Category Archives: Terminology and Documentation

M&A Acronyms

The field of M&A is full of acronyms, appropriate I suppose as the descriptor of the field is one.  In actual fact, mergers are very rare (in order for a transaction to be recognized as a merger under GAAP it has to meet numerous accounting criteria) and the activity really consists of acquisitions and divestitures or A&D.  In any case, I thought it might be helpful to clarify some acronyms used in the M&A process.

One of the first documents used in the M&A process is a no-names summary description of the opportunity typically called a teaser.  If the teaser is of interest then parties will sign an NDA or CA (Non-Disclosure Agreement or Confidentiality Agreement) to receive more detailed information about the company.  The comprehensive information document is called a CIM or just IM or sometimes OM (Confidential Information Memorandum or Information Memorandum or Offering Memorandum).

In order to assess whether parties reviewing the CIM are worthy of moving forward they are typically be asked to issue a non-binding EOI or IOI (Expression of Interest or Indication of Interest) which will identify a valuation range, rationale and transaction structure parameters.

If the EOI is acceptable, potential purchasers are furnished with still more information typically in the form of monthly income statements, revenue and customer analyses and whatever else is important to the potential purchaser under the circumstances.  At this stage the potential purchaser and seller will meet in person and a Data Room is set up that will contain the actual contracts to allow the purchaser to verify that everything that has been represented to date is actually true (these days more and more data rooms are virtual data rooms in cyberspace).

Subsequent to this an LOI (Letter of Intent) is sought and upon signing the LOI, a period of exclusive due diligence is awarded to the single final successful party.  Once the potential purchaser is sufficiently comfortable, work will begin on the PSA (Purchase and Sale Agreement) and signature on this document and its many companions will consist of the closing.  The PSA will define the deal structure which may contain a hold-back and/or a VTB (Vendor Take Back).  A hold-back is typically for a period of less than one year and contingent on receivables being paid, customers being retained or any indemnity claims the purchaser may have a right to as defined in the PSA.  A VTB or vendor note is a purchase loan from the seller to the buyer.  This is typically subordinated to a senior lender (i.e. a bank) and is usually of a term longer than one year.

On the financial/valuation side there are acronyms such as EBT, EBIT and EBITDA (Earnings Before Tax, Earnings Before Interest and Tax, Earnings Before Interest, Taxes and Depreciation and Amortization (non-cash items), EV and TEV (Enterprise Value and Total Enterprise Value), FYE (Fiscal Year End), LTM (Last Twelve Months), and YOY (Year Over Year).

For further terms not mentioned here please see:

An Overview of NDAs

Non Disclosure Agreements (NDAs, also called CAs for Confidentiality Agreements) are contracts that stipulate that information received from a counterparty will only to be used for the purpose as defined in the NDA and that it will not be used as a basis for competitive tactics or shared freely with others.  NDAs are signed in cases of divestitures but also for joint ventures and other collaborative and strategic relationships.  The term of an NDA is typically 1 to 3 years and the appropriateness of the term depends very much on the rate of change in the company and the industry in which it operates.

NDAs may include non solicitation and/or non circumvention clauses.  Non-solicitation clauses can apply to customers and/or employees.  Non circumvention clauses protect entrepreneurs with great ideas from well capitalized parties acting on the idea without acknowledging or compensating the entrepreneur.

Every NDA will include clauses that describe when the agreement does not apply; such as (i) if the information falls into the public domain, other than as a result of a disclosure in violation of the agreement; or (ii) if the information is already known to the recipient at the time of its disclosure; or (iii) if it is independently obtained or developed by the recipient.  The reasons for these are fairly self evident.  You can’t stop a person from acting on information that they already know or is publicly available (that everyone else can act on).

NDAs may need to be adjusted for different jurisdictions and for certain counterparties.  For example, NDAs usually address what the recipient should do with the information once one party determines the process is over.  This may include returning or destroying the information; however, in certain jurisdictions companies will want to retain a copy of the information in case it is required to be disclosed pursuant to applicable law, regulation or legal process.  Private equity and venture capital groups typically add a clause to protect their ability to invest in, or operate companies in the same or related fields of business as that engaged in by the company.

Certain companies will not sign NDAs at all (at least not in the initial stages).   IBM will not review blind teasers (i.e. a summary without disclosing the company name) and requires all introductory information to be marked “non-confidential”.  Microsoft’s policy is that NDAs are executed on the condition of aligned business group(s) willing to sponsor an engagement.  These companies see so many proposals and are in so many businesses that they have simply decided that it is not worth the expense of processing NDAs at an early stage.

So, do NDAs really protect you from counterparties using the provided information against you? And if someone contravenes an NDA, can you prove it?  Can you sue them.. yes, will it be worth it?  Rarely.  My view is you should always put an NDA in place before you share information but then use caution and share only select information that will not potentially harm your business.  Don’t view an NDA as a bullet proof vest.  Continue to be guarded particularly in the areas of new business partners, potential new customers and key employees.

What Does a CIM Include and How Do You Position It?

C.I.M. stands for Confidential Information Memorandum and it is the main overview document provided in the private company divestiture or private placement financing process.  A CIM is made available subsequent to signing an NDA and presents detailed company information as a basis for an indicative value discussion.

The CIM is typically prepared by the adviser and ranges from 40 to 100 pages.  CIMs describe the nature of the business (i.e. products/services, strategy, differentiation, revenue model, etc.), its history, ownership, legal structure, suppliers, customers, competitors, market opportunities, management, growth prospects, and high level financial information such as historical revenues, EBITDA and a balance sheet.  Customers, key suppliers and key management do not have to be identified by name.  It is still important to protect competitive intelligence at this point as there will be only one successful buyer and the company should not be put in a position where its competitors have access to sensitive information about the company.

The reader of a CIM will be looking to better understand the value proposition of the company and to identify attributes that drive sustainable value. Some examples of questions to be addressed include:

–       Has the seller transferred his/her relationships and know-how to management?
–       Are the revenues of a recurring nature or project based?
–       What are the key sustainable differentiators of the product or business model?
–       Is the customer base diversified / is the business reliant on key suppliers?

A CIM must not over-promise or leave less than flattering facts out because it forms the basis of an expression of interest that may turn in to an LOI and, ultimately a purchase and sale agreement.  Due diligence verification throughout this process will uncover all of the facts.

CIMs are different for early stage financings versus divestitures.  In the former case, it is more like a business plan outlining intentions and how to achieve them whereas for a divestiture it is more of a description of the business and the market the company competes in.  In the case of raising capital you need a detailed and logical use of funds explanation and this use of funds needs to generate a positive incremental return on investment.  In the case of a divestiture it is not so black and white because, in my view you would only include a forecast if you expect it to be substantially different from past trends. If you have a strong historical growth record and you expect this to continue then it may be best to just provide an estimate to the end of the current fiscal year.  This is because you don’t know what the buyer may be thinking and he/she may actually envision a future that includes leveraging its assets to construct a forecast that is much higher than what you would have prepared.

Should a CIM be written for the best buyer/investor? What I mean by this is, if there is a well capitalized large company acquiring businesses in your space, should the CIM be written to appeal directly to this potential buyer?  My view is yes and no.  Yes in that, you should exploit every angle to best position the company and no in the sense that you would do 90% of that anyway as you write the CIM to highlight sustainable value drivers.  A CIM undoubtedly raises further questions, and this is a good thing because it allows advisors to engage potential buyers on the opportunity, add color, clarify any misunderstandings and strengthen the main selling points specific to that potential buyer.  In short, create a two-way exchange of information and gain a better understanding of a buyer’s strategy which can be leveraged during negotiations.

In the end, a CIM is a marketing document and should present the business in its best light.  There is an art to writing a good CIM.  A good CIM provides all of the basic information plus it paints a rich picture of opportunities.

The Purchase and Sale Agreement

The Purchase and Sale Agreement (PSA or SPA in the case of a Share Purchase Agreement) is one document in a set of final documents that completes a company divestiture transaction.  Other documents typically include employment agreements, escrow agreements, non-competition agreements, releases, and more depending on the type of transaction being contemplated.

The closing documents are most efficiently prepared after a detailed LOI (Letter of Intent) has been agreed upon.  Remember that an LOI normally seeks exclusivity for the potential buyer as they will then commit to proceeding in the time-consuming and expensive due diligence and legal closing process.  For the seller it is critical that all potential “deal-breaker” issues are addressed in the LOI because exclusivity requires them to no longer engage with other interested parties.  It will be difficult to re-engage these parties should the exclusive closing process fail.  I noted before that a CIM should be positioned to present a company in a most positive manner but must not over-promise or leave less than flattering facts out because it forms the basis of an LOI and a PSA.  Due diligence will verify the assertions made in the CIM and the reps and warranties in the PSA will hold the seller to them.

A PSA is a sizable (typically more than 50 pages) document and will contain many common sections such as definitions, purchase price, representations and warranties of the vendor(s), the company and the purchaser, covenants and closing arrangements. There are various studies on common PSA parameters.  Here are select Canadian parameters for 64 PSAs closed in 2010 and 2011.  It should be noted that this is a small sample of reporting company acquisitions primarily in the resource and financial sectors.

  • 54% of the deals were all cash purchases and 53% were share, as opposed to asset, purchases
  • 21% of the deals included an earn-out and 38% of these tied this earn-out to either revenues or EBITDA for a period of 1 to 3 years
  • 70% of the deals included post-closing adjustments and 70% of those included working capital as an adjustment metric
  • 47% of the deals included an escrow between 5% and 10% and 86% did not create a separate working capital escrow
  • 83% of the deals included a Material Adverse Change (MAC) clause and 86% of those included general economic and financial market downturn carve outs
  • 40% of the deals included caps on claims equal to the purchase price
  • 78% of the deals included full disclosure reps such as a “no undisclosed liabilities” rep
  • 47% of the deals included a survival time to assert claims of 2 years
  • 40% of the deals included breach of rep or covenants minimum basket amounts in the 0.5% to 1.0% range of the deal value

This sample provides a preview of the many legal issues to be tackled in negotiating a PSA.  While the percentages are not absolute, they should guide expectations.  If you want to achieve parameters substantially different from the parameters noted above, it would be wise to bring these to the attention of the counter-party at the LOI stage rather than spending a lot of time and money on the PSA and, ultimately not closing a transaction.

What is Due Diligence and What Does it Consist Of?

Due diligence is an investigation of a business or person prior to signing a contract.  More specific to a divestiture, it is the process of verifying the representations made in the CIM and other marketing materials provided to the potential acquirer by the seller.  For example, in a CIM we may state that the seller’s customer contracts have an average life of three years and that no single customer accounts for more than 5% of revenues.  The potential acquirer will extend an expression of interest based, in part, on this information (remember, while the CIM highlights all the facts that drive sustainable value – it still holds back competitively sensitive information).  Business due diligence is the act of examining all of the signed and valid customer contracts and, in this example, confirming that customer contracts do, in fact, have an average life of three years and that no single customer does account for more than 5% of revenues.

A seller should always keep due diligence in mind when thinking about the sale of their business.   We typically provide sellers with a due diligence checklist early on in the process so that they can take the first several months of the process to get organized and assemble the documents.  I would be happy to share a due diligence checklist with anyone interested (just email me).  The  documents required for due diligence include all material signed contracts such as customer contracts, banking agreements, funding contracts, shareholder agreements, employment contracts, as well as resumes, benefit commitments, internal financial statements, receivables/payables aging schedules, capital acquisition and depreciation schedules, tax records, asset listings, articles of incorporation, the minute book, and perhaps software architecture documents, product roadmaps, environmental assessments, historical board presentations, and ultimately customer and bank reference calls.  These are just a few of the items typically included but, generally speaking, it consists of everything material to the well being of the company.  Clients provide us with these documents and we scan them and selectively, and in stages, make them available in a virtual data room to be shared with relevant parties.

Due diligence generally happens in phases.  Some due diligence is performed before exclusivity (i.e. a signed LOI) and most after.  The first phase of due diligence is business due diligence; this is where the acquirer’s executive and accounting teams figure out exactly how the revenue streams and products of the acquirer and target complement each other in order to determine how much they can pay for the target while meeting their own ROI targets.  Legal due diligence occurs during the exclusivity period and will include title searches and other searches to ascertain the target company is a valid company, owning the assets that it purports to own and operating within the regulations of the jurisdiction and that no lawsuits or claims are outstanding.  Once a certain amount of due diligence is completed parties typically initiate work on the purchase and sale agreement.  Sixty to ninety days is a typical timeframe from signing an LOI to closing the acquisition of a straight forward private company.

Finally, after exhaustive due diligence the seller will still be asked to represent that they did not withhold any information such as knowledge of potential lawsuits in a purchase and sale agreement.  In “What Does a CIM Include and How Do You Position It?”, I said: “ CIM must not over-promise or leave less than flattering facts out because it forms the basis of an expression of interest that may turn into an LOI and, ultimately a purchase and sale agreement.  Due diligence verification throughout this process will uncover all of the facts.” From the outline above I trust you will agree with me.