A Guide to Corporate Merger & Acquisitions (M&A)

Introduction

Corporate Mergers & Acquisitions (M&A) is a complicated subject matter that most senior business executives must contend with at one point or another over their careers. In addition, employees in various departments at different levels are also involved with the process. The topics presented in this article are those that I feel are critical for one to understand in order to have successful corporate M&A transactions. Corporate M&A subject matter is quite extensive, so I have limited this article to the following M&A sub-topics presented at a high level:

After reading this article, the reader should have a thorough understanding of basic corporate M&A concepts and practices. Please feel free to reach out to me if you have any questions on any subject matter in this document.

Corporate M&A Background

The phrase mergers and acquisitions (M&A) refers to the consolidation or combination of multiple business entities and assets through a series of financial transactions. The merger and acquisition process includes all the steps involved in merging companies or acquiring the assets of companies, from start to finish.  M&A gives buyers the option to expand and to achieve strategic goals sooner versus an alternative to organic growth which often takes time. M&A gives sellers an opportunity to cash out or to share in the risk and reward of a newly formed entity.

Difference Between Mergers and Acquisitions

A merger occurs when two separate entities combine forces to create a new, joint organization. A merger is an agreement between two companies to consolidate functions and assets, then continue as one combined company. A merger is a combination of two or more companies where only one firm survives as the legal entity. The acquiring firm usually maintains its name and identity. Mergers are legally straightforward because there is usually a single bidder and payment is made primarily with stock. The shareholders of each firm involved with the merger are required to vote to approve the merger.

In contrast to a merger, an acquisition occurs when one company purchases another company and its assets. In an acquisition one company absorbs another, but no new organization is created. An acquisition of all of a firm’s assets requires a vote of that firm’s shareholders. It also entails the costly transfer of legal title, but it avoids the minority interest that may arise if the acquisition is by purchase of stock. An acquisition by stock purchase is advantageous because it can be affected when management and the board of directors are hostile to the combination, and it does not require a formal vote of the firm’s shareholders.

M&A Deal Teams

Deal Team Size

M&A deal teams are composed of both internal company employees and external professionals and consultants. M&A deal teams can have as few as 5-7 members but can sometimes be as large as 30-50 people.  In smaller groups, the team member enjoy greater face-to-face contact and there is a high degree of interaction and communication. However, with larger groups, the amount of interacting decreases, as it becomes more challenging to schedule meetings and getting team members to agree on different issues. Very smaller deal teams usually are a recipe for disaster because there are not enough subject matter experts or individuals who have the bandwidth to get all of the work done. The fact is for larger companies with more complicated M&A transactions larger deal teams are needed. A good method of reducing the large group inefficiencies is to establish smaller working groups or committees focused on different aspects of the M&A transactions such as a tax, general accounting, operations, IT, human resources, integration or legal committees.  A downside of having larger teams is that there are more chances for confidential information to get disclosed as there are more people involved with the process. A good balance for M&A deal team size is from 10-20 individuals consisting of both internal employees and external specialists.

Team Members

A typical M&A deal involves a standard group of employees and external consultant with critical roles and responsibilities including the following:

External M&A Advisors

Legal Team

It is critically important for a successful M&A process that both the buyer and the seller hire outside law firms who specializes in M&A transactions. Some corporate attorneys and law firms state that they able to handle any type of M&A transactions, but this is far from true. M&A transactions involve complex, multifaceted agreements and deal structures, as well as challenging legal issues. To be effective, an M&A lawyer must be intimately familiar with both the business realities of M&A deals and the overall structure and inner workings of the acquisition agreement. Some M&A lawyers are specialized by industry so often it is best to find one with experience in your company’s particular sector.

Buyers and sellers should interview a few different law firms and their lead M&A partners to gain a better understanding who is the best fit for their M&A transaction. A key part of this process is also getting a detailed proposal from each law firm indicating the services that will offer and at what pricing points. Many large companies utilize top 10 M&A laws firm including:

Legal costs can be one of the biggest transaction advisory costs in an M&A transaction. Top M&A lawyers can charge from $2,000 to $3,000 per an hour. Note, note all companies need to utilize a top 10 M&A law firms. There are many regional law firms that are less expensive and have M&A practices that are equipped to handle complicated transactions.

Once a company has selected the law firm then the law firm should send and sign an engagement letter that clearly spells out all aspects of their legal advisory work. The outside legal team should include not only seasoned M&A attorneys, but also legal experts in appropriate specialty areas (such as tax, , intellectual property,  compensation and benefits, employee matters, cybersecurity, data privacy, antitrust, international trade, and real estate).

Investment Banking Team

Although every M&A transaction is different, generally an M&A investment banker experienced in M&A can bring significant value to the transaction on the seller’s behalf. Investment bankers can offer the following assistance: (4)

A key part of the investment banking firm selections process is also getting a detailed proposal from the investment banking firm indicating the services that will offer and at what pricing points. Similar to legal costs, investment banking fees can be the one biggest transaction advisory costs in a corporate M&A transaction with hourly rates over $1,000 per an hour for senior bankers. Many M&A investment bankers specialize in particular industries so often it is best to find one with experience in your company’s sector. Many companies hire top M&A Investment banking firms such as:

These top corporate M&A investment banking firms can be quite expensive. There are a host of regional investment banking firms that are equipped to do corporate M&A transactions, so you do not necessarily have to utilize one of those listed below. Once the investment banking firm is selected then it should send and signed engagement letter the clearly spells out all aspect of the transaction advisory work.

 Accounting Firms

Accountants plays a lead and pivotal role in any corporate M&A transaction and process. Accountant advisors help in drafting and structuring purchase-price adjustment mechanisms, due diligence and accounting for transactions. Accounts review considerations such as buyer/seller perspectives and preferences, letters of intent, major components of definitive purchase agreements. Accounting specialist review high-level tax considerations of buyers/sellers. Accountants review the classification of assets and liabilities as current and non-current which are particularly important as components of net working capital. Accountants play a critical role in preparing the Confidential Information Memorandum (CIM), organizing the data room, reviewing the sales agreement, and host of other due diligence services.

Most companies have internal accounting teams that have limited bandwidth to handle additional work outside of their normal scope of work. Corporate M&A transactions require hundreds of additional hours of accounting work to be completed and thus require firms to hire external accountants. Many companies hire specialized M&A accounting teams from the Big 4 accounting firms Deloitte, E&Y, KPMG or Price Waterhouse. These Big 4 accounting firms each have legions of accountants that specialize in every conceivable aspect of corporate M&A transactions from tax to securities filings. This expertise will cost you quite a bit in billable hours which adds up very quickly similar to M&A lawyer and investment banker fees. There are several sub-Big 4 and regional accounting firms that do have M&A capabilities at a lower pricing point including:

Once again shop around and ask every accounting firm for a detailed proposal on what services they will offer you and at what price. Also, make sure that you do not use the same accounting firm that does your regular audits or tax work for any M&A advisory work as it is a conflict of interest. Hiring them will invalidate your previous audits work and getting re-audited will be very expensive proposition.

M&A Laws

At the federal level, M&A activity is subject to several laws and regulations but the following 5 are the most well-known:

Federal Agencies Regulating M&A

In the United States 3 Federal Agencies are the primary regulators of corporate merger and acquisitions and related activities:

Benefits of M&A

Companies choose to pursue a merger or acquisition for a variety of reasons. There are several benefits of corporate M&A including the following:

Types of Corporate M&A

Traditionally there are 6 difference types of corporate M&A transactions as shown in the diagram below: (1)

Buy Side Stages of the M&A Process

The corporate M&A process from the buyer’s perspective is called the Buy Side and can be broken down into several steps. Note, some people like to break out the buy side M&A process to 8-12 steps, but I prefer showing 15 steps to show the entire process more clearly.

These steps need to be followed carefully to ensure that the overall M&A process is successful.  (2)

Sell Side Stages of the M&A Process

The corporate M&A process from the seller’s perspective called the Sell Side can be broken down into several steps.

These steps need to be followed carefully to ensure that the overall M&A process is successful for the seller. (3)

Online Data Room

Sellers should set up an online data room very early in the course of the M&A process to make the due diligence process easier for the buyer. The online data room is populated with the selling company’s important documents, including corporate documents, financial statements and financial information, contracts, intellectual property information, employee information, a capitalization table, and much more. The data room allows the seller to provide information to the buyer in a controlled manner that helps preserve confidentiality. Most online data rooms have functionality that allow the seller, sellers lawyer or investment banker to track who on the buyer’s team is reviewing which documents, when they use the document and to restrict access as needed. The selling company should not grant access to the online data room until the site has been fully set-up and populated.

There are a variety of issues and problems that arise with the information contained in online data rooms that can slows the due diligence process including:  (4)

Disclosure Schedules

Disclosure schedules are a very important part of any M&A transaction. The disclosure schedules contain information required by the acquisition agreement. An incorrect or incomplete disclosure schedule could result in a violation of the acquisition agreement and potentially entitle the buyer to walk away from the M&A transaction before closing. Usually, the drafting of the disclosure schedules is completed by senior management of the selling company, working with its external investment bankers, lawyers and accountants. The disclosure schedules often require several drafts and take a significant amount of time to finalize.

Selling companies often make mistakes in preparing the disclosure schedules including some of the following: (4)

Review the Seller’s Financial Statements and Projections

One of the most important diligence activities that a buyer will undertake is a review of the selling company’s financial statements and projections. The buyer needs to understand if the financial statements were correctly prepared in accordance with Generally Accepted Accounting Principles (GAAP). The financial statements need to accurately represent the sellers results of operations, financial condition, and cash flows. The buyer is also concerned with the seller’s projections of its future performance.

Senior executives at the seller (target) need to expect that the M&A team at the buyer will ask extensive questions on the following:

Protections for Hostile Corporate M&A Transactions

A merger involves the mutual decision of two companies to combine and become one entity and it can be seen as a decision made by two "equals." A takeover, or acquisition, is usually the purchase of a smaller company by a larger one. It can produce the same benefits as a merger, but it doesn't have to be a mutual decision. An acquisition or takeover is not always friendly with the buyer sometimes wanting to acquire a firm whose senior management, owners and investors does not want to be taken over or merged with the larger acquiring company.

In the United States , most corporate mergers or takeovers are friendly in nature, meaning that the majority of key stakeholders support the acquisition. However, corporate mergers and takeovers can sometimes become hostile. A hostile takeover or acquisitions  occurs when one business acquires control over another company against the consent of existing management or its Board of Directors. Typically, the acquiring company purchases a controlling percentage of the voting shares of the target company and usually along with the controlling shares the power to direct new corporate policy because they control seats on the Board of Directors.

There are a few defenses that companies can use to prevent hostile takeovers including the following:

This above list is non-exhaustive. The variety of defenses shows that companies do have possibilities to stop hostile takeovers and acquisitions. Some of these defenses are more effective than others and it depends on how they are executed by the Board of Directors and senior management teams.  

Conclusion

Corporate mergers & acquisitions (M&A) is a complicated subject matter.  The Board of Director, CEO, CFO and Internal M&A Deal team must work with external legal, investment banking  and accounting teams to complete M&A transactions. There are several federal laws that effect M&A Transaction which are enforced by the FTC, DOJ Antitrust unit and the SEC. There are several benefits of corporate M&A including economics of scale, value generation and increased market share.  There are 6 different types of mergers with the most common being horizonal or vertical mergers. There are several steps or stages in the Buy Side and Sell Side M&A processes which firms must follow to ensure successful M&A transactions.

Properly set-up online data rooms can greatly facilitate corporate M&A due diligence processes by reducing the time it takes. Seller’s disclosure statements need to be accurate and complete as any issues will delay a closing. The seller need to ensure that all of its financial statement information is correct and understand that the buyer will have detailed question which will takes time and resources to answer. There are a variety of defenses that target companies can utilize to stop hostile takeovers and acquisitions; with some being more effective than others.  Having a thorough understanding of all of the above concepts is critical to the success of any M&A transaction. Please feel free to contact me if you have any questions on any of the information discussed.      

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References