1. What are the types of transactions involved in M&A?
Mergers & Acquisitions involve the buying and selling of a business entity in exchange for value. In M&A activity, the type of transaction is determined by the desired outcome. If the acquired company survives and continues to operate, this transaction is known as an Acquisition. If the acquired company does not survive and instead merges with the surviving company, this transaction is known as a Merger.
Acquisitions may involve a change in control of the target company. This occurs when the acquiring company obtains over 50% of the ownership of the acquired company. When two or more companies combine to form one company, the surviving company acquires all the assets and liabilities of the merged company by operation of law (statutory merger).
Certain transactions involve the formation of a shell company to complete a merger. In a triangle merger, the acquiring company forms a wholly-owned subsidiary to purchase the target company. The subsidiary and target merge, leaving the subsidiary as the surviving company. If the target survives the merger, this is known as a reverse triangle merger. These types are transactions are used to reduce the burden of the shareholder approval requirements of an acquisition.
M&A transactions are paid for with cash, stock, or both, in exchange for assets, stock, or a combination of the two. This transaction can be conducted as cash-for-stock, cash-for-assets, stock-for-assets, or stock-for-stock transactions. In terms of payment, the transaction type is chosen based on the desired benefits of the deal. For example, a stock-for-stock exchange is not taxable, therefore any portion of the transaction involving Stock for Stock will not be taxable.
2. What are the different types of transactional structures in M&A?
The three types of M&A transaction structures are asset sales, stock sales, and mergers. In an asset sale, a company is bought through the purchase of its assets, such as inventory and property. A stock sale involves the purchase of company stock to acquire majority ownership in the company. In a merger, two companies come together to form one.
3. What drives the need for M&A?
The M&A space is a key platform for a company or individual to implement their growth or exit strategy. From an industry standpoint, mergers and acquisitions provide a company with increased market share in its pre-existing markets, as well as instant access to new markets and products. It is also a way to decrease competition and a means to enter a new industry by avoiding the complex process of building a new company.
Individuals considering an M&A transaction are looking to sell their company and move on. It can be a way for them to retire with financial comfort or exit the business and start something new with the proceeds.
4. When should you consider engaging in M&A?
In general, M&A transactions are used as a tool for both expansion and risk mitigation. Expansion through acquisition is when a company acquires another company that has already been established. Mitigation through acquisition is when an already established company is sold for the relief of its liabilities.
Traditional means of growth involve starting a new business, entering a new market, or introducing a new product. These traditional means have high costs and risk of failure, with the potential to decrease profits or increase losses. To avoid these risks and increases the potential for growth, a company should consider expansion by acquisition.
Conversely, an established company is in danger of failing when its liabilities cannot be sustained by its profits. Continuous loss of profits and increased liabilities may lead to bankruptcy when profits can no longer cover losses. Mitigation by acquisition could allow the company to pay off its debts and provide renewal with the financial backing of the new owner. In short, an established company may consider engaging in the M&A process to mitigate its damages.
5. Who are the major players in M&A?
The three major parties involved in an M&A transaction are the 1) buyers and sellers, 2) advisors, and 3) attorneys.
The buyers and sellers consist of private equity firms and venture capitalists who buy and sell companies as investment tools for financial gain.
Advisors provide advice throughout the M&A process. They are typically investment bankers, M&A consultants, and business brokers. Although they provide advisory services, their capabilities differ depending on the size of the deal, education requirements, and experience of the advisor.
Business attorneys are the legal counsel that oversee the documentation and legal issues that may arise throughout the transaction. They conduct legal audits of the target company, review their liabilities, and examine past and present legal actions against them.
It should be noted that M&A insurance brokers play a major role in facilitating middle market deals (involving transactions around $50 Million) and big business deals (involving transactions up to $3 Billion). Representation and Warranties Insurance (WRI) protects against potential risk associated with the transaction. M&A insurances brokers are becoming more commonly utilized due to the increased use of WRI in M&A transaction.
6. What are the key phases of the M&A process?
The M&A process is long and requires much planning and preparation to achieve a successful transaction. The process is broken down into smaller phases designed to keep the deal on track.
There are seven phases typically considered to be part of the M&A process, consisting of the Preparation Phase, Marketing Phase, Due Diligence Phase, Negotiation Phase, Closing Phase, Transition Phase, and Integration Phase. Each phase is of equal importance and requires careful attention. It is important to have advisors who have a complete knowledge of the M&A process and who can assist at any phase of the M&A process.
7. What is Due Diligence?
Due diligence is the process of fact checking and document collection to verify the target company’s financial situation, structure, and legal representation. The acquirer seeks to ensure that they are what they say they are and have what they say they have.
Part of the due diligence process is an audit of the legal health of the target company. The legal due diligence process is designed to uncover any risks related to the target company’s corporate structure, security, contracts, assets, and intellectual property, as well as any pending lawsuits.
8. What are the common risks associated with M&A?
Some common mistakes which may jeopardize an M&A deal or increase costs typically stem from poor planning and incomplete due diligence. A successful M&A transaction requires focus and clear planning from the inception of the deal. Poor planning can lead to missed deadlines and improper valuations of target companies. Due diligence is required to understand the financial and legal standing of the target company. A misstep here may lead to costly legal liabilities. Any past, present, and/or potential future litigation that the target company knows or should have known about must be presented to the buyer or they may be liable for fraud.
Note: The buyer also conducts their own due diligence to verify the seller’s claims or uncover information the seller missed or did not know about. It is imperative for buyers to conduct their own legal due diligence to preserve any potential future claims against the seller for breach or fraud.
9. What are the Regulatory considerations associated with M&A?
In the U.S., there are many federal regulations which you may need to consider depending on the size and nature of the deal. For example, large scale transactions may require antitrust approval from the Department of Justice (DOJ), healthcare M&A transactions must be approved by the Center for Medicare & Medicaid Systems (CMS) when there is a change of owner, and financial institution M&A transactions require the approval of the Federal Deposit Insurance Corporation (FDIC) when there is a merger of depository institutions. With so many industry-specific regulations which may require state and/or federal licensing or transaction approval, legal advice should be obtained at the onset of M&A activity.
10. What are the tax considerations associated with M&A?
It is important to consider any carryover tax interest to preserve tax benefits and limit tax liabilities associated with the deal. Tax interest such as Net Operating Losses (NOLs) carry over to the acquirer, who then may utilize them as deductions to their taxable income. Therefore, NOLs increase the value of the deal to both parties.
The deal structure is also important to the carryover of tax benefits in M&A transactions. Depending on the type of traction, NOLs are either immediately carried over or deducted over time. In an asset sale transaction, NOLs may be immediately applied to the step-up in bases received by the acquirer to further reduce overall gains associated with the transaction. In a stock sale transaction, NOLs maintain their deferred status and allow the acquirer to deduct the target’s past losses on its income taxes for future years.
Asset sales allow a step-up in bases and immediate use of NOLs. However, there are no future tax deductions. Stock sales allow the acquirer to monetize NOLs to be utilized over time, but they do not receive a step-up in bases. M&A transactions should focus on limiting tax consequences and increasing tax benefits. The best M&A strategies take into consideration how tax-related consequences are determined by the deal structure.
11. Horizontal Acquisitions Vs. Vertical Acquisitions
A horizontal acquisition is an acquisition of a company within the same industry. A horizontal merger provides companies with reduced production costs, reduced competition, and an increased market power or market share.
A vertical acquisition involves the purchase of a company in a supportive position of the acquiring company, such as a supplier or delivery truck company. Vertical transactions allow the acquiring company to gain a competitive edge and market advantage by investing in assets that increase profits and lower expenses.
12. What are the financial benefits of M&A (why would a company consider an M&A)
The main purpose of M&A activity is to increase profits and financial gain. The acquiring company receives increased profits at a minimal price. The acquiring company may also gain access to working capital from the cash on-hand of the acquired company. This working capital can be used to run the acquired business and/or provide financing for future investments or expansion. Other financial benefits may include tax carryover, which decreases their taxable income, and lowered cost on production of goods and services.