Back to School for GovCon Sellers: Do Your Homework Before Going to Market

• Know Your Contracts
  A seller should begin by developing an accurate picture of the government business being sold. Government contractors often perform through a mix of prime contracts, subcontracts, OTAs, purchase orders, indefinite-delivery vehicles, teaming agreements and other arrangements. Before going to market, sellers should understand the material terms of those agreements, including periods of performance, change of control/assignment requirements, security requirements and small-business status. In addition, contractors should understand any significant disputes or performance issues related to key contracts. This exercise also helps validate one of the central components of the company’s deal story: the durability of its government revenue. Sellers should be prepared to substantiate backlog, option periods, recompete assumptions and other information that buyers are likely to consider when assessing value.
• Consider the Transaction Structure Early
  For government contractors, the distinction between an equity sale and an asset sale may have consequences beyond traditional tax and commercial considerations. Federal law generally restricts the transfer or assignment of government prime contracts. Therefore, asset transactions generally require the Government to recognize the buyer as the successor in interest through a novation process under Federal Acquisition Regulation (FAR) Subpart 42.12. This process can add additional time, uncertainty and administrative burden to the deal process. An equity acquisition in which the contracting entity remains intact does not require novation. Contractors wishing to avoid novation should consider this early when determining how to structure the deal.
• Check Your Work Before the Buyer Does
  Government contractors make representations to the Government in a variety of contexts, including SAM.gov registrations, proposals, contract certifications, invoices and cybersecurity submissions. Before opening the data room, sellers should consider testing material representations against the company’s actual practices. Depending on the business, diligence may warrant particular attention to small business and socioeconomic status, cybersecurity compliance, domestic sourcing and supply-chain requirements, organizational conflicts of interest, cost and pricing matters, and ethics and disclosure obligations. An issue identified internally can often be investigated, explained or addressed before it becomes a deal problem. The same issue discovered for the first time by a buyer can create questions regarding both the underlying compliance matter and the reliability of other representations made by the company.
• Treat Cybersecurity as a Deal Issue
  Cybersecurity has become an increasingly important diligence issue for government contractors. Companies should be prepared to explain what sensitive government information they receive, where that information resides, which systems process or store it and what contractual cybersecurity requirements apply. For defense contractors subject to Cybersecurity Maturity Model Certification (CMMC) clauses and related Defense Federal Acquisition Regulation Supplement (DFARS) requirements, buyers may also examine the company’s CMMC status, prior assessments and affirmations, remediation items and subcontractor compliance.
• Know What Intellectual Property the Buyer Is Buying
  For many defense and technology contractors, intellectual property represents a substantial portion of enterprise value. Government contracting adds an important wrinkle: the Government may have rights in technical data or computer software developed or delivered under government contracts. Before going to market, sellers should understand what technology was developed at private expense, government expense or with mixed funding; what technical data or software has been delivered to the Government; what restrictions were asserted; and whether those materials were appropriately marked. Uncertainty regarding intellectual property ownership or government rights can quickly become a valuation issue rather than simply a contract-compliance question.
• Understand Small Business Issues
  A transaction also can impact a government contractor’s eligibility to pursue, perform and maintain certain work that is set-aside for small business or other preferred statuses (SDVOSB, 8(a), HUBZone, etc.). In addition, historical misrepresentations regarding size or status can open a contractor up to compliance risk. Therefore, contractors should consider both the impact of a future transaction on their pipeline, as well as any potential compliance issues related to small business size or other status.
• Understanding the Identity of the Buyer
  Companies performing classified work have long been subject to requirements concerning beneficial ownership or foreign ownership, control or influence (FOCI). A recent proposed rule would expand these requirements to apply to unclassified defense contracts and subcontracts valued in excess of $5 million, with certain exceptions. FOCI concerns should not necessarily deter a transaction involving foreign investment, but potential mitigation requirements can affect governance, integration and transaction timing. Thus, contractors should identify and consider these issues early in the process.

In short, the current market presents many opportunities for government contractors and defense technology companies going to market or seeking investments. Contractors that perform government contracts due diligence early in the process can favorably structure transactions and get ahead of potential buyer concerns.