This article is written by Shubham Kumar Singh, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
An acquisition is one of the various forms of business combination where one company (acquirer) purchases substantial shares or assets of another company (acquiree). The objective of an acquisition is to gain control in the target company and tapping the synergies to build upon the strength of the target company. Acquisition needs to be distinguished from other business combinations like mergers where only one company survives and amalgamation where neither company survives. An acquisition has not been specifically defined under the Companies Act, 2013 but the process is covered under Section 230 to 240 which provides for the various merger, acquisition transactions, and other arrangements involving companies. The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 defines acquisition under regulation 2 (1) (b) as directly or indirectly acquiring or agreeing to acquire, share or voting rights, or control over a target company.
Acquisition, merger, and amalgamation
There are various kinds of business combinations and the terms like merger, acquisition, and amalgamation are often used interchangeably in common parlance but in legal terms, there is a big difference in all these three types of business transactions.
1) Acquisition vs. merger
A merger is a corporate transaction where one company merges into another company and the merged company loses its legal entity and in the eyes of law, there is only one company now. Whereas in an acquisition transaction both the companies retain their legal entity and the acquirer gets control over the acquired company.
2) Acquisition vs. amalgamation
Amalgamation is a corporate transaction where both companies merge to form an entirely new entity. The legal status of both the entities ceases to exist and a new legal entity in the form of a new company is created.
The process of an acquisition transaction
i) Acquisition auction
- Potential bidder signs confidentiality agreement to receive information memorandum from the target company.
- Interested bidder gives access to the data room and any vendor due to diligence report (VDDR).
- The interested bidder submits a bid as part of a process run by an investment bank.
- The seller enters into exclusivity with the preferred bidder and completes the final negotiation of the terms of the Shareholders Agreement (SHA).
The signing of Shareholders Agreement (SHA), disclosure letter, and tax deed. These documents form the heart and soul of the whole acquisition process as they lay down all the terms and conditions that the parties need to fulfill under the said transaction.
- Conditions precedent: Some requirements need to be completed before the completion of the transaction and those requirements are called conditions precedent. In an acquisition transaction, the following are considered to be some basic conditions precedent but in practice, the requirements are largely industry-specific.
- Approval from Competition authorities: Any acquisition that would affect market competition as per the Competition laws of the country. In India, approval from the Competition Commission of India has to be sought.
- Assessment of business or Market MAC (Material Adverse Change): From the date of signing of the SHA to the completion date there could be some substantial change in the market and therefore before the final execution of the acquisition transaction it is important to assess the market for any MAC.
- Approval from other regulatory authorities: The other regulatory authorities could be the Securities Exchange Board of India or Income Tax authorities etc. from whom approval could be required to be attained before the final execution of the acquisition transaction.
- Payment of consideration and point where the buyer acquires target company: This is the final stage where the execution of the acquisition transaction takes place after getting all the approvals and final check on MAC.
- Statutory compliances: After the completion of the transaction, smooth integration of the target company with the acquirer company is essential to achieve the final goals of the acquisition. The statutory compliances would include paying the stamp duty of the transferring documents, paying outstanding tax liabilities, following up with the ongoing litigation, getting licenses and intellectual property rights transferred to the acquiring entity.
- Administrative Task: For a smooth integration, the most important aspect is the integration of the administrative system of the companies and to integrate the human resources of the company.
- Synergies: Finally, the parties should attain the final goal of the acquisition transaction that is synergizing their strengths and reducing their weaknesses. The acquiring company will build upon the strengths of the acquired company and tap their synergies to increase profits for the shareholders.
Due diligence consideration
Due-Diligence is one of the most important parts of an acquisition transaction and therefore needs separate elaboration. It is a process in which the acquirer conducts a thorough examination of the target company to determine its strengths and weaknesses. Due Diligence exercise is essentially conducted to uncover any issues related to the assets, liabilities, and operations of the counterparty and to mitigate the possible risks which may arise in the future. The concerns which are raised in the course of due diligence are offset by representations and warranties. Thus, due diligence is imperative like transactions involving high stakes.
- Accounts– Companies should do thorough due diligence while examining the accounts of another as the accounts of the company shall present the financial standing of the company.
- Valuation– Companies should appoint an independent valuation expert to value the other company in terms of its market standing and financial standing.
- Human Capital– Acquirer should also look into the human capital of the other company and examine the skills and value of its employees. It will help the acquirer to decide whether or not to acquire the management of the target company.
- Liabilities– Companies should do a thorough examination of all the liabilities of the other company that includes taxation, rent, etc. It will help both parties to strengthen their stand in negotiating the acquisition agreement.
- Market Reputation– Acquirer should conduct due diligence to understand and value the market reputation that the target company enjoys and then make a final decision whether to acquire it or not.
- Assets – Acquirer should also look into the assets of the target company and see whether just by acquiring the assets that include the intellectual property of the target company would suffice the objectives of the acquisition and if yes, then the acquirer can go for an asset sale rather than acquiring the whole company.
Dispute resolution clause
One of the most heavily negotiated clauses in an acquisition agreement is the dispute resolution clause. In a dispute resolution clause, parties decide the mechanism and forum to resolve their future disputes. There are popularly either of the two mechanisms adopted, that is Litigation or Arbitration. Parties can also go for a combination of both. In order to decide which mechanism is more suited to their interest, it is important to understand the pros and cons of both litigation and arbitration.
Benefits of litigation
- The value of precedent – before even entering litigation, a party can gain a sense of the determination of its case based on precedent cases that present similar facts – this provides a sense of predictability and certainty.
- There is a clear chain of appeal methods applicable to the dispute.
Drawbacks of litigation
- Cases can take a long time to be resolved in court.
- Public – the dispute can enter the public domain and cause personal and commercial reputational damage.
- Where the issue relates to complex or technical material, a judge may not be best equipped to handle the nuances of the dispute.
Benefits of arbitration
- Arbitration helps to reduce hostility between parties by encouraging amicable participation to collaboratively devise a resolution to the issue.
- Efficient – In an Arbitration, issues are usually resolved expediently, without the need of waiting for availability in court and a judge.
- Flexible – Arbitration provides for the greater scope to resolve the dispute parties in terms of the place of the arbitration and choice of disputes they want to bring before the tribunal.
- Private – Where matters are of a sensitive nature to the company’s reputation, arbitration occurs behind closed doors and the content of the arbitration is not available to the general public.
Drawbacks of arbitration
- i) There is limited recourse to appeal the decision of an arbitral tribunal.
- ii) There is a large amount of discretion in appointing arbitrators, which gives greater scope to subjectivity in the resolution process.
- Synopsis of the deal life cycle
Synopsis of the deal: life cycle
Prior to signing and announcement
- Headline Price
- Price for companies equity
- Process time and agreement
- Acquisition Contract (Entity Purchase Agreement or Asset Purchase Agreement)
Post signing and announcement
- Shareholders Approval
- Approval from competition authorities (Competition Competition of India).
- Approval from other regulatory authorities (Like Security Exchange Board of India etc.).
An additional item for merger
- Relative value and relative ownership
- Board composition management.
- The capital structure of the combined group
An acquisition is a corporate transaction to achieve substantial growth in a short period of time which contrasts with the organic growth of the company might take years. It could be an intelligent business decision if backed by thorough research and an effective implementation strategy. An acquisition transaction could backfire even after thorough research and market study if due importance is not given to the post-acquisition action that includes two-prong integration processes, one is statutory and the other is administrative. The corporate cultural differences might lead to a forced departure of the talent pool in the acquired company which could be fatal for the whole acquisition process. A well-planned and effectively executed acquisition could help a company to tap the synergies and achieve the desired growth.
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