This article is written by Eshvar Girish, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com.

Introduction

There can be many activities that influence an entity before it agrees to be merged or acquired. While some activities might enable an entity to expand and acquire other entities, other activities might place a company in a position wherein it has no choice other than being acquired. Internal restructuring might require the subsidiary companies to merge with the holding company whereas external restructuring takes place with companies other than the group companies. With this background, this article lays down the steps in the process of mergers and acquisitions which play a crucial role to seal the transaction between the interested entities.

Classification of mergers and acquisitions

Mergers and acquisitions can be classified into two categories:

1. Internal transactions: When a subsidiary of a holding company is facing administrative issues, or if a holding company is finding it difficult to manage multiple subsidiaries, then the said companies will be merged into the holding entity in order to make the administration simpler and easier in nature. Thus, this can be referred to as group restructuring since the restructuring takes place within the group of companies. Further, if a company wants to segregate its businesses into separate entities such as beverages, automobiles, grocery business etc., then it can demerge those businesses into a separate subsidiary. This can be observed in the case of Tata Sons (holding company), which has subsidiaries such as Tata Motors, Tata Steel, Tata Beverages, etc. However, such transactions have the same procedural requirements as external transactions. The major difference between internal restructuring and external restructuring is that the due diligence process would be a lot simpler in case of an internal transaction as opposed to that of an external transaction since the entities would be familiar with each other in case of an internal transaction.
2. External transactions: When it comes to listed companies, mergers and acquisitions include public shareholding and hence can be extensive since the shareholders must be given an option of exit. Further, external transactions take place outside the group companies, i.e. a holding company or a subsidiary can acquire or merge with an external entity that is not a part of the group companies.

Prior steps to an M&A transaction

Identification of the company’s needs

All activities of a business are inclined towards increasing the profits and efficiency of companies. The businesses can reach a certain stage wherein, it needs to consider whether it can increase its profits through its own resources or if it needs to acquire the resources of another entity or acquire the whole of another entity in order to expand and scale its profits. The company must decide according to its needs.

Potential target

If the acquiring entity decides that it would be an efficient solution to purchase another entity, it becomes necessary for it to search for potential targets in the market. Further, if the existence of a particular target seems like an attractive buy for the acquirer, this can motivate the company to proceed with the acquisition in order to expand. For instance, if the management of the acquirer feels that the acquisition of the target company might bring the required growth for its business, then the decision to acquire is finalized. 

While searching for a potential target, the management should bear certain points in mind. Firstly, the management of the company needs to assess which are the key growth areas of the acquirer. The growth areas can range from an additional product line, increasing logistical support, expansion of production capacity, and the like. The management must make an informed decision after evaluating the same and the specific area in which the potential target can foster its growth. Secondly, after the specific area of growth is realized, the management should frame a list of targets based on the requirements for that specific area. This is a rational method to arrive at a list of potential targets. Thirdly, the list of targets can be arranged according to how much value they can add to the acquirer based on how they can contribute to the growth of the company. Lastly, the ease of the transaction must also be taken into consideration and the acquirer must finalize the target accordingly. After all these steps are followed, the next most important thing is the preliminary due diligence of the target company.

Preliminary due diligence

After the acquirer finalizes the target company, it can approach the management of the target with an expression of interest. If the management of the target agrees, then the transaction is materialized. However, if the target’s management refuses the offer, the acquirer can move on to the next target in its priority list. Soon after, preliminary due diligence is conducted by the acquirer to ensure that the target meets the requirements, does not have any loopholes and is not hiding any material facts of economic importance that might jeopardize the value of the company like the possibility of bankruptcy, pending litigation, etc. The preliminary due diligence can be conducted as soon as the target accepts the expression of interest of the acquirer and before the letter of intent is signed. Also, preliminary due diligence is conducted to develop a rapport with the target, to identify red flags that indicate the infeasibility of the acquisition, to decide the price the buyer wants to offer the seller in the letter of intent, to check the reasons behind the sale of the target, to confirm whether the buyer actually wants to acquire the target, etc.

Steps which form a part of the transaction

After the preliminary due diligence, the legality of the transaction process begins. It consists of three stages:

Letter of intent

The purpose of the letter of intent is to ensure that both the parties agree to the price and the other terms before the acquisition is finalized. This plays a significant role before the target company agrees to grant exclusive rights of acquisition to the acquirer.

The key terms of the letter of intent include price or consideration, purchase price adjustments, transaction structure, timeline for due diligence, indemnification obligations of the target and the acquirer etc. The acquirer’s legal advisors draft the letter of intent and submit it to the target company.

Extensive due diligence

After the letter of intent is submitted to the target company, an extensive due diligence is conducted which involves a full assessment of risks related to corporate status, assets, contracts, securities, and employment of personnel of the target company. Further, a legal analysis is carried out on the inventory of the existing employment conditions and how the same would impact the post-deal harmonization of employment conditions. Moreover, a legal analysis is conducted on the target’s financials, the veracity of the financials presented, and revenue generation capacity of the target. After the due diligence is conducted, the parties finalize the deal through a share purchase agreement.

Share purchase agreement

Most of the processes discussed earlier are non-binding in nature which is why the parties enter into a share purchase agreement (SPA) through which they are legally bound to the terms and conditions. The SPA clearly defines what is being sold, i.e., whether it’s the company’s stocks or the company’s assets. The agreement will also lay down the purchase price, structure of the price, and the amount that goes into escrow.

Where a share acquisition is involved and the target is a listed company, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 need to be adhered to. However, if the target is an unlisted company, and if it survives even after the acquisition process is completed, then the mere signing of the SPA is sufficient. The target companies usually retain their existence in case of external transactions but they cease to exist in case of internal transactions. In cases where the entities cease to exist, a scheme of arrangement needs to be completed and the transaction would need to be approved by the National Company Law Tribunal.

Closing 

All the final actions contemplated in the share purchase agreement are carried out during the closing. During closing, it is important to not only finalize the share purchase agreement but also compile all the signing papers and the exhibits. Further, the parties should ensure that all requisite approvals have been obtained such as consideration for the purchase, legal opinion of the counsels, consideration for the purchase, etc.

Steps post the closing of the M&A transaction

• The integration of the operations and employees of both entities must be planned for the objective to be achieved. It could be immediate or in a phased manner. It must be ensured that there is a smooth transition for the employees of the target company.
• The performance goals of the resultant entity must be framed according to the objective of the transaction and must be carried out accordingly.
• Cultural integration is essential for integration to be successful and must be adequately addressed at all levels in the company.

Conclusion

After the closing of the transaction, it must be ensured that the integration of the two companies is smooth. In order for a transaction to be successful, smooth integration of the companies is necessary for the acquisition to translate into the growth of the companies involved.

References

1. https://corporatefinanceinstitute.com/resources/knowledge/deals/mergers-acquisitions-ma-process/
2. https://www.upcounsel.com/acquisition-process-how-to-acquire-other-companies
3. https://www.wallstreetmojo.com/ma-process/
4. https://blog.mgallp.com/your-merger-and-acquisition-guide-the-steps-in-an-ma-transaction

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