Due Diligence and Negotiating Definitive Contracts

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1 Due Diligence and Negotiating Definitive Contracts Robert A. Lucas & Michael G. Dailey

2 Due Diligence Robert A. Lucas

3 Due Diligence Buyer s Perspective Seller s Perspective

4 Buyer s Due Diligence First substantive look at Seller s business Used to determine: Purchase price Provisions of purchase agreement Consents Assumption v. termination (i.e., contracts, benefit plans) Whether to proceed with acquisition Want to minimize surprises

5 What to Request? Everything you want to see, But do not expect to see it all (at first) Continuous process

6 Specific Areas for Review Financial v. General Corporate Financial Financial statements Tax returns Loan portfolio Deposits

7 Specific Areas for Review General Corporate Organizational documents/minute books Shareholder information and stock records Real and personal property Contracts (very important depending on deal structure) Insurance policies Employee issues Litigation Regulatory issues Environmental matters IP

8 Seller s Perspective Preparation of requested materials Organization and delivery (Don t get cute!) First step in Disclosure Schedule preparation Don t Forget: due diligence not the same as Disclosure Schedules

9 Seller s Due Diligence Generally minimal, unless stock consideration Eyes of your shareholders

10 Negotiating Definitive Contracts Michael G. Dailey

11 Drafting Purchaser s Role Seller s Role

12 Parts of the Definitive Transaction Structure; Consideration; Exchange Procedures Representations and Warranties Covenants Conditions to Closing Termination

13 Transaction Structure; Consideration; Exchange Procedures Structure Merger - most common in banking industry Merger of holding companies or banks Asset Purchase/Liability Assumption Branch purchase transaction

14 Transaction Structure; Consideration; Exchange Procedures Consideration and Exchange Procedures Cash; Stock; Blend When and how Seller's shareholders receive consideration Lost certificates; signature guaranty; indemnity bond

15 Reps and Warranties - Seller Historical view of the bank; a snapshot What has the bank done (or not done) up to now? Seller is (is not) ; Seller has (has not) ; Generally qualified by "materiality Seller wants specific; Purchaser wants general/vague

16 Reps and Warranties - Seller Breach leads to: Purchaser walk-away Claim for indemnification Lawsuit

17 Reps and Warranties - Seller Disclosure Schedules Qualify reps and warranties Seller s entire team participates Lending Investments/Financial/Accounting Compliance Human Resources Trust Operations IT

18 Reps and Warranties - Seller Some Key Seller Reps and Warranties Financial Statements Correct, accurate, complete and in accordance with GAAP As of a certain date; generally end of most recent quarter

19 Reps and Warranties - Seller Absence of Undisclosed Liabilities References financial statements Watch for contract/agreement breaches Seller wants qualified by materiality Absence of Changes References financial statements Nothing has occurred and no facts or circumstances are known Seller wants qualified by materiality

20 Reps and Warranties - Seller Allowance for Loan and Lease Losses Seller should try to negotiate out or modify; adequacy of ALLL is subjective Purchaser wants in as added protection No Regulatory Matters Seller want qualified by materiality ; limit to enforcement actions by regulators Confidentiality of regulatory reports and MOU; hot button for regulators

21 Reps and Warranties - Seller No Conflict and Contracts Seller want qualified by materiality ; typically will be $$ amount Watch for contracts requiring consent or triggering termination - data processing and ATM equipment/services contracts can carry big $$ termination fees Purchaser should consider cost of contract termination in pricing transaction

22 Reps and Warranties - Seller Employee Benefits and Employment Matters Both Seller and Purchaser legal counsel review/input Purchaser s due diligence is key; know what ERISA and/or employment issues you are buying

23 Reps and Warranties - Purchaser Importance depends on type of consideration Cash - not so important Stock or blend - certain reps become important; Seller's Board is acting on behalf of shareholders

24 Reps and Warranties - Purchaser Some Key Purchaser Reps and Warranties Financial Statements Absence of Undisclosed Liabilities Absence of Changes No Conflicts Regulatory Matters

25 Covenants Agreement to do (or not do) certain things between signing definitive and closing Forward looking; a moving picture Seller, Purchaser and Joint

26 Covenants Key Seller Covenants Operation of Business General - operate business in the ordinary course, consistent with past practices Specific - generally negotiable; extent of limitations depend on condition/operating history of Seller, e.g.:

27 Covenants Limits on loans (negotiate $$ limits) Capital expenditure (negotiate $$ limits) Contracts (negotiate $$ limits or material); new or terminate Dividends (negotiate to declare regular dividends) Borrow funds (negotiate for customary borrowings) Hire/fire employees (negotiate replacements); increase compensation Issue, purchase, redeem, retire or split stock; grant options (negotiate for existing option plans)

28 Covenants Notify Purchaser of Material Changes Reps and warranties become untrue; update disclosure schedules Seller want updates to disclosure schedules to modify as of closing (i.e., no claim for breach); Purchaser want updates to be informational only (not modify) (i.e., reserve claim for breach)

29 Covenants Purchaser Access to Information and Management No Solicitation of Other Offers Seller s Board s fiduciary duty Notify Purchaser of unsolicited offer/interest; Purchaser right to top-up

30 Covenants Voting Agreements All directors and significant (10% or greater) shareholders Purchaser want to know has significant % vote in the bag

31 Covenants Key Purchaser Covenants Employees; Employee Benefits Purchaser agree to interview all employees; not agree to hire Maintain benefit plans; offer similar benefits Years of service credit for Seller s employees

32 Covenants Securities Issues (if stock consideration) Register shares Ensure listing on exchange/nasdaq (if applicable) SEC compliance

33 Covenants D&O Insurance Coverage Tail coverage for Seller s directors and officers; time period negotiable Notification of Material Change

34 Covenants Joint Covenants Mutual Cooperation to Achieve Closing Press Release Proxy Statement and Registration Statement (S-4) (if applicable) If S-4 Purchaser take the lead; Seller provide info/comments as needed If not public company or if only cash, Seller take lead on proxy statement; Purchaser provide info/comments as needed

35 Covenants Regulatory Application Purchaser generally take the lead; Seller provide info/comments as needed Confidentiality

36 Conditions to Closing Accuracy of Reps and Warranties as of Closing Date Compliance with Covenants Completion of all Obligations Prior to Closing Date

37 Conditions to Closing Mutual Conditions Seller s shareholder approval Regulatory approval Effectiveness of registration statement for stock (if applicable)

38 Termination Mutual agreement - requires action by both Boards By either party upon occurrence (nonoccurrence) of certain event, e.g.: No regulatory approval by certain date; or regulatory approval contains unacceptable conditions Seller's shareholders fail to approve Closing not occur by certain date Breach of rep, warranty or covenant by other

39 Termination By Seller upon occurrence of certain event, e.g.: Receive unsolicited better offer - fiduciary out Purchaser stock price fall below certain price Break-up Fees Compensate for expenses and opportunity costs Both Purchaser and Seller

Letter of Intent for Acquisition Purchase of Stock of the Business for a Combination of Cash and Purchaser s Stock (Pro-Buyer Oriented)

Form: Letter of Intent for Acquisition Purchase of Stock of the Business for a Combination of Cash and Purchaser s Stock (Pro-Buyer Oriented) Description: This is a sample Letter of Intent for the acquisition