Closing a multi-company merger and going public all on the same day is a difficult undertaking. This section details the individual steps, the mechanics of structuring a professional team, management philosophy, and the expenses involved in a public consolidation. Since time is the enemy of any deal, Kensington has given a lot of thought to a deal's administrative aspects so that every employee's productivity is maximized.
There are 15 steps to close a rollup:
These 15 steps are not necessarily sequential, and there is often substantial overlap.
Closing a public consolidation requires considerable skills and knowledge. Most people who attempt (let alone close) these deals have substantial experience in mergers and acquisitions and IPOs. Nevertheless, we believe that the best preparation is a combination of both "book" learning and on-the-job training. Book learning by itself only creates an academic. Although there's nothing wrong with being an academic, they don't get deals done. On-the-job training is valuable; however, one should also have a good theoretical understanding upon which practical experience can be built. Before we began this process, we spent nearly 3 years reading approximately 200 books and 1300 magazine articles and interviewing more than 750 people.
Closing a public consolidation is extremely expensive — substantially more than an ordinary IPO. Kensington estimates that the total pre-closing transaction costs.
Orchestrating a consolidation involves gathering an enormous amount of information. We have written a comprehensive information system — Kensington Information and Management System ("KIMS") — written in Microsoft Access, a powerful relational database management system. SIMS enables everyone on our team to access the same information about contacts, investment banks and investment bankers, lenders, and companies that have expressed a desire to participate. We take extensive notes at each step (such as who said what to whom and when) and enter them into KIMS, which allows us to "slice and dice" data almost any way we want.
There are approximately 35 investment banks that have the ability to underwrite an IPO of a company with a market capitalization greater than $100 million. Each of these has a dozen or more senior corporate finance professionals who specialize in initial public offerings. At every institution, no matter how prestigious, there is a "Bell Curve" of talent, and it is more widely dispersed than these firms would care to admit. Some of the investment bankers at these firms are attentive, responsive, and responsible; most are not. One's goal should be to find at each of the 35 underwriters at least three senior and three mid-level investment bankers whom one would be enthusiastic to work with and whom one could trust not to botch one's IPO.
Once the possible investment bankers and lenders have been identified, it is time to choose an industry. Nearly every intermediary who sends us deals claims that his client's industry is "ripe for consolidation." If you took all of them seriously, every industry in the United States will consolidate over the next 3 years. In reality, few industries will consolidate in the next decade, and only some of those should consolidate.
Consummating a public consolidation requires a lot of manpower. The task of choosing the right people is so critical that it has its own subsection.
Now it's time to find the companies that will participate in the consolidation. This task is much harder than it sounds because it is important to be selective about which companies are asked to participate. Only a small percentage of companies in any industry have outstanding management, reputation, financial performance, and prospects to warrant inclusion. It takes a considerable amount of time to determine the ones that do.
After finding several suitable companies, comes an even more difficult task: convincing them that they want to do this. One might think this would be relatively easy, given how well public consolidations have performed in the stock market. In reality, however, much persuasion is required, for the following reasons:
It typically takes 3 to 4 months to assemble 5 to 6 appropriate companies. It is wise to assemble one or two companies more than needed in case one or two drop out.
After the companies are identified, proposals are made. At this initial stage, Kensington prefers a non-binding Term Sheet outlining the overall structure and mechanics of the deal. The Term Sheet is intentionally non-binding because at this point the seller faces too many uncertainties regarding the specifics of the consolidation. The last thing we want is in unenthusiastic seller as part of our group. So rather than try to legally commit the sellers at this early stage, we prefer that they can back out of the deal without cost or obligation if they change their mind. Moreover, we have never met a seller who was willing to sign a Term Sheet unless he was serious. We have written the Term Sheet to be as unlegalistic as possible with a focus on important deal points rather than specific legal language. We prefer to negotiate all the significant deal points up front, rather than attempt to get a seller (and us) "pregnant," then do the real negotiating (a tactic we find unethical).
In addition to the merger agreement, several auxiliary agreements are negotiated, which then become exhibits to the merger agreement:
The sellers are legally committed to do the deal when they sign the Merger Agreement. From the time they sign the Term Sheet to immediately before they sign the Merger Agreement, we encourage sellers to discuss any concerns they have, as well as to check our references and do whatever other due diligence on us that they want to do (assuming they haven't completed this due diligence before they sign the Term Sheet). Since major underwriters work completely "on the come," they will insist that the acquired companies be legally bound to consummate the consolidation before they begin any significant work on the IPO. If lenders are involved in the transaction, they also will require that the sellers be committed legally.
In many cases there is a "flagship" or lead company which commits to the transaction first. Typically, agreements are negotiated, signed, and placed in an informal escrow; during this time Kensington identifies other companies to participate. Once the other companies sign the Merger Agreement, the initial Merger Agreement with the lead company is dated and released from escrow, and Kensington then has an agreed upon time period to complete the IPO. In exchange for being the lead company, this company has stronger input as to the other participants and deal specifics.
There are three things sellers can do to make this step go more smoothly:
One Attorney to Represent All Sellers. Once the basic financial terms have been negotiated, it would be tremendously advantageous and expedient if all the sellers agree to hire one lawyer to represent them all of them. Kensington believes that at this point the sellers have the same interests vis à vis Kensington. In addition, hiring one attorney will save considerable legal fees. Even more important, however, is that there will not be several lawyers, each with his own opinion, seeking to change or even rewrite the merger agreement. If each company insists on having its own counsel, the amount of time to complete this step will increase many times.
Comments Should Be Provided Early in the Process. Sellers should insist that their lawyer provide his comments as early in the process as possible. In one transaction, after forcing us to negotiate 14 drafts of a purchase agreement, the seller's lawyer then brought up new issues! A few drafts later, he stated that he didn't like our proposed legal opinion, so he wrote a new one from scratch. He then told us that he had not yet run his draft opinion by his opinion committee, so he might have to rewrite it again after the opinion committee reviewed it. None of his comments or proposed language were objectionable; however, that he waited so long to bring them up was objectionable. Shortly thereafter, the seller fired this lawyer (with so many drafts, the legal bills had exceeded $150,000), retained another lawyer, and we closed within 30 days.
The way the merger agreement is written, there is a short due diligence period during which Kensington verifies the various information received from the acquired companies. This period typically lasts 30 days. In reality, much of the due diligence is done before the Merger Agreement is signed. Nevertheless, there are always certain informational items that have to be pinned down, and neither side wants to incur expense until they know they really have a deal. Kensington uses its form Due Diligence Report as a starting point; questions that are irrelevant to a particular company are deleted, and relevant questions are added. Our goal is to present the underwriter with a complete due diligence package so that he has no need to do further due diligence on the acquired companies.
Once the Merger Agreements are signed, the companies engage a "Big Five" accounting firm to audit them. For an IPO of this size, it is essential to have a "Big Five" accounting firm as the auditors. It is also essential to have the same accounting firm audit all of the companies. For an S-1 registration statement, the SEC requires that income statements and statement of changes in financial condition and shareholder's equity be audited for the last 3 years, and balance sheets be audited for the last 2 years.
The audit will cost approximately $200,000 per company. We have found that the easiest way to reduce the audit bill is to have a competent internal financial person and well organized accounting records. The two expenses that sellers incur before the IPO closes are their audit and legal fees; all other expenses are paid by Kensington. Upon closing the IPO, Kensington reimburses the selling shareholders for the audit expense and up to $50,000 in legal expense. Although the cost of the audit is high, the accounting firm actually loses money on the audit, hoping to make it up by being the auditor for the foreseeable future. (A public company is tied to its auditor to a significant extent because any change in auditors has to publicly announced and might raise questions.)
Kensington and its counsel and the managing underwriter and its counsel now begin the process of writing the registration statement, most of which consists of the prospectus. This process usually begins with an "all hands" meeting of all the parties. Kensington prepares the first draft, which then will be heavily edited by the managing underwriter and its counsel. Kensington has prepared a form registration statement for a public consolidation to serve as the starting point. Compared to other legal documents, there is less legal "boilerplate" in a registration statement. Consequently, most of it has to be written de novo for each consolidation. The time and typesetting expense, however, are almost completely eliminated because we work with camera ready copy on every draft. To a large extent, all parties have the same interests — to write a prospectus that informs potential purchasers of the Buyer's securities of every conceivable risk faced by the Buyer so that if the stock price falls, these purchasers cannot later claim to have been misled. Typically there are several meetings with several drafts. During this time, the accounting firm is preparing the consolidated financial statements for the prospectus, based on the audited financial statements they previously prepared. Once the registration statement is in a relatively final form, a draft is filed with the SEC.
While the registration statement is being written, the underwriters contact potential purchasers of the Buyer's securities. The first draft of the prospectus is printed and distributed to these potential investors; this draft is called a red herring. After the red herring is distributed, the managing underwriter arranges a "road show," which is a series of trips to visit the institutional investors that own most of the publicly-traded securities in the world. The only executives that will be required to attend the road show are the CEO and CFO of the Buyer and one of Kensington's M&A professionals. Large institutional investors such as Fidelity and Vanguard merit private meetings, while smaller institutional investors attend a group meeting. At these meetings, the Buyer is permitted to be more "promotional" about its prospects than allowed in the prospectus. After the road show, the underwriters contact the potential investors and ask them to orally commit (or "circle") to the number of shares they wish to purchase.
While the road show is being conducted, the SEC reviews the registration statement and provides detailed comments. Some comments will be worthwhile, while some may appear silly. We have found that in many cases it is simply better to give the SEC what it wants, rather than argue with them. They have complete and absolute say over whether the IPO happens; unlike most other forms of government regulation, there is no effective redress in the courts. Fortunately, the SEC is staffed with competent lawyers and accountants. They may not have the same degree of urgency to get the deal done, but they don't seek to kill deals. (Their only concern is full disclosure.) Besides making the changes the SEC wants (or having persuasive reasons for not making them), it also helps to have securities lawyers who know how the SEC thinks and who regularly deal with them.
Once the SEC has approved the amended registration statement, a request for acceleration is made, which is almost always granted as a matter of course. The final pricing meeting is held between the Buyer and the underwriters — the final stock price is agreed upon and the Underwriting Agreement is executed by the Buyer and the underwriters. The Buyer and the acquired companies then merge by exchanging shares, and the underwriters purchase shares from the Buyer. Simultaneously, members of the selling syndicate execute the Agreement Among Underwriters. That same day, the underwriters distribute those shares to the selling syndicate, who then sell those shares to the investors that have agreed to purchase them. Trading typically begins that same day, although sometimes there is a 1 day delay in the commencement of trading. Approximately 5 days later, the underwriters wire the funds raised to the Buyer, which then distributes to the selling shareholders the funds to be paid to these shareholders upon the IPO.
Read James' essay on what position titles mean in a leveraged buyout firm.
September 16, 1998, version 1.3 | List of other essays written by James Mitchell | Copyright notice
Cite as “Fifteen Steps to Consummate a Rollup ” by James Mitchell. September 16, 1998, version 1.3.
www.BostonConvivium.com/jm_essays/steps_consummate_rollup.