Mergers & Acquisitions
DGCL Section 251: Statutory Merger (authority & process)
Section 253: Short-form merger
Section 251(f) cash mergers
Section 259, 261: the legal effect of a merger
Section 271: asset sale
Section 262: Appraisal rights of dissenting shareholders
Section 242: Single-firm reorganizations of capital structure (amending cert. of incorporation)
Section 123: Stock acquisitions
Section 203: restrains some hostile tender offers
INTRODUCTION TO MERGERS & ACQUISITIONS; APPLICABLE LAWS
Parties to an acquisition:
Financial buyer – not in the business of the target corporation. Usually private equity investors, intending to buy & grow the company (internally or through additional asset purchases) for a few years, and then sell. Short-term interest. Will often use a leveraged buy-out technique.
leveraged buy-out: borrow 80-90% of acquisition costs, provides higher return on investment. Company they acquire must generate enough revenue to pay debt.
Looking for management of selling company to stay in the business.
Strategic buyer – in the same industry. Playing the long game. Looking for this company as a means to develop the portfolio of companies he already has and to make the entire entity more attractive & profitable.
Already have their own management team and will replace existing management (typically in 8-12 months).
Public seller – multiple shareholders
Private sellers – closely held corporation (typically 5-15 sellers, often family members)
Investment bankers: usually one for each the seller and the buyer in larger deals. Advise on fairness of transaction, price, structure of the payout. Provide coverage – give advice to selling shareholders that price received for stock is fair.
Only care about getting the deal done (that’s when they get paid).
If problems arise post-deal, shirk responsibility to lawyers.
Accountants: Perform due diligence on seller financials to verify that they are what they appear to be (expenses haven’t been deferred, etc). Analyze books, perform tax work. Working on the same side, representing the same client. May be asked to provide a comfort letter (validating that transaction meets all accounting standards).
Earn outs – buyer and seller disagree on what company’s worth. Basing it on EBITA. Pay lower end now and if it turns out lower side is wrong, they pay out the higher side after a certain period.
EBIDTA: Earnings before interest, depreciation, taxes, and amortization.
Adjustment of purchase price after closing – i.e. purchase price is based on working capital of $30 million. If less at closing, increase/decrease dollar for dollar. Accountants can give analysis of historic working capital.
Due diligence – reviewing all relevant documents from the business. Prepare a memo for the client and point out all potential problems with deal based on documents. Find out everything you can about selling company and understand all contracts, all risks, all potential issues, etc. Environmental issues? Tax issues? Control issues?
Reps & Warranties – provision in acquisition agreement where seller makes certain reps & warranties about the business. Diligence helps to form reps & warranties.
Acquisition agreement – drafting. Buyer prepares 1st draft and sends to seller.
Timeline of a deal:
How do deals start?
CEOs of 2 companies discuss merger/combination of businesses
Client calls attorney about early discussion and requires confidentiality agreement to be able to exchange information
Mutual confidentiality agreement: stock as consideration (equity), will want to see financials on your company as well.
one-sided: consideration in cash, not giving them financial information about your company in return.
If these preliminary meetings are fruitful, the result may be a non-binding letter of intent (or term sheet).
Exchange information and retention of experts
Lawyers to negotiate and draft the details of the acquisition documents
Investment bankers and accountants to provide valuation estimates and other financial advice.
Attorney drafts Letter of Intent – generally non-binding agreement to lay out financial terms for the deal. The seller will typically agree to give the potential buyer exclusive negotiating rights for a period time while the buyer does due diligence and drafts/negotiates the details of any acquisition agreement
$$ in exchange for assets, $$ in a particular manner. Money in escrow in case certain things don’t come through, etc. Escrow typically 10% of purchase price. Post price adjustments (i.e. working capital adjustment), Exclusivity, etc.
Helps buyer & seller to focus on what they’re agreeing to.
Exclusivity – buyer wants agreement that seller doesn’t negotiate with anyone else while talking for a certain period of time. “No shop” clause.
For public deals, must have “fiduciary out” – Directors have obligation to get the highest price they can for shareholders. If higher offer comes in, we have the right to consider it.
Seller might want to include provision that if buyer returns with substantially different terms during discussions, they can go elsewhere.
Diligence Process: The buyer will do substantial investigation into the seller’s business. Lawyers/accountants pore over the books and records of the opposing party, checking the accuracy of factual representations and looking for trouble spots.
In stock swap deals, the seller will do limited due diligence of the buyer b/c the seller is accepting an ownership position in the buyer as a payment.
Due diligence continues after board approval (step vi) and through to closing to insure that the seller has, by the closing, satisfied the agreement’s conditions.
u are buying for X years (non-compete).
Indemnification provisions – spell out what happens (remedy) if seller breaches representation, warranty, or covenant.
Caps – on amount that can be recovered of purchase price. Usually 10%-30%.
Can have carveouts – i.e. for fraud
Survival period for all indemnity claims – usually 2 years with exceptions (if they did not have authority to do deal).
Mergers v. Acquisitions: The Basics
Acquisitions: buyer purchasing company for cash or cash equivalence
Stock acquisition: buy stock directly from the shareholders for cash. Target becomes wholly owned subsidiary of the buyer. Buyer has assumed all assets and all liabilities of target company. Buyer will want to buy controlling percentage (51%). May want 80% to be able to consolidate for financial & tax purposes. May want 90% to meet terms for short-term merger. **dangerous transaction! Don’t know what liabilities you’re assuming.
Results in 1 company with combined shareholders. Buyers shareholders are diluted in voting, but not in value (b/c you also assumed assets)
Both company shareholders must approve. (Section 251 of the DE Code). For common shareholders, need majority of issued or outstanding stock, whether present or not. Can increase rights from default rule. Can’t decrease rights (i.e. put in clause to defer voting rights for 2 years of ownership)
Class voting – require approval of majority of holders of preferred stock (or specific class) voting as a class. Negotiate through preferred stock certificate.
20% Exception to voting rights – 251F: shareholders of the surviving company don’t have the right to vote if transaction meets certain requirements. (Target companies still must vote)
Not changing surviving art. of corporation
Not sharing rights of shareholders in stock as set forth in certificates
Shares not diluted by more than 20%
Asset acquisition: Or buyer can purchase the assets of the corporation. Cash then gets distributed to shareholders. Buyer negotiates which liabilities he acquires. Tax on difference between basis of assets and purchase price. Also taxed when distributing funds to shareholders (liquidation).
The selling firm can dissolve after the transaction and pass the transaction proceeds received on to its shareholders in a liquidating distribution.