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Synopses of nearly three dozen landmark cases give real life insights into legal rulings from previous high profile mergers. Over the past decade, The Art of M&A has helped thousands of executives make sound decisions. Now, let it provide all the information you will need to buy or sell companies, whether public or private, domestic or foreign.
Even assuming that a reported price paid for a security is a proxy for "value," the first problem is to decide which quoted price to use -as there are several possibilities. Should one use the current closing price or lie average price over the past year, month, week, or day? In the M&A area the "20-day" figure-the average of the closing prices of the security over the past 20 trading days-is often used. Why, no one knows.
Furthermore, few people consider the other factors that have affected the price of a company's securities. Are takeover rumors inflating the price Are there "overhanging blocks" that have depressed the price? What is the "trading supply"? Has an investment banker-or worse yet, a deal principal-been "front-running" on the stock? These things not only can happen-they do.
In the case of a privately held company the problems are even fore complex because many transfers of shares in a closely held company ate, made for noneconomic purposes. In each case it is the set of circumstances behind the sale that must be divined and its effect on the price assessed.
The first thing a buyer should do is discover why the company is for sale. Sellers should also have their reasons well thought out. Yet some buyers seem reluctant to begin a negotiation with the question, "Why is the company for sale?"
Although most entrepreneurs know how to start businesses and run them profitably by watching costs, many fail to bring that same circumspection to the acquisition process. As buyers, entrepreneurs often overpay. Further, in selling their businesses, many owners have little idea how to price them. In general, however, buyers are far more skilled at buying than sellers are at selling. Why? Because most buyers buy many times and most sellers sell only once or twice.
Any company under consideration for sale merits competent, objective ` valuation, whether its stock is privately owned by one individual, closely held by several individuals (as in many family-owned companies), or publicly traded on one or more of the major exchanges or in the over-the-counter market. An entity also deserves careful valuation when it has no stock per se, but is part of a larger whole-whether as an operating division or simply a product line. All these situations demand and deserve proper valuation.
Many valuations are poorly done and are challenged in court-sometimes years later. The principal author has found in such cases that whenever a family-owned or family-controlled company has an investment banker involved with the buying group, undervaluations are quite common. In other cases, overvaluations by sellers result from factual distortions and deliberate misstatements, and by failure to reveal significant negative facts. There is even l outright fraud from time to time in setting prices for nonpublic companies. The principal author has been an expert witness in many valuation cases where the value was based on distortion of historic numbers. We are not talking about a few thousand dollars or a few percentage points; we're talking about millions of dollars and valuations off by 300 percent. Professional help in setting values is not only a practical necessity; it is required for the proper discharge of "due diligence" requirements, and that means employing a professional appraiser. Truly "professional" appraisals should not be confused with so-called fairness opinions issued by investment bankers. Such opinions are not objective when the bankers have a stake in the outcome of the transaction.
The appraiser's job is to come up with fair market value. That value is one arrived at between a willing buyer and a willing seller, both being adequately informed of the relevant facts, and neither being under any compulsion = to buy or to sell.
To help readers get a grip on this key area, this chapter first focuses on various valuation methods, and then develops the details of a typical discounted cash flow (DCF) analysis to discover the NPV of the focus company. This method has emerged in recent decades as the method of choice in valuation beginning with the World Bank's adoption of the method in the late 1960s.2 The second part of the chapter applies DCF in a practical way (o explain how leveraged buyouts (LBOs) are priced. Once the price is determined, it must be expressed in the pricing clauses of the acquisition agreements. The final portion of this chapter gives guidance in this area.
Most valuations should be operations-based. When investment bankers get involved in valuations, the valuations are often flawed: Investment bankers tend to set asset-based values because they understand assets but not Operations. Estimates from owners, especially owner-managers, are also frequently seriously flawed because their providers either are overenthusiastic about their prospects or are consciously distorting the numbers. In either case these insiders' projections are easily attacked in court. That is why values in any major merger/acquisition transaction must be backed up by the opinions of professional appraisers, whose primary business is appraising the value of operating companies and their subsidiaries.
Specialists abound in the valuation of going businesses. There are consultants and firms that value only printing companies, supermarket chains, knitting and weaving mills, paper mills, mining properties, shipping companies, or railroads. Other firms value only engineering consulting firms, accounting firms, or law practices. Banks, insurance companies, and even investment banking firms and "stockbrokers" have their valuation specialists with a similarly narrow scope.
Business brokers value and sell smaller businesses or "stores"-bar/taverns, car washes, dry-cleaning establishments, grocery stores, restaurants, and all kinds of franchised operations depending heavily on goodwill value-well into eight figures. And they may be worth it.
It's a tricky business because many stores underreport sales and earnings by substantial amounts. When they are put up for sale, the tax returns don't agree with the projected revenues. This same thesis may also apply to subsidiary units of larger companies that may not have kept an accurate set of books and may not have been audited by an outside independent auditor for many years.
This gives many buyers the idea that it is okay to pay much more than the going multiple of book for such enterprises. They don't always realize that stores that are part of national chains, which report store sales and profits accurately, may not be such a steal. Many inexperienced buyers coming from middle management and loaded with mid-six-figure cash settlements from their severance deal-very often a buyout of their postemployment benefits-think they're dealing with one of those "stores" and often overpay. Buyers should remember that by law the broker represents the seller and is out to maximize the price received. While it is possible to cut a deal with a broker to represent a buyer rather than a seller and buy at the lowest price, such brokers are hard to find in the business brokerage area.
High-technology companies in the health field can see overnight swings in valuation as investors alternately embrace or flee stocks as they learn the results from scientific testing or regulatory approval. In the United States, approval by the Food and Drug Administration can save or savage a pharmaceutical company's stock, particularly for a smaller company with a small product range. In the biotechnology arena, companies can attract capital for years without earnings or even revenue. But the same gleam-in-the-eye companies that -can attract $40 million or $50 million in an initial public offering (IPO) and $100 million in a secondary offering can have a poor clinical result and then lose hundreds of millions in a single day. When the IPO market shies away from these losers, they are forced into other modes of survival, and "what would have been IPOs . . . become M&A transactions., 13 Even conservative investors in conservative industries such as banking can get swept away. That happened with J.P. Morgan & Co. when it raised $1 billion to invest in undercapitalized banks (named "Corsair Partners" after J.P.'s fabulous yacht, which foundered off Acapulco in the late 1920s). By the time the fund was completed, most U.S. banks had refinanced themselves and didn't need Morgan's money. Roberto Mendoza, Morgan's chief M&A honcho, rushed an investment of $162 million into Spain's Banco Espanol de Credito, "Banesto," which everyone knew was badly managed. The investment, and Mendoza's advice as a board member, couldn't cure the problems and within a year the Bank of Spain had tossed out Banesto's board-including Mendoza.'
IBM's beta increased in the early-to-nud-1990s when the market deemed many large companies "dinosaurs," triggering rapid declines in their stock prices during a time of relative market calm.
It is the principal author's firm conviction that betas should not be used in assessing risk. A beta is simply a descriptor of the volatility of a particular stock over some arbitrary time period in relation to the volatility of the market itself and does not properly describe systematic risk except for very short and usually unusable time periods. As with IBM's beta, betas for many stocks change with time. Anyone who uses a beta as a proxy or a major component of risk in setting a purchase or selling price is taking a major risk of being wrong.
Mutual funds are constantly searching for ways to measure risk. The Securities and Exchange Commission (SEC) is concerned about the subject. Some funds use betas modified by the time it takes for the fund to "recover." Others use the standard deviation, which measures the probable variation in a fund's expected return based on its past fluctuations. The standard deviation is descriptive, not predictive.
See the calculation in Exhibit 3-1.) Special situations then call for documented reasons to add points to the discount rate either for inexperience in the geld, for high deviation rates on historical earnings for the company or its industry, or for other risk-related reasons.
In dealing with Scott Paper's planners many years back, the principal author discovered that Scott had developed different hurdle rates for entries into different industries that coincided with the comfort level of the executive corps' personal "feelings" about the industry, which, upon investigation, turned out to coincide with their familiarity with the industry. This approach appears rational but is not at all a proper proxy for risk because those assessing the risk were not necessarily the ones who would be managing the acquisition. As a result, Scott Paper at that time was notorious for making bad acquisitions.
But remember: Financial history doesn't just happen; it is created by the people who write about it. The legally permissible variations in accounting methodologies available to corporations in the United States are legion. Moreover, they often depend on the personal proclivities and experience of the corporate comptroller and his or her staff, and may or may not have been consistently applied over past periods. Any earnings history is only as good as the accounting processes that created the record. Consistency, uniformity, and comparability are the watchwords of good accounting practices. Only the establishment of a sophisticated audit trail will reveal the effect of accounting changes on the accuracy of historical reporting of accounting-based earnings. Activity-based costing can also help buyers and sellers alike perceive value accurately. ...
|Ch. 1||Getting Started in Mergers and Acquisitions||1|
|Ch. 2||Planning and Finding||11|
|Ch. 3||Valuation and Pricing||79|
|Ch. 4||Financing and Refinancing||139|
|Ch. 5||Structuring M/A/B Transactions: General, Tax, and Accounting Considerations||255|
|Ch. 6||The Due Diligence Inquiry||347|
|Ch. 7||Pension, Labor, and Compensation Concerns||387|
|Ch. 8||Negotiating the Letter of Intent and the Acquisition Agreement||445|
|Ch. 10||Postmerger Integration||643|
|Ch. 11||Workouts and Bankruptcies||697|
|Ch. 12||Special Issues for M&A in Public Companies||723|
|Ch. 13||M&A in Family Businesses, Partnerships, Franchises, and Nonprofits||799|
|Ch. 14||Beyond M&A: Spin-Offs and Strategic Alliances||817|
|Ch. 15||Special Issues for Transactions with International Aspects||839|
|Epilogue: M&A in the New Millennium||903|
|Case: A WOFC Case Study: J. T. Smith Consultants||927|
|Table of Cases||969|
|Landmark Legal Case Summaries||973|
If you sometimes feel the same way about approaching a seasoned merger/acquisitions/buyout specialist, you are not alone. Telemachus's attitude lives on in the arena of M&A and buyouts, where even the most inexperienced executives and professionals are expected to know it all before they begin their journey. The same principle operates across business and professional lines. Whether the subject is SBUs, S corporations, or swaps, everyone-newcomer and old hand alike-is expected to nod knowingly. Few have the courage to ask "What does that mean?" or "How does that work?" This is unfortunate, because only good questions, given good answers, foster true learning. That is why this 1999 edition of our M&A "classic" preserves the question-and-answer format used in the original text. What is a good question? What is a good answer? These change almost daily in the fast-paced M&A field. The Art of M&A: A MergerlAcquisitionlBuyout Guide, third edition, attempts to provide accurate and practical answers to over 1,000 questions you are likely to confront now or in the near future as a principal or an advisor when you buy or sell companies, whether public or private, domestic or foreign.
What is your burning question of the moment? It may be as basic as "What is a merger?" Or it may be as arcane as "Who is liable for tax on the sale of stock in a Section 338 election?" In either case, you need correct and current answers. Fortunately, you can find them here.
This book began at the height of the 1980s merger boom as the "joint effort of an entrepreneur and a law firm," as the first edition noted. The entrepreneur was Stanley Foster Reed and the law firm was Lane and Edson, P.C. Alexandra Reed Lajoux served as project manager. This new edition, with Reed as principal author and Lajoux as coauthor, contains many of the gems contributed in that first effort. Although Lane and Edson no longer exists as a law firm, the original contributions of its many brilliant principals-acknowledged in the first edition-continue to shine through in these pages. To these attorneys and the professionals cited below, the authors express enduring thanks.
Chapter 1, Getting Started in Mergers and Acquisitions, and Chapter 2, Planning and Finding, still contain wisdom from Dr. Robert H. Rock, President, MLR Holdings, Philadelphia, and Charles E. Fiero, Co-Chairman, MLR Holdings; Robert F. Burgess, Jr., Growth Strategies, Ltd., Alexandria, Virginia; Edward A. Weihman, Wasserstein Perella, New York City; Malcolm Pfunder of Hopkins, Sutter, Hamel & Park, Washington, D.C.; Gerald Wetlaufer, Professor of Business Law, Indiana University, Bloomington; Clive Chajet, Chairman, Lippincott and Margulies, New York City; and Mark Feldman, Partner, PricewaterhouseCoopers (formed from two predecessor firms). In addition, these chapters benefit from research conducted by the authors and referenced in the endnotes. Also, recent conversations with Bob Bates, an independent broker in Falls Church, Virginia, added valuably to the Chapter 2 section on finders and brokers. Whitney Adams, principal, Madison Financial Group, Washington, D.C., provided commentary and information on the subject of business and economic research. The authors also gratefully acknowledge the guidance of Martin Sikora, Editor, Mergers & Acquisitions; Thomas West, publisher, M&A Today; and Russell Robb, Editor, M&A Today, and Vice President, O'Conor, Wright, Wyman, Inc.
Chapter 3, Valuation and Pricing, still benefits from the expertise of Al Rappaport, Principal, The LEK/Alcar Consulting Group, La Jolla, California; and various partners at Wesray Capital Corporation, New York City. This chapter has been revised extensively, however. It features models developed by the principal author, Stanley Foster Reed.
Chapter 4, Financing and Refinancing, still contains the canny expertise of Lane and Edson attorneys credited in the first edition. Coverage here is updated and expanded-with extensive discussion on lease-based financing from Robert Neal, Managing Director, Newcourt Capital, Brookfield, Connecticut, a subsidiary of the Toronto-based Newcourt Credit Group.
Chapter 5, Structuring M/A/B Transactions: General, Tax, and Accounting Situations, remains heavily indebted to E. Burke Ross, Jr., Principal, Wesray Capital Corporation, and Harold Nidetz, Partner, Ernst & Young, Chicago. New guidance in this third edition has come from several attorneys at the law firm of Jones, Day, Reavis & Pogue, whose detailed guide to the Taxpayer Relief Act of 1997 (cited in the endnotes) was very helpful in highlighting and interpreting the most important sections of this extremely complex law. The authors would also like to acknowledge the expert guidance of Martin D. Ginsberg, Professor of Law, Georgetown University Law Center, Washington, D.C., and Jack S. Levin, Lecturer, University of Chicago Law School-and by extension their affiliated law firms. (Professor Ginsberg's professional firm is of counsel to the law firm of Fried, Frank, Harris, Shriver & Jacobson; and Professor Levin, through his professional firm, is a senior partner with the law firm of Kirkland & Ellis.) In updating this chapter, the authors relied heavily on the most recent edition of their two-volume, biannual reference work, Mergers, Acquisitions, and Buyouts: A Transactional Analysis of the Governing Tax, Legal, and Accounting Considerations (New York: Aspen Law & Business, 1998).
Chapter 6, The Due Diligence Inquiry, contains a checklist with elements suggested by Dan L. Goldwasser, an attorney based in New York City, and expanded by the authors.
Chapter 7, Pension, Labor, and Compensation Concerns, contains extensive discussion of employee stock ownership plans. As in the past, this discussion features information and insights provided by Corey Rosen of the National Center for Employee Ownership in Oakland, California. In this third edition, this chapter contains additional guidance from Dickson C. Buxton, Cofounder of Private Capital Corporation and former Chairman of Kelso and Company. It also includes materials from the coauthor' s new book, The Art of M&A Integration: A Guide to Merging Resources, Processes, and Responsibilities (New York: McGraw-Hill, 1998). The chapter benefited from the compensation experts consulted for that book, including Edwin Lewis, President, Lewis Consulting International, Westport, Connecticut; Alan Johnson, Managing Partner, Johnson Associates, Inc., New York City; and Aaron Berg, President, Pentech Corporation, Parsippany, New Jersey. The accounting aspects of postmerger compensation were provided by Scott Hakala and Travis Keath, of Business Valuation Services in Houston, Texas; Andrew Malec of Plante & Moran in Southfield, Michigan; and Dr. Robert Stobaugh, Emeritus Professor of the Harvard Business School.
Chapter 8, Negotiating the Letter of Intent and the Acquisition Agreement, and Chapter 9, Closing, still contain much from the Lane and Edson principals credited in the first edition.
Chapter 10, Postmerger Integration, is adapted from The Art of M&A In- tegration, cited above as a source for Chapter 7. As such, Chapter 10 owes a debt to many of the 50 postmerger experts consulted for that book. J. Fred Weston, Cordner Professor of Money and Financial Markets at the Graduate School of Management, University of California at Los Angeles, provided guidance in financial performance research. Planning expertise was provided by George A. Steiner, Kunin Professor of Management Emeritus at UCLA. Comments on the role of third parties in postmerger planning were provided by William J. Altier, CMC, President, Princeton Associates, Buckingham, Pennsylvania. Mark J. Feldman, an advisor to Chapter 1, imparted wisdom and experience on the importance of position statements in postmerger planning. Observations on the typical merger agreement came from Gabor Garai, of Ep- stein, Becker & Green, Boston. Eugene Grossman, Chairman, Anspach Grossman Enterprise, New York City, provided the "Audience/Media Com- munications Matrix." Information on noncompete agreements came from Lawrence F. Carnevale, Litigation Partner, Carter, Ledyard & Milburn, New York City. Guidance on integrated financial statements came from Kermit D. Larson, Arthur Andersen & Co. Alumni Professor of Accounting at the Uni- versity of Texas at Austin. Valuation materials in this chapter were provided by Hakala, Keith, and Malec, cited earlier as sources for Chapter 7. Chapter 11, Workouts and Bankruptcies, retains some of the information originally provided by Michael P. Marsalese, Esq., Adjunct Professor at Wayne State University in Detroit, and an attorney in private practice in Troy, Michigan.
Chapter 12, Special Issues for M&A in Public Companies, contains answers provided by Robert D. Ferris, President, Ruder & Finn Investor Relations, New York City; and James J. Hanks, Jr., partner, Ballard Spahr Andrews & Ingersoll, Baltimore.
Chapter 13, M&A in Family Businesses, Partnerships, Franchises, and Nonprofits, and Chapter 14, Beyond M&A: Spin-Offs and Strategic Alliances, are new to this edition. The authors wish to extend special thanks to J. Fred Weston (cited above in the credits for Chapter 10) for his contributions to Chapter 14.
Chapter 15, Special Issues for Transactions with International Aspects, includes materials originally provided by Van Kirk Reeves, Partner, Porter and Reeves, Paris, France, and Riccardo R. Trigona, a former Lane and Edson associate now in private practice in Rome, Italy. For this edition, we have consulted other international attorneys as well. They are credited in the endnotes. The authors also wish to thank the principals of Capital Management, Tokyo, Japan, for general guidance on international M&A. Capital Management is a joint venture of Deloitte Touche Tohmatsu and IntellAsset.
Our Epilogue, M&A in the New Millennium, is based on extensive readings and, but owes its greatest debt to the classic work of the late, great historian Ralph Nelson and to Bruce Wasserstein, Chairman and CEO, Wasserstein Perella & Co., author of Big Deal, cited herein. The WOFC Case Study: J. T. Consultants is a composite case based on consulting work by the principal author.
The Table of Cases and Landmark Legal Case Summaries concluding this book expand upon the prior work of Michael Marsalese, mentioned above. Information on the Healthco case came from Mark W. Parry, Esq., Partner, Moses & Singer, L.L.P., and Robert Stobaugh, cited in the credits to Chapter 7.
The authors also wish to extend thanks to Misty Grooms and Travis Piazza of Reed Associates, and Mary Graham and Braulio Agnese of Alexis & Co. Their skills all made a vital difference. Last but not least, the authors wish to thank the fine professionals at McGraw-Hill for their encouragement and expertise-especially Kelli Christiansen, our top-notch sponsoring editor; Judy Duguid, our fine-handed copy editor; Judy Brown, our miracle-working typesetter; Edwin Durbin, our thorough indexer; and to John Morriss, editorial supervisor par excellence. Thanks also to publisher Jeffrey Krames for his continuing commitment to the "big book."
In 1997, AT&T stunned the financial world when it announced that it was in merger discussions (soon canceled) with SBC Communications Corp. The combined firm would have been worth $50 billion-a staggering amount at the time. Yet now as we go to press in late 1998, this figure no longer seems gargantuan-considering 1998 announcements of mergers between BankAmerica and NationsBank (worth $60 billion) and between Citicorp and Travelers Group Inc. (worth $83 billion). The value of announced deals involving U.S. companies during the first half of 1998 was over $1 trillion-an all-time record-boosted by dozens of multibillion-dollar transactions. Advisors aren't flinching because they too are involved in massive consolidations-notably within major accounting, consulting, and law firms. But megadeals are still only a small percentage of the transactions that go on day in and day out in the heartlands of countries around the world. According to Securities Data Company of Newark, New Jersey (courtesy of Richard Peterson and Carrie Smith), the total number of M&A transactions completed worldwide in 1997 was 15,891, valued at $1,011,638 million (or just over $1 trillion). That gives us an average deal value (not counting transactions worth less than $5 million) of only $63.7 million-hardly beyond the grasp of most major companies.
Whether crafted in times of M&A boom or bust, whether valued at many billions or a few million, each deal must be planned, valued, financed, and structured. Each one must be checked out through due diligence, described in a written agreement, and formally closed. All these phases are described here-and augmented through special-issue chapters. This edition includes newly expanded guidance on buying troubled companies. It also features for the first time a chapter on postmerger integration, as well as one treating issues "beyond M&A" in the realms of spin-offs and strategic alliances. New to this edition also is guidance on issues faced by family businesses, franchises, partnerships, and nonprofits. The concluding chapter of this book is a big-picture review of M&A movements past and future.
In this new edition, we have spared few fine points and have provided much fine print in an attempt to teach the most important mechanics of the dealmaking process. We hope they get you where you need to go, whether you are just beginning your M&A journey or are already well on your way.
If you wish to contact . Stanley Foster Reed, please feel free at: firstname.lastname@example.org. If you wish to contact Alexandra Reed Lajoux, please feel free at: email@example.com. We look forward to hearing from you.