Discover the critical aspects of mergers and acquisitions, especially for government contractors, in our latest video and article. From major milestones to essential considerations, such as FAR 31.205-27 and DFARS 231.205-70 guidelines, we've got you covered. Watch now to learn more!
Mergers and acquisitions are common events in the government contracting industry because they are a mechanism for growth for a lot of companies. Most companies grow through that process of acquiring similar companies or acquiring companies to gain some additional expertise or past performance or technical capabilities to allow them to go after new contract vehicles. But in a nutshell, a merger is just what it sounds like: it's two entities merging together. Some common ownership is retained from both companies, and an acquisition is just an outright acquisition where a company is buying another company.
They may retain some of the key technical leaders or management for a period of time. But in general, they're acquiring that company, and it will be folded into the larger company on an ongoing basis.
One of the most significant risks I typically consider early on in the process is the required novation process. When the government awards a contract to a government contractor, they award it to that contractor, and they are able to assign the contract to a third party.
If someone's buying you, you can assign that. Still, you have to go through a novation process and provide a lot of information to the contracting officer in order for the government to determine if it's in their interest to novate that contract to the new owner. And in that situation, there's always some risk going into that. Novation typically occurs, but as you're acquiring, you certainly don't want to reach out to the contracting officer or customer in advance of closing the deal. But at the same time, there's a little finesse around the timing there, so novation is one of the risks.
The other risk is that you often enter into a letter of intent, and there's a lot of due diligence, and you find out that maybe this isn't the right thing to do, and the buyer backs away. But those costs around an acquisition typically fall into organizational costs, so they're unallowable and can be costly. There are a lot of advisors involved, and it can get expensive if you have a dry run or a deal that isn't complete.
When I think about a merger and acquisition, I usually think about it in terms of the cost associated with it. A lot of the work that we do here at Redstone is around helping sellers sort of prepare for that acquiring event or that exit event or in the process of working with buyers to go in and vet and validate a potential target and identify risks. Things like open year incurred cost submissions and the true value of that contract backlog, looking at contract waterfalls, and all sorts of things to help the buyer make a decision.
In the acquisition process, there are three phases that I like to think about, and I kind of call them allowable, unallowable, and maybe.
So that first phase, the allowable phase, is sort of your pre-acquisition process. You'll spend a lot of time upfront, sort of identifying acquisition targets out there if you're looking to buy another company. You may enter some discussions, all of which fall into economic planning, which is called within FAR 31, and those costs are allowable.
But at some point, you enter phase two, where you get unallowable costs. FAR 31-205-27 says that in the course of an acquisition, those costs associated with the acquisition are unallowable. And that's a very layman's explanation. There's a lot more in there. I'd suggest you read it.
But in a nutshell, usually, the line in the sand is either at the point where the board makes a resolution or okays or approves. We're going to go after this specific acquisition target. The other line in the sand can sometimes be the submission of the letter of intent, so kind of enter into that due diligence process. But once you cross that bridge, you're in unallowable cost territory.
And, as I said before, all the costs associated with an acquisition can be pricey. You're looking at paying for lawyers, investment bankers, and CPAs, people like us who help with due diligence. It adds up quickly, and those are unallowable costs. Then you've got your internal costs too. You've got your president, CFO, CEO, and all those executives involved with that process on both sides of the deal. Their time is unallowable as well.
The last phase is what I call the maybe phase. Post-acquisition restructuring, if you have DFARS, DOD contracts, there's a DFARS clause, DFARS 231.205-70, that covers restructuring. There are some specific requirements for pre-approval for restructuring activities.
It covers things like severance and some other costs. And when you're in that post phase, and you're sort of doing the restructuring, the company's been bought, and you're realigning things and doing the cultural alignment and all those fun things, it's maybe allowable. Generally, it is allowable, but you must do some extra due diligence.
Every buyer we've worked with has some general things that are common. They're looking for a company that is profitable and has ongoing contracts. There's some sort of value to that company post-acquisition. But increasingly, in this space, we're seeing acquisitions that are sort of centered around the strategic contract vehicle. So a company may have an OASIS contract, or they might have a VETS 2 contract, or whatever it may be.
The buyer wants access to that contract vehicle, so that's a lot of motivation for acquiring them. Past performance, technical capabilities, and things that can add to the buyer's portfolio in terms of going after future awards are certainly valuable. And then, you sort of look at other more kind of intangible things.
There may be synergies between a business and another business, and they think that if we're doing this plus this, it's greater than. So those kind of things can come into play. But the things that kind of trend across all acquisitions that we see is centering in on that contract backlog, doing a waterfall calculation, looking at everything that's on contract today, and it's been awarded, things that are out for award, and the probability of win on those, and then future opportunities that they're going to pursue, and sort of taking those future cash flows out, and then using discounted cash flows, bringing them back to the present, and that's how you kind of get to the valuation around it.
It's much more complex than that, but that's the general idea. Future values, or present value, future cash flows. So that's kind of a general overview. We're happy to answer questions.
