The M&A Symphony For In-House Counsel: Orchestrating Successful Deals

During Ward and Smith's annual In-House Counsel Seminar, Richard J. Crow provided an overview of the continually evolving landscape of mergers and acquisitions. The discussion featured key insights on best practices for in-house attorneys, essential aspects of due diligence, typical deal structures, and some of the common obstacles that can impede these highly complex transactions.

Crow previously served as the General Counsel of a large Wilmington-based company and has earned a reputation as the “go to” business lawyer for Eastern North Carolina's leading enterprises. His extensive experience in business law encompasses a broad range of topics, including mergers and acquisitions, joint ventures, corporate governance, tax planning, private securities offerings, and start-up businesses.

“Mergers and acquisitions are a critical element of business strategy because they can help add market share and growth, increase competitiveness, diversify risks and find synergies,” noted Crow, “so chances are strong you will be involved in one of these transactions at some point, if you haven't already.”

The process is extremely nuanced and in-house attorneys play a vital role in ensuring compliance, due diligence, communication, preparation, and contract review. “This is just a high-level overview because there are so many intricacies in the process, but I love talking about it with my clients. Most of it applies whether you're on the buy side or the sell side,” said Crow.

In-house attorneys are often tasked with developing a regulatory strategy, communicating with external counsel, and integrating the companies after the closing. “Some of this will seem elementary to many of you, but it helps to review the process because it's easy to overlook some things when you are stressed and there's a time crunch,” mentioned Crow.

Purpose of Due Diligence

Though many take shortcuts with due diligence, it is the foundation of a successful transaction. “It is important to be thorough about validating the data to ensure the valuation of the business is realistic,” added Crow.

Since the due diligence process can help to identify deal-breaker risks and potential trouble spots, it can help avoid wasting time on transactions with little chance of closing. Allocating risk between the buyer and seller is another important element of due diligence.

“Every scenario has some risk for both parties, however, being thorough with due diligence can help you appropriately allocate that risk,” Crow explained.

Additionally, due diligence assists with integration planning, helping acquirers understand the target's business and determine which internal subject matter experts need to be involved. “This will help you determine how to combine systems and processes or figure out what may be duplicative,” noted Crow. “Part of this includes naming the employees that are essential to the new entity as well as the ones that may need to be let go.”

Due diligence also supports regulatory filings and antitrust/CFIUS assessments. One regulatory hurdle for large companies is the Hart-Scott-Rodino (HSR) Act, which is an antitrust law requiring companies to notify the FTC and the DOJ to provide information before completing mergers or acquisitions.

The Committee on Foreign Investment in the US (CFIUS) is another consideration with mergers and acquisitions that has become increasingly significant.

Primary Components of Due Diligence

Some organizations use a form for due diligence requests. “This is okay but it should just be a starting point,” noted Crow, “and it should be adjusted based on the target, its business, and your goals.”

Legal due diligence is essential for understanding the other business, including its corporate structure, organizational documents and material contracts, as well as whether it maintains compliance with applicable regulations. In-house attorneys should closely scrutinize employment issues such as noncompete agreements, chain of title for IP, and “most favored nation” clauses.

“Due diligence will help you smoke out these issues early,” mentioned Crow. “This is increasingly important with data privacy compliance because so many companies are now storing data about consumers and their employees.”

Another key component of due diligence is financial due diligence, which assesses the quality of earnings, revenue streams, and expenses, such as liabilities and tax exposure. To validate financial health and support negotiations, Crow advises obtaining a quality of earnings report.

“Of course, you'll probably want a quality of earnings report if you're on the buy side. Right now, though, I am helping a seller, and we proactively got one to help us identify our working capital and adjust our EBITDA, which ultimately helped us market the company for a better price,” Crow said.

Though costly, the reports can also help to avoid unpleasant surprises after the closing of the transaction.

Operational and commercial due diligence is an essential step in the process. In-house attorneys often work with business teams to evaluate the business model and determine whether the operations of the target company mesh with their strategic objectives, as well as how to retain key employees and assess environmental risks.

Understanding the dynamics of the supply chain and identifying potential vulnerabilities is also critical, especially in the modern business landscape.

Committee on Foreign Investment in the United States (“CFIUS”) Review

CFIUS gives the government the authority to review certain transactions between a US business and a foreign person. “This has been around for a while,” explained Crow, “but its authority was expanded during the first Trump administration.”

Review from CFIUS may be triggered if a transaction involves foreign-controlled buyers or companies engaged in critical technology, infrastructure, or sensitive personal data. Similarly, a foreign investment transaction related to a US business involved in critical technology, critical infrastructure, or sensitive personal data (TID) may also warrant review from CFIUS.

Real estate transactions where a foreign-controlled person buys or leases property nearby airports, military installations and ports are covered by CFIUS.

“These are robust regulations that can be a trap for the unwary, so always try to consider whether the acquirer is foreign controlled, as well as whether your company or the target company is engaged with critical technology, critical infrastructure or the holding of sensitive data of US citizens,” added Crow.

Examples of TID include export-controlled “dual-use” items with both civilian and military applications, defense items, nuclear technologies, certain chemical agents, and emerging technologies. “I had a deal involving a polymers manufacturer that went under review because polymers are used, among many other uses, in fire resistant and heat resistant clothing and protective gear,” noted Crow.

The definitions of the terms in the regulations are broad, as the stated intent of CFIUS is to protect national security. “One of the catalysts for the expansion of CFIUS was the acquisition of an insurance company by a firm that was backed by the Chinese government,” said Crow. “The main source of revenue for the insurance company was insuring CIA agents and other sensitive personnel.”

For covered transactions, there is a mandatory filing requirement. The fees can be onerous, the process is slow and if CFIUS asks questions, the window to respond is very short.

When in doubt, seek specialized expertise to navigate CFIUS requirements. If national security appears to be an issue, a voluntary filing is advisable because avoiding doing so would give CFIUS the authority to review the transaction in perpetuity, even after closing.

In-house attorneys should consistently focus on identifying potential CFIUS implications, as a lack of compliance can result in severe penalties, mandatory divestitures, or an unwinding of the transaction.

Cybersecurity and Data Diligence

With the evolution of technology and the increasing use, storage and maintenance of customer data, cybersecurity and data diligence are now important components of mergers and acquisitions. “On the IP side, there are particular concerns about code that has been developed with AI tools,” mentioned Crow.

There may not be a way to copyright code that was generated by AI or from open source. “Finding that out is a key aspect of your due diligence,” added Crow.

Evaluating whether systems comply with NIST/ISO standards and determining if data rights transfer with the business are additional items to consider.

Best Due Diligence Practices for In-House Counsel

Prior to creating a Letter of Intent (LOI), the leadership should evaluate whether there is cohesion or internal strategic alignment with the target company. “Signing a nondisclosure agreement should be the first thing you do before any significant conversations,” advised Crow.

Nondisclosure agreements (NDAs) should be tailored to the specifics of the transaction. “A mutual NDA may not always be preferable,” noted Crow. “Including a non-solicit in the NDA is also usually advisable, so that you can protect your key employees.”

The LOI should typically be non-binding, with the exception of a few provisions, including a provision that prohibits shopping the deal around. After the LOI is finally complete, the confirmatory diligence phase begins, and this is often facilitated by virtual data rooms.

Properly organizing the files in the data room is essential. Doing so facilitates a smoother transaction, as it helps both parties maximize their time. Similarly, it is vital to have subject matter experts get involved in the process early and prioritize issues by the severity of the risk.

Negotiating deal points, producing key documents, and working to ensure regulatory as well as third-party approvals are essential next steps. Planning for the integration of employees and systems will also be necessary.

Additional best practices for in-house attorneys to consider include centralizing communications, using issue trackers, setting escalation paths for deal-critical decisions, coordinating regulatory strategy, and protecting internal confidentiality.

Representation and Warranties Insurance

Crow ended by mentioning that the use of Representation and Warranties Insurance (“RWI”) has become increasingly prevalent. RWI covers breaches of sellers' representations and warranties. It provides a number of advantages, including that it allows the seller to limit escrow/holdback amounts, speeds negotiations, and shifts the indemnity risk to the insurer.

The cost of the premiums, of course, can add to the costs associated with the transaction. Significantly, most policies exclude cybersecurity vulnerabilities, data privacy compliance gaps, AI models and data provenance risks, and red flags identified during due diligence.

In terms of RWI, in-house attorneys should ensure the diligence scope matches the policy coverage, manage disclosure schedules carefully, negotiate retention, survival periods, and sunset provisions, and coordinate insurer calls with external counsel.

Comments on Structure

Mergers and acquisitions can be structured in a variety of ways. A typical stock purchase structure allows for simple continuity and a possible qualified small business gain exemption. The buyer assumes all liabilities, however, and they are not allowed to deduct the purchase price as depreciation.

If the transaction is structured as an asset purchase, the buyer can select the asset(s) of their choosing and avoid unwanted liabilities. This type of deal structure also offers depreciation deductions for the buyer but there are drawbacks for the seller, including the potential for increased tax liabilities. A buyer may opt for this structure if the seller has legacy risks.

Mergers can have complex statutory requirements. Consents are often unnecessary or minimal, however, and this form of a transaction can allow for clean corporate succession.

An F Reorganization is a tax-free reorganization used to allow a seller to reorganize before selling, as well as the facilitation of S-Corp deals, private equity rollovers, and the preservation of tax attributes. It can be used when an S-Corp wants to sell to a buyer taxed as a partnership or corporation, to enable a buyer to purchase equity while getting tax benefits, and to simplify post-closing integration and maintain legacy contracts.

While there were additional questions, due to time constraints, the presentation ended there, with the audience wanting more.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.