This article is written by Miheer Jain pursuing Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.
Many factors come into play when an entity agrees to be merged or acquired. While certain activities may allow a company to succeed and acquire other entities, others may force a company to be acquired by another entity. Internal restructuring can necessitate the merger of subsidiary companies with the holding company, while external restructuring occurs with companies outside of the group. With this context in mind, this article outlines the steps in the mergers and acquisitions process that are critical to completing the deal between the parties involved. The mergers and acquisitions (M&A) process involves multiple phases and can take anything from six months to several years for completion. Google’s acquisition of Motorola in 2011 was an example of how companies delve into different markets by acquiring smaller companies that exist in such markets. This article provides a brief on the acquisition process from beginning to end, explains the different forms of acquisitions, explores the value of synergies, and defines transaction costs in this guide to the process of M&A transaction.
Reasons for mergers
- Financial synergy for lower capital costs: Value from synergy is often generated when two companies combine or merge.
- Revenues (higher revenues), costs (lower expenses), or the cost of capital may all be used to determine the synergy effect (lowering of the overall cost of capital).
- Improving business performance and accelerating growth: The inflow of assets, personnel, and funds from the company purchased or merged with increases growth and performance opportunities.
- Creating economies of scale: Increased fund flow opens up further doors for more restructuring and growth, reducing potential fund flow constraints.
- Diversification for high-growth goods or markets: Diversification reduces overall risk. It is the equivalent of not putting all the eggs in one basket.
- Increased market share and positioning allow for greater market access: Increased market share aids in the creation of loyal customers and the retention of repeat business.
- Creating a technical shift and a strategic realignment: The consolidated or purchased corporation would provide technology that would improve the organization’s ease of doing business. This is something that the purchasing or merged company would greatly benefit from.
- For tax purposes, the opportunity to benefit from the losses of the company being purchased or incorporated may be enticing for any corporation, as it would reduce the entity’s losses.
- Getting a better price by buying a target that is undervalued: Since it is coming cheap, purchasing or combining a company may be a great deal.
Classification of mergers and acquisitions
The following are the two types of mergers and acquisitions:
If a holding company’s subsidiary is having administrative problems, or if a holding company is having trouble managing several subsidiaries, the entities would be merged into the holding company to make administration simpler and easier. Since the restructuring occurs within the community of firms, it is referred to as group restructuring. Furthermore, if a corporation wishes to divide its companies into distinct bodies, such as alcohol, cars, and grocery stores, it may demerge those businesses into a separate subsidiary.
This can be seen in the case of Tata Sons, which has subsidiaries such as Tata Motors, Tata Steel, and Tata Beverages, among others. However, these transactions must follow the same procedures as external transactions. The main difference between internal restructuring and external restructuring is that in the case of an internal transaction, the due diligence process will be much easier than in the case of an external transaction since the companies would be familiar with each other.
When it comes to publicly traded firms, mergers and acquisitions require public shareholding and can be very large because shareholders must be given an exit opportunity. Furthermore, external transactions occur outside of the group companies, i.e., a holding company or a subsidiary may buy or combine with a non-group company.
Steps prior to an M&A transaction
Identification of the company’s needs
Every aspect of a company’s operations is geared toward rising profits and productivity. Businesses may reach a point where they must decide if they can increase their profits by their own resources or whether they need to buy the resources or the entire business of another organisation in order to grow and scale their profits. The organisation must make a decision based on its requirements.
If the acquiring entity determines that purchasing another entity will be a cost-effective option, it must check the market for possible goals. Furthermore, if the presence of a specific goal appears to be an appealing buy for the acquirer, the business might be motivated to continue with the purchase in order to expand. For example, if the acquirer’s management believes that acquiring the target company would provide the necessary growth for its business, the decision to acquire is made.
Certain considerations should be made by management when looking for a future goal. To begin, the company’s management must determine which of the acquirer’s main growth areas are. The areas of expansion can include adding a new product line, improving logistical support, increasing production capability, and so on. After assessing the situation and the particular area in which the potential goal will develop, management must make an informed decision.
Second, once the particular area of growth has been identified, management can develop a list of priorities focused on the needs of that area. This is a method for generating a list of possible goals that are based on logic. Finally, the list of goals can be organised based on how much value they can bring to the acquirer and how they can contribute to the company’s growth. Finally, the ease of the deal must be considered, and the acquirer’s goal must be determined accordingly. Following all of these measures, the target company’s preliminary due diligence is the next most important phase.
Preliminary due diligence
After the acquirer has completed its due diligence on the target business, it will approach the target’s management with an expression of interest. If the target’s management approves, the deal will be completed. If the target’s management rejects the bid, the acquirer will move on to the next priority target on its list. Soon after, the acquirer conducts preliminary due diligence to ensure that the goal meets the criteria, has no loopholes, and is not concealing any material details of economic significance that could jeopardise the company’s value, such as the risk of bankruptcy, pending litigation, and so on. Prior to signing the letter of intent, the acquirer will perform preliminary due diligence as soon as the goal recognises the acquirer’s expression of interest. Preliminary due diligence is also performed to establish a rapport with the target, identify red flags that indicate acquisition infeasibility, determine the price the buyer wants to offer the seller in the letter of intent, investigate the reasons for the target’s sale, and confirm whether the buyer actually wants to acquire the target, among other things.
Steps that form a part of the M&A transaction
After the preliminary due diligence, the legality of the transaction process begins. It consists of five stages:
Letter of intent
Before the acquisition is completed, the letter of intent is used to ensure that both parties agree on the price and other terms. This is important to know before the target corporation decides to grant the acquirer exclusive takeover rights.
Price or consideration, purchase price changes, contract structure, due diligence schedule, goal, and acquirer indemnification obligations, and other terms are included in the letter of intent. The letter of intent is written by the acquirer’s legal counsel and sent to the target company.
Extensive due diligence
Following the submission of the letter of intent to the target business, rigorous due diligence is carried out, which includes a full evaluation of threats related to the target company’s corporate status, properties, contracts, shares, and staff jobs. In addition, a legal study of the inventory of current employment conditions is conducted, as well as how the same will affect post-deal harmonisation of employment conditions. A legal review of the target’s financials, the veracity of the financials presented, and the target’s revenue-generating capability is also performed. After conducting due diligence, the parties seal the transaction with a share purchase agreement.
Share purchase agreement
The parties enter into a share purchase agreement (SPA), which legally binds them to the terms and conditions since most of the procedures discussed previously are non-binding. The SPA specifies what is being sold, i.e., whether the company’s stocks or properties are being sold. The agreement would also specify the purchase price, the price structure, and the amount that will be held in escrow.
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 must be followed when a share acquisition is involved and the aim is a publicly-traded business. If the goal is an unlisted business that will continue to exist until the acquisition process is finished, however, simply signing the SPA will suffice. When it comes to external transactions, the target companies normally stay the same, but when it comes to internal transactions, they vanish. A scheme of arrangement must be completed in situations where the companies cease to exist, and the transaction must be authorised by the National Company Law Tribunal.
During the closing, all of the final steps outlined in the share purchase agreement are completed. It is important to not only finalise the share purchase agreement but also to gather all of the signing papers and displays during the closing process. Furthermore, the parties should ensure that all required approvals, such as consideration for the purchase, legal opinion of counsel, consideration for the purchase, and so on, have been obtained.
Steps post the closing of the M&A transaction
- The integration of all organisations’ activities and staff must be prepared in order to achieve the goal. It could happen right away or in stages. It must be ensured that the target company’s workers have a smooth transition.
- The resulting entity’s output expectations must be framed in accordance with the transaction’s goal and carried out accordingly.
- Cultural integration is critical for effective integration and must be discussed at all levels of the organisation.
Case study on Google’s acquisition of Motorola Mobility: Understanding the commercial acumen
Reason for acquisition
In 2011, Google was able to purchase Motorola for $40 per share. Motorola was the only company in the entire smartphone market that refused to join Microsoft’s Windows Phone reboot, and Google rewarded the business by purchasing it for $12.5 billion. The primary goal of the acquisition was to obtain Motorola’s patent portfolio in order to shield it from lawsuits from Apple and Microsoft.
Troubled waters for Motorola (pre-acquisition)
Motorola was struggling to stay up with Samsung and HTC in terms of Android innovation in their industry. Even though the business was celebrating the introduction of the Droid and Droid X, it was losing money after Motorola’s XOOM failed to sell, and difficulties with the launch of 4G smartphones developed.
Benefits for Google
With a total value of $12.5 billion, Google’s acquisition of Motorola Mobility is the highest in the history of the company.
Intellectual property acquisition
Prior to the acquisition, Google held 17,000 patents, with another 7,500 pending. Google’s patent portfolio grew to over 37,000 patents after the acquisition. This broader portfolio aided Google in defending the Android operating system’s sustainability and competing against major rivals such as Apple.
Sale of assets to the Arris Group
On December 19, 2009, Google announced the sale of Motorola’s cable modem and set box company to the Arris Group in a cash and stock transaction worth USD 2.35 billion to Google.
Sale of assets to Lenovo
On January 24, 2014, Google announced the sale of Motorola Mobility to Lenovo in a cash and stock transaction that saw USD 2.91 billion in cash and USD 750 million in stock change hands. Motorola Mobility was purchased by Google only for its patents, not for its manufacturing capabilities. Because Motorola has a large patent portfolio that may be used to defend Android licensees against Apple’s patent threats, customers of Android and Google are concerned.
Sale of Motorola’s factory
This was sold to Flextronics by Google in 2013.
Acquisition of Motorola Mobility’s cash reserves
Google gained USD 3.5 billion as a result of the acquisition, which was taken over by Google.
Google received a tax benefit as a result of the purchase. Since Motorola Mobility made a loss and Google made a profit, the total amount of the loss and profit resulted in a reduction in profit, allowing Google to save $1 billion in taxes and another $ 700 million due to Motorola’s foreign operating loss.
After the deal is completed, the seamless integration of the two firms must be ensured. Smooth integration of the companies is required for a merger to be effective and for the acquisition to result in the growth of the companies involved. Post-merger integration of the companies, their cultures, diversity, and employees is equally important.
Hence it can be said that before taking up a merger or undergoing an acquisition, each company must be well aware of its strengths, weaknesses, and goals so as to ensure a smooth transaction.
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