Structural changes between companies under commercial law, referred to as M&A, make it possible to increase the economic potential of an entity, as well as to enter new markets and expand the target audience. What do M&A transactions are about and what is worth knowing about them?
What is M&A?
M&A is an acronym derived from the English phrase Mergers & Acquisitions. This term is used to describe a set of processes and procedures that aim to transform market participants into entities.
Basically, M&A can be divided into two types:
- mergers, which aim to combine two independent entities into one;
- acquisitions, where one entity is taken over by another, with the result that the former is no longer in existence.
In practice, there are other types of M&A, such as reverse takeovers, which involve shareholders of the target company taking control of the acquiring company. Due to the varied nature of M&As, it is essential to plan them individually each time, as there is no one-size-fits-all scheme of action to ensure success.
Acquisitions can also be divided into horizontal, vertical, conglomerate or concentric, with the criterion for division being the purpose of the M&A transaction and the business profile of the companies involved.
For what purpose is an M&A carried out?
A merger or acquisition can be carried out for one or more of several different purposes. A typical rationale for M&A is to increase the economic potential of an entity by improving its business performance, expanding the geographical reach of the goods or services it offers, and acquiring additional, often specialised resources for business-related purposes (e.g. personnel, technology).
Another motive for M&A is to gain influence in new markets or to reach a different customer segment with an offer. In this way, the participants in the process can join forces to dominate a specific sector or to offer products and services complementary to each other.
Still another reason for M&A is tax optimisation by creating a favourable business environment and taking advantage of a favourable tax or administrative jurisdiction.
The literature also points to managers’ reasons, i.e. aiming to simplify the process of management of a set of companies. This type of action is prevalent in corporate groups when the management path of individual parent and subsidiary entities becomes too complex.
How is M&A financed?
The financing of the M&A process can occur in one of several ways. The most basic source is cash. The entities involved in the transaction cover the merger or acquisition process with their own funds. Although logistically this is the simplest option, it will not always give optimal results in terms of profit.
An alternative way is so-called debt financing, i.e. relying on capital provided by third parties, such as a bank. As a result, it becomes possible to diversify the risk and use the leverage effect, as a relatively low cost in terms of interest can generate a much higher profit.
Yet another solution is for private equity funds to finance the venture in exchange for taking a controlling stake or shares, or to issue securities (e.g. shares, bonds) to be taken up by investors.
Stages of M&A
Several stages of M&A can be distinguished. Due to the vastness of the entire process, it is difficult to identify clear boundaries between them. The most important M&A milestones include the following phases.
M&A – the preparatory phase
The first phase of M&A involves determining the sources of financing for the entire operation, as well as which model is to be followed. The transition of the company can take place as:
- share deal – a transaction on shares that are transferred to the buyer;
- asset deal – an M&A transaction involving the transfer of individual assets from the target company to the acquiring company.
Once a strategy has been developed, the company must find an entity or entities that will be interested in the transaction.
M&A – due diligence
A due diligence report, is an extensive study that identifies specific areas of risk associated with a transaction. It is prepared by the acquirer. It is usually preceded by a non-disclosure agreement (NDA), which protects the parties from disclosing business-critical information to third parties.
Due diligence can cover areas such as tax, real estate, litigation, employee or compliance aspects of the company, among others. The outcome of the investigation is an important argument in negotiations, as it can influence the price of the M&A and sometimes even the termination of a potential cooperation if the risks are too many or not properly managed.
Sometimes, in addition to the classic due diligence report, the seller prepares a so-called vendor due diligence. It allows the company to be adequately prepared for the sale and reduces the risk of the operation failing.
M&A – contract negotiation
The next stage is the negotiation of the M&A transaction, i.e. determining which liabilities are taken over by the acquirer and on what terms. Many factors influence the course of negotiations, including precisely the outcome of due diligence, the method of valuation of the company and the type of acquisition (share deal or asset deal). A detailed list of agreements and obligations is prepared for the contract.
When formulating the provisions of the contract, it is very important to provide for mechanisms to safeguard the seller’s interest in the event of a deferred payment. Solutions such as payment into an escrow account or obtaining a bank guarantee or surety are usually used.
M&A – performance of the contract
Drawing up even the best contract for the purpose of M&A is still not enough. It is extremely important to obtain the relevant approvals of the corporate bodies (e.g. the board of directors). In certain regulatory situations, it will also be necessary to obtain approval from the antitrust authority for the concentration of capital or influence.
Often, in addition to the main acquisition agreement, companies enter into ancillary agreements with each other to ensure that the transaction is adequately secured. Misunderstandings often arise at the execution stage due to the absence of an Representation&Warranties clause or its imprecise wording. It is worth ensuring that it is clearly defined on what terms the sale of the company takes place.
M&A – PMI integration
After the actual merger or acquisition has been completed, a so-called Post Merger Integration is carried out, i.e. the merger of two businesses that previously operated separately. PMI should address every aspect of the company’s operations, from the implementation of uniform administrative and AML procedures, to the creation of a common offering of goods or services, the definition of unified margins, the division of positions and the dresscode.
The more carefully PMI is carried out, the quicker the employees of the two companies will work together, and the better the effect of that collaboration will be. In fact, it is the smoothly executed integration that will determine whether the M&A transaction will actually strengthen the entity’s position in the market and allow synergies to be exploited.
How long does an M&A take?
M&A transactions are a complex process that often takes up to several months. Factors that have a decisive impact on the time it takes to complete a merger or acquisition include, above all, the complexity of the business, its scale and the number of processes that need to be correlated with each other. The quality of the due diligence reports (and possibly vendor due diligence) prepared at the initial stage is also important.
The fewer doubts and reservations the parties have about the valuation of companies or the identification of risk areas, the shorter the negotiations will last and the easier it will be to reach a common position.
Practice shows that up to 80 per cent of mergers and acquisitions that are carried out without the support of professional legal services do not take place or produce results that are worse than expected. Therefore, companies planning such operations should consider using professional legal assistance to coordinate the various stages of the process.