BUSINESS ACQUISITIONSTHE ACQUISITION

AGREEMENT:

General Introduction to M&A Agreements

AND PURCHASE PRICE©2010 Joseph D. Lehrer

BASIC TYPES OF AGREEMENTS

• Asset Purchase

• Stock Purchase

• Cash Merger

• Stock Merger

WHAT THE ACQUISITION AGREEMENT COVERS

• Describes the transaction structure, purchase price and procedures for closing

• Allocates risk between the buyer and seller for both known and unknown liabilities and obligations

• Contains promises (i.e., covenants) of the parties

• Contains indemnification procedures

• Contains the extent of commitment to close the transaction.

WHAT THE BUYER WANTS

• Receiving what is expected at closing– Good Title to the Purchased Assets or Stock– All of the Facilities, Individuals, Assets,

Rights, Contracts and other Items Needed to Continue and Enhance the Business

• The option to “bail out” if the business is not what has been represented or what is expected

• Post-closing protection against contingent or unknown risks

WHAT THE SELLER WANTS

• Certainty and speed of Closing

• Receiving the Purchase Price without Risk

• Not being at risk for the assets, liabilities or operations of the business after the closing

GENERAL COMPONENTS• Introduction and Description of Transaction

• Consideration for Transfer of Business

• Closing

• Representations and Warranties of Seller

• Representations and Warranties of Buyer

• Covenants of the Parties

• Conditions to Closing

• Termination Procedures and Remedies

• Indemnification

PURCHASE PRICE

• Simple Purchase Price is Provided For in Cash at Closing

• All or part of the Purchase Price could be paid with a promissory note

• Part of the Purchase Price could be Contingent (e.g., an “earn out” based on future profits, gross margins or other measures)

Purchase Price

• Often the Purchase Price is Expressed as a Specific Number (Which is the “Enterprise Value”), Less “Indebtedness”.

• “Indebtedness” Means Debt for Borrowed Money (e.g., Bank Debt) and “Capital Leases” (Leases which is Really In Lieu of Financing)

ADJUSTMENT OF PURCHASE PRICE

• Adjustment is usually made for change of events from the financial statements used to set price to the time of the Closing

• The Adjustment is measured based upon the change from a Specific Date or from a Targeted Number in the Amount of – Net Worth of the Target, or – the Change in the Target’s “Working Capital”

Last Balance Sheet (12/31/09)

Due DiligenceLetter of Intent 1/15/10

Negotiate and Sign Agreement 2/28/10

Closing3/31/10

TIME LINE

How Do We Take Into Account Changes From 12/31/09 Through 3/31/10?

2.2 PURCHASE PRICE

The purchase price (the "Purchase Price")for the Shares will be $______________plus the Adjustment Amount.

SIMPLE PURCHASE PRICE

2.5 ADJUSTMENT AMOUNT (Model SPA) The Adjustment Amount (which may be a positive or negative number) will be equal to (a) the consolidated stockholders' equity of the Acquired Companies as of the Closing Date determined in accordance with GAAP, minus (b) $______________.

ADJUSTMENT OF PURCHASE PRICE(Based on Change in Net Worth)

2.5 ADJUSTMENT AMOUNT

The Adjustment Amount (which may be apositive or negative number) will be equalto (a) the consolidated stockholders'equity of the Acquired Companies as of theClosing Date determined in accordance withGAAP, minus (b) $______________.

ADJUSTMENT OF PURCHASE PRICE(Based on Changes in Net Worth)

2.5 ADJUSTMENT AMOUNT

The Adjustment Amount (which may be apositive or negative number) will be equalto (a) the consolidated stockholders'equity of the Acquired Companies as of theClosing Date determined in accordance withGAAP, minus (b) $______________.

ADJUSTMENT OF PURCHASE PRICE(Based on Changes in Net Worth)

2.5 ADJUSTMENT AMOUNT

The Adjustment Amount (which may be apositive or negative number) will be equalto (a) the consolidated stockholders'equity of the Acquired Companies as of theClosing Date determined in accordance withGAAP, minus (b) $______________.

ADJUSTMENT OF PURCHASE PRICE(Based on Changes in Net Worth)

"GAAP"--generally accepted UnitedStates accounting principles, appliedon a basis consistent with the basis onwhich the Balance Sheet and the otherfinancial statements referred to inSection 3.4(b) were prepared.

"Balance Sheet"--as defined in Section 3.4.

3.4(b) a consolidated balance sheet of theAcquired Companies as at [DATE]________(including the notes thereto, the "BalanceSheet"),

2.5 ADJUSTMENT AMOUNT

The Adjustment Amount (which may be apositive or negative number) will be equalto (a) the consolidated stockholders'equity of the Acquired Companies as of theClosing Date determined in accordance withGAAP, minus (b) $______________.[NOTE:This is usually the stockholders’ equityas of the date of the financial statementused in determining the Purchase Price]

ADJUSTMENT OF PURCHASE PRICE

ISSUES IN PURCHASE PRICE ADJUSTMENTS

• Tricky Accounting Issues– GAAP vs. “Consistency”– Questions of “Materiality”

• Mechanics: – Who prepares the Closing Balance Sheet– Manner of Resolving Disputes

• Avoid “Double Dipping” Caused by Both Indemnification for a Misrepresentation and by the Purchase Price Adjustment.

2.6(a) Sellers will prepare and will cause _____________________, the Company's certified public accountants, to audit consolidated financial statements ("Closing Financial Statements") of the Company as of the Closing Date and for the period from the date of the Balance Sheet through the Closing Date, including a computation of consolidated stockholders' equity as of the Closing Date. Sellers will deliver the Closing Financial Statements to Buyer within sixty days after the Closing Date

ADJUSTMENT OF PURCHASE PRICE(Based on Net Worth)

If within thirty days following delivery of the Closing Financial Statements, Buyer has not given Sellers notice of its objection to the Closing Financial Statements (such notice must contain a statement of the basis of Buyer's objection), then the consolidated stockholders' equity reflected in the Closing Financial Statements will be used in computing the Adjustment Amount. If Buyer gives such notice of objection, then the issues in dispute will be submitted to ________________, certified public accountants (the "Accountants"), for resolution

ADJUSTMENT OF PURCHASE PRICE

(ii) the determination by the Accountants, asset forth in a notice delivered to bothparties by the Accountants, will be bindingand conclusive on the parties;

ADJUSTMENT OF PURCHASE PRICE

if the Purchase Price is greater than theaggregate of the payments made pursuant toSections 2.4(b)(i) and 2.4(b)(iii) and theaggregate principal amount of the PromissoryNotes, Buyer will pay the difference to Sellers,and if the Purchase Price is less than suchaggregate amount, Sellers will pay the differenceto Buyer. All payments will be made together withinterest at _____% compounded daily beginning onthe Closing Date and ending on the date ofpayment.

ADJUSTMENT OF PURCHASE PRICE

USING WORKING CAPTIAL For Purchase Price Adjustment

• Often, the Purchase Price Adjustment is based on Working Capital (Current Assets –Current Liabilities)

• The Purchaser is Concerned that it Acquires a Business that has “Normalized” Working Capital, so that it Doesn’t have to Invest Additional Money to Maintain the Target’s Business.

USING WORKING CAPTIAL For Purchase Price Adjustment

• If there is an “Open System” in the Acquisitions Agreement (i.e., the Seller retains the Target’s cash), the Adjustment Protects Buyer from Target’s Accelerating Collection of Accounts Receivable or Delaying the Payment of Payables to Generate Cash Which is not Acquired by Buyer, or Which is Used to Pay Down Un-assumed Bank Debt.

• The Purchase Price is Increased or Decreased based upon the Excess or Deficiency from “Normalized” or “Targeted” Working Capital as of the Closing.

2.8 ADJUSTMENT AMOUNT AND PAYMENT (Model APA) The "Adjustment Amount" (which may be a positive or negative number) will be equal to the amount determined by subtracting the Closing Working Capital from the Initial Working Capital. If the Adjustment Amount is positive, the Adjustment Amount shall be paid by wire transfer by Seller to an account specified by Buyer. If the Adjustment Amount is negative, the difference between the Closing Working Capital and the Initial Working Capital shall be paid by wire transfer by Buyer to an account specified by Seller. All payments shall be made together with interest at the rate set forth in the Promissory Note, which interest shall begin accruing on the Closing Date and end on the date that the payment is made. Within three (3) business days after the calculation of the Closing Working Capital becomes binding and conclusive on the parties pursuant to Section 2.9, Seller or Buyer, as the case may be, shall make the wire transfer payment provided for in this Section 2.8.

Purchase Price Adjustment based on Changes in Working Capital

ISSUES IN PURCHASE PRICE ADJUSTMENTS

• What is the Source of Payment of the Purchase Price Adjustment?– From the Buyer’s perspective, is part of the

Purchase Price placed in Escrow at Closing to Provide for a negative adjustment in the Purchase Price?

• Should there be some “de minimis ” amount of change before there is an adjustment in the Purchase Price?

PAYMENT BY NOTE

• Is the note secured? By what?

• What is the ability of the Buyer to Pay?

• Is the ability to pay dependent on the profits of the sold business?

• Will the note be subordinate to the bank debt borrowed to pay the cash portion of the purchase price?

2.4(b) Buyer will deliver to Sellers:

(i) the following amounts by bank cashier's orcertified check payable to the order of [or bywire transfer to accounts specified by] A and B,respectively: $_________ to A and $_________ to B;

(ii) promissory notes payable to A and B in therespective principal amounts of $_______ and$_______ in the form of Exhibit 2.4(b) (the"Promissory Notes");

(iii) the sum of $________ to the escrow agentreferred to in Section 2.4(c) by bank cashier's orcertified check;

PAYMENT OF PURCHASE PRICE

EARN OUTS

• An “Earn Out” is where a portion of the Purchase Price is Contingent, Based upon the Occurrence of Future Events

• An Earn Out is used when the Parties can’t agree on the Value of the Target.

• From the Buyer’s Perspective, an Earn Out protects against overpaying based on optimistic projections

• From the Seller’s Perspective, it allows a higher Purchase Price if the Target Reaches Certain Goals

ISSUES IN EARN OUTS• What is the Criteria or Benchmark for the Earn Out?

– Financial, Such as a an amount of EBIT EBITDA above a Base Amount?

– Non-Financial, such as Obtaining a Patent

• What is the Measuring Time Period?– Is the Criteria Annual or Cumulative?– If the Criteria is Missed in one year, can it be “caught up”

in a subsequent year?

• Accounting Issues (for Financial Earn Outs)– The Target must be Separately Accounted For– Consistency of Accounting Policies– Who settles accounting disputes?

ISSUES IN EARN OUTS

• What is the Earn Out Payment’s “Priority” with respect to the Buyer’s Financing Sources?

• How is the Business Operated after the Closing, and How do Changes in Operation affect the Earn Out?

• Who has “Control” of the Business after the Closing?– The management which operated the Target

before the Closing?– New Management appointed by the Buyer?

Will your client have all the continuing risks of the business,

with none of the upside?

IN ADVISING YOUR CLIENT REGARDING A DEFERRED PAYMENT or

EARN OUT, CONSIDER