Key Issues for Due Diligence of Government Contracts – Part II

February 9, 2017

Practice Area: Business & Corporate Law

In a recent blog post, I highlighted key issues to be analyzed when performing due diligence on a target company that performs government contracts. In addition to the review of government contracts, comprehensive due diligence review of any target company should also include evaluation of five other broad categories relating to general business matters discussed below as part II of key issues to be considered when performing due diligence in M&A transactions for government contractors.

1.    Entity Formation Basics. Corporate due diligence review begins with confirming the good standing status of the entity in the state or commonwealth of formation. Delinquency in payment of fees, taxes, or renewals can be easily cured but are embarrassing to have to point out to sellers. Review of the target company’s charter or articles of incorporation as well as bylaws to understand the equity structure, governance, and history of the corporate entity is important for a buyer’s due diligence review. The corporate record or minute book that contains the charter and bylaws of the corporation or operating agreement in the case of a limited liability company, should also have any amendments to those documents to reflect changes to corporate governance matters. The stock or ownership certificates and the stock ledger should reflect a clear chain of title of ownership. An inquiry should be made as to whether there are any outstanding options, warrants, restrictions on shares and, if so, those documents should be carefully reviewed to understand the terms of any exercise rights. 

2.    Registrations and Permits. Corporate due diligence review should also include an examination of the company’s registrations, licenses, and permits. It is important to confirm that the company has registered to do business as a foreign corporation in all states where it is conducting business and registered all trade names in the states that so require. All permits, businesses licenses, and similar authorizations from governmental agencies necessary for the lawful conduct of business should be renewed and up to date. 

3.     Employee Related Matters. When buying a target company, it is important for a buyer to know what it is being acquired with respect to the human talent in the target company. Are there bonus award plans, for example, that the acquiring company must continue to fulfill after buying the target. Does the ownership of the target company involve an ESOP which may complicate acquisition and should be evaluated and understood? Are there any types of equity-linked plans such as phantom stock plans or stock appreciation rights plans that will continue as obligations of the buyer after purchase of the target or will they go away upon the sale of the company? A careful review of all employee benefits, handbooks, policies, and codes of conduct is critical to ensure they have been updated and are legally compliant. Is the company aware of and/or addressing any known environmental, health or workplace safety issues?  The seller must disclose any outstanding or unresolved issues with employees. 

4.    Intellectual Property Related Matters. Depending on the nature of the industry and business, evaluation of the target company’s protection of its intellectual property will impact the value of the intangible assets being acquired. Due diligence review of IP will include evaluation of any filed patent and trademark applications, prosecution histories and issued patents, and any registered copyrights or pending applications. Protecting other intangible assets such as methods, proprietary information or the company’s “secret sauce” is imperative to maintaining target company’s value. Measures taken to protect these trade secrets should be evaluated to determine if the seller has taken reasonable steps to guard the secrecy of its trade secrets. Are there contracts such as employment agreements, confidentiality, and non-compete agreements executed and in place limiting access, use, and disclosure of confidential information. 

5.    Financial and Other Business Related Matters. Gaining a clear picture of the financial health and operations of the target company during due diligence is imperative. This will include scrutiny of reviewed or audited financial statements, quarterly projections and targets, and current balance sheets. All outstanding liabilities of the company in the ordinary course of business and – more significantly – those arising outside of the target company’s business must be investigated. All taxes must have been properly paid to federal, state, and local authorities. Any liens of creditors on the company’s assets and the restrictions the company is subject to when trying to qualify for additional credit facilities must be disclosed. A thorough UCC financing statement search should be conducted. A clear understanding must be obtained of all real property owned or leased, and all title records, lease agreements, and amendments must be in order. All insurance policies must be up to date and premiums paid. Finally, all remaining documents that the target company has entered into must be reviewed to ensure they are in order and to determine if approvals from other parties must be obtained or notifications given before or after closing. 

Due diligence analysis of these five broad categories together with the sixth area of government contracts detailed in my previous blog, will ensure that buyers have a comprehensive picture and understanding of the target company they are acquiring.

About the Author:  Kimi Murakami is counsel with PilieroMazza and focuses her practice on corporate transactions with an emphasis on mergers and acquisitions of government contractors. She also has experience advising on intellectual property matters including trademarks and trade secrets. She can be reached at kmurakami@pilieromazza.com.

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