There are many reasons why you may consider acquiring or merging with another business. Maybe there’s a competitor of yours that you’d like to own. Or perhaps you’d like to expand into another sector and see a merger as the quickest route to market. Successful businesses often look to a merger or acquisition as a way to achieve their ambitions. In this guide, we answer the questions our clients most frequently ask us in connection with M&As.
Jump to individual FAQs:
- What’s a lawyer’s role in mergers and acquisitions?
- What legal documents are involved in a merger or acquisition?
- 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 (‘JV’)?
- What’s the importance of due diligence in mergers and acquisitions?
- What is the City or Takeover Code?
- Who does the Takeover Code (City Code) apply to?
- What’s the impact of mergers and acquisitions on shareholders?
- What’s the impact of mergers and acquisitions on employees?
- What restrictions might apply to a merger or acquisition?
- What are the different types of synergies in mergers and acquisitions?
- 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 is a company valued for acquisition?
- Are there any tax issues in connection in mergers and acquisitions?
What’s a lawyer’s role in mergers and acquisitions?
You will normally need the support of a solicitor for M&A transactions as they are usually complex, and the terms heavily negotiated by the lawyers on your behalf. Sellers in particular should take legal advice to minimise the risk associated with potential post-transaction liability. Your lawyers will explain to you the different types of M&A, help you with due diligence, draw up and negotiate the legal documents, liaise with third parties such as the Takeover Panel, and complete the sale.
What legal documents are involved in a merger or acquisition?
These are the documents that are typically involved in a M&A:
- A letter of intent
- A non-disclosure agreement
- An exclusivity agreement
- A sale and purchase agreement for the shares. This is usually prepared by the seller’s solicitors unless it’s a sale by auction. The sale and purchase agreement will contain extensive warranties by the seller in favour of the buyer
- A disclosure letter that qualifies the seller’s warranties
- A tax deed where the seller and the buyer agree the amount to be paid to the buyer in respect of tax liabilities due pre-completion
- Board minutes dealing with the changes to the company as a result of the merger
- Stock transfer forms
- Employment and directors’ service contracts if these are to be revised
- Third party consents
- Banking documents and releases of security
What are the benefits of mergers and acquisitions?
The main perceived benefit of an M&A is that the merged company will be stronger than the individual companies taken separately.
Here are the most common objectives of an M&A deal:
- To obtain a wider market reach or larger market share
- To increase shareholder value
- To eliminate a competitor
- To gain economies of scale
- To diversify products or services
- To acquire new staff, customers, know-how or technology
- To enable the seller shareholders to exit
What is a buyout?
A buyout is where the management team or employees of a company become its owners by buying its shares. Usually, a newco is created that borrows the funding for the buyout. Where newco uses its assets as security for the loan, this is called a ‘leveraged buyout’.
What is a divestiture?
Divestiture, or divestment, is where a company disposes of some of its assets or functions, normally by selling or closing them. This often takes place post-merger or acquisition where under-performing or unwanted parts of the business being acquired are sold off.
Divestitures can also be ordered by law when a M&A results in a company that is deemed an anti-competitive monopoly.
What’s the difference between a merger and a joint venture (‘JV’)?
With a merger, two companies will join forces to become a new company, which will result in a third, separate legal entity with an entirely new name, board, and ownership. But, in a joint venture, two companies agree to work together for a specific project or period, but also each continues their individual businesses. Sometimes a newco is created to carry on the JV, but this is entirely separate from the two companies who came together to work on their common goal or project.
What’s the importance of due diligence in mergers and acquisitions?
Before committing to any transaction, you’ll want to ensure that you have every possible detail available to you. This will ensure that you know exactly what you’re buying, the extent of liabilities that you’re taking on, any potential risks that are in the pipeline such as outstanding litigation or contracts that may be problematic. For peace of mind and to get a clear understanding of what you’re getting involved in when merging with or purchasing another company, the buyer will need to investigate the following:
- The state of the seller’s finances, including its accounting records, assets, tax position and performance.
- The seller’s strategic and commercial position, including its market share and industry knowledge, its competitors, its technology and IPR (patents, trademarks etc.)
- The seller’s legal position, including any disputes or litigation, licensing and regulations that apply to it, any IPR issues such the right to operate software.
- What contracts the seller has entered into, and their terms.
- The seller’s operations including their company structure, insurance, employees, management, sales pipeline, and customer details.
What is the City or Takeover Code?
The Takeover Code (also referred to as the City Code) regulates the takeover process for UK companies, and is designed to ensure that shareholders in a M&A transaction are treated fairly, are not denied the chance to decide on the merits of a takeover and are afforded equivalent treatment by the buyer. It’s administered by the Takeover Panel.
There are six main principles that must be followed under the Takeover Code:
- All the target’s shareholders of the same class must be treated equally, and if a buyer gains control of a target, the other shareholders must be protected.
- The target’s shareholders must have enough time and information to enable them to reach an informed decision on the bid. Where it advises shareholders, the board of the target must provide its views on how the deal will affect staff, employment conditions and the target’s places of business.
- The board of the target must act in the interest of the company as a whole and not prevent the shareholders from deciding on the merits of a bid.
- A ‘false market’ in the shares of either the target, the buyer or any other company affected by the transaction must not be created (where the share price is artificially raised or lowered, and the market is therefore distorted).
- A buyer must announce a bid only after making sure it can pay in cash, if this is being offered, and that it can finance the rest of the bid.
- A target mustn’t be prevented from doing business longer than is reasonable by virtue of the bid for its shares.
Who does the Takeover Code (City Code) apply to?
It applies to all companies with their registered offices in the UK, the Channel Islands or the Isle of Man if any of their shares are listed on a regulated market such as the Main Market of the London Stock Exchange, the Alternative Investment Market (AIM), or any stock exchange in the Channel Islands or the Isle of Man.
It also applies to unquoted public companies with their registered offices in the UK, the Channel Islands or the Isle of Man if the Takeover Panel that administers the Code believes their place of central management and control is in one of those jurisdictions.
The Takeover Code does not normally apply to private companies registered in the UK, the Channel Islands or the Isle of Man.
What’s the impact of mergers and acquisitions on shareholders?
Normally a merger results in a higher share price for shareholders, and if the merger is successful, increased dividends. The merging companies’ shareholders may initially have their voting power diluted due to the increased number of shares released during the merger process.
What’s the impact of mergers and acquisitions on employees?
The Transfer of Undertakings (Protection of Employment) Regulations (or TUPE Regulations) will usually apply in a M&A where the employees will transfer to a newco, so that employees automatically transfer. Their terms and conditions will remain the same and there should be no redundancies as a result of the merger itself. However, if the buyer is aiming to make efficiencies, redundancies and reorganisation often result over the longer term. Mergers therefore inevitably create a degree of uncertainty for employees in both companies proposing to merge, and you will need to consult with employees or their representatives prior to the sale.
In an acquisition where shares are acquired, the employees will automatically transfer with the company when it changes hands.
What restrictions might apply to a merger or acquisition?
Before entering into negotiations for a merger or acquisition, you or your corporate lawyer should check the Articles of the target company and any shareholders’ agreements to make sure that there are no restrictions on the transfers of shares.
In addition, there may be restrictions on acquiring companies that operate in certain sensitive sectors such as defence, rail, financial services, energy and broadcasting/publications, and companies that have large contracts with the public sector.
What are the different types of synergies in mergers and acquisitions?
Synergy is the potential 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 operational efficiency.
These are some examples of cost-cutting synergy:
- Shared IT and platforms and access to technology.
- Supply chain efficiencies leading to lower costs.
- Improved sales, marketing, finance and administration – the merger will allow both companies to strengthen their marketing channels and increase sales at a lower cost.
- Tax savings – both from the transaction itself and from the structure created.
- Research and development – a merger allows companies to share innovations, combine ideas and cut R&D costs.
- Combining and consolidating assets such as premises and intellectual property such as patents and licenses.
And revenue-enhancing synergy:
- Access to IP that enables newco to develop more high-value products.
- Combining products to achieve higher sales, more diversity and enhanced customer satisfaction.
- Increased access to customers and markets leading to higher sales and market share.
- Better use of assets such as technology leading to increased sales and revenues.
What is a scheme of arrangement in mergers?
A scheme of arrangement is where a company proposes a takeover bid to its shareholders. For the scheme (proposed takeover offer) to be effective, you must obtain the consent of a requisite number of the company’s members before the High Court can sanction the scheme as binding. If it does, the bidder 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 are a number of differences between a scheme of arrangement and a contractual takeover offer:
|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. A scheme of arrangement can also be useful if the offeror is not confident of securing 90% of the vote, 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 (a statutory procedure that allows the offeror to purchase 100% shares if it obtains 90% acceptance). Alternatively, an offeror can 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, 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?
The mandatory bid rule contained in Rule 9 of the City Code refers to a bid where the bidder, and those acting in ‘concert’ with them, acquire 30% or more of the voting shares of a target.
It also applies where the bidder, and those acting in concert, who between them own not less than 30% or more than 50% of the voting rights of the target, increase their holding.
Where Rule 9 applies, the bidder must make a mandatory offer in cash (or accompanied by a cash alternative) for any interest in shares of the relevant class, and at the highest price paid by the bidder or its associates, held during the 12 months prior to the bid announcement.
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 of a target if it has already acquired (or unconditionally agreed 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 the required number of shareholders agree to sell, then it can buy out the remaining 10% (or squeeze them out). A minority shareholder can apply to court to prevent being squeezed out if it believes that ‘special circumstances’ apply to them and the squeeze out will be unfair, but these applications are rare.
How do you identify a suitable target company for an acquisition?
Most buyers use a professional advisor or broker to select a suitable target company for acquisition, once they’ve identified their strategic needs and budget. Your choice will largely depend on your objectives for the merger (increased customers, access to technology, undervalued target for example) and the sector in which you operate.
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 is a company valued for acquisition?
There are a number of different ways to value a company. It’s best to consult an accountant, 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. 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, a start-up or early-stage business.
On an earning basis, the future earnings of the target are multiplied by an appropriate multiplier (which is usually related to comparable 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, so the 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.
Combination: 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 is worth.
Are there any tax issues in connection in mergers and acquisitions?
Stamp duty is normally payable on the sale of shares, as a percentage of the amount paid for them. In addition, a corporate seller will pay corporate tax on any increase in value of the shares sold.