Series 79 – Investment Banking Representative Exam Due Diligence & Deal Structuring 2 — Questions and Answers
Question 1: In an asset purchase transaction, which of the following is a primary advantage for the buyer?
- The buyer assumes all known and unknown liabilities of the seller
- The buyer receives a step-up in tax basis for acquired assets (Correct answer)
- The buyer avoids the need for target shareholder approval
- The buyer inherits the seller's existing debt obligations
Correct answer: The buyer receives a step-up in tax basis for acquired assets
In an asset purchase, the buyer can step up the tax basis of acquired assets to fair market value, increasing future depreciation and amortization deductions and reducing taxes.
Question 2: An earnout provision in a deal structure requires the seller to receive additional consideration contingent upon:
- The buyer successfully completing an IPO within two years of closing
- The target achieving specified future financial performance milestones (Correct answer)
- The target's existing management team remaining employed for one year
- The buyer refinancing the acquisition debt at favorable rates
Correct answer: The target achieving specified future financial performance milestones
An earnout ties a portion of the purchase price to future performance metrics such as revenue or EBITDA targets, bridging valuation gaps between buyer and seller.
Question 3: A 'material adverse change' (MAC) or 'material adverse effect' (MAE) clause in a purchase agreement primarily allows:
- The seller to increase the purchase price if the company outperforms expectations
- The buyer to terminate the agreement if a significant negative event occurs before closing (Correct answer)
- The target's board to solicit competing bids after signing
- The investment bank to collect a higher advisory fee if the deal closes on schedule
Correct answer: The buyer to terminate the agreement if a significant negative event occurs before closing
A MAC/MAE clause gives the buyer the right to walk away from the deal without penalty if a significant adverse development materially impairs the target's business before closing.
Question 4: In deal structuring, an indemnification escrow arrangement typically serves to:
- Fund the target company's operations during the transition period post-closing
- Provide the buyer with recourse for post-closing breaches of representations and warranties (Correct answer)
- Compensate the seller's financial advisors for services rendered
- Satisfy regulatory capital requirements imposed by the SEC
Correct answer: Provide the buyer with recourse for post-closing breaches of representations and warranties
An escrow holdback retains a portion of the purchase price to compensate the buyer for losses arising from the seller's breach of representations, warranties, or indemnification obligations.
Question 5: A 'working capital adjustment' in a purchase agreement is designed to:
- Compensate the seller for transaction-related expenses incurred before closing
- Ensure the buyer receives the target with a normal level of operating liquidity at closing (Correct answer)
- Adjust the purchase price based on changes in the target's share price
- Reallocate purchase price among individual assets for tax purposes
Correct answer: Ensure the buyer receives the target with a normal level of operating liquidity at closing
Working capital adjustments true-up the purchase price so that the buyer receives the target with a normalized level of net working capital, preventing the seller from draining cash before closing.
Question 6: A 'representations and warranties' section in a purchase agreement primarily serves to:
- Outline the buyer's post-closing integration plan for the target
- Allocate risk by having each party certify that certain statements of fact are true (Correct answer)
- Define the earnout performance metrics and measurement period
- Establish the governance structure of the combined entity after closing
Correct answer: Allocate risk by having each party certify that certain statements of fact are true
Representations and warranties are factual statements made by each party that allocate risk; if a rep proves false, the harmed party may seek indemnification.
Question 7: In a leveraged buyout (LBO) transaction structure, the acquisition vehicle is typically:
- A publicly registered investment company regulated under the 1940 Act
- A newly formed holding company that incurs debt to purchase the target (Correct answer)
- An existing subsidiary of the private equity fund's portfolio
- A special purpose acquisition company (SPAC) listed on a stock exchange
Correct answer: A newly formed holding company that incurs debt to purchase the target
LBOs use a newly formed 'newco' shell entity that borrows the majority of the acquisition financing, using the target's assets and cash flows as collateral.
Series 79 – Investment Banking Representative Exam Due Diligence & Deal Structuring 2
In an asset purchase transaction, which of the following is a primary advantage for the buyer?