Market Watch | The fine art of government-services acquisitions

Over the past 15 years, the number and variety of government-services merger and acquisition transactions have dramatically increased. There is a significant number of serial acquirers that continually expand their due diligence lists and activities from the lessons they've learned. Moreover, the requirements of the Sarbanes-Oxley Act and financial institution covenants call for a deeper due diligence process. Higher valuation multiples also are causing buyers to want a more thorough understanding of the target company and any risk factors.

Consequently, acquirers have become more sophisticated in analyzing acquisition opportunities, often using the help of professionals such as lawyers, accountants, investment bankers and consultants with specialized knowledge of the government contracting industry. A cottage industry of professionals and advisers has come into being.

Due diligence now covers all legal, financial, accounting and tax matters with particular focus on government contracts, contract backlog, cash flow, and the taxable status of the company.

A lot of attention is focused on the ability to transfer small business and set-aside contracts, compliance with the Federal Acquisition Regulation, sellers' accounting systems and practices, the next 12 months of revenue, and customer relationships including past performance and sustainability.

More attention than ever is focused on softer issues: intellectual capital, quality of management, culture and overall reputation. Buyers of government services companies typically require retention agreements for key managers of a company.

This is done to give them a higher level of certainty that those managers will continue with the buyer, and that their subordinates will follow. A considerable focus is put on the capabilities and customer relationships of the senior managers.
Experienced buyers also want a thorough understanding of the target company's culture and how it compares to their own cultures. Each company has its own personality, usually reflecting the principal owner.

Comparing employee benefits is critical, as a buyer cannot offer less benefits if it wants most of the employees to stay with the new company. A lack of sensitivity to culture is probably the primary reason that some government services acquisitions do not succeed and integration plans don't work.

Consider that it is not unusual for a buyer's diligence team to consist of more than 20 highly specialized experts that will examine every aspect of a seller's business. More than ever, buyers are highly sensitive to potential risk or liability that could impact their expected rate of return. To avoid surprises, sellers should plan and prepare extensively before coming into the market. Professional advisers should be engaged to thoroughly review legal, government contract, accounting, tax and personnel issues.

Both buyers and sellers will spend considerable time, expense and opportunity during the due diligence phase. As a result, it is in the interest of both parties to create a higher level of certainty that a transaction will close before the two companies enter into an exclusive arrangement.

Establishing a high degree of certainty is accomplished through a combination of disclosure and preparation. It has never been more important that sellers disclose potential liabilities early in the process and be well-prepared for an extensive examination.

With the recent advent of online data rooms, sellers can and should allow potential buyers to perform as much due diligence as they want before putting the company under a definitive letter of intent. This minimizes the chance of the deal being renegotiated or not closing.

The seller should conduct reciprocal due diligence on the buyer, focusing on how the cultures fit and understanding the plan for integration.

Richard Knop is senior managing director and co-head of the defense and government services group at BB&T Capital Markets/Windsor Group, Reston, Va.