Government contractors have significantly increased mergers and acquisitions in recent years. A stream of recent stories in the Washington Post and New York Times have documented this. The acquisition of a business that has earned a government contract frequently provides the buyer an opportunity to increase its market share and strengthen its capabilities within an existing industry. The addition may also allow the new parent company to expand their portfolio to market and develop a new government contracting capability that was previously not available.
The Case at Hand
In September 2017, United Technologies and Rockwell Collins announced they had brokered a deal for United Technologies to acquire the airplane electronics and avionics parts manufacturer, Rockwell Collins for $30 billion. Through the transaction, UTC Aerospace Systems, which will be renamed Collins Aerospace Systems, will increase its aerospace capabilities and technology aerospace systems.
Also in September 2017, Northrup Grumman shared that it would acquire a rocket and defense contractor, Orbital ATK, for $7.8 Northrup's portfolio will expand to include a missile defense business and the ability to launch rockets that carry satellites into space.
Companies and private equity funds that want to expand their portfolios through the purchase of SMB government contractors must take particular caution through the due diligence process because such acquisitions are fraught with potential landmines that will slow or even terminate the proposed deal. To acquire a company that holds government contracts both parties must comply with many federal regulations before the government approves the transaction. The agency must recognize the buyer as a successor-in-interest for the seller's government contracts or subcontracts. All compliance obligations transfer to a buyer, therefore the buyer must be able to fulfill its new set of compliance responsibilities to the satisfaction of the government's contracting officers.
12 M&A Issues for Government Contractors
12 M&A Issues for Government Contractors
My name is Joe Whitcomb I am founder and president of Whitcomb Selinsky, PC. We are a veteran owned and operated law firm situated in South Metro Denver Colorado. This morning I'm going to speak to you about a subject about which I get a fair number of questions. It doesn't come up every day, but it comes up regularly enough that I felt like it was worth dedicating a webinar to. And it's on the issue of mergers and acquisitions and the 12 special legal issues that government contractors have to deal with. Now as a law firm, we do a good bit of government contracting. Most of our clients are veteran owned or service-disabled veteran-owned small businesses situated around the country. And like any other business, the owners want to get ready at some point with potentially merging with another company. purchasing another company, or selling to another company. Some are eager to retire while others may want to move on to another venture. So today we're going to talk about 12 issues that are particular to government contractors. Some of them are issues that deal specifically with government contractors that operate in the socio-economic space like women-owned businesses, 8(a)s, service-disabled veteran-owned small businesses. You'll hear me use the term SDVOSB or service-disabled veteran-owned small business interchangeably. We want to cover those issues today. I hope you find the information informative and useful.
1. [Contractual or Regulatory Non-Compliance]
The first begins with a disclosure of any contractual or regulatory non-compliance that predates the transactions including violations as a False Claims Act. Put simply, this means if you're purchasing a company you want to know about any infractions that this company may have encountered. It can be something as small and potentially innocuous as a notice to show cause or a cure notice from the government from a contracting office which could impact past performance ratings in the future. Or it could be as something as serious as a False Claims Act violation, a Services Contract Act violation, or violation of Davis-Bacon. As a potential buyer, you need to know about these items as they can obviously impact the company's value after the purchase. For example, these violations could impact the target company’s ability to engage in government contracting. Violations of important government regulations could result in debarment. So, as a buyer, you want to know about these issues and as a seller you need to disclose it. Disclosure of this information will ultimately impact the purchase or selling price of your company. It could also impact that company's ability to do government contracting in the future.
2. [Prior Suspensions or Debarments]
The second issue that needs to be disclosed or discovered are any prior suspensions or debarment with the company that you are either purchasing or selling. Obviously, the reason that this is important if you're purchasing a government contractor is that you need to make sure that you can still engage in government contracting. Also, a change in management or ownership does not normally eliminate the debarment.
Fortunately, you can do some research as simple as looking at sam.gov to find out whether there are any listed exclusions for the company that you are purchasing or selling. As a buyer, you should definitely ask for representation from the seller that it is not subject to debarment. As a seller you be sure to represent, if true, that your company is not subject debarment or suspensions to your knowledge. Disclosing the possibility of debarment is the only way to inoculate you from suit in the future if you're the seller. Making sure you ask the question could inoculate you as a buyer from any surprises. If those representations are made and they prove to not be true in the future, then the buyer has some recourse. As a buyer, you may have the ability to claw back some or all of the purchase price or get back some of the money that you have held in escrow, typically referred to as a holdback.
3. [Past Performance Ratings]
If you are the buyer, you will want to know about the target company's past performance. This is especially true as it relates to a particular area that you are interested in competing. If the company you are buying is a jack-of-all-trades, and your company is interested in a particular industry, you will certainly want to know about any past performance issues as relates to that NAICS code. If you are selling a company, you don't want to wink at any of those past performance issues, or shrug them off as no big deal. It is better to disclose those and have the buyer know about them and be at ease with them than to face a lawsuit later about a material misrepresentation about your company's past performance.
4. [Remaining Years on Contracts and Accounts Receivable]
As a buyer, you will also want to do an analysis of the remaining years and a potential accounts receivable income from existing contracts. Separately, you will want to know about outstanding proposals that could potentially become new contracts. What you are basically looking for is where is the target company in its performance of option years or base years. If the target company is four years into a five-year contract that will obviously impact the value of the company you are purchasing. Once those contracts expire they would be subject to re-competition. As you would expect, there are no guarantees. As our firm has informed many clients, options are options. Those options belong to the government to exercise or not. So, be sure you know where those contracts are in the course of performance. Also, make sure that you value future options for what they are, options to perform.
Be sure to look at the accounts receivables on any of the contracts that your target company is performing. Of course different types of contracts have different levels of security. For example, it’s fair to assume that a contractor would be allowed to complete the construction contract just so long as the government does not run out of money or the contractor does not fail in its performance. Importantly, you have some ability to affect that as the buyer or as the seller.
As a buyer, you also want to know whether or not the target company is being paid on time. Not every government agency pays with the type of regularity that you might hope. So, be sure to look to see whether or not the company is struggling to receive payments from the government; whether it's had some difficulties with its invoice submissions; and whether the government is paying on time. Alternatively, look to see if the government might be looking for an excuse to cancel a contract for convenience or for cause.
As I mentioned earlier, as a buyer, you also want to know about any outstanding proposals. As a seller, you want to make the potential value of any outstanding proposals on contracts that you have not yet won is incorporated into your selling price. The buyer and the seller should be able to incorporate the likelihood of success on those proposals into a contingency portion of the sale price. So, make sure you know what proposals have been submitted, what the value of those contracts are, and whether or not you as the new owner of the company are going to be able to perform those contracts if they are awarded. The relationships that the selling company has may not always transfer to the buying company. Therefore, your ability to perform those new contracts may be in question. So, be sure to have that investigated.
5. [Novation of Contracts]
It is important to look at the assignment of Novation of government contracts from the business being purchased. Novation is a big deal, especially if you are buying a company's assets. If you're buying the entire company, meaning all of its shares, then the FAR does not require you to novate contracts. There may be some verification issues if you are purchasing a socioeconomic qualifying company. For example, if the target company is a service-disabled veteran-owned small business, you must make sure that you as the purchasing individual or the new LLC members or board members will still qualify under the SBA and/or CVE’s regulations for a service-disable small-businesses. You will want to get a legal opinion as to whether Novation is required and whether it can be accomplished. Novation lies almost entirely within the discretion of contracting officers. So, it is good to have some written representations from the contracting officers that novation will not be difficult.
6. [Loss of Small Business or Socioeconomic Status]
You want to look at the loss of small business or socioeconomic status of the contractor that you are purchasing or selling. If you are purchasing a government contractor with a relatively low size standard, like one that is 7.5 million, you want to make sure that you have reviewed the selling company's financials. Make sure you have looked at the top line of the target company’s tax returns and averaged those t if the company’s size standard is regulated by receipts. Now not every NAICS code in the small business universe is regulated by receipts. Some of them are regulated by the number of employees. But, you want to investigate to make sure that the company you were purchasing is not about to graduate from its size status pursuant to the SBA's rules. Be specially mindful of the NAICS codes in which you are interested in competing as a small or socioeconomic business. Importantly, a company may qualify as small for some NAICS codes, but not all. Be sure that you know where the target company stands in its socioeconomic status and in its small business status. If the transaction is a merger, be sure that the combined receipts of the companies for the past three to five years does not exceed the size standard.
7. [Security Clearances]
Now you want to make sure that the any secret or top-secret security clearances that the company you are purchasing or selling will transfer to the buyer. This is not automatic. If the business that you as the seller are engaged in involves top secret clearances, then normally the character of the of the owners matters as it relates to the issuance of these top-secret clearances or secret clearances. It would be important that the buying company’s owners would be able to also get at least of interim clearance upon purchase so that can continue to perform those contracts.
It is hard to know that exactly but it is good to do some internal investigation to make sure that the entities issuing secrets of top-secret clearances will not have any reason for pause. You will want to pay attention to items like financial difficulties and bankruptcies within the last seven years. Certainly, any felonies within the last seven years will impact the buying company's ability to gain top-secret clearances needed to perform the contract. Also, many times facility clearances matter. If there are top-secret documents involved, facility clearances will matter. As a buyer, you want to make sure that covered during due diligence and that you are comfortable with your company’s ability to obtain the clearances. Alternatively, you will want to ensure that there is some language baked into the purchase agreement that is contingent upon those top-secret clearances or facility clearances transferring.
8. [Transfer of Intellectual Property]
You want to investigate and disclose the transfer of intellectual property as it relates to the company you are selling or buying. Intellectual property includes things like logos, trademarks, trade dress, copyright, patents, and certainly trade secrets. You want to make sure that all of that intellectual property or as much of that intellectual property as you intend to transfer will in fact transfer. You as the seller may want to hold on to some of your intellectual property. You want to make sure that is disclosed in your representations and warranties, which is the subject of another video presentation. The buying company will want to make sure that you are getting everything for which you bargained. If there are patents pending, you will want to investigate to make sure that those patents have a high likelihood of being issued. The seller should disclose foreign patents and other foreign intellectual property that that is registered and ensure that those registrations have been adequately policed. Otherwise the buyer could be purchasing intellectual property that can be jeopardized soon after the purchase.
9. [Conflicts of Interest]
You want to investigate any conflicts of interest as it relates to the purchasing or selling company's ability, especially as relates to government contracts. The selling company could have an institutional conflict of interest, which could impede the buying company’s ability to compete for contracts in the future. If, for example, the seller had a big hand in the negotiating of or formulating of the RFP that fact could negatively impact its ability to compete for that contract again in the future. So, as a buyer, look out for any sort of institutional conflicts of interest that would preclude the selling company's ability to compete again in the future on the contracts that it’s performing.
10. [Federal Supply Schedules]
You want to look at Federal Supply schedules, GSA schedules, VA Federal Supply schedules, to make sure that those Federal Supply schedules are in good standing; to make sure that they are not about to expire; or if they are about to expire that you will not encounter a great deal of difficulty in getting the Federal Supply schedules reissued. Remaining on those schedules could be important as it relates to your company's ability to continue to perform contracts, make money, and thrive. Typically, an expiring federal supply schedule could take anywhere from six to eight months to renew. Renewing a federal supply schedule is essentially a start from scratch. The prices that you are bidding become public and they are scrutinized and investigated by the GSA, if it's a GSA supply schedule. Be sure that these schedules are fully disclosed and that you are fully aware of the status of those Federal Supply schedules.
11. [Subcontractor Relationships]
As a buyer, you will want to look at to investigate the selling company’s subcontractor relationships. One question to answer includes, is their ability to perform tethered to their relationships to subcontractors. This can often be true of general contractors in the construction space. A general contractor may have plenty of relationships with electrical subcontractor. However, a general contract for a VA facility that was awarded under a SDVOSB set-aside will have limitations in subcontracting in play. As a buyer, you may want to make sure that there is a decent supply of subcontractors that are also CVE verified SDVOSBs. As a buyer, you may want to look into those subcontractor relationships to make sure they are in good standing. Be sure the target company has made a habit of paying subcontractors on time. Make sure the subcontractors have been in the habit of showing up to work on time and meeting benchmarks and deadlines. These are things you will want to know as a buyer.
You also want to look into and investigate the existence of joint ventures and teaming agreements. There could be some successor liability as it relates to those teaming agreements or joint venture agreements that are in place. Understand that those are different things. In a joint venture agreement, you are forming a different entity illegal entity. A teaming agreement a subcontracting agreement that is typically written in order to satisfy a government agency or RFP requirements. Therefore, the government has relied on the existence of this teaming agreement in order to make an award. Therefore if you are going to replace teaming members, you will need to involve the government or at least let them know that you are replacing teaming members.
12. [Foreign Purchases]
Lastly, you will want to look at foreign purchases. This can be as simple as understanding any of the target’s relationships with foreign governments or foreign entities. This can include exporting goods overseas and ensuring that the seller’s export controls or ITAR compliance is in place. Also, make sure that it has regulatory compliance protocols in place, because otherwise you could be purchasing a company that has run afoul of the State Department or is selling goods overseas that it should not be selling.
These twelve things that we’ve just outlined, will be included in the written text to accompany this video that you'll be able to follow along and use for posterity. It is also my intension to get the audio for these videos into podcasts, so that you can review them again later if needed. My name is Joe Whitcomb. I just covered the twelve legal issues of mergers and acquisitions that while not unique to government contractors are certainly a priority for them. If you have any questions or concerns, of course we are a resource. We welcome your questions.