01 Investment banking 08 Sources of funds to execute 15 Net operating losses

process merger in M&A?

02 Phases of M&A 09 Steps to create merger model? 16 What is impact of M&A

on F/Statements

Why do Goodwill and other

03 Teaser / PitchBook 10 Intangible Assets gets created
17 Synergies in merger
model
in M&A

04 Letter of 11 Goodwill in Merger model 18 Why would acquisition be

Interest/Indication dilutive?
of Interest

05 Letter of Intent/ 12 DTA and DTL in M&A

Indication of Intent

06 Definitive 13 What is 338(h)(10)?

agreement/Merger
agreement

07 C Corp & S Corp 14 Transaction structure of M&A

Investment banking floors-Summary
Investment Bank

Investment banking Investment Bank

division (IBD) Wealth Management Research Trading &Brokerage

M&A Due Diligence Fixed Income Research Proprietary Funds

Trading for client

Equity (IPO,OFS etc.) Equity Research (Hedge/Pension fundsetc.)

Capital Markets

Debt(Leverage finance,
restructuring etc.) Commodity Research
 M&A

Sell Side Buy Side

• Helps clients to sell his assets/Company. • Helps clients to buy assets/Company.

• Think of a real estate transaction, if you decide to sell your • Think of a real estate transaction, if you decide to buy house
house you will visit broker. you will visit broker.
• He will help you to value your house, Market it and find • He will help you to find ideal house as per specific needs at
buyers for your property. attractive valuation.
• Similarly investment bankers can help clients to Value, • Similarly investment bankers can help clients who are
Market and sell their business. willing to grow into different geography, new products, cost
• Only difference between real-estate agent and Investment savings etc. by helping them acquire other businesses.
banker is the deal size. Real estate agent is doing deals • Strategic buyers generally take longer to finalise the deal but
worth lakhs of Rupees. Investment bankeris doing deal buys company at higher valuation and Financial sponsors
worth 100’s of crores Rupees . closes the deal fast but at lower valuation.
 Phases of M&A

Merger negotiation
Pre merger Phase phase Post merger phase

• Pitching idea to client • Signing of NDA • Announcement of deal

• Getting hired as financial advisor • Sharing pitch book with clients • Legal formalities
• Due diligence • Preliminary Due diligence from clients end • Pay-outs
• Valuations • Submission of Letter of Interest • Integration
• Preparation of marketing material • Creation of data rooms and extensive due
(Pitch Book , Teaser) diligence from clients end
• Reach out to potential clients • Submission of Letter of Intent
• Meeting with prospective buyers
• Structuring the deal
• Final offer
• Signing definitive agreement
 Teaser walk through
A small marketing document sent out to potential investors in an opportunity.

Investment Teaser typically includes the following:

• Title page-The teaser title page will have some photo representing the company and a project name to keep it confidential.

• Industry highlights: Growth rate of industry, Competitive landscape etc.

• Investment Highlights: These include three to five points that outline the Unique Selling Points (USP) of the investment or acquisition

opportunity.

Example :High growth, break through technology, Market leadership, High margins, superior product etc.

• Company Overview: Brief description of the company (Without its name).

• Product and/or Sales Mix: A list of the main products/services offered and the revenue generated from each one

• Financial Summary: Summary of key historical financial metrics (Revenue, EBITDA, profit margin etc.) and forecasted figures.
Pitch books
A detailed marketing material on investment opportunity

Types

Deal Pitch book Management

Bank Introduction
presentation

To get the client Buy side When the client finalizes

the deal with the
Investment bank,
management presentation
Sell side is used by client to pitch to
investors

IPO

Raising capital
Components of Sell side pitch book
Every pitchbook is different but generally contains:-

1 . Market overview 2. Positioning/Equity 3. Company profile

story

4. Valuation summary 5 Potential targets/buyers 7. Summary

Sell side deal M&A process
2. Collect details 5. Approach
about client’s 3. Prepare marketing prospective buyers
1. Get signed as 4. Build valuation
business & due material teaser &
investment banker model (IV & RV) (Strategic buyer &
diligence pitch book
Financial Sponsors)

6. Indication of 10. Submission of

7. Meeting with 8. Submission of letter 9. Build virtual data
Interest from buyers bids by and potential
interested buyers of intent room
and sign NDA buyers

12. Meeting of top

11.Selection of final 13. Signing definitive 14. Public
executives and final
buyers agreement announcement
bidding offer
Letter of Interest/Indication of Interest
An IOI is a non-binding formal letter written by a buyer and addressed to the seller, with the purpose of expressing
a genuine interest in purchasing the company. An IOI should approximate the target company valuation, outline
the general conditions for getting a deal done, and more. Elements of a typical IOI often include, but are not
limited to:

• Approximate price range; can be expressed in a dollar value range (i.e. $10-15 million) or stated as a multiple of
EBITDA (i.e. 3-5x EBITDA)
• Buyer's general availability of funds and sources of financing
• Necessary due diligence items and a rough estimate of the due diligence timeline
• Potential proposed elements of the transaction structure (asset vs. equity, leveraged transaction, cash vs.
equity, etc.)
• Management retention plan and role of the equity owner(s) post-transaction
• Time frame to close the transaction

Importantly, the LOI is also the point at which buyers will seek to lock up your company for an exclusive period of
time in which the buyer can conduct a full due diligence process before purchasing the company. If you accept and
execute the LOI, it also prohibits you as the seller from speaking with other buyers -- an IOI does not require this
exclusivity
Letter of Intent/ Indication of Intent
If both the business owner and the prospective buyer(s) are interested in continuing the M&A process, the
buyer(s) should submit a Letter of Intent (LOI) outlining the buyerʼs proposed deal structure and terms The LOI
should include a summary description of all of the material deal terms that will later appear in the Purchase
Agreement. The following are the common terms you should expect to see in an LOI:

1. Deal Structure. Defines the transaction as a stock or asset purchase. Generally, the seller prefers a stock
transaction from a tax and legal perspective. Asset transactions are preferred by the buyer to protect against
prior liabilities and provides a stepped-up tax basis.

2. Consideration. Outlines the form(s) of payment -- including cash, stock, seller notes, rollover equity,
and contingent pricing.

3. Closing Date. The projected date for completing the transaction. This date is an estimation and will likely
change based on surprises in due diligence or the Purchase Agreement.
Letter of Intent/ Indication of Intent
4. Closing Conditions. Lists the tasks, approvals, and consents that must be obtained prior to or on the Closing
Date to close the transaction.

5. Exclusivity Period (Binding). It is common practice for a buyer to request an exclusive negotiating period.
This period is meant to ensure the seller is not shopping their deal to a higher bidder while appearing to
negotiate in good faith. Expect to see requested periods of 30 to 120 days. The duration may be negotiable,
but the presence of the exclusivity term will likely be nonnegotiable.

6. Break-up Fee (Binding). It is relatively common to have a break-up fees in larger deals above $500 million if
the business owner decides to cancel the deal. Break-up fees can either be a percentage (typically 3%) or a
fixed amount.

7. Management Compensation. Describes who in the senior management will be provided employment,
equity plans, and employment agreement. This term is often vaguely worded to provide the buyer with
latitude since they may not be prepared to make commitments to senior management.

8. Due Diligence. Describes due diligence requirements of buyer.

Letter of Intent/ Indication of Intent
9. Confidentiality (Binding). Although both parties have probably signed a confidentiality agreement, this
additional term ensures all discussions regarding the transaction are confidential.

10. Approvals. Lists any approvals needed by the buyer (e.g. board of directors) or seller (e.g. regulatory
agencies, customers) to complete the transaction.

11. Escrow. Provides the summary terms of the buyerʼs expected escrow terms for holding back some
percentage of the purchase price to cover future payments for past liabilities. The escrow is typically highly
negotiable and often excluded from the LOI and presented for the first time in the Purchase Agreement.

12. Representations and Warranties. This clause will include indemnifications in the Purchase Agreement so
the best practice is to include any terms that may be contentious or non-standard
Definitive agreement/Merger agreement
Once the Letter of intent is signed, the next major legal document is the Purchase Agreement. This document
incorporates both terms agreed upon in the LOI and new terms and conditions and will be the reference point in any
post- transaction questions or issues.

Merger Agreement can be found in 8k near the time of deal from EDGAR. Following are the most common material
terms found in Definitive agreement:-
• The Buyer and Seller
• Price (per share, or lump sum for private companies), and
• Effective closing date
• Type of Transaction.
• Treatment of Outstanding Shares, Options, and RSUs and Other Dilutive Securities
• Representations and Warranties
• Covenants
• Solicitation (“No Shop” vs. “Go Shop”)
• Financing
• Termination Fee (or “Break-Up Fee”)
• Indemnification
• Material Adverse Change (MAC) and Material Adverse Effect (MAE) Clauses
• Closing Conditions
C Corp & S Corp
• The C corporation is the standard (or default) corporation under IRS rules. The S corporation is a corporation that
has elected a special tax status with the IRS and therefore has some tax advantages. The C corporation is the
standard (or default) corporation under IRS rules. The S corporation is a corporation that has elected a special tax
status with the IRS and therefore has some tax advantages.

• C corporations: C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes
at the corporate level. They also face the possibility of double taxation if corporate income is distributed to
business owners as dividends, which are considered personal taxable income. Corporate income tax is paid first at
the corporate level and again at the individual level on dividends.

• S corporations: S corps are pass-through taxation entities. They file an informational federal return (Form 1120S),
but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” to
the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the
owners.

• Shareholder restrictions: S corps are restricted to no more than 100 shareholders, and shareholders must be US
citizens/residents. C corporations have no restrictions on ownership.
C Corp & S Corp
• Ownership: S corporations cannot be owned by C corporations, other S corporations (with some exceptions),
LLCs, partnerships or many trusts.

• Stock: S corporations can have only one class of stock (disregarding voting rights), while C corporations can
have multiple classes.

S corporation advantages:-

• Single layer of taxation: The main advantage of the S corp over the C corp is that an S corp does not pay a
corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual
level.

• 20% qualified business income deduction: The Tax Cuts and Jobs Act of 2017 gave eligible S corp shareholders
a deduction of up to 20% of net “qualified business income”.

• Pass-through of losses: The losses of an S corp pass-through to its shareholders, who can use the losses to
offset income (subject to restrictions of the tax law).
C Corp & S Corp
S corporation disadvantages:-

• Limited number of shareholders: An S corp cannot have more than 100 shareholders, meaning it can’t go
public and limiting its ability to raise capital from new investors.

• Other shareholder restrictions: Shareholders must be individuals (with a few exceptions) and U.S. citizens or
residents. This also makes it harder for an S corp to obtain equity financing, particularly because venture capital
and private equity funds tend to be ineligible shareholders.

• Preferred stock not allowed: To be eligible for S corp status the corporation cannot have different classes of
stock. Some investors want preferences to distributions or other privileges. An S corp cannot provide that.

• Transfer restrictions: Most S corps will restrict their shareholders’ ability to sell or transfer their shares. That’s
to make sure they don’t end up with an ineligible shareholder which will cause the IRS to terminate its S corp
status. This makes it harder for the shareholders of an S corp to exit the corporation.
C Corp & S Corp
C corporation advantages
• Unlimited number of shareholders
• There is no limit on the number of shareholders a corporation taxed under Subchapter C can have.
• No restrictions on ownership -Anyone can own shares, including business entities and non-U.S. citizens.
• No restrictions on classes:- A C corp can issue more than one class of stock, including stock with preferences to
dividends and distributions.
• Lower maximum tax rate:- The 2017 tax reform act lowered the corporate tax rate to a flat 21% and eliminated the
alternative minimum tax. Even with the personal income tax rates being slightly lowered, this rate is lower than the
maximum personal tax rate (which is currently 37%).
• More options for raising capital:- Because Subchapter C of the tax code does not impose the same restrictions on
ownership as Subchapter S, it is easier for a C corp to obtain equity financing.
C Corp & S Corp
C corporation disadvantages

• Double taxation:- The main disadvantage of the C corporation is that it pays tax on its earnings and the
shareholders pay tax on dividends, meaning the corporation’s earnings are taxed twice.
Sources of funds to execute merger

1. Cash available on balance sheet (Cheapest)

2. Fresh debt taken (Slightly expensive)
3. Shares exchange (Most expensive)

Most preferred way of financing a M&A will be cash because it is cheapest source of financing
Steps to create merger model?
A financial model that is used to analyse a merger agreement i.e. purchase price, how purchase price is
transferred and buyer EPS accretion or dilution.

1. Create financial data of buyer and seller stand alone

2. Make assumption related to merger like Purchase value, Mode of payment, transaction cost
3. Calculation of fair value of assets and liabilities created due to merger
4. Calculation of goodwill creation due to merger
5. Create merged company opening balance sheet
6. Project merged companies P&L and supporting schedule
7. Project merged companies Balance sheet
8. Project merged companies CFS
9. Calculate changes in EPS (accretion vs dilution)
10.Run sensitivities
Why do Goodwill and other Intangible
Assets gets created in M&A
Goodwill and other intangible assets like represent difference between Fair market value and book value .
Other intangible assets represent asset like customer relationship, Brands, etc. which are valuable but are not
financial asset and therefore do not show on balance sheet

Goodwill is tested for impairment and other intangible assets are amortized over years

Intangibles written down in M&A

• In process R&D - Research & Development projects that were purchased in the acquisition but which have
not been completed yet. Unfinished R&D required resources to complete, and as such, the “expense” must
be recognized as part of the acquisition.

• Deferred revenue- When the seller has collected cash for a service but not yet recorded it as revenue, and
the buyer must write-down the value of the Deferred Revenue to avoid “double-counting” revenue.
Goodwill in Merger model
Goodwill is the price paid over the fair market value of seller

Allocable goodwill = Equity purchase price - Book value of equity +Seller existing goodwill
-Assets writeups-Existing DTL + New DTL created + Existing DTA written down - New DTA creates (rarely happens)

• Existing goodwill is written because it gets written down in M&A

• Asset write up is deducted because it increases asset base and will increase book value of equity and thus
reduces goodwill amount therefore subtracted.

• Merger transaction (LBO is also merger of PE fund and Seller company) revalue asset and liabilities in books of
accounts (not in tax books) thus creates lots timing differences and ultimately give birth to DTA & DTL.

• DTA is created because of NOL and you will use these NOL offset post transaction entity’s net income
 DTA and DTL in M&A
1. Asset write up or liability write down in books of accounts - creates DTL

Deferred Tax Liability = (Asset Writeup * Combined companies(Generally buyer’s) Tax Rate

2. Asset write down or liability write up in books of accounts - creates DTA

Deferred Tax Asset = (Asset Write-Down) * Combined companies(Generally buyer’s) Tax Rate

An asset write-up creates higher depreciation expense on the asset written up, which means you will save on taxes in the
short-term – but eventually you’ll have to pay them back, hence the liability.

An asset write-down creates lower depreciation expense on the asset written down, which means you will pay more taxes
in the short-term – but eventually you’ll have save taxes back, hence the asset.

DTA/DTL is not created in asset deal and 338(h)(10) because asset base is written up . They are only created in Stock deal
3. General rule-
Step-up of asset base- DTA/DTL is not created
No Step-up of asset base DTA/DTL is created
What is 338(h)(10)?
Section 338(h)(10) election

Section 338(h)(10) is covered under Internal revenue code 338

It pertains to sale of certain business
In order to make a valid 338(h)(10) election, among other requirements, a “qualified stock purchase” must occur.
A qualified stock purchase generally means a purchase of 80% or more of voting power and value of the acquired
corporation’s stock within a 12 month period.

Section 338(h)(10) election causes what would be a regular stock sale (Favourable to seller) to be disregarded
and then be treated as an asset sale to both parties (advantageous the buyer)
Transaction structure of M&A
1. Asset purchase
2. Stock purchase
3. Section 338(h)(10) election

1. Asset purchase
• Buyer buys only selected assets and liabilities of seller
• Generally book value of asset base acquired increases and thus buyer gets step-up up of asset base therefore
no DTL is created.
• Seller have to pay tax on increased value of asset base (Revalued Value - Book Value) and pay capital gain on
proceeds.

2. Stock purchase
• Buyer buys all the assets/liabilities and off balance sheet items of seller
• No step up for tax base is received by buyer thus DTL is created
• Capital gain tax on seller
Transaction structure of M&A
3. Section 338(h)(10) election
A Section 338(h)(10) election is best of both worlds. Provides benefits of a stock purchase and an asset purchase:
• Legally it is a stock purchase, but accounting-wise it’s treated like an asset purchase.
• The seller is still subject to double-taxation – on its assets that have appreciated and on the proceeds from the
sale.
• But the buyer receives a step-up tax basis on the new assets it acquires, and it can depreciate/amortize them so
it saves on taxes.

Why every deal is not structured as Section 338(h)(10) election?

Because it is requirement of Section 338(h)(10) that the buyer must be a C corporation. Seller must be either a
U.S. corporate subsidiary of a parent company or an S-Corporation.

• Buyer buys all the assets/liabilities and off balance sheet items of seller.
• Seller have to pay tax on increased value of asset base (Revalued Value - Book Value) and pay capital gain on
proceeds.
• Generally book value of asset base acquired increases and thus buyer gets step-up up of asset base therefore
no DTL is created.
• To compensate for the buyer’s favorable tax treatment, the buyer usually agrees to pay more than it would in
an Asset Purchase.
Net operating losses in M&A?
1. Sec 382 of IRS is used to determine how many NOLs are useable each year

2. Allowable NOLs = Equity Purchase Price * Highest of Past 3 Months’ Adjusted Long Term Rates
(There is the federal long-term tax-exempt rate for a particular month that is used in the calculation of the
amount. The rate is determined by the Internal Revenue Service)

Jan 2022 rates-

https://www.irs.gov/pub/irs-drop/rr-22-01.pdf
What is impact of M&A on F/Statements
1. Increase in number of outstanding shares(only in case of stock deal)
2. Increase in debt in balance sheet and interest expenses in P&L (If debt is used to finance the deal)
3. Foregone interest on cash available on the balance sheet used fund the deal
4. Creation of Goodwill & Other Intangibles – These Balance Sheet items that represent a “premium” paid to a
company’s “fair value” also get created.

In company overpays excessively for seller it will create high amount of goodwill and which can generate
impairment of goodwill in future years
Synergies in merger model
Synergies is generated when buyer gets more value from M&A than suggested by financials. Basically it is 1+1=3

Type of synergies-

• Revenue synergies- Increase in sale of combined company than buyer and seller would have achieved .
• Cost synergies- Decrease in cost of combined company than buyer and seller would have incurred.

Revenue synergies are difficult is predict than cost synergies,

Why would acquisition be dilutive?
Acquisition can be dilutive because of additional of Net Income the seller contributes to combined company is not
enough to offset:
1. The buyer’s foregone interest on cash,
2. Additional interest paid on fresh debt taken to fund the deal,
3. Amortization of intangibles
4. Effects of issuing additional shares.