Mergers and Acquisitions (M and A) and corporate restructuring are a big part of corporate finance world-Every day, wall street investment bankers arrange M and A transactions which bring separate companies together to form larger ones.
Defining M and A
The main idea:
One plus one makes three, this equation is special applicable one to M and A, the key principle behind buying a company is to create value of the two companies, of course two companies together are more valuable than two separate companies – at least that is the reason behind M and A
This rationale / principle is applicable when times are rough, strong companies will act to buy other companies to create more competitive, cost-efficient company.
The companies will often agree to be purchased when they know they can not survive alone.
Distinction between M and A
Although they are uttered in the same breath and used as identical, but they mean different thing.
When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition from legal point of view, the target company ceases to exist.
The buyer swallows the business and the buyer’s stock continues to be traded.
Even though both terms, M and A refer to corporate reorganizations, to transfer ownership control from one firm to the other, but strictly speaking they are different, their distinction is however sometimes ambiguous.
When we use the term ”merger” we are referring to the merging of two companies, where one company will continue to exist, the Merging Agreement between the two parties will specify the terms and conditions of such merging.
Synergy
Synergy is the magic force that allows for enhanced cost efficiencies of the new company. Synergy takes the form of revenues enhancement and cost savings such as:
- Staff reduction – job cuts
- Economies of scale – size matter – big companies to place orders can save more on costs, improving purchasing power.
- Acquiring new technology
- Improved market reach and industry visibility
Regardless of their category or structure, all mergers and acquisitions have one common goal, the value of the combined companies greater than the sum of the two parties.
The success of a M and A depends on whether this synergy is achieved.
Valuation Matters
Investors in a company aiming to talk over another one must determine whether the purchase will be beneficial to them.
They must ask themselves, how much the company being acquired is really worth.
Naturally, both sides of an M and A deal will have different ideas about the worth of a target company, its seller will tend to value the company at a high price as possible, while the buyer will try to get the lowest price that he can.
There are however many legitimate ways to value companies, the most common method is to look at comparable companies in an industry.
Legal Consideration
When one company decides to acquire another company, a series of negotiation will take place between the two companies, the acquiring company should have a well-developed
negotiating strategy and plan in place, if the target company believes the merger is possible, the two companies will enter into a letter of intent.
This letter of intent outlines the terms for future negotiation and commitment of the both parties, this letter of intent should give the acquiring company the green light to move into phase 11 (Due Diligence)
The following are the clauses to be inserted in the letter of intent:
- How will the acquisition price have determined?
- What is the form of payment? Will the acquiring company issue stock, pay cash, issue notes, or use a combination of stock, cash, and/or notes?
- What is the estimated time frame for the merger? what law firms will be responsible for creating the M and A Agreement?
- What is the scope of due diligence? What records will be made available for completing due diligence?
- How much time will the Target Company allow for negotiations? The Letter or intent will usually prohibit the Target Company from ”shopping itself” during negotiations.
- Will there be any operating restrictions imposed on either company during negotiations? For example, the two companies may want to postpone hiring new personnel, investing in new facilities, issuing new stock, etc. until the merger has been finalized.
- If the two companies are governed by two states or countries, which one will govern the merger transition.
- Will there be any adjustment to the final purchase price due to anticipated losses or events prior to the closing of the merger.
Due Diligence:
There is a common thread runs throughout the M and A process, it is called Due Diligence.
Due Diligence is a very important factor detail and extensive evaluation of the proposed merger.
Due Diligence is also very broad and deep extending well beyond the functional areas (finance, production and human resource … etc.) this is extremely important since due
diligence must expose all the major risk associated with the proposed merger, some of the risk area to be investigated:
- Market
How large is the target’s market? Is it growing? What is the major threat? Can we improve it through merger?
- Customer
Who are the customers? Can we furnish? These customers new services or products?
- Competition
Who competes with the merger company? What are the barriers to competition? How will a merger change the competitive environment?
- Legal
What legal issues can be expected due to an M and A? what liabilities, lawsuits and another claim are outstanding against the target company?
Making Due Diligence work
Since due diligence is a very difficult undertaking, you will need to enlist your best people including outside experts, such as investment bankers, auditors, valuation specialists …. etc. goods and objectives should be established and clearly defined, making sense that everyone understands what must be done since there is a tight time frame for can pelting due
diligence-communication channels should be update continuously so that people can update their work as new information becomes avoidable, it to senior level management.
Due diligence must be aggressive, collecting as much as information as possible about the target company, this may require some undercover work, such as sending out people with
false identities to confirm critical issues. A lot of information must be collected in order for due diligence to work, such as:
- Corporate Records
- Financial Records
- Tax Records
- Regulatory Records
- Debt Records
- Employment Records
- Property Records
- Miscellaneous Agreement
Good due diligence is well structured a very pro-active, trying to anticipate how customers, employees, suppliers, owners and other will react once the merger is announced.
One an analyst was asked about the three (3) most important things / factors in due diligence, his response was ”detail, detail and detail”.
Failure to perform due diligence
This can lead to disastrous; the reputation of the acquiring company can be severely damaged a classic case of what has gone wrong is the merger between HFS and CUC International, it discovered that there were significant accounting irregularities, the newly formed company lost 14 billion in market value, the chairman resigned and in year 2000, Emst and Young was forced to settle with shareholders for 335 million.
Due diligence is absolutely essential for uncovering problem areas, exposing risk liabilities and helping to ensure that there are no surprises after merger is announced.
Once all issue has been included and addressed to the satisfaction of both parties, the merger and acquisition is executed by signing the M and A agreement.
Culture of the company
When a company is acquired, the decision is typically based on products and market, but cultural difference are often ignored, it is a mistake to assume that personnel issues are easily overcome, for instance employees at a target company may be accustomed to easy access to top management flexible work schedules or even a relaxed dress Code these aspects of a working environment may not seem significant, but if new management removes them, this can be interpreted by the employees as an insult / humiliation or arrogance on the part of the new management and lead to shrinking productivity.
