By Matt Daus
Editor’s note: This article is part of Matt Daus’ article in the February 2021 issue entitled Buy, Sell, Retire? Weighing Your Post-Pandemic Options. Daus discusses the pathways available to transportation operators now and in the future as the virus continues to stymie travel and transportation.
Even with loans and grants available to transportation companies--including the Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDLs) through the Small Business Administration (SBA)--such programs often function as stop-gap measures as the pandemic affects long-term revenues and business development. The solution may instead come from strategic transactions such as selling the company, buying another company synergistic with the existing business, seeking an equity investment, or even entering into a joint venture. With so many companies in distress and a reduction in the overall market, the pace for mergers and acquisitions will naturally quicken.
Having handled many transportation company deals over the years, as counsel for buyers, sellers, and investors in mergers, acquisitions, joint ventures, and investments, we have seen how complex and time consuming such transactions and the related due diligence process can be—even for transactions with smaller dollar values. Clients often prepare simple term sheets for such transactions with the expectation that it will be easy to quickly complete the deal. Unfortunately, that is often not a realistic expectation.
The most frequent source of delay is the seller’s failure to prepare the target company for sale in advance and deal with risks, liabilities, and other matters of concern to buyers and investors, such as issues with stock ownership, permits and licenses, intellectual property rights, tax matters, debts and guarantees, or pending lawsuits. When these matters are first identified in the course of the buyer’s or investor’s due diligence investigation, and raised in the middle of negotiating a transaction, that often results in extensive delays, causes the deal to lose momentum, and sometimes even kills the deal.
Due Diligence and Disclosure Schedules
Due diligence is an important aspect in any transaction and is an extensive process undertaken in order to thoroughly and completely assess the target company’s business, assets, liabilities, capabilities, and financial performance. Part of this will be business and financial due diligence, in which the buyer will review the target company’s financial statements, accounts receivables and accounts payables, and other books and records to determine matters such as:
- Does the business have healthy cash flow?
- Where are the sources for the revenue stream?
- How is the target company calculating its revenues and earnings? Should there be adjustments? And what multiple is it placing on those?
- How reliable are the target company’s financial projections?
- How big is the market for the target company’s products or services?
- If the company has physical assets, what are they and are they valued correctly and fairly?
- What are target company’s liabilities? Are there any hidden liabilities?
Checklist for legal review of target company contracts: The buyer or investor will have its legal counsel review and prepare a summary report of the target company’s contracts to determine matters such as:
- Does the target company have key customer or business partner contacts that account for significant portions of its revenue stream? Do these contracts reasonably limit the company’s warranties and liability risks?
- Does the target company have leases, software licenses, or other vendor contacts that it depends on for its key assets, systems, and rights? Do the contracts convey the ownership and rights that the company purports to have?
- Have employees signed contracts assigning their business intellectual property rights, or agreeing to confidentiality, non-solicitation, and/or non-competition covenants?
- Has the company acquired other businesses or entered into joint ventures? What were the key terms?
- When will these contracts expire? Can they be terminated voluntarily and/or for cause?
- Is the target company in breach of any of its contracts? Are the counterparties?
- Do the contracts have restrictions on assignments, changes in control or other transactions that would be triggered by the contemplated sale transaction?
- Do the contracts impose any restrictions on the current or future business? Subject the company to royalties or profit sharing terms?
Checklist for review of target company’s records: The buyer or investor and its legal counsel also customarily undertake other legal and operational due diligence, reviewing the target company’s books and records to determine matters such as:
- Are the company’s organizational documents (articles of incorporation, bylaws, operating agreements, board meeting minutes, stock records, etc.) complete?
- Have employee stock options and other equity grants complied with tax laws, including requirements for deferred compensation (g., IRC Section 409(A)), incentive stock option status, qualified profits interests, and Section 83(b) elections?
- Is the business in good standing and up to date on its taxes and state filings?
- Does the target company have adequate insurance coverage?
- Are there complete employee files, including as to employment eligibility status? What are their salaries, bonuses, commissions, and benefits?
- Is there an employee handbook? What are the company’s employee policies?
- Are any employees inaccurately characterized as independent contractors, or as exempt employees under the Fair Labor Standards Act?
- Does the target company have any employee benefit plans or retirement plans?
- Does the target company have any registered or unregistered intellectual property (e.g., trademarks or patents)? What is the status of any applications or registrations for such intellectual property?
- Have any intellectual property infringement claims been asserted or threatened against the company, or by the company against third-parties?
- Does the company have any other pending or threatened litigation?
- Does the company have any other environmental hazards or violations?
- Is the company in compliance with all other laws?
The buyer or investor will also need to review and understand any permits or business licenses that are required for the target company to operate, and the status of those licenses. This includes operating licenses with federal, state, and local licensing agencies. Even if the licenses are in good-standing, are they transferrable? Assuming they are transferrable, what is the process for regulatory approval to assume a license as the new “owner?” Also, are there any other necessary governmental or agency approvals required in order to transfer the business (including federal antitrust filings under the Hart Scott Rodino Antitrust Improvements Act of 1976)?
The buyer or investor and its tax advisors will also want to assess the tax status of the target company by reviewing its federal, state, local, foreign, and other tax returns and records. For example, has the target company timely filed all tax returns and paid all taxes due (including all income taxes, capital gains taxes, sales and use taxes, transfer taxes, franchise taxes, payroll taxes, etc.)? Has it been filing returns and paying taxes in all jurisdictions where it is legally required to file? Has it claimed deductions that it was not entitled to under tax laws? Has it properly withheld payroll taxes from employees? Improperly characterized any employees as independent contractors?
Even if the buyer or investor does not conduct careful due diligence on these matters, the definitive acquisition agreement will typically have a robust set of representations and warranties that will require the seller and its legal counsel to carefully review these materials and prepare schedules which set forth various lists, summaries, and disclosures regarding these and other matters. Accordingly, any problems will come to the attention of the buyer or investor sooner or later. When they do, that can cause delays, bring negotiations to a halt, and sometimes even kill deals.
Accordingly, if you are looking to sell your company or seek investors in the near future, your business should be reviewed by and discussed with legal counsel now, with an eye towards identifying and resolving or mitigating weaknesses and risks where possible. This will help maximize company value, as well as the likelihood of closing any future deal that you may secure with a buyer or investor.
Matt Daus is a partner with the law firm Windels Marx, president of IATR, and a leading authority on ridesharing apps. He can be reached at email@example.com.