Business acquisition
Business acquisition is the process of acquiring a company to build on strengths or weaknesses of
the acquiring company. A merger is similar to an acquisition but refers more strictly to combining all of
the interests of both companies into a stronger single company. The end result is to grow the
business in a quicker and more profitable manner than normal organic growth would allow.
Process[edit]
The process begins with defining the type of business that would make a good acquisition. Generally
businesses within the same segment or a highly complementary market segment are targeted. Once
defined the target business is approached and if interest is shown due diligence is performed to
ascertain the financial and other conditions of the business.
When the financial terms are agreed upon, and the contract is signed the merger portion of the
acquisition begins. Overlapping processes, personnel and products are evaluated and the better-
performing pieces are retained.
Single business acquisitions and split and sell[edit]
A single acquisition refers to one company buying the assets and operations of another company and
absorbing what is needed while simply discarding duplicated or unnecessary pieces of the acquired
business. "Split and sell" acquisitions involve buying an entire business in order to gain one or two
pieces of the business. The acquiring business may wish to retain the customer list and a product line,
while moving manufacturing and other production related duties to an existing line. In this case the
excess is often sold off to recapture some of the acquisition cost.
Affiliate acquisitions[edit]
Businesses that use affiliates to sell and market their products may find themselves in the position of
losing control of the marketing portion. This presents a danger as the entire business cycle is
dependent on the sales cycle, which is now external to the business. In this scenario the acquiring
business may be forced into paying a premium to the affiliate, to regain control of the process without
upsetting current customers and cash flow. In rare instances the affiliate will gain so much influence
that it can purchase the parent company.
Acquisition
An acquisition or takeover is the purchase of one business or company by another company or
other business entity. Such purchase may be of 100%, or nearly 100%, of the assets or ownership
equity of the acquired entity. Consolidation occurs when two companies combine together to form a
new enterprise altogether, and neither of the previous companies remains independently. Acquisitions
are divided into "private" and "public" acquisitions, depending on whether the acquiree or merging
company (also termed a target) is or is not listed on a public stock market. An additional dimension or
categorization consists of whether an acquisition is friendly or hostile.
Achieving acquisition success has proven to be very difficult, while various studies have shown that
50% of acquisitions were unsuccessful.
[1]
The acquisition process is very complex, with many
dimensions influencing its outcome.
[2]
"Serial acquirers" appear to be more successful with M&A than
companies who only make an acquisition occasionally (see Douma & Schreuder, 2013, chapter 13).
The new forms of buy out created since the crisis are based on serial type acquisitions known as an
ECO Buyout which is a co-community ownership buy out and the new generation buy outs of the
MIBO (Management Involved or Management & Institution Buy Out) and MEIBO (Management &
Employee Involved Buy Out)
Whether a purchase is perceived as being a "friendly" one or a "hostile" depends significantly on how
the proposed acquisition is communicated to and perceived by the target company's board of
directors, employees and shareholders. It is normal for M&A deal communications to take place in a
so-called "confidentiality bubble" wherein the flow of information is restricted pursuant to
confidentiality agreements.
[3]
In the case of a friendly transaction, the companies cooperate in
negotiations; in the case of a hostile deal, the board and/or management of the target is unwilling to
be bought or the target's board has no prior knowledge of the offer. Hostile acquisitions can, and often
do, ultimately become "friendly", as the acquiror secures endorsement of the transaction from the
board of the acquiree company. This usually requires an improvement in the terms of the offer and/or
through negotiation.
"Acquisition" usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a
smaller firm will acquire management control of a larger and/or longer-established company and
retain the name of the latter for the post-acquisition combined entity. This is known as a reverse
takeover. Another type of acquisition is the reverse merger, a form of transaction that enables
a private company to be publicly listed in a relatively short time frame. A reverse merger occurs when
a privately held company (often one that has strong prospects and is eager to raise financing) buys a
publicly listed shell company, usually one with no business and limited assets.
[4]
The combined evidence suggests that the shareholders of acquired firms realize significant positive
"abnormal returns" while shareholder of the acquiring company are most likely to experience a
negative wealth effect. The overall net effect of M&A transactions appears to be positive: almost all
studies report positive returns for the investors in the combined buyer and target firms. This implies
that M&A creates economic value, presumably by transferring assets to management teams that
operate them more efficiently (see Douma & Schreuder, 2013, chapter 13).
There are also a variety of structures used in securing control over the assets of a company, which
have different tax and regulatory implications:
The buyer buys the shares, and therefore control, of the target company being purchased.
Ownership control of the company in turn conveys effective control over the assets of the
company, but since the company is acquired intact as a going concern, this form of transaction
carries with it all of the liabilities accrued by that business over its past and all of the risks that
company faces in its commercial environment.
The buyer buys the assets of the target company. The cash the target receives from the sell-off is
paid back to its shareholders by dividend or through liquidation. This type of transaction leaves
the target company as anempty shell, if the buyer buys out the entire assets. A buyer often
structures the transaction as an asset purchase to "cherry-pick" the assets that it wants and leave
out the assets and liabilities that it does not. This can be particularly important where foreseeable
liabilities may include future, unquantified damage awards such as those that could arise from
litigation over defective products, employee benefits or terminations, or environmental damage. A
disadvantage of this structure is the tax that many jurisdictions, particularly outside the United
States, impose on transfers of the individual assets, whereas stock transactions can frequently be
structured as like-kind exchanges or other arrangements that are tax-free or tax-neutral, both to
the buyer and to the seller's shareholders.
The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one
company splits into two, generating a second company which may or may not become separately
listed on a stock exchange.
Legal structures
Corporate acquisitions can be characterized for legal purposes as either "asset purchases" in which
the seller sells business assets to the buyer, or "equity purchases" in which the buyer purchases
equity interests in a target company from one or more selling shareholders. Asset purchases are
common in technology transactions where the buyer is most interested in particular intellectual
property rights but does not want to acquire liabilities or other contractual relationships.
[7]
An asset
purchase structure may also be used when the buyer wishes to buy a particular division or unit of a
company which is not a separate legal entity. There are numerous challenges particular to this type of
transaction, including isolating the specific assets and liabilities that pertain to the unit, determining
whether the unit utilizes services from other units of the selling company, transferring employees,
transferring permits and licenses, and ensuring that the seller does not compete with the buyer in the
same business area in the future.
[8]
Mergers, asset purchases and equity purchases are each taxed differently, and the most beneficial
structure for tax purposes is highly situation-dependent. One hybrid form often employed for tax
purposes is a triangular merger, where the target company merges with a shell company wholly
owned by the buyer, thus becoming a subsidiary of the buyer. In a "forward triangular merger," the
buyer causes the target company to merge into the subsidiary; a "reverse triangular merger" is similar
except that the subsidiary merges into the target company. Under the U.S. Internal Revenue Code, a
forward triangular merger is taxed as if the target company sold its assets to the shell company and
then liquidated, whereas a reverse triangular merger is taxed as if the target company's shareholders
sold their stock in the target company to the buyer.
[9]
Documentation[edit]
The documentation of an M&A transaction often begins with a letter of intent. The letter of intent
generally does not bind the parties to commit to a transaction, but may bind the parties to
confidentiality and exclusivity obligations so that the transaction can be considered through a due
diligence process involving lawyers, accountants, tax advisors, and other professionals, as well as
businesspeople from both sides.
[8]
After due diligence is completed, the parties may proceed to draw up a definitive agreement, known
as a "merger agreement," "share purchase agreement" or "asset purchase agreement" depending on
the structure of the transaction. Such contracts are typically 80 to 100 pages long and focus on four
key types of terms:
[10]
Conditions, which must be satisfied before there is an obligation to complete the transaction.
Conditions typically include matters such as regulatory approvals and the lack of any material
adverse change in the business.
Representations and warranties by the seller with regard to the company, which are claimed to be
true at both the time of signing and the time of closing. If the representations and warranties by
the seller prove to be false, the buyer may claim a refund of part of the purchase price.
Covenants, which restrict operation of the business between signing and closing.
Termination rights, which may be triggered by a breach of contract, a failure to satisfy certain
conditions or the passage of a certain period of time without consummating the transaction.
Business valuation[edit]
The five most common ways to value a business are
asset valuation,
historical earnings valuation,
future maintainable earnings valuation,
relative valuation (comparable company & comparable transactions),
discounted cash flow (DCF) valuation
Professionals who value businesses generally do not use just one of these methods but
a combination of some of them, as well as possibly others that are not mentioned above, in order to
obtain a more accurate value. The information in the balance sheet or income statement is obtained
by one of three accounting measures: a Notice to Reader, a Review Engagement or an Audit.
Financing M&A
Mergers are generally differentiated from acquisitions partly by the way in which they are financed and
partly by the relative size of the companies. Various methods of financing an M&A deal exist:
Cash[edit]
Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the
shareholders of the target company are removed from the picture and the target comes under the
(indirect) control of the bidder's shareholders...
Stock[edit]
Payment in the form of the acquiring company's stock, issued to the shareholders of the acquired
company at a given ratio proportional to the valuation of the latter.
Financing options[edit]
There are some elements to think about when choosing the form of payment. When submitting an
offer, the acquiring firm should consider other potential bidders and think strategically. The form of
payment might be decisive for the seller. With pure cash deals, there is no doubt on the real value of
the bid (without considering an eventual earnout). The contingency of the share payment is indeed
removed. Thus, a cash offer preempts competitors better than securities. Taxes are a second element
to consider and should be evaluated with the counsel of competent tax and accounting advisers.
Third, with a share deal the buyers capital structure might be affected and the control of the buyer
modified. If the issuance of shares is necessary, shareholders of the acquiring company might prevent
such capital increase at the general meeting of shareholders. The risk is removed with a cash
transaction. Then, the balance sheet of the buyer will be modified and the decision maker should take
into account the effects on the reported financial results. For example, in a pure cash deal (financed
from the companys current account), liquidity ratios might decrease. On the other hand, in a pure
stock for stock transaction (financed from the issuance of new shares), the company might show
lower profitability ratios (e.g. ROA). However, economic dilution must prevail towards accounting
dilution when making the choice. The form of payment and financing options are tightly linked. If the
buyer pays cash, there are three main financing options:
Cash on hand: it consumes financial slack (excess cash or unused debt capacity) and may
decrease debt rating. There are no major transaction costs.
It consumes financial slack, may decrease debt rating and increase cost of debt. Transaction
costs include underwriting or closing costs of 1% to 3% of the face value.
Issue of stock: it increases financial slack, may improve debt rating and reduce cost of debt.
Transaction costs include fees for preparation of a proxy statement, an extraordinary shareholder
meeting and registration.
If the buyer pays with stock, the financing possibilities are:
Issue of stock (same effects and transaction costs as described above).
Shares in treasury: it increases financial slack (if they dont have to be repurchased on the
market), may improve debt rating and reduce cost of debt. Transaction costs include brokerage
fees if shares are repurchased in the market otherwise there are no major costs.
In general, stock will create financial flexibility. Transaction costs must also be considered but tend to
have a greater impact on the payment decision for larger transactions. Finally, paying cash or with
shares is a way to signal value to the other party, e.g.: buyers tend to offer stock when they believe
their shares are overvalued and cash when undervalued.
[12]
