DOMESTIC MERGERS AND ACQUISITIONS: Legal Challenges to Successful Expansion

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DOMESTIC MERGERSAND ACQUISITIONSLegal
Challenges to Successful Expansion

• Presented by Andrew J. Haliw, III
• HSM Law Offices
• Farmington Hills, MI

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Topics of Discussion

• Overview and History
• Sarbanes-Oxley
• Valuation of a Corporation
• Intellectual Property
• Antitrust Implications
• Acquisition of Bankrupt Corporations

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OVERVIEW AND HISTORYThe 1980s

• There was a steady increase through the 1980s
  for Mergers Acquisitions
• The 1980s saw the largest decade increase for
  total value of Mergers and Acquisitions
• Activity briefly slowed at the end of the decade
  due to slowdown of the economy, collapse of the
  junk bond market, and increased corporate
  governance regulations

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OVERVIEW AND HISTORYThe 1980s
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OVERVIEW AND HISTORYThe 1990s

• The real boom of MA activity took place through
  the 1990s
• There was an increase in total value of MA
  activity every year in the 1990s
• This increase came through
• interest groups lobbying congress
• corporations modifying their governing structure
  and
• modifying management incentives to induce MA
  activity

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OVERVIEW AND HISTORYThe 1990s
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SARBANES-OXLEY ACT of 2002

• The purpose of Sarbanes-Oxley is to respond to
  corporate scandal and increase accountability
  standards
• Increase disclosure of internal control by
• Maintain an annual internal control report
• Independent audit firms must attest to internal
  control procedures
• Quarterly disclosure of any activity that has a
  substantial impact on internal control system

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SARBANES OXLEY ACT of 2002Achieving Compliance

• All NYSE listed corporations must attain
  compliance with Sarbanes-Oxley
• Greater degrees of due diligence are placed on
  corporations
• Described as a war of attrition to attain
  compliance
• SEC delayed compliance deadlines twice to
  accommodate companies with complex valuation
  structures

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SARBANES OXLEY ACT of 2002Avoiding
Non-Compliant Targets

• Penalties for non-compliant corporations are
  severe
• Financial penalties, suspension of operations,
  and negative impacts on costs of capital
• Willful falsification of control reports can
  result in up to fines of 5 million and/or 20
  years in prison
• Acquiring non-compliant targets is very risky and
  costly, if not totally disastrous
• The costs of bringing a non-compliant target to
  compliance are very substantial. Avoid these
  targets.

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SARBANES OXLEY ACT of 2002Sustainability of
Compliance

• Developing Personnel
• Creating Formal Operational Processes
• Upgrading Technology

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Sarbanes-Oxley Act of 2002Developing personnel

• Define the role of every person in the company
  that affects internal control
• Update job descriptions
• Create new jobs solely to manage internal control
• Systematic training programs to improve personnel
• Enhance communication channels
• Identify and improve skill and competency
  deficiencies

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Sarbanes-Oxley Act of 2002Creating Formal
Operation Processes

• Internal Control must be run 365 days a year
• Management must look beyond quarterly and yearly
  goals
• Long term vision required See the forest for
  the trees
• Operation process should consider
• Financial risk assessment
• Effectiveness of company procedures
• Ability to fix deficiencies and
• Documentation, recordkeeping, and accuracy of
  communication

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Sarbanes-Oxley Act of 2002Upgrading Technology

• Compliance can be streamlined more efficiently
  through appropriate technology
• Types of technology to help this aspect
• To manage documentation, testing, monitoring, and
  reporting
• To integrate the financial and internal control
  systems
• To monitor the IT environment on a continuous
  basis
• Specialized software can be found at
• http//www.aicpa.org/pubs/jofa/feb2004/winters.htm
  impact

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III. VALUING A CORPORATION

• Independent approval boards should be hired to
  obtain fair value
• Three types of valuation approaches
• Market Approach
• Asset Approach
• Income Approach

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VALUING A CORPORATIONMarket Approach

• Value based on actual sales of comparative
  companies or securities
• Two types of comparisons can be made
• Recent transactions of similarly merged companies
• Value of a comparable publicly traded company

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VALUING A CORPORATIONAsset Approach

• Value is figured by comparison of currently owned
  assets to current liabilities
• Net Asset Value (NAV) and Asset Accumulation
  Method are common under this approach
• In the Asset Accumulation Method, tangible and
  intangible assets are measured separately

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VALUING A CORPORATIONIncome Approach

• Present value of future income expected to be
  earned by the owners of the business
• Future income must be valued by what this company
  would make if the merger/acquisition never took
  place
• Courts do not allow the valuation to be
  influenced by the merger/acquisition itself
• Direct Capitalization Method and Yield
  Capitalization Method are popular under this
  approach

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IV. INTELLECTUAL PROPERTY

• Major issues with IP in MA transactions
• Valuation of IP in MA transactions
• Maximizing IP opportunities in MA transactions

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INTELLECTUAL PROPERTYMajor IP issues

• What type of IP is available?
• Is the product offered protection under IP law?
• Will the acquiring company but out the rights
  held by the target company?
• Will the transaction expose the IP to the global
  marketplace?
• Who will enforce the protection of the IP rights?

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INTELLECTUAL PROPERTYValuation of IP

• In the early 1990s, very few businesses took
  advantage of the full value of IP
• The average company only uses about 20 of its
  potential IP
• The maximum value of IP is estimated to be three
  to four times more than the maximum value of
  tangible property
• Gordon Petrash developed a six step process to
  maximize the value of a companys IP
• Petrashs efforts increased IP revenue at Dow
  Chemical from 25 million to 125 million and
  reduced costs by 50 million

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INTELLECTUAL PROPERTYValuation of IP The
Petrash Strategy

• Step One Define the role of IP in your business
• Step Two Assess the IP strategies of competitors
• Step Three Classify the IP portfolio to
  determine
• What you have, what you use, and what you are
  lacking
• Step Four Evaluate the worth of your IP assets
• Step Five Invest by identifying gaps in your IP
  portfolio and fill the gaps by creating new IP
• Step Six Formally assemble an IP portfolio and
  repeat the process ad infinitum

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INTELLECTUAL PROPERTYIP Opportunities

• Determining accurate value of a company requires
  careful assessment of the companys IP
• Acquiring companies may gain an edge by a company
  who fails to accurately assess its own IP
• Target companies must do a careful assessment to
  avoid being taken advantage of
• The intangible nature of IP makes it an easy
  asset to overlook
• According to Deloitte Touche Tohmatsu, IP assets
  account for 70 of the market value for SP 500
  companies
• Only one out of ten companies operate IP as a
  valuable asset

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V. ANTITRUST IMPLICATIONS

• Basic reasons for MA transactions
• Investment opportunity
• Growth and stability for a company
• Hostile takeover
• Product diversification
• Stay competitive with foreign companies
• Antitrust investigations may be triggered by
  these
• The Department of Justice (DOJ) may block any
  transaction that violates the Sherman Antitrust
  Act
• The DOJ may refuse to look at the intent to
  compete with foreign companies if the transaction
  violates Antitrust regulations

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VI. ACQUIRING BANKRUPT CORPORATIONS

• Investment opportunity for acquiring company
• Careful analysis of bankrupt target is required
• Major issues to consider
• How will the targets debts be discharged?
• Will the acquiring company owe a duty to
  creditors?
• Will the creditors or bankruptcy judge block the
  acquisition?
• What are the tax implications of the acquisition?

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ACQUIRING BANKRUPT COROPORATIONSTax Implications

• IRC 269 provides that if the sole purpose of an
  acquisition is to avoid taxes, then the costs of
  acquisition cannot be used to reduce tax
  liability
• Evidence to show tax avoidance is not being
  practiced includes allowing target to operate
  its old business and having the target retain
  its operating losses