Mergers & Acquisitions
Spring 2011
Economic Justifications for Acquisitions
· Economic Considerations
o Valuing stock of a business
o Discounting back to the present
o The riskier the investment the higher the expected return
o The efficient capital markets hypothesis
§ Semi-Strong Form: Stock price reflects all publicly available information
§ Strong Form: Stock price reflects all available information about the company, whether that information is public or not
o Many people believe that if you combine complimentary businesses then you will get a bang (benefit)
o Some people combine companies just because they want to raise market share
· Methods of Buying or Selling a Firm or Business
1. Merger
§ Direct or forward
§ Triangular
2. Stock Purchase/Sale
§ Privately negotiated
§ Tender offer
3. Asset purchase/Sale
o All three of these are effectuated by an agreement between the parties
o In these situations there are statutory procedures that comply in order to effectuate the merger
o The purchase and sale process often begins with due diligence
§ Usually the seller will ask the buyer to sign a confidentiality agreement stating that the information disclosed is only to be used for due diligence purposes
o Parties will also usually sign a intent letter which will outline the major terms of the transaction
o At some point a definitive agreement will be signed
o Closing: is the time and place where the performance occurs (merger/purchase of stock/purchase of assets) Until the closing occurs you just have an executory contract
o Consideration goes to whomever owned the assets
o Biggest advantage of asset purchases is buyer gets a step-up in basis in the assets and can choose which liabilities of the seller is to assume
§ This means that the parties get to allocate risk in any way they so choose
§ This is often very useful because sometimes businesses have unknown liabilities
o Indemnification Provision of Asset Purchase
§ Will usually say … if it turns out that the buyer ultimately faces liability as a result of a liability that was supposed to be excluded from this deal, then the seller will be liable for such
o Next advantage of asset sales is absence of voting
§ There is no corporate law requirement of a vote on the part of the buyers stockholders to approve the transaction
§ There is not a corporate law requirement for the sellers shareholders unless it is a sale for substantially all of the seller’s assets
o Another advantage of asset sales is that the federal securities laws, specifically 10b and 10b5 are not going to apply because there is no purchase or sale of a security involved in the matter
o Disadvantages of an asset sale
§ It is a pain in the neck to document.
· It takes a lot of lawyer time, a lot of accountant time, consulting, etc.
§ The notion of third party consents
· There are often contractual arrangements with third parties (i.e. leases, licensees, permits, etc). Many times these contracts will have provisions in them that state that they cannot be transferred to third parties without the consent of the third party to the contract.
§ Many states will tax asset sales (transfer taxes)
o Advantages of a Stock Purchase
§ You could say that no stockholder vote is required
· The one exception is if the seller company is trying to increase the amount of authorized stock then the stockholders have to approve that because it requires a change to the Cert. of Incorp.
§ It is a very straight-forward agreement
§ Third party consent problem is usually mitigated to a very significant degree or mitigated entirely
o Every state has a statue that parties have to comply with when engaging in a merger
o Mergers are a combination of contract and statue law
o DGCL 251 is the basic Delaware merger statue
§ Governs mergers between two Delaware corporations
· Choice of Law in Mergers
o Which state statute governs mergers
§ You look to the state of the constituent corporations, where these corporations are incorporated
§ If they are incorporated in different states then usually each state will have a statute that deals with this issue, which governs mergers between corporations from two different states
· You must follow the statutory procedure for a legal merger to occur
o You cannot contract around the statue
· There is always a survivor in a merger
o The merger agreement will define who the survivor is
o DGCL 259 specifically says in the statue that the surviving corporation is now assumes all assets, liabilities, and debts of the non-surviving corporation. You cannot contract around this in a merger.
o The merger agreement also has to state and define what the final certificate of incorporation is going to be
o Merger agreement must also state what type of consideration is going to be used (i.e. stocks)
o Every merger must be approved by the stockholders of each constituent corporation!
§ The majority of the outstanding shares must vote to approve the merger (DE). Other states will have different voting requirements.
Methods of Buying or Selling a Firm or Business
· Asset purchase/sale
· Stock purchase/sale
o Privately negotiated
o Tender offer
· Merger
o Direct or forward
o Triangular
· DGCL §251 (covers basic merger procedure)
· DGCL §259 (impact of a merger on the surviving and constituent corporations)
Arm’s Length Mergers – Mechanics
· The classic form of the merger precedes all other
· Both sides negotiate and execute an agreement
· Thereafter the boards submit the agreement to the shareholders, who must approve the merger for it to become effective
· The Agreement is then filed with the Secretary of State (this filing completes the merger)
· By operation of the law, the surviving corporation succeeds to all the assets of the constituent corporations and is subject to all of their liabilities
Merger Agreement
· Must be agreed upon by both boards, target and buyer
· Must say who is the surviving entity
· Must also say what the certificate of incorporation will be for the surviving corporation
· Has to state what consideration is being used (cash, stock, etc.) Generally each of the constituent stockholders of both companies must approve the merger
o Each state defines what “approval” means
§ In DE it is the approval of the majority of the outstanding shares (that’s not majority of shares voting)
§ Other states have a 2/3rds voting requirement (10-15 states still require this)
o If cash is the sole consideration, there is no target shareholders in the “after” picture, they go away because they are bought out. This is called a cash-out merger
· After the merger agreement is adopted by both boards of directors and then approved by the shareholders, the merger agreement must then be filed with the Secretary of State
o DGCL §103 tells you how to file a certificate with the secretary of state. (we need not need to read §103 for class)
o You don’t have to file the merger agreement itself, you can instead file a “certificate of merger” which is a short-form basic summary of your merger agreement
§ Agreement must specify (as stated in §251(b))
· Terms and conditions of the merger
· Any changes in the articles of incorporation of the surviving company
· The manner of converting shares of each constituent corporation into share of the surviving corporation
· And if shares are to be cancelled, the consideration that will be paid for them
o This is the last step! At this instance the merger becomes effective unless you state a later date in your merger agreement in which you want the merger to become effective
§ Many states have a provision that says that BOD (of either company) is allowed to terminate the merger before the merger has been filed with the secretary of state (Keep in mind that this may well be a breech of the merger agreement)
o At the effective time of the merger, the non-surviving corporation disappears! And all the rights privileges, powers, duties, debts, etc (the good the bad and the ugly) goes to the surviving corporation
§ DGCL §259(a) is where you will see this. You cannot contract around this! It is an operation of law!
o What you wind up in a basic merger is one entity (the merger acquirer and target)
§ The shareholders in this basic merger are the shareholders of both the acquirer’s and target’s old shareholders
· Certain exceptions to the stockholders having to approve a merger agreement
o §251(f) Small-Scale Merger Exception
§ Basic idea is that if the merger isn’t big enough in relation to the size of the survivor, then the stockholders of the survivor do not need to vote to approve the merger
§ Basically says so that as long as the cert. of incorporation of the survivor is not being changed and as long as each share of the survivors stock is not being changed with regard to its rights, and unless the Cert. of Incorp say otherwise, no vote of the stockholders of the survivor is required to vote and approve the merger.
· Avoid the vote of the big entity’s stockholders!
· On the side of the acquirer, only the board has to vote
· Note that the targets board and shareholders still have to vote (nothing is changed here)
§ What is small enough for these purposes? DGCL basically says that after the merger, the stock of the surviving corporation cannot have increased by more than 20%
§ §251(f) does NOT address what happens in cash-out mergers but the received wisdom is that if cash is used as the consideration then the people who used to be the shareholder of the acquirer (the acquirer’s original shareholders), need to come out of the deal owning at least 83% of the combining company (compared to the 100% of the company they used to hold before the merger)
§ Does not expressly address cash acquisitions!
· Could read the statute to permit cash acquisitions of any size without having a stockholder approval! (no case law on this or article commentary)
o Flucos has a problem with this. He says that historically there is a notion that if a merger is small scale than you don’t have to get a vote. Then why would you get a pass (meaning you don’t have to get a vote) for an enormous cash acquisition??
o §253 Short-Form Merger
§ Parent that owns at least 90% of the stock of a subsidiary. In such a case, the approval of the parent board is the only approval that is necessary to make the merger effective.
· Note this merger may raise other issues, such as fiduciary duty issues (we will get to this in Ch 9) which will make the merger unlawful
o State Anti-Takeover Statues
§ May introduce significant variations in shareholder voting requirements based on which state you are in (will see this in Ch 7)
o Dissenter Appraisal Rights
§ I am a stockholder and I am not satisfied and I make it known that I am against the merger, and this may trigger dissenter appraisal rights (will get to this in Ch 9)
· Does structuring a transaction as a merger, eliminate the issue of third party consents?
o Say I own a business and I am selling it and I have a bunch of agreements with GM in which they are going to. The agreement will say that these agreements cannot be assigned to another party without the consent of GM.
o Often times in an asset sales transaction the buyer has to obtain the consent of the third party in order to get it closed.
§ Usually third parties will give their consent
§ Usually the issue just ends up being a logistical issue, it takes time and money, and the third party will often try and negotiate something out of you to get their consent. Doesn’t usually end up being a deal-breaker
o If I have a statutory agreement as we do in DE that says by operation of a law in a merger that all rights go to the survivor in a merger agreement (§259), then are these assignment type provisions enforceable, or are they just trumped by the statute. The courts often will say that the statute §259 simply superseded the assignment type provisions.
§ A lot of times the target will have insurance policies that are extremely valuable and that policy may say that the third party (insurance company) has to consent to the merger. Most third parties will consent, however, some states will say we don’t care if the third party consents or not, our statute (i.e. DGCL §259) our statue says that all rights (including the insurance policy) transfers to the surviving corporation. This is a disputed issue, nothing is formally settled on it, it will depend what state you are in.
§ The outcome of this issue will depend on the state and the statute
o Ordinary commercial agreement (leases, contracts, etc.) usually would not contain change of control provisions
o Bank documents may well contain change of control provisions
· Class Voting
o In the classic case, each of the corporations only have one class of stock.
o However, many corporations have various classes of stock, so how does that work when you say a majority of outstanding shares have to approve the merger?
§ Not specifically addressed in some states such as Delaware
· Default rule is DE is one share one vote §212(a), unless the certificate of incorporation states otherwise.
· If the cert. of incorporation does not address the issue of voting, presumably that means that all the shares (all classes) vote together as one class. Mostly the common stock will highly outweigh the preferred shares so this would mean that if the COI is silent with regard to voting rights, then the common stock will drown the preferred stock. In such a case if a merger occurs the common stock will likely eliminate the preferred stock since they are in
ax-free is not really the correct term to use, it should be called “tax-deferred” reorganizations
o If you sell a capital asset the tax rate that is used is the “capital gains tax-rate”
· Stock for asset exchange: “C” reorganization –Section 368(a)(1)(C)
o C-Reorganization applies to asset sales
o If you fit within it you get certain favorable tax treatment
o 3 Requirements
§ Only available when seller is selling “substantially all” of assets; AND
§ Meet the continuity of interest requirement: which means that 80% of the total consideration paid in the transaction has to be in the form of voting stock of the buyer (the buyer is allowed to use other consideration for the other 20%; this remaing 20% is referred to as “the boot”); AND
§ The seller must then distribute all of its assets to its shareholders (which means liquidation of the seller)
o Benefits
§ The selling corporation pays no tax on the assets and
§ The sellers stockholders don’t have to pay tax on the shares they receive in the distribution at this time (these shareholders will ultimately pay tax on the shares when they sell them)
o Note that if boot (the extra 20%) is used, then this part is taxable!!
· Stock-for-stock exchange: “B” Reorganization –Section 368(a)(1)(B)
o NOTE: In a normal stock transaction, the corporation who is being purchased pays NO tax. But the selling individual stockholders of the seller do pay tax on their sale. The B reorg is an exception to this
o Requirements
§ Harder to meet than the “C” reorganization
§ Continuity of interest requirement is more stringent: the only consideration that can be used is the voting stock of the buyer (in other words, NO CASH). And the buyer has to end up with 80% of the entirety of the stock of the target
· This form requires the exchange of voting stock of the seller solely for voting stock of the buyer. The buyer must acquire control of at least 80 percent of all nonvoting classes of stock. This is difficult in a voluntary exchange transaction unless the seller is closely held.
· No cash consideration is permitted. Receipt of any nonqualifying consideration (boot) destroys the tax-free nature of the B reorganization.
o Benefits
§ If you are in the B reorganization, the target shareholders do not pay tax on the shares they have acquired at that time. Deferral on tax until the stock that was party to the transaction is sold
· Merger/Consolidation: “A” reorganization- Section 368(a)(1)(A)
o NOTE: Unless you fall into one of these reorgs, the merger is a taxable event. Even the non-surviving entity may be taxed. The point is that If the merger is taxable the stockholders of the target may be deemed to have sold their stock for tax purposes so they will pay a tax on any gain (this is a taxable transaction).
o The IRC has created eorgs for merger as well
o A reorganization
§ Requirements
· Need a valid statutory merger under state law (ex. DGCL 251)
· Generally cannot be used for triangular mergers- usually only applicable to direct mergers
· Continuity of interest requirement (Little more vague than that of a C & B reorg):
o A “substantial portion” of the total consideration has to be paid for in stock of the buyer or surviving entity.
o Need not be voting stock and there is not exact precision on the amount of total consideration that has to be paid in stock (no one is sure what “substantial portion means”)
§ Flucos said that “substantial portion” is commonly understood to be 45-50% although it is not entirely clear
§ 45-50% has to be in the form of some kind of buyer stock
· Benefit
o The target or non-surviving stockholders defer paying tax until you sell your new shares that you received in the transaction
o Remember, that if there is any boot, you do have to pay tax on that portion
o The only disadvantage of this form is that the merger must be between the acquiring and the acquired corporations. This creates difficulty for many acquiring firms because the triangular merger- between a subsidiary of the acquiring firm and the target- is often preferred
o This form is simply a merger between buyer and seller. No particular form of consideration need be given to the seller’s shareholder. But the continuity of interest rules re quire a continuing substantial ownership interest in the buyer be held by the former seller shareholders, and that these seller shareholders retain that interest for a while. This recognizes the policy behind non-recognition of gain – that when the seller shareholders remain shareholders in the continuing enterprise-there really isn’t the substance of a sale.
o Continuity of interest rules require some substantial proportion of the consideration to be the buyer’s stock. The balance can be anything else – cash, debt, etc. (called boot). The buyer can give seller’s shareholders a choice of cash or stock, so long as the stock proportion is substantial. Receipt of cash is taxable, however
· Federal Tax Reorganizations that apply to Triangular Mergers “2D Reorganization” – Section 368(a)(2)(D)
o Assumes a triangular structure
o Requirements
§ Requires you to use as merger consideration, stock of the parent of the merger subsidiary
§ Continuity of interest requirement
· Same as A reorganization
o A “substantial portion” of the total consideration has to be paid for in the form of stock of the parent of the acquisition subsidiary
o “Substantial portion” is commonly understood to be 45-50% although it is not entirely clear
