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Implementation: Search Through Closing --Phases 3-10

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Title: Implementation: Search Through Closing --Phases 3-10


1
Implementation Search Through Closing --Phases
3-10
2
A man that is very good at making excuses is
probably good at nothing else.
Ben Franklin
3
(No Transcript)
4
Current Learning Objectives
  • To Provide Students with an understanding of
  • how to conduct an acquisition search, to screen
    potential candidates, and to make initial contact
    with potential targets
  • the four concurrent activities within the
    negotiation phase and how they interact to
    determine purchase price, and
  • the importance of pre-closing planning and
    post-closing execution

5
The Acquisition Process
  • Phase 1 Business Plan
  • Phase 2 Acquisition Plan
  • Phase 3 Search
  • Phase 4 Screen
  • Phase 5 First Contact
  • Phase 6 Negotiation
  • Phase 7 Integration Plan
  • Phase 8 Closing
  • Phase 9 Integration
  • Phase 10 Evaluation

6
Phase 3 Initiating the Search
  • Two step procedure
  • Establish primary selection criteria (e.g.,
    industry and maximum size of transaction)
  • Develop search strategy to identify potential
    targets using computerized databases directory
    services legal, banking, and accounting firms
    and the Internet.
  • Brokers and finders
  • A broker has a fiduciary responsibility to either
    the seller or buyer.
  • A finder introduces both parties without
    representing either party.
  • Fee structures are normally negotiated and may
    include a basic fee, a closing fee, and an
    extraordinary fee (i.e., fees paid if closing
    delayed due to obtaining antitrust approval, a
    hostile takeover, etc.)
  • Put everything in writing

7
Phase 4 The Screening Process
  • As a refinement of the search process, screening
    involves increasing the number of selection
    criteria to reduce the list of potential
    candidates.
  • In addition to the industry and maximum size of
    transaction used in the search process,
    additional criteria could include
  • Market segment
  • Product line
  • Profitability
  • Degree of leverage
  • Market share
  • Cultural compatibility (e.g., AOL/Time Warner)

8
Phase 5 First Contact
  • The appropriate approach strategy depends on
  • Size of target
  • Whether target is publicly or privately held
  • Acquirers timeframe for completing transaction
  • Trust and relationship building when time is not
    critical
  • Discussing value
  • Preliminary legal documents
  • Confidentiality agreements
  • Term sheets (price range/formula, form of
    acquisition, extent of due diligence, no-shop
    provision))
  • Letter of intent (price range/formula, form of
    acquisition, form of payment, non-competes,
    employee contracts, no-shop provision)

9
Phase 6 Viewing Negotiation as a Process
If No, Walk Away1
Perform Due Diligence
Profiling Target Market Firm
First Contact
Structuring the Deal Form of
Acquisition Form of Payment Tax
Considerations Accounting Considerations Acquisiti
on Vehicle Post-Closing Organization Legal Form
of Selling Entity
Develop Financing Plan/ Structure
Decision Proceed to Closing or Walk Away
If Yes, Initiate Negotiations
Refine Initial Valuation
Negotiation
Process
1Alternatively, the potential buyer could adopt a
more hostile approach such as initiating a tender
offer to achieve a majority stake in the target
firm.
10
Phase 6 Negotiation
  • Negotiating strategy
  • Initially determine areas of agreement and
    disagreement
  • Solve the easiest areas of disagreement first
  • Establish and maintain trust throughout the
    process
  • Concurrent activities
  • Refining valuation
  • Deal structuring
  • Conducting due diligence (buyer, seller, and
    lender)
  • Developing the financing plan

11
Key Deal Structuring Considerations
  • Form of Acquisition
  • Form of Payment
  • Tax Considerations
  • Accounting Considerations
  • Acquisition Vehicle
  • Post-Closing Organization
  • Legal Form of Selling Entity

12
Phase 6 Buyer Due Diligence During Negotiation
  • Objectives
  • Validate preliminary valuation assumptions (e.g.,
    growth, cost, productivity, etc.)
  • Identify additional sources/destroyers of value
    (i.e., those providing upside potential fatal
    flaws)
  • Activities
  • Detailed legal (e.g., contracts) and financial
    record reviews
  • Management interviews (consistency in questions
    asked)
  • Site visits (e.g., inspect equipment, inventory,
    etc.)
  • Customer and supplier interviews

13
Determining the Purchase Price
  • Total consideration (TC)
  • PVTC C PVS PVND
  • Where C, PVS and PVND represent Cash, PV of
    acquirer stock, and PV of acquirer debt issued to
    seller, respectively.
  • Composition of offer price
  • Total purchase price (TPP) or enterprise value
    (EV)
  • PVTPP
    PVTC PVAD
  • Where PVTPP, PVTC, and PVAD PV of total
    purchase price, PV of total consideration, and PV
    of assumed debt, respectively.
  • Offer price plus long-term
    assumed liabilities
  • Net purchase price (NPP)
  • PVNPP PVTPP PVOAL- PVDA
  • (C PVS PVND PVAD) PVOAL- PVDA
  • Where PVOAL and PVDA represent PV of oethr
    assumed liabilities and PV of discretionary
    assets, respectively.
  • Actual cash cost of
    acquisition

14
Due Diligence and Negotiation
  • Reliable Appliances, a leading manufacturer
    of washing machines and dryers, acquired the
    stock of competitor, Quality-Built, which had
    been losing money during the last several years
    for 100 million in cash. Reliable also assumed
    20 million (present value 18 million) of
    Quality-Builts outstanding long-term debt. To
    help minimize losses, Quality-Built reduced its
    quality-control expenditures and began to
    purchase cheaper parts. Quality-Built knew that
    this would hurt business in the long run, but it
    was more focused on improving its current
    financial performance in the months prior to
    being sold. Reliable Appliances saw the
    acquisition as a way of obtaining market share
    quickly at a time when Quality-Builts market
    value was the lowest in 3 years.
  • Quality-Built had been selling its
    appliances with a standard industry 3-year
    warranty. Claims for the types of appliances sold
    tended to increase gradually as the appliance
    aged. Quality-Builts warranty claims history
    was in line with the industry experience and did
    not appear to be a cause for alarm. Not
    surprisingly, in view of Quality-Builts cutback
    in quality-control practices and downgrading of
    purchased parts, warranty claims began to
    escalate sharply within 12 months of Reliable
    Appliances acquisition of Quality-Built. Over
    the next several years, Reliable Appliances paid
    out 15 million in warranty claims (PV 12
    million). The intangible damage may have been
    much higher because Reliable Appliances
    reputation had been damaged in the marketplace.
    At the end of the second year, Reliable sold
    certain non-strategic Quality-Built assets for 2
    million, equivalent to a PV of 1.5 million.
  • 1. What was the total consideration, total
    purchase price, and net purchase price ultimately
  • paid for Quality-Built?
  • 2. Why was it important to Quality-Built to
    improve its current financial performance?
  • 3. How should Reliable Appliances have been able
    to anticipate this warranty problem from its due
    diligence of Quality-Built?
  • 4. How could Reliable have protected itself from
    the outstanding warranty claims in the
    definitive agreement of purchase and sale?
  • 5. In what sense had Reliables reputation been
    damaged?

15
Discussion Questions
  1. Identify several criteria that might be used to
    select a manufacturing firm as a potential
    acquisition target? A financial services firm? A
    hi-tech firm?
  2. Describe how the various activities that occur
    concurrently during the negotiation process
    affect the determination of the final purchase
    price for the target. Be specific.

16
Phase 7 Developing the Integration Plan
  • Use due diligence to determine post-closing
    sequencing of events necessary to realize
    potential savings and revenue enhancements
  • Resolve contract-related transition issues in
    purchase agreement
  • Employee payroll and benefit claims processing
  • Seller reimbursement for products shipped before
    closing for which payment not received
  • Buyer reimbursement for vendor supplies/services
    received before closing for which payment had not
    yet been made
  • Ensure contract closing conditions include those
    necessary to facilitate integration (e.g.,
    employee contracts, agreements not to compete)
  • Develop post-merger integration organization
    consisting of both target and acquirer managers
    to
  • Build a master schedule of what should be done,
    by whom and by what date
  • Establish work teams to determine how each
    function and business unit will be combined
  • Establish post-closing communication strategy for
    all stakeholders

17
Phase 8 Closing
  • Obtain all necessary consents
  • Shareholder
  • Regulatory (e.g., state and federal)
  • Third party (e.g., customer, lender, and vendor)
  • Complete definitive agreement
  • Purchase price
  • Allocation of purchase price
  • Assumption of liabilities
  • Representations and warranties
  • Covenants
  • Closing conditions
  • Indemnification
  • Loan documents
  • Etc.

18
Phase 9 Implementing Post-Closing Integration
  • Communication plans (e.g., consistent and
    continuous)
  • Employee retention (e.g., retention bonuses)
  • Satisfying cash flow requirements (e.g., deferred
    maintenance expenditures)
  • Employing best practices (e.g., competitor or
    similar business)
  • Cultural issues (e.g. joint work teams,
    co-location of acquirer and target employees)

19
Oracle Integrates Sun Microsystems
  • Following closing its acquisition of Sun in early
    2010, Oracle must rationalize and consolidate
    Suns manufacturing operations and substantially
    reduce the number of products the firm offers.
    Fewer products will mean less administrative and
    support overhead. Furthermore, Oracle has
    introduced a build to order mentality rather
    than a build to inventory marketing approach.
    With a focus on build to order, hardware is
    manufactured only when orders are received rather
    than for inventory in anticipation of future
    orders. By aligning production with actual
    orders, Oracle expects to reduce substantially
    the cost of carrying inventory however, it does
    run the risk of lost sales from customers who
    need their orders satisfied immediately. Oracle
    also intends to pare the number of suppliers in
    order to realize savings from volume purchase
    discounts. Historically, Oracle has been a more
    bottom line and less bureaucratic firm than
    Sun.
  • Discussion Questions
  • 1. What specific challenges do you believe
    Oracle will face in its efforts to integrate Sun
    Microsystems?
  • 2. What do you believe Oracle should do to
    overcome each of these challenges? Be specific.

20
Phase 10 Conducting Post-Closing Evaluation
  • Dont change performance benchmarks
  • Ask the difficult questions
  • Learn from mistakes

21
Discussion Questions
  1. What is the purpose of the buyer and the seller
    performing due diligence? What other parties
    might want to perform due diligence on the target
    firm?
  2. Describe the financing plan. In what sense is it
    a reality check?
  3. Of the various activities conducted during
    post-closing integration, which do you believe is
    the most important and why?

22
Things to remember...
  • The search phase involves using relatively few
    criteria to identify potential targets, while
    screening involves narrowing the list by
    employing more criteria
  • How first contact is initiated depends on target
    size, availability of intermediaries with
    contacts in target, and time criticality
  • Actual purchase price determined during the
    negotiation phase
  • Integration planning must be done before closing
    when buyer has greatest leverage with the seller
  • Closing involves completion of final
    documentation, obtaining necessary approvals, and
    resolving remaining transition issues
  • Post-closing integration focuses on effective
    communication to all stakeholders, employee
    retention, and identifying and resolving
    immediate cash flow needs
  • Post-closing evaluation provides opportunity to
    learn what worked and what didnt
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