Franchising and Licensing Two Powerful Ways to Grow Your Business in Any Economy_12 ppt

Thus, some of the most common reasons thatfranchisors consider a merger or acquisition with another franchisor or whynonfranchise companies consider franchise systems as viable acquisiti

of competing or complementary franchise systems are a viable strategy forresponding to these pressures Thus, some of the most common reasons thatfranchisors consider a merger or acquisition with another franchisor or whynonfranchise companies consider franchise systems as viable acquisition tar-gets include:

❒ The desire to add new products or services to its existing lines withoutthe expense and uncertainty of internal research and development

❒ The desire to expand into a new geographic market or customer basewithout the expense of attracting new franchisees into these locations

or developing a new advertising and marketing program

❒ The need to increase size to effectively compete with larger companies

or to eliminate the threat of a smaller competitor

❒ The desire for market efficiencies through the acquisition of suppliers(backward integration) or existing franchisees or distributors (forwardintegration)

❒ The need to strengthen marketing capabilities or improve the quality ofmanagement personnel

There are numerous complex issues involved in the merger or acquisition

of any company, including both legal and business considerations This isespecially true for franchisors, however, who must address not only the po-tential issues related to taxes, securities regulation, labor laws, employeebenefits, antitrust, environmental regulation, corporate governance, bank-ruptcy, and antitrust compliance but who also must understand the nature ofthe assets of the franchise system being acquired and the unique relationshipbetween the franchisor and its franchisees Franchisors that are consideringtheir first acquisition must understand that the transaction is a process, not

an event The management of the process, the quality of the franchisor’s team

of advisors, and a clear understanding of the franchisor’s transactional tives will all go a long way toward ensuring that the completed deal is ulti-mately a success for the franchisor, its shareholders, and the overall system

objec-A key component of the management of this process will also be an analysis

of how the proposed transaction may affect the franchisor-franchisee tionship, including the potential dilution of its brands, the overlap of itsterritorial rights, and potential confusion in the product and service mixesoffered to consumers

rela-Key Trends and Observations

It goes without saying that the last few years have been very challengingfor M&A transactions from deal offer, deal valuation, and deal structuringperspectives and in getting deals done, especially when compared to the

1997 to 2000 time frame The events of September 11, 2001, have not madethings any easier, but it is premature to throw in the towel in regard to gettingdeals done or in thinking that the near future will not once again be a vibrant

and active period for M&A activity Set forth below are some of my tions on the current state of the M&A marketplace.

observa-1 The pace and frenzy of M&A deals had slowed—even before September11th and more recent events and fears, but seem to be picking up slowly.The better deals are getting done, but there are fewer players pushingtheir way for a place to sit at the table

2 Capital is still available to get certain types of transactions completed—capital has tightened to weed out the weaker deals—which is part of anatural economic cycle and not necessarily a bad thing, given that manydeals in 1999 and 2000 should never have been consummated

3 Valuations on the seller’s side have become much more realistic, creatingmany opportunities for buyers who have cash (or access to cash) and theright internal and advisory teams to get deals done The Federal Re-serve’s active bias toward low interest rates reduces borrowing andtransactional costs for the right types of transactions, which lend them-selves to leveraged finance

4 Reduced valuations have also created opportunities for consolidation;many venture capitalists and private equity funds are very motivatedand willing to sell the ‘‘dogs’’ and perceived underperforming compa-nies at a fraction of what they paid, and failed roll-ups are starting toliquidate some of their holdings

5 Deals are closing within a slower time frame—the rush to get deals donequickly has subsided except in special circumstances and the due dili-gence periods have become extended and issues more complex, rangingfrom increased litigation, more challenging intellectual property issues,underwater stock option plans, etc.—especially in a post–Sarbanes-Oxley environment

6 Professional advisors must be extra careful in drafting the tions and Warranties in the Acquisition Agreement to address the newdue diligence challenges and demands brought on in the new age ofscrutiny—as well as the scope and terms of indemnification and othercovenants to protect the buyer against surprises

Representa-7 Tax breaks to facilitate mergers and acquisitions may be in the works aspart of the overall economic stimulus packages currently being consid-ered by Congress and the White House and—the regulatory and antitrustapproval process should also be a bit more relaxed as we strive towardeconomic recovery

8 Cross-border deals have slowed down as more global companies are cused on shoring things up in their own backyard and are reluctant totravel; it seems as though the desires to live in a global village and buildglobal companies have been put on hold for awhile, as overseas compa-nies refine their U.S penetration and capital investment strategies

fo-9 The elimination of pooling by FASB has not completely killed mergersand acquisitions activity (as feared), but the new rules do require a gameplan in place for several key financial issues, such as how goodwill will

be allocated and amortized (if at all), the impact of the proposed deal onearnings, and other related tax and accounting issues.

10 During these challenging times, it is more critical than ever to have theright ‘‘deal team’’ assembled, made up of both internal executives andexternal advisors who have the experience and the tenacity to get dealsdone properly

Unlike the go-go times of a few years ago, the leaner and meaner economyleaves little margin for error and is quick to penalize those companies thatoverpay or make structural mistakes in their M&A strategy The list of house-hold-named acquirers whose stocks are down 60, 70, or 80 percent off theirhighs because they persisted in doing deals where intended synergies werenever achieved, the buying prices were too high, or the post-merger culturesare not melding is too long to mention here—but we all know who they areand don’t want to join their misery

As franchisors considering M&A as a growth or expansion strategy,some issues for consideration include:

1 What lessons can we learn from the meltdown and significantly reducedpostclosing valuations of the companies that were very acquisitive in1998–2001? Is the GE–Tyco model dead? How can conglomerates builtvia acquisition ever achieve scale and full value? What can we learn fromthe multibranded franchising systems models of Cendant, YUM, theDwyer Group, and others?

2 What new due diligence, deal structuring, and negotiation techniques andpractices have emerged in a post–Sarbanes-Oxley environment? Willthese new ‘‘rules of the game’’ put a damper on the M&A environment?

3 How will global events and fears affect the level cross-border tional activity? Will everyone decide to focus on his or her own backyard?

transac-Or are those just the growing pains of globalization as we move toward atruly interdependent world?

4 What does postclosing synergy really mean anymore? What went wrong?Why have so many deals failed to achieve postclosing integration andeconomics of scale objectives? Will shareholders trust their leaders andrecommended deals?

5 Are your advisory teams prepared to deal with the fact that intellectualproperty and intangible assets (e.g., brands, relationships, know-how,databases, patents, teams, etc.) make up the lion’s share of the assets orvalue being purchased? Does the team have the skills and experience torecognize these assets, make sure they have been properly protected, andidentify their full potential on a postclosing basis?

Analysis of One or More Target Companies

The acquiring company must begin the acquisition or merger process with aplan identifying the specific objectives to be accomplished by the transaction

and the criteria to be applied in analyzing a potential target company ing within the targeted industry Once acquisition objectives have been iden-tified, the next logical step is to narrow the field of candidates Some of thequalities that a viable acquisition target might possess include:

operat-❒ Operates in an industry that demonstrates growth potential

❒ Has taken steps necessary to protect any proprietary aspects of its ucts and services

prod-❒ Has developed a well-defined and established market position

❒ Possesses ‘‘strong’’ franchise agreements with its franchisees with mal amendments or ‘‘special exceptions.’’

mini-❒ Has good relationships with its franchisees and strong customer faction and brand loyalty to its core products and services offered by itsfranchisees

satis-❒ Is involved in a minimal amount of litigation (especially if the litigation

is with key customers, distributors, franchisees, or suppliers)

❒ Is in a position to readily obtain key third-party consents from lessors,bankers, creditors, suppliers, and investors (where required); the failure

to obtain necessary consents to the assignment of key contracts or toclear encumbrances on title to material assets may seriously impede thecompletion of the transaction

❒ Is in a position to sell so that negotiations focus on the terms of the sale,not whether to sell in the first place

In addition to the general business issues discussed above, the followingissues should be examined when evaluating the potential acquisition of afranchise system:

❒ The strength and registration status of the target’s trademarks and otherintellectual property

❒ The quality of the target’s agreements and relationships with its chisees

fran-❒ The status of any litigation or regulatory inquiries involving the target

❒ The quality of the target franchise sales staff

❒ The quality of the franchisee relationships, including the regularity ofthe franchisor’s cash flow from royalty obligations

❒ The strength of the target franchisor’s training, operations, and field port programs; manuals; and personnel

sup-❒ The existence of any franchisee association and its relationship with thefranchisor

❒ The strength and performance of the target’s company-owned units(where applicable)

Sometimes, instead of the acquisitor’s affirmatively seeking acquisition gets, the process is reversed, and it is the target, rather than the acquisitor,

tar-that is soliciting offers to be acquired Such an acquisition candidate mayoffer an excellent opportunity for the acquisitor, although the target’s opera-tions and financial condition should be closely inspected for any liability orpotential pitfall that may be hidden behind the good intentions of the sellers.(See Figure 16-1 for a breakdown of the acquisition process.)

The inspection of a potential target will be necessary regardless of whoapproaches whom (often referred to as the due diligence review) Prelimi-nary due diligence may be undertaken before any offer is made, and morethorough due diligence will certainly need to be completed by the acquisi-tor’s in-house and outside business and legal advisors before completing thedeal

The Due Diligence Review

Before conducting a thorough due diligence review of an acquisition date, the franchisor may want to conduct a preliminary analysis In mostcases, the principals of each of the companies will meet to discuss the possi-ble transaction The key areas of inquiry at this stage are the financial per-formance to date and projected performance of the target, the strength of thetarget’s management team, the target’s intellectual property, the condition ofthe target’s franchise system, including an understanding of the terms of thetarget’s existing franchise and area development agreements, any potentialliabilities of the target that may be transferred to the franchisor as a successorcompany, and the identification of any legal or business impediments to thetransaction, such as regulatory restrictions or adverse tax consequences Inaddition to a direct response from the target’s management, information may

candi-be obtained from outside sources, such as trade associations, customers andsuppliers of the target, industry publications, franchise regulatory agencies,

Figure 16-1 The franchisor’s acquisition process.

The franchisor’s planning and implementation of an acquisition program typically involves the following steps:

1 Develop acquisition objectives.

2 Analyze projected economic and financial gains to be achieved by the acquisition.

3 Assemble an acquisition team (managers, attorneys, accountants, and investment bankers) and begin the search for acquisition candidates.

4 Prepare due diligence analysis of prime candidates (franchise systems, vertical suppliers, systems that could be developed or converted into franchise systems, etc.).

5 Begin initial negotiations and valuation of the selected target.

6 Select the structure of the transaction.

7 Identify sources of financing for the transaction.

8 Undergo detailed bidding and negotiations.

9 Obtain all shareholder and third-party consents and approvals.

10 Structure the legal documents.

11 Prepare for the closing.

12 Hold the closing.

13 Performpost-closing tasks and responsibilities.

14 Implement the integration of the two entities.

chambers of commerce, securities law filings if the company is publiclytraded on a stock exchange or through the NASDAQ stock markets, or privatedata sources such as Dun & Bradstreet, Standard & Poor’s, and Moody’s.Some of this information may be readily available on the Internet.

Once the two companies have agreed to move forward, a wide variety

of legal documents and records, where applicable, should be carefully viewed and analyzed by the acquiring entity and its legal counsel The pur-pose of due diligence is to help answer two very basic questions: (1) Why are

re-we doing this deal? and (2) What risks will re-we assume if re-we decide to moveforward?

The following is an illustrative list of some of the questions that theacquisitor and its legal and accounting representatives will be trying to an-swer as they begin to draft the acquisition agreements that will memorializethe deal:

❒ What approvals will be needed to effectuate the transaction (e.g., directorand stockholder approval, governmental consents, lenders’ and lessors’consents, etc.)?

❒ Are there any antitrust problems raised by the transaction? Will filing benecessary under the premerger notification provisions of the Hart-Scott-Rodino Act?

❒ Are there any federal or state securities registration or reporting laws tocomply with?

❒ What are the potential tax consequences to the buyer, seller, and theirrespective stockholders as a result of the transaction?

❒ What are the potential postclosing risks and obligations of the buyer? Towhat extent should the seller be held liable for such potential liability?What steps, if any, can be taken to reduce these potential risks or liabili-ties? What will it cost to implement these steps?

❒ Are there any impediments to the transfer of key tangible and intangibleassets of the target company, such as real estate or intellectual or otherproperty?

❒ Are there any issues relating to environmental and hazardous waste laws,such as the Comprehensive Environmental Response Compensation andLiability Act (the Superfund law)?

❒ What are the obligations and responsibilities of buyer and seller underapplicable federal and state labor and employment laws (e.g., will thebuyer be subject to successor liability under federal labor laws and as aresult be obligated to recognize the presence of organized labor and there-fore be obligated to negotiate existing collective bargaining agreements?)?

❒ To what extent will employment, consulting, confidentiality, or petition agreements need to be created or modified in connection with theproposed transaction?

noncom-❒ What are the terms of the target’s agreements with its existing franchisees?Are these agreements assignable? Do they contain clauses giving the fran-

chisor discretion to change the system or ownership? Could any of theseterms cause problems for the acquiring franchisor at a later date?

❒ Is the target currently involved in litigation with franchisees, creditors,competitors, or suppliers? Threatened litigation? Potential litigation?What is the risk of exposure to the acquiring franchisor?

❒ Have the target’s registration and disclosure documents been properlyfiled and updated?

Figure 16-2 provides some common mistakes made during due diligence.Some of the questions that will be analyzed by the acquisitor’s business andaccounting advisors include:

1 Does the target franchisor fit into the long-range growth plans of theacquiring franchisor?

2 What are the target franchisor’s strong points and weaknesses? Howdoes management of the acquiring franchisor plan to eliminate thoseweaknesses?

3 Has the acquiring franchisor’s management team developed a hensive plan to integrate the resources of the target?

compre-4 What is the target franchisor’s ratio of company-owned outlets to chisees?

fran-Figure 16-2 Common due diligence mistakes.

• Mismatch between the documents provided by the seller and the skills of the buyer’s review team It may be the case that the seller has particularly complex financial statements or highly technical reports that must be truly understood by the buyer’s due diligence team Make sure there is a capability fit.

• Poor communication and misunderstandings The communications should be open and clear between the teams of the buyer and the seller The process must be well orchestrated.

• Lack of planning and focus in the preparation of the due diligence questionnaires and in the interviews

with the seller’s team The focus must be on asking the right questions, not just a lot of questions.

Sellers will resent wasteful ‘‘fishing expeditions’’ when the buyer’s teamis unfocused There should be

a clear fit between the questions asked and the compelling strategic rationale that underlies the transaction.

• Inadequate time devoted to tax and financial matters The buyer’s (and seller’s) CFO and CPA must play an integral part in the due diligence process in order to gather data on past financial performance and tax reporting, unusual financial events, or disturbing trends or inefficiencies.

• The buyer must insist that its team will be treated like welcome guests, not enemies from the IRS! Many times the buyer’s counsel is sent to a dark room in the corner of the building to inspect docu- ments without coffee, windows, or phones It will enhance and expedite the transaction if the seller provides reasonable accommodations and support for the buyer’s due diligence team.

• Failure to closely examine the intangible factors that drive a deal’s success Many deals fail because

of a lack of a shared vision or conflicting corporate cultures The franchisor’s due diligence must include a process for measuring the likelihood that the two cultures and systems will ultimately fit on

a post-closing basis.

5 Are the target’s products and services competitive in terms of price,quality, style, and marketability?

6 Does the target franchisor manufacture its own products? What tions are purchased from outside sellers?

propor-7 What is the target’s past and current financial condition? What aboutfuture projections? Are they realistic?

8 What is the target franchisor’s sales history? Has there been a steadyflow of franchise sales and royalty payments?

9 What is the target franchisor’s attrition rate? Have there been many cent terminations or transfers? Have any of these been contested by fran-chisees as lacking good cause?

re-The Role of the Franchisee in a Proposed Merger or Acquisition

Unlike other types of growing companies involved in mergers and tions, franchisors have existing contractual vertical distribution systems inplace through their franchisees The interests of these franchisees ought to

acquisi-be taken into account when the franchisor’s counsel analyzes the legal quences and potential costs of the proposed merger or acquisition Thesefranchisees are clearly ‘‘interested parties,’’ whose contractual and otherlegal and equitable rights must be considered Although there is no statutory

conse-or legal basis fconse-or disclosing the intent to engage in a merger conse-or acquisition,nor is there typically a contractual requirement to obtain their approval, good

‘‘franchisee relations’’ practice would dictate their involvement in somefashion The cooperation of the franchisee networks of both buyer and sellercan either greatly facilitate the transaction or virtually kill the deal, depend-ing on how this communication problem is handled

For example, if the franchisor acquires another franchisor in a tive or parallel line of business, careful merger planning and negotiation will

competi-be necessary to ensure a smooth integration of the target’s franchise systeminto the buyer’s existing operations (assuming that only one system will sur-vive after the transaction) and to avoid potential litigation or costly settle-ment with affected franchisees of either system In addition, if conversion orchange is planned as a result of the merger or acquisition, franchisors shouldexpect to involve franchisees, at least to a certain extent, in the decision-making process The acquiring franchisor should not automatically assumethat franchisees in the acquired system will be willing to convert to the buy-er’s existing system When change or conversion is contemplated, some attri-tion and/or franchisee resistance should be expected in both systems, andthe impact and costs of this attrition and resistance will typically be reflected

in the purchase price of the target franchisor

On one hand, the franchisee is typically neither a shareholder, creditor,investor, officer, or director of the franchisor and would technically be gov-erned only by the terms of franchise agreements, which usually gives broadlatitude to the franchisor to assign rights or modify the franchise system Yet

to ignore the fact that the franchisee is clearly an interested and affected

party in any change in the franchisor’s organizational structure or system isunrealistic and could result in very costly litigation that might even out-weigh any anticipated benefits to the proposed merger or acquisition SeeFigure 16-3 for a list of legitimate concerns that a franchisee might have re-garding a merger or acquisition.

Figure 16-3 Legitimate concerns of the franchisee network in a merger

or acquisition.

Clearly, the franchisee will have some legitimate questions and concerns when it first learns of the proposed transaction The savvy franchisor will anticipate these concerns and integrate the proposed solutions into its acquisition plan and communications with the franchisees and/or the franchisee association:

1 What are the acquiring franchisor’s plans for the acquired system? Consolidation and sion? At whose cost? Liquidation? Growth?

conver-2 What is the reputation and management philosophy of the acquiring franchisor? What are its attitudes toward field support and ongoing training?

3 Will the acquiring franchisor be sensitive to the rights and concerns of the franchisees? Or will the franchisees adopt a ‘‘we’d rather fight than switch’’ mentality toward the new buyer in anticipation of hostile negotiations?

4 What is the financial strength of the acquiring franchisor? Will the acquiring franchisor open up new opportunities for the franchisees, such as access to new product lines, financing programs for growth and expansion, produce purchasing, and cooperative advertising programs?

5 If the target franchisor owns real property that is leased to franchisees, will the terms and conditions of the current leases be honored by the acquiring franchisor? What about other contractual obligations? Are there any special relationships with third-party vendors that will be affected or damaged by the transaction?

Special Problems Relating to Franchisees of the Acquiring or the Acquired Franchise System

There are a number of potential issues for dispute between the acquiring oracquired franchisor and its franchisees that may arise as a result of a merger

or acquisition Whether or not these issues will arise will, of course, depend

on a variety of factors, including the similarity of the businesses of the ing systems, the territories in which they operate, the terms of the contractswith existing franchisees in each system, the size and market power of themerging franchisors, the competitors (or lack of) of each of the franchisors,and most important, the plans of the surviving company Because there is animplied obligation on franchisors to act in good faith and in a commerciallyreasonable manner, a covenant recognized by many state courts in their in-terpretation of the franchise relationship, the issues to which both fran-chisors should pay special attention include:

merg-❒ The extent of any territorial exclusivity granted to the franchisees of eachsystem Is exclusivity given only for a certain trademark or line of busi-ness? Is territorial exclusivity conditioned on the performance of the fran-chisees? Will substantially similar franchisees violate this exclusivity?

❒ Will all existing franchisees of both systems be maintained, or will a solidated distribution system result in termination of some franchisees?

con-❒ Will franchisees be required or requested to convert to a new businessformat? Who will pay the costs of building conversion, new training,products, and services? Will the franchisor finance all or part of the con-version costs?

❒ Will existing franchisees of each system be forced to add the products andservices of the other? Will this present tying or full-line forcing problems?

❒ Does the acquiring franchisor have sufficient support staff to adequatelyservice the new franchisees, or will the acquiring company’s existing fran-chisees be ignored in order to develop and market the new acquisitions?What rights do the existing franchisees have to challenge this lack of at-tention?

❒ Will a new, third type of system combining the products and services ofthe acquiring and acquired franchisors be offered to prospective fran-chisees of the surviving entity?

❒ Will existing franchisees of either system be eligible to convert to this newsystem?

❒ Can the acquiring franchisor legitimately enforce an in-term covenantagainst competition when the franchisor itself has acquired and is operat-ing what is arguably a competitive system?

❒ Do the franchisees of either franchisor have a Franchisee Association orFranchisee Advisory Council? Must these groups be consulted? Whatduty does the franchisor have to involve these groups in merger planning?What about regional and multiple franchisees holding developmentrights?

❒ Does either franchisor have company-owned outlets in its distributionsystem? What will be the status of these outlets after the merger or acquisi-tion?

❒ To what extent will royalty payments, renewal fees, costs of inventory,performance quotas, and advertising contributions be affected by the con-templated merger or acquisition? On what grounds could franchiseeschallenge these changes as unreasonable, breaches of contract, or viola-tions of antitrust laws? How and when will these changes be phased intothe system? Will the franchisees be given a chance to opt in or opt out(mandatory vs optional changes)?

❒ Will the proposed transaction result in the termination of some of thefranchisees of either system due to oversaturation of the market, territorialoverlap, or underperformance? What legal and statutory rights of the fran-chisee are triggered?

The Consequences of Inadequate Planning and Due Diligence

The consequences of inadequate pretransaction planning and investigation

to both the acquisitor and the target in a transaction combining two or more

franchise systems can be financially devastating, often resulting in years oflitigation while the franchise system suffers—for example, in a recent stockpurchase acquisition of a food concept by another similar concept Theseller’s management intentionally concealed from the buyer material infor-mation concerning certain contractual defaults and potential litigation prob-lems Although the buyer escrowed some of the purchase price to cover thecosts of defending franchisee litigation that was disclosed, the undisclosedlitigation was costing far in excess of the amount reserved To make mattersmore complicated, the same management who had concealed the litigationwrought indemnification from the buyer, who had agreed to limited indem-nity for the sellers and their managers because of the ability under certainfranchise and trade practices statutes of a claimant to sue individual officersand directors personally Now, the buyer must address both the successorliability claim and the dispute with the former management.

In another example, the owners of a franchise system that was to be soldfailed to inform the buyer of serious disagreements with its franchisees Therelationship between the seller and the franchisees had deteriorated to thepoint where they had retained a lawyer to represent them at a meeting withthe franchisor Fortunately, the buyer learned of the meeting and the prob-lems, and decided to delay the transaction pending the seller’s ability towork the probe out with the franchisees Finally, in one other example, twopublicly traded franchise companies signed a letter of intent to move forwardwith a combination that would be paid for in stock of the acquisitor Negoti-ating the basic terms of the transaction took a substantial amount of time andeffort by both companies and their representatives Finally, after agreement

in principal was reached, the companies discovered serious securities lawimpediments and after further expense and effort on everyone’s part, theysimply could not satisfy the regulators at the Securities and Exchange Com-mission The deal was scrapped

Thus, the difficult legal and strategic issues that are triggered in a merger

or acquisition by and among franchisors can either be resolved, and litigationavoided, with careful pretransaction planning and investigation by the ac-quiring and acquired franchisors, or can cause the deal to fail Among thecritical steps toward a successful transaction, communication with the fran-chisees of both systems is of paramount importance

Preparing the M&A Documentation

Once the due diligence has been completed, valuations and appraisals ducted, and the terms and price initially negotiated and financing arranged,the acquisition team must work carefully with legal counsel to structure andbegin the preparation of the definitive legal documentation that will memori-alize the transaction The drafting and negotiation of these documents willusually focus on the past history of the seller, the present condition of thebusiness, and a description of the rules of the game for the future They alsodescribe the nature and scope of the seller’s representations and warranties,the terms of the seller’s indemnification of the buyer, the conditions prece-

con-dent to closing of the transaction, the responsibilities of the parties duringthe time period between execution of the purchase agreement and actualclosing, the terms and structure of payment, the scope of postclosing cove-nants of competition, the deferred or contingent compensation components,and any predetermined remedies for breach of the contract.

Figure 16-4 is designed to be a diagnostic tool to ensure that the chisor and its team and all other parties to the transaction understand theacquisition agreement and to ensure that the three key categories of issues—namely, consideration, mechanics, and allocation of risk—have been ad-dressed and that the definitive documents are reflective of the businesspoints reached between the parties Virtually all key issues in the acquisitionagreement fall into one of these three categories

fran-Other Key Issues in Preparing and Negotiating the Acquisition Agreement

Allocation of Risk

As discussed above, the heart and soul of the acquisition agreement is, inmany ways, merely a tool for allocating risk The franchisor as buyer willwant to hold the seller accountable for any postclosing claim or liability thatarose relating to a set of facts that occurred while the seller owned the com-pany or that has occurred as a result of a misrepresentation or material omis-sion by the seller The seller, on the other hand, wants to bring as muchfinality to the transaction as possible to allow some degree of sleep at night.When both parties are represented by skilled negotiators, a middle ground isreached both on general and on specific issues of actual or potential liability.The franchisor’s counsel will want to draft changes, covenants, representa-tions, and warranties that are strong and absolute to protect its interests as abuyer and the seller’s counsel will seek to insert phrases like ‘‘except insig-nificant defaults or losses that have not, or are not likely to, at any time

Figure 16-4 Understanding the acquisition documents.

Consideration Mechanics Allocation of Risk

• Structure • Conditions to Closing • Representations and

Warrant-• Scope of Purchase • Timetable ies (R&W’s) 2-Way Street

• Price • Covenants (including Cove- (Due Diligence Driven)

• How/When Paid nants Not to Compete) • Indemnification

• Deferred Consideration/ • Third-Party and Regulatory • Holdbacks and Baskets

• Earn-Outs and Contingent • Schedules (Exceptions/ Stock or Notes, then R&W’s

• Other Ongoing Financial • Opinions • Collars

Relationships between • Dispute Resolution • R&W Insurance

Agreements

• Post-Closing Adjustments

before or after the closing, result in a material loss or liability to or againstthe buyer,’’ leaving some wiggle room for insignificant or nonmaterialclaims The battleground will be the indemnification provisions and any ex-ceptions, carve-outs, or baskets that are created to dilute these provisions.The weapons will be the buzzwords referenced below.

Scope of the Assets

The typical buyer will want to specify a virtual laundry list of categories ofassets to be purchased, but the classic seller will want to modify the list byusing words like ‘‘exclusively’’ or ‘‘primarily.’’ The seller may want to ex-clude all or most of the cash-on-hand from the schedule of assets to be trans-ferred In some cases, the seller may want to license some of the technologyrights in lieu of an outright sale or, at the very least, obtain a license back ofwhat has been sold

Security for the Seller’s Takeback Note

When the seller is taking back a note from the buyer for all or part of theconsideration, the issue of security for the note is always a problem Natu-rally, the seller will want noncontingent personal and corporate guarantiesfrom the buyer and anyone else that it can manage to get The buyer will bereluctant to offer such broad security Several ‘‘creative’’ compromises havebeen reached between the parties, including partial or limited guaranties,the acceleration of the note based on postclosing performance, the right torepurchase the assets in the event of a default, the issuance of warrants orpreferred stock in the event of default, commercial lender–like covenants toprevent the buyer from getting into a position where it is unable to pay thenote (such as dividend restrictions, limitations on excessive salaries, etc.), orcontingent consulting agreements in the event of a default

Who’s on the Line for the Financial Statements

The financial statements provided by the seller to the buyer in connectionwith the due diligence and prior to closing are often hotly contested items.The timing and scope of the financial statements as well as the standard towhich they will be held is at issue The buyer and its team may prefer a ‘‘hot-off-the-press’’ and recently completed audited set of financials from a Big 5accounting firm, and the seller will want to serve up a ‘‘best-efforts’’ unaud-ited and uncertified guesstimate Somewhere in between is where most dealswind up, with verbiage such as ‘‘of a nature customarily reflected’’ and ‘‘pre-pared in substantial accordance with GAAP’’ and ‘‘fairly present the finan-cial condition’’ being bantered around The scope of the liabilities included

on the statements and the matter of who will bear responsibility for unknown

or undisclosed liabilities will also be negotiated in the context of the cial statements overall discussion

finan-Playing with the Buzzwords

Any veteran transactional lawyer knows that there are certain key buzzwordsthat can be inserted into sections of the acquisition agreement that will de-tract or enhance or even shift liability by and among the buyer and seller.Depending on which side of the fence you are on, look out for words orphrases like the following as tools for negotiation and as phrases:

Ordinary course of business

To which we are aware

Would not have a material adverse affect on

Primarily relating to

Substantially all

Might (instead of ‘‘would’’)

Exclusively

Have received no written notice of

Have used our best efforts (or commercially reasonable efforts) to Even merely ‘‘endeavor to ’’