The term “Mergers and Acquisitions (M&A)” is generally used in one breath, but they are different. Let us go back to basics.

A merger means 2 companies combine to become one with some legal variations where one company loses its identity, or share the identity or create a new one. Though mergers are between companies, in some cases the Government may help facilitate a merger by passing a law. This is rare and controversial.

An acquisition means purchasing of assets of another entity. The assets could be shares in whole or part, business, property or combinations of them. However, in this case, the acquiring entity is the dominant one.

The philosophy for both may be for growth and size. The reasons may be taking advantage of a bigger name, market access, clearing past mistakes, pool resources, reboot the respective businesses, combining products or simply to be bigger.

The risks of M&A have been covered in an earlier article When Mergers & Acquisitions Don’t Work. In addition to the problems listed there, there are also legal risks of anti-trust and anti-monopoly laws in large M&As.

 

M&A process

1. Strategy
2. Identification
3. Preliminary Due Diligence
4. Expressions of Interest
5. Detailed Due Diligence
6. Definitive Documentation
7. Post M&A

 

1. Strategy:

M&A begins with an idea in a company that helps it increase market share and access, talent acquisition, product or technology acquisition, growth and size. Each of these deal drivers help narrow down the potential target companies and the regions they operate in. The prepared profile also helps in the preliminary due diligence.

At this point, it is also important to know the type of company to be added to the company’s portfolio. Whether there is a philosophical fit and proper post-integration timelines have been added.

Why M&A:

• Why and what are you acquiring?
• Boosting current performance
• Acquiring resources, premium pricing
• Acquiring resources, lower cost
• One-stop shop
• Reinventing business model
• Acquiring a disruptive business model
• Acquiring to decommoditize
• Paying the right price
• Avoiding integration mistakes

2. Identification:

In line with strategy, identification of potential companies for a merger or an acquisition by a company takes place. Identification can be conducted by business and management consultants, investment bankers, business brokers, lawyers, accountants or simply, by the company/individual itself.

Most target companies that are amenable to acquisition (not merger) may be distressed companies i.e., debt laden. They may also have management or shareholder issues, hit a sales / revenue ceiling, danger of disruption, funding issues.

Acquiring a business:

• Brokers: Business and management consultants, investment bankers and bank special assets group, business brokers, lawyers, accountants, news sites, business sites, networks and close circles
• Reference/reputation check: market information, clients, employees
• Level of distress
• Meeting, discussions and negotiations with owner
• External affecting factors such as lenders, shareholders, third parties
• Continued use of target, reinvent or retain current business plan
• Requirements of target and cost of acquisition including IP, database and assets
• Goodwill and reputation

3. Preliminary Due Diligence

During or simultaneous with the identification process, a preliminary due diligence or DD should take place. Available online search including LinkedIn on the key persons involved, other directories with brief information, reportage about the company and persons involved, references from common friends and resources, ex-management and employees.

An important aspect of DD is that it is not a singular process. It can be in two parts. One, if there is trust and two, the detailed DD.

The deeper the general DD, the longer lasting the M&A. Identification is not only about targets that add to the bottom line. It greatly improves the credibility of the target when the representations made matches with the final DD.

A few dollars spent in the initial stages will go a long way in either a long-lasting relationship or a much valuable and cheap lesson learnt for future projects. It is a relationship because it involves not only internal personnel, but clients and customers post M&A as well.

4. Expressions of Interest

The companies may then reach out directly or through third parties to evince or find out interest in M&A. A series of meetings will take place. May also involve exchange of contracts relating to confidential information, circumvention or solicitation.

Next is an exchange of expressions of interest. These may be simple email exchanges, formal letter of offer, binding or non-binding term sheets, memorandum of understanding or an agreement.

5. Detailed Due Diligence

A formal process involving exhaustive inspection and review of documents and information to see if assets represented are true and uncover any unstated liabilities. DD may involve commercial, financial, technical or legal DD. The DD process may take over 3 months to conclude.

6. Definitive Documentation

These are the final documents signed and executed and assets transferred. They may include – sale and purchase, share transfer, share subscription, management/key employment agreements or variations of these. There may be additional documents such as restated charter documents, shareholder, escrow, closing and future engagement contracts.

7. Post M&A

This involves philosophy, leadership, legal documentation review, management review, integration, training, regulatory and statutory compliance, corporate compliance, operations, human capital reorganization, customer/client contracts, change and culture management, risk management, name change processes, corporate communications.

 

 

 

 

Merged & Acquired – Solution

• M&As are delicate subjects. In these cases, I say that the shortest distance between two points is never a straight line. Diplomatic skills, EQ, empathy, motivational theory applications, change management and cultural integrations are pre-requisites for a successful M&A. This actually saves time in the long run and are the multiple points that in fact bring the main 2 points together.

• Capture and reallocation of HC in merged or acquired companies. This capital which has high return on investment in an M&A.

• Guanxi – Like most Chinese expressions, guanxi is complex. Simply put, it means “relationships” (but without hierarchy). Build understanding and acceptance before M&A. It forms what I call Human Due Diligence.

• Find professionals that give you the paradoxical and elusive “Collaborative M&A with Organic Growth” that consider contribution by all parties to an M&A to help each other increase output, increase customer base, improve and develop new products and successfully deploy HC.

Flashing back to Part 1, a liquidity event is an exit strategy for investors to convert their equity into cash and occurs when any of the following typical change of control events takes place:

1. merger
2. acquisition
3. sale purchase – part or whole, shares or assets
4. leveraged recapitalization – debt to finance purchase of equity
5. ESOP
6. IPO of a company

The occurrence of liquidation, dissolution or winding up of a company may also be included as a liquidity event.

Continuing on from Part 2: 8 Considerations before the liquidity event, which in summary talked about the below 8 considerations, we now move on to Part 3: 8 Legal Points to note during a liquidity event.

1. Types of entities involved
2. Cash receipts or pay-outs
3. Escrow Consideration
4. Type of Equity
5. Value of Equity
6. Local Laws
7. Effects on Employment
8. Tax matters

As if Part 2 were not exciting enough, here is where the real exciting part comes. Here are practical things to take note of DURING the event itself. You’ve flirted ideas with your buyer/investor and finally there is some understanding and mutual agreement after a courtship process.

However, here is where you will need to get really cautious and have a full understanding on what each part means and why it is done. The below is a far from exhaustive list but points out some essential points to note.

 

8 Legal Points to note

 

At the liquidity event itself, the following legal issues should be considered:

1. Representations and warranties in contract containing the liquidity events that could make or break a deal

Sometimes overlooked as standard clauses, a target is willing to give any and all representations and warranties that an acquirer is looking for. But this could be quite dangerous as the sale and purchase agreement will invariably contain indemnity clauses and this will affect the deal. In a sale and purchase agreement, certain specific representations and warranties are covered within the substantive part of the agreement itself and many so-called standard clauses are covered as an annexure, schedule or attachment to the main agreement. The standard clauses are mostly the sum total of the experiences of professionals and standard templates that have evolved over time. Involvement of local lawyers is required. Misrepresentations could have serious legal repercussions.

 

2. Covenants (to do or not to do something) and obligations. On pre-closing, closing and post-closing

As with all financial transactions, a buyer would seek to protect his money and delay payment until all conditions are satisfied and a seller would agree to do anything to receive the pay-out at the earliest. Incapacity to pay, failure to fulfil conditions, non-receipt of corporate and statutory approvals are some of the factors where the deals fall through. Post-sale, many negative covenants such as non-disclosure, non-compete, non-solicit and non-circumvention would continue to operate and can operate against the seller/target and affect the future operations of the target.

 

3. Special rights that are covered in the agreement, such as options, transfer, approvals, put-call, drag-tag along, lock-ins/lock-ups, share-asset price ceilings

Liquidity events call for perusal and scrutiny of past and future contracts for sale and purchase, subscription and shareholders agreements. Many corporate, statutory and regulatory approvals are required. The constitution or articles of the target may also contain special rights of existing shareholders. In some occasions, agreements between shareholders may be privy and enforceable between shareholders and not involve the company. In these circumstances, the company will not be liable for the contract inter se shareholders unless these rights are enshrined within the constitution documents.

 

4. Indemnification, liabilities and remedies. Who bears consequences

Liabilities and indemnification thereto vis-à-vis the seller are called for misrepresentations and failure to comply with conditions of transfer. Similarly, the buyer can also be liable by forfeiting his deposit at the time of signing a contract as well as be liable for indemnification for non-payment/non-fulfilment of conditions of the contract. Legal liabilities should be monitored during and after the liquidity event.

 

5. Set offs. Does cash pay-outs or equity issuance create set-offs on price and valuation?

If projections are not met or if conditions fail during the course of a transaction that does not involve a bullet payment, this will affect the cash pay-out as well as issuance of equity. Some events for set-offs in terms of cash and time may be mitigated by force majeure clauses. Even in bullet payments, if negative covenants are violated, the seller can still be dragged into litigation and set-offs may not mitigate the risk.

 

6. Other contracts relating to or effecting the liquidity event

The occurrence of liquidity events affects many other factors in the target. Investors will seek blanket clauses covering their investment in the present and near future and will look out for other contracts entered into by the target that affect the valuation of the company or its shares. The other contracts would include existing shareholders agreement, deeds of adherence, options agreements, voting agreements, warrants, management agreements, key employee agreements, debt instruments and agreements, share subscription agreements, constitution documents – where the company is bound to do or not do certain acts. Documents such as warrants may also contain provisions for protection when public acquisitions take place. Normally, a due diligence covers these issues. Negligence of a proper due diligence affects the investor greatly rather than the target.

 

7. Governing law. This is particularly relevant on cross-border transactions

Some countries provide specifically for the place where the cause of action arises and thus bring the parties within that jurisdiction. Some countries may completely ignore the governing law and protect its citizens, individuals and corporates. The governing law also matters as contracts are interpreted differently, whether under civil law or commonwealth law or general law by different countries. There have been instances where the governing law is of a jurisdiction different from the nationalities of both parties.

 

8. Dispute resolution. Arbitration, mediation or local courts

Alternate dispute resolutions such as mediation, arbitration and conciliation may mitigate consequences when heads of the respective parties meet, but these may be exercises in futility. Where the parties are from different countries, treaties between the countries where the parties reside will dictate whether a judicial order passed can be enforced against the penalized party. Many parties settle for international arbitration which can be slightly more expeditious than established court systems. This is because arbitration takes only a particular matter into consideration whereas the courts have to handle all matters relating to its jurisdiction.

Stay tuned for the LAST part of the series: 8 Points on Initial Public Offerings