Curious about mergers and acquisitions (M&A)? We’ve answered some common mergers and acquisitions FAQs that our business clients often have.
Jump to individual mergers and acquisitions FAQs:
- What’s the difference between mergers and acquisitions?
- What’s a lawyer’s role in mergers and acquisitions? Do I need a solicitor?
- What are the benefits of mergers and acquisitions?
- What is a buyout?
- What is a divestiture?
- What’s the difference between a merger and a joint venture?
- What due diligence needs to be done during mergers and acquisitions?
- What is the City Code, or Takeover Code?
- Who does the Takeover Code apply to?
- How does a merger affect shareholders?
- How will a merger affect employees?
- What is synergy in a merger?
- What is a scheme of arrangement in mergers?
- What’s the difference between a scheme of arrangement and a takeover offer?
- What is the mandatory bid rule in UK mergers?
- What is a ‘squeeze out’ in mergers and acquisitions?
- How do you identify a suitable target company for an acquisition?
- How can a target company be valued?
What’s the difference between mergers and acquisitions?
As we explain briefly on our main M&A legal services page, the terms often go together, and transactions can be so complex as to blur the distinction between the two. The term ‘mergers and acquisitions’ is now coming to mean a transaction that results in the consolidation of two companies or businesses.
However, legally speaking, the main differences between a merger and an acquisition are:
- A merger is the combination of two companies, usually into a new company (often called an amalgamation). The previous companies are then dissolved. Mergers are often perceived as ‘friendly’ and, in theory, a merger can result in the two companies becoming equal partners in the new company.
- An acquisition is a company purchasing another, usually smaller, company (or a controlling interest in its shares). Where the target is a listed company, an approach by a potential acquirer is sometimes unwelcome, and the transaction is termed a “hostile takeover”. However, with private limited companies it is virtually impossible for one company to acquire another unless all parties are willing. The acquired company becomes a subsidiary of the acquiring company, so unlike a merger, no new company is created. Acquisitions are far more common than mergers where private companies are concerned.
What’s a lawyer’s role in mergers and acquisitions? Do I need a solicitor?
A solicitor will nearly always be absolutely necessary for a merger or acquisition. Mergers are legally complex, and an acquisition will require the negotiation of a share purchase agreement, which is usually a lengthy document. If you are selling a company, you will need legal advice to minimise the risk of any claims being brought against you by the buyer after the sale is completed.
Find out about our M&A legal services here and meet our expert M&A solicitors:
What are the benefits of mergers and acquisitions?
The benefits of a merger or acquisition will depend on the specifics of each individual deal. In general, though, a merger takes place because two companies see that they will be stronger together than they were separately. In acquisitions, the acquiring company has the chance to grow more rapidly than it otherwise might, and the owners of the target company have the opportunity to realise their investment.
Whatever the individual details, the goal of most M&A deals is to bring about the following benefits:
- A bigger market reach or share
- Greater shareholder value
- One less competitor (direct or indirect)
- Cost efficiencies through economics of scale
- Diversification of products or services
- Access to better management, business intelligence, staff, or systems
- An exit for the selling shareholders
What is a buyout?
A buyout usually takes the form of a management buyout where the management team of a company buys the shares in the company from the owners. This usually involves the creation of a new company as the acquiring vehicle, with the new company raising funds to finance the buyout. Employee buyouts can happen in the same way. A leveraged buyout happens when the buyer uses borrowed money to buy the company, and the lender treats the company’s assets as security for the debt.
What is a divestiture?
Divestiture, or divestment, is the opposite of investment, and refers to a company shedding (or disposing of) some of its assets or functions, usually via a sale or closure. Divestiture can happen after a merger or acquisition as the dominant company identifies underperforming or redundant parts of the company it has merged with or acquired, which it will then sell or close.
Divestitures can also be ordered or required by law, when a company has created a monopoly that is anti-competitive.
What’s the difference between a merger and a joint venture?
In a merger, two companies combine permanently to make one new company that is separate entity, and the previous companies usually cease to exist.
In a joint venture, two companies enter a legal agreement to work together for a specific task or an agreed period of time, but each retains separate ownership and management of their business. There may be a new company (the “joint venture company”) created to carry on the joint venture, but the two companies who formed the joint venture will continue as separate entities.
What due diligence needs to be done during mergers and acquisitions?
Before merging with or purchasing another company, the buyer will need to be fully aware of the assets and liabilities of that company. This is why it is important to instruct a solicitor and other professionals to carry out rigorous due diligence. Due diligence will fall into these broad areas:
- Financial – including accounting, resources, financial performance, tax.
- Strategic/commercial – including market position and industry knowledge, competitor analysis, technology and intellectual property.
- Legal – including litigation proceedings, regulatory issues, exposures and risks, IP, review of agreements and contracts.
- Operational – including company structure and governance, insurance, employee and management issues, sales pipelines and intelligence.
What is the City Code, or Takeover Code?
The Takeover Code (also referred to as the City Code) is a set of binding rules establishing the standards of commercial behaviour, made and administered by The Panel of Takeovers and Mergers (‘the Panel’).
The Code regulates the takeover process for companies. Through specific rules and general principles, the Code ensures target company shareholders of the same class are treated fairly, equally, and are given an opportunity to decide on the merits of a takeover with sufficient information, that a false market is not created in the offeror or target company and no action is taken by the target company’s management, which could frustrate an offer, unless shareholder consent has been obtained first. The Code does not deal with the financial or commercial aspects of a particular takeover, these are matters for the target company to consider.
The Code also regulates the process and timeframe in which a takeover must be completed. For example, if a person or company acquires interest in shares carrying more than 30% of the company’s voting rights, then a cash offer must be made to all other shareholders at the highest price paid in the 12 months before the offer was announced. The effect of this is that shareholders receiving the takeover offer benefit from any high price paid by the offeror, before the offer, such as the high price paid when the offeror built their stake.
Through its Executive, the Panel oversees the day-to-day application of the Code and issues informal guidance or Practice Statements to assist companies with interpretation and practical application of the Code.
Who does the Takeover Code apply to?
The Takeover Code applies to companies involved with offers falling into three categories:
- Firstly, offers for companies in the UK, Channel Islands, and Isle of Man, which have securities admitted to trading on a regulated market (a system which brings together third party buying and selling interests in financial instruments in line with non-discretionary rules and concludes in a contract), a multilateral trading facility (a trading system that facilitates the exchange of between multiple parties, allowing parties to collect and transfer securities, particularly those without an official market) in the UK, or a stock exchange in the Channel Islands or Isle of Man.
- Secondly, offers including all of the above characteristics (at any time over the previous 10 years) but not falling within that category, which are offers for public and some private companies and which have their registered office in the UK, the Channel Islands, or Isle of Man if they are considered to have central management and control in the aforementioned areas. This also includes offers in the past 10 years where shares in a company of this type have been marketed or traded or where the company has filed a prospectus for the offer, admission to trading or issue of securities with Companies House or any other relevant authority, on a public record, in the UK, the Channel Islands or the Isle of Man.
- Thirdly, offers for companies where there is a shared jurisdiction between the UK and other EEAmember states. One example of this might be an offer for a company which has its registered office in another member state of the EEA, whose securities are admitted to trading on a regulated market in the UK and not on a regulated market in any other member state of the EEA.
How does a merger affect shareholders?
A merger will affect the shareholders of both companies proposing to merge in a number of different ways. The conditions of the merger may mean that different shareholders and their share prices are affected differently by the merger. Some factors which may have an affect might be the sizes of the two companies looking to merge, the management of the merger process ( for example, shareholders of both companies may initially have a dilution of voting power due to the increased number of shares released during the merger process) and the economic climate the companies are operating in. The newly merged company should create a higher share price for shareholders and provided that there are not other negative economic factors at play, shareholders should find that dividends are improved in the longer term as a result of the merger.
How will a merger affect employees?
A merger is a business transfer and as such is likely to fall within the TUPE Regulations. This means that employee terms and conditions should remain the same and their jobs should not be at risk because of the transfer, but they will be employed by the new entity created by the merger. However, it is likely that the merger is taking place in order to bring about efficiencies and this may well mean redundancies and uncertainty for employees in both companies which are proposing to merge.
What is synergy in a merger?
Synergy is the potential financial benefit achieved through the combining of companies. Synergy can refer to increased profits due to more productive use of assets, or may refer to cost savings due to efficiency of operation.
For example, there are a great deal of cost saving synergies which may arise from a merger:
- Share information technology – the access to the technology of the other company increases efficiency, as the companies save on the high cost of relying on a third party’s technology.
- Supply chain efficiencies – companies will have access to better supply chain relationships and likely greater economies of scale, meaning that the companies can benefit from lower supply costs.
- Improved sales, marketing, finance and administration – the merger will allow both companies to strengthen their marketing channels and improve distribution sales at a lower cost as resources are spread over a bigger business base.
- Tax savings – both from the transaction itself and from the structure created.
- Research and development – a merger allows companies to access the other’s innovative developments to combine ideas and cut overall costs.
- Corporate property – there can be short term cost reductions in combined corporate real estate and the opportunity to strategise over long term optimisation of property.
- Patents – companies can transfer the right to use a patent for a fee smaller than that charged by a third party, meaning a cut in costs.
Similarly, there’s many revenue-enhancing synergies that may result from a merger:
- Patents – the access to the other company’s patent allows the merged entity to create more competitive products which achieve a higher revenue.
- Complementary products – the merger allows the companies to combine their products and produce higher sales and stronger customer relationships by being able to offer their customers more variety and better product mixes.
- Complementary geographies and customers – the merger will also allow the companies to benefit from an increased access to different customers, markets, and geographical locations, so enabling increased sales and greater market share.
- Margin improvement – there is the opportunity for a better pricing strategy to be employed to improve margins.
- Improved asset utilisation and return on investments – by more efficient, better and likely more frequent use of existing assets. If one of the companies has invested in new technology infrastructure for example, both companies will be able to use and gain benefits from this, post-merger.
What is a scheme of arrangement in mergers?
A scheme of arrangement is a statutory procedure governed by section 895 to 899 of the Companies Act, whereby a company proposes a takeover offer to its shareholders. For the scheme (proposed takeover offer) to be effective, the requisite approval of shareholders must be obtained before the High Court can sanction the scheme as binding. Upon the High Court’s sanctioning, the offeror will obtain 100% ownership of the company.
The requisite members’ approval means that the scheme must be approved by:
- A majority in numbers of each class of shareholders whose shares are the subject of the scheme of those present and voting; and
- That majority must be from shareholders holding at least 75% in value of the shares (of those present and voting) and cannot include shareholdings held by the offeror company or its associates.
What’s the difference between a scheme of arrangement and a takeover offer?
There’s a number of differences between a scheme of arrangement and a contractual takeover offer.
|Aspect||Scheme of arrangement||Contractual takeover offer|
|Flexibility||If the offeror can’t obtain the required support from shareholders and the cooperation of the target company, its offer will fail. The tight schedule imposed by the High Court’s timetable also makes this procedure less flexible.||This is usually more flexible than a scheme of arrangement, as the offeror has more control over the process and timescales.|
|Ownership||The main benefit of a scheme of arrangement is that an offeror can be certain that if the transaction goes ahead, it will definitely obtain 100% ownership of the target company (for securing a minimum of 75% shareholder support) because the scheme is binding on all shareholders once approved by them and the High Court and once a copy of the High Court order has been filed at Companies House.
A scheme of arrangement can also be useful if the offeror is not confident of securing 90% of the vote on the above principles, which would be required for a compulsory purchase.
|The offeror will only get 100% of the target company if all the shareholders accept the offer. Alternatively, the offeror may acquire 100% ownership if the offeror relies on compulsory acquisition (the statutory procedure set out in Chapter 3 Part 28 of the Companies Act, which allows the offeror to purchase 100% shares if it obtains 90% acceptance).
Another alternative would be for an offeror to threaten to delist the company once it has acquired 75% of the shares (as only a special resolution is needed to delist). This provides incentive for the minority shareholders to accept the offer.
|Success rate of hostile bid||Highly unlikely to be successful if the target company and shareholders are resistant to the offer, largely as cooperation is required to meet High Court timescales.||Hostile contractual takeover offers are common, but a lack of cooperation from the target company, particularly in hindering access to information for due diligence purposes, can make a hostile takeover more difficult. There is also a risk that the offeror may need to make a more attractive offer due to reluctant shareholders, and that competitors may make a competing offer.|
|Effectiveness of stake-building||It’s ineffective to purchase shares in the target company in the lead up to the offer because these shares are not included in establishing the requisite 75% support, and it also reduces the number of ‘friendly’ shareholders that will make up the requisite 75% approval. As a result, it will be harder to have the scheme approved and sanctioned.||Shares owned before an offer can count towards the ‘greater than 50%’ threshold which makes the offer unconditional. As a result, shares already owned and shares acquired in the lead up to the offer can be effective in helping an offeror increase its total ownership in the company.
However, shares already owned and the shares acquired before the offer don’t count towards the 90% shares required to rely on the compulsory acquisition procedure.
|Control of the offer process||The target company and its directors control the timing and implementation (within the High Court timescales).||The offeror is in control as it is the one making the offer to shareholders, but the whole process may take longer, as acquiring 100% is likely to take longer than under a scheme of arrangement.|
What is the mandatory bid rule in UK mergers?
A mandatory bid must be made under Rule 9 of the Takeover Code, if an offeror and any persons act in concert (persons who by agreement co-operate to obtain or consolidate control of a company or to prevent a successful offer for a company) to acquire shares through a single or multiple transactions carrying 30% or more of the voting rights of a target company. A mandatory bid must also be made if an offeror, and any persons acting in concert, holding not less than 30% but not more than 50% of the voting rights increases its holding. The mandatory bid or offer must be made to all holders of any class of equity share capital and holders of any other class of transferable securities with voting rights, to purchase their shares and must:
- have an acceptance condition of over 50%;
- be for cash or cash alternative (as opposed to bidder securities); and
- be at the highest price the offeror or any concert party paid for any interest in shares of the same class in the 12 months preceding the offer.
The aim of this rule is to allow the other shareholders the right to sell their shares when the offeror acquires a controlling interest (30% or more). Since the mandatory offer is at the same price the offeror paid other shareholders, all shareholders are treated equally with regards to value received for their interests.
There are some circumstances where the Panel may dispense with the mandatory bid rule:
- under the ‘whitewash procedure’ after shareholders independent of the transaction pass a resolution approving the waiver. ( provide further details of this procedure).
- in certain other situations set out in Rule 9, for example if a single member of a concert party becomes interested in 30% or more of the voting rights in a target company, or if his interest is between 30% and 50% and he acquires any further interest in shares as a result of an acquisition from another member of the concert party (but where the interest of the concert party as a whole is unchanged).
What is a ‘squeeze out’ in mergers and acquisitions?
A ‘squeeze’ out in mergers and acquisitions is a statutory procedure in which an offeror can acquire the minority shareholding if it has acquired (or unconditionally contracted to acquire):
- not less than 90% in value of the shares to which the takeover offer relates; and
- not less than 90% of voting rights carried by the shares to which the offer relates.
This means that if an offeror makes a takeover offer and shareholders together holding 90% in value of the shares accept the offer, and 90% of the voting rights carried by those shares, then the offeror will be able to buy the remaining 10% of shares on the same terms set out in the offer and ‘squeeze out’ the non-assenting minority shareholders, subject to any court order stating otherwise.
It’s important to note which shares can be included in the calculation of the 90% acceptance condition. Shares acquired before the offer (prior to the offer period) cannot be included in the calculation of 90%. This means any shares held prior to the offer won’t count towards establishing a 90% that enables the squeeze-out procedure.
The offeror can also, in these circumstances, be forced by the minority shareholders themselves to acquire their outstanding shares. A minority shareholder is also entitled to apply to the court to resist being ‘squeezed out’. It is rare for these applications to be made and for the court to deem that the shareholder has ‘special circumstances’ and acquiring their shares would be unfair. If the court does deem this to be the case, it can order that the compulsory acquisition may not go ahead, or that the shares should be acquired on different terms from those under the offer.
How do you identify a suitable target company for an acquisition?
If you’re considering acquiring a company, you should consider the strategic needs of your business, and your budget. Once you have an idea, you should seek advice from a professional advisor in your sector, as they will know which companies are best to acquire and which company would be a good match for your business. It is critical that data on target companies is collected and considered in detail and that target companies are prioritised before they are approached in order of those which are likely to offer the greatest synergies and fulfil the criteria which is most important to your business and how you would like it to look, post-acquisition.
For example, based on the sector and industry, you may aim for a target company which is well established to strengthen your business contacts, share ‘know how’ and widen your customer base. Alternatively, you may want a company which is undervalued or which has cash shortages or excessive debt and may be prepared to sell quickly and at a lower price, or which has succession issues in management, clear inefficiencies or financial investors looking to make an exit, because you may be able to make the required improvements quickly, ensuring a profitable transaction.
Having found a few potential target companies which match your requirements, it’s important to consider the general culture of that company. To be a successful acquisition, the companies need to have a consistent work environment for employees. Consistency and clarity in leadership and operational processes and receptivity to change will be fundamental in providing a smooth and successful transition, post-acquisition. Tension and inability to work together will prevent cooperation and communication across the larger entity, which could hinder productivity and undermine the success of the acquisition.
For a more in depth look at identifying a suitable target for acquisition, read our guide on How To Evaluate A Company For Acquisition which details key factors to consider before making your decision.
How can a target company be valued?
There are a number of different ways to value a company. It’s best to consult an accountant on valuing a company, or, if the business is in a particularly niche market, a specialist valuer in that sector.
Broadly, however, the main ways in which a company would be valued prior to a merger are:
- Debt free/cash free
This method values the company under the assumption that there’s no cash or debt in the target company at completion. Such a value would not account for the net cash or net debt held by the company at closing.
The benefit of this valuation is that it makes it easier for the seller to compare offers for the target company. However, this isn’t a popular valuation method for buyers since it doesn’t give a very accurate valuation of the business.
- Net asset value
The net asset value (NAV) involves valuing the company using the balance sheet to determine a fair value of the net assets. This method takes into account the assets of the business as stated in its audited accounts, minus liabilities to creditors or tax authorities, bank borrowings and redundancy payments due. The benefit of this is that it allows consideration of the target’s significant property and other tangible assets.
Since the buyer will want to confirm the NAV hasn’t changed since the last accounts were drawn up, a second valuation will be done after completion. To account for any difference in value, the parties usually agree a price adjustment using completion accounts. Although this creates uncertainty for both parties (in terms of the amount that will be paid), it does mean there is an accurate and up-to-date valuation of the target.
- Earning basis
The earning basis reflects the earning potential of the target company, as opposed to its current assets. This is common for companies where the net assets do not reflect the company’s full worth – for example, it is a research and development company yet to make a profit.
On an earning basis, the future maintainable earnings of the target are multiplied by an appropriate multiplier (which is usually related to comparable quoted companies).
- Replacement cost
This method is similar to the net asset value in that the valuation is based on the cost of replacing the target company. If the value of the company is its total assets, then this will be the purchase price. The buyer could subsequently ask the seller to sell at that price, or it will create a competitor for the same cost.
The disadvantage of this method is that it’s hard to value people and ideas. For this reason, this method may not be the most accurate.
- Comparative ratios
Comparative ratios involve using different ratios, such as ‘price-earnings ratio’ (calculated by dividing the company’s share price by its earnings per share) and ‘enterprise-value-to-sales ratio’ (compares the total value, as measured by enterprise value of the company, to its sales) to make a comparison between the target’s value and companies in the same industry.
This method allows an offeror to determine an accurate value of the target, whilst also getting a view of its performance in comparison to competitors in the market.
The best way to value the company might be to combine one or more methods of valuation. It’s advisable to get professional advice to ensure that you’re not paying more than the target’s value.