A merger can be a time-consuming and laborious endeavor. Before business parties spend the bulk of the time and incur the bulk of the transaction costs that are necessary to consummate a deal, it is usually prudent to ensure that they have a general understanding of the key terms on which their efforts will be based. A well-drafted letter of intent, or term sheet, is essential to achieving this understanding.

The letter of intent summarizes the central terms of the deal. These terms usually include some or all of the following: legal parties to the transaction; price; form of consideration to be paid by the buyer (e.g., cash, stock, debt, or some combination of the three); legal structure of the transaction (e.g., stock purchase, asset purchase, statutory merger); general description of assets purchased and liabilities assumed or excluded (if asset deal); expected tax consequences; key personnel issues; important technology matters; regulatory requirements (e.g., antitrust approval, SEC filing requirements); certain contingencies (e.g., due diligence investigations, board and shareholder approvals); any escrow arrangement and holdback of a portion of the consideration; and a handful of other terms.

The letter of intent is usually not the final, binding merger agreement between the parties. Instead it provides a roadmap for the parties to negotiate, draft, and sign a more detailed, definitive merger agreement that will serve as the binding contract for the deal.

However, it’s common for the letter of intent to nonetheless contain a few binding terms. For example, the buyer may seek a binding “no-shop” provision which prohibits a seller under certain circumstances from negotiating with other prospective buyers during a limited period of time while the current buyer attempts to get the deal done. The seller may in return seek a fiduciary carveout to ensure that its board of directors can comply with its fiduciary obligations when considering the sale of the business. Other terms may be binding such as expiration date of the letter and selection of the state law that will govern the binding terms.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 1: Introduction

Mergers & Acquisitions Primer | Part 2: Overview of the acquisition process

Mergers & Acquisitions Primer | Part 3: Nondisclosure Agreement

Most businesses should enter into a tailored nondisclosure agreement (NDA) before sharing confidential information and entering into substantive merger discussions. The seller usually is the party who has the most at stake since the seller usually provides the most information about its business.

However, in some cases, it is equally important for the seller to obtain certain confidential information about the buyer. For example, in cases where the buyer is a privately-held company and is offering its own stock or long term debt as part of the consideration, the seller will want to obtain confidential information about the buyer’s business. In these cases, the seller is essentially making an investment decision to buy stock or debt of the buyer in exchange for the seller’s business.

A tailored NDA will define confidential information for the parties (with appropriate carveouts), restrict the use and dissemination of confidential information, govern what happens to shared confidential information upon any termination of the merger discussions, address any applicable export compliance matters, and contain disclaimers, injunctive relief provisions, and other terms appropriate for this type of NDA.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 1: Introduction

Mergers & Acquisitions Primer | Part 2: Overview of the acquisition process

Mergers & Acquisitions Primer | Part 4: Letter of Intent

Federal and state laws govern the issuance and sale of securities by a business. If the instrument being issued or sold is not a “security”, the securities laws do not apply. A key question, then, is whether an instrument that a company is issuing or selling is a security. Both federal and state laws define a “security” and those definitions largely overlap. The definitions are lengthy and include numerous types of instruments, but in this Securities Law Primer we’ll identify some of the most common types.

A security includes those types of equity instruments which are commonly understood to be securities, such as common stock and preferred stock. A security also includes notes, bonds, and any instrument that is convertible into a security, such as an option to buy a share of common stock (i.e., a stock option), a warrant to purchase a share of preferred stock, and a promissory note that is convertible into stock.

A security encompasses any agreement to sell a security. For example, an owner of corporation sends a simple letter to a prospective employee that states, “Come work for my company and in one year I’ll sell you 20% of the company.” The prospective employee accepts. That letter is itself a security because it includes the right to buy an equity interest in the business.

Finally, federal and state laws include catch-all definitions. Under both federal and California law, an arrangement is a security if it is classified as an “investment contract”. Under California law, an arrangement is also a security if it meets a “risk capital test”. Several factors are analyzed to determine whether an arrangement satisfies the investment contract or risk capital tests, but essentially, these tests are met if a person gives money to another person for use in a venture or enterprise and any return or growth in the value of those funds are dependent primarily on the efforts of someone other than the person who gave the money.

The broad scope of what constitutes a security is intended, in the words of a seminal Supreme Court case, “to meet the countless and variable schemes devised by those who seek the use of the money of others.” (SEC v. W. J. Howey Co., 1946)

A common question is the extent to which interests in partnerships and limited liability companies constitute securities. The answer generally depends on whether the particular interest is accompanied by management responsibility of the business. Thus, a general partnership interest is typically not a security because the interest holder is usually responsible for the operations of the business (along with other general partners). On the other hand, a limited partnership interest is most always a security because limited partners do not have management responsibility in the partnership. An interest in a member-managed LLC, where all members in fact participate in the management of the business, is treated like a general partnership interest and generally is not a security. Whereas, an interest held by a non-manager in a manager-managed LLC is treated like a limited partnership interest and is usually a security.

Other posts in this series (more to come):

Securities Law Primer | Part 1: Applicability of securities laws

Buyers and sellers of companies find one another through a variety of means. Frequently, executives at companies already know many of the businesses in the industry and can identify candidates with a few phone calls. Investment bankers and business brokers often are employed to find candidates. And sometimes a merger partner is identified when a business receives an unsolicited phone call from the prospective partner.

In the initial discussions, merger partners discuss overall interest in buying or selling, the strategic and technological fit, price, and a few other high-level matters. Basic information may be shared, such as financial statements, bookings, and app user adoption rates. Prudent businesses negotiate and execute nondisclosure agreements before sharing any confidential information.

If the interest of the parties is high enough to proceed, a written term sheet or letter of intent is usually the next step, along with the sharing of more information. The letter of intent will outline the key terms of the deal and frequently is not binding on the parties (at least for certain business terms).

In most cases, the buyer also undertakes a comprehensive due diligence investigation of the seller. If, during this investigation, no information is uncovered that impedes the deal or causes either party to walk away, the parties proceed to negotiate and sign a definitive acquisition agreement. If there are ancillary agreements that are part of the deal (employment agreements, escrow agreements, etc.), these are frequently negotiated and drafted as well.

Once the acquisition agreement is executed, the deal is not yet completed in many cases. Acquisition agreements frequently have delayed closings built into the structure of the deal. This delay is necessary to ensure certain conditions are satisfied prior to the transfer of the seller’s business. These conditions include obtaining approvals from the parties’ shareholders, government agencies, and certain parties with whom the buyer or seller have contracted. When these conditions are satisfied, the closing of the acquisition can occur. At the closing, the buyer delivers the consideration, any required ancillary agreements are signed, and legal title to the seller’s business passes to the buyer.

Finally, the parties integrate their companies to achieve the business purpose for the deal, taking into account their respective human resources, IT infrastructures, sales channels, accounting and financial systems, lines of businesses, and so on.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 1: Introduction

Mergers & Acquisitions Primer | Part 3: Nondisclosure Agreement

Mergers & Acquisitions Primer | Part 4: Letter of Intent

Companies buy, sell, and merge with other companies for a variety of reasons: to grow; to remain competitive, get competitive, or become more competitive; to liquidate shareholders’ investments; to survive.

Some large public companies are serial acquirers and have experienced acquisition teams. Other businesses, such as privately-held RF/microwave companies and small makers of mobile software apps, are founded and run by engineers and software designers who have a taste for product performance or the latest social media trends, but who may have managed few, if any, company mergers.

This Mergers & Acquisitions Primer will seek to provide a roadmap for the M&A process and to outline some of the common issues that arise in deals involving private-held businesses.

Other posts in this series (more to come):

Mergers & Acquisitions Primer | Part 2: Overview of the acquisition process

Mergers & Acquisitions Primer | Part 3: Nondisclosure Agreement

Mergers & Acquisitions Primer | Part 4: Letter of Intent

For closely-held businesses that are not backed by venture capitalists or other outside professional investors, securities law compliance can be unfamiliar territory.

Federal and state securities laws generally apply to every issuance or sale of securities by a business. These laws (i) govern the information that the business must disclose to investors, (ii) regulate various types of conduct in connection with an issuance, and (iii) establish a regulatory filing scheme to demonstrate compliance with the laws.

When closely-held businesses issue or sell securities, the issuance either must be registered with the U.S. Securities and Exchange Commission (and applicable state authorities) or an exemption from registration must be available and used. Registering a securities issuance with the SEC essentially means that the company goes public in an initial public offering. IPOs and the compliance burdens of being a public company can be enormously expensive endeavors. Since bearing these costs are impractical for most businesses, the focus then is on finding an available exemption from registration and following the rules to comply with the exemption.

Other posts in this series (more to come):

Securities Law Primer | Part 2: Knowing when you are issuing a “security”

Beginning July 1, 2015, California employers must provide paid sick leave to their employees. The new law, called the Healthy Workplaces, Healthy Families Act of 2014, applies to hourly employees and exempt employees. Unlike some employment laws, there is no exemption for small employers.

The law does not apply to providers of in-home supportive services or, under certain conditions, to members of an air carrier flight deck or cabin crew. In addition, in a continuing trend of statutory exemptions being granted for employers with unions, the law does not apply under certain conditions to certain unionized employees. The law applies to all other employees as provided below.

Under the new law, employees who work in California 30 or more days within a given year (starting from the date of employment) are entitled to paid sick leave at an accrual rate of not less than 1 hour for every 30 hours worked (i.e., about 5 to 6 hours per month for a full time employee). Sick leave hours begin to be accrued on the later of (i) the first day of employment, or (ii) July 1, 2015. An employee who is exempt from overtime requirements is deemed to have worked 40 hours per week, unless the exempt employee’s normal workweek is less than 40 hours, in which case the employee accrues paid sick leave based on that reduced workweek.

An employee is entitled to begin using accrued sick leave on the 90th day of employment. Unused, accrued sick leave carries over to the following year, except that an employer may cap the total accrued sick leave to 48 hours or 6 days. An employer may also limit an employee’s use of paid sick leave to 24 hours or 3 days in each year of employment. However, if an employer provides at least 24 hours of sick leave generally at the beginning of each employment year, then the accrual and carryover rules do not apply. That is, no sick leave needs to be carried over to the following year and an employer can avoid the burden of incrementally accruing sick leave throughout the year by granting the full 24 hours of sick leave up front.

An employee may use sick leave for a broad range of purposes, including injury, illness, and preventive care. The leave may be used for the employee or for the employee’s family members (which is broadly defined). In addition, sick leave may also be used for time off due to domestic violence, sexual assault, and stalking.

If an employer already has a paid time off, or PTO, policy (which usually combines paid vacation and sick leave), the employer is not required to provide additional paid sick leave, so long as the PTO policy provides an employee with paid leave for the same purposes, at least under the same rates, and under the same conditions as required under the new law.

Unlike vacation pay, an employer is not required to pay out accrued sick leave upon an employee’s termination of employment. If, however, the employee is rehired within one year, then the employee’s prior accrued sick leave must be reinstated. In addition, if the sick leave is included in a PTO policy as described above, then all accrued PTO must be paid out on termination of employment.

Employers must post a notice in the workplace disclosing certain specified portions of the law. Employers must also give written notice on each pay day to each employee of the amount of sick leave accrued (or PTO accrued in lieu of sick leave). The notice must be given either through the employee’s wage statement or by a separate writing. Employers must keep records of sick leave accruals, hours worked, and sick leave used for at least three years.

Additional rules apply regarding, among other things, how sick leave is calculated and paid, employee notification requirements upon a foreseeable sick leave, advance lending of sick leave by the employer, and the setting of minimum sick leave increments that may be used at any one time.

Finally, an employer may not discriminate or retaliate against employees who use sick leave. Violation of the new law subjects an employer to considerable penalties, including in certain cases attorneys’ fees incurred in actions against the employer to enforce the law.