Due Diligence in Mergers — Two Areas to Consider

When two companies consider a merger, both companies should be engaging in due diligence. Particularly when private companies are involved, due diligence starts with detailed inquiries, and important, prying questions must be asked, and answered. Private companies generally enjoy a level of secrecy not shared by publicly traded companies, so there is often a lot of important information each party must learn about the other as part of the merger process.

The following is a discussion of two of the many areas which should be the subject of intense inquiry and robust discussion prior to any merger.

Existing Contracts

Every company has contracts, from real estate leases to supplier contracts. Before considering a merger, examining existing contracts is critical to get a better view of how the company is situated. The types of contracts which may exist depend in part on the nature of the business. However, some common contractual commitments include:

· Employment agreements;

· Collective bargaining agreements / union contracts;

· Non-compete clauses;

· Exclusivity agreements;

· Distribution agreements;

· Advertising commitments;

· Franchise agreements;

· Licensing agreements;

· Equipment leases;

· Real estate leases;

· Customer contracts;

· Supplier contracts;

· Loans; and

· Credit agreements.

Potential buyers should also be mindful of and carefully consider any contracts in existence which, if terminated, could have an adverse effect on its ability to continue to operate the target’s business or on profitability of that business.

Employee Issues and Management Issues

When merging with another company, understanding the roles of employees and management structure is critical to the future success of the combined company. Acquiring companies should begin by examining the organizational chart of the target. In addition to a hierarchy of roles, biographical information of those filling the roles should be reviewed. If there are consultants critical to the company’s success, their qualifications, as well as their consulting agreements should also be reviewed.

Employee compensation should be carefully reviewed. Compensation is often not just salary and bonuses, but can also involve important non-cash compensation (such as employee vehicles, use of company owned season tickets, etc.). Ideally, this review should go back at least three years for officers and key employees. Further, each party should review all employee benefits offered by the other party, including profit sharing, deferred compensation, pension plans, and retirement plans, to determine if there are significant mismatches. With companies that offer stock options, also review evidence of IRC Section 409A compliance. If the company offers separate management incentive or bonus plans, review these plans — both the policy governing the incentives, and how those incentives or bonuses are implemented in practice.

Finally, investigate the possibility of any labor disputes within the company. It is reasonable to ask for summaries of past labor disputes as well as ongoing labor disputes. Additionally, it is reasonable to ask about any pending labor stoppages, or potential labor stoppages or strikes, regardless of how remote the company believes the threat to be.

Compensation is often key to the success of a merger and should be carefully considered. For key employees, has seller implemented any agreement to retain the employees through the merger? Will buyer offer any bonuses post-merger? Have key employees been identified? What discussions, if any, have taken place to ensure employees are interested in and willing to stay post-merger. How will these payments and employees be integrated into buyer’s existing compensation systems?

Will layoffs be an issue or a potential issue (there are strict rules governing layoffs of groups of employees)? How much will severance costs amount to? Is there a collective bargaining agreement or union contract which governs severance costs? In evaluating layoff costs, don’t forget to include vacation pay and any other transition assistance (such as education assistance).

If You are Considering a Merger

If you are considering a merger, bear in mind, existing contracts and employee and management issues are just two of many areas of due diligence a company must perform. At VLP Law Group, LLP, we have the experience you need to assist you in the complicated process of mergers and acquisitions. Let our attorneys assist you so you can ensure you are protected in this important transaction. Contact us to discuss your needs.