Mergers and acquisitions is a general term that describes the consolidation of companies or assets through various types of financial transactions.
How the transaction is communicated to shareholders, employees and the board plays a role in determining whether a deal is considered a merger or acquisition.
What is a merger?
A merger, in the classic sense, takes place when two companies combine their businesses on a fairly equal footing. The idea behind it is that a new, stronger business is created with the shareholders of the original businesses coming together in a more or less equal way to share and control the new business. It may be that the shareholders of one business sell their shares to the other company in return for shares in that other company. Or it may be that a new company is formed and the shareholders in each business transfer their shares to that new entity in return for shares in that new entity therefore creating a group structure.
In either example, to repeat, when one thinks of a “merger” one thinks of businesses of similar size and strength joining forces with the shareholders in each company who come together on a more or less equal basis. In practice, though, deals which are called “mergers” are sometimes more like acquisitions where a larger business swallows a smaller one. The deal is labelled a “merger” to give the impression to the outside world (or even the business being acquired) that things were being done in a more equal way.
Broadly speaking, there are two main types of mergers: (1) horizontal, and (2) vertical.
A horizontal merger is where two competing companies which produce/provide broadly the same goods/services. An example of this type of merger is Exxon’s 1998 merger with Mobil to form the modern oil & gas company ExxonMobil.
A vertical merger is where two companies in the same supply chain merge, for example, where a drinks producer merges with a bottle manufacturer. EBay merging with PayPal in 2002 is an example of this type of merger.
Other types of merger include a conglomerate merger (where two companies without goods/services or client crossover merge) or a congeneric (where two companies without goods/services crossover, but operate in the same markets, merge).
What is an acquisition?
An acquisition is where one company purchases another business outright. The buyer is usually larger than the purchased company, meaning that the former absorbs the business of the smaller company.
With acquisitions, the acquiring company purchases the majority or all of the assets of the target business or all of the target’s issued share capital.
Asset or Share Purchase?
The decision as to whether to acquire the target business by purchasing its assets or by purchasing its shares is driven by several factors. Here are some of them:
If the buyer acquires all the issued shares in the target company, it is buying a business with all the assets and liabilities that come with it. Although there are things the buyer you do to protect itself against unexpected liabilities, for example, by obtaining warranties from the selling shareholders, it is not ideal being in a position where it is necessary to make a warranty claim. In an asset purchase, the buyer can select which assets they are going to acquire and which liabilities will stay with the business.
Unless the purchaser is only interested in acquiring some specific assets (so not really buying the business as a whole) it is usually more straightforward to purchase the shares in a business. With a share purchase there is no need to consider which assets are being transferred / which liabilities will remain with the target company because the only thing being acquired is the issued share capital. The target company remains intact – it is only the shareholders and directors who will change.
Connected with this, there is no need to obtain the consent of the target company’s customers to have their contracts transferred to the buyer. That said, if the target has entered into contracts containing clauses that allow for the other side to terminate if there is a “change of control” in the target then the risk of those contracts being terminated following completion of the transaction must be taken into account.
Share purchases do though need the consent of the shareholders of the target company to be effected while asset purchases only need the consent of the directors so for some deals an asset purchase may be easier to transact. For smaller companies, though, the shareholders and directors tend to be the same so only needing director consent isn’t an advantage.
It is usually tax advantageous for a buyer to acquire a business through an asset purchase while from the seller’s perspective a share purchase is generally more tax efficient. This asymmetry arises as a result of the interaction of the substantial shareholding exemption for corporate sellers on a share sale (or for individuals who are sellers the availability of business asset disposal relief or investors relief) and the ability for buyers to claim amortisation relief on the price paid for intangible fixed assets on an asset purchase.
Tax treatment may be the key factor that drives the choice of acquisition structure and therefore should be considered at the outset.
If the target company is in an administration, receivership or liquidation, any acquisition would almost certainly be structured as an asset purchase so the buyer can avoid taking on responsibilities for the targets creditors and other liabilities.
Is an acquisition easier than a merger to transact?
Acquisitions tend to be more straightforward than mergers because the owners of the business being acquired usually walk away once the deal is completed or, if the owners were also the directors of the business, some of them may continue to be engaged for a couple of years to help the new owners get to grips with the new business and maintain relationships. If assets are being purchased, the target company usually winds down post completion.
The M&A process
Unless the target company is in administration or similar financial difficulty the M&A transaction would typically follow this kind of process:
Once the buyer and the seller have expressed an interest in going ahead with the sale and purchase of the target business the parties should sign a non-disclosure agreement (NDA). The NDA will protect any confidential information that one party (mainly the seller) provides to the other in connection with the potential acquisition and the state of affairs of the respective businesses.
At this stage the buyer may undertake some due diligence on the target (mainly financial due diligence) to get more of an idea of the financial position of the target.
Heads Of Terms
Having exchanged this information the buyer will then be in a position to make an offer to purchase the target. The parties will negotiate the offer and once the commercial bones of the deal are agreed they will then be in a position to sign heads of terms.
Full Due Diligence
Once heads of terms are signed the buyer will conduct full due diligence. This will entail more in depth financial due diligence, legal due diligence and technical due diligence. Especially if the transaction is to be structured as a share sale, the seller will need to disclose substantial amounts of information about the state of the target company.
The seller’s lawyers and wider team will advise on the due diligence process and set up a data room where the required information will be uploaded to enabling the parties’ teams to manage and view the information.
Asset Purchase Agreement / Share Purchase Agreement
The next stage which can happen before the due diligence process is complete is for the buyer’s lawyers to prepare the asset purchase agreement or share purchase agreement depending on how the deal is being structured. These kinds of agreements tend to be “heavy” and involve several rounds of negotiations.
Establishment of Top Co and Shareholders Agreement
If a merger is taking place, it is common for a parent company to be established and a shareholders agreement will need to be negotiated. The shareholders agreement will govern the relationship between the new shareholders transferring from the targets to the top company. If a parent company is not being set up then a shareholders agreement will still be needed for the target shareholders joining the existing buying entity.
Other documents will need to be prepared as well. The share purchase agreement or asset purchase agreement will contain warranties i.e. statements about the state of the target which the buyer expects the seller to make. If a warranty turns out to be untrue the buyer will be able to sue the seller for any loss incurred (subject to limitation of liability protections that the seller includes in the sale contract). The seller’s lawyers will therefore prepare a disclosure letter qualifying the warranties where appropriate to protect the sellers from being sued. A simple example of this would be where the buyer includes a warranty in the sale contract that the target is not involved in any litigation and the disclosure letter describes a claim that the target is defending from ABC Limited. Having disclosed details of the claim, the buyer will not then be able to sue the seller after completion for breach of that warranty unless the target is involved in claims other than with ABC Limited.
Other documents will need to be prepared as well such as board minutes, resolutions, stock transfer forms (for a share sale), novation and assignment agreements (for an asset sale).
If the transaction has been concluded through an asset sale and there are employees in the target company, the buyer and seller will need to have followed the Transfer of Undertakings (Protection of Employment) Regulations 2006. In a nutshell, the employees of the target will transfer to the buyer and they must be consulted about this.
There are various things that will need to be taken care of post completion. These include arranging for stock transfer forms to be stamped at HMRC (in the case of a share sale) or stamp duty to be paid on the transfer of any property (in the case of an asset sale).
On a share sale, some or all of the existing directors in the target company will be replaced by the buyer’s nominated directors unless a merger is taking place in which case it is possible that the directors in the target businesses will remain and become directors in the top company if a group is being established.
Most deals take several months to conclude and involve a lot of work on the part of the lawyers. The documentation and process outlined above will be needed no matter how small the deal is unless the buyer is prepared to take on the risk of buying a business with liabilities that it cannot pursue the seller for.
If the target company is in administration, the buyer will almost certainly want to acquire certain assets of the business and there will be little scope for negotiation on the asset sale agreement or for the buyer to conduct any due diligence. These sorts of deals are usually conducted very swiftly. As such they can be very risky for the buyer – it depends on what kind of industry the target business is in and the assets that the buyer wants to obtain.
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