The current environment of mergers and acquisitions (“M&A”) is evolving. There is constant movement in the mortgage industry with the desire for growth and expansion. It is easy to become blinded by the end goal of increasing loan volume and quality origination talent. Thus, it has never been more important to focus on due diligence in analyzing a mortgage industry acquisition target.
In a typical transaction, the due diligence checklist can be overwhelming—pages upon pages in length. The checklist covers such broad areas and topics as: organizational structure; litigation; compliance; intellectual property; real property; financial and tax; labor and employment; material, vendor, and software contracts; insurance; and customers. Under each key heading, the checklist goes into great detail to uncover potential issues that could devalue the business, expose a buyer to liability, or even jeopardize the transaction. This article is not intended to be an all-encompassing review of due diligence, but is meant to address some key M&A diligence areas and keep the topic top-of-mind.
Branding/Intellectual property: Trade names, DBAs, and domain names
Trade names, DBAs, trademarks, fictitious business names or assumed business names are what the world knows the business as. If the name recognition has value or importance for future operations, you want to insure the name or names are properly registered within each State where the business is being conducted or with the U.S. Patent & Trademark Office. A buyer wants the right to use those names and marks with superior title from the rest of the world. The last thing a buyer wants is to find out after the deal closes that the founder of the business registered a name or trademark in their own name and never properly assign it to the company. The same is true of domain names. Verify the business owns the domain name. Even if the intent is not to continue to use a website, the buyer wants to control it to redirect future searches.
Regulatory compliance
The mortgage industry is heavily regulated and subject to scrutiny by both State and Federal agencies. This is a potential minefield. Are there any pending or threatened investigations not widely known to the public? Any data privacy breaches? Is the seller subject to a probationary review? Have complaints been submitted that could impact any licenses or “tickets” from government-sponsored enterprises? Is there a potential pattern of questionable practices and activities based upon allegations filed with government organizations? It is not an understatement to say that any of the aforementioned questions being answered yes could be a deal breaker. It is often easy enough to do an initial online search to look for red flags.
Material contracts
There may be numerous contracts containing provisions that may trigger liability or exposure upon the sale of a business. One particular concern relates to software licenses. With the sophistication of the mortgage industry, contracts with software vendors are extremely necessary and costly. Key issues include financial penalties for early termination, restrictions on the assignment of the contract upon a change in ownership of the seller, and incompatibility for the transfer of data to another system. Even if the buyer uses the same provider, are they required to continue to pay for a second license based upon the seller’s existing contract. The contracts must also be reviewed to ensure appropriate regulatory flow-down requirements for vendors. These issues are not a consideration when the M&A discussions begin, but it could significantly impact the final purchase price in order to address an unforeseen liability.
Key executives and employees
An obvious concern of the purchaser is the ability to retain key people. What about those people you do not want to keep? Are those employees subject to non-competes, confidentiality and non-solicitation agreements? Are those agreements assignable to the buyer? All these documents must be reviewed. Also, have any employees been promised future equity in the seller? This could be through a formal agreement or plan, in an employment agreement, or even an email. The acquirer wants to insure there are no employees post-closing that claim they should have been paid at closing or were required to consent to the sale.
Miscellaneous/Conclusion
This heading of miscellaneous is deceptive. All these items matter. Here is a further sample of the numerous detailed items to examine during due diligence: (i) Trailing Loan Liabilities (Buy Backs, Indemnity Agreements, Defective Loans, EPO/EPD under MLSAs); (ii) Joint Marketing Agreements, Joint Ventures, Affiliated Business Arrangements, and other Essential Business Relationships; (iii) Office Profit and Loss Agreements; (iv) Loan Pipelines; and (v) Safeguard and Procedures for Confidential Consumer Information – State and Federal Level.
The devil is in the details when it comes to due diligence. It requires a team to not only understand general issues that are common to M&A, but members of the team must understand the industry and its nuances. Do not let the excitement of deal cause anyone to rush the process.
Gary M. Remer is a shareholder at Maddin Hauser. Gary focuses on mergers, acquisitions, joint ventures, franchising, tax, and employee benefits matters for businesses across the spectrum, including the mortgage industry. He also serves as outside general counsel for his clients, assisting with legal and operational issues.
Brian A. Nettleingham is a shareholder at Maddin Hauser. Brian’s financial and mortgage services industry practice encompasses regulatory, transactional, and litigation matters, including capital and secondary market transactions, mortgage lending and origination, reverse mortgage products, correspondent programs, joint marketing agreements, and financial vendor agreements.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the editor responsible for this piece: zeb@hwmedia.com.
