9.6 Deal structuring considerations

Deal structuring is a critical aspect of business valuation, determining how ownership and assets transfer between parties. It encompasses various types of structures, each with unique implications for taxes, legal liabilities, and operational continuity. Understanding these structures is crucial for aligning strategic objectives with financial considerations.

Key financial considerations form the core of deal structuring, including purchase price allocation, financing options, and tax implications. These elements require careful planning to ensure value creation for all parties involved. Proper financial analysis helps in negotiating favorable terms and maximizing the deal's potential for success.

Types of deal structures

• Deal structures in business valuation determine how ownership and assets transfer between parties
• Different structures impact tax implications, legal liabilities, and operational continuity
• Choosing the right structure aligns with strategic objectives and financial considerations

Stock vs asset purchases

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• Stock purchases involve buying ownership shares of the target company
  • Buyer acquires all assets and liabilities
  • Simpler transaction with continuity of contracts and licenses
• Asset purchases involve buying specific assets of the target company
  • Buyer can cherry-pick desired assets and avoid unwanted liabilities
  • More complex with potential need to renegotiate contracts
• Tax implications differ (stepped-up basis in asset deals)
• Due diligence requirements vary between stock and asset deals

Mergers vs acquisitions

• Mergers combine two separate entities into a single new company
  • Typically involves exchange of stock and consolidation of operations
  • (Merger of equals) where companies are similar in size and stature
• Acquisitions involve one company purchasing control of another
  • Can be friendly (agreed upon) or hostile (unwanted by target)
  • May result in the target company becoming a subsidiary or being absorbed
• Regulatory scrutiny differs between mergers and acquisitions
• Impact on branding, culture, and management structure varies

Leveraged buyouts

• Acquisition of a company using a significant amount of borrowed money
• Debt typically secured against the assets of the acquired company
• Aims to improve the target company's value and sell for a profit
• Requires careful financial modeling to ensure debt can be serviced
• (Private equity firms) often use this strategy to acquire companies
• Can lead to significant restructuring and cost-cutting measures

Key financial considerations

• Financial aspects form the core of deal structuring in business valuation
• Proper financial planning ensures the deal creates value for all parties
• Understanding these considerations helps in negotiating favorable terms

Purchase price allocation

• Process of assigning the purchase price to specific assets and liabilities
• Impacts future depreciation, amortization, and tax calculations
• Requires valuation of tangible and intangible assets (goodwill, patents, brand value)
• Follows accounting standards (ASC 805 in US GAAP)
• Can affect the acquiring company's financial statements post-acquisition
• May involve third-party valuation experts for complex allocations

Financing options

• Cash financing uses available funds or raises new capital
  • Provides certainty but may strain liquidity
• Stock financing involves issuing new shares to the seller
  • Preserves cash but dilutes existing shareholders
• Debt financing leverages borrowed funds to complete the transaction
  • Increases financial risk but can enhance returns
• Hybrid financing combines multiple methods (cash, stock, debt)
• Seller financing where the seller provides a loan to the buyer
• Consideration of cost of capital and optimal capital structure

Tax implications

• Different deal structures lead to varying tax consequences
• Asset purchases allow for stepped-up basis and higher depreciation
• Stock purchases may preserve tax attributes (net operating losses)
• Tax-free reorganizations under specific IRS code sections
• International tax considerations for cross-border transactions
• Impact on future cash flows and after-tax returns

Due diligence process

• Due diligence is a critical phase in deal structuring and business valuation
• Thorough investigation helps identify risks, opportunities, and deal breakers
• Findings from due diligence often influence deal terms and valuation

Financial due diligence

• Examines historical financial statements and projections
• Analyzes working capital requirements and cash flow patterns
• Identifies off-balance sheet items and contingent liabilities
• Assesses quality of earnings and sustainability of revenue streams
• Reviews tax compliance and potential tax exposures
• Evaluates financial systems and controls

Legal due diligence

• Reviews corporate documents and organizational structure
• Examines material contracts and commitments
• Investigates pending or potential litigation
• Assesses intellectual property rights and protections
• Reviews regulatory compliance and licensing requirements
• Examines employment agreements and labor issues

Operational due diligence

• Evaluates operational efficiency and scalability
• Assesses supply chain and vendor relationships
• Reviews customer base and concentration risks
• Examines management team capabilities and key personnel
• Investigates IT systems and cybersecurity measures
• Analyzes market position and competitive landscape

Valuation methods in deals

• Valuation methods provide a framework for determining fair deal prices
• Multiple approaches are often used to arrive at a comprehensive valuation
• These methods inform negotiations and help bridge valuation gaps

Discounted cash flow analysis

• Projects future cash flows and discounts them to present value
• Requires careful forecasting of revenues, expenses, and capital expenditures
• Uses weighted average cost of capital (WACC) as the discount rate
• Considers terminal value for cash flows beyond the projection period
• Sensitivity analysis helps understand the impact of key assumptions
• Often viewed as the most theoretically sound valuation method

Comparable company analysis

• Compares the target to similar public companies
• Uses financial ratios and multiples (EV/EBITDA, P/E, P/S)
• Adjusts for differences in size, growth, and profitability
• Provides market-based valuation benchmarks
• Requires careful selection of truly comparable companies
• May need to apply private company discounts

Precedent transactions

• Analyzes recent M&A deals in the same or similar industries
• Provides insight into what buyers have been willing to pay
• Uses transaction multiples (EV/EBITDA, EV/Revenue)
• Considers control premiums paid in previous deals
• Adjusts for market conditions and company-specific factors
• Useful for understanding strategic value and synergies

Risk mitigation strategies

• Risk mitigation is crucial in deal structuring to protect both buyers and sellers
• These strategies help align interests and provide safeguards against uncertainties
• Proper risk allocation can facilitate deal completion and post-deal success

Earnouts and contingent payments

• Bridges valuation gaps by tying part of purchase price to future performance
• Seller receives additional payments if specific targets are met
• Aligns interests of buyer and seller post-transaction
• Requires clear, measurable performance metrics (revenue, EBITDA, milestones)
• Can lead to disputes if not carefully structured
• May impact accounting treatment of the transaction

Representations and warranties

• Statements of fact made by the seller about the business being sold
• Covers areas such as financial statements, contracts, and compliance
• Buyer relies on these statements when deciding to purchase
• Breaches can lead to indemnification claims
• Often backed by representations and warranties insurance
• Negotiation focuses on scope, materiality thresholds, and survival periods

Indemnification clauses

• Protects the buyer against losses from breaches or undisclosed liabilities
• Specifies conditions under which the seller must compensate the buyer
• Includes caps, baskets, and time limits on indemnification obligations
• May be secured through escrow accounts or holdbacks
• Can be supplemented with representation and warranty insurance
• Negotiation balances buyer protection with seller's desire for clean exit

Regulatory considerations

• Regulatory factors play a significant role in deal structuring and business valuation
• Compliance with regulations is crucial for deal approval and long-term success
• Understanding regulatory landscape helps anticipate potential obstacles

Antitrust review

• Assesses potential anti-competitive effects of the transaction
• (Hart-Scott-Rodino Act) requires pre-merger notification for larger deals
• May result in divestiture requirements or deal rejection
• Involves analysis of market share and industry concentration
• Can significantly extend deal timelines
• Requires careful planning and proactive engagement with regulators

Industry-specific regulations

• Varies by sector (financial services, healthcare, telecommunications)
• May involve approval from industry-specific regulatory bodies
• Can impact deal structure and post-transaction operations
• Affects valuation due to compliance costs and operational constraints
• Requires specialized due diligence to ensure compliance
• May necessitate restructuring or carve-outs to meet regulatory requirements

Cross-border transaction issues

• Involves navigating multiple jurisdictions' legal and regulatory frameworks
• Requires consideration of foreign investment review processes
• Addresses currency exchange and repatriation of funds issues
• Deals with tax treaty implications and transfer pricing regulations
• May face national security scrutiny (CFIUS review in the US)
• Necessitates understanding of local business practices and cultural norms

Post-deal integration planning

• Integration planning is critical for realizing the full value of a transaction
• Begins during due diligence and continues well after deal closing
• Impacts the ultimate success and return on investment of the deal

Synergy realization

• Identifies and quantifies potential cost and revenue synergies
• Develops detailed plans for capturing synergies post-closing
• Prioritizes quick wins and longer-term strategic initiatives
• Establishes clear accountability and timelines for synergy realization
• Monitors and reports on synergy capture progress
• Adjusts plans based on actual results and changing conditions

Cultural integration

• Assesses cultural differences between merging organizations
• Develops strategies to align corporate values and working styles
• Addresses potential conflicts in decision-making processes
• Implements communication plans to manage employee concerns
• Focuses on retaining key talent and managing cultural change
• May involve creating a new, blended culture

Operational alignment

• Harmonizes business processes and systems across merged entities
• Standardizes policies, procedures, and operational metrics
• Integrates IT systems and data management practices
• Aligns organizational structures and reporting lines
• Manages redundancies and potential workforce reductions
• Ensures continuity of customer service and supplier relationships

Negotiation strategies

• Effective negotiation is crucial for achieving favorable deal terms
• Requires understanding of both parties' objectives and constraints
• Balances the need for compromise with protecting key interests

Valuation gaps

• Addresses differences in perceived value between buyer and seller
• Uses earnouts or contingent payments to bridge disagreements
• Employs creative deal structures (stock vs cash, performance-based components)
• Leverages third-party valuations to provide objective benchmarks
• Focuses on underlying assumptions driving valuation differences
• May involve phased transactions or option structures

Deal breakers vs deal makers

• Identifies critical issues that could derail the transaction
• Distinguishes between non-negotiable points and areas for compromise
• Develops strategies to address potential deal breakers early in the process
• Focuses on creating win-win solutions for contentious issues
• Uses concessions on less critical points to gain leverage on key issues
• Maintains flexibility to explore alternative deal structures

Negotiation tactics

• Employs anchoring to set favorable starting points for negotiations
• Uses BATNA (Best Alternative To a Negotiated Agreement) to maintain leverage
• Manages information flow strategically during the negotiation process
• Builds rapport and trust to facilitate productive discussions
• Utilizes silence and patience as tools to gain concessions
• Considers the use of deadlines to create urgency and drive decisions

Legal documentation

• Legal documents formalize the terms and conditions of the deal
• Requires careful drafting to reflect the agreed-upon deal structure
• Serves as the basis for enforcing rights and obligations post-closing

Letter of intent

• Non-binding document outlining key terms of the proposed transaction
• Includes purchase price, payment terms, and deal structure
• Specifies exclusivity period for negotiations
• Outlines due diligence process and timeline
• Addresses confidentiality and non-disclosure obligations
• Serves as a roadmap for drafting definitive agreements

Purchase agreement

• Legally binding contract detailing all aspects of the transaction
• Includes precise description of what is being bought or sold
• Specifies purchase price, payment terms, and any adjustments
• Contains representations and warranties from both parties
• Outlines conditions precedent to closing
• Includes indemnification provisions and dispute resolution mechanisms

Ancillary agreements

• Supplements the main purchase agreement with additional contracts
• Employment agreements for key personnel retention
• Non-compete and non-solicitation agreements
• Transition services agreements for post-closing support
• Escrow agreements for holdback amounts
• Intellectual property assignment or licensing agreements
• Real estate leases or property transfer documents

Timeline and milestones

• Deal timelines provide structure and momentum to the transaction process
• Helps manage expectations and coordinate activities among all parties
• Allows for proper planning and allocation of resources throughout the deal

Pre-signing phase

• Initial contact and preliminary discussions between parties
• Execution of non-disclosure agreements (NDAs)
• High-level due diligence and valuation assessments
• Negotiation and signing of letter of intent (LOI)
• Formation of deal teams and engagement of advisors
• Development of detailed due diligence plan and data room setup

Signing to closing

• Comprehensive due diligence process (financial, legal, operational)
• Negotiation of definitive agreements
• Obtaining necessary third-party consents and approvals
• Addressing any issues uncovered during due diligence
• Finalizing financing arrangements
• Preparing for day-one operations and integration planning
• Signing of purchase agreement and ancillary documents

Post-closing activities

• Transfer of ownership and assets
• Implementation of integration plans
• Communication with employees, customers, and suppliers
• Execution of transition services agreements
• Monitoring and realization of synergies
• Post-closing purchase price adjustments
• Ongoing compliance with any regulatory requirements