Mergers & Acquisitions Basics

© 2017 HUB International Limited.1 © 2017 HUB International Limited.1
Mergers &
Acquisitions
Basics
IFLP Boot Camp
May 16, 2018

John Albright
Chief Legal & Compliance Officer
HUB International Limited

Agenda
1. Introduction
2. M&A Process
3. Deal Structure
4. Key Documents
5. Wrap-up

Introduction
1

© 2017 HUB International Limited.5
Why People Engage in M&A
1. Improve the target company’s performance
2. Consolidate to remove excess capacity from industry
3. Accelerate market access for the Target’s (or buyer’s) products
4. Get skills or technologies faster or at lower cost than they can be built
5. Exploit a business’s industry-specific scalability or economies of scale
6. Pick winners early and help them develop their businesses
7. Execute a roll-up strategy
8. Transformational mergers
9. Buy cheap

Global M&A Volume
Source: Mergermarket.com

Laws Governing M&A Transactions:
q Corporate Law/Merger statutes
q Tax Laws
q Securities Laws
q Antitrust
q Labor and Employment Laws
q International Laws (global footprint acquisitions)

Factors Most Important to Deal Success
q Correct Valuation / Deal Price
q Effective Due Diligence
q Cultural Considerations
q Regulatory Environment
q Well-Planned and Well-Executed Integration Plan
q Positive Economic Conditions

M&A Process
2

The M&A Deal Lifecycle
The M&A
Cycle
Term Sheet
Exclusivity
Due Diligence/
Contract
Negotiation
Closing
Interim
Period
Sign
Announce
Post-Closing
Integration

Process Timing & Logistics
● Pre-M&A work
● Organizing
diligence material
● Preliminary due
diligence
● Negotiate letter of intent
or term sheet with
potential buyer(s)
● Detailed due diligence
● Draft and negotiate
definitive agreements
● Attend to closing conditions ● Post-closing integration
0-2 weeks 2-4 weeks 4-8 weeks 0-3 weeks
LOI Exclusivity Begins Closing
§ Typical length of time: 2-3+ months
§ Auction scenario similar but front-loaded diligence and bid (e.g., indication of interest,
letter of intent and then term sheet)
§ Extended deal length scenarios
§ Antitrust / Hart-Scott-Rodino
§ Public company involvement
Sign Definitive Agreement

M&A Transaction Process
1. Agree on confidentiality procedures.
2. Prepare a working group list.
3. Review a copy of the term sheet or letter of intent.
4. Perform due diligence.
q Business is in the condition described by seller
q Key contracts are valid
q Assets are owned free & clear
q Agreements are in place with employees
q Complete understanding of all liabilities that transfer
q Anti-corruption

M&A Transaction Process
5. Finalize disclosure schedules.
6. Draft ancillary agreements, such as employment, consulting / transition
services agreements and escrow agreements.
7. Conduct legal research on legal issues that may arise.
8. Prepare memoranda and presentations to the management or board.
9. Prepare a proxy statement and/or registration statement.
10.Obtain waivers and consents for existing contracts of Target.

14
Due Diligence Objectives
q Gathering information to validate the proposed valuation
and to justify the business reasons for closing the deal;
q Learning more about the seller’s business and operations
§ collecting information that may be critical to operating the
seller’s business post-transaction, or
§ extracting institutional knowledge seeded in seller’s personnel
that may not continue on with surviving entity;
q Uncovering and identifying the current and potential issues,
risks and liabilities posed by the transaction;
q Determining how to effectively integrate the business

Key Due Diligence Categories
15
Financial, Business Plan, Forecasts and
Budgets
§ Establish projections for the combined companies
§ Determine short term and long term working capital
needs of Target business post-closing
§ Identify assumed liabilities
§ Compare forecasts and budgets to historical results
Material Contracts
§ Review customer and supplier agreements
§ Review warranties or guarantees to customers
§ Review acquisition agreements, JV’s and
agreements regarding indebtedness
§ Identify any restrictions on business activities
§ Identify indemnification obligations and other long
term liabilities
Capitalization
§ Review capitalization table and historical stock
issuance documentation to tie out cap table
§ Confirm that stock issuances were approved by
the requisite stockholder votes and complied with
federal and state securities laws
§ Review option ledger and board minutes to tie out
option ledger
Intellectual Property
§ Confirm proper assignment of intellectual property
rights from employees and contractors to Target
§ Review documentation related to registered
intellectual property
§ Identify and review any material inbound or
outbound licenses or other encumbrances on
Target’s intellectual property

Key Due Diligence Categories, Cont’d
16
Tax
• Review state and local tax returns
• Determine expected tax liabilities for prior periods
and any stub period
• Analyze value of any tax assets (e.g. NOL’s)
• Consider tax impact of the structure of the
transaction
Employees / Employee Benefits
§ Review employee compensation information and
compare to offer letters
§ Identify any accelerated vesting terms or transaction
bonuses that will result from the acquisition of Target
§ Review benefit plans to confirm ERISA compliance
§ Develop integration plan for employees/benefit plans
Litigation
§ Identify any threatened or pending litigation or
investigations and review the underlying facts
§ Review historical litigation and investigation
records to determine key areas of risk
§ Assess risk of enforcement from governmental
agencies
Corporate Governance
§ Review corporate governance documents to
confirm proposed treatment of stockholders and
option holders in the acquisition of Target
§ Review board and stockholder actions to confirm
that necessary consents were obtained with
respect to material historical matters
§ Identify any special consents that will be required
to complete acquisition of Target

Deal Structure
3

M&A Transaction Structures:
q Stock/Share purchase. Acquisition by stock purchase where buyer
accepts ownership of all assets and liabilities, as documented in a Stock
Purchase Agreement.
q Asset purchase. Buyer buys all (or part) of the seller’s assets and
assumes only the seller’s liabilities, as expressly agreed, as documented
in an Asset Purchase Agreement.
q Merger. Two companies combine to form one, with the surviving entity
assuming all liabilities and assets as documented in a Merger Agreement.

Structure No. 1 — Stock Purchase

Advantages of a Stock Purchase Structure
q Relatively quick and simple way to consummate a transaction, as it
generally requires fewer third party consents and transfers.
q Aside from express indemnification obligations, selling
shareholders do not retain any liabilities post-closing.
q It is generally advantageous for a seller because of the benefit from
capital gains tax rates.

Disadvantages of a Stock Purchase Structure
q Due diligence can be more extensive.
q It requires each individual stockholder selling shares to agree to
transfer ownership and, usually, to provide indemnity.
q Impractical in public company transactions because of the diffusion
of the target company’s shareholder base.
q Assumption by buyer of unknown liabilities
and less advantageous tax positioning

Structure No. 2 — Asset Purchase

Examples of Acquired Assets
q Tangible property, including equipment, fixtures, and inventory
q Owned and leased real estate
q Contract rights
q Cash and accounts receivable
q Permits, books, customer lists, and records
q Rights to bring lawsuits and to tax refunds
q Intellectual property and R&D
q Rights to employee personnel and related contracts

Examples of Acquired Liabilities
q Liabilities reserved or accrued on the balance sheet.
q Liabilities for taxes.
q Liabilities arising under assumed contracts.
q Employment and benefits liabilities.
q Liabilities associated with acquired real estate.
q Other liabilities arising before or after closing.

Advantages of an Asset Purchase Structure
q Generally consummated without 100% shareholder consent.
q Buyer can be selective in choosing which assets and liabilities it wishes to assume.
q Unless the seller will be dissolved, the seller (as opposed to its shareholders) will
typically bear responsibility for post-closing indemnification obligations to the buyer.
q The target’s tax attributes (e.g., NOLs), may be used immediately to offset the
target’s taxable gain. Any remaining tax attributes are lost if the target liquidates.
q The buyer assumes a stepped-up cost basis in the target’s net assets—a more
favorable structure from a buyer’s tax perspective than a stock sale.

Disadvantages of an Asset Purchase Structure
q May require significant/difficult to obtain third party consents.
q Some assets may be used by both the sold and retained businesses,
complicating extraction of an independent enterprise.
q Potentially two layers of tax applicable to the seller.
§ Corporate layer, where seller recognizes taxable gain/loss on sale of the assets.
§ Shareholder layer, in which shareholders recognize gain taxed as ordinary
income if Target liquidates.
q Sale of all assets impractical for public companies.

Structure No. 3 — Negotiated Merger

Advantages of a Negotiated Merger Structure
q Enables buyer to obtain ownership of 100%
of Target’s stock even if less than all of the
shareholders agree to the sale.
q Unless specifically retained by the seller
shareholders, all assets remain held by the
“merged” company.
q Aside from express indemnifications, selling
stockholders do not retain any liabilities of
the Target post-closing.
q As in a stock purchases, it generally
requires fewer third party consents and
instruments of transfer than an asset sale.
q Sellers benefit from capital gains tax rates.

Disadvantages of a Negotiated Merger Structure
q Given the need to obtain
shareholder approval, it may take
longer to close a merger transaction
than an asset purchase.
q Target shareholders may have
appraisal/dissenters’ rights to
receive a court determined value in
lieu of merger consideration.
q Other disadvantages to buyers
associated with stock deals.

Structure No. 4 — Two-Step Merger / Tender Offer

Structuring Analysis and Considerations
q Form of Target entity
q Requisite shareholder approvals
q Breadth of operations domestically and globally
§ Tax impact of alternative structures
§ Availability of NOLs and other tax assets
q Credit / real estate obligations
q Key relationships (manufacturers, suppliers and customers)
q Assignability of contracts / third party consents
q Employment and equity incentive arrangements
q Regulatory filings and requirements (e.g., Antitrust, OFAC, FCPA)
q Successor liability and due diligence logistics
41

Deal Structure Considerations
q Stock Purchase
§ Simplicity and flexibility on terms
§ Continuity of entity and contracts
§ Problem of holdouts
q Merger
§ Majority vote cures holdout problem
§ Less flexibility on terms
§ Continuity of entity can be preserved
q Asset Purchase
§ Maximum flexibility on terms; maximum complexity
§ Contractual assignment problem
§ Requires wind-up and dissolution, resolution of excluded liabilities

Forms of Consideration
q Cash
§ Simplicity
§ Taxable
§ Eliminates upside potential
q Stock
§ Requires securities law registration/exemption
§ Can be tax-free in certain circumstances
§ Affords continued participation in future upside (and risks)
§ Evaluation of minority protection/rights considerations
q Mixed Cash & Stock
§ Greater complexity and equitable treatment considerations
§ Can offer choice to stockholders
§ Similar issues to “stock” deals, including tax-free treatment of stock portion

Key Documents
4

Documents Signed Before
Principal Transaction Agreement
q Confidentiality Agreements
§ Entered into at commencement of discussions
§ Ensure confidentiality of information and protect solicitation of employees
q Letters of Intent
§ Generally non-binding
§ Lay out general transaction framework and key terms
§ Simplify negotiations by crystallizing key terms earlier in process.
q Exclusivity Agreements
§ Prohibit the seller from attempting to sell to a third party for a period of
time (typically, 15-60 days).
§ Sought by buyers who do not wish to compete for a deal.
§ Without exclusivity, buyers may not invest time and resources in due
diligence and negotiating transaction.

Major Components of M&A Transaction Agreements
q Representations and Warranties—statements made by a party
referring to facts or matters about the party making them.
§ Speak negatively—“there is no litigation pending. . .” and affirmatively—“each of
the company’s employees earning more than $100,000 per year are listed. . .”
§ Significance of “knowledge” and “materiality” qualifiers.
§ Closely linked to the disclosure schedule.
q Covenants—assure buyer the acquired business will not
significantly change between signing and closing.
§ Can address process requirements to close (e.g., shareholder approval)
§ Covenants may survive closing (e.g., non-compete/solicit).

q Conditions to Closing—things that must happen/not happen
to obligate close of acquisition.
q Indemnification—who pays for liabilities arising post close.
§ What is an “indemnification cap”?
§ What is escrow and why is it used?
§ What is a “basket”?
Major Components of M&A Transaction Agreements

Additional Stock Purchase/Merger Agreement Terms
q Transfer [or cancellation and conversion] of Target shares
q Mechanics for payment of purchase price and transfer of [or tendering of
cancelled] shares
q Process for filing certificates of merger or other regulatory filings
q Appraisal (dissenters’) rights
q Termination rights under specified circumstances, such as a material
adverse effect on the target company

Additional Asset Purchase Agreement Terms
q Specific enumeration of assets and liabilities being transferred.
q Provisions for necessary legal instruments to transfer ownership, such as
bills of sale, assignment and assumption agreements, and intellectual
property assignments.
q Differences in seller representations and warranties include a rep that
acquired assets are sufficient to run acquired business.
q Provisions governing treatment of assets that are used in both the business
of seller and acquired business (shared assets).

Disclosure Schedules
q Attachments to the deal’s principal transaction agreement that serve to provide
party disclosures and qualify or limit representations and warranties.
q Seller and buyer may have schedules but seller schedule is far more common.
q Disclosures are generally tied to specific representations and warranties.
q Incorrect, incomplete, or misleading disclosure schedules can result in a breach
of the acquisition agreement and lead to significant liability to the sellers.
q Because disclosure schedules require a significant amount of time to assemble,
preparation of the initial drafts should be undertaken early in the process.

Documents Needed Between Signing and Closing
q HSR Filings
§ Provide information to FTC and DOJ for determining whether the
transaction has an anti-competitive effect.
§ If the FTC and DOJ have no concerns, parties may close the transaction
30 days after making the HSR filing.
q Third Party Consents
§ Many Targets are subject to agreements with third parties that restrict
their ability to consummate a deal.
§ When such restrictions cannot be avoided through deal structuring,
parties must obtain third party consents.

Documents Delivered At or Effective After Closing
q Legal Opinions
q Assignment and Assumption Agreements
q Transition Services Agreements
q Employment Agreements
q Noncompetition Agreements
q Resolutions approving the transaction
q Escrow Agreements
q Stock Certificates
q Bills of Sale

Documenting the Deal
53
Structural Mechanics
• Execution of transaction (stock, merger, asset)
• Allocation of consideration
• Computation of earnouts / royalties
• Treatment of equity incentive arrangements
• Working capital or other adjustments
• Delivery of shares / assets
• Payment mechanics and timing
Closing Conditions
§ Accuracy of Representations & Warranties
§ Performance of Covenants
§ Shareholder Approval
§ Governmental / Third-Party Consents
§ Absence of Litigation
§ Employee Matters
§ Material Adverse Effect
§ Legal Opinion
Pre-Closing Covenants
§ Ordinary course of business / limitations on actions
§ No public announcement
§ Shareholder meeting / approval
§ Regulatory approvals (HSR)
§ Third-party notices and consents
§ Access and diligence
§ Exclusivity / fiduciary out
Post-Closing Covenants
§ Non-competition / non-solicitation
§ Confidentiality
§ Continuation of D&O indemnity obligations
§ Transition services
§ Prior period tax preparation and payment
§ Expenses
§ Release of claims

Documenting the Deal (Reps & Warranties)
54
Fundamental Representations
• Organization
• Authorization
• Enforceability
• Tax
• ERISA
• Capitalization
• Brokers
Specialist Representations
§ Tax
§ Employment / ERISA
§ Intellectual property
§ Regulatory
§ Environmental
§ Real estate
Typical Areas of Negotiation
§ Materiality and knowledge qualifiers
§ Time and dollar thresholds
§ Applicability and scope of disclosures
§ Updating of disclosure schedules
§ 10b-5 (no material omissions or misstatements)
General Representations
§ Financial statements / undisclosed liabilities
§ Sufficiency of Assets
§ Contracts
§ Absence of change
§ Compliance with laws / litigation
§ Insurance / product liability
§ Customers and suppliers; trade relations
§ Interested party transactions

Documenting the Deal (Indemnification)
55
Areas of Indemnity
• Breach of representations and warranties
• Breach of covenants
• Working capital
• Tax
• Breach of Ancillary Agreements
• Third-party claims
Limitations of Liability
§ Limits on types of recoverable damages
§ Survival period
§ Aggregate cap on recovery
§ Exclusion of fundamental and specified reps
§ Baskets / mini-baskets
§ Exclusivity of indemnity as remedy
§ Insurance / tax offsets
Typical Areas of Negotiation
§ Materiality and knowledge scrapes
§ Limitations of liability
§ Recovery for third party claims in absence of final
judgment
§ Right to control defense / settle claims
§ Anti-sandbagging
§ Authority of stockholder representative
Sources of Recovery
§ Escrow held with third party
§ Holdback of funds
§ Offset of future payment obligations
§ Joint versus several recovery
§ Direct recovery from stockholders

Wrap-up
5

What We Learned!
Due diligence is
critical to M&A
success
Deal structure can be used to optimize
risks, tax exposure and timing to close.
The Disclosure Schedule
often proves to be the
most critical document—
as well as the longest and
most difficult to compile
in that it is often tied to
post-close legal exposure.
Identifying and obtaining
third party consents
triggered by an asset
purchase or change in
control, as well as locking in
key personnel post close,
can be critical to longer
term deal success.
M&A process can take 2-3
months or more to complete
from NDA to close.
Most transactions are stock
deals, but asset deals offer
unique advantages to buyers.

Questions?

Thank you.

Mergers & Acquisitions Basics

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