This article is written by Sahaja, from NALSAR University of Law, Hyderabad. This article talks about the significance of the commercial intent of the parties in an M&A and the importance of negotiation in an M&A transaction.
Mergers and acquisitions
Mergers and acquisitions (M&A) are deals in which two or more companies merge in some way. Despite the fact that the terms mergers and acquisitions (M&A) are sometimes used interchangeably, they have distinct legal meanings. Two companies of similar size merge to establish a new single company in a merger. For example, the very recent merger that happened between Vodafone and Idea gave rise to ‘Vodafone Idea’(Vi).
An acquisition, on the other hand, occurs when a larger corporation buys a smaller company and absorbs the smaller company’s business. For example, Facebook’s acquisition of Whatsapp. M&A deals can be friendly or hostile, depending on the target company’s board of directors’ consent and the intentions of each party entering the M&A. The target company will be valued differently by both parties participating in an M&A transaction. The seller will certainly try to sell the company for the greatest possible price, while the buyer will try to buy it for the lowest possible price.
A horizontal merger occurs when two organisations in comparable industries join, whether they are direct competitors or not. Along the supply chain, a vertical merger occurs between a corporation and its supplier or client. The corporation wants to consolidate its position in the sector by moving up or down its supply chain. Conglomerate mergers are frequently done for the purpose of diversification and involve companies from different industries.
Reasons for mergers and acquisitions to take place
M&A take place for various reasons, some of which are mentioned below:
- Mergers and acquisitions (M&A) are commonly used to produce synergies that make the merged firm worth more than the two enterprises separately. Synergies can occur as a result of cost savings or increased income.
- When opposed to organic growth, inorganic growth through mergers and acquisitions (M&A) is usually a speedier technique for a firm to obtain bigger sales. A corporation can benefit from acquiring or merging with a company that has cutting-edge capabilities rather than risk developing those capabilities internally.
- A horizontal merger will give a new organisation a larger market share and the ability to influence prices. Vertical mergers also provide a corporation with more market power since it has more control over its supply chain and can prevent external supply disruptions.
- Companies in cyclical industries feel compelled to diversify their cash flows in order to avoid severe losses during a downturn. A corporation can diversify and reduce market risk by acquiring a target in a non-cyclical industry.
Documentation of an M&A
A letter of intent is frequently used to begin the documentation of an M&A deal. The letter of intent does not bind the parties to a deal, but it may bind them to secrecy and exclusivity commitments so that the transaction can be reviewed through a due diligence process involving lawyers, accountants, tax consultants, and other specialists from both sides. A letter of intent is a document that contains the commercial intent of the parties involved in the M&A transaction.
Following the completion of due diligence, the parties may proceed to draught a definitive agreement, which may be referred to as a “merger agreement,” “share purchase agreement,” or “asset purchase agreement” depending on the transaction structure. Contracts of this type are typically 80 to 100 pages lengthy and focus on essential provisions. Some of these essential provisions are:
- There are several conditions that must be met before the transaction can be completed. Regulatory authorization and the absence of any major adverse change in the target’s company are common conditions.
- The seller’s representations and warranties about the company, which are claimed to be true at the time of signing and at the time of closing.
- Covenants control the behaviour of the parties both before and after the closing.
- Termination rights, which can be triggered by a breach of contract, failure to meet specific requirements, or the passage of time without the transaction being completed, as well as fees and damages due in the event of a termination for specific occurrences.
Certain aspects of the purchase agreement, including the purchase price, may still be adjusted after the closing. In some cases, the enforceability of these changes may be a problem.
Letter of intent
Before beginning the merger and acquisition process, both parties should agree on the basic conditions of the deal. These parameters (commercial intents of the parties) are outlined in a letter of intent, which the parties can review and negotiate to verify that they are in general agreement on the fundamental provisions of the eventual agreement before investing resources in the transaction. The usual contents of a letter of intent are:
- Fundamental terms of the transaction.
- The commercial intent of both (or more) the parties.
- A statement that the parties are still negotiating the final terms of the deal.
- A provision that provides one party with compensation if an adverse event occurs.
Though a letter of intent is not a legally enforceable commitment in an M&A transaction, it can help shield parties from losses if things go wrong throughout the process. A letter of intent can provide some of the following protections:
- Regarding the proposed merger or acquisition, each party is expected to negotiate and behave in good faith. If it is revealed that one party behaved in bad faith in some way, the other party may be entitled to restitution, contract termination, or both.
- M&A transactions necessitate the disclosure of a considerable quantity of information about the firm being bought, including the expected selling price and other financial facts. Non-disclosure agreements are prevalent in letters of intent, as are provisions for damages if material information is disclosed.
- Breakup costs are fees given to one party if the other party makes a mistake or makes a decision that prohibits the contract from being completed.
Significance of letter of intent
The letter of intent is significant because it lays out the fundamentals of the eventual deal, including the purchase price and terms, closing date, exclusivity period, approvals, and commercial intents of both parties involved in the M&A. But the letter of intent is not always the final agreement. It’s more of a framework or road map for the final agreement. The transaction may vary depending on what each side discovers during due diligence and/or when the company’s profits drop. The letter of intent serves as a foundation for the transaction, but it also commits both parties to go forward with the transaction solely. As a result, the letter of intent gives the seller, the trust that the prospective buyer is serious, and it also gives the buyer, the confidence that the seller is dedicated to complete the sale.
Some important elements of a letter of intent:
- It usually involves a lock-up period during which the seller is out of the market and unable to negotiate with other purchasers. Sellers should exercise extreme caution when granting exclusivity and should do everything necessary to limit the period of time they are unable to speak with other buyers.
- If the buyer discovers that the seller has signed a letter of intent (even if the terms are kept confidential), the notion may arise that the buyer discovered something incorrect and walked away.
By flagging areas that require more discussion, the letter of intent helps minimise misinterpretations, inhibits re-negotiation of crucial points, and aids in the negotiation of definitive agreements. During negotiations, the binding exclusivity assures a potential buyer that the seller will not use the offer as leverage to negotiate or sell the business to another buyer. The letter of intent frequently establishes clear deadlines for exclusivity, due diligence, and the signing of definitive agreements, which serve as a framework for the transaction and allow both parties to plan forward. Third parties, such as lenders and government authorities, can use the letter of intent to document the planned transaction.
A letter of intent must be entered into by both the buyer and the seller or the two parties, with due caution and care, and after thorough negotiations. This is because straying away from a letter of intent once signed or deciding not to continue can have legal and economic repercussions on the party that decides not to continue with the agreement. Observing this from the point of view of the buyer/ the other party, the letter of intent and its terms are equally important because the first party, which decides to quit the agreement, cannot do so without any repercussions or consequences following. Therefore, it is important that the loss suffered by both the parties in case there are differences of opinions in a later stage of documentation must be minimum and to some extent compensated by the other party. Such terms can be agreed upon and mentioned in the letter of intent.
Negotiation is the mutual debate and structuring of the conditions of a transaction in order to reach a settlement or agreement. Negotiation is the most critical step when it comes to mergers and acquisitions. It is the stage where the deal either comes together with the way the negotiators want it to or falls apart because their efforts have exhausted them. Negotiation is a lengthy process that begins with the signing of a letter of intent and typically extends all the way to the final stages of the transaction. Negotiations form the sole basis of a merger or acquisition. It is the most significant and the most important foundation that sets the background for a letter of intent to be formed.
The ultimate goal of negotiating a merger or acquisition is to negotiate a deal in which two companies conclude a transaction that generates shareholder value for both the buyer and the seller. While there are some small disputes in the early phases of the M&A process, the most essential negotiations concern the proposed transaction’s value and terms.
Cooperation, transparency, and flexibility are the business characteristics that allow buyers and sellers to receive what they want, or can fairly expect to get, out of a negotiation. Each party comes to the table with a prioritised list of “musts” and “wants” that characterise their respective negotiating positions. Because instant agreement on all points is uncommon, most corporations or firms engaging in M&A negotiations focus first on areas of common ground and then move on to the issues that will be more difficult to resolve.
This step is very important because both the parties want to get the best for their individual companies or for themselves through such an agreement and this can be achieved only through open and honest discussions. The parties aim at a win-win situation and hope for both the parties to get the best out of the agreement as the parties will be merging or one party will be buying the other’s assets. To maintain the confidence and trust required to close the agreement, it is normally recommended that both sides display personal and business integrity at all times. A substantial degree of collaboration and negotiation between the buyer and seller is required to execute a successful transaction.
One of the most important uses of negotiation concerning an M&A is the terms specified in the letter of intent. It is of utmost importance to discuss and agree upon the same terms before documenting them. Therefore, negotiations play an important role in making sure that the parties agree upon the same thing when they sign a letter of intent. Negotiating the letter of intent reveals that there are numerous issues to resolve beyond the price before granting a buyer access to the business’s inner workings and confidential information.
A well-written letter of intent will speed up the negotiation and documentation process involved in a deal, increasing the likelihood of success. Therefore, negotiating terms and conditions in a letter of intent are important in order to make further negotiations easier and to ensure the process is streamlined, with the parties sailing on the same boat. It is also often advised to negotiate any kind of term or conditions with the help of a neutral third party/ negotiator. This neutral third party would make sure that both the parties would benefit equally from the transaction and that the terms are not biased.
While a letter of intent can be very useful in facilitating a smooth negotiation, a poorly written LOI may not only fail to deliver the promised benefits, but it may also cause hatred or distrust between the parties. The commercial intent of parties and the negotiations in a merger or an acquisition transaction play a very important role. It would not be wrong to call them the heart and soul of an M&A agreement. It is the driving force behind the agreement and also the glue that sticks together both the parties involved, thus facilitating greater benefits and satisfying commercial intents, and fulfilling the dreams of both parties.
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