losely-Held Selling a usiness

Closely-Held Business

Practical Wisdom, Trusted Advice.

www.lockelord.com
www.lockelord.com

Practical Wisdom, Trusted Advice.

Atlanta, Austin, Chicago, Dallas, Hong Kong, Houston, London, Los Angeles, New Orleans, New York, Sacramento, San Francisco, Washington DC

Atlanta, Austin, Chicago, Dallas, Hong Kong, Houston, London, Los Angeles, New Orleans, New York, Sacramento, San Francisco, Washington DC

Locke Lord LLP is an international, full-service business law firm. Among our many strong practice areas are aviation, bankruptcy/restructuring, business litigation, class action litigation, corporate, employee benefits, energy, environmental, financial services, health care, insurance and reinsurance, intellectual property, international, labor and employment, litigation, mergers and acquisitions, private equity, public law, real estate, regulatory, REIT, tax, technology, and white collar criminal defense and internal investigations. About 650 Locke Lord attorneys practice in offices located in Atlanta, Austin, Chicago, Dallas, Hong Kong, Houston, London, Los Angeles, New Orleans, New York, Sacramento, San Francisco and Washington, D.C. Our lawyers regularly represent various participants in the sale of businesses, including owners of closely-held businesses in a variety of industries. We counsel the owners with respect to the process and assist in negotiating and documenting these M&A transactions, which include taxable and tax-deferred sales, leveraged buyouts and leveraged recapitalizations. For further information please contact: Louis Dienes ldienes@lockelord.com (213) 687-6737 Christopher Husa chusa@lockelord.com (213) 687-6743 Dan Peters dpeters@lockelord.com (213) 687-6778

This brochure was prepared by members of Locke Lord LLP. It is intended for general information purposes only and does not constitute legal advice. This information is not intended to create, and it does not create an attorney-client relationship. Readers should not act upon this information without first consulting a lawyer. If you would like to be removed from our mailing list, please contact us at either unsubscribe@lockelord.com or Locke Lord LLP, 111 South Wacker Drive, Chicago, Illinois 60606, Attention: Marketing. If we are not so advised, you will continue to receive this brochure. Attorney Advertising. 2013 Locke Lord LLP

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Table of Contents Page Introduction 4 Chapter 1 The Decision to Sell 5 Reasons for Selling ........................................................................................................ 5 Advantages and Disadvantages ..................................................................................... 5 Alternatives.................................................................................................................... 6 Price Considerations ...................................................................................................... 7 Timing Considerations ................................................................................................ 10 Chapter 2 Pre-Sale Planning 12 Retaining Advisors ...................................................................................................... 12 Business and Financial Analysis ................................................................................. 14 Tax and Estate Planning .............................................................................................. 15 Restructuring ............................................................................................................... 16 Chapter 3 Overview of the Process 17 Finding a Buyer ........................................................................................................... 17 Confidentiality Agreements ........................................................................................ 18 Due Diligence .............................................................................................................. 19 Letters of Intent ........................................................................................................... 20 The Definitive Agreement ........................................................................................... 21 Ancillary Agreements.................................................................................................. 22 Securing Consents and Approvals ............................................................................... 24 Closing ......................................................................................................................... 24 Post-Closing Obligations ............................................................................................. 24 Chapter 4 Structuring the Transaction 25 Alternative Structures .................................................................................................. 25 Types of Consideration ............................................................................................... 28 Chapter 5 Tax and Accounting Considerations 31 Federal Income Tax ..................................................................................................... 31 State and Local Taxes.................................................................................................. 35 Accounting for Business Combinations ...................................................................... 35 Chapter 6 Legal and Regulatory Concerns 37 Securities Laws............................................................................................................ 37 Antitrust Laws (Hart-Scott-Rodino)............................................................................ 38 Exon-Florio ................................................................................................................. 39 Regulated Industries .................................................................................................... 40 Bulk Sales .................................................................................................................... 41 WARN ......................................................................................................................... 41 Chapter 7 The Definitive Agreement -2Locke Lord LLP

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Deal Provisions............................................................................................................ 43 Representations and Warranties .................................................................................. 44 Covenants .................................................................................................................... 47 Conditions to Closing .................................................................................................. 48 Indemnification ........................................................................................................... 49 Termination ................................................................................................................. 50 Miscellaneous Provisions ............................................................................................ 50 APPENDIX A Comparison of Sales of Stock and Assets APPENDIX B Glossary B-1 A-1

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INTRODUCTION Some business owners sell several companies over the course of their careers, but for most business owners this is a unique, one-time experience. The decision to sell can be driven by business objectives or by personal reasons, such as a desire to diversify or lack of a satisfactory plan of succession. This booklet will cover the factors to be considered in making a decision to sell and some of the alternatives. We will then discuss pre-sale planning and the sale process, stressing the particularly significant matters that can arise during the negotiation and closing of a sale. It is important that those considering a sale become fully familiar with this process and the potential problems that might be encountered so there will be no surprises. Once the process begins, a great deal of time and effort will be devoted to the project, and the expense can be considerable. This is not something that should be undertaken without a great deal of thought and preparation. Accordingly, the remainder of the booklet is devoted to a general discussion of some of the tax, accounting and legal issues, and the form that the documentation for the sale of a closely-held business typically takes. In addition, we have included as Appendix B a glossary of terms commonly used in the context of buying and selling a business. We have written this booklet strictly from a sellers perspective, which we believe will be most helpful in advancing the knowledge of those considering the sale of a business. The sale of a business in corporate form often presents more difficult planning considerations from a tax and corporate standpoint than a business operated as a sole proprietorship, a partnership or a limited liability company. Therefore, we will principally address the sale of an incorporated business. But most of the discussion also will pertain to the sale of any business, whatever the form. Recognizing that the actual seller can be a corporation or its shareholders, for convenience we will make general reference to a seller or sellers unless this distinction becomes important.

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CHAPTER 1 THE DECISION TO SELL Reasons for Selling Owners of closely-held businesses may consider selling for a wide variety of reasons. One of the most common is that the owners are reaching retirement age and do not have either a management team able to operate the business without the continued involvement of the owners or a succession plan to transfer the business to younger family members. Others may wish to sell in order to achieve liquidity and diversify their holdings. Some may be motivated by a belief that current industry and market conditions may present an uncommon opportunity to realize a particularly attractive price. Strategic reasons for selling a business may include the ability of a buyer to provide greater access to capital, technology or marketing and distribution resources than are available on a stand alone basis. There may also be negative reasons for selling a closely-held business. These may include concern over increasing competition, product or service obsolescence, excessive debt, adverse industry or regulatory conditions, poor health or death of the owner-manager or a falling out among multiple owners. The reasons that owners are considering a sale may have a significant impact on the transaction, affecting their willingness or ability to continue as managers or consultants after the sale, the price range that is acceptable, their willingness to finance a portion of the purchase price and the timing of the transaction. Thus, it is important for them to take the time to analyze their motivations for selling and, in the case of multiple owners, to understand each others motivations. The decision to sell a closely-held business will usually be the single most important economic decision that an owner makes. To make a sound decision, an owner should develop as much information as possible as to whether his or her motivations can be fulfilled given current economic, industry and market conditions and the circumstances of the particular business. Careful consideration of the potential advantages and disadvantages of a sale and of the alternatives, as well as a realistic valuation analysis, all as described below, are important parts of the decision process. Advantages and Disadvantages The advantages that the owner of a closely-held business may realize from a sale closely parallel the various reasons for selling and may include one or more of the following: Freedom to retire or pursue other interests Diversification of investment and elimination of the risk of concentration of the owners wealth in a single enterprise -5Locke Lord LLP

 Liquidity Access to greater resources Despite the significant tangible advantages that may result from the sale of a business, there are subjective factors that must be carefully weighed. A significant factor to consider is the personal effect of becoming disassociated from the enterprise that the owner has devoted a substantial portion of his or her life to building and which has been the focus of most of his or her business career. Another subjective factor is the impact of a sale on management of the business. Many owners have a strong commitment to their managers who, in many cases, have been with the business for years and played a significant role in its development. These owners will want to balance their personal goals against their managers concerns for job security and compensation. Following the sale of a business, the former owner may have to adjust to living on less income. While a sale may result in substantial wealth, it often will not produce enough net proceeds after expenses and taxes to provide investment yields as great as the amounts the owner was previously able to draw from the business through a combination of compensation, perquisites and dividends. An owner who continues as an employee-manager of the business will have to deal with the loss of personal control. Former owners can become frustrated by the management style of the buyer or simply by the fact that the new corporate structure does not permit the same flexibility and responsiveness on issues that existed prior to the sale. Although a seller may in good faith be promised a great deal of autonomy in managing the business, there can never be the degree of autonomy previously enjoyed. Alternatives Of course the sale of a business cannot be viewed in a vacuum and other alternatives also should be evaluated. The principal alternatives would be an initial public offering (IPO) or a leveraged recapitalization. While an IPO would provide new equity capital, it would not afford an owner some of the advantages of a sale as discussed above. For example, an IPO would not afford immediate liquidity and diversification and probably would require continuing involvement in the business and accountability to the public shareholders. Moreover, the IPO market cannot be depended upon. Unfavorable economic or market conditions, for example, can make it difficult to undertake an IPO. Finally, the heightened regulatory requirements, substantial costs and increased public scrutiny have dissuaded many from effecting an IPO. These same factors have also caused a number of the smaller public companies to revert to private status in recent years. -6Locke Lord LLP

A leveraged recapitalization is a means by which a portion of the owners equity would be sold and the company would be recapitalized through a combination of equity (including a roll over of the owners remaining equity and new private equity) and various layers of debt. This would permit an owner to retain some control over the business while obtaining a degree of liquidity, but would involve operating the business in a leveraged environment, continuing active participation in the business, and some restrictions on decision making. Price Considerations In many cases, owners of closely-held businesses have unrealistically high price expectations. If the owner sets and maintains an unrealistically high asking price, it is likely that the business will not be sold and eventually will be taken off the market. To avoid this disappointment, prospective sellers are well advised to undertake a realistic valuation analysis in the course of making a decision to sell. A financial advisor or valuation firm can provide valuable assistance in making such an analysis and will usually be more objective than the business owner. Many owners draw substantial compensation and other perquisites from their businesses over and above the compensation and benefits that would be necessary to pay a nonowner-manager to operate the business. In making a valuation analysis, it is appropriate to prepare proforma financial statements adjusted for the owners compensation and expenses that the business would not continue to bear after the sale. When a realistic range of values has been developed, an owner can make a more informed decision about selling the business. In addition to simply considering the expected purchase price, the owner will want to analyze the returns that can be expected from investing the net proceeds of the sale of the business after expenses and taxes and compare those projected returns to what the owner is currently drawing from the business. In many cases, particularly those involving mature businesses that do not require continuing major capital expenditures, the projected investment returns will be less than the owner draws from the business. The Valuation Method. The fair value of a business is customarily defined as the price at which the business would change hands between a willing buyer and a willing seller, both being fully informed and neither being under a compulsion to buy or sell. This rubric is of little help, however, in actually determining the fair price for a particular business. Numerous methods and formulae have been developed and are employed in valuing businesses. In some industries, there are customary or standard methods for determining a purchase price. For example, prices may often be set based on a multiple of revenues for insurance agencies, a price-per-subscriber for health maintenance organizations or cable television companies, a price-per-bed for hospitals and nursing homes or a multiple of book value for financial institutions. In most cases, however, there is no single method that can be used. -7Locke Lord LLP

Generally, the value of a business to the buyer is based on the stream of income that the business will produce. As a result, factors such as earnings and cash flow are more significant in arriving at a valuation than net asset value, net book value and replacement cost. Investment bankers or business appraisers retained to value businesses or give fairness opinions as to a price typically employ several methods, including earnings multiples, discounted cash flow, market comparables, comparable transactions, and leveraged buyout (LBO) analyses, and combine the results to produce a range of values. Because a buyer is principally interested in the income stream, the valuation method that often receives the most weight involves multiplying the historical business earnings by an appropriate multiple. The application of a multiple to measurable historical earnings implies an assumption that historical earnings are to some extent predictive of future performance. The period selected for measurement may be the last fiscal year, the last four quarters or the most recent 12 months. The earnings measured may be either before or after taxes, before interest and taxes (EBIT) or before interest, taxes, depreciation and amortization (EBITDA), depending on which measure the evaluator believes gives the clearest indication of the factors significant to the particular business. The art in this method is in selecting the multiple. Multiples may vary widely with the industry, the size of the business, the general market and economic conditions and factors intrinsic to the particular business, such as growth expectations or possession of proprietary intellectual property. To select a multiple, valuation professionals generally analyze sales of other businesses considered comparable. They may also analyze the multiples at which stocks of publicly traded companies in the same industry are traded, although closely-held businesses do not generally command earnings multiples as high as a publicly traded business. Frequently, a valuation professional will conclude that a range of multiples, rather than a single multiple, is appropriate, resulting in a range of values. Another method used in valuing a business is discounted cash flow. The theory underlying this method is that the value of a business is equal to the present value of the total cash flow it will produce over a given period of years plus the present value of the estimated terminal value at the end of the period. To apply this method, the cash flow of the business must be projected for the selected period, often three to six years, and a terminal value must be estimated. A discount rate is applied to determine the present value of the total projected cash flow for the selected period. In practice, the resulting present value may be discounted again to reflect the uncertainty of projected outcomes. The discounted cash flow method involves numerous uncertainties and educated guesses. The first and most significant is the projection of future cash flows. Others include the determination of the appropriate periods of projection, the estimated terminal value and the discount rates. Market comparables are of little use in a discounted cash flow analysis because cash flow projections for the comparable companies are generally unavailable.

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In a market comparables analysis, the valuation professional will attempt to identify a number of sale transactions involving companies considered to be comparable to the business being valued. By analyzing the relationship of numerous financial factors to the purchase price such as net assets, book value, revenues, earnings and others, one can develop ranges or averages to apply to the same financial measures of the business being valued. The result is a range of market values. An accurate market comparables analysis for a small business is often difficult to achieve because financial information about other comparable small companies is generally not publicly available. An LBO analysis is an estimate of the leveraged capital structure that could be supported by the operating returns of the business after all operating and capital needs are met. In an LBO, a substantial portion, often 60% or more, of the purchase price is financed with debt incurred by the business being sold or carried by the seller, and the balance represents equity. The operating returns must be sufficient to service the various tiers of senior and subordinated debt and provide an adequate return to the equity investors. The LBO value is largely a function of the availability and cost of credit and the return expectations of equity investors in the current environment. An LBO analysis may be a valid valuation method even though it is not anticipated that the business will be sold in an LBO. Economic and Market Factors. General economic and market conditions can have a significant impact on prices at which businesses change hands. As a result, the price for a business several years ago may have little bearing on the price that may be realized today for essentially the same business. The level of merger and acquisition (M&A) activity and pricing is influenced by a number of factors, including the availability of financing, trends in various industries and the strength of the equity markets and the economy in general. The level of corporate profits and amount of cash held by private equity groups and by corporations will also have an impact on the level of activity and pricing. Other Factors. Factors in addition to earnings, cash flow and economic and market conditions may significantly affect the price paid for a particular business. A business that has developed a valuable proprietary technology, for example, might command a price much higher than would be predicted based on common valuation methods. Similarly, a business that has secured certain exclusive rights or strategic contractual relationships might also be priced at a premium. So might a business that can satisfy a strategic need that the potential buyer cannot satisfy internally on a timely basis or without great expense. Conversely, various negative factors could result in a price substantially lower than might be indicated by comparable transactions.

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Timing Considerations The time from the initial consideration of a decision to sell a closely-held business until the closing of a transaction may range from a few months to more than a year. The following time line gives an idea of how the various tasks might overlap under optimum conditions for a sale using a financial advisor:
Selection, analysis and valuation Prepare memorandum Search for buyer Due diligence Draft and negotiate agreement Closing 0 1 2 Month 3 4 5

In many cases, it will be possible to complete tasks more quickly than the times indicated. In some cases, the project may become more prolonged for a variety of reasons, such as a lengthy search for a buyer, the buyers need to arrange financing for the purchase, or securing regulatory approvals. External Factors. Because the amount of M&A activity and pricing levels will vary from time to time, there may be a sellers market at certain times and a buyers market at other times. It will obviously be to a sellers advantage to be able to time a sale to take advantage of a sellers market. Timing may, however, be more dependent upon an owners desire to sell and a buyers ability to finance a transaction. A business owner motivated to sell by a desire to retire should begin the process early enough to complete it by his or her desired retirement date. In addition to the time required to complete the transaction, one should consider the possibility that he or she will be expected by the buyer to continue for a number of months or years as an employee or consultant. A seller motivated to cash in his or her investment, achieve liquidity and diversify may have the luxury of timing a sale to coincide with favorable market or industry conditions. A seller seeking access to capital, technology or marketing and distribution resources may have little control over timing and must be prepared to sell when an appropriate strategic buyer appears. Internal Factors. The owner who can be flexible in timing the sale of the business will want to sell when the condition of that business is most favorable. A sale when the business is in an apparently sustained period of growth will produce a more attractive price than if revenues and earnings are flat or declining. Similarly, a business which has just completed a successful launch of a major new product may be more attractive to prospective - 10 Locke Lord LLP

buyers than one with a major product still in research and development. Of course it is much more difficult on an emotional level to sell when things are going well. Sellers motivated by what can be described as negative reasons will probably wish to sell as soon as possible after identifying the motivating circumstances so as to complete a sale before conditions worsen and the seller becomes desperate or the business fails. For example, the companys principal product may be at the end of its lifecycle and the owners may not have the capital needed to invest in newer technologies. Since it is likely that a careful buyer will discern at least some of the sellers motivation, it will generally be more difficult to complete such a sale and the price will likely be less attractive than for other transactions.

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CHAPTER 2 PRE-SALE PLANNING Once the decision to sell a business has been made, planning should be undertaken to organize the process in a manner designed to achieve a successful conclusion. Retaining Advisors At an early stage, advisors should be retained to assist in evaluating, planning and effecting a sale. The key advisors will be attorneys, accountants and financial advisors or intermediaries. Sometimes sellers will already have access to professionals who are knowledgeable about the sale of a business. Often, however, they must seek this expertise outside their normal group of advisors. The order in which the advisors are retained is not important. There can be some overlap in their areas of expertise and each might be helpful in recommending others. It is important, however, that they work well together and collectively have the expertise to properly guide the seller. While the average seller may only sell one company in a lifetime, the average buyer will make four or five acquisitions. Accordingly, most buyers are quite knowledgeable about acquisitions, which is all the more reason for a seller to engage advisors who can provide this type of expertise. Interviews should be conducted with several prospects before retaining any advisor. Not only is this useful in selecting those in whom the seller can have confidence, but it also can be a learning process. The advisors should complement the sellers strengths and weaknesses. For example, if the seller prefers that the advisors negotiate the terms of the transaction, this particular skill should be sought in the interviewing process. To use advisors to the best advantage, one must understand their role and perspective. Attorneys will identify and evaluate potential risks and problems to protect their clients. It may therefore appear that they have a negative attitude toward the deal. By contrast, intermediaries are compensated only if the sale takes place. They have an economic incentive to minimize problems and find solutions to those that threaten the deal. However, the sellers (not the attorneys or intermediaries) must make the ultimate business decisions taking into account the advice given by these advisors based on their experience. Attorneys. Legal counsel can play an important role in advising a seller. Not all attorneys are experienced in structuring, negotiating and documenting M&A transactions; most helpful would be an attorney with an active M&A practice who is associated with a larger firm that has attorneys specializing in areas of the law that commonly are relevant to M&A transactions, such as tax, labor, intellectual property, employee benefits, environmental and real estate. A buyers counsel ordinarily will be quite experienced, and it is therefore important that the sellers counsel be able to match that experience and knowledge. - 12 Locke Lord LLP

The role of the attorney is to provide general guidance and to evaluate the legal risks and potential consequences of various issues or courses of action so that the seller can make informed business decisions. The attorney should conduct a preliminary examination of the company and be prepared to guide the process to conclusion and help resolve any issues by suggesting solutions to bridge the gap. Attorneys who are knowledgeable about acquisitions can more readily suggest solutions to problems that arise in negotiations on the basis of their experience in other transactions they have handled. Accountants. The principal role of the accountants is to help gather financial data and to interface with the buyers representatives and accountants. Sometimes the sellers accountants, rather than the attorneys, will have responsibility for analyzing the tax consequences to the seller of various structures and of suggesting alternatives to minimize any adverse tax impact. It is essential at the outset that responsibility for tax analysis is clearly assigned to the attorneys, the accountants or both. Most buyers will require that a sellers financial statements for recent periods be audited (or at least reviewed) to provide some comfort as to historical performance and selected balance sheet items, such as accounts receivable and inventories. Consequently, the reputation and independence of the sellers accountants may be important. Financial Advisors and Intermediaries. Sometimes a prospective buyer will contact and negotiate with the seller directly, in which case engaging a financial advisor or intermediary may not be as important. However, a financial advisor or intermediary can be essential where the seller needs assistance in valuing the business, or negotiating with or finding potential buyers. Financial advisory and intermediary services are provided by investment banking firms and by M&A specialists. Many accounting firms and banks also provide some of these services using their data bases of active buyers. Abilities vary considerably among advisors. At one end of the spectrum are investment banking firms that offer a full range of services, including research and evaluation of the market, advice on sale strategies, valuation analysis and seeking potential buyers; and at the other end are business brokers or finders who are only engaged in finding buyers. Some firms or individuals concentrate in the middle-market and some may have particular expertise in the industry in which the seller is involved, which can be helpful in identifying strategic buyers. In some cases, advisors also have the capability of finding or, in the case of merchant bankers, providing capital and, when required, rendering opinions as to the fairness of a transaction. To a great extent, the type of advisor that is best suited to assist a seller will depend on the size of the business, the industry and the complexity of the sale transaction. Compensation. The compensation of financial advisors and intermediaries varies. If, as in many cases, a descriptive memorandum (often referred to as a book) is prepared for potential buyers, a retainer fee might be charged that becomes payable at regular intervals or at various stages of preparation of the memorandum. Some advisors also - 13 Locke Lord LLP

can provide a valuation analysis of the business for the owner and will receive a fee for this effort. While it may be helpful to obtain a preliminary indication of value, the real value of course cannot be determined until the marketplace is tested and a buyer found. If an intermediary is engaged to find a buyer, a transaction fee will be charged that is based on a percentage of the consideration received. Transaction fees are negotiable and the amount will depend on the services to be rendered, which may simply involve making an introduction or finding a buyer and participating in negotiations. Historically, most intermediaries charged the Lehman formula, which was 5% of the first million of consideration, 4% of the second million, 3% of the third, 2% of the fourth and 1% of the excess. In recent years, a variation in the formula or, particularly in larger transactions, a flat percentage of the total consideration is normally used. Some suggest an increased percentage over a certain target price as incentive to obtain a higher price. If any potential buyers already have been contacted and expressed an interest, these might be carved out and a reduced percentage applied. Many intermediaries will require a minimum fee regardless of the amount of the consideration received, which they consider an opportunity cost for the time and effort devoted to the project. Engagement Letter. Before allowing a financial advisor or intermediary to render any services or contact potential buyers, the seller should insist on a writing (usually called an engagement letter) setting forth the fee arrangement and other terms of the engagement. A proposed form of letter will normally be prepared by the advisor and presented to the seller. It is important that the sellers counsel be asked to review the form of letter presented. Like any other contract, the terms and responsibilities of the parties should be clear so as to avoid any later misunderstandings. Particularly important are the nature and term of the engagement, the services to be provided, the method of computing the fees and any limitations on expense reimbursement or contacting potential buyers. Most engagement letters require payment of a fee if a sale is made within a specified period of time (called a tail) following termination or expiration of the engagement. Often this is limited to transactions with those prospects approached by the intermediary or with whom the seller had contact during the engagement. Business and Financial Analysis In preparing a business for sale, its strengths and weaknesses must be understood so that the strengths can be highlighted to potential buyers and the weaknesses addressed. The earlier that problems are disclosed in the process, the better. There is greater risk to the deal if they become points of contention at the later stages of the process. This understanding of the business can be gained by a careful examination by the advisors. The attorneys can conduct a corporate check, which consists of a review of corporate minutes and other records, material contracts and legal compliance. This might include a review of employee benefits, securities and antitrust compliance, together with licensing and intellectual property protection. The purpose is to uncover any significant corporate or legal - 14 Locke Lord LLP

problems and recommend corrective action or, if such action is not feasible, evaluate the risk to a potential buyer. The accountants can assist the sellers personnel in gathering and analyzing historical financial data, including results of operations, asset values, cash flows and segment or product line breakdowns of revenues and expenses. Budgets and forecasts also can be prepared with the assumptions developed and documented. Most buyers will require that financial statements be prepared in accordance with generally accepted accounting principles (GAAP) and that those for recent periods be audited or at least reviewed by independent accountants. For publicly-held buyers, audited statements for one to three fiscal years may be required under the accounting rules of the Securities and Exchange Commission (SEC). Some companies maintain sufficient historical records to permit accountants to render audit reports on their financial statements. This may not be possible, however, for manufacturers where the accountants have not observed the opening inventory for the period to be audited. Generally, one can anticipate that a buyer will closely test and analyze accounts receivable and related reserves, inventories, intangibles, post-retirement benefits, officers compensation, long-term contracts, related-party transactions, significant customer arrangements and nonrecurring transactions. The seller and the accountants can prepare items for a potential buyers review that may require an explanation. As a general rule, the greater the quantity and quality of financial information available, the greater the ability of a buyer to analyze the business and arrive at an acceptable price. If a buyer is satisfied with the information, payments contingent on future performance might be avoided. Other information concerning the business, its future prospects, the market and competition should be compiled and analyzed. Factors unique to the business or industry need to be addressed, such as a patent protection, assignability of material contracts, market share and dependence on customers. Once gathered and analyzed, some of this information can then be integrated into a memorandum or booklet for distribution to potential buyers. Tax and Estate Planning Tax issues for the seller and buyer can be critical in the sale of any business and will be a driving force in structuring the transaction. Before embarking on the sale, the seller and advisors should determine the amount of gain that would be recognized in a fully-taxable sale. In this manner, the seller can determine the optimum after-tax proceeds that can be derived from a sale, against which the alternatives can be measured.

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The amount of gain will depend in part on the companys tax basis in its assets (inside basis) and/or each shareholders tax basis in his or her stock (outside basis). For S corporations, a shareholders tax basis can change each year. Separate calculations for tax basis should be made for federal and state taxes. Once this information is obtained, different structures can be analyzed to determine the net proceeds that could be obtained for a given purchase price. These structures would include the sale of stock, a merger, the sale of assets followed by liquidation and the sale of assets with the company continuing in existence. The effect of retaining certain assets such as real estate also should be considered. The income tax impact of other alternatives such as a tax-free transaction or an installment sale should be compared so that the potential advantages can be quantified. The sellers liquidity needs over short and longer -term time horizons also must be considered. Many of these tax considerations are discussed in Chapter 5. The seller also should consider various techniques to minimize income and estate taxes for his or her family. For example, stock might be gifted to family members prior to the sale, or the sale might be made through a charitable remainder trust. For an owner with a low tax basis, a tax-free transaction might avoid, rather than defer, income tax if the seller still owns the stock received at death because the heirs tax basis in the stock would be adjusted (stepped-up) to fair market value of the shares at death, resulting in a significant tax saving to the heirs. Of course, this plan may not afford sufficient investment diversification to the seller and would subject the seller to market risk. Restructuring In some cases, a restructuring or reorganization of the business may be necessary to better posture it for sale. This pre-sale planning might include the transfer or disposition of unrelated assets, the reorganization of operations the owners wish to retain, the combination of separately-owned businesses or the acquisition of related assets or operations critical to the success of a business. Because of tax implications and other factors, it often is helpful to complete these transactions far in advance of any sale.

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CHAPTER 3 OVERVIEW OF THE PROCESS This Chapter, in a general way, outlines the actual sale process and describes the discrete steps of the process in their typical sequence. Finding a Buyer Types of Buyers. One of the first steps in attempting to sell a business is finding the right buyer. Buyers generally fall into a few discrete categories, sometimes with a blend of each. A strategic buyer generally is one that is interested in the business because it fits into or complements its existing business and operations. A financial buyer might be a private equity firm or a fund sponsored by a private equity firm or other experienced M&A specialists, usually leveraging their own equity capital with debt (a leveraged buyout or LBO). Often the management, who previously may have had no (or an insignificant) ownership interest, will join forces with a financial buyer to acquire the business from its existing owners (a management buyout or MBO). The distinction between strategic and financial buyers can sometimes become blurred, as for example when a financial buyer has an operating company in its portfolio that becomes the buyer. Publicly-held companies are active in the M&A market and often are among those solicited for sale of a business. The SEC has imposed requirements on public companies specifying the periods for which acquired businesses must have audited financial statements depending on the percentage relationship of certain financial items of the seller to those of the public company. An inability to produce the audited statements, because of lack of physical inventories or other reasons, can preclude a public company from becoming a buyer. Approaches to Finding a Buyer. Owners may find a buyer, or be found by a buyer, in one of a number of ways. By word of mouth in the industry or the community, one party may learn of anothers interest. A seller may receive unsolicited inquiries from potential buyers or intermediaries acting on their behalf that are familiar with or have researched the company and concluded that it may fit into their expansion plans or serve as the entree to an industry. These inquiries may come from existing customers, suppliers or competitors. Many acquisitions come about in this manner. An owner who has decided to sell can, of course, be proactive, engaging a financial advisor or intermediary or asking its attorneys or accountants to suggest prospective buyers. A competent intermediary will be familiar or quickly get familiar with the industry and the sellers position in the industry and, through data bases or other sources, identify prospective buyers. The intermediary can assist in screening and discretely approaching prospects, making introductions and starting the negotiation process. - 17 Locke Lord LLP

In recent years, it has become more common for sellers to engage in what amounts to a controlled auction. With the aid of an investment banker or other intermediary, a group of likely prospects is identified and sent a teaser briefly describing the business and presenting the opportunity. Those expressing an interest are then provided with a memorandum (often called a book) describing in considerable detail the company, its business and its financial condition and results of operations (both historical and projected). After allowing time for review of the book, management presentations and initial investigation of the business, those remaining in the process typically are asked to submit an indication of interest that includes the proposed structure and pricing of a transaction. On the basis of these submissions, the group is narrowed down to the most likely prospects, each of which is sent a bid package, inviting them to make an offer. Such packages normally contain a list of bidding criteria and a proposed form of acquisition agreement. Prospective bidders are told they may specify changes in the proposed form of agreement, but that any changes will be weighed critically in the evaluation of their bid. In this situation, the seller in effect turns the table on buyers who traditionally have more say in the content of acquisition agreements. Once the responses are received, a decision is made as to which party or parties are the best prospects for finalizing the terms of an acquisition and intensive negotiations are undertaken. Confidentiality Agreements Whenever a seller begins to deal with prospective buyers, it is critical that the parties enter into an agreement concerning the treatment of confidential information that may be provided (often called a confidentiality agreement or nondisclosure agreement). Sometimes the form of agreement will be provided by a prospective buyer, but often the seller will have a form that it proposes to use. Because these agreements can have significant legal consequences, it is important that they be reviewed by the sellers counsel before signing. Where financial advisors or intermediaries are engaged, they will often prepare an agreement in their own form on behalf of the seller before the more detailed financial and other information concerning the business is furnished to prospective buyers. A confidentiality agreement can be unilateral or bilateral. A unilateral agreement protects only the sellers confidential information, and provides that the information is only to be used for the limited purpose of evaluating a possible transaction. A bilateral agreement provides that each side agrees to keep the others information confidential, and is useful where it is likely that both parties will be sharing confidential information. These agreements also will require the return of all confidential information if, for any reason, the deal is not consummated. Confidentiality agreements often prohibit a prospective buyer from later soliciting employees of the seller if the deal is not consummated.

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Due Diligence Because a closely-held business has no public history and has not been subjected to the scrutiny of the public trading market, a prospective buyer will want to conduct a very thorough investigation of the business, its financial history, prospects, legal compliance, current and potential liabilities and other matters of potential concern. This process of investigation is referred to as due diligence, and is a vitally important and often very time consuming part of the process. As part of the buyers due diligence, the seller will be asked to provide access to all manner of documents, agreements, records and other information, including trade secrets, customer lists and other confidential information. Typically, attorneys and accountants for the buyer will deliver due diligence request lists to the seller which are meant to cover as much information as possible that is relevant to the sellers business. In addition, the seller may receive confidential information of the buyer in the course of negotiations, particularly if the buyer will be offering stock as part of the consideration. Because of the nature of this information, the due diligence effort often is staged so that the most sensitive information will be disclosed at the very end of the process. A buyers initial due diligence is generally limited to an assessment of the sellers business to determine whether it is an appropriate acquisition target, i.e., whether it fits into the buyers strategic plan. Next, the buyer will examine the financial statements and accounting records to determine how the business is performing and any discernible trends. If the buyer is still interested after this initial phase, serious due diligence begins. Frequently, the sellers counsel will facilitate the delivery of information and documents in the due diligence process. To limit knowledge of the potential acquisition, due diligence might be conducted in an offsite data room, which is often established in the office of sellers counsel. In recent years, sellers have used a password-protected online data room where all relevant documents are posted for review by the buyer and its advisors, thereby avoiding the need to provide hard copies of often voluminous records. Buyers will also want access to the companys accountants and their work papers. Sellers counsel also has an interest in conducting due diligence of the sellers business because it will be helpful in negotiating and preparing the disclosure schedules for the definitive agreement and, in some transactions, counsel on both sides will be asked to deliver formal opinions as to various aspects of their respective clients business organizations and enforceability of the acquisition agreement. A variety of factors influence the level of a due diligence investigation. If the sellers business is one which is closely regulated, deals with toxic substances or has a history of labor or employment problems, a buyer is likely to be very cautious and require a great deal of detailed information on these issues because the potential for liability can be substantial. This is particularly true in a stock purchase or a merger, because the buyer in effect becomes - 19 Locke Lord LLP

responsible for all of the sellers liabilities in the acquisition and cannot exclude certain liabilities as in an asset sale. If real property is involved in the transaction, the buyer usually will require a Phase I environmental audit and possibly a Phase II site assessment. Conversely, if the buyer and the seller are fairly sophisticated, the sellers business is relatively clean and the buyer is anxious to complete the transaction, the buyer will likely have a higher risk tolerance and the due diligence process can be completed more easily. Letters of Intent The purchase and sale of a business necessarily involves the parties negotiating and documenting their agreement. Generally, the parties to most transactions of any significance have the task of identifying and dealing with existing and potential problems by agreement. If they fail to do so, our legal system may leave one or the other without adequate protection. As a consequence, business acquisitions almost always are documented in considerable detail. Sometimes fairly early in the negotiating process the parties will enter into a letter of intent (sometimes called a memorandum of understanding or agreement in principle) outlining the basic terms of the transaction. Also, it is common for a letter of intent to contain a no-shop provision pursuant to which the seller, for some period of time, agrees not to entertain offers from other prospective buyers. (Sellers sometimes receive special compensation for taking their company off the market before final agreement has been reached on all points.) Letters of intent normally do not purport to cover all particulars of the transaction and leave much for the final, definitive acquisition agreement, such as the terms and conditions under which the seller will indemnify the buyer in respect of problems affecting the business. Consequently, where the parties are careful, the letter of intent will say that it is not binding or that only some parts of it are binding (e.g., a no-shop provision or a confidentiality covenant binding the buyer) and that no legal obligation to buy and sell will be created until a definitive agreement has been signed. A considerable amount of litigation has arisen over letters of intent which were not clear on these points. Buyers generally favor using letters of intent because they tend to reduce a seller s negotiating leverage and can at least take a seller off the market for awhile. Sellers are always concerned about maintaining confidentiality and will have to balance this and other disadvantages against the benefits of moving the transaction forward and memorializing the details of the negotiations. If the buyer is a public company, reaching agreement on the principal terms, particularly if evidenced by a letter of intent, can force public disclosure of the proposed transaction. M&A lawyers also differ about the efficacy of letters of intent. Some would say that they often waste time and energy that could be devoted to negotiating the definitive agreement. Others argue that they are useful in avoiding misunderstandings and, even

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though they may not be binding, they do provide some moral suasion for the parties to proceed toward consummation of the transaction. The Definitive Agreement At an early stage in the process, whether or not a letter of intent has been signed, the parties will commence the negotiation of the definitive acquisition agreement and, perhaps, various ancillary agreements. The initial draft of the acquisition agreement normally is prepared by counsel for the buyer, except in an auction process. The buyer, as a general proposition, will be more interested in a comprehensive document that contains extensive representations and warranties and that puts the risk for problems that may arise after closing on the seller. Drafting generally commences as soon as the structure of the transaction (e.g., purchase of stock or assets) and basic terms (e.g., price and manner of payment) have been agreed upon. Whatever the form and terms of the acquisition, the format of the agreement is generally the same: Deal Provisions. The structure, price, form of consideration, payment terms and security for any deferred portion of the price are set forth. There also may be provision for a post-closing adjustment in the price, for example an adjustment based on changes in net worth or working capital from the date of the sellers last available financial statements to the date of the closing. The agreement will provide when and where the closing actually will take place, although it has become increasingly common for closings to occur without a gathering of the parties in one location, often using email to exchange executed documents. Representations and Warranties of the Seller. The seller will be asked to make various representations and warranties about authority to sell and the financial and other condition of the business and, where a particular representation cannot be made because it would not be true, to make an exception or qualification on a written disclosure schedule. (If the buyer does not like the exception, it can attempt to renegotiate the price or other terms, or walk away.) Representations and Warranties of the Buyer. Where the buyer is paying cash, it may not be asked to make many representations and warranties. (In such a transaction, the number of pages devoted to the sellers representations and warranties can be ten times the number devoted to the buyers representations and warranties.) Where it is acquiring the business in exchange for its own securities, however, the buyer may be asked to provide representations and warranties similar to those the seller provides. Covenants. Because there normally is an interval, sometimes a considerable one, between signing the definitive agreement and the closing, the seller will agree to operate the business only in the usual and ordinary manner during that interval. If it has not already signed a confidentiality agreement, a covenant binding the buyer not to disclose information about the business if the transaction does not close also may appear in the covenants section. - 21 Locke Lord LLP

Conditions to Closing. Each partys obligations to actually consummate the transaction are subject to the satisfaction of a number of conditions at or before the scheduled closing, e.g., the continued accuracy of the other partys representations and warranties, the receipt of any required governmental or other third-party consents, and the receipt of title or environmental audit reports. Often, the buyers obligations will be conditioned on the seller executing a covenant not to compete or on certain key personnel entering into employment or consulting contracts with the buyer. Indemnification. Aside from documenting the agreement on price and basic payment terms, the most important thing the parties will do in an acquisition agreement is to allocate risk between themselves concerning problems that may surface after the closing with respect to the business being sold. The buyer will seek to allocate as much of that risk as possible to the seller by insisting on extensive representations and warranties and by demanding that the seller provide unlimited indemnification. In its indemnification, the seller generally agrees to fully compensate the buyer in respect of any loss the buyer may suffer on account of a situation covered by one of the sellers representations and warranties or on account of being required to discharge a liability of the business which the buyer did not assume. A well advised seller will anticipate this and be prepared to forcefully argue for more limited representations and warranties and to seek to curtail indemnification exposure by demanding both (i) a provision indicating that no claim for indemnification can be made after some specified period following the closing, and (ii) monetary and other limitations on the indemnification obligation itself. While compromises normally are made, more than one acquisition transaction has failed because the parties could not agree on the allocation of risk. Termination. For any number of reasons, a transaction contemplated by the definitive agreement may fail. That possibility should be addressed in a section indicating the circumstances under which the agreement may be terminated and the legal consequences if it does. The definitive agreement may provide that either party may elect to terminate in certain circumstances without a penalty, or that the seller or buyer must pay the other a termination fee or reimburse it for its out-of-pocket expenses if the deal is terminated for specified reasons (e.g., breach by a party of its representations and warranties or failure of the buyer to obtain financing). Miscellaneous Provisions. The final portion of a definitive agreement contains miscellaneous provisions, including terms that are generally applicable to commercial contracts. A more complete discussion of the various subjects covered in a definitive agreement is provided in Chapter 7. Ancillary Agreements In addition to the definitive agreement, there often are ancillary agreements that must be entered into as a condition to closing the transaction. These agreements can be for the - 22 Locke Lord LLP

benefit of the seller, the buyer or both. Some of the ancillary agreements that are most often used in acquisitions are described below. Consulting and Employment Agreements. In order to maintain the continuity of business operations, a buyer will generally want to retain the services of those primarily responsible for the development and success of the business. In a closely-held business, these persons are commonly the sellers who thus have an interest in the transaction as well. In this manner, a buyer can have greater assurance that these sellers will remain employed and, as described in Chapter 5, there may be some tax advantages to the buyer. If it is expected that the sellers or managers will be involved in day-to-day operations after the acquisition, this can be accomplished with an employment agreement which sets forth, among other things, compensation and benefits, a minimum term of employment and the conditions under which the employee can be terminated. If, following the acquisition, the sellers or managers will not be involved in day-to-day operations, the buyer may want to retain their services using a consulting agreement. This may afford an opportunity to apportion part of the consideration directly to the sellers. For tax purposes, however, the treatment of the consulting fee to the buyer will depend on its reasonableness in relation to the services to be rendered. Covenants Not to Compete. Most buyers will want to obtain a covenant from the sellers which restricts their right to compete following the acquisition. The enforceability of covenants not to compete is a matter of state law. As a general rule, all agreements which restrict competition are void in California except in situations involving the sale of a business. To be enforced, covenants must be of reasonable duration and the activities restricted must be limited to those carried on by the seller at the time of sale. (An exception may be business activities or product lines not existing at the time of sale that were under development by the seller or in the sellers business plan and which influenced the buyer in valuing the business.) Finally, the restrictions must be limited to the geographic area where the business is conducted. This may include areas where products or services are marketed, and not just where plants or offices are located. Covenants not to compete (sometimes called noncompetition agreements) are often heavily negotiated in terms of scope and duration because they can effectively preclude sellers from engaging in the only business they know. In some cases, sellers seek to obtain employment agreements extending for the period of the covenant so they at least have some assurance of being employed while they are unable to compete. Leases. When the facilities of the acquired company are owned separately (by shareholders or others) and are not transferred with the rest of the business, it may be necessary to negotiate a lease between the property owner and the buyer. If there is a lease already in effect, the parties may have to negotiate changes in the rental rate or other terms to satisfy a buyer. Sometimes, the term of the lease has to be extended or shortened, or provisions may be added to extend the lease term at the option of the buyer. In some asset - 23 Locke Lord LLP

sales, real property might be retained and distributed to shareholders. This also may require negotiating a new lease with the buyer. Securing Consents and Approvals If the seller is a corporation, the laws of most states require the approval of the shareholders and the board of directors, unless the transaction involves only a purchase of outstanding stock directly from the shareholders. Unless otherwise provided by law or the charter, approval by holders of a simple majority of shares and of the directors is all that is necessary to authorize the transaction. In an asset sale, many of the sellers material agreements with its suppliers, customers and lenders will require the consent of the other party to assign those agreements to the buyer. This also may be true in the context of a stock sale or a merger, because control of the seller will be shifting to new ownership. Many of the permits and licenses under which the seller has previously operated also will need to be transferred. Typically, obtaining the consents to assign material contracts and transferring permits and licenses are conditions to the buyers obligation to close the transaction. Closing Once all conditions have been satisfied, the closing will occur during which payment of the purchase price will be made against receipt of bills of sale, stock certificates or other appropriate instruments of transfer. The closing also will involve the exchange of other documents and evidence that the conditions to closing have been satisfied. As mentioned above, it has become increasingly common for closings to occur without a gathering of the parties in one location, often using email to exchange executed documents. Post-Closing Obligations If the deal provides for a post-closing price adjustment or an earn-out arrangement, the parties will have obligations after the closing is completed. Typically, these calculations are based on financial statements as of the closing or as of a certain date thereafter. If funds have been placed in escrow to cover these arrangements or post-closing indemnification, an escrow agreement typically will govern how the funds are to be distributed.

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CHAPTER 4 STRUCTURING THE TRANSACTION Alternative Structures The sale of an incorporated business generally takes one of three basic forms: a sale of stock, a sale of assets or a merger. If the business to be sold is not a corporation, the structuring alternatives differ. Stock Sale. Perhaps the simplest way of accomplishing the sale of a corporation is by selling all of its outstanding stock. In a stock sale, the corporation continues to exist and maintains all of its assets, liabilities and contractual relationships. The buyer enters into an agreement directly with the shareholders to acquire their stock. If the stock is owned by more than one shareholder, each must agree to the sale for the buyer to acquire all of the outstanding stock. Although the buyer generally will want to acquire all of the stock, it need not do so. A buyer that acquires at least 90 percent of the stock may be able to effect a merger which will eliminate any minority shareholders.1 Asset Sale. A more complex approach than a stock sale, but one which offers greater flexibility, is an asset sale. In an asset sale, the buyer enters into an agreement with the selling corporation to acquire certain of its assets and to assume specified liabilities and contractual relationships. Because the selling corporation is not itself purchased, generally only those assets, liabilities and contractual relationships which are specifically acquired or assumed will pass to the buyer. While asset sales typically involve the acquisition of all or substantially all the assets, liabilities and contractual relationships of the seller, the parties have the flexibility to exclude any of these items from the transaction. Any assets, liabilities or contractual relationships excluded from the sale generally remain with the seller. Merger. A merger is a statutory procedure that allows a corporation to merge with and into another corporation or other entity. One corporation remains intact or survives and the other corporation ceases to exist as a separate entity or disappears. All states have laws which authorize mergers. The operative document is an agreement of merger, which details the terms of the merger including the designation of which corporation disappears and which survives. At the time the merger becomes effective (usually upon the filing of the agreement of merger with the appropriate state authority), all the assets of the disappearing corporation (generally including legal and contractual rights) automatically become vested in the survivor and the survivor automatically assumes all liabilities (generally including contractual obligations),
1

Some state statutes provide for a share exchange in which all shareholders are bound to sell their shares if approved by holders of the requisite number of shares.

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known and unknown, of the disappearing corporation. The pre-merger assets and liabilities of the surviving corporation are unaffected by the merger. The merger provisions of most state laws permit the agreement of merger to provide for shares of the disappearing corporation to be converted into stock, cash, debt securities, warrants or any combination. It is not uncommon for a merger to involve a wholly-owned subsidiary of the buyer, often newly-formed expressly to effect the merger. In this case (referred to as a triangular merger because three corporations are involved), the corporation being acquired merges into the subsidiary, and the subsidiary survives. Where the subsidiary merges into the acquired corporation and the acquired corporation survives, the transaction is referred to as a reverse triangular merger. Often shares of the acquired corporation are converted into shares of the subsidiarys parent corporation. Leveraged Buyouts. Leveraged buyouts, or LBOs as they are popularly known, came into vogue in the 1980s. Many high profile and tremendously successful deals heightened interest in LBOs but the luster faded somewhat with an economic downturn and a number of publicized failures. Today LBOs still are undertaken with success, if not with the former glamour. A leveraged buyout, as the term suggests, is the acquisition of a business in a transaction financed largely by debt (thus the opportunity to engage in an LBO depends on the availability of financing). The buyers equity investment is small in relation to the debt. The lenders generally look to the assets of the acquired business for collateral and to its cash flow from operations as the source of repayment of the loans. An LBO can be structured as an asset sale, a stock sale or a merger. Appropriate LBO candidates typically are established businesses with clean balance sheets, large debt capacity but little or no debt, liquid and undervalued assets and quality management. Management, in fact, often is the leading force in an LBO. Because such a large portion of the cash generated from operations must be used to repay the loans, an LBO may be unworkable in a business which is capital intensive or requires upgrading or modernization. An LBO frequently involves three levels of financing: senior, secured debt that generally comprises the largest portion of the financing; subordinated or mezzanine (usually unsecured) debt often convertible into stock of the acquired business or coupled with warrants to acquire stock; and equity, consisting of common or preferred stock of the acquired business. The large amount of debt that characterizes a leveraged buyout will, if the acquisition is successful, magnify the buyers return on equity. But with such a heavy debt load, there is substantial risk that the acquired company will be unable to service the debt, resulting in a - 26 Locke Lord LLP

painful financial restructuring or even bankruptcy. A failed LBO can lead to fraudulent conveyance and other claims against the parties, and in the bankruptcy context may cause creditors and debtors in possession to seek to recover payments made to the selling shareholders as part of the transaction on grounds that the debtor did not receive reasonably equivalent value and was left insolvent, unable to pay its debts or with unreasonably small capital as a result of the LBO. Comparing Alternative Structures. Although there is some truth in the adage that a seller will prefer a stock sale and a buyer an asset sale, the structure of a particular transaction is in fact dependent upon a host of considerations. A number of these considerations, such as tax and accounting implications, corporate authorization and regulatory concerns, are discussed in other chapters of this booklet and will not be examined here. A chart showing some of the advantages and disadvantages of a sale of stock and a sale of assets is included as Appendix A. In a stock sale, the selling corporation continues to exist and thus its permits, licenses, leases of real and personal property and other legal and contractual rights generally will continue in force without separate action. The same generally is true with respect to mergers, even where the selling corporation disappears (since the disappearing corporations assets, including legal and contractual rights, automatically vest in the surviving corporation). It is possible, however, that some permits and licenses will need to be reissued, and the consent of contracting parties obtained, in connection with a stock sale or merger. In an asset sale, on the other hand, permits and licenses of the selling corporation generally must be reissued to the buyer, and the buyer may need to obtain the consent of contracting parties to the assignment of contract rights. The process of having permits and licenses reissued and obtaining the necessary consents can be difficult and time-consuming, and sometimes unsuccessful. Additionally, in granting consents, contracting parties (particularly lessors) may require that the seller remain liable for contractual obligations. The documents required to effect an asset sale are typically more involved than those for a stock sale or merger. In an asset sale, documents must be prepared conveying the selling corporations assets. This is unnecessary in a stock sale because the corporate ownership of each asset remains the same, only the stock ownership changes. This also is unnecessary in a merger, even where the acquired corporation disappears, because all the assets of the disappearing corporation automatically vest in the surviving corporation. An asset sale also requires that the parties agree on an allocation of the purchase price among the various assets acquired. This can be difficult, even apart from the scope of the task, because the interests of the buyer and seller, particularly from a tax standpoint, may differ dramatically. Despite these complexities, asset sales are often attractive to a buyer because it generally acquires only specified liabilities and thus may be able to avoid assuming unwanted or unknown liabilities. However, under some circumstances the buyer may be - 27 Locke Lord LLP

subject to successor liability for certain claims, including products liability and environmental liability, even though these liabilities were not expressly assumed. In situations where the buyer is more interested in the underlying assets of the seller than its ongoing business, an asset sale gives the buyer the flexibility to pick and choose assets without the need to take over the sellers contractual obligations or other liabilities. In a merger, the laws of most states give the shareholders of the disappearing corporation the right to sell their shares to the corporation for cash at their fair market value or fair value in lieu of accepting the consideration offered by the acquiring corporation. Generally, all that is necessary to trigger these appraisal rights is that the affirmative vote of the acquired corporations shareholders is required and the shareholder did not vote in favor of (but need not have voted against) the transaction (a dissenting shareholder). Dissenting shareholders must then perfect their appraisal rights by meticulously following detailed procedures, which vary from state to state. In some states, these rights are also afforded shareholders of corporations in asset sales. Because obtaining an appraisal of stock in a closely-held corporation can be a very expensive and lengthy process, the appraisal remedy is not really a satisfactory alternative for most shareholders. Types of Consideration The single most important issue in the minds of the buyer and seller of a business is frequently -- and understandably -- the price. Sometimes the issue is as simple as agreeing on a dollar amount that will be paid in cash at the closing. More commonly, however, the issue involves both the type of consideration and method of payment. There are a surprising number of alternative types of consideration and methods of payment, most of which can be used regardless of whether the acquisition is structured as a stock sale, an asset sale or a merger. As was the case with the choice of acquisition methods, the determination of the type and method of payment of the price is dependent upon a wide variety of factors, including tax, accounting and regulatory issues which are discussed at length in other chapters. The following discussion is a brief overview of some of the more common types and methods of payment of the purchase price. Cash. Cash is the least complex type of consideration. But even a cash purchase price can be complicated by the method of payment. It is possible, for example, for the buyer to hold back a portion of the cash purchase price (or place it in escrow) for some period of time to be used as an offset against undisclosed liabilities or misrepresentations or breaches of warranties by the seller in the definitive agreement. Common Stock. The purchase price also may be paid in common stock of the buyer (or its parent corporation). A buyer may wish to use its stock when the stock is trading at a high multiple of earnings or simply because it is short of, or wishes to preserve, cash. There are several difficulties in using this type of consideration. If the buyers stock is not publicly traded, establishing its value can be a problem. If the buyers stock is publicly traded, the - 28 Locke Lord LLP

buyer and seller must decide when to value the stock, since changes in the market after the value is calculated but before the stock is delivered at the closing will affect the ultimate price paid for the business. A seller will want the consideration measured in dollars, rather than shares, while a buyer will prefer a fixed ratio so that it has control over the number of shares to be issued and the effect on its earnings per share. Collars can be used to limit the risk of volatility, with a right of termination or an adjustment when the collar thresholds are reached or exceeded. Another difficulty relates to the liquidity of the stock. If the buyers stock is not publicly traded, the seller may have to hold the stock indefinitely. Even if the stock is publicly traded, the shares received by the seller may be restricted stock that cannot be sold in the trading market for a period of time. It may be possible, however, to structure the transaction so the stock is immediately saleable, with certain restrictions. It may also be possible for the seller to obtain the buyers agreement to register the stock at some future time so the stock can be sold without restriction. These issues are discussed more fully in Chapter 6. Preferred Stock. Sellers may also accept preferred stock of the buyer as part of the consideration. Preferred stock in this instance would generally function as a form of financing by the seller. The preferred stock would provide for quarterly or annual dividends and the buyer, the seller or both would be able to redeem the stock by payment of a given amount. The seller might be given a right to convert the preferred to common stock if the buyer has not redeemed or retired the preferred stock by a certain date. The conversion of a substantial amount of the preferred stock could significantly dilute the buyers interest in the business, thus providing the buyer with an incentive to maintain the dividend payments and retire the preferred stock on time. Payment Deferral. Another method that can be used by a buyer desiring to preserve cash is to defer payment of all or a portion of the purchase price, typically evidenced by a promissory note. A buyer also may favor this approach as a means of holding back a portion of the purchase price as an offset against undisclosed liabilities or other breaches by the seller. A seller may prefer this as a means of deferring taxes on gain from the sale as discussed in Chapter 5. In periods of tight money, use of seller financing may be the only way to bridge the gap in pricing. Nonpayment of the note is a sellers greatest risk in using this method of payment. An attempt should be made to secure the note, for example with assets or stock, or possibly through the use of letters of credit or guarantees. However, often this debt is deeply subordinated to other bank financing in the deal structure, which generally means that no payment of principal can be made on the subordinated debt until the senior debt is paid in full. A buyer may try to hedge its risk by tying repayment of the note to future earnings goals. If the goals are met, the note is repaid (or repaid over a shorter period); if the goals are not met, the note is not repaid (or is repaid over a longer period). In this way, both buyer - 29 Locke Lord LLP

and seller have a stake in the future performance of the business and the projections which induced the buyer to purchase the business. Earn-Outs and Contingent Payments. Earn-outs and contingent payments are postclosing payments by the buyer to the seller based on the performance of the business after the closing. Earn-outs are typically used to bridge the gap when the buyer and seller are unable to agree on the value of the business on the basis of historical and projected financial results or when the business is subject to significant future developments affecting value, such as regulatory approval of a drug application or the renewal of a major contract. There is no standard formula for earn-out provisions. Each is crafted to meet the particular goals of the parties and the nature of the business. Negotiating and drafting an agreement that adequately addresses the parties concerns and interests and that anticipates all the issues that might arise is often difficult. Some of the complexities are defining the business, measuring future performance of the business and delineating, if applicable, the obligation of the buyer to support growth and to provide the necessary capital and other resources and the control to be exercised by the seller. If there is to be no ongoing relationship with the acquired business, a seller may justifiably be wary of an earn-out because of an inability to influence operations and limited access to records. Even when earn-outs are drafted with considerable thought and care, disputes can and often do arise. Nevertheless, earn-outs should not be summarily dismissed because they can benefit a seller and result in a substantial increase in the price paid for a business.

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CHAPTER 5 TAX AND ACCOUNTING CONSIDERATIONS When the sale of a business is being negotiated, the parties must choose among a variety of forms for the transaction. A determination of the most beneficial structure will be based on both tax and nontax considerations, but inevitably the tax considerations will weigh heavily in the decision. Because what is beneficial for a seller may disadvantage a buyer, this process necessarily involves negotiation and compromise. Many of these tax considerations, including federal, state and local taxes, as well as the methods used in accounting for an acquisition, are discussed below. Federal Income Tax The initial choice facing corporate sellers, from the standpoint of the federal income tax, is between a taxable and a tax-free transaction (actually a tax-deferred transaction). This decision faced by a corporate seller will be dictated largely by an analysis of the amount of gain or loss to be recognized by the shareholders and by the target (selling) company and also by the form of payment of the purchase price (cash, equity or other consideration). The shareholders may have different interests. For example, older shareholders may wish to receive stock of the buyer, as is required in a tax-free transaction, in order to avoid income tax both on current appreciation when the stock is received and on future appreciation by retaining the stock and obtaining a step-up in tax basis at death. To achieve a tax-free transaction, however, they must be willing to accept some exposure to market volatility, i.e., the risk that the value of the buyers stock received will decline. A taxable transaction may involve two levels of tax, one at the corporate level on the sale of the assets and another at the shareholder level when the proceeds of the sale are distributed to the shareholders. In that case, the seller should consider the amount of gain to be recognized on appreciated assets and whether the gain will be taxed as capital gain or ordinary income. The seller also should consider methods of minimizing the double tax on total consideration with payments directly to the shareholders from the buyer through consulting or employment agreements, covenants not to compete and other arrangements. In contrast, the buyer in a taxable transaction usually is interested in increasing the tax basis of the assets acquired to achieve greater depreciation or other deductions. The buyer also will want to avoid assuming any existing tax liability of the target. Taxable Transactions. There are three basic forms of taxable transactions: (i) a stock acquisition by purchase or merger, (ii) an asset acquisition by purchase or merger, and (iii) a stock acquisition treated as an asset acquisition under Section 338(h)(10) of the Internal Revenue Code (the Code). There also are hybrid transactions that may be taxable to some shareholders and not to others. A stock acquisition can be structured as a simple purchase of stock or as a reverse merger, whereby a subsidiary of the buyer merges into the target which remains in existence. - 31 Locke Lord LLP

The latter form is often used by financial buyers where the acquisition is financed by lenders requiring a security interest in the assets acquired. In a sale of stock, the selling shareholders generally will recognize gain or loss measured by the difference between the consideration received and the sellers tax basis in the shares. Such gain or loss will generally be longterm capital gain or loss if the shares are held as capital assets for more than one year. The recognition of gain usually can be deferred under the installment method to the extent that the seller obtains debt obligations of the buyer payable over future years, subject to an annual interest payment on the deferred tax liability applicable to installment notes exceeding $5 million at year end. If the seller has a significant tax basis in the shares, it is important to structure the deferred payments in amounts that would avoid capital losses in all years. If that is not possible, as in certain earn-out sales, it may be advisable for the seller to elect out of installment method treatment. For federal purposes, the maximum tax rate on capital gains of individuals is 20% for shares held more than one year. By contrast, the maximum federal tax rate on ordinary income of individuals is 39.6%. An additional 3.8% net investment income tax may apply to gain on the sale of stock. Noncorporate taxpayers may exclude 50% of the gain from the sale of certain stock in a C corporation constituting a qualified small business and actively engaged in a qualifying business, which was originally issued after August 10, 1993 and has been held for more than five years.2 If this exclusion applies, the maximum tax rate on the gain is 14% (50% of the gain taxed at the 28% capital gain rate for qualified small business stock). However, the amount of gain eligible for the exclusion is limited, and a portion of the excluded amount is an alternative minimum tax preference item. An individual may elect a tax free roll over of capital gain from the sale of qualified small business stock held for more than six months if other qualified small business stock is purchased within 60 days after the sale, to the extent that the gain does not exceed the cost of other qualified small business stock. The buyer acquires a tax basis in the shares purchased equal to the price paid. The tax attributes of the target, including the basis of the assets, are generally unchanged, subject to the limitations on the buyers use of any net operating loss or credit carryforward. An asset acquisition may take the form of a simple purchase of assets with a transfer of title followed by a liquidation of the target, or a forward merger of the target into the buyer or an entity established by the buyer. In an asset sale, the target will recognize gain or loss on an asset-by-asset basis, and the gain or loss will be taxed as ordinary income or loss or capital gain or loss, depending on the character of each asset. Ordinary income results from such items as depreciation recapture and other previously deducted tax benefits. In
2

The exclusion is increased to 60% of the gain for certain empowerment zone stock which was acquired by a qualifying corporation after December 21, 2000 and held for more than five years. The increased exclusion does not apply to gain attributable to periods after 2018. The 50% exclusion is 75% for stock acquired after February 17, 2009 and before September 28, 2010, and 100% for stock acquired after September 28, 2010 and before January 1, 2014.

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addition to tax consequences at the corporate level, the surrender of shares in exchange for cash or property in complete liquidation is treated as a taxable sale of the shares by the shareholders. Gain or loss to the shareholders is measured by the difference between the fair market value of the assets received and the tax basis of the shareholders stock. Because of the double tax, the seller may want to use this structure only where there are losses at the corporate level or where the target is an S corporation which does not have built-in gains subject to corporate tax. Under certain conditions, if assets are sold for debt obligations which are distributed in liquidation, shareholders can report their gain on the debt obligations using the installment method. A buyer will attempt to allocate the purchase price to assets that will permit a greater tax benefit, often to the detriment of the seller who will recognize ordinary income. Generally, the buyer will want to allocate greater amounts to inventories and accounts receivable to reduce income on subsequent sale or collection and to assets that are subject to depreciation and amortization over shorter periods of time. However, the Code requires that an allocation to any amortizable section 197 intangible must be capitalized and amortized over a 15-year period. In addition to patents, trademarks and other assets generally considered as intangibles, amortizable section 197 intangibles include goodwill, covenants not to compete and similar arrangements (such as consulting agreements to the extent they represent unreasonable compensation for the services performed). To discourage taxpayers from taking inconsistent positions, the Code requires that the buyer and seller each file a form with the Internal Revenue Service that allocates the purchase price in a taxable transaction among the various categories of assets acquired. Valuation firms often are retained to establish the values of machinery and equipment or other assets. A qualifying purchase and sale of stock in which an election is made under Section 338(h)(10) will be treated for corporate law purposes as a stock acquisition but for tax purposes as if the target had sold all its assets and then distributed the proceeds to its shareholders in liquidation. The amount of gain or loss, and the character of the gain or loss as capital or ordinary, is determined on an asset-by-asset basis. Qualifying target companies include members of a selling consolidated return group, members of a selling affiliated group filing separate returns and S corporations. The tax on any gain for an S corporation would be incurred at the shareholder level except that any built -in gain on assets held on the effective date of an S corporation election and on the date of the sale of stock would be taxed at the corporate level unless at least ten years have elapsed since the effective date of the election. Additionally, the S corporation may be subject to certain state taxes. As in the case of an asset sale, the availability of a basis step-up for the buyer in this deemed asset sale may justify a higher purchase price to the seller. Tax-Free Transactions. Certain types of acquisitions can be tax-free (really taxdeferred) to the target and its shareholders if the shareholders receive no more than 60% in cash or other nonqualifying consideration (commonly called boot) and the remainder in stock of the acquiring company. They will be taxed on any boot received on the lesser of the value of the boot or the amount of the gain on the transaction, as capital gain or ordinary - 33 Locke Lord LLP

income, depending on whether the receipt of boot is essentially equivalent to a dividend. Dividend treatment is tested under the redemption provisions of the Code. Generally, the larger the size of the acquiring company relative to the target, the easier it is to avoid dividend treatment. The recognition of gain on the stock received will be deferred until the stock is sold, measured by the difference between the shareholders tax basis in the stock and the proceeds from the sale. To the extent that the stock is still held at death, the basis would be stepped up (or down) to fair market value at the date of death. In general, the shareholders of a target company can sell any or all of the acquiring company stock received in an otherwise tax-free acquisition at any time without affecting the tax-free treatment of the acquisition, so long as the sale does not involve the acquiring company or a related party. Accordingly, the sale of stock in the market following the consummation of an acquisition will not affect the tax-free treatment of the acquisition. Of course, if the shareholders of the target intend to sell all of the stock received shortly after the acquisition, there may be little advantage to the shareholders in structuring the transaction as tax-free. However, if the form of a taxable acquisition would result in taxable gain to the target (such as a merger of the target into the acquiring company or its subsidiary), a tax-free acquisition will avoid that gain. In a tax-free acquisition, the acquiring company generally will take over the tax attributes of the target. Therefore, the acquiring company will not be able to obtain the advantage of writing up the assets for purposes of depreciation or amortization as it would in a taxable asset sale or a deemed asset sale through a Section 338(h)(10) election. The three principal types of tax-free reorganizations and certain aspects of each are as follows: A reorganization -- a statutory merger or consolidation of two corporations. A merger, which permits more latitude in the type of consideration which can be used (including nonvoting and nonstock consideration), is often used in more complex transactions. Forward triangular mergers, in which the target merges into a subsidiary of the buyer, or reverse triangular mergers, in which a subsidiary of the buyer merges into the target as the survivor, are generally treated as A reorganizations for tax purposes, and each has special requirements. B reorganization -- a stock-for-stock acquisition in which one corporation, solely in exchange for its voting stock (or the voting stock of its parent), acquires stock of another corporation, if immediately after the transaction the acquiring corporation has at least 80% control. The risk is that the use of any consideration other than voting stock will disqualify the reorganization from tax-free treatment. C reorganization -- a stock-for-assets acquisition in which one corporation, solely in exchange for its voting stock (or the voting stock of its parent), acquires substantially all of the assets of another corporation. For advance ruling purposes, the IRS requires the acquisition of at least 90% of the fair market value of the net assets and - 34 Locke Lord LLP

70% of the fair market value of the gross assets immediately prior to the acquisition. Up to 20% of the consideration can be other than voting stock, but liabilities assumed or taken subject to are counted as consideration which is other than voting stock. In a tax-free reorganization, the shareholders generally recognize no taxable gain or loss to the extent of the stock (other than nonqualified preferred stock) received, and in A and C reorganizations, any property received other than such stock (called boot) may be taxed either as capital gain or as a dividend. Generally, neither the acquiring nor target corporation recognizes gain or loss, and in an A or a C reorganization the acquiring corporation obtains a basis in the assets equal to the basis of the target. In a C reorganization, the target company must liquidate and distribute the stock it receives to the target shareholders, who generally take a tax basis in the stock of the acquiring company equal to the tax basis of their shares of the target company. Hybrid Transactions. To compromise conflicting objectives of the parties, acquisitions may be structured to embody some features of both a taxable and a tax-free transaction. One example is a cash-option merger, whereby shareholders receive shares of the acquiring company or its parent and, to the extent they so elect, cash. The aggregate amount of cash payable may be limited to 60% of the total consideration. Other hybrid transactions include cash mergers following an exchange of stock. These types of transactions must be carefully reviewed to determine whether the tax objectives are achieved. State and Local Taxes State and local tax issues also should be considered in connection with the sale of a business. While generally of lesser significance than the federal income tax, these taxes can have a significant bearing on the structure of a transaction and on the economic outcome. State and local taxes might include income and franchise taxes, sales and use taxes, property taxes, documentary transfer taxes, employment taxes and business license taxes. Accounting for Business Combinations Some years ago, there were two alternative methods used to account for a business combination: the pooling-of-interests method and the purchase method. The pooling-ofinterests method was generally applied to the acquisition of a business for stock and was accounted for as the uniting of ownership interests in which the assets and liabilities continued to be carried at historical cost, and the income of the entity after the transaction included the recast historical results of the combined companies for all prior periods. As a consequence, no goodwill was recorded when the purchase price exceeded book value. In 2001, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 141 requiring that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. The change expresses the FASBs concern that the poolingof-interests method failed to provide investors with an accurate picture of the real cost of an - 35 Locke Lord LLP

acquisition. With the purchase method, the acquiring company records the assets acquired and the liabilities assumed at fair value, and the income of the target is reported only prospectively from the date of acquisition. The excess of the purchase price over the net assets is recorded as goodwill. Concerns about the loss of the pooling-of-interests method were lessened to some extent by the FASBs position on goodwill. Historically, purchase accounting required that goodwill be amortized, which frequently resulted in a lengthy drag on earnings. However, under FASB Statement No. 142, also issued in 2001, goodwill is no longer amortized. Instead, goodwill is to be tested for impairment at least annually, and written down only if its fair value declines below its book value. In 2007, FASB Statement No. 141(R) replaced FASB Statement No. 141 with respect to business combinations occurring in fiscal years beginning after December 31, 2008. FASB Statement No. 141(R), among other things, applied what is now called the acquisition method (formerly the purchase method) to a wider range of transactions and events and required that certain acquisition costs be expensed as incurred instead of being included as part of the purchase price. In 2009, the FASB established the Accounting Standards Codification (ASC) as the source of authoritative non-SEC accounting principles. FASB Statement No. 141(R) has been codified as ASC Topic 805, Business Combinations, and FASB Statement No. 142 has been codified as ASC Topic 350, IntangiblesGoodwill and Other.

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CHAPTER 6 LEGAL AND REGULATORY CONCERNS Even the simplest transactions can involve federal, state and local laws and regulations that the parties must address. As transactions get larger and more complicated, or if the buyers or the sellers business is in a regulated industry, regulatory issues can develop into substantial obstacles to closing the deal. Listed below are some of the most prevalent regulatory issues that parties may encounter in acquisition transactions. An exhaustive list of all regulatory issues affecting mergers and acquisitions is a substantial undertaking and well beyond the scope of this Chapter. Securities Laws When securities of a company are being offered and sold, federal and state securities laws will need to be considered. The Securities Act of 1933 (33 Act) requires registration of securities with the SEC, unless a specific exemption is available. The sale of all of the outstanding shares of a closely-held business usually will be exempt from registration, but registration becomes an issue when the consideration being offered includes securities of a buyer. Although stock issued in an acquisition can be registered on a special form (Form S4), it often is impractical due to the effort required and the related cost. Nevertheless, if there are a large number of shareholders, it may be necessary unless a fairness hearing (discussed below) is a reasonable alternative. There are several exemptions from registration that can be used in acquisitions of closely-held companies. The one most often used is the private offering exemption under Section 4(2) of the 33 Act. In a private offering, the sellers must represent that they are taking the stock for investment and not with a view to distribution. Absent registration, the stock could then be sold in the market in compliance with Rule 144. The conditions of Rule 144 vary depending upon whether the issuer of the stock reports to the SEC under the Securities Exchange Act of 1934 and whether the holder of the stock is an affiliate of the issuer. The conditions include a holding period before any shares can be sold that ranges from six months to one year and limitations on the number of shares that may be sold during any three-month period (the volume limitations). To avoid these conditions, an acquiring company can register the stock for resale on Form S-3, which is a short-form registration statement. Registration could probably be accomplished within two to three weeks following the acquisition. However, this would not be entirely within the shareholders control, as the acquiring company would have to commit to register the stock. If the number of shares that might be sold is substantial, some companies will be concerned with the possible impact on the market of the sale of the shares or of the overhang from registering a large block of stock for sale from time to time in the future. It also is not unusual for an acquiring company to impose conditions on its obligation to register stock for resale, such as those relating to intervening corporate developments or release of earnings. - 37 Locke Lord LLP

Another possible exemption is a fairness hearing under Section 3(a)(10) of the 33 Act. This Section affords an exemption from registration for stock issued after a hearing by a governmental authority as to the fairness of the acquisition. California is one of the few states where this exemption can be used, because the California Commissioner of Corporations is authorized by statute to conduct such a hearing. The acquiring company would file an application with the California Department of Corporations, which would then hold a hearing at which testimony would be presented as to the arms-length nature of the acquisition and its fairness. Based on the findings in the hearing, the Commissioner would then issue a permit. If available, this would avoid registration and shareholders could resell their stock in the market, but some (generally executive officers, directors and 5% shareholders of the target) would still be subject to the volume limitations of Rule 144 as to any resales. Aside from the regulatory limitations, there is also a practical aspect to any analysis of liquidity with respect to the stock being acquired. The ability to sell that stock will depend on the number of shares held relative to the volume of trading in the acquiring companys stock. In addition, regardless of whether a sale of securities is exempt from registration, it will be subject to the anti-fraud provisions of Rule 10b-5 under the Securities Exchange Act of 1934. Rule 10b-5 prohibits making any untrue statement of a material fact or omitting to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading. This can create liability for a seller when a transaction is structured as the sale of stock or a merger, and for a buyer when its securities are used as part of the consideration. Antitrust Laws (Hart-Scott-Rodino) The sale of a business may also raise federal antitrust concerns. For example, Section 7 of the Clayton Act prohibits stock and asset acquisitions that may substantially lessen competition, or tend to create a monopoly. It is not necessary that the acquisition actually lessen competition, only that there is a reasonable probability that it will. Although Section 7 is the primary federal antitrust statute applying to mergers or acquisitions of businesses, these transactions may also be challenged under other statutes, such as Sections 1 and 2 of the Sherman Antitrust Act, and applicable state laws. Acquisitions (for this purpose, called mergers) are generally divided into three categories -- horizontal, vertical and conglomerate -- based on the economic relationship between the merging firms. Horizontal mergers are mergers between competitors. As this type of merger directly reduces the number of competitors in a market, it is the most likely to have adverse competitive consequences. Vertical mergers involve acquisitions between firms at different levels of production or different levels in the chain of distribution. By tying such firms together in an exclusive relationship, this type of merger may foreclose competitors from important suppliers or customers. This type of merger also has been - 38 Locke Lord LLP

challenged on the grounds that it increases entry barriers or eliminates potential competition. A conglomerate merger involves the combination of firms that neither compete nor are on a vertical relationship with each other, including product-extension mergers, geographic market-extension mergers and mergers between firms with no discernable commercial relationship. To give the federal government the opportunity to review certain proposed acquisitions for potential violations of the antitrust laws, the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR) requires parties and transactions meeting the jurisdictional requirements to give advance notice to the Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ) and to wait a designated period during which the FTC and the DOJ may determine whether they wish to question a transaction before it is consummated by the parties. If notice is required, each acquiring and acquired person (or each acquiring person, in the case of a cash tender offer) must complete and file the prescribed notice, each acquiring person must pay a non-refundable filing fee3 and the parties must wait 30 days (or 15 days in the case of a cash tender offer) from filing the notice (accompanied by a letter of intent or definitive agreement) before consummating the proposed transaction. At any time during the waiting period, the FTC or DOJ may request additional information, which further extends the relevant waiting period, or may grant early termination of the waiting period. Because of the waiting period and the amount of information to be gathered for the filing, it is important to address HSRs requirements early in the negotiations. HSR advance notification provisions apply to any merger, consolidation or acquisition of assets or voting securities that satisfy three tests the commerce test, the sizeof-the-parties test and the size-of-the-transaction test. The test thresholds are revised annually by the FTC based on the change in gross national product. The thresholds that are applicable until the effective date of the next annual revision (which is expected to be in or about February 2014) are as follows: No transaction is reportable unless it results in the buyer holding at least $70.9 million of assets or voting securities of the acquired business. For transactions valued between $70.9 million and $283.6 million, one party to the transaction must have sales or assets in excess of $141.8 million and the other party must have sales or assets in excess of $14.2 million. Transactions valued in excess of $283.6 million must be reported regardless of the size of the parties. Exon-Florio The Exon-Florio amendments to the Omnibus Trade and Competitiveness Act of 1988, as amended by the National Defense Authorization Act for Fiscal 1993 and the Foreign Investment and National Security Act of 2007, allow the President or the Presidents designee to conduct investigations to determine the national security effect of proposed
3

The filing fee ranges from $45,000 to $280,000 depending upon the size of the transaction.

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acquisitions of U.S. enterprises by foreign persons and mandate such investigations when a foreign buyer is controlled by or acting on behalf of a foreign government. If the President has credible evidence to believe that a foreign buyer might take action that threatens to impair the national security and no other provision of law provides adequate and appropriate authority to protect the national interest, the President may suspend or prohibit the acquisition, and his decision is not subject to judicial review. In addition, if the acquisition has been consummated, the President may seek all appropriate relief, including divestment. In considering whether a transaction may impair the national security, factors to be considered include, among other things, (i) domestic production needed for projected national defense requirements; (ii) the capability and capacity of domestic industries to meet national defense requirements; (iii) the control of domestic industries by foreign citizens as it affects the capability and capacity of the U.S. to meet national security requirements; (iv) the potential effect of the transaction on sales of military goods, equipment or technology to a country that supports terrorism; (v) the potential effect of the transaction on U.S. technological leadership in areas affecting national security; and (vi) the potential national security-related effect of the transaction on U.S. critical infrastructure, including major energy assets, and on U.S. critical technologies. Parties to a pending acquisition may voluntarily file notice with the Committee on Foreign Investment in the United States (CFIUS). Generall y, CFIUS has 30 days to review the notice and determine if an investigation should be undertaken. 4 If CFIUS decides to investigate or is otherwise required to investigate, it must begin its investigation within 30 days of receiving the notice and the investigation may last no longer than an additional 45 days. On completion of its investigation, CFIUS submits a report and its recommendation to the President. The President then has 15 days to take action. Regulated Industries In certain regulated industries, the proposed sale of a business may require that notice be given to, or approval of the transaction be sought from, the governmental agency or authority having primary responsibility for regulating that industry. Examples of governmental agencies with such authority include the Interstate Commerce Commission, the Federal Energy Regulatory Commission and the Federal Communications Commission, and in the case of financial institutions, the Board of Governors of the Federal Reserve System, the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Even if the seller is not in an industry which is generally considered a regulated industry, it may have licenses and permits which will require administrative action to transfer them to the buyer. Generally, the responsibility of transferring the licenses and permits is delegated to the seller and completion of the process is a condition to closing.

During the 30-day review period, the Director of National Intelligence, although not a member of CFIUS, also is required to analyze a transaction for any threat to the national security of the United States.

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Bulk Sales If the buyer is purchasing a major part of a sellers inventory and equipment, the transaction may be subject to the bulk sales provisions of the Uniform Commercial Code. In jurisdictions that have adopted the bulk sales provisions of the Uniform Commercial Code, the provisions generally apply if a sellers principal business is the sale of inventory from stock (including a seller that manufactures what it sells), and the sale is not in the ordinary course of its business. In California, a sale of assets generally is exempt from the bulk sales law if the value of the assets being sold is less than $10,000 or more than $5,000,000, or if the buyer expressly assumes the sellers debts. The bulk sales law generally requires that a buyer prepare a formal notice describing the proposed sale and, at least twelve business days before the closing, record the notice with the appropriate county recorder, send a copy of the notice to the county tax collector and publish the notice in a newspaper of general circulation. Creditors may file a claim for any money owed, and the buyer must arrange to pay the creditors out of the purchase price. If the buyer fails to comply with all of the requirements of the bulk sales law, creditors of the seller may be able to recover the debts of the seller from the buyer. If the buyer decides that the burden of complying with the bulk sales law is greater than the benefit it receives, it may consciously elect not to comply. Instead, it may be satisfied with the sellers indemnification against claims that its creditors may make against the buyer. WARN The Worker Adjustment and Retraining Notification Act of 1988 (WARN) requires employers to give at least 60 days advance written notice of certain plant closings and mass layoffs to the affected employees (or their union representatives) and certain local governmental officials. The federal WARN requirements apply to any employer with at least 100 full-time employees or at least 100 employees who in the aggregate work at least 4,000 hours per week, excluding overtime. A plant closing under the federal WARN is defined as the permanent or temporary closing of a single site of employment or a facility or an operating unit within a single site of employment that causes an employment loss of at least 50 full-time employees during any 30-day period. A mass layoff under the federal WARN is a reduction in the work force at a single site of employment that causes an employment loss of at least 500 full-time employees, or at least 50 full-time employees if those employees constitute at least 33% of the work force at that site, during any 30-day period. In addition to termination of employment (other than for cause, voluntary departure or retirement), employment loss is defined under federal WARN to include a greater than 50% reduction in hours of work during each month of any six-month period or a layoff of more than six months. California has adopted its own WARN requirements, which apply to any employer with 75 or more full or part-time employees. Under Californias WARN requirements, - 41 Locke Lord LLP

employers are generally required to give at least 60 days advance written notice of mass layoffs of 50 or more employees within a 30-day period, relocations or terminations at a covered establishment, regardless of the percentage of the workforce affected. There is no specific numerical threshold under California WARN to qualify as a termination or relocation. Termination is the cessation or substantial cessation of industrial or commercial operations at a covered establishment. Relocation is a move to a different location 100 miles or more from the original location. Under both federal and California law, a seller is responsible for providing WARN notices for the period up to and including the effective date of a sale of the business. After the effective date, the buyer will be responsible for such notices and, for this purpose, all full-time employees of a seller are considered to be the buyers employees. As a result, unless the seller and buyer can agree on pre-sale notices, a buyer may be required to wait 60 days after the effective date of the sale to shut down a plant or lay off a certain portion of the work force under WARN.

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CHAPTER 7 THE DEFINITIVE AGREEMENT After the basic structure of the transaction has been agreed upon, the parties and their attorneys begin the task of reducing the agreement to writing. While the principals may have sketched a broad framework for an agreement, they likely will discover that there are significant issues they have not fully considered. The definitive agreement contains much more than just the principal terms of the transaction, and is used to elicit information, to document agreements about the conduct of the business, to establish the mechanics for the consummation of the transaction and, perhaps most importantly, to allocate risk. As a result, negotiations about the actual language of the definitive agreement can be lengthy and sometimes difficult. In the typical negotiated transaction, the buyer will prepare the first draft of the definitive agreement. (In an auction setting and in certain other limited circumstances, the seller may prepare the first draft.) These definitive agreements are generally comprised of several discrete but interrelated elements. Deal Provisions The terms of the transaction are generally described in the first section of the definitive agreement. These provisions identify the structure of the transaction as a sale of stock, a sale of assets or a merger, and set forth the purchase price and the specific payment terms and mechanics. The particular deal provisions will vary depending upon the structure of the transaction. In a stock sale, the deal provisions identify the stock being purchased from each shareholder, including the number of shares and the purchase price. In an asset sale, the deal provisions specify which assets are being acquired, the purchase price and method of payment, and often will contain provisions by which the buyer expressly agrees to assume certain liabilities of the seller. In a merger, the deal provisions set forth how the stock of the acquired company will be converted into cash or securities of the buyer, the rights of the shareholders of the seller, and the identity and structure of the new combined corporation. Many definitive agreements contain provisions by which the purchase price will be adjusted after the closing. For example, a buyer may insist on a purchase price adjustment for the sellers uncollectible accounts receivable, or for changes in the sellers net worth or working capital from the date of the sellers last available financial statements to the date of the closing. These price adjustments vary significantly from transaction to transaction. If there are ancillary agreements critical to the transaction, such as employment or consulting agreements, covenants not to compete, leases or promissory notes, these will be identified and in most cases attached as exhibits. The time and place of the closing will also - 43 Locke Lord LLP

be specified, unless the closing is to occur concurrently with signing the definitive agreement. Representations and Warranties The next part of the definitive agreement usually contains representations and warranties of the parties. It is not unusual for the representations and warranties of the seller to be lengthy, and typically much more extensive than the representations and warranties of the buyer. Purpose of Representations and Warranties. The sellers representations and warranties convey important information about the seller and its business. The seller knows its business better than anyone else, and the buyer wants to learn all that the seller knows. To this end, the seller will be asked to make representations and warranties about many different aspects of its business operations, material agreements, compliance with laws and potential liabilities. The extensive representations and warranties are designed, in part, to expose problems, hidden risks and undisclosed liabilities. If the previously undisclosed risks are too great, the buyer may seek an adjustment to the purchase price or, in some cases, decide not to proceed with the transaction. Another purpose of the representations and warranties is to allocate risk. For example, the seller may be asked to represent and warrant that its operation of the business has complied with all laws and regulations. Even though it seems impossible for a seller to know if its operations have complied with the requirements of all the laws and regulations affecting its business, this may not be particularly relevant. The purpose of such a representation and warranty is to allocate the risk of certain claims, known or unknown, that arise from circumstances existing before the closing. By requiring the seller to represent and warrant that its operations are in compliance with law, the buyer is attempting to shift to the seller the risk of any losses or damages that might result from a violation of law. If the buyer suffers damage, it will want to recover from the seller for the damages caused by the misrepresentation. Limitations on Representations and Warranties. A seller will attempt to modify and limit the representations and warranties contained in the buyers first draft of the definitive agreement. These limitations most often fall into three categories: scheduled exceptions, knowledge qualifiers and materiality qualifiers. Scheduled Exceptions. A buyers first draft usually includes seller representations and warranties that are inaccurate, to which the seller will object. For example, the buyer may ask the seller to represent that there are no lawsuits pending against the seller. If there are lawsuits pending, the seller will list them as an exception on a schedule to the definitive agreement. In this way, the buyer will have the opportunity to investigate and assess the risk involved in the lawsuits listed on the schedule, and negotiations will determine which party will bear the expense and the risk of an adverse result. These schedules supplement the - 44 Locke Lord LLP

representations and warranties and directly affect risk allocation. As a result, they can become the focus of considerable attention. In an effort to understand and allocate risk, sellers will spend much time and effort preparing the schedules, and buyers will carefully review the exceptions listed. Knowledge Qualifiers. A buyers first draft usually seeks to have the seller represent and warrant facts that are beyond its knowledge. For example, the seller may be asked to represent that there is no threatened litigation. In any business with significant operations, it may be impossible for the management to know about all threatened litigation. In many cases, the seller will propose to limit the representation to the facts and circumstances actually known to sellers management. The representation might be changed to read to the sellers knowledge, there is no threatened litigation against the seller. The buyer may resist the knowledge qualifier on the basis that, known or unknown, the particular risk should be allocated to the seller. (As noted above, if the purpose of the representation is risk allocation, the actual knowledge of the seller is not particularly relevant.) Of course, the term sellers knowledge is not precise and could include the knowledge of any employee or agent of the seller, so the parties sometimes specify those individuals whose knowledge will qualify. They might also provide whether knowledge means only actual knowledge or what someone, after a reasonable investigation or by virtue of his or her position, ought to know. Materiality Qualifiers. A seller will often object to some representations and warranties on the basis that they include all kinds of insignificant matters that are too small to bother investigating or disclosing. Rather than representing that there is no pending or threatened litigation, the seller may offer to represent that there is no pending or threatened litigation of a material nature. Reasonable buyers usually understand the time and expense involved in the sellers efforts to identify all exceptions to a representation, but may resist the materiality qualifier if the representation is particularly important to the buyer or if the buyer prefers to address the materiality issue in the context of the indemnification provisions. Keep in mind that materiality is an elastic concept and carries risk for both the buyer and seller. What appears to be immaterial at the time of the agreement may later, in hindsight, seem very material. Occasionally, the buyer and seller will attempt to define the concept of materiality by reference to specific dollar amounts or to the standards used for financial statement disclosure. Specific Representations. The seller may be asked to make representations and warranties concerning such things as its corporate authority and standing (including articles of incorporation and bylaws, capitalization and stock ownership, and subsidiaries or other corporate affiliates), its assets and liabilities (including financial statements, real property, equipment, inventory and accounts receivable), its contracts and obligations (including debt, liens, open contracts and any contracts requiring consent to transfer), intellectual property (including patents, trademarks, trade secrets and copyrights), litigation (including claims and insurance coverage), employee matters (including employment agreements, union activities and compliance with labor and safety laws), employee benefit plans (including all health and - 45 Locke Lord LLP

welfare plans, retirement plans, tax treatment of all plans and compliance with ERISA), environmental matters (including compliance with laws and matters affecting ground, air and water) and operational matters (including payment of taxes, compliance with laws, permit requirements and any needed governmental consents). A few of the representations and warranties that typically require significant negotiation are discussed below. Accounts Receivable. In a sale of assets, the seller might retain accounts receivable and thereby bear the risk of collectability. Otherwise, buyers will seek representations from the seller that trade receivables represent valid obligations arising from sales made or services performed in the ordinary course of business and as to their ultimate collectability. A seller will want to avoid being a guarantor of receivables, or at least provide that reserves for doubtful accounts be taken into account, that a reasonable period for collection be provided, that the buyer exercise diligent collection methods and, in the event of failure of collection, that the seller be entitled to obtain the uncollected accounts for which it pays the buyer. Inventories. For those businesses in which inventories are important, sellers often will be asked to represent that all the inventories consist of a quality and quantity usable, and with respect to finished goods, saleable in the ordinary course of business, and that all obsolete items have been written down to net realizable value. Inventory valuation requires subjective judgments, particularly as to what is obsolete or otherwise not saleable, and this representation often is the subject of intense negotiation. Labor and Employment. The seller often will be asked to make representations that it has complied with all collective bargaining agreements, employment agreements, wage and hour laws, safety laws, antidiscrimination laws, job protection laws, and other laws and regulations regarding employee hiring, accommodation and termination. Even though it is difficult for the seller to know whether it has complied with all of the laws and regulations affecting employment, the buyer often insists that the seller assume the risk of any violations. Employee Benefits. The seller often will be asked to make extensive representations about past and present plans sponsored, maintained or contributed to by the seller for the benefit of any current or former employee, including pension, retirement, profit sharing, stock bonus, deferred compensation, incentive compensation, health, insurance, severance and other benefit plans. The Employee Retirement Income Security Act of 1974 (ERISA) can impose significant liability on the buyer if the seller used inaccurate or incomplete descriptions of a plan, has unfunded liabilities under a plan, failed to timely file required reports with respect to a plan, or has failed to meet its obligations under any multi-employer plan. Accordingly, the seller likely will be asked to represent and warrant that it has fully complied with ERISA and all other laws and regulations regarding employee benefit plans. Environmental. Given the potentially high cost of environmental matters and the difficulty of obtaining appropriate insurance coverage, buyers are usually very concerned about potential environmental exposure. A seller often will be asked to make representations that it has complied with all laws regarding the use, creation, storage, discharge, release, - 46 Locke Lord LLP

transportation and disposal of any hazardous or toxic substance, material or waste. The seller also may be asked to represent that it has not been threatened with any claim for environmental liability, that it has no knowledge and has received no notices regarding any possible environmental problems on, under or around its property, that it has no underground storage tanks, that it has properly handled and disposed of all hazardous waste and that its property and buildings contain no asbestos. The seller may be required to disclose the results of any environmental audits performed on its property and, if no recent audit has been conducted, the buyer may require that audits be performed. Even if the seller does not own real property, the environmental representations and warranties may still be extensive because environmental liability can attach to those who lease property and to those who generate or use any hazardous substances. For example, the seller may have environmental liability if a waste removal company improperly disposes of the sellers hazardous waste. Buyers typically will attempt to assign to the seller all the economic risk for environmental problems that existed prior to the closing. If there is a significant likelihood of such a problem arising, a buyer may refuse to proceed with the transaction or may seek to defer or escrow a portion of the purchase price until the amount of the liability is known. Product Liability. In an attempt to limit exposure to potential product liability claims, buyers often seek broad representations with respect to such liability. These broad representations are intended to shift to the seller the economic risk of any product liability claims. A seller often will be asked to make representations that there have been no claims or complaints relating to products it has manufactured or sold, that it has manufactured and sold its products in accordance with its product specifications and good manufacturing practices, that it has not recalled any of its products, that it has at all times maintained adequate product liability insurance and that it has promptly notified its insurance carriers of any and all product liability claims. The seller also may be asked to represent that none of the products it manufactured or sold would provide a basis for any product liability claim. The buyer will want to review the sellers product liability insurance to determine to what extent the coverage will protect the buyer. Generally, product liability concerns may be addressed if the parties mutually adopt a plan to provide appropriate insurance coverage before and after the closing. Covenants Once the definitive agreement is signed, the parties are obligated to consummate the transaction if all of the conditions are satisfied. Of course, the buyer will be concerned about how the business is operated between the signing of the agreement and the closing. In order to place limits on the activities of the seller during this interim period, the buyer will insist that the seller agree (or covenant) to do certain things and not to do others. The seller may be asked to agree (unless it obtains the prior written consent of the buyer) that it will conduct the business the same way it did prior to the agreement, that it will give the buyer access to its operations and records, and that it will not declare dividends or issue stock, amend its articles of incorporation or bylaws, give bonuses or raises, hire or fire employees, change any employee benefits, sign new contracts or cancel existing contracts, incur new debt, make - 47 Locke Lord LLP

any significant expenditures, sell or encumber assets or negotiate with other parties regarding the sale of the business. The seller may object to some restrictive covenants because the buyer has not actually purchased the business, but the buyer does have a legitimate basis for requesting some reasonable restrictions on the sellers conduct because it is obligated to buy the business if all the conditions are satisfied. While many of the covenants will relate only to the sellers conduct, some will be mutual. Mutual covenants might include an agreement that the parties will keep the terms of the agreement confidential, will obtain all necessary approvals and consents and will use their best efforts to satisfy the conditions to closing. If the seller does not perform a covenant, the buyer can waive the sellers noncompliance or the seller could be liable for damages. (Of course, the same is true if the buyer does not perform.) Furthermore, compliance with the covenants is often a condition of the closing and, if either party fails to comply, the other party can refuse to close. Conditions to Closing The agreement also will specify the conditions that must be satisfied in order for the parties to close the transaction. These provisions will relieve the parties of their obligation to close if some unexpected adverse event occurs or some additional facts are discovered between the time of the signing of the definitive agreement and the closing. Typical conditions to the buyers obligation to close the transaction might include: the sellers representations and warranties are true and correct the seller has performed all covenants required to be performed by it under the agreement all necessary government approvals have been obtained all necessary third party consents have been obtained the buyer has obtained a comfort letter from sellers accountants regarding any unaudited financial statements of the seller the parties have received appropriate tax rulings the buyer has received all required closing documents and certificates there is no pending litigation to restrain the transaction no material adverse changes have occurred in the sellers business

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The conditions to the sellers obligation to close will cover some of the same areas as the buyers conditions, but typically will be fewer in number. As a condition of closing, the buyer may ask for a legal opinion from the sellers counsel regarding certain aspects of the transaction. The opinion might cover the status and power of the corporation, the corporate action taken to authorize the transaction, the existence of conflicts between the definitive agreement and the sellers organizational documents or other agreements, and the enforceability of the definitive and ancillary agreements. The buyer would like the opinion to cover as much as possible but, because many matters covered by such opinions involve legal conclusion unsettled areas of the law, the sellers counsel will attempt to limit the opinion. As a result of this tension, legal opinions can sometimes prove difficult to negotiate. Conditions, unlike representations and warranties, can be waived by the parties. (Of course, each party can only waive conditions that are for its benefit.) If a condition is not satisfied, the party can refuse to close or can waive the condition. While damages normally are not available for the failure of a condition, the parties likely have at least a good faith obligation to try to satisfy the conditions. Moreover, most parties would like to avoid giving the other party an opportunity to refuse to close. Including a covenant to the effect that the parties will use their best efforts to satisfy the conditions to closing can result in a damages award if a party breaches the covenant. Indemnification Under general principles of contract law, if one party breaches a representation, warranty or covenant contained in the definitive agreement, then the other party is entitled to recover for damages caused by the breach. Nevertheless, most definitive agreements include detailed indemnification provisions specifying that each party will be liable to the other party for damages caused by its breach. These indemnification provisions tend to be among the most heavily negotiated terms because they provide for a specific allocation of risk. Indemnification provisions usually contain a broad statement of liability. Each party agrees to defend, indemnify and hold harmless the other party from any damages, costs and expenses arising from the inaccuracy of any representation, the breach of any warranty or the nonfulfillment of any covenant. The buyer also may seek to include specific indemnification for certain other potential liabilities (whether or not they would be a breach), such as pending litigation, taxes, environmental problems, product liability or employee benefits. In reviewing any proposed indemnification provision, each representation, warranty and covenant should be carefully reviewed and the connection between those provisions and indemnification evaluated. While the indemnification obligations may be stated broadly, the parties often negotiate time and dollar limitations. Time limitations on indemnification claims will vary depending upon the type of business and likely source of the claim, and the parties may negotiate longer time limits for tax or environmental liabilities. For most liabilities, sellers - 49 Locke Lord LLP

argue that they should become known within a year or two following the closing or a shorter time following the first post-closing audit. Dollar limits may provide a minimum and maximum amount of indemnification. The minimum level (also known as the basket or cushion) provides a dollar amount in losses or damage, which will vary depending on the size of the transaction, that would have to be exceeded before the buyer could make a claim for indemnification against the seller. The basket establishes a threshold amount which, once crossed, either entitles the buyer to payment for all its damages (from the first dollar) or entitles the buyer to payment for all its damages in excess of the threshold amount. Because the use of a basket also relates to materiality, buyers will often permit either materiality qualifications or a basket but not both. At the other end of the spectrum, the parties often agree to an upper limit on indemnification (a cap or ceiling) which often bears some relationship (e.g., by way of a percentage) to the total purchase price, but may provide that certain claims (e.g., one based on fraud or intentional misrepresentation) will not be subject to the limitation. Indemnification provisions typically specify how the indemnification procedure will operate. For example, they spell out the rights and obligations of the buyer and seller with respect to lawsuits filed by third parties, and how and when the parties must pay indemnified claims. If the buyer is concerned about the sellers ability to pay indemnification claims, the buyer may ask that a portion of the purchase price be placed into escrow, may seek the right to set off indemnified claims against future payments due to the seller, or may ask for a standby letter of credit. In addition to indemnification, the parties also may investigate the possibility of obtaining insurance to cover some of the risks. Termination In the event the deal cannot be consummated, the definitive agreement should provide for the circumstances and the manner in which it may be terminated. It is not unusual to provide that either party may elect to terminate if all conditions have not been satisfied by a given date (sometimes called the drop dead date) and, in such event, that neither party wi ll be liable to the other so long as it was not in default of an obligation to use reasonable (or best) efforts to satisfy conditions within its control. However, in certain circumstances the agreement may provide that the seller must pay the buyer a termination fee if the seller terminates the deal (also called a bust-up fee or a break-up fee), and if the seller terminates to pursue a better offer, this fee could be based on a percentage of any increase in consideration that the seller will realize (called a topping fee). Miscellaneous Provisions Toward the end of most definitive agreements are a few pages of miscellaneous provisions, usually containing terms that are generally applicable to commercial contracts. While these provisions are sometimes derided as boilerplate, they are important and can significantly affect the rights of the parties. - 50 Locke Lord LLP

Miscellaneous provisions may specify the governing law, provide that all understandings or agreements are contained in the definitive agreement, limit assignability, bind successors, disclaim the interests of third parties, provide mechanisms for formal notices and other communications between the parties, set forth the procedures for amendments and waivers, and allocate the responsibility for expenses and fees. Terms relating to the recovery of attorneys fees and, if desired by the parties, the procedures for alternative dispute resolution (such as mediation or arbitration) are usually part of the miscellaneous provisions.

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APPENDIX A COMPARISON OF SALES OF STOCK AND ASSETS

STOCK SALE
Factors Common to Buyer and Seller Ease of transfer--no deeds, bills of sale, assignments, etc. May avoid sales or other transfer taxes Facilitates employee transition--employees remain employed by acquired company rather than having a new employer May avoid requiring (i) consents of third parties to the transfer of contracts (e.g. leases) and (ii) transfer or reissuance of permits or other governmental authorizations Advantages to Seller One tax incurred by shareholders generally at capital gain rates Liabilities go with acquired company, so shareholder liability is limited to indemnification Disadvantages to Buyer No opportunity to write up assets and depreciate from higher tax basis or to amortize goodwill for tax purposes* Acquired company retains all liabilities (whether known, unknown, contingent, etc.) Difficult to exclude (i) unwanted assets without adverse tax consequences or (ii) contractual obligations (e.g., collective bargaining agreements)

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ASSET SALE
Factors Common to Buyer and Seller Transfer is more complex--deeds, bills of sale, assignments, etc. Sales or other transfer taxes may be incurred Complicates employee transition--employees become employed by buyer Increases likelihood of requiring (i) consents of third parties to transfer of contracts (e.g. leases) and (ii) transfer or reissuance of permits or other governmental authorizations Advantages to Buyer Easier to exclude unwanted assets or other assets, such as accounts receivable, for which seller will remain responsible Can avoid some liabilities other than those specifically assumed Can write up assets and depreciate from a higher tax basis and amortize goodwill for tax purposes Might avoid contractual obligations (e.g., collective bargaining agreements) Advantages to Seller Seller can retain certain assets
*If the acquired company is an S corporation or a member of an affiliated group, a joint election can be made under Section 338(h)(10) of the Internal Revenue Code of 1986 to treat the sale of stock as a sale of assets, followed by a distribution of the proceeds to the shareholders in liquidation. This would avoid a double tax, except that a built-in gain on assets held on the effective date of an election as an S corporation and on the date of the sale of stock must be recognized at the corporate level unless ten years have elapsed since the effective date of the election.

Disadvantages to Seller Sales proceeds are subject to double income tax--a tax at the corporate level and another tax at the shareholder level on distribution of the sale proceeds* Seller remains responsible for liabilities not assumed

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APPENDIX B GLOSSARY A reorganization: A reorganization under Section 368(a)(1)(A) of the Internal Revenue code that is structured as a statutory merger or consolidation of two corporations and meets certain other tests, allowing for the deferral of recognition of income (or loss) for federal income tax purposes with respect to the buyers stock (or stock of its parent) received by the targets shareholders. Acquisition: A generic term referring to the acquisition of a business, whether the form is a purchase of assets, a purchase of stock, a merger of some variation. Acquisition accounting: The accounting treatment accorded all business combinations since the elimination of pooling-of-interests accounting. Formerly referred to as purchase accounting. The buyer recognizes goodwill on its financial statements, which is measured by the excess of the cost of the acquired business over the sum of the amounts assigned to identifiable assets that are acquired at their fair value less the liabilities assumed. Intangible assets that do not have a finite life are also included in goodwill. See also Pooling-ofinterests accounting. Add-on acquisition: An additional acquisition, usually involving a financial buyer, within the same line of business to add to a platform acquisition. See also Platform acquisition. Allocation of risk: The distribution of risk among parties to an acquisition as a result of the parties bargaining and documented in an acquisition agreement as to which party will bear the financial or economic risk of certain conditions, events or occurrences. A buyer will attempt to shift to the seller the risk of any losses or damages that might be incurred after the closing. A seller will attempt to reduce its risk through use of qualifiers such as material and actual knowledge. Ancillary agreements: Agreements, other than the acquisition agreement (e.g., employment or consulting agreements, noncompetition agreements, leases, or escrow agreements), that are delivered in connection with an acquisition. Forms of the ancillary agreements typically are attached as exhibits to an acquisition agreement, and execution and delivery are conditions to closing. Sometimes they are signed and delivered concurrently with the execution and delivery of the acquisition agreement. Appraisal rights: Statutorily created rights of shareholders in a merger (or sometimes the sale of substantially all the assets) of a corporation, to require the corporation to purchase their shares for cash at their fair market value or fair value in lieu of the consideration offered by the buyer. Appraisal rights are generally triggered when the affirmative vote of the acquired corporations shareholders is required to approve the transaction and the B-1
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dissenting shareholder did not vote in favor of (but need not have voted against) the transaction. Asset acquisition: The acquisition of all or some of a targets assets, usually accompanied by the assumption of certain of its liabilities. Assignment: The transfer by a party of intangible personal property or contract rights, as distinguished from a bill of sale, which is typically used to transfer tangible personal property. Sometimes an assignment and a bill of sale are combined in one document. See also Bill of sale. Assumed liabilities: A term often used in an acquisition agreement to refer to those liabilities being assumed by the buyer. Assumption (of liabilities): An undertaking to assume and discharge liabilities. Auction: A process for the sale of a business, ranging from a controlled auction, in which negotiations are conducted with a limited number of potential buyers without any specific time constraints, to a formal auction, in which multiple potential buyers are approached or a proposed sale is publicly announced and the time parameters are highly structured. Audit: An examination of the accounting books and records of a business by independent, outside auditors for the purpose of evaluating whether specified financial statements are fairly presented, in all material respects, in conformity with GAAP. An audit results in rendering an auditors report on the financial statements. B reorganization: A reorganization under Section 368(a)(1)(B) of the Internal Revenue Code that is structured as a stock-for-stock acquisition in which one corporation, solely in exchange for its voting stock (or voting stock of its parent), acquires stock of another corporation, such that immediately after the transaction the acquiring corporation has at least 80 percent control and meets certain other tests, allowing for the deferral of recognition of income (or loss) for federal income tax purposes with respect to the buyers stock (or stock of its parent) received by the targets shareholders. Basis: The value assigned to a taxpayers investment in property that is used to compute gain or loss from sale of the property. The basis can be an outside basis, i.e., the basis of stock owned by a shareholder, or an inside basis, i.e., the basis of an entity in its assets. Basket: A term describing a provision in an acquisition agreement dealing with indemnity obligations, so named because only certain types of claims or those exceeding in the aggregate a specified dollar amount are said to hit or fill the basket. Typically, recovery for indemnification is permitted only for the excess over the amount specified. Sometimes called a cushion, deductible, or deductible basket. See also Threshold.

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Bill of sale: An instrument for the transfer of title to tangible personal property, as distinguished from an assignment, which is typically used to transfer intangible property or contract rights. See also Assignment. Book (the): A marketing document, generally prepared by the seller with the assistance of its financial advisor, which is distributed to potential buyers and includes an overview of the sellers business and operations, limited industry information, managements background and selected historical and projected financial results. Also called an offering memorandum, a confidential memorandum or simply a memorandum. Book value: The historical cost of an asset less accumulated depreciation, depletion and amortization. Also, in an aggregate sense, the excess of total assets (net of accumulated depreciation, depletion and amortization) over total liabilities of an enterprise as they appear on a balance sheet. In the latter case, also called shareholders equity or net worth. Boot: A term used in connection with a tax-free reorganization to refer to consideration other than stock and securities that are permitted to be received without recognizing gain. Breach: A breach of a warranty or failure to perform or comply with a covenant or obligation in an agreement. Normally, also applies to the inaccuracy of a representation. Break-up fee: A payment promised by a target or its shareholders to the buyer if it loses the acquisition to another party. Usually a buyer is concerned about losing to higher bidders, but sometimes it asks for more general protection against termination of the acquisition agreement. Also called a bust-up or termination fee, although the latter may be payable if the deal is not completed for any reason. See also Topping fee. Built-in gain: The fair market value of assets in excess of their tax basis at the effective date of an S corporation election. Bulk sale: A sale, not in the ordinary course of business, of a major part of the sellers inventory when the sellers principal business is the sale of inventory from stock. Where applicable, the bulk sales law generally requires, among other things, that a buyer provide notice of the transaction to a sellers creditors a specified number of days prior to the closing. Business combination: A generic term that applies to the acquisition by one company of another or the consolidation of several companies, whatever the legal form. C reorganization: A reorganization under Section 368(a)(1)(C) of the Internal Revenue Code that is structured as a stock-for-assets acquisition in which one corporation, solely in exchange for its voting stock (or voting stock of its parent), acquires substantially all of the assets of another corporation, and meets certain other tests, allowing for the deferral of recognition of income (or loss) for federal income tax purposes with respect to the buyers stock (or stock of its parent) received by the targets shareholders. B-3
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Cap: A maximum limit on indemnity claims in an acquisition agreement. Also called a ceiling. Capital gain/loss: The profit or loss realized for federal income tax purposes upon the sale or exchange of a capital asset. If it is a long-term profit or loss, it ordinarily will be taxed at a rate less than the rate at which ordinary income is taxed. Ceiling: See Cap. Closely-held business: A business owned by a single person or a small group of persons, who often are active in the conduct of the business. Closing: Generally, the completion of the acts required to effect an acquisition or other transaction. At the typical closing of an acquisition, the buyer provides the consideration and the target delivers instruments of transfer (in an asset sale) or the shareholders deliver stock certificates (in a stock sale or merger). The appropriate parties will also execute and deliver ancillary agreements and other closing documents contemplated by an acquisition agreement. The date on which a closing occurs or is deemed to have occurred is called the closing date. It has become increasingly common for closings to occur without a gathering of the parties in one location, often using email to exchange executed documents. Closing conditions: Conditions in the acquisition agreement that must be satisfied or waived in order for the transaction to be consummated. A condition, for example, might be the absence of an event or the delivery of a document. Common stock: An equity security that represents the residual unit of ownership of a company and which generally will have full voting and dividend rights. Comparable companies method: A methodology for valuing a company by reference to companies that are comparable, in material respects, to the company to be valued. Comparable transactions method: A methodology for valuing a company by reference to sales of comparable companies in transactions involving a change in control. Conditions to closing: Any of a number of different conditions written into the definitive agreement which must be satisfied or waived by the parties before the transaction is closed. Confidentially agreement: An agreement or provision in an acquisition agreement, a letter of intent or an agreement in principle, whereby a party agrees to treat as confidential and neither use nor disclose non-public information received from another party, including in many cases the negotiations, the terms of the transaction or the fact that a transaction is being considered. Often, the agreement or provision is reciprocal. Sometimes called a nondisclosure agreement.

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Conglomerate merger: For antitrust purposes, involves the combination of firms that neither compete nor are in a vertical relationship with each other, including productextension mergers, geographic market-extension mergers and mergers between firms with no discernible commercial relationship. Consulting agreement: An ancillary agreement providing for an individual (usually a member of management or owner of the target) to render consulting services after the acquisition for a specified period of time. Contingent payment: Post-closing payments by the buyer to the seller based on the performance of the business after the closing. Also called an earn-out. Convertible preferred stock/security: Preferred stock or another security that can be converted, in whole or in part, into a specified class or series of stock in accordance with the terms set forth in the document evidencing the security. Corporate check: The process of investigation by which attorneys review minutes and other records, material contracts and legal compliance. (Part of the due diligence process.) Covenant not to compete: An ancillary agreement or provision in an acquisition agreement restricting competition by a seller and/or some or all the shareholders or employees of the seller, typically required by applicable law to be reasonably limited in terms of scope, geography and time. When contained in an ancillary agreement, provisions protecting confidential information and precluding hiring of employees are often included. Sometimes referred to as a noncompete or noncompetition agreement. Covenants: Agreements of the parties in an acquisition or ancillary agreement to do (affirmative covenant) or not to do (negative covenant or forbearance) certain things. An example is an agreement of the target to conduct its business in the ordinary course during the period between the signing of the acquisition agreement and the closing. Cushion: See Basket. Data room: The site at which documents relating to a party to an acquisition (generally the target) are placed for due diligence review by other parties and their advisors. May be a physical location where hard copies of documents are available or an online data room where electronic copies of documents are accessible. Definitive agreement: The primary agreement between a seller and buyer whereby the buyer agrees to acquire the sellers business by purchasing its assets, by purchasing its outstanding stock or by merger. The definitive agreement generally will specify the purchase price, structure, payment and other terms of the transaction, and contain representations and warranties, covenants and conditions.

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Disappearing corporation: In a merger, the corporation that is merged into another corporation and ceases to exist as a separate entity. Disclosure schedules: Schedules accompanying an acquisition agreement in which the target or its shareholders are required to disclose specific aspects of the business operations, material agreements, and other matters, and to list exceptions and qualifications to their representations. Sometimes called a disclosure letter or simply schedules. Discounted cash flow (DCF): A methodology for valuing a company that applies an appropriate discount rate to future projected cash flows to derive a present value for the company. Dissenting shareholder: A shareholder of a corporation who did not vote in favor of (but need not have voted against) a transaction to merge with, or sell substantially all the corporations assets to, another corporation when the affirmative vote of the acquired corporations shareholders is required. Dissenting shareholders are generally entitled to appraisal rights. Drop dead date: The date after which either party may terminate the transaction, if all conditions to the closing have not been satisfied or waived. Due diligence: The process by which a party assesses the benefits and liabilities of a proposed acquisition by reviewing all pertinent legal documents, contracts, intellectual property, financial statements, litigations, properties, etc., and interviewing selected employees and members of management. Earn-out: A term for a provision in an acquisition agreement giving the target or its shareholders the right to receive additional consideration after the closing if the targets (or its successors) performance meets certain negotiated thresholds. Also called a contingent payment. EBIT: Acronym for earnings before interest and taxes. EBITDA: Acronym for earnings before interest, taxes, depreciation, and amortization. Effective time: Sometimes acquisition agreements specify an effective time at a specific date (that may not be the closing date) and time. For example, the effective time may be when an agreement of merger is filed or, in an asset acquisition, when the transfer of assets and assumption of liabilities, and the related risk of loss, is to occur. The parties may also agree on an effective time for accounting and financial purposes that differs from the closing date.

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Engagement letter: An agreement with a financial advisor or other intermediary for services to be rendered in connection with a proposed acquisition and setting forth, among other things, the fees for the services and the basis on which they will be charged. ERISA: Employee Retirement Income Security Act of 1974, as amended, a federal law governing pensions and certain other employee benefits. Escrow: Usually, a portion of the purchase price, whether cash or securities, that is held by a buyer or a third-party in a separate account to secure the targets or its shareholders indemnification obligations. See also Holdback. Exclusivity agreement: An agreement whereby a target provides a potential buyer a limited period of time to conduct due diligence and negotiate an acquisition agreement without soliciting or talking with other potential buyers. See also No-shop. Exon-Florio: The Exon-Florio amendments to the Omnibus Trade and Competitive Act of 1988, as amended by the National Defense Authorization Act for Fiscal 1993 and the Foreign Investment and National Security Act of 2007, which permits the President of the United States or his designee to block acquisitions of U.S. enterprises by foreign persons on the basis of national security. Fairness opinion: A letter from a financial advisor to the effect that the consideration to be received in an acquisition is fair, from a financial point of view, to the target, the buyer or their shareholders, as the case may be. Financial Accounting Standards Board (FASB): A body charged with the responsibility of establishing and revising standards of accounting and reporting. Financial advisor: An investment banker, business broker or other professional retained by a seller to value a business, to find a buyer, to render an opinion as to fairness or, in certain circumstances, to find capital. Financial buyer: One that acquires a company for financial reasons and not to run the business over the long term. These are often funds sponsored by private equity firms formed for the purpose of acquiring, consolidating, expanding, and ultimately exiting businesses by reselling or taking them public for the benefit of their investors. See also Strategic buyer. Finder: One who introduces parties to a proposed business combination, but is not involved in negotiations. Finders fee: The fee received by a finder normally in a completed transaction. Forward merger: A merger in which the target is merged into the buyer, with the buyer being the survivor. See also Reverse merger.

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Forward triangular merger: A merger in which the target merges into a subsidiary of the buyer that is generally formed for purposes of the acquisition, with the subsidiary being the survivor. See also Reverse triangular merger. Fraudulent conveyance/transfer: A doctrine whereby creditors may void a transfer or seek satisfaction of their claims from a buyer if the transaction is found to be a fraudulent conveyance or transfer. The issue generally arises if a party makes a transfer or incurs an obligation without receiving fair or reasonably equivalent value and as a result is rendered insolvent, i.e., unable to pay its debts as they become due, or is left with unreasonably small capital in the business. The fraudulent conveyance laws are found in federal law (U.S. Bankruptcy Code) and state law (based mostly on the Uniform Fraudulent Conveyance Act or the Uniform Fraudulent Transfer Act). Generally accepted accounting principles (GAAP): A series of accounting principles generally accepted by the accounting profession. GAAP is jurisdictional, e.g., U.S. GAAP, Canadian GAAP. Good faith deposit: A deposit in cash made to demonstrate a partys commitment to proceed with, discuss further or close a proposed acquisition. Goodwill: When used in acquisition accounting, the excess of the cost of the acquired business over the sum of the amounts assigned to identifiable assets acquired at their fair value less the liabilities assumed. See also Acquisition accounting. Hart-Scott-Rodino (HSR): The Hart-Scott-Rodino Antitrust Improvements Act of 1976, a federal antitrust law which requires parties and transactions meeting the jurisdictional requirements to give advance notice to the Federal Trade Commission and the Antitrust Division of the Department of Justice and to wait a designated period before an acquisition can be consummated. Holdback: Deferral of a portion of the purchase price as a means of financing the acquisition or as protection for the indemnification obligations of the seller or both. See also Escrow. Horizontal merger: For antitrust purposes, a merger or acquisition between competitors. Indemnity/indemnification: Terms for provisions generally included in an acquisition agreement whereby a target or its shareholders agree to indemnify and hold harmless (and typically defend) the buyer against any losses or damages suffered by the buyer based on any breach of the targets or its shareholders representations, warranties or covenants contained in the acquisition agreement. Typically, the buyer also indemnifies the target or its shareholders, but on a more limited basis.

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Indication of interest: A preliminary, nonbinding proposal submitted by a potential buyer or a bidder in an auction. Inside basis: The tax basis of a company in its assets. Installment treatment: A means of deferring a portion of the federal income tax to be paid on gains into later years to correspond with payments of the purchase price which has resulted in the gains. Investment bank: The term encompasses a broad range of global, regional, and boutique financial services firms. Investment bank sometimes refers to the entity, and investment bankers to the individuals working at the investment bank, but the term investment banker is often used to refer to the entity as well. See also Financial advisor. Knowledge qualification: A qualification to representations based on the knowledge of a party or of certain specified individuals. Knowledge can be actual or constructive, and can be conditioned upon an investigation or can expressly disavow any investigation obligation. Lehman formula: A formula sometime used by financial advisors to determine their compensation for an acquisition, which is based on 5 percent of the first million dollars of consideration, 4 percent of the second million, 3 percent of the third million, 2 percent of the fourth million, and 1 percent of the excess, or is based on some variation of that formula. Letter of intent (LOI): A document signed by the parties outlining the key aspects (price, structure and significant terms) of an acquisition. It is usually expressly nonbinding, except with respect to certain narrow issues such as confidentiality, nonsolicitation of employees and exclusive negotiations. Sometimes called a memorandum of understanding (MOU). See also Term sheet. Leveraged buildup: An acquisition by a financial buyer involving several companies in the same industry. Leveraged buyout (LBO): The acquisition of a business where a high percentage of the purchase price is financed by leverage (borrowing). If the management of the target has a large participation, it is also called a management buyout (MBO). Leveraged recapitalization (recap): A transaction in which a company borrows a substantial amount of cash and distributes it to the shareholders by a dividend, self-tender, or otherwise. M&A: A term used generally to refer to mergers and acquisitions. Management buyout (MBO): Generally, a leveraged buyout in which management has a large participation. See also Leveraged buyout.

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Management presentation: A formal presentation by management of a target to potential buyers, usually as part of the process in an auction. Sometimes called a dog and pony show. Memorandum: See Book. Memorandum of understanding (MOU): See Letter of intent. Merchant bank: A firm that offers a combination of advisory and investment banking services and is able to use its own capital to assist a client in achieving its objectives. Merger: A statutory combination of two corporations or other entities. One entity (called the disappearing entity) is absorbed by another (called the surviving entity) by operation of law, with the surviving entity acquiring the assets and liabilities of the disappearing entity. Middle-market: Companies with revenues in the middle range, as to which there is no consensus. Often, those with revenues of $10 million to $25 million at the lower end of the range and $500 million to $1 billion at the higher end. No-shop: A term for a provision in a letter of intent or an acquisition agreement that prohibits the target or its shareholders from soliciting or entertaining offers from any other prospective buyers for a certain period of time or until the acquisition is consummated or the agreement is terminated. See also Exclusivity agreement. Noncompete agreement (NCA): See Covenant not to compete. Nondisclosure agreement (NDA): See Confidentiality agreement. Offering memorandum: See Book. Outside basis: The tax basis of shareholders in their shares. Phase I: An assessment of potential environmental contamination in property resulting from past or present land use. The assessment usually is based on site inspections and interviews, adjacent land use surveys, regulatory program reviews, aerial photograph evaluations and other background research. Phase II: A subsurface investigation of property through selected soil samples, laboratory analysis and testing. Platform acquisition: The acquisition of one or more companies in an industry to use as a platform for add-on acquisitions within that same industry. See also Add-on acquisition. Pooling-of-interests accounting: A method of accounting, no longer permitted for transactions initiated after June 30, 2001, under which a transaction was accounted for as the B-10
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uniting of ownership interests in which the assets and liabilities of the target continued to be carried at their historical costs, and the income of the entity after the transaction included the recast historical results of the combined companies for all prior periods. See also Acquisition accounting. Post-closing adjustment: An adjustment in the purchase price typically based on the increase or decrease in various items in the balance sheet as of the closing (e.g., working capital or net worth) as compared with those same items at a date or an average over a period prior to the closing (usually prior to entering into the acquisition agreement). Also called a true-up. Preferred stock: A hybrid security with some characteristics of both an equity security and a debt security. It usually contains preferences over common stock (and perhaps over other series of preferred stock), often including priority as to payment of dividends and distributions on liquidation. Purchase accounting: See Acquisition accounting. Purchase price adjustment: See Post-closing adjustment. Reorganization: A reorganization under Section 368(a) of the Internal Revenue Code allowing for the deferral of recognition of income (or loss) for federal income tax purposes with respect to the buyers stock (or stock of its parent) received by the targets shareholders. Representations (reps): Technically, statements that a target or its shareholders make in an acquisition agreement about various aspects of the business operations, material agreements, compliance with law, potential liabilities, and other matters. The buyer also makes representations, but they are generally much more limited. Often referred to in combination with warranties. The legal distinction between representations and warranties has been all but eliminated in the U.S., but the distinction is sometimes still recognized abroad. When recognized, the typical distinction made is that representations apply to past or existing facts, whereas warranties are promises that existing or future facts are or will be true. Restricted stock: Stock or other securities of a buyer acquired by the seller or its shareholders which are restricted from resale under the federal securities laws. Reverse merger: A merger in which the buyer is merged into the target with the target being the surviving corporation. See also Forward merger. Reverse triangular merger: A merger in which the buyer forms a subsidiary, and the subsidiary is merged into the target with the target being the surviving corporation. See also Forward triangular merger.

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Rollup: The acquisition of companies in the same industry at or about the same time as part of a consolidation strategy. Schedules: See Disclosure schedules. Section 338(h)(10) election: An election to have a transaction governed by Section 338(h)(10) of the Internal Revenue Code, such that it will be treated for corporate law purposes as a stock acquisition but for tax purposes as if the target had sold all its assets and then liquidated. Securities Act: The Securities Act of 1933, a federal law that governs the offer and sale of securities. Selected solicitation: The process by which potential buyers are selected and indications of interest solicited for the sale of a company. Seller financing: A means by which the seller can assist in the financing of an acquisition, normally by accepting a promissory note of the buyer for a portion of the purchase price or agreeing to installment payments of the purchase price. Shareholder representative: One or more persons or entities designated by the shareholders involved in an acquisition to represent their interests in connection with any indemnification claims, post-closing adjustments, earn-outs, or other matters. Stalking horse: A colloquial term for a prospective buyer in a pending negotiated transaction that is being used principally to attract higher offers. Step-up (in basis): The increase of the tax basis of assets to the new cost in an acquisition, thereby allowing them to be depreciated from a higher tax basis. See also Basis. Stock acquisition: A transaction in which the outstanding stock of a target is acquired directly from the shareholders, and the target continues to exist and maintains all of its assets, liabilities and contractual relationships. Strategic buyer: Typically an operating company that makes an acquisition for strategic business or long-term operational reasons, and not purely for financial reasons. See also Financial buyer. Subordinated: Usually, the deferred portion of the purchase price which is subject to prior right of payment to bank debt or other senior debt of the buyer. Surviving corporation (or survivor): In a merger, the corporation into which another corporation is merged and which continues to exist as a separate entity.

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Tail: The period following termination or expiration of the term of an engagement letter from an intermediary during which a target or its shareholders remain responsible for payment of a success fee if a sale occurs. Also, the extension of the period under an insurance policy during which an insured remains covered for claims, which usually can be obtained under the original policy for payment of an additional premium. Target: A business that a buyer wishes to acquire. Tax basis: The basis in an asset for tax purposes that is used for calculation of depreciation and to measure gain or loss on sale. Tax-free: The opposite of taxable. Tax lawyers often avoid using the terminology tax free and rather tend to characterize such transactions as deferring recognition for tax purposes. See also Reorganization. Tax-free reorganization: See Reorganization. Taxable: A transaction is said to be taxable if it is immediately taxable to the target or its shareholders for federal income tax purposes. Terminal value: The residual value of a business for the years beyond those projected in the determination of discounted cash flow. Termination fee: See Break-up fee. Term sheet: A recital of general terms of a proposed transaction, typically intended to be nonbinding. Term sheets are usually unsigned, in contrast to letters of intent. See also Letter of intent. Threshold: A term describing a provision in an acquisition agreement whereby once a threshold is reached or exceeded, the party seeking indemnification has the right to recover all amounts claimed from the first dollar. This is to be distinguished from a basket. Sometimes called a trigger, trip wire, first-dollar, dollar one, or tipping basket. See also Basket. Topping fee: A type of break up fee paid to the prospective buyer in a negotiated transaction. Its purpose is to give the buyer some recompense where a seller terminates a transaction because of a higher price offered by another party. The fee is a percentage of the amount by which the final purchase price exceeds the price that is being topped. See also Break-up fee. Triangular merger: A merger in which the target is merged with a subsidiary of the buyer, thus becoming a subsidiary of the buyer. See also Forward triangular merger and Reverse triangular merger.

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Vertical merger: For antitrust purposes, a merger or acquisition between firms at different levels of production or different levels in the chain of distribution. Waiver: An intentional or voluntary relinquishment of a known right or conduct that warrants an inference of the relinquishment of a right. WARN: The Worker Adjustment and Retraining Notification Act of 1988, as amended, a federal law which requires employers meeting certain threshold requirements to give at least 60 days advance written notice of certain plant closings and mass layoffs to the affected employees (or their union representatives) and certain local governmental officials. Some states have their own versions of the WARN Act.

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