Mergers and acquisitions: an anatomy

Jun 10, 2019

Written By Becky Kells

One of the biggest processes a client can go through is a merger or acquisition—in fact, there’s an entire area of practice devoted to it. Here’s a brisk run through the basics, so you’ll be able to keep up the next time you read about one!

Your merger and acquisition dictionary

Merger: When two companies combine on a fairly equal level to form a new, joint organisation. No cash is required for a merger, but some authority will be given up on both sides, as a new company structure will need to be achieved. This kind of transaction in its pure form, with both companies on completely equal footing, is very rare.

Acquisition: When one company is taken over by another company. The smaller company is swallowed by the larger one and ceases to exist. Sometimes companies will undergo an acquisition, but it will be publicised as a merger, as acquisitions can have negative connotations. So, you may hear of a company being involved in a merger, when really it’s being acquired. Throughout this article, we’ll use the word “merger” to describe this type of transaction.

Target/selling company: The company being acquired or bought.

Buying company: The company buying, absorbing or acquiring another company.

Due diligence: The reasonable steps taken to avoid committing a tort or offence. The business being acquired will be comprehensively appraised by the buying business’s legal team to establish assets, liabilities and potential. This is a very important part of the M&A process.

Letter of Intent: A non-binding document that sets out the aims of the potential merger. It’s compiled and signed early on in the planning stage of the merger.

Exclusivity agreement: An agreement that comes about early in the M&A process, around the time of the Letter of Intent. This type of agreement would prevent the seller from negotiating with third parties over the sale, limiting negotiations to the buyer and seller involved. The selling company would be required to terminate all other talks and focus their negotiations on just one buyer.

Online data room: An online platform with restricted access granted to specific individuals, where the documents required for due diligence can be uploaded, viewed and checked.

Reasons for Mergers & Acquisitions

There’s not one single reason why a company might merge, and the decision to do so requires a lot of careful consideration of the market, the benefits and the drawbacks. Sometimes a company has very little choice: for example, if it’s being acquired by a much more powerful company at a time of economic strife. Other times, both companies involved can carefully consider their options.

To expand reach geographically. With globalisation on the rise, M&As that open up both companies to foreign markets and expand the existing customer base into a different location can ensure financial security.

To change position in the market. Mergers often involve combining like with like: two energy companies, for example, or two entertainment companies. If the companies previously shared the same sector, combining into one super-company creates a stronger position within that market.

To expand services (rounding out). A company might merge with a related, but not identical, company. Doing so creates a stronger provision in an area where a company may not have had much focus before, allowing both companies to fill in each other’s gaps.

To improve financial position. A company might be doing well and may be looking to acquire a different company in order to bolster its success. Alternatively, a company might be ailing and could be open to being bought by a larger, more powerful company.

Steps to a merger

There’s no exact timeframe for a merger or acquisition—a period four to six months is standard, but it can vary depending on how long each of these components takes to complete. As required, the legal teams and company directors might spend longer than typical on one step (negotiation, for example). But some parts of the merger can move quite quickly, particularly if the company being bought is facing administration or some other financial difficulty. It can get confusing when thinking about hypothetical mergers and acquisitions, so we’ve invented two companies—Collins Enterprises and Zapas Capital—to talk you through the process.

Identifying opportunities

This is the point at which the merger seed is planted. Collins Enterprises, which is looking to acquire a smaller, similar company, will put feelers out. It’s likely that representatives of Collins Enterprises will look at the market and take into account any predictions within their own company: are they financially secure enough to undergo a big change?

A few target companies might be identified. A big part of this stage is data analysis; researchers will identify how the demographic, employees and competitors align with their own. Ultimately, they will come away with an idea for an acquisition target that meets their needs: in our scenario, that’s Zapas Capital.

Analysis

Once the target company is identified, the representatives from Collins Enterprises formulate an action plan. They will take a good look at the financial position of Zapas Capital, considering all factors: the revenue it’s made recently, its credit position and its balance sheet. This ultimately helps to figure out the cost of acquiring it as a business.

Decision

After deciding that a merger with Zapas Capital is beneficial, Collins Enterprises will approach representatives to propose the transaction. Zapas Capital then decides internally whether or not to proceed with the merger. The decision-making process can take a while, but for Zapas Capital it’s an easy yes. Negotiations can now begin.

Letter of Intent

At this point, the first significant document of the merger is produced: the Letter of Intent. This sets out the contractual terms of the intended transaction, including the purchase price, any adjustments as a result of negotiation, warranties and any non-compete covenants or confidentiality clauses. The Letter of Intent also communicates the expected timetable for the merger. Both Zapas Capital and Collins Enterprises sign the letter of intent, but only the confidentiality and exclusivity clauses are legally binding at this point.

The letter of Intent is a big and exciting step for both parties: advisers can be appointed and it’s now that the legal work truly begins.

Valuation

This is a particularly important stage and must be carried out expertly. There are a number of different ways in which Zapas Capital could be valued. Comparable Company Analysis (CCA) means evaluating the company based on other businesses of a similar size in the same industry. Comparable transaction analysis looks into the value of the business based on similar transactions that have, preferably, taken place recently. Discounted cash-flow analysis (DCF) is a valuation method based on future cash flows of the investment, based on the present value using a discount rate.

There can be negotiation at this stage. Zapas Capital chooses to make a counter offer, which Collins Enterprises accepts.

Due diligence

After the offer is accepted, due diligence begins. Zapas Capital will be required to disclose data on any litigation, tax, anti-trust/regulatory issues and insurance. Everything must be disclosed before the acquisition can take place, and information provided previously must be fact-checked. Zapas Capital uploads all of this into an online data room.

Lawyers acting for Collins Enterprises will then scour the documents for issues, opportunities and risks. Risks include obligations being assumed, any contingent liabilities, problematic contracts, litigation, risk and IP issues.

In mergers involving private companies, due diligence will be lengthier, as companies floated publicly often undergo more scrutiny before going onto the stock market.

Lawyers are heavily involved at this stage; they advise Zapas Capital of the documents they’ll need to provide as part of due diligence. As part of due diligence they check that documents are signed by both parties, and that all of the relevant documents are submitted and complete.

Definitive acquisition agreement

Once the lawyers complete their due diligence, the definitive acquisition agreement will be produced. The agreement is drafted and prepared by counsel and may go through several iterations. It will include definition, structure of the transaction, the price and other financial terms, details of stock issue and closing conditions. It will also include the general obligation to sell, as well as any conditions related to continuation of employment.

Transaction executed

Following the definitive acquisition agreement, the boards of directors of Zapas Capital and Collins Enterprises will each call a meeting with their shareholders. Any opposition to the merger by creditors and bondholders must be communicated within 60 days of resolution.

Implementation

After this, all that remains is to implement the merger… and ZapCol, a newly-merged company, is born. But it doesn’t end there: the new company will need to work through any challenges posed in terms of HR, law and regulation. Share prices will adjust to the share-exchange ratio, and only time will tell if the new company will sink or swim.

Commercial Insights