Beginner’s Guide To Mergers & Acquisitions
In the commercial world, we often hear the term ‘M&A’. In a nutshell, mergers and acquisitions are nothing more than companies selling and buying each other. In a merger, two companies are combined to become a new one, whereas, in an acquisition, one company is purchased by another without the formation of a new company. This article will give you an introduction to different purposes of M&A investments and an overview of the steps in an M&A process.
Various objectives for M&A
This is the basic M&A, where business units combine to become more profitable. It can be horizontal or vertical integration aimed at earning more money through improving efficiency or acquiring a larger market share.
Pre-IPO/ Venture capital
The objective is to finance small or emerging companies. This is to propel their growth and increase their valuation for a trade sale or an IPO exit. Typically, the investor only buys a small stake in the company (less than 20%) and the management team does not change.
The company is selling 100% of its shares but the funds come from a variety of sources. While some buy-out funds complete the transaction on their own, usually a buy-out fund couples with a management team that puts in a little bit of money. This may happen in the context where a founder of a long-standing company wants to retire and cash out. The directors of the company are young, committed, and want to be in the game. But they don’t have enough financing to buy out their boss. In this sort of circumstance, the senior management team will work with a buy-out fund to take the former owner out. They will then run the company themselves. Ultimately the buy-out fund may sell again or go public.
In this type of M&A transaction, no one buys anybody out, instead, each party brings something to the table and they collectively explore the particular business opportunity. At its most limited form, a joint venture can just be a contract to cooperate. For example, an entrepreneur has some know-how that he wants to grow and the other investor has financial resources, they then pull those together and distribute the benefits that come from that R&D cooperation. At its full form, an investor may be contributing new assets into a company, and that company is then 50/50 owned by the investor and the original owner.
In general, all M&A deals follow this life cycle:
The purpose of this stage is to see if the deal is possible. The seller and the buyer would engage in preliminary commercial discussions regarding the target company. At a minimum, they will express an intention to sell and buy and negotiate a rough price range. The parties may sign a term sheet that sets out the key terms, a rough timeline and an exclusivity period during which the seller may not approach other buyers. This term sheet is typically only an expression of intent and is not binding on the parties except with respect to the paragraphs titled “Confidentiality”, “Exclusivity”, “Expenses” and “Governing Law and Dispute Resolution”. The term sheet is mainly for setting expectations. And allowing the investor a certain window of clear space to investigate the target company.
When the preparatory phase is at the halfway point, the buyer should feel reasonably certain that the deal is possible. Then the buyer shall start doing due diligence. This process can be lengthy in time. It all depends on the nature and complexity of the underlying assets and cooperation of the seller. Financial due diligence is the driver of the deal, to see how much the company is really worth or how profitable it will be in the future. A buyer should watch out for a number of key issues: whether he is buying the right thing at the right price, whether the seller owns the shares or the assets, whether there are any contingent liabilities and whether the business is operating on solid legal grounds. The buyer should identify all the potential problems and address them accordingly. Immaterial issues may be ignored while more serious risks may lead to adjustments to the purchase price and agreement terms. In the worst-case scenario, the buyer may have to withdraw from the deal.
Documentation and signing
The documentation phase begins after due diligence is completed. The key transaction document would usually be a subscription agreement or a sale and purchase agreement. The key issues in negotiation include the deal structure, the purchase price, condition precedents, condition subsequents and representations and warranties. There will also be other related documents such as a shareholders agreement (SHA) if there is more than one shareholder. The key objective of a SHA is to regulate ownership and control. There are usually provisions governing the issue of new shares, transfer of existing shares, board composition and minority shareholder rights. After lawyers prepare all the necessary documents, the buyer and seller will sign the documents.
Perhaps not known to everyone, signing does not equate to closing. At the time of signing, parties put pen to paper but money does not change hands. Prior to signing, the purchaser will flag all of the relevant conditions precedents and in the period between signing and closing, the seller procures the fulfilment of closing conditions necessary for the transfer to become effective. For the sale and purchase of tangible assets such as a factor or a building, the post-signing period can be very brief with minimal condition precedents to be satisfied, but when the transaction involves the sale of more complicated assets, say the shares of a company, there will be more to do between signing and closing.
During the post-signing phase, the seller should be busy checking off the CPs while still running the business. On the other hand, the purchaser is mainly in waiting mode. That is, unless it needs financing for the deal, which is less common. At this point, the only thing stopping closing is the condition precedents, so usually, both sides will want to narrow the pre-closing window as much as possible.
Closing and Post-closing
At closing, money and shares change hands. Upon closing, the target company will be integrated into the Buyer group. The buyer takes over the assets and starts running the business. The buyer and purchaser will still have some duties even though the sale and purchase is officially completed. If some immaterial conditions were not fulfilled prior to closing but both sides agreed to deal with it afterwards, they will be pushed to post–closing. There are also some post-closing action items per the transaction documents, which include the filing of updated registers of members and the registration of charges. The completion of all regulatory steps marks the end of the M&A transaction.
Many companies see M&A as a quick way to scale their business, this road is not foolproof by any means. The above is just a simple overview of a typical M&A process, according to a research conducted by the Harvard Business Review in 2011, the average failure rate for corporate M&A deals can be as high as 90%. Particularly in this time of global economic and political instability, companies interested in M&A shall cautiously weigh the risks and rewards of engaging in these ventures before committing to massive investments.
This article does not constitute legal advice
The opinions expressed in the column above represent the author’s own.