Deal Forum

Digest

The second annual Deal Forum returns to the Inner Harbor!

M&A Mid-Year Market Check The Reign of Uncertainty

By NaNette C. Heide, PartNer, aNd Keli WHitloCK, PartNer, duaNe Morris The fourth quarter of 2012 left m&a professionals feeling, well, hopeful. There was a marked increase in the number of deals, which, when put together with other factors like significant cash on the balance sheets of potential acquirors, $400B in private equity dry powder, a renewed willingness on the part of banks to lend, a still-flagging IPo market and a good inventory of willing sellers, made it seem like we were on the verge of an m&a recovery. But then Q1 2013 turned in the worst performance for m&a activity since 2003, showing the uptick in Q4 2012 activity to be a consolidation of Q4 and Q1 activity rather than an actual increase.
Nanette C. Heide is a partner in the New York office of Duane morris and practices in the area of corporate law, representing multinational corporations (public and private) and mid-sized companies and investors, as well as start-up companies, in a wide variety of transactions, including institutional private placements, middle market private equity investments, debt and equity structuring transactions, mergers and acquisitions, restructurings and recapitalizations. she has worked with private equity and other funds on formation, structuring, and regulatory and securities issues. she can be reached at 212.692.1003 or ncheide@duanemorris.com.

What is keeping buyers out of the market? uncertainty caused by lack of confidence in the uS economic recovery, a low growth environment and global economic uncertainty. Tomorrow may be another day, but C-Suite memories from 2008 still have not faded. When management teams began scrambling to accumulate cash and reduce debt and expenses in 2008, a trend that continued through 2011, they did so because they were concerned about the economy. While many herald the arrival of recovery, skepticism abounds in corporate boardrooms. Coupled with the specters of inflation and a continued low growth environment, the acquisition pace is understandably low. It is clear that the stock markets do not currently reflect the economy generally as the stock markets are climbing ever higher buoyed by continued quantitative easing and bursts of mainly unsupported consumer confidence. record high profit margins on relatively flat revenues this year have bought some time for potential acquirors. High margins have allowed management to delay questions about the sustainability of those margins amidst concerns about the uncertain cost of acquisitions. With 271 companies of the S&P 500 having reported earnings, only 19% have seen revenues increase beyond guidance while 30% dropped lower than expected. expense uncertainty encourages hoarding cash and keeping rosters trim. employees are typically the single largest expense in a company and growing by acquisition means acquiring more employees. Healthcare costs and other taxes are still undetermined and employers hesitate to acquire additional employees en masse without fully understanding the associated costs. Private equity funds face uncertainties related to the cost of doing business in the m&a market. regulators want more transparency, more consistency in valuing illiquid assets

and higher taxes. each of these new requirements carries its own set of costs and challenges for a private equity fund. acquisitions are made based on the cost of acquisition and ownership compared to forecast exit scenarios. If the cost of owning companies could skyrocket, it makes it very difficult to forecast the exit required to reach a particular return. With the IPo market still flagging, the most lucrative exit is, at least temporarily, less viable. This means that a sale of the asset is a more likely exit. It is also more likely to be a less profitable exit than an IPo. These factors go into the determination of purchase price and in this market may delay or derail transactions because of a disconnect between what sellers believe their businesses to be worth and what buyers are able to pay given their financial modeling. The history of returns over the past decade as well as the longer holding period for investments because of the continuing liquidity crunch has caused many limited partners to significantly reduce their participation in private equity or exit the asset class all together. This puts increased pressure on the remaining private equity funds to perform, which means they have to be right about valuations when going into an acquisition: a difficult task when the costs are undefined. Data analytics play an increasingly important role in m&a decision-making. For the past several years we have been gathering data on the behaviors of our potential targets. Investment bankers study acquirors (and serial sellers) to find the ideal suitors for a particular company. Sophisticated acquirors study the costs and benefits of acquisitions from employee retention to the effectiveness of IP. Private equity funds are relentless in their understanding of the competitive landscape and how companies will or wont benefit from a combination. No matter the perspective, data analytics is increasingly used to shape choices. While it is true that the quest for certainty leads to missed opportunity, data can be used quite effectively as a guide. The Other Side of the Coin Despite global economic conditions, activity in highgrowth markets increased slightly in 2012, and these markets should remain attractive options for transactions in 2013. Healthcare and oil & gas are busy industries and commercial real estate is making a comeback. Southeast asia and South america continue to be top investment destinations.

Keli Whitlock is a partner in the Baltimore office and serves as co-chair of the Venture Capital/ emerging Companies Practice. she represents clients in connection with corporate and securities transactions, focusing on venture capital, public and private securities offerings, mergers and acquisitions and the representation of emerging growth and middle market companies. ms. Whitlock represents a number of leading venture capital firms and angel investors. in 2005, ms. Whitlock was named one of the 40 under 40 outstanding business leaders in Baltimore by the Baltimore Business Journal. she can be reached at 410.949.2912 or kwhitlock@duanemorris.com.

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Deal Forum Digest 3

Slow & Steady as She Goes

By lee duraN, PartNer aNd Private equity PraCtiCe leader at Bdo a majority of private equity professionals entered into 2012 optimistic about the year ahead. Both 2010 and 2011 saw year-over-year increases in the overall level of deal flow volume and capital invested and private equity firms were sitting on more than $450 billion of dry powder just waiting to be invested. add to that the fact that the u.S. economy finally appeared to be improving and it seemed almost certain that 2012 was poised to be the best year for the private equity industry since the financial downturn in 2008. The reality, however, was quite different, as a number of factors contributed to an unexpected decline in total deal flow volume and capital invested through September 2012. even so, the end of the year brought with it signs of hope: according to PitchBook, the amount of capital invested neared levels not seen since the fourth quarter of 2011, and, before then, the fourth quarter of 2010. looking ahead to 2013, the fourth annual BDo uSa, llP Perspective Private equity Study asked senior private equity professionals to weigh-in on the outlook for the industry in the coming year. So, what can we expect for the remainder of the year? Deal Flow to Trend Upwards looking into 2013, 36 percent of fund managers expected to close more than four new deals during the next 12 months. Thats compared to 26 percent of fund managers who reported closing five or more deals in 2012, and, if expectations hold true, it could point to a compelling uptick in deal flow volume in 2013. Fund managers arent expecting a sudden boom, however. a majority (57 percent) still expect to close between two and four new deals during the next 12 months. Thats compared to 47 percent who indicated that they did so in 2012. Secondary Buyouts to Drive Deal Flow When it comes to opportunities for deal flow, secondary buyouts are expected to be a primary driver of activity in 2013. That stands to reason considering that, according to PitchBook, 47 percent of the more than 6,500 private equity-backed companies at the end of 2012 were acquired from 2005 to 2008. many private equity funds will be looking hard for opportunities to exit their mature investments in 2013, while others will be eager to put their dry powder to work. Manufacturing & Technology Industries to Attract Investors When it comes to investment opportunities by industry, the largest percentage of private equity fund managers identified manufacturing and technology (equally, 25 percent) as the sectors that will provide the greatest opportunities for new investments during the next 12 months. expectations for manufacturing were consistent with last years study when 28 percent of respondents identified it as the sector that will provide the greatest opportunities. expectations for technology, however, represent a marked improvement from last year, when only 10 percent of fund managers identified it as the most attractive sector for new investments in 2012. With declining economic uncertainty, many companies are looking to invest in new technologies that will help them increase their productivity and grow their businesses. This trend is once again piquing private equity funds interest in the technology sector, which has traditionally been a growth industry. The healthcare and biotech industry was also identified as an attractive sector for new investments in 2013, with 19 percent of respondents indicating that it will provide the greatest opportunities, followed by natural resources and energy (17 percent), financial services (5 percent), media/information (4 percent) and retail and distribution (3 percent). The BDo Perspective Private equity Study is a national survey conducted by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry. more than 100 senior executives at private equity firms throughout the u.S. with $15 million to $157 billion in assets under management responded to BDos latest study, which was conducted from November through December 2012. Material discussed is meant to provide general information and should not be acted on without professional advice tailored to your firms individual needs.

Lee Duran is a Partner and Private equity Practice leader at BDo. He can be reached at lduran@bdo.com.

BDO is the brand name for BDo usa, llP, a u.s. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDo has provided quality service through the active involvement of experienced and committed professionals. the firm serves clients through 45 offices and more than 400 independent alliance firm locations nationwide. as an independent member Firm of BDo international limited, BDo serves multi-national clients through a global network of 1,204 offices in 138 countries. BDo usa, llP, a Delaware limited liability partnership, is the u.s. member of BDo international limited, a uK company limited by guarantee, and forms part of the international BDo network of independent member firms. BDo is the brand name for the BDo network and for each of the BDo member Firms. For more information please visit: www.bdo.com

Deal Forum Digest

Dont Overlook Sell-side Due Diligence

By Joe KiNsloW, PartNer traNsaCtioN advisory serviCes, MCGladrey Private equity exits are expected to increase this year. Secondary buyouts comprise the majority of private equity exits, as Pe firms continue to use each other to source deals and achieve liquidity. With this heightened amount of deal activity combined with greater scrutiny from many directions, the role of sellside due diligence has never been more critical. Concerns brought to the surface by buy-side due diligence have increasingly delayed deals, caused them to fail or eroded the value of companies due to unanticipated issues. In this atmosphere, it is imperative to retain control of the sales process and provide a transparent, balanced and credible view of the business to establish trust with a potential buyer and expedite the deal timeline. Properly preparing for an acquisition The growth in sell-side due diligence is largely attributed to sellers and investment bankers recognizing the value of this service. The amount of previously failed and delayed deals have encouraged groups to seek assistance on the sell-side to ensure financial, tax and operational details are properly positioned prior to buyers evaluating the business. Sell-side due diligence is gaining more traction as sellers understand the value of being prepared. Several questions and information requests will be presented as part of any buy-side due diligence exercise. oftentimes, sellers underestimate the amount of diligence required to get to close. Sell-side due diligence adds valuable bandwidth to the management team, relieving stress on key personnel, allowing them to focus on the day-to-day business and ensuring that targets are attained, while historical results are successfully prepared in anticipation of a transaction. a firm providing sell-side assistance also helps to identify potential add-backs at a detailed level that certain investment bankers may not focus on, thus increasing the enterprise value of a business. Carve-out concerns a transaction involving a carved-out division inherently presents unique issues. a carve-out often has allocations between divisions, with certain difficulty determining whether it is truly independent with dedicated management, and oftentimes, the financial statements may be combined within other divisionsespecially when the transaction only involves a specific product line. Bridges are required throughout the divestiture process to reconcile historical financial data with the ultimate deal-based financials. From a sellers perspective, sell-side due diligence helps to truly understand the structure of carve-outs and historical business trends, making the situation easier for a potential buyer to comprehend. The value of sell-side due diligence reports a sell-side report will often eliminate the majority of the questions that a potential buyer will ask from the outset, as answers are already contained in the report. This helps to expedite the process, removing a significant amount of deliberation that often occurs with buy-side due diligence. The remaining questions normally involve testing some of the larger assumptions or commentary in the report. any other business or risk issues that have been identified in the process are also evaluated, as a prospective buyer will want to make sure they have a complete understanding. another challenge that sell-side due diligence can alleviate is managing an involved process where questions must be answered from multiple potential buyers. The service can preserve managements time, while satisfying the demands of any number of buyers. This is certainly an important factor to consider when dealing with bidding situations. Is sell-side due diligence a good fit? Sellers often underestimate the time and necessary due diligence requirements of potential buyers. In certain situations an outside adviser may not be necessary; however, examples of where sell-side due diligence should be used are companies that: Have undergone certain transformational changes, such as leadership changes, acquired or sold business or divisions employ a lean accounting staff Implemented or are in the process of implementing cost-saving initiatives Suffered changes in the customer base or employee turnover, especially in key accounting roles experienced growth are considering the sale of a division or segment of a business In these situations, sell-side due diligence allows the seller to avoid surprises, maintain control of the process and minimize disruptions, which significantly increase the probability of a successful transaction. learn more about sell-side due diligence, including how to alleviate the unique issues related to carve-outs and the value of uncovering and positioning tax liabilities and benefits, in mcGladreys white paper, available at http://mcgladrey.com/ Private-Equity-Groups/Private-Equity-Exit-Strategy.
Deal Forum Digest 7

leading the transaction advisory services practice for the mid-atlantic region, Joseph S. Kinslow has been with mcgladrey llP since 1999. He specializes in providing advisory services to both private equity funds and strategic investors, including due diligence investigations and pre-transaction planning, analysis and assessment. Joe also has experience with sell-side engagements, working capital analysis, profitability improvement and strategic planning. For several years, Joes expertise included performing business valuations, financial analysis, business planning, profit analysis and litigation support. He has assisted start-ups and established businesses with raising capital and executing acquisition strategies, as well as financial projects related to budgeting, pricing analysis and profit improvement. He has also prepared businesses for sale through strategy development, preparation of marketing materials, recasting financial statements and advising on structure and negotiations. in 2003, Joe transitioned into transaction services, which includes leading due diligence and pretransaction planning engagements with a focus on accounting and business issues surrounding buy-side acquisitions. He has successfully completed due diligence for private equity groups with transaction sizes ranging from $5 million to $500 million, including the preparation of comprehensive reports detailing quality of earnings, quality of working capital, and observations of key deal issues for a variety of industries. He can be reached at 410.246.9190 or joe.kinslow@ mcgladrey.com.

After the Deal Closes: Establishing a PostClosing Legal Program for Portfolio Companies
KeviN aCKliN, PartNer, saul eWiNG llP Private equity and venture funds spend billions of dollars annually on legal fees in acquiring and investing in target portfolio companies, but too often the legal discipline that defines the deal negotiations quickly dissipates after the closing. Fund managers can tell horror stories of portfolio companies tanking because of significant, but preventable, legal issues that arise post-closing, often without sufficient or timely visibility by fund managers to react appropriately. after the closing of the deal, fund managers join the companys board of directors and properly focus their attention on business, operational and market issues. often times, company management is left to engage their own company legal counsel for ongoing matters. This decision can be costly, as post-closing mistakes in commercial contracts, failures to address employment issues, mishandling of intellectual property licensing issues, misunderstanding of complex regulatory issues, and ongoing commercial litigation matters all have actual and opportunity costs that drag company, and thereby, overall fund performance. Having spent much of my career representing private equity and venture funds in negotiating platform acquisitions and investments, I have witnessed these costs first hand. I have fielded the calls from fund managers well after the issues had arisen, often as a surprise to them, and lamented the lack of more efficient management of legal services across a funds entire portfolio. Fund managers often convince themselves that deferring the decision on engaging legal counsel to each companys management team makes perfect sense, because funds are investing in that team. While that may be true, the question begs, however: why would any private equity or venture fund permit its deployment of significant investor capital to be subjected to risks of not having consistent and coordinated legal counsel at the portfolio company level after the closing? The answers to this question are, of course, practical in nature. often times, it is simply not cost effective to engage the funds higher-priced law firms to handle day-to-day portfolio company matters after closing. as a result, company management usually relies on its legal counsel, a firm that may or may not address these issues in a manner preferred by the fund. moreover, many funds 8
Deal Forum Digest

do not have full time in house counsel with sufficient bandwidth to work with the portfolio company to properly address these risks. There is a better way. after the deal closes, funds should strongly consider the value of incorporating the newly-acquired portfolio company into a coordinated portfolio-wide program of legal services. We have participated in establishing and managing these programs for funds, and they have worked well to help minimize risks of legal issues arising at the portfolio company level, maximizing visibility to fund managers at the board level, and recognizing economies of scale in the provision of legal services across the funds entire portfolio. The main features of establishing a portfolio company legal program are as follows: Develop a clear list of matters that require review and approval by legal counsel prior to execution by the company; Implement a system for analyzing legal risks and effectively communicating such risks to the board on a regular basis; Identify the types of contracts and actions that require prior review and approval by the board; Specify internal approval processes and signature matrix identifying officers authorized to sign contracts on behalf of the company; manage company general counsel and corporate governance issues, including minutes of board actions and records of incentive plan awards; Conduct initial audits of the portfolio companys significant contracts, employee documents, and regulatory issues immediately after the deal closes; Develop company-specific forms of contracts and commercial terms and conditions; Present training on legal program to company management and senior personnel; and Conduct periodic audits to confirm portfolio company compliance with the program. In our experience, the legal fees incurred in establishing a portfolio company legal program may be proportionally shared across the portfolio.

Kevin Acklin is a corporate lawyer with extensive experience in mergers and acquisitions, recapitalizations, and private equity and venture capital transactions. He also serves as outside general counsel to various technology, manufacturing and real estate investment companies. Kevin advises his clients on debt and equity financings, securities, technology, emerging company formation and growth, and corporate governance issues. He also is active in Pittsburghs nonprofit community with numerous board positions. He has provided pro bono representation to victims of domestic violence in protection from abuse matters. Kevin received his J.D., cum laude, from georgetown university law Center and his a.B. in government, cum laude, from Harvard College.

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How does the JOBS Act affect your business?

By MiCHael KeNNedy, reGioNal direCtor, Merrill datasite The JoBS act was enacted on april 5th 2012, and was designed to help start-ups raise capital by lifting some of the legal restrictions on equity-based crowdfunding as well as to encourage small businesses to go public by easing accounting and disclosure requirements. The act was created based on the idea that allowing companies easier access to the capital markets would spur growth and create jobs. Its been over one year since the act was passed, and while the long term success of the JoBS act initiatives has yet to be determined, some initial trends have been observed, such as increased share prices for companies that went public under the JoBS act and the uptick in usage of crowdfunding platforms. We at merrill DataSite aim to explore the topics which affect our global economy and we strive to produce content and share thoughts with our clients and prospects on the important issues impacting our daily business decisions. We decided to tackle the subject of the JoBS act and recently hosted the webinar: JoBS act: leveling the Playing Field for Small-Cap companies in the Capital markets. We invited participants to learn and understand more about how the regulatory changes could affect the over half a million businesses that are started every month in the u.S., how these start ups raise money; what sector opportunities to expect from the IPo market in 2013; and what effect the JoBS act could have on creating companies that seed the future of middle market m&a and IPo opportunities. The discussion centered on the following topics: The upsides presented by the JoBS act for companies as well as investors The lifting of the general solicitation ban and its impact on small companies seeking funding The allowance for crowd funding portals; their potential benefits and risks The new definition of early growth companies (eGCs) and its impact on small companies navigating the IPo filing process The risk of fraudulent solicitation on crowd funding portals in comparison to other investment methodologies led by an esteemed panel featuring experts in crowdfunding, IPo and corporate finance, the discussion proved to be very insightful and we would consider it to be one of our most successful webinars to date. at the start of the webinar participants were polled on whether they felt that the JoBS act would spur economic growth, 32% answered yes. at the closing of the webinar, participants were polled again with the same question; the response was a positive leap to a majority yes of 62%. If you were unable to join the webinar the first time round, we invite you to register to download the full transcription of the webinar here, in this free roundtable report: http:// www.datasitedeal.com/US-154?LeadSource=Advertising& CampaignID=701C0000000hrw7.

Michael B. Kennedy has been with merrill for 21 years in various technology, management and leadership positions. During his tenure at merrill he has been involved in developing Document management solutions for the Corporate, investment Banking and law Firm communities globally. Currently he is regional Director for Datasite, merrills virtual due diligence tool. michael is one of the visionaries behind merrills push to move the corporate due diligence processes from a purely paper oriented environment into an electronic medium leveraging the technological advances of the past decade. last year michael was involved in over 550 m&a transactions that totaled over 8 million pages. michael holds a Bachelors of science degree in Finance from Virginia Polytechnic institute and state university.

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Deal Forum Digest

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