M&A transactions involving government contractors attract regulatory and industry-specific considerations. These can impact the said deal’s success. If neglected, this could potentially lead to significant hurdles down the line. This article provides a quick rundown of the challenges and important considerations for federal contractors acquiring another company.
Assignment and Novation
M&A transactions involving federal contractors need to start with understanding the specific regulations and requirements for government contractors in said transactions. Note that government contracts cannot be reassigned without undergoing novation. The latter begins right at the close of the transaction. This process takes a considerable amount of time. Other than delay, this process adds a level of uncertainty. As such, while making pertinent arrangements, you want to explicitly outline each party’s responsibility throughout the novation process. The seller in the transaction is held legally responsible for the performance of the transaction even after the novation is completed.
You must craft a definitive agreement for the acquisition of government contractors. You want to carefully evaluate the target company’s compliance with government contract regulations. This is particularly true as a host of representations and warranties are related to said contractors.
By evaluating the target company’s regulatory compliance, you understand the potential value and liability of said transaction. Consequently, it’s easier to choose the right indemnification caps with the ultimate aim being achieving long-term survival.
The first step in evaluating regulatory compliance is to verify any preferential status. Further, you need to check compliance with common regulations. It includes the following:
- Federal Acquisition Regulation
- Foreign Corrupt Practices Act of 1977
- Defense Federal Acquisition Regulation
Finally, you want to check applicable statutes of limitation for certain liabilities. This will further help you acquire the right indemnification caps.
Assessing the Impact on Outstanding Contracts, Proposals, and Bidding Opportunities of Contractors
You want to grasp the potential impact on existing contracts and bidding opportunities. Start by assessing the number of proposals and the nature of programs that the seller is competing to win. You want to understand whether the seller can perform the work if they win the contract. Further, you want to understand the pipeline of work needed to win new contracts or orders under the existing agreements.
Suppose the government contractor being acquired currently holds some security clearances issued by the Defense Security Service (DSS). You’ve got to consider the potential impact on said clearances and security protocols.
Note that acquisitions of federal contractors that hold said DSS security clearance, often referred to as “cleared” contractors, can be problematic. The facility security clearances (FCLs) cannot be transferred to the buyer. This means that you’ve got to obtain your own FCL. The buyer may assume management roles at the cleared contractor following the closing of the transactions. They effectively become key management personnel (KPM) which means additional security clearance must be applied for from the DSS.
Understanding the security clearances is the best way of ensuring the continuity of a cleared contractor’s KMP and FSO post-transaction. The idea is to ensure that the entity in question retains clearance after the transaction.
Subcontracts, Teaming Agreements, and Joint Ventures
An important consideration is the potential consequences of a change of ownership in subcontractors and teaming agreements. You need to consider the contractual relationships that the seller has with other companies. It pertains to the performance of government contracts.
You will be looking for exclusivity and non-compete provisions, unusual terms, conditions, or restrictions, and the adequacy of the description of the scope of work between contractors. Further, you want to access any terms guaranteeing workshare or revenue percentage within each contract, change in ownership notice approvals, and any existing breach events.
As part of your subcontractor review process, consider including a seller’s internal processes or procedures review. The latter should include a review of processes undertaken by additional fourth parties. It includes other subcontractors and vendors working with the subcontractor being reviewed. Here, you’ll be looking for the status of contractor purchasing systems and any approvals or reviews. Further, you ought to inspect the adequacy of the FAR ‘flow down’ clauses during the different agreements.
The goal is to identify any key or essential subcontractors or teammates who are integral to successfully completing work. Additionally, you will be looking for any loopholes. These might lead to the deterioration of an existing subcontractor or vendor relationship with links to the performance of a contract.
Suppose you are a buyer considering a business that qualifies for small business set-aside contracts. When considering M&A transactions, you ought to evaluate the potential impact of the transaction on the company’s status as a small or disadvantaged business. This is because changes in ownership or rapid increases in size can change your business classification.
Note that when the resulting entity no longer qualifies for the designation, it can sometimes continue performance on any of the existing contracts. However, it might not be eligible for any new small business set-aside contracts or work moving forward.
For this purpose, a company’s size is determined under the contract-specific North American Industry Classification System (NAICS). The latter is based on the gross revenue of the entity in question, the size of its employee pool, and its affiliates.
Identify the Potential Impact on the Company’s Ability to Receive Future Government Funding
Seeing post-transaction, the resulting entity will require to be recertified based on the size standard; the new entity might have its ability to receive future government funding jeopardized. This falls under the unique operational risks that you ought to be aware of. As such, consider mandating the backlog report by the seller. This will typically capture all active and remaining contract funding. From these backlogs, you can also get a better understanding of which incrementally-funded contracts are approaching a funding ceiling.
Consider this a basic contract administration task. From these, it becomes easier to identify any contract funding or financial risks.
Post-transaction Integration Issues
An important consideration in an M&A transaction involving federal contractors is the potential impact of saithe d transaction on the company’s culture and employee morale.
You are going to need a pre-close plan with a clear integration strategy and effective prioritization of high-payback activities that will bring about better synergy. Note that at the root of post-transaction integration issues are inadequate communication planning, which leads to disengaged not only leadership but also weak synergy programs.
To ensure that there are little to no post-transaction issues, you ought to embark on slow organizational planning designed to ensure that no employee is left in limbo, which could damage productivity and morale. Additionally, enact an end-state transition process that should be well-defined and communicated.
Organizational Conflict of Interest
As you make arrangements for an M&A transaction, it is important to understand any conflicts of interest that exist where a contractor plays two or more roles that are in conflict with each other.
The risk therein can be classified as either transaction risk or business risk. Transaction risks exist where the buyer’s and seller’s contract portfolios prevent the buyer from acquiring or performing certain transactions. On the other hand, business risk is present in situations where existing portfolios from both parties prevent the buyer from pursuing certain business opportunities in the future.
You will be looking for any impaired objectivity, biased ground rules, or unequal access to information before entering the transaction. Further, you want to be on the lookout for any OCI clauses that prohibit specific work. OCI due diligence includes accessing the nature and scope of work that each of the parties perform or plan to perform to avoid any overlaps.
Understand the Potential Implications for the Company’s Relationships With Government Agencies and Officials
When it comes to an understanding the potential implications for the company’s relations with government agencies, the first point to start is with issues of bribery, gifts, and gratitude.
Note that federal law prohibits any bribery or improper gifts and gratitude being given to government agency officials. In fact, these are classified as federal crimes, which then call for a reexamination of any of the standard commercial sales practices during the transaction. As part of the due diligence, consider assessing the seller’s written policies and procedures and conducting employee training to ensure compliance with regulations.
A further consideration when it comes to the parties’ relationships with government agencies and officials is the Anti-Kickback Act (41 U.S.C. 51). Specifically, federal law prohibits the giving of anything of value to any prime contractor or subcontractor with the intent of obtaining unfair treatment in relation to a contract.
You ought to be aware that there are commercial sales practices that can be construed as being potential kickbacks in the federal landscape. This increases the compliance risks to the parties in the transaction. The due diligence involves reviewing said sales practices and tactics to weed out any that could be considered kickbacks.
Note that there are potential implications for the company when it comes to hiring government officials. Right off the bat, it is important to note that government employees pose a range of compliance risks for the buyer. In fact, the “Revolving Door” restrictions were enacted to ensure that specific government officials don’t work on certain matters.
Under 18 U.S.C. 207, there are lifetime restrictions for some government employees when it comes to their personal or substantial participation in some matters. Further, note that there’s a two-year ban for certain senior government personnel.
It is important to note that the DOD does require certain senior government officials to obtain ethics opinion letters prior to receiving any compensation from a new contractor employee. Further, former government employees with access to proprietary or source selection sensitive information could result in OCI-like unfair advantage are banned from taking up roles in the new entity two years after the termination of the government contract.
Agile IT has completed hundreds of mergers for regulated industries, including defense, finance, and healthcare. Our focus on DFARS and CMMC compliance when merging tenants into GCC and GCC high assures your organization remains compliant throughout the process. To find out more, request a free consultation today.