Dan
Welcome to sound business insights. I’m Dan Watkins. This episode is about mergers and acquisitions. This podcast is not intended to provide legal advice.

Neil
Dan today’s topic is mergers and acquisitions. Uh, what can you tell us overall, just basically about the area of mergers and acquisitions,

Dan
Mergers and acquisitions is a big topic. It covers a lot of things and the way you should visualize mergers and acquisitions, you think of mergers as way over to the left, where you want to do business with somebody, or you’ll want to combine your resources with their resources or assets and so forth. That would be one of the many forms of mergers joint ventures. And then you take it all the way to the right where you simply want to acquire. And I’ll just give you money. You give me that in between those big giant areas of law, there are hundreds of different types of agreements, formats, and ways in which businesses can buy and sell and merge and JV and everything else.

Neil
So what are the basic legal vehicles that are available when you’re approaching a merger or an acquisition?

Dan
Well, first of all, you got to decide, you have to do your own due diligence. You got to look at the physical assets of the company you’re going to do business with as well as the financial assets, the market, the, uh, Goodwill and the tech. You got to look at everything, but there are two basic ways companies buy and sell each other one through a stock purchase and ones through an asset purchase. And also there’s this question of joint, venture and merger, but for the basic purchasing and sale of a company, it’s either going to be an asset sale or a stock sale.

Neil
And Dan, the most common of these two asset purchase or stock purchase, you said by far as the asset purchase, tell me a little bit about transferring the legal title to an asset

Dan
Transferring title to an asset. Well, first of all, the reason you want to do an asset purchase is because they’re buying the actual assets they’re being described, and they’re being sold to you in a manner where you don’t have to worry about all the other problems or secrets this corporation and its shareholders may have an asset purchase, will often entail an escrow. You create an escrow for the company and you send out a notice that I bought this company’s assets. And if you’re a creditor, you have 60 days to come and make a claim. Otherwise, after that I’ll own not only the, the equipment I’ll own, the Goodwill, I’ll own the name, the, uh, IP, everything free and clear. If any creditors claims, when you buy the shares, then you end in a situation where you’re not buying the assets, you’re buying, whatever the shares have power over, and that can be complicated and hard to understand or even know what you’re getting. So from that point of view, and also for the tax advantages of depreciating assets and other things, most people prefer an asset purchase.

Neil
Absolutely. So when an asset is encumbered, is it the responsibility of the seller to disclose that? And how do you handle when there are UCCS and encumbrances against an asset

Dan
That happens a lot and you provide for what we call carve outs or clauses in the agreement where the money comes in, goes into an escrow account, whether it’s the, the attorney trust account or an actual commercial escrow company, like Chicago title first American title. And then you put escrow instructions in and say, okay, when the money comes in, the escrow, officer’s instructed to pay off this creditor or that creditor, or you also have a carve out, will say, you’ll enter into a new agreement with the vendors or the creditors to keep doing business with them. So all those types of things are included when you do an asset purchase.

Neil
So Dan, in each of these transactions, the buyer has advantages and disadvantages as, as the seller, what’s the advantage to the buyer in an asset purchase?

Dan
Well, it’s harder to be a buyer. It’s easy to be a seller. A buyer has the harder task cuz the buyer gives money and the buyer has to verify what it’s getting. And that’s when we come up with a term called schedules, depending on how expensive or, or a larger transaction is, you’re going to have more schedules. If you’re smart than you are, like, let’s say a real easy and, and less expensive transaction schedules are what we use to, uh, organize and identify the assets of a company. For example, you have your real estate schedules, you’ll have a disclosure by the seller of what they own and all the contracts they’ve signed with respect to real estate. You’ll have, uh, equipment schedules and they’ll be listed and, and the seller will have to disclose and you’ll have cash value and you’ll have accounts and good will and taxes and all the things that you want to do as a buyer in an organized fashion to review a, to make sure you know what you’re getting and B to make sure you get representations from the seller that this is what I’m giving you in case later on, it turns out they weren’t telling the truth.

Dan
You got them dead to rights.

Neil
So basically an asset purchase protects the buyer from down the line contingencies. Once you buy it, you own it.

Dan
Well, it tries to protect. There’s no guarantees, but, uh, trying to protect. And that’s why some buyers will want to spend a bunch of money. Making sure they have complete due diligence done by council and CPAs and other professionals and other buyers who have been in the business and know the other company pretty well. Don’t want to waste the money or spend overspend the money on investigating and researching because they’re very confident in what they’re buying.

Neil
How detailed are these schedules, Dan, with relation to the condition and the, the specific description of the assets that are being acquired,

Dan
They can be very detailed and they take a lot of time and they have to be confirmed and they have to have, you know, review and representations by all parties. It depends on again how much the, uh, the client wants. So the client really wants to make sure they’re getting what they’re paying for. And it’s a large transaction and the amount of money for the lawyers and the CPAs to do their job is small compared to the total price tag. Yeah. They can be 25 schedules in a transaction.

Neil
And what are the risks of an asset purchase,

Dan
Not getting what you paid for. Here’s a good example. You like examples. So I’ll give you a good example. We had a client come to us. They bought a company from the owner, been in business for 15 years, successful company. And two years later, the owner had opened up the same exact business within a mile of the location of this business and started trying to take away all the Goodwill, right? Although was already in the agreement. That’s the biggest, the biggest one I see. And that’s the one we try to write the strongest clauses against, because it’s just really, it’s basically stealing.

Neil
So Dan, the other vehicle you mentioned was a stock purchase. What’s the difference primarily between an asset purchase and a stock purchase?

Dan
Well, the asset purchase is leaving the corporate or limited liability company, entity alone. They don’t want it. They don’t want to have control. They don’t want to vote in it. They just want to have nothing to do with that company. Uh, stock purchases, when you buy stock in a company, for example, if you buy all the stock in a company where you want to keep the corporation going or keep the LLC going and maybe keep some key employees, maybe keep the, let’s say they have stock incentives going on. You have employees that have been there a long time. They have a vested interest in seeing that corporation go forward. So you might want to do a stock transaction that way, that time are

Neil
Stock purchase transactions always a hundred percent or can they be varying?

Dan
No, if you have a stock purchase and it’s not a hundred percent, you’re going to want to have a shareholder’s agreement unless it’s a publicly traded corporation. Then of course, you’re just going in a whole different area. But for privately held transactions like small companies, you’re going to want a shareholder agreement. So when you buy it just like an operating agreement, you have your shares. You have, let’s say 70% of the shares in the company. You’ll have an agreement that outlines what powers you have as the majority and what powers you don’t and you’ll know ahead of time, whether you can do what you want with that company, for the money you’re putting in.

Neil
So are there situations where the stock purchase is really the only option? Are there specific types of property you can’t just acquire in an asset purchase?

Dan
There aren’t specific types of assets. For example, we sold a hotel and it had a restaurant and a bar with a liquor license in that situation, you’re going to want to break up the sale of the hotel and the real estate into a different transaction from that of the restaurant and the bar and the liquor license, because the ABC gets involved and you have to do a bunch of different types of things to get that transaction done.

Neil
So in that transaction, you might have part of it in a stock purchase and part of it in an asset purchase.

Dan
Exactly you could have that you could have, like I said, the spectrum on mergers and acquisitions includes a whole bunch of joint venture possibilities. You can have, um, management agreements, you can have service agreements involved. You also have to have new transactions with all the vendors that you want to keep. You have to have permission to get rid of some of the vendors that you don’t want anymore and key employee agreements. So these things can get rather complex because sometimes you need the owner or the primary owner to stay on, on board to make the transaction work and you have to hire them. And they get paid for an employment contract for three years and they have certain requirements of effort and Goodwill and good faith. So yeah, it gets really complicated

Neil
To make sure that the business survives the transition.

Dan
Well, we want to have all of the agreements that are applicable that will help the company survive and, and do better. And the way we do that is we have lawyers have been here with, with us for 30 years or more. And we have a transaction formed bank of all of the transactional documents we’ve prepared over the years. And in that 30 or 40 years of transactional documents, our lawyers have probably come across the same type of agreement and the same type of deal you are proposing. We’ll go back and we’ll find maybe four or five of these similar agreements. And we’ll also compare that to our paid litigation research bank. And we’ll make sure it’s current in the law and we’ll run it by you. And then we’ll also be able to tell you as older lawyers that this is what other clients have done and it worked for them. So in addition to just writing up the agreement, as you ask, we can also give practical advice of this is what people did and it didn’t work. And this is what people did and it did work and they’re still around today.

Neil
So Dan, what are some other reasons to do a stock purchase?

Dan
Well, when you have a corporation for a long time, it becomes another person, a citizen, and you get credit for that corporation that corporation can sign leases, that corporation can sign vendor contracts, it can get licenses, it can do all kinds of things that have built up, uh, over the years. Whereas if you have a brand new company, you’re guaranteeing everything. So if you want to buy a company that’s already running, you don’t have to renegotiate everything and you just come over with a good shareholder agreement and a stock purchase. You can step into the shoes of a very successful company and just hope it makes a profit.

Neil
And so basically that’s the advantage to the buyers that you’re stepping into the shoes of the seller. Correct? So what’s the advantage to the seller

Dan
Sellers have tax advantages in selling stock. That’s, that’s always good because a, a stock sale on something you’ve held for a long time, it’s going to be taxed at a better rate. Also it’s a cleaner transaction. You just sell the stock, there’s still going to be due diligence and you still have to make representations and warranties about the company. So it’s still going to be your liability if you’re not honest and truthful, but you definitely would prefer to do a stock sale.

Neil
And what are some of the strategies you’ve mentioned holdovers in the past, you’ve mentioned having people work across the transition, what are some of those strategies?

Dan
Well, there’s always something. And as a deal maker, that’s what a transaction lawyer is. You want to come up with creative ways to get the deal done while certain contingencies wait, we have had money and, and trust accounts on deals for two years while a contingency is fulfilled by the seller. So you’ll pay 2 million for a project and there’s $200,000 coming to the company, but it’s not going to come for a while. So the seller will say, well, let’s keep the 200,000 for me in, uh, escrow until the company I’m selling, you gets that 200,000 and we get the deal done.

Neil
And the buyer has the ability then to kind of verify what they’ve got.

Dan
Well, once the money comes in, then the buyer says release the money to the seller and everybody’s happening. It’s a win – win.

Neil
Sure. What’s the risk from a stock purchase Buyer’s point of view,

Dan
Again, getting what you’re paying for, knowing what you’re getting full disclosure, a Goodwill, the problem, people taking off and forming another company and competing with you, and also not having the expertise that the, the seller has. So yeah, full disclosure and expertise. Those are probably the key things we see in whether companies we acquire are successful.

Neil
So Dan, I think we’ve covered the acquisition side stock and asset purchases. Tell me more about the merger side of the equation.

Dan
Well, a merger and common law, I would just call it a, a partnership, a joint venture to entities or parties coming together to form a single entity in some way or another. And they go forward. However, mergers that include stock transactions, stock options, employee transactions, employee incentives, bonuses, and things like that can be more complicated. For example, lots of times we have companies coming from out of state or out of town, and they’re a larger company and they want to acquire smaller companies and they will acquire and merge with that smaller company. So the seller a gets a cash payout and B the seller gets a piece of the profit pie at the end of the transaction. Let’s say they bring their book of business to this large company, with its, with its marketing budget and they sell it for a million dollars. And then they get a fee as the company’s successful and grows in the future where it could be worth a lot more than that. So that would be a form of a merger that works for small business.

Neil
And Dan, what is the difference between a merger and a joint venture? And when should a company consider a joint venture

Dan
Joint ventures are like mergers, but usually the term refers to, uh, we’re going to buy this property and develop it. You’ll be the broker I’ll be in charge construction, and you you’ll be the bank and will enter into a, a joint venture agreement where it delineates, who does what and who gets what returns for their efforts. And so that would be an excellent example of a joint venture. I’ve seen them in, uh, in real estate, in business. We’ve all seen them in the local bar, down the street where five guys get together. Um, so all kinds of joint ventures, we’ve done, them all. And they’re usually short term or very specific as to what they’re trying to do.

Neil
So the joint venture allows you to keep your identity and protects you a little bit from the risks of going into a different market or a different geographic location.

Dan
I would say. Yeah, sort of, I mean, a joint venture is like, I want to try this. And then if you try this with, with a couple partners and it works, then you might want to set up a process by which you do it over and over again, and perfect your ability. And then you start merging with companies and graduating to a larger transactions.

Neil
So Dan, can you share a couple examples of some interesting sales that you’ve done? Well,

Dan
We do over a hundred million dollars in transactions a year. So we get a lot of them. And one thing we get to do is we get to get a feel for what types of businesses are in play. For example, we sold and bought five or 10 surgery centers. About 15 years ago, they were in play and every surgery and center around was, I mean, doctors were forming them and then selling them and, and bringing in new members and new doctors. And that, that was hot. And then we have sold and purchased physical therapy centers, hundreds of them over the years, um, because they build up a good book of business. Somebody wants to retire. Another company comes into town with a supposedly better business model and they want to take over and improve the profit and service of that physical therapy center, or maybe 10 or 12 of them.

Dan
And we do this with eye centers. We’ve been doing a lot of transactions with the eye centers, they’re in play. Sometimes these large companies get together and they say, we want to buy half of the I centers in this, in the state of, California. And there’ll be lots of them out there looking for eye centers. So yeah, it’s really interesting to see when you see somebody coming in and say, we want to buy this type of thing or this type of restaurant or this type of construction company, and you see it happening. And when, when you hit two or three of them, you know, that this type of company’s in play.

Neil
So Dan, you just gave a couple of healthcare examples. One thing that seems really hot right now is the management service organizations MSOs.

Dan
Yeah, they’re hot. And they’re very topical when it comes to the law, the legislature’s been thinking about changing or tweaking, how you can and cannot use MSOs in healthcare. They didn’t do it this year. They might do it next year, but we form them. We create them and we make sure that they’re in compliance with all the laws when it comes to being a healthcare practitioner. And it is a way for doctors to provide more services to their patients.

Neil
Well, Dan, this has been a broad ranging conversation. What are some of your final thoughts about those that are considering buying a business or selling?

Dan
First thing I would do is create a list of what you want. If you have a buyer or a seller in mind, get together with them and write out a letter of intent or a memoir of an of understanding. Uh, you don’t have to run to your lawyer for the, you know, what do I do? You could run to your CPA and find out what your company’s worth, uh, and you can come to us too, and we can help you with that. But, uh, get a rough idea and then go, come by and talk to us about what you want to do. And we’ll add a bunch of things to that list and give you some good ideas of what to think about and tell you some war stories or some, uh, other purchase and acquisition stories that we’ve had in similar, similar clients like you. And then perhaps you can come up with some good terms and come to an agreement with the, uh, buyer or seller. And that’s what our transaction lawyers do. They make deals, so they’ll help you close the deal.

Neil
Thanks, Dan.

Dan
Okay.

Dan
You can learn more about the Watkins firm@watkins.com or call our office at (858) 535-1511.