MERGERS & ACQUISITIONS
INTRODUCTION
Why merge? Why sell?
1. A division of a company might no longer fit into larger corp’s plans, so corp sells division
2. Infighting between owners of corp. Sell and split proceeds
3. Incompetent management or ownership
4. Need money
5. Business is declining (e.g. a buggywhip company)
6. Industry-specific conditions
7. Economies of scale
BASIC DEFINITIONS:
MERGER:
Owners of separate, roughly equal sized firms pool their interests in a single firm. Surviving firm
takes on the assets and liabilities of the selling firm.
PURCHASE:
Purchasing firm pays for all the assets or all the stock of the selling firm. Distinction between a purchase and a merger depends on the final position of the shareholders of the constituent firms.
TAKEOVER:
A stock purchase offer in which the acquiring firm buys a controlling block of stock in the target. This enables purchasers to elect the board of directors. Both hostile and friendly takeovers exist.
FREEZE-OUTS (also SQUEEZE-OUTS or CASH-OUTS):
Transactions that eliminate minority SH interests.
HORIZONTAL MERGERS:
Mergers between competitors. This may create monopolies. Government responds by enacting Sherman Act and Clayton Act
VERTICAL MERGERS:
Mergers between companies which operate at different phases of production (e.g. GM merger with Fisher Auto Body.) Vertical mergers prevents a company from being held up by a supplier or consumer of goods.
LEVERAGED BUYOUTS (LBOs):
A private group of investors borrows heavily to finance the purchase control of an ongoing business.
RECAPITALIZATIONS:
Does not involve the combination of two separate entities. Here, a firm reshuffles its capital structure. In a SWAP, the corp takes back outstanding equity stocks in return for other types of securities (usually long term bonds or preferred stock)
RESTRUCTURINGS:
This term refers to a corporation’s changing form to downsize their operations. Examples of restructurings are divestitures, carve-outs, split-ups, and spin-offs.
STEPS UNDERTAKEN TO COMPLETE A MERGER:
1. Preliminary negotiation:
High level executives get together, letter of intent, and confidentiality agreement. No binding Ks are signed yet
2. Serious negotiation:
Bring in the lawyers, I-Bankers, and other professionals. Lawyers go over the affairs of the companies. Due diligence is done. Lawyers raise legal issues
3. Acquisition K
Binding agreement to finish the deal. Board votes on the transaction
4. SH notice and proxies mailed out.
Boards disclose relevant information and recommend that SHs approve the deal.
5. SH vote
If SHs vote yes, then close the deal. If SHs vote no, then back to the drawing board
6. Closing
Forms sent to secretary of state. 2 companies become one.
7. Appraisal
Dissenting SHs sue merged corp to get fair value of pre-merger stock they owned
Risk involved w/mergers: There is a risk between the end of negotiations (step 3) and closing (step 6) that one corp’s stock will rise or fall in price so much that the deal is no longer worthwhile to pursue. In order to protect against the risk, there can be a walk-away clause in the acquisition K that kicks in if one corp’s stock fluctuates too much. Also, there can be a provision that if the stock price of the acquiring corp falls too much, that the acquiring corp must make up the difference in cash.
Other ways to reduce risk: (pg. 12)
1. Floating exchange ratio (an exchange ratio that is set when the board votes on the agreement of merger and does not change through the closing. Seller’s SHs bear the general market risk and the specific risk associated with value of buyer’s stock.)
2. Price collars (upper and lower market price limits to the transaction)
3. Walk away provision (an express condition that gives the seller the option to walk away if the buyer firm’s stock price falls below a specified price level.)
4. Fill or kill option (If buyer’s stock price falls, they can waive the price collar and also gain the right to issue seller’s SHs more buyer corp’s shares in order to make seller corp’s SHs whole. This way, the merger can go through.)
5. Contingent value rights (selling SHs who take buyer’s stock get a price protection in the form of additional compensation by the buyer)
TYPES OF MERGERS:
A Corp = Buyer
B Corp = Seller
STOCK FOR STOCK MERGERS (a.k.a. The stock swap statutory merger):
Mechanics (Del Corp. Code §§ 251, 259-61):
1. A corp gives its stock to B corp.
2. B “magically” ceases to exist and B shares become worthless
3. A is surviving corp
3. All of B’s assets and liabilities go to A
4. B SHs get A corp stock
5. A corp takes on all assets and liabilities of B. B creditors now have a claim against A
Voting:
1. A board and A SHs vote, as long as this is not an 80%-20% “whale-minnow” merger in Del. (If it is whale-minnow, then only A board votes – A’s SHs do not vote)
2. B board and B SHs vote
3. Majority of outstanding shares must vote in favor of agreement
4. B creditors and tort claimants cannot vote on proposed merger
5. Preferred SHs do not get to vote on merger under Del. law, but they do get to vote under MBCA
6. Appraisal rights for A (if they get to vote) and B SH dissenters
7. SH voting rules may be augmented by K
8. Dissenting B SHs must give up their shares, but they get appraisal rights.
Taxes:
This is a tax-free transaction (an A reorganization)
CASH FOR ASSETS (Del. Corp Code §§ 122, 271):
Mechanics:
1. A pays B cash consideration for B’s assets
2. A and B get to choose which of B’s assets and liabilities are transferred to A
3. (Optional step 2 of transaction) B dissolves, dispensing cash to creditors and SHs
4. Creditors don’t usually (but sometimes do) have claims against A. Claimants must sue directors
and SHs of B
Voting:
1. A and B boards vote
2. B SHs vote if B is selling “substantially all the assets”
3. B SHs get to vote (again) if B plans to dissolve after sale
4. A SHs do not vote
5. B SHs do not get appraisal rights
Taxes:
This is a taxable transaction
SALE OF “SUBSTANTIALLY ALL OF THE ASSETS”: DEL. CORP LAW §271
If corp sells all or “substantially all” its assets, corp’s SHs are entitled to vote on the transaction. A majority of all outstanding shares entitled to vote must approve the transaction in order for transaction to be approved. §271 covers “sale, lease, or exchange” dispositions. §272 says that SHs do not get to vote if corp mortgages or pledges its assets.
MBCA says that “substantially all” means any disposition that would leave the corp without a significant continuing business activity.
SALE OF SUBSTANTIALLY ALL ASSETS CASES:
Gimbel v. Signal Companies, Inc (29) (Del. 1974)
Ct said that Signal did not sell “substantially all” its assets, because the total amount (value) of assets sold constituted only a small portion of Signal’s total assets. Ct used
-owned subsidiary of A Corp.
4. Everything else remains the same.
HOW TO GET RID OF MINORITY SHS AFTERWARD:
1. A corp may do a back-end merger to completely integrate B corp into A corp, if it wishes. A corp might be able to do this with a simple A board resolution (the 90%-owned subsidiary rule.) A corp gives the minority SHs cash or debt in return for their shares.
2. A corp may also drop down C corp and merge its B corp subsidiary into this new C corp. C corp takes B corp’s assets and liabilities and minorities get cashed out. Also, creditors of B corp can’t go after A’s assets because B/C corp is still only a subsidiary of A.
(3. Reverse stock split: A corp can say that each share of B corp is now worth 1/1,000,000 of a share of B corp: A “one for a million stock split.” Since each minority SH only owns a fraction of a share, A corp can cash all of them out.)
CLASS VOTING CASE:
Shidler v. All American Life (33) (Iowa – the land where the tall corn grows)
1. This involved a merger attempt between GUG corp and All American Delaware corp. (a subsidiary of AALC.) All of GUG corp’s Class B common stock and less than 50% of the regular common stock was held by AALC. (So the parent corp of merger partner of GUG owned most of GUG’s stock.) P was a public SH of GUG stock.
2. All of the GUG SHs as a giant group voted on the merger and approved it (which would happen, of course, because AALC owned most of GUG’s total stock!)
3. P claimed that each class should be entitled to vote separately on the transaction.
4. ISSUE: Was this transaction a “cancellation” of P’s GUG shares? If it was, then Iowa Corp Law mandates that each class vote separately. D claimed that it wasn’t cancellation, but merely a “conversion.”
5. Ct held that it was a cancellation, and each class of shares should have voted separately. Ct. voided the merger.
6. Ct looked to the reality of the transaction, rather than the characterization of the merger in merger agreement. Hence, Iowa uses a “substance over form” approach to analyzing mergers. This is different from the Delaware approach, which we will see later involves a “form over substance” analytical approach.
7. In the future, Iowa corps will try to structure their deals in a little more complex way than GUG did, so that ct will not void the merger later.
DE FACTO MERGERS:
De facto merger: Though the parties to a transaction say that they aren’t performing a “merger,” courts may look to the substance of the transaction to determine that it actually is a merger.
Why don’t corps want their transactions to be deemed statutory mergers?
1. Both corps’ SHs get to vote in a statutory merger.
2. Dissenting SHs get appraisal rights in a statutory merger.
3. Creditors of target corp may go after surviving corp’s assets after a merger.
4. In an asset sale, there are no appraisal rights for dissenting SHs, so corps really like these.
