Acquisition terms are worth their weight in gold
Market Watch | Financial views of a competitive environment
Due diligence and the negotiation of terms and conditions in connection with mergers and acquisitions of government contractors have become increasingly complicated and protracted.
The terms and conditions of a transaction are as important as, if not more so than, the purchase price because they primarily relate to the buyer and seller sharing the risk.
This trend of deeper due diligence and more difficult negotiations is a product of several factors, including the Sarbanes-Oxley Act, increased board oversight, new Small Business Administration recertification rules, higher valuations, a changing procurement environment, serial buyers and private-equity groups becoming more sophisticated and experienced in the government, and increased use by buyers of experienced outside consultants and advisers.
Buyers are analyzing in detail small-business and set-aside contracts; compliance with the Federal Acquisition Regulation; retention of key management and employees; tax issues such as S Corporation status, the validity of revenue and earnings before interest, tax, depreciation and amortization projections; and all legal and accounting systems and issues.
Over the years, a body of customary transaction terms for federal information technology transactions has developed. Some of the current trends relate to:
- Contingent consideration or earnouts.
- The form of the transaction ? stock purchase vs. asset purchase.
- Escrows and holdbacks.
- Retention of key employees.
- Representations and warranties.
- Noncompete agreements for sellers and key employees.
There also has been an increased use of earnouts, escrows and holdbacks to mitigate risk caused by the transfer of set-aside contracts and valuations based on projected continued strong growth of the target company and in situations where there are contract or legal issues.
Every transaction of a privately held company involves detailed representations and warranties and indemnification by the sellers. The negotiation of these terms has become increasingly detailed and sophisticated.
The other major focus of buyers of federal services companies is on contractual provisions to ensure that the intellectual capital of the seller is retained by the buyer.
Customarily, retention agreements are entered into by the seller with his key employees before closing and approved by the buyer.
Sellers want to reward key employees, and buyers want to retain them and restrict their ability to compete with them.
As a result of a lot of experience with these retention agreements during the past 10 years, the language and mechanisms employed for retention have become increasingly sophisticated.
The way to obtain the most favorable terms and conditions in a government contractor's M&A is a controlled auction, in which the company for sale has a detailed and accurate offering memorandum presented by its M&A advisers to the most strategically motivated buyers at the appropriate decision-making level.
The use of a virtual data room for the final three to five potential buyers gives them the detailed information they need to submit a detailed offer that includes most of the key terms and conditions that would ordinarily be negotiated in the purchase and sale agreement.
This mitigates the risk and expense for the buyer and allows the seller to compare not only the purchase price and valuation from the finalists but also the critical
and equally important terms and conditions.
The use of qualified and experienced advisers for both sellers and buyers has never been more important than it is today.
Rick Knop is senior managing director and head of international banking investment at BB&T Capital Markets, of Reston, Va.