private Equity on the Rise
Favorable macroeconomic trends and positive regulatory developments continue to make Latin America an attractive destination for private equity investors looking for acceptable returns in relatively stable emerging markets. Not surprisingly, some challenges remain for foreign private equity investors entering the region, but most of these risks should be manageable for investment teams and advisors with sufficient experience in those jurisdictions.
Read the full article.

Tax Considerations When Acquiring Non-U.S. Portfolio Companies—Mitigating Subpart F Inclusions
Subpart F income can diminish returns for investors acquiring non-U.S. portfolio companies by increasing tax cost. The article discusses pitfalls to be avoided and strategies for mitigating this cost.
Read the full article.

Private Equity Funds at Higher Risk of Antitrust Fines
Recent developments in competition law enforcement in Europe mean that private equity funds are increasingly exposed to potential liabilities for alleged infringements of their portfolio companies. In this article, we look at how private equity funds investing in Europe can take practical steps to mitigate this risk.
Read the full article.

Traditionally, a cross-border “migration” of a company from one European Union (EU) Member State to another EU Member State, while technically possible, has been cumbersome and costly.  Such a migration would involve either a wholesale move of the subject company’s business seat (i.e., the location of its chief executive office) or a cross-border merger of national companies could be considered.  But that has now changed. 

Recently, however, the VALE judgment of the European Court of Justice issued on July 12, 2012 has opened the door for EU companies to take advantage of a cross-border “conversion” (i.e. , the transfer of the registered office from one jurisdiction to another, including a change of applicable law, without the requirement of winding up, liquidating the company ).  Even though the VALE judgment was handed down in 2012, the precise procedural rules, in particular how local commercial registers would apply the rulings of the VALE judgment, remained unclear until recently.

In a recent judgment, the High Court of Nuremberg has become the first German High Court to apply the rulings of the VALE judgment.  The case concerned a conversion of a private limited liability company organized under the laws of Luxemburg into a private limited liability company organized under the laws of Germany.  Upon application, the company was deregistered from the Luxemburg register.  Subsequently, the subject company applied for registration with the German commercial register and for conversion into a German limited liability company.  The registration was rejected by the German Regional Court.  This decision was recently overruled by the High Court of Nuremberg citing the VALE judgment and its authorization of cross-border conversions.

The case is of key importance for companies that plan a corporate migration within the EU and, in particular, the relocation of their business to Germany.  Such a migration might be necessary in course of an international restructuring, a post-acquisition integration or after a change of market conditions.  The key aspect of a conversion is that the company maintains its legal identity, which means that no transfer of company contracts and assets occurs.  In practice, the cross-border conversion is one of the simplest ways to move business activities from one EU Member State to another EU Member State and should be taken into account in the future by companies considering international reorganization or restructuring.

I recently appeared on an episode of the Private Equity FunCast: “The Art (and Science?) of the LOI” to talk deal terms with private equity masters Devin Mathews and Jim Milbery.  This well-spent hour got me thinking about how confusing some of the deal terms in a Letter of Intent (LOI) must be for first time sellers.  As a result, we are launching a series of blog posts that will deconstruct the LOI into easily understandable parts. In this series, we will be covering the following topics:

  1. The purchase price and how it is calculated;
  2. The structure of the transaction;
  3. Key tax issues;
  4. Key deal terms, including working capital, representations and warranties, and indemnification/escrow arrangements; and
  5. The legal “mumbo-jumbo.”

We covered much of this during the FunCast, but will take a deeper dive here with a more intense focus.

The Purchase Price and how it is Calculated

For most business sellers the purchase price is the purpose of the deal – cashing in on years of sweat and hard work.  At the beginning of every LOI, the buyer sets the price (sometimes called the “enterprise value”), which is a top line number meant to entice the seller.  Keep reading.  Much of the rest of the LOI contains terms that over time may reduce the price.  So, let’s start with how the price is actually calculated, which in a typical buyout is composed of a few standard parts:

  1. Enterprise valuation (every buyer has a different philosophy on how the enterprise is valued but it is often based on a multiple of EBITDA);
  2. Reduction of enterprise valuation for debt and other identified liabilities;
  3. Increase of enterprise valuation for cash of the business (taken together, parts two and three are sometimes referred to as doing the deal on a “debt-free, cash-free basis”);
  4. Reduction of enterprise valuation for the seller’s costs of selling the business (e.g., transaction bonuses to employees, certain taxes payable by the company and the fees of lawyers, accountants and investment bankers hired by the sellers to help sell the company);
  5. Increase or decrease of enterprise valuation based on the variation in working capital at closing from a working capital target, which is generally set to approximate a normalized (i.e., average) level of working capital for the company (we will spend some time in a later blog post discussing the working capital adjustment in much more detail).

A numerical example of the purchase price calculation described above would be helpful.  The example below is based on a business with $10 million of EBITDA being valued at a 10x multiple:

Enterprise Valuation:  $100 million; less

Debt:  $20 million (assuming here that the business has a $20 million credit facility with a third party lender); plus

Cash:  $1 million; less

Transaction Expenses:  $2 million; less

Working Capital Adjustment:  Reduction of $3 million (assuming here that at closing the business fails to achieve the required working capital target)

Net Proceeds at Closing:  $76 million

But wait, don’t celebrate yet, there’s more: In most transactions there is a holdback or a third party escrow of a portion of the price to satisfy post-closing claims by the buyer against the seller, usually for 12 to 24 months.  In this example, let’s call it 10 percent of the enterprise valuation, which may or may not ultimately get paid to the seller.  In our example, this reduces the proceeds payable to the seller at closing by an additional $10 million.

Net Proceeds at Closing:  $66 million

And more: In some transactions, there is a requirement that the seller either rollover a portion of the proceeds into new equity of the buyer (rollover equity) or provide some seller financing for the buyer to close the transaction (i.e., a “seller note”).  The rollover equity usually only gets paid when the buyer ultimately sells the business.  The seller note should, at the latest, get paid when the buyer sells the business, but will often have a set term to it (e.g., two to five years).  If there is rollover equity or a seller note this could account for another 20-50 percent of the proceeds.  In our example, let’s assume a 20 percent rollover or $20 million.

Net Proceeds at Closing:  $46,000,000 (which you will note, is not $100,000,000).

In our example, however, the seller would still own 20 percent of the company on a go-forward basis due to the rollover of 20 percent, which, depending on the seller’s objectives and views of the company’s future prospects, can be a positive thing.  Moreover, the value attributable to the rollover is usually not taxable at such time – but that is a whole other subject…

The moral of the story is that when selling a business, don’t just focus on the topline number.  Read the fine print!

Stay tuned for future installments as we continue to deconstruct the LOI.

It is quite common during the course of legal due diligence to discover that a target company has issued more stock than it had legally authorized through its certificate of incorporation.  Many companies, particularly emerging growth companies, are often too preoccupied with ambitious growth plans and raising critical private capital and overlook basic corporate housekeeping.  Or they dole out lots of equity to employees and business partners in order to conserve much needed cash, but forget that there is actually a legal limit to the number of shares they can grant.  These and other legal flaws, or “defective corporate acts,” can exist undetected for years in privately held companies, but they come to light at the worst possible time – when the company is being sold or when a significant capital raise is being undertaken.  Previously, the lawyers would advise that these past errors placed a troublesome legal cloud over the company that presented risks that could not be eliminated, which often resulted in potential acquirors or investors simply abandoning a proposed transaction.

Fortunately, beginning April 1, 2014, new Sections 204 and 205 of the Delaware General Corporation Law (DGCL) will provide corporations with two clear mechanisms to rectify defective corporate acts. New Section 204 sets forth “self-help” procedures for corporations to ratify defective corporate acts, and new Section 205 vests the Court of Chancery with jurisdiction to hear and determine the validity of any potentially defective corporate act.  These two provisions make it so that no defective corporate act will be potentially invalid “solely as a result of a failure of authorization,” if the act is ratified in accordance with Section 204 or validated by the Court of Chancery in a proceeding brought under Section 205.

The new law will apply to all corporate acts that are within a corporation’s power under the DGCL, but that are defective, whether due to a failure to obtain the requisite authorization, or a violation of the corporation’s certificate of incorporation, bylaws or any contract to which the company was a party, and where such failure or violation renders the act potentially invalid under Delaware law.

Section 204

In order to ratify a defective act under Section 204, a company’s board of directors must adopt a resolution that includes, among other things: (i) the time of the defective act; (ii) the nature of the failure of the authorization; and (iii) approval by the board of the ratification of the defective act.  If the defective act relates to the unauthorized issuance of stock (putative stock), the resolution must also specify the number and type of shares of putative stock issued and the date or dates when the shares were purported to have been issued.  If stockholder approval was originally required under the DGCL, the company’s certificate of incorporation or bylaws, or by contract, then the board must submit the ratifying resolutions to the stockholders for approval.  Section 204 also sets forth the notice, quorum and approval requirements for the stockholder vote.

Once the applicable approvals are obtained, if the original act would have required a filing under the DGCL (e.g., a certificate of amendment or certificate of designations), then the corporation must make a new filing called a “certificate of validation” with the Delaware Secretary of State, which will provide a public record that the corporation has ratified the defective act pursuant to Section 204.  In addition, the corporation must provide notice of any ratification effected without stockholder approval to all then-current holders of valid and putative stock and all holders of valid and putative stock as of the date of the defective corporate act to be ratified (to the extent such holders can be determined from corporate records).

 

Unless the ratification is challenged in court, following these procedures will magically erase the legal flaw and (i) each defective act ratified will be deemed effective retroactively to the time of the original defective corporate act, and (ii) each share of putative stock issued pursuant to a ratified defective act will be deemed to be an identical share of outstanding stock as of the time it was issued.

Section 205

Ratification under Section 204 may not always be available.  For example, if a board of directors was elected with putative stock, then the election could be invalid and the board could be acting outside the scope of its proper authority.  In such a case, the company can turn to the Court of Chancery for ratification of the putative stock and affirmance of the board’s authority.  Under new Section 205, the Court of Chancery is vested with broad authority to determine the validity and effectiveness of any corporate act or transaction and any stock rights or options to acquire stock.  These claims may be brought by the corporation (or its successor entity), a director, any record or beneficial owner of valid or putative stock (including those holding stock at the time of the defective corporate act), among others.

In sum, these two provisions in the DGCL will provide a clear pathway out of what otherwise could be deal-killing legal mess.  Corporations, and the attorneys asked to render opinions on the validity of past corporate actions, can take comfort that there exists now statutory mechanisms to avert a historically troublesome area of corporate law.

McDermott recently released the Winter 2014 issue of Inside M&A, which focuses on current issues surrounding mergers and acquisitions.  Articles in this issue include:

Delaware Court of Chancery Upholds Forum Selection Bylaws
During the last several years, shareholders have challenged nearly every merger and acquisition (M&A) transaction that targeted a U.S. public company where the value of the transaction was greater than $100 million and the offer price was at least $5 per share.  As a result of this litigation explosion, many corporations have adopted forum selection bylaws that require such challenges to be brought in the target company’s state of incorporation.  Chancellor Leo E. Strine Jr.’s decision in Boilermakers Local 154 Retirement Fund v. Chevron Corp. to uphold such bylaws is an important step toward reducing the burden and expense of litigation over M&A deals.
Read the full article.

Crying Revlon: Delaware Courts Dismiss Claims in Morton’s Restaurant Group Acquisition
In In Re Morton’s Restaurant Group, Inc. Shareholders Litigation, Chancellor Leo E. Strine Jr. dismissed all claims in an action arising out of the acquisition of Morton’s Group, Inc.  This case is another example of attempted misuse of the so-called Revlon “entire fairness” test by plaintiffs.  It also demonstrates that a board engaged in a sale process can protect itself and the transaction by conducting an extensive market check and by sharing the proceeds of the sale ratably amongst all stockholders.
Read the full article.

Managing Risk—Captive Insurance Companies
Soaring insurance costs combined with sound risk management policies often lead risk managers to consider a strategy that includes self-insurance, often taking the form of a captive insurance company.  Properly constructed and maintained, a captive insurance company can produce both business and tax benefits.
Read the full article.