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Silicon Valley is littered with so many struggling technology companies that deals between two healthy companies are rare. More often than not, the target in a mergers and acquisitions deal is a financially strapped enterprise that is fast running out of time. At first glance, it seems simple — and cheap — to snap up a dying company. But tech lawyers are finding that buying bankrupt, or nearly bankrupt, companies requires an artful approach and packs a wide range of risks. “All of this is strategic and like a chess game,” said Lillian Stenfeldt, a Palo Alto, Calif.-based bankruptcy partner at Gray Cary Ware & Freidenrich. Technology companies with enough cash on hand to buy up cheap companies are looking for bargains. But they’re also increasingly weighing whether to rescue a struggling target or starve it out. If starvation is the plan, M&A teams are counting on the expertise of bankruptcy lawyers to help out. Stenfeldt is commonly called in before negotiations start so she can help the buyer decide whether to move quickly and buy a target outright. In that case, buyers conduct due diligence a little differently than in a typical purchase, Stenfeldt said. In such a scenario, they are putting more emphasis on learning who the target’s creditors are and what kinds of demands they may make in the future. “Sometimes you don’t want the liabilities, but you take them because it’s not worth the risk [of losing the target],” Stenfeldt said. Losing the target to another buyer is the downside of the other alternative, which is to wait out a target until it files for bankruptcy and goes on the block for public auction, Stenfeldt said. “If it goes to auction, you don’t control it anymore,” she said. How much money the target has to burn before being snuffed out is a key factor in determining how long a buyer should wait, according to lawyers and restructuring specialists. “A good scenario is when you have enough [time] to run a process that will take three to four months to market the company effectively,” said Bill Kosturos, a partner at accounting giant Andersen LLP who heads the firm’s Northern California corporate restructuring practice. That means showing the company to upwards of 30 potential buyers, Kosturos said. But that’s a luxury most targets just don’t have. “The nightmare scenario is when you’re out of money, and that’s really what everyone’s facing today,” Kosturos said. “So what you have is a very robust M&A market for troubled companies.” That has changed the practices of bankruptcy partners like Gibson, Dunn & Crutcher partner Kathryn Coleman. Two years ago, Coleman’s corporate partners called on her to assess the risks of some transactions. At that time, almost none of her work involved assessing potential M&A deals. But so far this year, however, she’s helped structure some 25 M&A deals involving a target headed for bankruptcy. One of the hardest tasks involved, she said, is educating tech executives on what’s ahead. “They cannot get their heads around the fact that it comes out in a very public way and everybody is subject to being overbid,” Coleman said. “These things are public auctions and there is no incentive for prices to be low.” Another major struggle occurs when buyers want to extricate some of the assets, and leave behind others along with the liabilities, Coleman said. Bankruptcy courts will go along with the selling off of assets of companies in bankruptcy, but won’t protect anyone from liabilities, she added. “From an acquirer’s standpoint, they [think] “I don’t want to fork over my cash until I get the protections,” Coleman said. Michael Dorf, a San Francisco-based partner at Wilson Sonsini Goodrich & Rosati, suggests clients simply push ahead — and quickly — when they see something they want to buy. “You’re better off, if you want to lock up the deal, to move quickly before [the target] files for bankruptcy,” Dorf said. And for other targets, the horrible fate they’re trying to avoid isn’t bankruptcy, but being delisted from the Nasdaq, Dorf said. But the buyer’s strategy for snatching up or starving a target isn’t what eats up a lot of Dorf’s negotiating energy these days. It’s arranging for the target to survive long enough for a deal to happen. “I do spend a lot of time negotiating interim financing,” Dorf said. “It’s normally the target that needs to move quickly, and that will be reflected in the deal terms.”

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