Detailed explanation of Due Dilligence?

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Briney Spring Gun
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Detailed explanation of Due Dilligence?

Postby Briney Spring Gun » Thu Jan 22, 2015 8:39 pm

Can someone who works (preferably) in M&A give me a basic explanation of what due diligence is, an approximation of how much of your time is spent conducting it, and what prior skills/classes/experiences are best to prepare you for it? I've googled it and read up on it a bit, but I think it would be more useful to get a more detailed answer from someone who has actually done it.

Edit: Would be most interested in hearing from someone working in NYC just because that's where I will be, but open to hearing from all with experience.

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sundance95
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Re: Detailed explanation of Due Dilligence?

Postby sundance95 » Thu Jan 22, 2015 9:09 pm

Briney Spring Gun wrote:Can someone who works (preferably) in M&A give me a basic explanation of what due diligence is, an approximation of how much of your time is spent conducting it, and what prior skills/classes/experiences are best to prepare you for it? I've googled it and read up on it a bit, but I think it would be more useful to get a more detailed answer from someone who has actually done it.

Edit: Would be most interested in hearing from someone working in NYC just because that's where I will be, but open to hearing from all with experience.

lol

Hutz_and_Goodman
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Re: Detailed explanation of Due Dilligence?

Postby Hutz_and_Goodman » Thu Jan 22, 2015 9:14 pm

To do due diligence:
Be extremely neurotic
Be very organized
Be very detail oriented
Be willing to accept huge amounts of anger over any error
Be able to function at full capacity for 24-48 hrs with no sleep
Be able to treat the most boring possible document review as though it were a scintillating experience

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Desert Fox
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Re: Detailed explanation of Due Dilligence?

Postby Desert Fox » Thu Jan 22, 2015 9:24 pm

Not being able to find due diligence on good is a good example of being bad at due diligence. check yoy liens

Briney Spring Gun
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Re: Detailed explanation of Due Dilligence?

Postby Briney Spring Gun » Thu Jan 22, 2015 9:35 pm

I guess I was just curious about what kinds of documents you review, what you're expected to be doing or looking for with each one, and how much of one's time is spent conducting due dilligence.

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5ky
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Re: Detailed explanation of Due Dilligence?

Postby 5ky » Thu Jan 22, 2015 10:34 pm

Hutz_and_Goodman wrote:To do due diligence:
Be extremely neurotic
Be very organized
Be very detail oriented
Be willing to accept huge amounts of anger over any error
Be able to function at full capacity for 24-48 hrs with no sleep
Be able to treat the most boring possible document review as though it were a scintillating experience


it's not that bad

Anonymous User
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Re: Detailed explanation of Due Dilligence?

Postby Anonymous User » Thu Jan 22, 2015 10:41 pm

Briney Spring Gun wrote:I guess I was just curious about what kinds of documents you review, what you're expected to be doing or looking for with each one, and how much of one's time is spent conducting due dilligence.


1. In the extreme version, any contract the company has ever entered into. Tons of random leases for stupid stuff like storage facilities, contracts with suppliers for $1000 of electrical equipment, etc. Sometimes the client will have mercy and ask you to only review contracts with the 100 largest suppliers, or only contracts with a value of $100,000 or more, usually because it would actually be physically impossible for you to complete reviewing all of the contracts before signing, if by "you" we mean "every single junior associate at your law firm working together".

2. Mostly, you're looking for "red flags", but because no one ever finds "red flags", and they aren't cutely labeled with actual red flags in the contracts, you'll never find any. Instead, you'll stop paying attention to anything except whether the contract would be voided by a change of control because that's relatively easy to spot.

3. When someone actually asks you to do diligence, all of your time. When the client decides that the deal has to close on Tuesday, and it's Thursday, and there are three weeks of diligence to do but no one cares because the junior will get it done, you will spend every waking hour (which probably means every hour--this is M&A, everyone prides themselves on being to function without sleep for at least 100 hours straight) doing diligence from Thursday until Tuesday. On Tuesday morning, you will hand your diligence report to the partner, who will casually flip through it while asking if there were any red flags. Then, after you leave their office, said partner will toss it in the recycling. The client's copy of the report will be ignored and filed in triplicate in their West Virginia storage facility along with all of the diligence reports other associates have prepared for other acquisition targets over the years and whose lease some other M&A associate at some other firm will eventually review when the client becomes an acquisition target.
Last edited by Anonymous User on Thu Jan 22, 2015 10:46 pm, edited 1 time in total.

Briney Spring Gun
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Re: Detailed explanation of Due Dilligence?

Postby Briney Spring Gun » Thu Jan 22, 2015 10:46 pm

Anonymous User wrote:
Briney Spring Gun wrote:I guess I was just curious about what kinds of documents you review, what you're expected to be doing or looking for with each one, and how much of one's time is spent conducting due dilligence.


1. In the extreme version, any contract the company has ever entered into. Tons of random leases for stupid stuff like storage facilities, contracts with suppliers for $1000 of electrical equipment, etc. Sometimes the client will have mercy and ask you to only review contracts with the 100 largest suppliers, or only contracts with a value of $100,000 or more, usually because it would actually be physically impossible for you to complete reviewing all of the contracts before signing, if by "you" we mean "every single junior associate at your law firm working together".

2. Mostly, you're looking for "red flags", but because no one ever finds "red flags", and they aren't cutely labeled with actual red flags in the contracts, you'll never find any. Instead, you'll stop paying attention to anything except whether the contract would be voided by a change of control because that's relatively easy to spot.

3. When someone actually asks you to do diligence, all of your time. When the client decides that the deal has to close on Tuesday, and it's Thursday, and there are three weeks of diligence to do but no one cares because the junior will get it done, you will spend every waking hour doing diligence from Thursday until Tuesday. On Tuesday morning, you will hand your diligence report to the partner, who will casually flip through it while asking if there were any red flags. Then, after you leave their office, said partner will toss it in the recycling. The client's copy of the report will be ignored and filed in triplicate in their West Virginia storage facility along with all of the diligence reports other associates have prepared for acquisition targets over the years and whose lease some other M&A associate at some other firm will eventually review when the client becomes an acquisition target.


Thanks, this is more along the lines of what I was curious about. Appreciate it.

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Re: Detailed explanation of Due Dilligence?

Postby Anonymous User » Fri Jan 23, 2015 7:44 pm

Hutz_and_Goodman wrote:To do due diligence:
Be extremely neurotic
Be very organized
Be very detail oriented
Be willing to accept huge amounts of anger over any error
Be able to function at full capacity for 24-48 hrs with no sleep
Be able to treat the most boring possible document review as though it were a scintillating experience

In other words, having a prescription for adderall... seriously. ADHD meds are fairly common to stay awake and to stay focused.

Anonymous User
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Re: Detailed explanation of Due Dilligence?

Postby Anonymous User » Fri Jan 23, 2015 7:57 pm

Seriously, idk how transactional people do what they do for 30 min without adderall. I wanted to rip my eyeballs out when I rotated through those groups as a summer.

mvp99
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Re: Detailed explanation of Due Dilligence?

Postby mvp99 » Fri Jan 23, 2015 10:11 pm

Anonymous User wrote:Seriously, idk how transactional people do what they do for 30 min without adderall. I wanted to rip my eyeballs out when I rotated through those groups as a summer.


lol.. I've heard the same words from transactional associates but directed at lit. work.. I think it might be a way for associates in both sides to rationalize their choice

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Desert Fox
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Re: Detailed explanation of Due Dilligence?

Postby Desert Fox » Fri Jan 23, 2015 10:15 pm

mvp99 wrote:
Anonymous User wrote:Seriously, idk how transactional people do what they do for 30 min without adderall. I wanted to rip my eyeballs out when I rotated through those groups as a summer.


lol.. I've heard the same words from transactional associates but directed at lit. work.. I think it might be a way for associates in both sides to rationalize their choice


Maybe back when lit was mostly doc review, but I can't see it.

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PvblivsScipio
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Re: Detailed explanation of Due Dilligence?

Postby PvblivsScipio » Sat Jan 24, 2015 1:08 am

So if I'm terrible at journal editing (bluebook, all that shit) I'd probably be terrible at due diligence. M&A sounds so awful.

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fats provolone
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Re: Detailed explanation of Due Dilligence?

Postby fats provolone » Sat Jan 24, 2015 1:36 am

Desert Fox wrote:
mvp99 wrote:
Anonymous User wrote:Seriously, idk how transactional people do what they do for 30 min without adderall. I wanted to rip my eyeballs out when I rotated through those groups as a summer.


lol.. I've heard the same words from transactional associates but directed at lit. work.. I think it might be a way for associates in both sides to rationalize their choice


Maybe back when lit was mostly doc review, but I can't see it.

I almost killed myself after reading that post

Anonymous User
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Re: Detailed explanation of Due Dilligence?

Postby Anonymous User » Sat Jan 24, 2015 10:35 am

PvblivsScipio wrote:So if I'm terrible at journal editing (bluebook, all that shit) I'd probably be terrible at due diligence. M&A sounds so awful.


Meh. This is a bigger signal for hating litigation. Due diligence isn't nearly so formalized as journal editing.

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Desert Fox
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Re: Detailed explanation of Due Dilligence?

Postby Desert Fox » Sat Jan 24, 2015 12:35 pm

Anonymous User wrote:
PvblivsScipio wrote:So if I'm terrible at journal editing (bluebook, all that shit) I'd probably be terrible at due diligence. M&A sounds so awful.


Meh. This is a bigger signal for hating litigation. Due diligence isn't nearly so formalized as journal editing.


If ur job in lit involves a lot of bluebooking you are a paralegal or an idiot nobody trusts to do real work.

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JusticeHarlan
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Re: Detailed explanation of Due Dilligence?

Postby JusticeHarlan » Sat Jan 24, 2015 1:45 pm

To add a little more to the summary above:

One thing you always look for when doing diligence for M&A deals are the assignment/change of control clauses. Let's say there's a contract between the company your client wants to buy (the "target") and their main supplier, and that contract is really key to the main product produced by the target. That contract has a clause that says "neither party hereto may assign this Agreement or its rights and obligations hereunder without the consent of the other party." Does that mean the acquiring company won't be able to count on being able to get supplies from the contract? Well, it depends on how the merger is structured. If it's an asset purchase, then the client needs to reach out to the supplier to make sure they're ok with the merger; if it's a reverse triangular merger or stock purchase, then you should be fine. Sometimes it's not notice, not consent, that's required, but that's still something you need to figure out how advise the client on.

But let's say that same clause was written, "neither party hereto may assign this Agreement or its rights and obligations hereunder, including by change of control, without the consent of the other party." Then even if you have a more favorable structure, then the supplier has the ability to get out of deal if your client buys the target. So, it's a matter of knowing what kind of deal you have and reading the contacts to see how the deal will be treated by the contact. One place this always comes up with is in commercial leases - landlords are always dicks and will try to exact something (lease extension, more money) before they give consent.

Or if the company has a debt facility, there are going to be negative covenants, including that it can't get bought up in a merger without the bank's consent. They're also going to want to know what other things they target is restricted from doing, like signing a new lease, without the bank's ok.

Another thing you sometimes get caught up doing is capitalization diligence (or, "cap diligence"). Think about it like this - if your client is buying the target for $100 million, how does it get divvied up? Who owns what chunk of the target? If it's a public company, that's pretty easy, but if it's a venture backed or PE portfolio company, it can have a complex capital structure. You have to backtrack over the stock purchase agreements, subscription agreements, convertible notes - any way that people that bought equity in the target. Do the warrants they issued get automatically exercised? Does the Series D get paid out in full before the Series C, or are they pari passu? You have to make sure that people are getting their actual share of the merger consideration so that no one pops up later and says "you guys owe me $5 million for my piece of the company!" And if they sold a million shares of Series B-1 Preferred Stock two years ago, did they actually have that much Series B-1 stock authorized and available to sell? You'll need to read their certificate of incorporation and their board minutes and such to see if they were doing everything properly. If not, they've got a problem.

Another bucket is IP. Sometimes this gets farmed out to IP specialists in the firm, but sometimes the corporate folks take a look. If the company is really dependent on key patents, you want to read their agreements with the folks who invented the technology in question to make sure the IP rights were properly assigned to the target company. This could involve looking at employment/consulting agreements and making sure they use present assignment language ("hereby assigns") instead of weaker, non-self executing assignment language ("agrees to assign"). And the rules are just a little different for patents v. copyrights, employees v. independent contractors, etc. If the target licensed the IP from another company, want to check the assignability of the license, what markets they have the right in (just where the target is operating now, or in potential future markets your client might expand into?), etc.

In terms of "red flags," you want to make sure there aren't any balloon/milestone payments coming up (or that are triggered by the merger itself!) that you're client would be on the hook for if they buy the target, but that don't show up on current financial statements because they haven't been triggered yet. For instance, if the target has licensed the rights to distribute a product, they have to pay royalties on it, which everyone can tell by looking at the books. But once they sell ten million units in the US, the now owe the licensor a $15 million milestone payment! You're gonna want to point that out to your client so they can adjust their purchase price accordingly.

Or, things like restrictions on doing business: maybe the target has a contract with someone with whom they do business, but in return have agreed not to compete in another field or region. You're going to want to let the client know that. Or if they have any "most favored nation" clauses, does that hurt the value of the target? And not just the target, but you want to read the clauses to see if the restrictions might also apply to the acquirer, in which case things can get dicey and really drive down the price of the merger.

Employee contracts are another bucket. For example, you want to check any "golden parachute" provisions in executive contract - if you terminate the existing CEO within 12 months of the merger, does he get a big fat check? Do his stock options/restricted stock instantly vest? That's something your client wants to know, because maybe they want to put in new leadership. But on the flip side, what if the business of the target is really keyed on a few key employees - you don't want to drop a fortune on the target and then have the key people leave, so you want to take a look at their employment contracts and see if they have non-competes, etc., that would make it more difficult for them to leave. And for rank and file employees, what's in their standard employment documents? Do they have non-disparagement clauses? Do they have NDAs and confidentiality provisions, so they can't blab about company information?

In the end, it can be a lot of really boring, seemingly substantive-less work. But often, it involves really understanding how a company works, how certain kinds of agreements get drafted, how the merger will affect the business of the company, and so on.

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North
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Re: Detailed explanation of Due Dilligence?

Postby North » Sat Jan 24, 2015 4:21 pm

JusticeHarlan wrote:To add a little more to the summary above:

One thing you always look for when doing diligence for M&A deals are the assignment/change of control clauses. Let's say there's a contract between the company your client wants to buy (the "target") and their main supplier, and that contract is really key to the main product produced by the target. That contract has a clause that says "neither party hereto may assign this Agreement or its rights and obligations hereunder without the consent of the other party." Does that mean the acquiring company won't be able to count on being able to get supplies from the contract? Well, it depends on how the merger is structured. If it's an asset purchase, then the client needs to reach out to the supplier to make sure they're ok with the merger; if it's a reverse triangular merger or stock purchase, then you should be fine. Sometimes it's not notice, not consent, that's required, but that's still something you need to figure out how advise the client on.

But let's say that same clause was written, "neither party hereto may assign this Agreement or its rights and obligations hereunder, including by change of control, without the consent of the other party." Then even if you have a more favorable structure, then the supplier has the ability to get out of deal if your client buys the target. So, it's a matter of knowing what kind of deal you have and reading the contacts to see how the deal will be treated by the contact. One place this always comes up with is in commercial leases - landlords are always dicks and will try to exact something (lease extension, more money) before they give consent.

Or if the company has a debt facility, there are going to be negative covenants, including that it can't get bought up in a merger without the bank's consent. They're also going to want to know what other things they target is restricted from doing, like signing a new lease, without the bank's ok.

Another thing you sometimes get caught up doing is capitalization diligence (or, "cap diligence"). Think about it like this - if your client is buying the target for $100 million, how does it get divvied up? Who owns what chunk of the target? If it's a public company, that's pretty easy, but if it's a venture backed or PE portfolio company, it can have a complex capital structure. You have to backtrack over the stock purchase agreements, subscription agreements, convertible notes - any way that people that bought equity in the target. Do the warrants they issued get automatically exercised? Does the Series D get paid out in full before the Series C, or are they pari passu? You have to make sure that people are getting their actual share of the merger consideration so that no one pops up later and says "you guys owe me $5 million for my piece of the company!" And if they sold a million shares of Series B-1 Preferred Stock two years ago, did they actually have that much Series B-1 stock authorized and available to sell? You'll need to read their certificate of incorporation and their board minutes and such to see if they were doing everything properly. If not, they've got a problem.

Another bucket is IP. Sometimes this gets farmed out to IP specialists in the firm, but sometimes the corporate folks take a look. If the company is really dependent on key patents, you want to read their agreements with the folks who invented the technology in question to make sure the IP rights were properly assigned to the target company. This could involve looking at employment/consulting agreements and making sure they use present assignment language ("hereby assigns") instead of weaker, non-self executing assignment language ("agrees to assign"). And the rules are just a little different for patents v. copyrights, employees v. independent contractors, etc. If the target licensed the IP from another company, want to check the assignability of the license, what markets they have the right in (just where the target is operating now, or in potential future markets your client might expand into?), etc.

In terms of "red flags," you want to make sure there aren't any balloon/milestone payments coming up (or that are triggered by the merger itself!) that you're client would be on the hook for if they buy the target, but that don't show up on current financial statements because they haven't been triggered yet. For instance, if the target has licensed the rights to distribute a product, they have to pay royalties on it, which everyone can tell by looking at the books. But once they sell ten million units in the US, the now owe the licensor a $15 million milestone payment! You're gonna want to point that out to your client so they can adjust their purchase price accordingly.

Or, things like restrictions on doing business: maybe the target has a contract with someone with whom they do business, but in return have agreed not to compete in another field or region. You're going to want to let the client know that. Or if they have any "most favored nation" clauses, does that hurt the value of the target? And not just the target, but you want to read the clauses to see if the restrictions might also apply to the acquirer, in which case things can get dicey and really drive down the price of the merger.

Employee contracts are another bucket. For example, you want to check any "golden parachute" provisions in executive contract - if you terminate the existing CEO within 12 months of the merger, does he get a big fat check? Do his stock options/restricted stock instantly vest? That's something your client wants to know, because maybe they want to put in new leadership. But on the flip side, what if the business of the target is really keyed on a few key employees - you don't want to drop a fortune on the target and then have the key people leave, so you want to take a look at their employment contracts and see if they have non-competes, etc., that would make it more difficult for them to leave. And for rank and file employees, what's in their standard employment documents? Do they have non-disparagement clauses? Do they have NDAs and confidentiality provisions, so they can't blab about company information?

In the end, it can be a lot of really boring, seemingly substantive-less work. But often, it involves really understanding how a company works, how certain kinds of agreements get drafted, how the merger will affect the business of the company, and so on.

TYFT/QFP. You should write a book on how to be a transactional associate w/ no business background because I would 100% buy it.

Briney Spring Gun
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Joined: Sat Jul 26, 2014 2:25 pm

Re: Detailed explanation of Due Dilligence?

Postby Briney Spring Gun » Sun Jan 25, 2015 11:51 am

JusticeHarlan wrote:To add a little more to the summary above:

One thing you always look for when doing diligence for M&A deals are the assignment/change of control clauses. Let's say there's a contract between the company your client wants to buy (the "target") and their main supplier, and that contract is really key to the main product produced by the target. That contract has a clause that says "neither party hereto may assign this Agreement or its rights and obligations hereunder without the consent of the other party." Does that mean the acquiring company won't be able to count on being able to get supplies from the contract? Well, it depends on how the merger is structured. If it's an asset purchase, then the client needs to reach out to the supplier to make sure they're ok with the merger; if it's a reverse triangular merger or stock purchase, then you should be fine. Sometimes it's not notice, not consent, that's required, but that's still something you need to figure out how advise the client on.

But let's say that same clause was written, "neither party hereto may assign this Agreement or its rights and obligations hereunder, including by change of control, without the consent of the other party." Then even if you have a more favorable structure, then the supplier has the ability to get out of deal if your client buys the target. So, it's a matter of knowing what kind of deal you have and reading the contacts to see how the deal will be treated by the contact. One place this always comes up with is in commercial leases - landlords are always dicks and will try to exact something (lease extension, more money) before they give consent.

Or if the company has a debt facility, there are going to be negative covenants, including that it can't get bought up in a merger without the bank's consent. They're also going to want to know what other things they target is restricted from doing, like signing a new lease, without the bank's ok.

Another thing you sometimes get caught up doing is capitalization diligence (or, "cap diligence"). Think about it like this - if your client is buying the target for $100 million, how does it get divvied up? Who owns what chunk of the target? If it's a public company, that's pretty easy, but if it's a venture backed or PE portfolio company, it can have a complex capital structure. You have to backtrack over the stock purchase agreements, subscription agreements, convertible notes - any way that people that bought equity in the target. Do the warrants they issued get automatically exercised? Does the Series D get paid out in full before the Series C, or are they pari passu? You have to make sure that people are getting their actual share of the merger consideration so that no one pops up later and says "you guys owe me $5 million for my piece of the company!" And if they sold a million shares of Series B-1 Preferred Stock two years ago, did they actually have that much Series B-1 stock authorized and available to sell? You'll need to read their certificate of incorporation and their board minutes and such to see if they were doing everything properly. If not, they've got a problem.

Another bucket is IP. Sometimes this gets farmed out to IP specialists in the firm, but sometimes the corporate folks take a look. If the company is really dependent on key patents, you want to read their agreements with the folks who invented the technology in question to make sure the IP rights were properly assigned to the target company. This could involve looking at employment/consulting agreements and making sure they use present assignment language ("hereby assigns") instead of weaker, non-self executing assignment language ("agrees to assign"). And the rules are just a little different for patents v. copyrights, employees v. independent contractors, etc. If the target licensed the IP from another company, want to check the assignability of the license, what markets they have the right in (just where the target is operating now, or in potential future markets your client might expand into?), etc.

In terms of "red flags," you want to make sure there aren't any balloon/milestone payments coming up (or that are triggered by the merger itself!) that you're client would be on the hook for if they buy the target, but that don't show up on current financial statements because they haven't been triggered yet. For instance, if the target has licensed the rights to distribute a product, they have to pay royalties on it, which everyone can tell by looking at the books. But once they sell ten million units in the US, the now owe the licensor a $15 million milestone payment! You're gonna want to point that out to your client so they can adjust their purchase price accordingly.

Or, things like restrictions on doing business: maybe the target has a contract with someone with whom they do business, but in return have agreed not to compete in another field or region. You're going to want to let the client know that. Or if they have any "most favored nation" clauses, does that hurt the value of the target? And not just the target, but you want to read the clauses to see if the restrictions might also apply to the acquirer, in which case things can get dicey and really drive down the price of the merger.

Employee contracts are another bucket. For example, you want to check any "golden parachute" provisions in executive contract - if you terminate the existing CEO within 12 months of the merger, does he get a big fat check? Do his stock options/restricted stock instantly vest? That's something your client wants to know, because maybe they want to put in new leadership. But on the flip side, what if the business of the target is really keyed on a few key employees - you don't want to drop a fortune on the target and then have the key people leave, so you want to take a look at their employment contracts and see if they have non-competes, etc., that would make it more difficult for them to leave. And for rank and file employees, what's in their standard employment documents? Do they have non-disparagement clauses? Do they have NDAs and confidentiality provisions, so they can't blab about company information?

In the end, it can be a lot of really boring, seemingly substantive-less work. But often, it involves really understanding how a company works, how certain kinds of agreements get drafted, how the merger will affect the business of the company, and so on.


Thank you so much Harlan. Between this and your post in the "What's Your Day Like" thread, you've been a MASSIVE help.




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