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Now that the blush is off the new economy rose, why hasn’t the locus of dealmaking activity in the big tech firms moved down the hall from the IPO and VC lawyers to the M&A team? It only stands to reason that as cash reserves dwindle and investors hunker down, tech industry clients will look for the only other likely source of capital — selling out to the highest bidder. But it isn’t all that simple. There are mergers and acquisitions to be done, but they’re more complicated — and less plentiful — for a host of reasons. For starters, it’s no longer possible to do everything on Internet time. Even small deals are hard to get done. Negotiations take longer, and more deals fall apart. Although most firms did more deals last year than in 1999 — three key California firms (Wilson Sonsini Goodrich & Rosati; Brobeck, Phleger & Harrison; and Fenwick & West) represented principals on 137 M&A deals valued at $150 million or more last year, compared to 102 in 1999 — the work slowed down considerably late in the year. Just look at Web business deals: 60 percent of last year’s were done in the first quarter, while the fourth quarter accounted for a mere 6 percent, according to a report by Webmergers.com, a San Francisco�based research firm. And it’s only gotten worse since then. What does this mean for M&A specialists? Forget about putting together nice, neat stock-for-stock transactions. Nobody can agree on what stocks are really worth, and entrepreneurs sometimes are a few steps removed from the new, harsh realities about how to value their creations. M&A lawyers must flex different muscles, think creatively, and counsel their clients safely out of the abyss. The theme for 2001 so far is uncertainty. “You have struggling dot-coms merging together to create synergies, or more dominant players looking for good deals,” says William “Alex” Voxman, who heads Latham & Watkins’ venture and technology practice in Los Angeles. The trouble is, some of the principals have stocks that are worth pennies. Finding a buyer under these circumstances might be impossible, as demonstrated by the fall of eToys Inc., the popular online retailer. The Santa Monica, Calif.�based company had been looking in vain for a buyer since last December. But in February, eToys announced that because its stock was worthless, it would focus on a breakup sale of its assets. EToys’ stock hit a high close of $84 a share in October 1999, but pending the company’s announcement that it expects to be delisted from the Nasdaq, the price per share was down to 9 cents. Those companies that do have cash can wait it out a little longer, lay off staff, or make other cuts. But clients running out of money are skittish — either wary of acquiring a company whose stock may plummet before the deal is closed, or just unable to value themselves according to that bleakest of measures, the Nasdaq. Like a contestant on Survivor, a weak company hoping to stay alive can form an alliance with a competitor or wait until that competitor is so far gone it becomes insolvent. Voted off the island, so to speak. It’s questionable whether the alliance-builders will win in the end. HealthCentral.com, an online health store, has gobbled up some of its competition, including More.com, DrugEmporium.com, and Vitamins.com. The strategy is obvious, says Tim Miller, president of Webmergers.com: “flying directly into the eye of the hurricane” and buying its way to profitability. By doing so, HealthCentral is acquiring infrastructure — technology and relationships — that may help it weather the storm. Or not. HealthCentral’s own stock has dropped 97 percent from its high of $14. There’s always the risk that a deal will be called off because one side is dying on the vine. Probably the most extreme example of this was when Verizon Communications Inc. terminated its agreement to acquire a majority stake in DSL wholesaler NorthPoint Communications Group Inc. in late November. NorthPoint had to file for Chapter 11 in January, and the company filed suit against Verizon in San Francisco for breach of contract. The case is pending; Verizon has denied the claims. Clearly, mergers in a volatile economy are risky any way you cut it. Even when they are brought to a close, these deals may require more elbow grease. “Buyers have the leverage to be tougher in negotiations,” says Richard Climan, head of M&A at Palo Alto’s Cooley Godward. He’s also done more asset deals lately in which the buyer takes the assets of the target — the software or the tech-savvy personnel, perhaps — and leaves the unwanted liabilities alone. In some cases when dealing with troubled companies, lawyers must work out an added sweetener or protective measure. Richard Vernon Smith, a partner at San Francisco’s Orrick, Herrington & Sutcliffe, negotiated a stock and cash deal for New York�based iVillage Inc. with its chief rival, San Mateo, Calif.�based Women.com Networks, Inc. Both companies rely primarily on online advertising for revenue, and both have been hammered in the stock market: Women.com’s price per share has dropped by about 96 percent from its all-time-high close at $20, and iVillage had sunk by 98 percent from its $113 high. The sites probably wouldn’t have come together had it not been for an added bonus, devised by the management team at Women.com and its lawyer, Cooley Godward’s Mark Tanoury. The Hearst Corporation, one of Women.com’s largest shareholders, agreed to invest $20 million in iVillage, through a limited stock offering, as part of the merger. The cash offer was too good to pass up for iVillage, which wants to be profitable this year. (Its stock price rose from $1.71 to $2.38 after the February announcement.) “In this climate, where there’s next-to-zero chance of raising capital, it [was] hard to ignore,” says Orrick’s Smith. Still, the fact that Women.com was almost out of cash required additional finessing. Smith and Tanoury negotiated a closing condition: If Women.com runs out of money before the merger closes, Hearst agrees to put more cash into the deal. Smith says that this type of agreement is “very typical in private deals but not for public deals.” It was a necessary cushion, he says. “The market would have just greeted it with horror” if iVillage couldn’t predict a profitable year. Now that Nasdaq inspires little faith, dealmakers must work harder to make the future look rosy. For example, a public company acquiring a private company may structure earn-outs in the deal that reward the target’s shareholders for meeting performance goals. Likewise, it has become more common to build in an escrow arrangement to provide incentives for valuable founders to join the new company and stay for a period of time. Both measures promise some security, say experts, but both are complicated for tax and other reasons. When you have a client that’s in distress, says Latham’s Voxman, enlist the help of bankruptcy lawyers and hone your insolvency knowledge. When a company is in real trouble, the fiduciary duty of the directors shifts from making a profit for shareholders to protecting creditors. That means that the low offer the client got from a potential buyer might require a second look — by law. Deal terms aside, clients whose incredible (paper) wealth has been rapidly vaporized require more than just a lawyer’s killer deal-making skills. They need someone to help them hash out their alternatives�and tell them when to bail out. It’s pretty painful for an entrepreneur to sell his creation for one-tenth of what it was worth a year ago. “There are the emotional issues,” says Tanoury. “These entrepreneurs have been all about beating the long odds,” and the “companies are like family to [them] … . You have to have a very candid conversation with them when it’s time to call it a day.” So practice tough love — it’s billable.

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