The sale of a company, division, business, or collection of assets (“target”) is a major event for its owners (shareholders), management, employees, and other stakeholders. It is an intense, time-consuming process with high stakes, usually spanning several months. Consequently, the seller typically hires an investment bank and its team of trained professionals (“sell-side advisor”) to ensure that key objectives are met and a favorable result is achieved. In many cases, a seller turns to its bankers for a comprehensive financial analysis of the various strategic alternatives available to the target. These include a sale of all or part of the business, a recapitalization, an initial public offering, or a continuation of the status quo.

An auction is a staged process whereby a target is marketed to multiple prospective buyers (“buyers” or “bidders”). A well-run auction is designed to have a substantial positive impact on value (price and terms) received by the seller due to a variety of factors related to the creation of a competitive environment. This environment encourages bidders to put forth their best offer on both price and terms, and helps increase speed of execution by encouraging quick action by buyers.

EXHIBIT 6.2 Advantages and Disadvantages of Broad and Targeted Auctions

The traditional auction is structured as a two-round bidding process that generally spans from three to six months (or longer) from the decision to sell until the signing of a definitive purchase/sale agreement (“definitive agreement”) with the winning bidder (see Exhibit 6.3). The timing of the post signing (“closing”) period depends on a variety of factors not specific to an auction, such as regulatory approvals and/or third-party consents, financing, and shareholder approval. The entire auction process consists of multiple stages and discrete milestones within each of these stages. There are numerous variations within this structure that allow the sell-side advisor to customize, as appropriate, for a given situation.

EXHIBIT 6.3 Stages of an Auction Process

At the onset of an auction, the sell-side advisor works with the seller to identify its objectives, determine the appropriate sale process to conduct, and develop a process roadmap. The advisor must first gain a clear understanding of the seller’s priorities so as to tailor the process accordingly. Perhaps the most basic decision is how many prospective buyers to approach (i.e., whether to run a broad or targeted auction).

Sale process preparation begins with extensive due diligence on the part of the sell-side advisor. This typically begins with an in-depth session with target management. The sell-side advisor must have a comprehensive understanding of the target’s business and the management team’s vision prior to drafting marketing materials and communicating with prospective buyers. Due diligence facilitates the advisor’s ability to properly position the target and articulate its investment merits. It also allows for the identification of potential buyer concerns on issues ranging from growth sustainability, margin trends, and customer concentration to environmental matters, contingent liabilities, and labor relations.

The selection of an appropriate group of prospective buyers, and compilation of corresponding contact information, is a critical part of the organization and preparation stage. At the extreme, the omission or inclusion of a potential buyer (or buyers) can mean the difference between a successful or failed auction. Sell-side advisors are selected in large part on the basis of their sector knowledge, including their relationships with, and insights on, prospective buyers. Correspondingly, the deal team is expected to both identify the appropriate buyers and effectively market the target to them.

Marketing materials often represent the first formal introduction of the target to prospective buyers. They are essential for sparking buyer interest and creating a favorable first impression. Effective marketing materials present the target’s investment highlights in a succinct manner, while also providing supporting evidence and basic operational, financial, and other essential business information. The two main marketing documents for the first round of an auction process are the teaser and confidential information memorandum (CIM). The sell-side advisors take the lead on producing these materials with substantial input from management. Legal counsel also reviews these documents, as well as the management presentation, for various potential legal concerns (e.g., antitrust²⁰⁰).

Teaser The teaser is the first marketing document presented to prospective buyers. It is designed to inform buyers and generate sufficient interest for them to do further work and potentially submit a bid. The teaser is generally a brief one- or two-page synopsis of the target, including a company overview, investment highlights, and summary financial information. It also contains contact information for the bankers running the sell-side process so that interested parties may respond.

EXHIBIT 6.4 Sample Teaser

Confidential Information Memorandum The CIM is a detailed written description of the target (often 50+ pages) that serves as the primary marketing document for the target in an auction. The deal team, in collaboration with the target’s management, spends significant time and resources drafting the CIM before it is deemed ready for distribution to prospective buyers. In the event the seller is a financial sponsor (e.g., selling a portfolio company), the sponsor’s investment professionals typically also provide input.

Financial Information The CIM contains a detailed financial section presenting historical and projected financial information with accompanying narrative explaining both past and expected future performance (MD&A). This data forms the basis for the preliminary valuation analysis performed by prospective buyers.

EXHIBIT 6.5 Sample Confidential Information Memorandum Table of Contents

A confidentiality agreement (CA) is a legally binding contract between the target and each prospective buyer that governs the sharing of confidential company information. The CA is typically drafted by the target’s counsel and distributed to prospective buyers along with the teaser, with the understanding that the receipt of more detailed information is conditioned on execution of the CA.

The first round begins with the contacting of prospective buyers, which marks the formal launch of the auction process. This typically takes the form of a scripted phone call to each prospective buyer by a senior member of the sell-side advisory team (and/or the coverage banker that maintains the relationship with the particular buyer), followed by the delivery of the teaser and CA.²⁰⁴ The sell-side advisor generally keeps a detailed record of all interactions with prospective buyers, called a contact log, which is used as a tool to monitor a buyer’s activity level and provide a record of the process.

Upon receipt of the CA, a prospective buyer presents the document to its legal counsel for review. In the likely event there are comments, the buyer’s counsel and seller’s counsel negotiate the CA with input from their respective clients. Following execution of the CA, the sell-side advisor is legally able to distribute the CIM and initial bid procedures letter to a prospective buyer.²⁰⁵

Prospective buyers are typically given several weeks to review the CIM,²⁰⁶ study the target and its sector, and conduct preliminary financial analysis prior to submitting their initial non-binding bids. During this period, the sell-side advisor maintains a dialogue with the prospective buyers, often providing additional color, guidance, and materials, as appropriate, on a case-by-case basis.

Initial Bid Procedures Letter The initial bid procedures letter, which is typically sent out to prospective buyers following distribution of the CIM, states the date and time by which interested parties must submit their written, non-binding preliminary indications of interest (“first round bids”). It also defines the exact information that should be included in the bid, such as:

The management presentation is typically structured as a slideshow with accompanying hardcopy handout. The sell-side advisor takes the lead on preparing these materials with substantial input from management. In parallel, the sell-side advisor works with the management team to determine the speaker lineup for the presentation, as well as key messages, and the preparation of answers for likely questions. Depending on the management team, the rehearsal process for the presentations (“dry runs”) may be intense and time-consuming. The management presentation slideshow needs to be completed by the start of the second round when the actual meetings with buyers begin.

EXHIBIT 6.6 Sample Management Presentation Outline

The data room serves as the hub for the buyer due diligence that takes place in the second round of the process. It is a location, typically online, where comprehensive, detailed information about the target is stored, catalogued, and made available to pre-screened bidders.²⁰⁸ A well-organized data room facilitates buyer due diligence, helps keep the sale process on schedule, and inspires confidence in bidders. While most data rooms follow certain basic guidelines, they may vary greatly in terms of content and accessibility depending on the company and confidentiality concerns.

The investment bank running the auction process (or sometimes a “partner” bank) may prepare a “pre-packaged” financing structure in support of the target being sold. The staple, which is targeted toward sponsors, was a mainstay in auction processes during the LBO boom of the mid-2000s. Although prospective buyers are not required to use the staple, historically it has positioned the sell-side advisor to play a role in the deal’s financing. Often, however, buyers seek their own financing sources to match or “beat” the staple. Alternatively, certain buyers may choose to use less leverage than provided by the staple.

EXHIBIT 6.7 General Data Room Index

On the first round bid date, the sell-side advisor receives the initial indications of interest from prospective buyers. Over the next few days, the deal team conducts a thorough analysis of the bids received, assessing indicative purchase price as well as key terms and other stated conditions. There may also be dialogue with certain buyers at this point, typically focused on seeking clarification on key bid points.

Valuation Perspectives - Strategic Buyers vs. Financial Sponsors As discussed in Chapters 4 and 5, financial sponsors use LBO analysis and the implied IRRs and cash returns, together with guidance from the other methodologies discussed in this book, to frame their purchase price range. The CIM financial projections and an initial assumed financing structure (e.g., a staple, if provided, or indicative terms from a financing provider) form the basis for the sponsor in formulating a first round bid. The sell-side advisor performs its own LBO analysis in parallel to assess the sponsor bids.

Accretion/(Dilution) Analysis As a general rule, public companies are reluctant to pursue dilutive transactions due to the potential detrimental effect on their share price. Therefore, a given public buyer’s perception of valuation and corresponding bid price is often guided by EPS accretion/(dilution) analysis. Maximum accretive effects are achieved by minimizing purchase price, sourcing the least expensive form of financing, and identifying significant achievable synergies. However, while certain transactions may not be accretive on day one, they may create escalating value over time. Hence, buyers evaluate the accretive/(dilutive) effects of a transaction on a forward-looking basis taking into account the target’s future expected earnings, including growth prospects and other combination effects such as synergies.

EXHIBIT 6.8 First Round Bids Summary

EXHIBIT 6.9 Accretion/(Dilution) Analysis^(a)

The management presentation typically marks the formal kickoff of the second round, often spanning a full business day. At the presentation, the target’s management team presents each prospective buyer with a detailed overview of the company, ranging from basic business, industry, and financial information to competitive positioning, future strategy, growth opportunities, synergies (if appropriate), and financial projections. The core team presenting typically consists of the target’s CEO, CFO, and key division heads or other operational executives, as appropriate. The presentation is intended to be interactive with Q&A encouraged and expected. It is customary for prospective buyers to bring their investment banking advisors and financing sources, as well as industry and/or operational consultants, to the management presentation so they can conduct their due diligence in parallel and provide insight.

Site visits are an essential component of buyer due diligence, providing a firsthand view of the target’s operations. Often, the management presentation itself takes place at, or near, a key company facility and includes a site visit as part of the agenda. Prospective buyers may also request visits to multiple sites to better understand the target’s business and assets. The typical site visit involves a guided tour of a key target facility, such as a manufacturing plant, distribution center, and/or sales office. The guided tours are generally led by the local manager of the given facility, often accompanied by a sub-set of senior management and a member of the sell-side advisory team. They tend to be highly interactive as key buyer representatives, together with their advisors and consultants, use this opportunity to ask detailed questions about the target’s operations. In many cases, the seller does not reveal the true purpose of the site visit as employees outside a selected group of senior managers are often unaware a sale process is underway.

In conjunction with the management presentation and site visits, prospective buyers are provided access to the data room. As outlined in Exhibit 6.7, the data room contains detailed information about all aspects of the target (e.g., business, financial, accounting, tax, legal, insurance, environmental, information technology, and property). Serious bidders dedicate significant resources to ensure their due diligence is as thorough as possible. They often enlist a full team of accountants, attorneys, consultants, and other functional specialists to conduct a comprehensive investigation of company data. Through rigorous data analysis and interpretation, the buyer seeks to identify the key opportunities and risks presented by the target, thereby framing the acquisition rationale and investment thesis. This process also enables the buyer to identify those outstanding items and issues that should be satisfied prior to submitting a formal bid and/or specifically relating to the seller’s proposed definitive agreement.

During the second round, the final bid procedures letter is distributed to the remaining prospective buyers often along with the draft definitive agreement. As part of their final bid package, prospective buyers submit a markup of the draft definitive agreement together with a cover letter detailing their proposal in response to the items outlined in the final bid procedures letter.

Final Bid Procedures Letter Similar to the initial bid procedures letter in the first round, the final bid procedures letter outlines the exact date and guidelines for submitting a final, legally binding bid package. As would be expected, however, the requirements for the final bid are more stringent, including:

Definitive Agreement The definitive agreement is a legally binding contract between a buyer and seller detailing the terms and conditions of the sale transaction. In an auction, the first draft is prepared by the seller’s legal counsel in collaboration with the seller and its bankers. It is distributed to prospective buyers (and their legal counsel) during the second round—often toward the end of the diligence process. The buyer’s counsel then provides specific comments on the draft document (largely informed by the buyer’s second round diligence efforts) and submits it as part of the final bid package.

EXHIBIT 6.10 Key Sections of a Definitive Agreement

Upon conclusion of the second round, prospective buyers submit their final bid packages to the sell-side advisor by the date indicated in the final bid procedures letter. These bids are expected to be final with minimal conditionality, or “outs,” such as the need for additional due diligence or firming up of financing commitments. In practice, the sell-side advisor works with viable buyers throughout the second round to firm up their bids as much as possible before submission.

The sell-side advisor works together with the seller and its legal counsel to conduct a thorough analysis of the price, structure, and conditionality of the final bids. Purchase price is assessed within the context of the first round bids and the target’s recent financial performance, as well as the valuation work performed by the sell-side advisors. The deemed binding nature of each final bid, or lack thereof, is also carefully weighed in assessing its strength. For example, a bid with a superior headline offer price, but significant conditionality, may be deemed weaker than a firmer bid at a lower price. Once this analysis is completed, the seller selects a preferred party or parties with whom to negotiate a definitive agreement.

Often, the sell-side advisor recommends that the seller negotiates with two (or more) parties, especially if the bid packages are relatively close and/or there are issues with the higher bidder’s markup of the definitive agreement. Skillful negotiation on the part of the sell-side advisor at this stage can meaningfully improve the final bid terms. While tactics vary broadly, the advisor seeks to maintain a level playing field so as not to advantage one bidder over another and maximize the competitiveness of the final stage of the process. During these final negotiations, the advisor works intensely with the bidders to clear away any remaining confirmatory diligence items (if any) while firming up key terms in the definitive agreement (including price), with the goal of driving one bidder to differentiate itself.

The sell-side advisor and legal counsel negotiate a final definitive agreement with the winning bidder, which is then presented to the target’s board of directors for approval. Not all auctions result in a successful sale. The seller normally reserves the right to reject any and all bids as inadequate at every stage of the process. Similarly, each prospective buyer has the right to withdraw from the process at any time prior to the execution of a binding definitive agreement. An auction that fails to produce a sale is commonly referred to as a “busted” or “failed” process.

In response to a proposed offer for a public company, the target’s board of directors typically requires a fairness opinion to be rendered as one item for their consideration before making a recommendation on whether to accept the offer and approve the execution of a definitive agreement. For public companies selling divisions or subsidiaries, a fairness opinion may be requested by the board of directors depending on the size and scope of the business being sold. The board of directors of a private company may also require a fairness opinion to be rendered in certain circumstances, especially if the stock of the company is broadly held (i.e., there are a large number of shareholders).

Once the seller’s board of directors votes to approve the deal, the definitive agreement is executed by the buyer and seller. A formal transaction announcement agreed to by both parties is made with key deal terms disclosed depending on the situation (see Chapter 2). The two parties then proceed to satisfy all of the closing conditions to the deal, including regulatory and shareholder approvals.

Regulatory Approval The primary regulatory approval requirement for the majority of U.S. M&A transactions is made in accordance with the Hart-Scott-Rodino

Antitrust Improvements Act of 1976 (the “HSR Act”).²¹⁵ Depending on the size of the transaction, the HSR Act requires both parties to an M&A transaction to file respective notifications and report forms with the Federal Trade Commission (FTC) and Antitrust Division of the Department of Justice (DOJ). Companies with significant foreign operations may require approval from comparable foreign regulatory authorities such as the Competition Bureau (Canada) and European Commission (European Union).

One-Step Merger In a “one-step” merger transaction for public companies, target shareholders vote on whether to approve or reject the proposed transaction at a formal shareholder meeting pursuant to relevant state law. Prior to this meeting, a proxy statement is distributed to shareholders describing the transaction, parties involved, and other important information.²¹⁶ U.S. public acquirers listed on a major exchange may also need to obtain shareholder approval if stock is being offered as a form of consideration and the new shares issued represent over 20% of the acquirer’s pre-deal common shares outstanding. Shareholder approval is typically determined by a majority vote, or 50.1% of the voting stock. Some companies, however, may have corporate charters, or are incorporated in states, that require higher approval levels for certain events, including change of control transactions.

Two-Step Tender Process Alternatively, a public acquisition can be structured as a “two-step” tender offer²¹⁸ on either a negotiated or unsolicited basis, followed by a merger. In Step I of the two-step process, the tender offer is made directly to the target’s public shareholders with the target’s approval pursuant to a definitive agreement.²¹⁹ The tender offer is conditioned, among other things, on sufficient acceptances to ensure that the buyer will acquire a majority (or supermajority, as appropriate) of the target’s shares within 20 business days of launching the offer. If the buyer only succeeds in acquiring a majority (or supermajority, as appropriate) of the shares in the tender offer, it would then have to complete the shareholder meeting and approval mechanics in accordance with a “one-step” merger (with approval assured because of the buyer’s majority ownership). However, if the requisite threshold of tendered shares is reached as designed (typically 90%), the acquirer can subsequently consummate a back-end “short form” merger (Step II) to squeeze out the remaining public shareholders without needing to obtain shareholder approval.

In parallel with obtaining all necessary approvals and consents as defined in the definitive agreement, the buyer proceeds to source the necessary capital to fund and close the transaction. This financing process timing may range from relatively instantaneous (e.g., the buyer has necessary cash-on-hand or revolver availability) to several weeks or months for funding that requires access to the capital markets (e.g., bank, bond, and/or equity financing). In the latter scenario, the buyer begins the marketing process for the financing following the signing of the definitive agreement so as to be ready to fund expeditiously once all of the conditions to closing in the definitive agreement are satisfied. The acquirer may also use bridge financing to fund and close the transaction prior to raising permanent debt or equity capital. Once the financing is received and conditions to closing in the definitive agreement are met, the transaction is funded and closed.

While auctions were prevalent as a sell-side mechanism during the LBO boom of the mid-2000s, a substantial portion of M&A activity is conducted through negotiated transactions. In contrast to an auction, a negotiated sale centers on a direct dialogue with a single prospective buyer. In a negotiated sale, the seller understands that it may have less leverage than in an auction where the presence of multiple bidders throughout the process creates competitive tension. Therefore, the seller and buyer typically reach agreement upfront on key deal terms such as price, structure, and governance matters (e.g., board of directors / management composition).

EXHIBIT 6.11 Advantages and Disadvantages of a Negotiated Sale