Mergers and Acquisitions from A to Z

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  • Copyright: 11/3/2010
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Mergers and acquisitions represent a successful growth strategy for many companies, but, while potentially profitable, M&A transactions are complex and often risky. Covering the latest trends, developments, and best practices for the post-Madoff era, this comprehensive, hands-on resource walks readers through every step of the process, offering practical advice for keeping deals on track and ensuring post-closing integration success. Filled with case studies and war stories illustrating what works and why, the third edition of Mergers and Acquisitions from A to Z offers valuable tools, checklists, and sample documents, providing crucial guidance on: preparing for and initiating the deal; regulatory considerations; due diligence; deal structure; valuation and pricing; and financing even during turbulent market conditions. M&A transactions can quickly spell a company's doom if they are not conceived and executed carefully, legally, and sensibly. This is the classic, comprehensive guide to mergers and acquisitions, now completely updated for today's market.

Author Biography

ANDREW J. SHERMAN is a partner in the office of Jones Day and an internationally recognized authority on the legal and strategic issues of emerging and established companies. He has been interviewed by The Wall Street Journal, USA Today, Forbes, Time, and countless other publications and is the author of several books, including Raising Capital and Franchising and Licensing.

Table of Contents

Acknowledgmentsp. ix
Introduction To The Third Editionp. xi
The Basics of Mergers and Acquisitionsp. 1
Understanding Key Termsp. 1
What's All the Fuss About?p. 3
Why Bad Deals Happen to Good Peoplep. 8
Why Do Buyers Buy, and Why Do Sellers Sell?p. 9
Preparing for the Dance: The Seller's Perspectivep. 13
Conducting a Thorough EOTB Analysisp. 17
Preparing for the Sale of the Companyp. 17
Common Preparation Mistakesp. 29
Other Considerations for the Sellerp. 31
Getting Deal Terms and Structure That Fit the Seller's Objectives, Personal Needs, and Postclosing Plansp. 32
Initiating the Deal: The Buyer's Perspectivep. 34
Assembling the Teamp. 34
Developing an Acquisition Planp. 35
Applying the Criteria: How to Narrow the Fieldp. 43
Approaching a Company That Is Not for Salep. 44
Dealing with the Seller's Management Teamp. 45
Directory of M&A Resources for Prospective Buyers (and Sellers)p. 46
The Letter of Intent and Other Preliminary Mattersp. 49
Proposed Termsp. 52
Binding Termsp. 52
Common Reasons Why Deals Die at an Early Stagep. 59
Preparation of the Work Schedulep. 60
Another Predeal Task: The Growing Debate About the Role and Usefulness of Fairness Opinionsp. 61
Due Diligencep. 65
Best Practices in Due Diligence in the Era of Accountability 2.0p. 66
Legal Due Diligencep. 74
Business and Strategic Due Diligencep. 83
Conclusionp. 91
Post-Sarbanes-Oxley Due Diligence Checklistp. 92
The Disclosure Requirementsp. 93
Checklist of Items Post-Sarboxp. 97
An Overview of Regulatory Considerationsp. 101
Introductionp. 101
Environmental Lawsp. 102
Federal Securities Lawsp. 103
Federal Antitrust Lawsp. 106
Waiting Periodsp. 109
Labor and Employment Lawp. 113
Structuring the Dealp. 120
Stock vs. Asset Purchasesp. 122
Tax and Accounting Issues Affecting the Structure of the Transactionp. 126
One-Step vs. Staged Transactionsp. 130
Method of Paymentp. 132
Nontraditional Structures and Strategiesp. 135
Valuation and Pricing of the Seller's Companyp. 144
A Quick Introduction to Pricingp. 146
Valuation Overviewp. 147
Financing the Acquisitionp. 155
An Overview of Financing Sourcesp. 156
Understanding the Lender's Perspectivep. 159
Financing Deals in Times of Turmoilp. 160
Steps in the Loan Processp. 164
Equity Financingp. 168
The Purchase Agreement and Related Legal Documentsp. 189
Case Study: GCC Acquires TCIp. 191
Sample Schedule of Documents to Be Exchanged at a Typical Closingp. 209
Keeping M&A Deals on Track: Managing the Deal Killersp. 252
Communication and Leadershipp. 253
Diagnosing the Source of the Problemp. 254
Understanding the Types of Deal Killersp. 254
Curing the Transactional Patientp. 256
Maintaining Order in the M&A Process: Simple Principles for Keeping Deals on Trackp. 257
Conclusionp. 258
Postclosing Challengesp. 259
A Time of Transitionp. 260
Staffing Levels and Related Human Resources Challengesp. 264
Customersp. 267
Vendorsp. 268
Physical Facilitiesp. 268
Problems Involving Attitudes and Corporate Culturep. 269
Benefit and Compensation Plansp. 271
Corporate Identityp. 272
Legal Issuesp. 272
Minimizing the Barriers to the Transitionp. 273
Postmerger Integration Key Lessons and Best Practicesp. 277
Conclusionp. 280
Alternatives to Mergers and Acquisitionsp. 281
Joint Venturesp. 282
Franchisingp. 287
Technology and Merchandise Licensingp. 299
Distributorships and Dealershipsp. 306
Indexp. 309
Table of Contents provided by Ingram. All Rights Reserved.


Introduction to the Third Edition

‘‘It was the best of times, it was the worst of times.’’

When Dickens first shared this quote with the world, he was not referring

to the merger and acquisition (M&A) market from 2005 to 2009,

but he might as well have been. In the time between the publication of

the second edition of this book in 2005 and today, the overall financial

markets and the levels of M&A activity have experienced both polar

opposites and everything in between. From the seemingly insatiable appetite

for middle-market companies that private equity firms and other

buyers had in 2006 and 2007, thereby driving valuations through the

roof, to the fast ending to the party and the sobering effects of a virtual

halt in 2008 to 2009, sending valuations on a downward spiral, this was

not a good time if you prefer merry-go-rounds to roller-coaster rides at

the amusement park.

According to mergermarket, the total number of deals announced

worldwide in the first half of 2009 numbered 3,873, with a total value

of $709 billion. These figures represent the worst six months on record

since the end of 2003. While merger and acquisition activity in the

United States increased slightly in terms of the number of deals from

the first quarter of 2009 to the second quarter of 2009, the total deal

value fell from $183 billion to $171 billion, according to Bloomberg.

Mergers and acquisitions are a vital part of both healthy and weak

economies and are often the primary way in which companies are able

to provide returns to their owners and investors. Mergers and acquisi-

tions play a critical role in both sides of this cycle, enabling strong

companies to grow faster than their competition and providing entrepreneurs

with rewards for their efforts, and ensuring that weaker companies

are more quickly swallowed or, worse, made irrelevant through

exclusion and ongoing share erosion.

Mergers and acquisitions have played a variety of roles in corporate

history, ranging from the ‘‘greed is good’’ corporate raiders buying

companies in a hostile manner and breaking them apart, to today’s

trend of using mergers and acquisitions for external growth and industry


During the 1980s, nearly half of all U.S. companies were restructured,

more than 80,000 were acquired or merged, and over 700,000

sought bankruptcy protection in order to reorganize and continue operations.

The 1980s featured swashbucklers and the use of aggressive

tactics to gain control over targets. The 1990s were equally dynamic in

terms of companies evolving through upsizing and growth, downsizing,

rollups, divestitures, and consolidation, but focused on operational synergies,

scale efficiencies, increases in customer bases, strategic alliances,

market share, and access to new technologies. This period,

however, came to a crashing end with the bursting of the tech bubble

and the global recession that followed.

The wave of M&A activity seen from 2004 to 2007 was driven by

the more general macroeconomic recovery and several key trends. First,

many companies had exhausted cost cutting and operational efficiencies

as a means of increasing profitability and were looking to top-line

growth as a primary enabler of shareholder return. The increased pressure

to grow turned the spotlight on the opportunity to achieve growth

through acquisition. Second, the M&A market had been supported by

the return of corporate profits and, with them, improved stock price

valuation. The improved valuations enabled corporations to leverage

their internal currencies to acquire target companies that were willing

to swap their illiquid private stock for valuable public-company shares.

Third, interest rates were hovering at historical lows, enabling firms to

cost-effectively utilize debt to finance acquisition-based growth.

From 2008 to late 2009, the most recent wave of M&A activity was

driven by weak economic conditions around the globe. The strong,

cash-rich companies and firms began bargain shopping, picking off distressed

and downtrodden competitors at a fraction of their market value

compared to expectations just a short 12 to 18 months earlier. Large

and midsize companies began to refocus on their core business lines,

triggering divestitures and spin-offs of underperforming divisions or

subsidiaries. Private equity firms and even hedge funds, under pressure

to provide returns to their limited partners, turned stepchild investments

into small buckets of cash in order to hold off a tyranny or management


Yet, although so many dollars have been changing hands, the number

of readily available resources for business executives and professional

advisors to turn to for strategic and legal guidance on mergers

and acquisitions remains very limited. This book is intended to be such

a resource.

There is no more complicated transaction than a merger or acquisition.

The various issues raised are broad and complex, from valuation

and deal structure to tax and securities laws. The industries affected by

this rapid activity are also diverse, from banking and computer software

companies to retailers and health-care organizations. It seems that virtually

every executive in every major industry faces a buy or sell decision

at some point during her tenure as leader of the company. In fact, it is

estimated that some executives spend as much as one-third of their time

considering merger and acquisition opportunities and other structural

business decisions. As we will see in the chapters to follow, the strategic

reasons for considering such transactions are also numerous, from

achieving economies of scale, to mitigating cash flow risk via diversification,

to satisfying shareholders’ hunger for steady growth and dividends.

The degree to which the federal government intervenes in these

transactions varies from administration to administration, depending

on the issues and concerns of the day. During the Reagan-Bush years,

the government took a passive role, generally allowing market forces to

determine whether a given transaction would have an anticompetitive

effect. During the Clinton years, regulatory bodies took a more proactive

approach, with more intervention by the U.S. Department of Justice

and the Federal Trade Commission, such as a refusal to provide the

necessary approval for the proposed merger of Staples and Office

Depot in mid-1997. The second Bush administration took a more

laissez-faire approach, only to have the European Union take a more

aggressive role in preventing potentially anticompetitive mergers. The

European Competition Commission’s landmark rejection of GE’s proposed

acquisition of Honeywell in 2001 signified a shift in the role that

the EU played in the global M&A marketplace. Under the Obama administration,

we are likely to see an increase in antitrust and regulatory

oversight, but also an anxiousness to facilitate transactions that will be

beneficial from an economic recovery perspective.

Recent years have also seen a significant increase in merger and

acquisition activity within industries that are growing rapidly and evolving

overall, such as health care, information technology, education,

infrastructure, and software development, as well as in traditional industries

such as manufacturing, consumer products, and food services.

Many of these developments reflect an increase in the number of strategic

buyers and a decrease in the amount of leverage used, implying that

these deals were being done because they made sense for both parties,

which is very different from the highly leveraged, financially driven deals

of the late 1980s.

The small- to middle-market transactions have clearly been the

focus of this book in each of its editions since the 1990s. Fortunately

for this audience, middle-market transactions continue to attract compelling


Companies in the small- to middle-market segment need to understand

the key drivers of valuation, since they are often able to focus

their operating goals in order to maximize the potential valuation range.

Therefore, it is important to know that the multiple a company achieves

for its business is directly correlated with the following seven characteristics:

1. Strong revenue growth

2. Significant market share or a strong niche position

3. A market with barriers to entry by competitors

4. A strong management team

5. Strong, stable cash flow

6. No significant concentration in customers, products, suppliers,

or geographic markets

7. Low risk of technological obsolescence or product substitution

Successful mergers and acquisitions are neither an art nor a science,

but a process. In fact, regression analysis demonstrates that the

number one determinant of deal multiples is the growth rate of the business.

The higher the growth rate, the higher the multiple of cash flow

that the business is worth.

A study of deals that close with both buyer and seller satisfied shows

that the deal followed a sequence, a pattern, a series of steps that have

been tried and tested. This book focuses on conveying this process to

the reader, as we seek to understand the objectives of both buyer and

seller in Chapters 2 and 3, move through the process of negotiations

and closing in Chapters 4 through 10, and focus on closing and beyond

in Chapters 11, 12, and 13.

For example, when a deal is improperly valued, one side wins big

while the other loses big. By definition, a transaction is a failure if it

does not create value for shareholders, and the easiest way to fail, therefore,

is to pay too high a price. To be successful, a transaction must be

fair and balanced, reflecting the economic needs of both buyer and

seller, and conveying real and durable value to the shareholders of both

companies. Achieving this involves a review and analysis of financial

statements; a genuine understanding of how the proposed transaction

meets the economic objectives of each party; and a recognition of the

tax, accounting, and legal implications of the deal.

A transaction as complex as a merger or acquisition is fraught with

potential problems and pitfalls. Many of these problems arise either in

the preliminary stages, such as forcing a deal that shouldn’t really be

done (i.e., some couples were just never meant to be married); as a

result of mistakes, errors, or omissions owing to inadequate, rushed, or

misleading due diligence; through not properly allocating risks during

the negotiation of the definitive documents; or because integrating the

companies after closing became a nightmare. These pitfalls can lead to

expensive and protracted litigation unless an alternative method of dispute

resolution is negotiated and included in the definitive documents.

This book is designed to share the pitfalls of such transactions, with the

hope that buyers and sellers and their advisors can avoid these problems

in their future transactions.

Finally, with merger and acquisition activity continuing to grow at

rapid rates, and entrepreneurs and venture capitalists continuing to

form new entities and pursue new market opportunities, it is critical to

have a firm grasp of the key drivers and inhibitors of any potential deal.

With so much money on the line, it is essential to understand how to

maximize price and valuation goals while ensuring that the transaction

is successfully consummated.

Andrew J. Sherman

Bethesda, Maryland

Fall 2009

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