MERGERS AND BUYOUTS OF CLOSELY HELD BUSINESSES, PART 1 & PART 2 First Run Broadcast: December 5 & 6, 2013 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Planning and drafting for the sale of a closely held company is unlike the sale of public companies. Agreeing on a valuation can be very difficult because there is no regular market of buyers and sellers and information on comparable sales is scarce. The companies are often financially structured to benefit a few shareholders, frequently members of a family, and require their financial statements and distribution policies to be normalized. There are can be substantial issues of liability, including successor liability in asset deals, requiring carefully crafted reps and warranties. Confidentiality is often essential in these transactions as sellers try not to unsettle existing commercial or workplace relationships. This program will provide you with a practical guide to major planning and drafting considerations in the mergers and buyouts of closely-held businesses. Day 1 – December 5, 2013:

• Major considerations in planning and drafting the merger or sale of a closely held company

• Confidentiality considerations in the sale and negotiation process • How due diligence differs in the closely held companies – financial, operational and

workforce red flags • Types of transactions (stock v. asset) and forms of consideration (cash v. equity v. asset

exchanges) • Valuing profitable companies in illiquid markets • Use or of “earnouts” to bridge the gap in valuation

Day 2 – December 6, 2013:

• Reps, warranties, indemnity and baskets – drafting issues common to closely held companies

• Successor liability concerns where assets are transferred • Asset transfer issues – intangible assets, including intellectual property • Transition issues – management, employees, business relationship, contract issues • Escrow and post-closing issues

Speaker: Tyler J. Sewell is an attorney in the Denver office of Morrison & Foerster, LLP, where he specializes in mergers and acquisitions. He focuses his practice on advising financial and strategic buyers and sellers in public and private M&A transactions and complex corporate transactions. He negotiates and documents leveraged acquisitions, divestitures, asset acquisitions, stock acquisitions, mergers, auction transactions, and cross-border transactions. Mr. Sewell received his B.S., with merit, in ocean engineering from the United States Naval Academy and his J.D., magna cum laude, from the University of Pennsylvania Law School.

Alson R. Martin is a partner in the Overland Park, Kansas office of Lathrop and Gage, LLP, where he has a national practice focusing on business law, taxation, health care, and retirement plans. He is a Fellow of the American College of Tax Counsel and the American College of Employee Benefits Counsel. Mr. Martin is the author of "Limited Liability Companies and Partnerships" and the co-author of "Kansas Corporation Law & Practice (Including Tax Aspects)." He is the president and a director of the Small Business Council of America. Mr. Martin received his B.A., with highest distinction, from the University of Kansas, and his J.D. and LL.M. from New York University School of Law.

VT Bar Association Continuing Legal Education Registration Form

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Mergers and Buyouts of Closely Held Businesses, Part 1

Teleseminar December 5, 2013

1:00PM – 2:00PM 1.0 GENERAL MCLE CREDIT

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association) Amount: _________ Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # _______________________________________ Exp. Date _______________ Cardholder: __________________________________________________________________

VBA Members $75

Non-VBA Members $115

NO REFUNDS AFTER November 28, 2013

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information and fax or email with credit card info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name ________________________ Middle Initial____Last Name___________________________

Firm/Organization _____________________________________________________________________

Address ______________________________________________________________________________

City _________________________________ State ____________ ZIP Code ______________________

Phone # ____________________________Fax # ______________________

E-Mail Address ________________________________________________________________________

Mergers and Buyouts of Closely Held Businesses, Part 2

Teleseminar December 6, 2013

1:00PM – 2:00PM 1.0 GENERAL MCLE CREDIT

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association) Amount: _________ Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # _______________________________________ Exp. Date _______________ Cardholder: __________________________________________________________________

VBA Members $75

Non-VBA Members $115

NO REFUNDS AFTER November 29, 2013

Vermont Bar Association

CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: December 5, 2013 Seminar Title: Mergers and Buyouts of Closely Held Business, Part 1 Location: Teleseminar Credits: 1.0 General MCLE Credit Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

Vermont Bar Association

CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: December 6, 2013 Seminar Title: Mergers and Buyouts of Closely Held Business, Part 2 Location: Teleseminar Credits: 1.0 General MCLE Credit Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

Private Company:Mergers and Acquisitions

Alson R. MartinLathrop & Gage, LLP - Overland Park, Kansas

(o) (913) 451-5170amartin@LathropGage.com

&Tyler J. Sewell

Morrison & Foerster LLP – Denver(o) (303) 592-2215tsewell@mofo.com

Day 1Process Overview

Confidentiality Considerations in theSale and Negotiation Process

• Confidentiality agreement– Non-use– Non-solicit/no-hire provision– Confidentiality of process

• Anti-trust and other regulatory issues• Industry concerns• Social considerations

– Management team– Seller’s relationship with the team– Selecting the right group to “cross-the-wall”– Location of due diligence

3

Due Diligence Generally

• Liabilities

• Indebtedness

• Third Party Consents

• Governmental Consents

• Licenses/Permits

• Encumbrances

• Federal Contracts

• Employee Benefits

• Environmental

• Industry Specific

4

Due Diligence involvingClosely Held Companies

• Process– Data Room

• Physical vs. Electronic

• Who Hosts?

– Use of Advisors

• Financial– Audited or Reviewed

– Preparation

• Operational– Management Structure

– Organizational Fit

– Workforce

5

Asset vs. Stock Deals

• Asset Transaction

– Buyer purchases some or all of Seller’s assets

– Seller may or may not remain in existence

– Seller’s shareholders generally must approve if“substantially all” of Seller’s assets

– Generally favored by Buyer for tax and liability reasons

• Stock Transaction

– Buyer purchases the entity

– Generally requires all shareholder to be involved

– Generally favored by Sellers for tax and liability reasons

6

Asset vs. Stock Deals (cont.)

• Advantages of Asset Transaction

– Ability to select assets to purchase and liabilitiesto assume/leave behind

– Stepped-up basis in acquired assets

– Generally avoids dissenters’ appraisal rights

7

Asset vs. Stock deals (cont.)

• Disadvantages of Asset Transaction– Purchased assets and assumed liabilities must be

identified

– Deal documents and process more complex

– Seller’s contracts may require consent to assignment thatcould be avoided with merger or sale of stock

– Employees are effectively terminated and hired by Buyer

– Assuming Seller is not “flow-through” entity or division,Seller will bear double tax in sale

8

Forms of Consideration

• Cash– Method of Payment– Timing of Payment

• Equity– Stock vs. Other Equity– Contribution Agreement– Capital Accounts– Securities Issues– Successor Liability Concerns

• Promissory Note– Secured vs. Unsecured– Subordinations– Set-off Rights

9

Tax Issues

• Double taxation

• Basis Step-up

• Income Tax

– Pre-closing

– Post-closing

– Straddle Period

• Real Property Transfer Taxes

• General Transfer Taxes

• Bulk Sales Taxes

• Sales/Use Tax

• Post-closing Filings

• Benefits of Transaction Expense Deduction

10

Asset Sales - Bulk Sales

• General rule in most states: A Buyer in a “bulk sale” must withhold from thepurchase price an amount equal to the Seller’s unpaid sales tax liability or else canbe liable for those unpaid liabilities of the Seller

• Many states have bulk sale notice procedures, which vary by state

• Under those notice procedures, the Buyer in a bulk sale transaction usuallyprovides advance notice to the state of the impending acquisition

• The state then notifies the Buyer of how much unpaid sales tax is owed by theSeller that should be withheld out of the purchase price.

• State response times to notices also vary significantly (as little as 10 days,sometimes up to 6 months), and this can hold up a closing or require that funds beplaced in escrow

11

Process Consideration

• Financial Buyer

– Financing

• Financing risk allocation

• Financing assistance

– Deal certainty

• Reverse break fee

• Guarantees and commitment letters

– Operational diligence

– Exit strategy

12

Process Consideration (cont.)

• Strategic Buyer– Process

• Corporate process• Deal points

– Anti-trust issues• Risk allocation• Gun-jumping

– Nature of buyer• Parent guarantee?

– Business/practical issues• Integration planning• Synergies

13

Valuation Issues

• Valuation Issues in Closely Held Context– Operating History

– Regulatory or other Approvals

– Financial Reporting

– Status of Intellectual Property

– Liability Management

– Tax Treatment

– Tax Assets

14

Use of “Earnouts” to Bridge the Gap in Valuation

• Earnouts– Mechanism to bridge “value gap”– Often source of post-closing dispute

• “converts today’s disagreement over price into tomorrow’slitigation over the outcome.” (Airborne Health Inc. v. Squid SoapLP)

– Drafting issues– Higher on the P+L = less risk and less benefit

• Revenue• EBITDA/Earnings

– Also can use development or other milestones (e.g., drugapproval steps for life sciences company)

– Related covenants can constrain post-closing operation ofacquired business (Sonoran Scanners, Inc. v. PerkinElmer, Inc.)

15

Day 2Contracting Issues

Representations and Warranties

A risk shifting mechanismthat allocates the risks inherent

in the business (and the transaction)between Buyer and Seller.

17

Representations and Warranties (cont.)

• Purposes– Disclosure and diligence

– Closing condition

– Tied to what is being purchases and liabilities are assumed

– Value protection through post-closing indemnity claims

– Asset vs. stock transaction

18

Representations and Warranties (cont.)

• Key Representations– Traditional “Fundamental Representations”

– Sufficiency of assets (carve-outs and asset transactions)

– Financial statement representation

– Events subsequent to last audit or financial statements

– Material Contracts

– Accounts Receivable/Payable

– Inventory

– Absence of liabilities

– Absence of litigation

– Tax Matters

– Intellectual Property

– Employee representation

– Compliance with law

19

Representations and Warranties (cont.)

• Date Representation Given “as of”

• Knowledge and Materiality Qualifications (MAE vs. material)– “[B]uyer faces a heavy burden when it attempts to invoke a material

adverse effect clause in order to avoid its obligation to close. Manycommentators have noted that Delaware courts have never found amaterial adverse effect to have occurred in the context of a mergeragreement. This is not a coincidence. ” (Hexion Specialty Chemicals,Inc. v. Huntsman Corp.)

• Knowledge often limited to identified people vs. “imputedknowledge”

20

Asset Transfer Issues – Intellectual Property

• PTO Filings

• Domain Names

• Transferring Licenses

– Cincom Systems Inc. v. Novelis Corp.• “[I]n the context of intellectual property, a license is presumed to be non-assignable and

nontransferable in the absence of express provisions to the contrary.”

• “Simply put, in the context of a patent or copyright license, a transfer occurs anytime an entityother than the one to which the license was expressly granted gains possession of the license.”

– SQL Solutions v. Oracle• Reverse triangular merger violated a non-assignment clause in a non-exclusive copyright

license under California law

– Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH• Reverse triangular merger did not violate a non-assignment clause that prohibited assignment

by operation of law under Delaware law due to doctrine of independent legal significance

– Generally• Non-exclusive IP license may not be assigned without licensor’s consent

• Split authority on assignability of exclusive IP license without licensor’s consent

• Licensor may assign IP license without licensee consent

21

Asset Transfer Issues – Other Assets

– Transferring Commercial Contracts

• Anti-assignment provisions

• Novation

– Government Contracts

• FAR Novation requirements

– Real Property

• Title policies

• Mortgages

• Surveys

• Environmental Review

– Receivables

– Securities

• Assignment Instruments

• Possession of Security

• Lost Securities22

Stock Transfer Issues

• Change of Control Provisions

• Rights of First Refusal

• Capitalization Issues

• Liability Assumption

– Undisclosed

– Contingent

• Regulatory Approvals

23

Successor Liability In Assets Transactions

• Successor Liability– General rule: Liabilities do not transfer with assets, but:

• de facto merger theory

• “Mere continuation” theory

• Federal Law– Employment claims

– Environmental claims

– Other claims

24

Transition Issues

• Management– Employment agreements– Identifying the team– Incentive compensation

• Employees– WARN Act – Employers must provide 60 days’ notice (or pay and benefits in lieu of) in

event of significant layoffs, including in acquisition context• 50-employee threshold; aggregation of smaller layoffs• Consider impact of state “Mini-WARN” statutes

– COBRA Health Insurance Continuation• Federal right to obtain continued health insurance coverage at own expense when loss of employment

leads to loss of coverage• 20-employee threshold• Parties in a transaction are free to negotiate responsibility to provide notices and coverage• Regardless of parties’ agreement, IRS rules shift obligation to Buyer in asset transactions where Seller

discontinues health plan• As a result, a Buyer can end up with the obligation to cover employees already on COBRA at time of

transaction (who never worked for Buyer)• Provision of required notices is key; COBRA is an adverse selection regime, and failure to provide

notice can give employees a “second bite at the apple.”• Consider state COBRA provisions

25

Transition Issues (cont.)

• Business Relationship

– Commercial arrangements• Buyer to provide certain incentives?

• Buyer to utilize existing relationships?

– Role-out Strategy• Defining the message and timing

• Contract Issues

– Consent Covenant

– Operation of Business Covenant

– Role Out Strategy

26

Post-closing Issues

• Escrow/Holdback– Source of post-closing recourse for purchase price

adjustment and indemnities– Typical range of 5% - 20%. Mean and median about 10%

• Typically available during survival period for generalreps and warranties (12 – 24 months)– Although escrow period often shorter (12 months)

• Potential for staged release• Usually not sole source of recourse for all claims• Consider side pocket escrow for purchase price

adjustments and special indemnities

27

Post-Closing Issues (cont.)

• Indemnification

– Drafted to provide remedies greater than common law breach of contract

– Indemnifying Party - may want to look past the selling entity to principalstockholders if only a shell is left post-transaction

– Who pays?

• Collecting money beyond escrow presents practical as well as legal difficulties

• Guarantees

– Key Concepts

• Cap

• Deductible/Basket

• Materiality Scrape

• Sandbagging

• Exclusive remedy

• Joint vs. Several

28

PROFESSIONAL EDUCATION BROADCAST NETWORK

Speaker Contact Information

MERGERS AND BUYOUTS OF CLOSELY HELD BUSINESSES,PART 1 & PART 2

Alson R. MartinLathrop & Gage, LLP - Overland Park, Kansas(o) (913) 451-5170amartin@LathropGage.com

Tyler J. SewellMorrison & Foerster LLP – Denver(o) (303) 592-2215tsewell@mofo.com