What is a Merger?

A merger refers to an agreement in which two companies join together to

form one company. In other words, a merger is the combination of two
companies into a single legal entity. In this article, we will look at different
types of mergers that companies can undergo.

Types of Mergers

There are five basic categories or types of mergers:

1. Horizontal merger: A merger between companies that are in direct

competition with each other in terms of product lines and markets
2. Vertical merger: A merger between companies that are along the same
supply chain (e.g., a retail company in the auto parts industry merges
with a company that supplies raw materials for auto parts.)
3. Market-extension merger: A merger between companies in different
markets that sell similar products or services
4. Product-extension merger: A merger between companies in the same
markets that sell different but related products or services
5. Conglomerate merger: A merger between companies in unrelated
business activities (e.g., a clothing company buys a software company)
Horizontal Mergers

A horizontal merger is a merger between companies that directly compete

with each other. Horizontal mergers are done to increase market
power (market share), further utilize economies of scale, and exploit merger
synergies.
A famous example of a horizontal merger was that between HP (Hewlett-
Packard) and Compaq in 2011. The successful merger between these two
companies created a global technology leader valued at over US$87 billion.

Vertical Mergers

A vertical merger is a merger between companies that operate along the same
supply chain. A vertical merger is the combination of companies along the
production and distribution process of a business. The rationale behind a
vertical merger includes higher quality control, better flow of information
along the supply chain, and merger synergies.

A notable vertical merger happened between America Online and Time

Warner in 2000. The merger was considered a vertical merger due to each
company’s different operations in the supply chain – Time Warner supplied
information through CNN and Time Magazine while AOL distributed
information through the internet.
Market-Extension Mergers

A market-extension merger is a merger between companies that sell the same

products or services but that operate in different markets. The goal of a
market-extension merger is to gain access to a larger market and thus a
bigger client/customer base.

For example, RBC Centura’s merger with Eagle Bancshares Inc. in 2002 was a
market-extension merger that helped RBC with its growing operations in the
North American market. Eagle Bancshares owned Tucker Federal Bank, one of
the biggest banks in Atlanta, with over 250 workers and $1.1 billion in assets.

Product-Extension Mergers

A product-extension merger is a merger between companies that sell related

products or services and that operate in the same market. By employing a
product-extension merger, the merged company is able to group their
products together and gain access to more consumers. It is important to note
that the products and services of both companies are not the same, but they
are related. The key is that they utilize similar distribution
channels and common, or related, production processions or supply chains.

For example, the merger between Mobilink Telecom Inc. and Broadcom is a
product-extension merger. The two companies both operate in the electronics
industry and the resulting merger allowed the companies to combine
technologies. The merger enabled the combination of Mobilink’s 2G and 2.5G
technologies with Broadcom’s 802.11, Bluetooth, and DSP products. Therefore,
the two companies are able to sell products that complement each other.

Conglomerate Mergers

A conglomerate merger is a merger between companies that are totally

unrelated. There are two types of a conglomerate merger: pure and mixed.

 A pure conglomerate merger involves companies that are totally

unrelated and that operate in distinct markets.
 A mixed conglomerate merger involves companies that are looking to
expand product lines or target markets.

The biggest risk in a conglomerate merger is the immediate shift in business

operations resulting from the merger, as the two companies operate in
completely different markets and offer unrelated products/services.

For example, the merger between Walt Disney Company and the American
Broadcasting Company (ABC) was a conglomerate merger. Walt Disney
Company is an entertainment company, while American Broadcasting
company is a US commercial broadcast television network (media and news
company).
What is diversification strategy?
Diversification strategy, as we already know, is a business growth strategy
identified by a company developing new products in new markets. That
definition tells us what diversification strategy is, but it doesn’t provide any
valuable insight into why it’s an ideal business growth strategy for some
companies or how it’s implemented.
Why do companies diversify?
First and foremost, companies diversify to achieve greater profitability.
Diversification is used by businesses to help them expand into markets and
industries that they haven’t currently explored. This is achieved by adding new
products, services, or features that will appeal to the customers in these new
markets.

Horizontal diversification
If your company decides to add products or services that are unrelated to
what you offer currently, but may meet some more needs of your existing
customers, this is known as horizontal diversification.

Horizontal diversification is typically the diversification strategy with the least

amount of risk involved, as you’re working mostly within familiar customer and
market segments. Say you’re the CEO of the Dunder Mifflin Paper
Company — it might make complete sense to move into the production of
printers. This is a different product altogether, but it has the potential to attract
many of your existing customers. (And with excellent quality control, hopefully
those printers won’t catch on fire.)

Concentric diversification
Concentric diversification occurs when a company enters a new market with a
new product that is technologically similar to their current products and
therefore are able to gain some advantage by leveraging things like industry
experience, technical know-how, and sometimes even manufacturing
processes already in place. Concentric diversification can be beneficial if
sales are declining for one product, as loss in revenue can be offset by a rise
in sales from other products.

An example of concentric diversification would be a computer manufacturer

who diversified from clunky desktop PCs into laptop production. This would
allow them to immediately take advantage of the new wave of computer users
who demanded more portable solutions.
Conglomerate diversification
If you’re looking to diversify into completely new markets with unrelated
products to reach brand new customer bases, this is known as conglomerate
diversification. The term conglomerate refers to a single corporate group
operating multiple business entities within entirely different industries. The
parent company that owns all of the individual entities is known as a
conglomerate, and it became one by successfully implementing a
conglomerate diversification strategy.

An example of conglomerate diversification would be Tata Group, which was

founded in 1868 and diversified from its humble beginnings as a hotel
company into a global multinational encompassing 100 individual companies.
It now employs 706,000 people across a variety of sectors such as chemicals,
steel, automotive, engineering, telecommunications, information systems, and
consumables.

Vertical diversification
Vertical diversification is also known as vertical integration, and occurs when a
company moves up or down the supply chain by combining two or more
stages of production normally operated by separate companies. This typically
means the company decides to start taking over some or all of the functions
related to the production and distribution of their core product, such as the
purchase of raw material, manufacturing processes, assembly, distribution
and sale.

For example, If you’re a retailer, vertical diversification might mean moving

into manufacturing the products you currently sell. While this can help lower
costs by covering all the needs of your business “in house”, the downside is
that it can reduce the flexibility of your business and reduce the opportunity for
horizontal diversification in the future.

There are two forms of vertical diversification, which are identified by the
direction you move in the supply chain.

1. Forward diversification

If you’re at the beginning of a supply chain in terms of your business

positioning, you might decide you want to control operations further along the
chain as well. An example of this could be a mining company that decides it
wants to expand into processing and development of its raw product.

2. Backward diversification

If you’re closer to the end of a supply chain, you can think about how to
diversify into the markets that funnel into your product. For example, Netflix
began as a media distribution platform, but now manufactures its own content.

What is a takeover? Definition and meaning

A takeover or acquisition is the purchase of one company by another. We call the

purchaser the bidder or acquirer, while the company it wants to buy is the target. It is a
type of merger, but not of equals. In the case of an acquisition, there is a predator and a
prey.

A takeover may also refer to the acquisition or colonization of a country. This article
focuses on the word’s meaning in the world of business.

There are different types of takeovers, including friendly, hostile, and backflip ones.
There are also reverse ones.

A friendly takeover
As the name suggests, a friendly takeover occurs when the target company is happy
about the arrangement. In other words, its directors and shareholders have approved
the offer.

The bidder tells the target’s board of directors about its intention and makes an offer.
The board then advises its shareholders to accept the offer. Subsequently, the friendly
takeover goes ahead.
 A friendly takeover is an
acquisition where the owners of both companies agree to the terms of the transaction.

In the majority of private companies, takeovers tend to be friendly. This is because the
board members are usually the main shareholders.

A hostile takeover
In a hostile takeover situation, the target company does not want the bidder to acquire
it. This can only really happen in a publicly-listed company because the directors are not
typically majority shareholders.

The bidder does not back always off if the board of a publicly-listed company rejects the
offer. If the bidder still pursues the acquisition, it becomes a hostile takeover situation.

Sometimes there may also be a hostile takeover situation if the bidder announces its
firm intention to make an offer, and then immediately makes the offer directly – thus, not
giving the board time to get organized.

If the bidder can divide board and or shareholder opinion, it has a better chance of
succeeding. There are five different ways that a hostile takeover situation can play out.

ender offer

The bidder may make a public offer at a fixed price above the current market price. In
other words, it offers more per share than its current stock market value. We call this
a tender offer.
In the United States, bidders must include comprehensive details of a tender offer in
their filing to the SEC. SEC stands for the Securities and Exchange Commission. It
must also provide the target company with details regarding its tender offer.

The filing must include data on the bidder’s plans for the company after it has acquired
it. It must also reveal its cash source and offer terms.

Proxy fight
The bidder can also engage in a proxy fight. In a proxy fight, it tries to persuade
enough the majority of stockholders to replace the whole management. It may target
just some key members. Put simply; the hostile bidder tries to get more acquisition-
friendly people on the board.

Creeping offer
Alternatively, the hostile bidder may discreetly buy enough stocks of the company in the
open market. We call this a creeping offer. Eventually, it has enough shares to effect a
change in management.

In all successful hostile takeovers, the management tries to resist the acquisition, but
eventually fails.

Hostile takeovers are risky

It is harder for the bidder to conduct extensive due diligence if the target is resisting the
acquisition attempt. Therefore, hostile takeovers generally carry more risk for the bidder
than friendly ones. Due diligence refers to carrying out a thorough examination of the
other party’s financial and operational status and history.

If the bidder requires loans in order to purchase the target company, it will have a
serous problem. How can it convince the bank to lend the money if it cannot conduct
extensive due diligence?

A famous hostile takeover was AOL’s acquisition of Time Warner Time Warner was
considerably bigger than AOL. In 2000, it was hailed the deal of the millennium.

However, the new AOL Time Warner company lost over $200 billion in value in less
than two years. The huge loss occurred after the dotcom bubble burst.
A common strategy for the target company is to make itself less attractive to the hostile
bidder. It may deliberately increase its debts or sell its best assets. Additionally, it may
acquire assets the hostile bidder does not like. We call this a Kamikaze defense
strategy.

A reverse takeover
A reverse takeover occurs when a private company purchases a publicly-listed
company.

In fact, it is an effective way for the private company to ‘float’ itself. In other words, it can
go public without all the IPO expense and time. IPO stands for Initial Public Offering.

Backflip takeovers
This occurs when the acquiring company becomes a subsidiary of the company it
purchases.

Imagine your company is called John Doe Inc. It has lots of money but very few people
globally know it exists. You hear that BaliBubu Plc is in financial trouble. It is also a
company with products that are famous all over the world.

If you acquire it, you will probably drop the John Doe name and continue with BaliBubu.

Texas Air Corporation acquired debt-laden Continental Airlines in 1982. The Continental
name prevailed because it was more famous than Texas Air Corporation.

Joint Venture
Definition: Joint Venture can be described as a business arrangement, wherein two or more
independent firms come together to form a legally independent undertaking, for a stipulated
period, to fulfil a specific purpose such as accomplishing a task, activity or project. In other
words, it is a temporary partnership, established for a definite purpose, which may or may
not uses a specific firm name.

For example, Maruti Ltd. of India and Suzuki Ltd. of Japan come together to set up Maruti
Suzuki India Ltd.
Objectives of Joint Venture
 To enter foreign market and even new or emerging market.
 To reduce the risk factor for heavy investment.
 To make optimum utilization of resources.
 To gain economies of scale.
 To achieve synergy.

Examples Of Joint Venture

The following are the examples of Joint Venture:

Example 1
Google parent company and the pharma company Glaxo and Smith decided to enter into a joint venture

agreement to produce bioelectric medicines the ratio of the ownership was 45%-55%. The joint venture

lasted and was committed for 7 years with a capital of Euro 540 million.

Example 2
Another example of a joint venture is the joint venture between the taxi giant UBER and the heavy vehicle

manufacturer Volvo. The joint venture goal was to produce driverless cars The ratio of the ownership is

50%-50%. The business worth was $350 million as per the agreement in the joint venture.

Example 3
Sony and Ericson’s example is also a good example of Joint Venture as they joined hands to manufacture

smartphones and gadgets. After several operating years, Sony eventually acquired Ericson mobile

manufacturing division.
Benefits of a Joint Venture
Creating a JV provides an opportunity for the parties to benefit from one another’s expertise. Other
benefits include:

 Enables the parties to offer their customers new products and services
 Helps the parties to save money in operating, marketing, and advertising costs
 Helps the parties save time
 Helps the parties acquire new business associates and referrals
 Enables the parties to gain new technological know-how or new geographical market territories
 Does not require a long-term commitment
The firms joining hands in a joint venture are called Co-venture, which can be a private
company, Government Company or foreign company. The co-venture come to a contractual
agreement for carrying out an economic activity, which has shared ownership and control.
They contribute capital, pooling the financial, physical, intellectual and managerial resources,
participating in the operations and sharing the risks and returns in the predetermined ratio.

Joint ventures are primarily formed for construction of dams and roads, film production, buying
and selling of goods etc.

The type of joint venture is based on the various factors like, the purpose for which it is formed,
number of firms involved and the term for which it is formed.

A strategic alliance goes a step further.

Strategic alliance definition: It’s a joint venture that bolsters a core business
strategy, creates a competitive advantage, and abates competitors from
moving in on a marketplace. It allows individual companies to achieve more
together than they would have on their own.
In other words: Coopetition.
Strategic alliances can take many different forms, but they often fall into three
categories:
1. Joint Venture
 A joint venture is a child company of two parent companies. It’s
maintained by sharing resources and equity with a binding
agreement. Whether it’s formed for a specific purpose or an ongoing
strategy, a joint venture has a clear objective, and profits are split
between the two companies.
 In 2016, Google’s parent company Alphabet announced a joint
venture with GlaxoSmithKline to research treating diseases with
electrical signals. The joint venture, Galvani Bioelectronics, has
continued to grow, bringing on more partners to build devices and
further research in the emerging field of bioelectronics.
2. Equity Strategic Alliance
 An equity strategic alliance occurs when one company purchases
equity in another business (partial acquisition), or each business
purchases equity in each other (cross-equity transactions).
 An example of an equity strategic alliance is Tesla’s relationship with
Panasonic. Their relationship began with a $30 million investment
from Panasonic to accelerate battery technology for electric vehicles
and grew to include building a lithium-ion battery plant in Nevada.
3. Non – Equity Strategic Alliance
 In a non-equity strategic alliance, organizations create an agreement
to share resources without creating a separate entity or sharing
equity. Non-equity alliances are often more loose and informal than a
 partnership involving equity. These make up the vast majority of
business alliances.
 Taking equity-sharing out of the equation can be a strategic
advantage in research and development, production, and sales and
marketing. In the previously mentioned example of Galvani
Bioelectronics, there are many non-equity strategic alliances that
have grown out of the original joint venture through Project Baseline.
This is a connected ecosystem of organizations all working together
to create “a more comprehensive, precise map of human health.”
According to the Ivey Business Journal, a strategic business alliance
needs five key components to be successful.

A successful strategic alliance:

1. It is critical to the success of a core business goal or objective.
 2. It is critical to the development or maintenance of a core competency or
other source of competitive advantage.
3. Blocks a competitive threat.
4. Creates or maintains strategic choices for the firm.
5. It mitigates a significant risk to the business.

Advantages And Disadvantages Of Strategic Alliances

Advantages of strategic alliances

 Sharing resources and expertise. A strategic alliance should combine the

best both companies have to offer. This can be a deeper understanding of the
product, sales, or marketing knowledge, or even just more hands on deck to
increase speed to market.
 New-market penetration. In some cases, a strategic alliance gives access to
new markets with a solution that wouldn’t have been possible for either
company on their own. For instance, companies going global often work with
a trusted local partner to get an advantage in an emerging market.
 Expanded production. When it comes to manufacturing and distributing
products, strategic alliances allow partners to increase their capabilities and
scale quickly to meet demand.
 Drive innovation. With the right alliance, partners can outpace the
competition with new solutions that are a complete package for their
customers. These alliances are creative and revolutionary and change the
market landscape in a dramatic way.
Strategic alliances allow partners to scale quickly, build innovative solutions for their
customers, enter new markets, and pool valuable expertise and resources. And, in a
business environment that values speed and innovation, this is a game-changer.
Disadvantages of strategic alliances

 Loss of control. In an alliance, both organizations must cede some control
over how their business is run and perceived. A strategic alliance requires
honesty and transparency, but that trust isn’t built overnight. Without
significant buy-in from both parties, an alliance may suffer.
 Increased liability. In a joint venture or equity strategic alliance, both
companies are on the hook for the outcome. If something happens to stall
production or create unhappy customers, both partners are at risk for the loss
in reputation. For instance, in the case of Tesla and Panasonic, what was
originally an advantageous relationship became fraught when batteries
weren’t produced and shipped quickly enough, causing delays in Tesla
vehicle production and shipments. Reports now say that Tesla is putting its
capital behind building its own battery technology to reduce dependence on
Panasonic.
Strategic alliances can fail when partners misrepresent what they bring to the table, do
not fully commit to the partnership, or fail to bring their resources together effectively.
UNIT 2

Provisions of Companies Act

A business may grow over time as the utility of its products and services is recognized. It may
also grow through an inorganic process, symbolized by an instantaneous expansion in work
force, customers, infrastructure resources and thereby an overall increase in the revenues and
profits of the entity. Mergers and acquisitions are manifestations of an inorganic growth process.
While mergers can be defined to mean unification of two players into a single entity, acquisitions
are situations where one player buys out the other to combine the bought entity with itself. It may
be in form of a purchase, where one business buys another or a management buy out, where the
management buys the business from its owners. Further, de-mergers, i.e., division of a single
entity into two or more entities also require being recognized and treated on par with mergers
and acquisitions regime as recommended below, and accordingly references below to mergers
and acquisitions also is intended to cover de-mergers (with the law & Rules as framed duly
catering to the same).

Mergers and acquisitions are used as instruments of momentous growth and are increasingly
getting accepted by Indian businesses as critical tool of business strategy. They are widely used
in a wide array of fields such as information technology, telecommunications, and business
process outsourcing as well as in traditional business to gain strength, expand the customer base,
cut competition or enter into a new market or product segment. Mergers and acquisitions may be
undertaken to access the market through an established brand, to get a market share, to eliminate
competition, to reduce tax liabilities or to acquire competence or to set off accumulated losses of
one entity against the profits of other entity.

The process of mergers and acquisitions in India is court driven, long drawn and hence
problematic. The process may be initiated through common agreements between the two parties,
but that is not sufficient to provide a legal cover to it. The sanction of the High Court is required
for bringing it into effect. The Companies Act, 1956 consolidates provisions relating to mergers
and acquisitions and other related issues of compromises, arrangements and reconstructions,
however other provisions of the Companies Act get attracted at different times and in each case
of merger and acquisition and the procedure remains far from simple. The Central Government
has a role to play in this process and it acts through an Official Liquidator (OL) or the Regional
Director of the Ministry of Company Affairs. The entire process has to be to the satisfaction of
the Court. This sometimes results in delays.

Provisions of Companies Act

A business may grow over time as the utility of its products and services is recognized. It may
also grow through an inorganic process, symbolized by an instantaneous expansion in work
force, customers, infrastructure resources and thereby an overall increase in the revenues and
profits of the entity. Mergers and acquisitions are manifestations of an inorganic growth process.
While mergers can be defined to mean unification of two players into a single entity, acquisitions
are situations where one player buys out the other to combine the bought entity with itself. It may
be in form of a purchase, where one business buys another or a management buy out, where the
management buys the business from its owners. Further, de-mergers, i.e., division of a single
entity into two or more entities also require being recognized and treated on par with mergers
and acquisitions regime as recommended below, and accordingly references below to mergers
and acquisitions also is intended to cover de-mergers (with the law & Rules as framed duly
catering to the same).

The Committee was of the view that contractual mergers may be given statutory
recognition in the Company Law in India as is the practice in many other countries.
Such mergers and acquisitions through contract form (i.e. without court intervention),
could be made subject to subsequent approval of shareholders by ordinary majority.
This would eliminate obstructions to mergers and acquisitions, ex-post facto protection
and ability to rectify would be available.

There has been a steady increase in cross-border mergers with the increase in global
trade. Such mergers and acquisitions can bring long-term benefits when they are
accompanied by policies to facilitate competition and improved corporate governance.

The Committee went into several aspects of the provisions in the existing law
constituting a separate code in themselves and regulating a very important aspect of
restructuring and consolidation of business in response to the economic environment.
An effort was made to identify the areas of concern under the present law and to
recommend means of addressing them.

At present, in case of a proposed scheme for amalgamation of company which is being

dissolved without winding up, the law requires a report from the Official Liquidator (OL)
or Registrar of Companies (ROC) that the affairs of company have not been conducted
in a manner prejudicial to the interest of its members or to public interest. The Act also
requires that no order for dissolution of any transferor company shall be made by the
Court unless the OL makes a report to the Court that the affairs of the company have
not been conducted in a manner prejudicial to the interest of its members or to public
interest. The Committee felt that the above two requirements under the present law can
be covered by issuing notices to ROC and OL respectively; who may file before the
Court, information that may have a bearing on the proposed merger. There is no
requirement of a separate information in response to the notice to be filed for the
purpose. Filing of such report may be time-bound, beyond which it may be presumed
that ROC/OL concerned have no comments to offer.

The Companies Act, 2013 (2013 Act) has seen the light of day and replaced the 1956
Act with some sweeping changes including those in relation to mergers and
acquisitions (M&A).
The new Act has been lauded by corporate organizations for its business-friendly
corporate regulations, enhanced disclosure norms and providing protection to investors
and minorities, among other factors, thereby making M&A smooth and efficient. Its
recognition of interse shareholder rights takes the law one step forward to an investor-
friendly regime. The 2013 Act seeks to simplify the overall process of acquisitions,
mergers and restructuring, facilitate domestic and cross-border mergers and
acquisitions, and thereby, make Indian firms relatively more attractive to PE investors.

The term ‘merger’ is not defined under the Companies Act, 1956 (“CA 1956”), and
under Income Tax Act, 1961 (“ITA”). However, the Companies Act, 2013 (“CA 2013”)
without strictly defining the term explains the concept. A ‘merger’ is a combination of two
or more entities into one; the desired effect being not just the accumulation of assets
and liabilities of the distinct entities, but organization of such entity into one business.

On 7th November, 2016 Central Government issued a notification for enforcement of

section 230-233, 235-240, 270-288 etc w.e.f. 15th December, 2016. But still rules were
not available till date for CAA.

MCA vide notification dated 14th Dec, 2016 has issued rules i.e. The Companies
(Compromises, Arrangements and Amalgamations) Rules, 2016. These rules will
be effective from 15th December, 2016. Consequently, w.e.f. 15.12.2016 all the matters
relating to Compromises, Arrangements, and Amalgamations (hereafter read as “CAA”)
will be dealt as per provisions of Companies Act, 2013 and The Companies
(Compromises, Arrangements, and Amalgamations) Rules, 2016.

Where a compromise or arrangement is proposed for the purposes of or in connection

with scheme for the reconstruction of any company or companies, or for the
amalgamation of any two or more companies, the petition shall pray for appropriate
orders and directions under section 230 read with section 232 of the Act.

Section relating to Merger & Amalgamation Section 230 & 232.

In this article COMPROMISE & ARRANGEMENT (C&A) will be read in relation to
Merger & Amalgamation only.

In Case of application filing u/s 230 for Compromise & Arrangement in relation to
reconstruction of the Company or companies involving merger or the amalgamation of
any two or more companies should specify the purpose of the scheme.

REASON OF M&A
· Expansion and Diversification·
TERMS
Optimum Economic Benefit· De-risking
Strategy

Amalgamation – means combination of

two or more independent business
corporations into a single enterprise
· Scaling up of operation for
competitive advantages Demerger– means transfer and vesting of
an undertaking of a company into another
· Increase the Market capitalization company

· Cost reduction by reducing Reconstruction- means re-organization

overheads of share capital in any manner; varying the
rights of shareholders and/or creditors
· Increasing the efficiencies of
operations Arrangement- All modes of reorganizing
the share capital, including interference
· Tax benefits with preferential and other special rights
attached to shares
· Access foreign markets

Who can file the application for Merger & Amalgamation propose: Section 230(1)

An application for Merger & Amalgamation can be file with Tribunal (NCLT). Both
the transferor and the transferee company shall make an application in the form of
petition to the Tribunal under section 230-232 of the Companies Act, 2013 for the
puspose of sanctioning the scheme of amalgamation.

Joint Application

Where more than one company is involved in a scheme, such application may, at the
discretion of such companies, be filed as a joint-application.
However, where the registered office of the Companies are in different states, there will
be two Tribunals having the jurisdiction over those, companies, hence separate petition
will have to be filed.

Regulations by SEBI, Scheme of Amalgamation, Approval

from Court
Companies Act, 1956

Sections 390 to 394 of the Companies Act govern a merger of two or more companies under Indian
law. The Merger Provisions are in fact worded so widely, that they would provide for and regulate all
kinds of corporate restructuring that a company may possibly undertake; such as mergers,
amalgamations, demergers, spin-off / hive off, and every other compromise, settlement, agreement or
arrangement between a company and its members and / or its creditors.

Scheme of Mergers and Acquisitions

Procedure for merger and amalgamation is different from takeover. Mergers and amalgamations are
regulated under the provisions of the Companies Act, 1956 whereas takeovers are regulated under the
SEBI (Substantial Acquisition of Shares and Takeovers) Regulations.

Although chapter V of the Companies Act, 1956 comprising sections 389 to 396-A deals with the
issue and related aspects covering arbitration, compromises, arrangements and reconstructions but at
different times and under different circumstances in each case of merger and amalgamation
application of other provisions of the Companies Act, 1956 and ruled made there-under may
necessarily be attracted.

A scheme of compromise or arrangement must be approved by a resolution passed by not less than
three-fourths in value of the total creditors (or class of creditors) or members (or class of members),
as the case may be, present and voting either in person or through proxies. There is no rigid formula
for determining a class of creditors or members. It is the discretionary power of the court to
determine these classes. Essentially, ‘class’ means persons whose rights are so similar that they can
be combined together with a view to achieve a common interest. Generally, secured creditors and
unsecured creditors could form distinct classes of creditors and members can be categorized into
preference shareholders and common equity shareholders.

Procedure under the Merger Provisions

Since a merger essentially involves an arrangement between the merging companies and their
respective shareholders, each of the companies proposing to merge with the other must make an
application to the Company Court having jurisdiction over such company for calling meetings of its
respective shareholders and/or creditors. The Court may then order a meeting of the
creditors/shareholders of the company. If the majority in number representing 3/4th in value of the
creditors/shareholders present and voting at such meeting agrees to the merger, then the merger, if
sanctioned by the Court, is binding on all creditors/ shareholders of the company. The Court will not
approve a merger or any other corporate restructuring, unless it is satisfied that the company has
disclosed all material facts. The order of the Court approving a merger does not take effect until the
company with the Registrar of Companies files a certified copy of the same.

Securities Laws

As per the ICDR Regulations, if the acquisition of an Indian listed company involvesthe issue of new
equity shares or securities convertible into equity shares by the target to the acquirer, the provisions
of Chapter VII contained in ICDR Regulations will be applicable in addition to the provisions of the
Companies Act mentioned above. We have highlighted below some of the relevant provisions of the
Preferential Allotment Regulations.

Approvals for the Scheme

The scheme of merger / amalgamation is governed by the provisions of Section 391-394 of the
Companies Act. The legal process requires approval to the schemes as detailed below.

Approvals from Shareholders

In terms of Section 391, shareholders of both the amalgamating and the amalgamated companies
should hold their respective meetings under the directions of the respective high courts and consider
the scheme of amalgamation. A separate meeting of both preference and equity shareholders should
be convened for this purpose. Further, in terms of Section 81(1A), the shareholders of the
amalgamated company are required to pass a special resolution for issue of shares to the shareholders
of the amalgamating company in terms of the scheme of amalgamation.

Approval from Creditors / Financial Institutions / Banks

Approvals are required from the creditors, banks and financial institutions to the scheme of
amalgamation in terms of their respective agreements / arrangements with each of the amalgamating
and the amalgamated companies as also under Section 391.

Approval from Respective High Court

Approvals of the respective high court(s) in terms of Section 391-394, confirming the scheme of
amalgamation are required. The courts issue orders for dissolving the amalgamating company
without winding-up on receipt of the reports from the official liquidator and the regional director,
Company Law Board, that the affairs of the amalgamating company have not been conducted in a
manner prejudicial to the interests of its members or to public interests.

Report of Chairman to the Court

 The chairman of the meeting must within the time fixed by the court or where no time is fixed within
7 days of the date of the meeting, report the result of the meeting to the court. The report should state
accurately the number of creditors or class of creditors or the numbers of members or class of
members, as the case may be, who were present and who voted at the meeting either in person or by
proxy, their individual values and the way the voted.

Takeover Code
THEINTACTFRONT23 APR 20181 COMMENT

The concept of Takeover

Although, the term ‘Takeover’ has not been defined under the said Regulations, the term
basically envisages the concept of an acquirer taking over the control or management of the
target company . When an acquirer, acquires substantial quantity of shares or voting rights of the
target company, it results in the Substantial acquisition of Shares.

For the purposes of understanding the implications arising from the aforementioned paragraph, it
is necessary for us to dwell into what is the actual meaning of substantial quantity of shares or
voting rights

1. Meaning of substantial quantity of shares or voting rights

The said Regulations have discussed this aspect of ‘substantial quantity of shares or voting
rights’ separately for two different purposes:

 For the purpose of disclosures to be made by acquirer(s)

 5% or more shares or voting rights

A person who, along with ‘persons acting in concert’ (“PAC”), if any, acquires shares or voting
rights (which when taken together with his existing holding) would entitle him to more than 5%
or 10% or 14% shares or voting rights of target company, is required to disclose the aggregate of
his shareholding or voting rights to the target company and the Stock Exchanges where the
shares of the target company are traded within 2 days of receipt of intimation of allotment of
shares or acquisition of shares.

2. More than 15% shares or voting rights

An acquirer who holds more than 15% shares or voting rights of the target company, shall within
21 days from the financial year ending March 31 make yearly disclosures to the company in
respect of his holdings as on the mentioned date.
The target company is, in turn, required to pass on such information to all stock exchanges where
the shares of target company are listed, within 30 days from the financial year ending March 31
as well as the record date fixed for the purpose of dividend declaration.

For the purpose of making an open offer by the acquirer

(a) 15% shares or voting rights

An acquirer who intends to acquire shares which along with his existing shareholding would
entitle him to more than 15% voting rights, can acquire such additional shares only after making
a public announcement (“PA”) to acquire at least additional 20% of the voting capital of the
target company from the shareholders through an open offer [ix].

(b) Creeping limit of 5%

An acquirer who is having 15% or more but less than 75% of shares or voting rights of a target
company, can consolidate his holding up to 5% of the voting rights in any financial year ending
31st March. However, any additional acquisition over and above 5% can be made only after
making a public announcement [x]. However in pursuance of Reg. 7(1A) any purchase or sale
aggregating to 2% or more of the share capital of the target company are to be disclosed to the
Target Company and the Stock Exchange where the shares of the Target company are listed
within 2 days of such purchase or sale along with the aggregate shareholding after such
acquisition /sale. An acquirer who has made a public offer and seeks to acquire further shares
under Reg. 11(1) shall not acquire such shares during the period of 6 months from the date of
closure of the public offer at a price higher than the offer price.

(c) Consolidation of holding:

An acquirer who is having 75% shares or voting rights of target company, can acquire further
shares or voting rights only after making a public announcement specifying the number of shares
to be acquired through open offer from the shareholders of a target company.

In order to appreciate the implications arising here from, it is pertinent for us to consider the
meaning of the term ‘public announcement’.

3. Public Announcement

A Public announcement is generally an announcement given in the newspapers by the acquirer,

primarily to disclose his intention to acquire a minimum of 20% of the voting capital of the
target company from the existing shareholders by means of an open offer.

However, an Acquirer may also make an offer for less than 20% of shares of target company in
case the acquirer is already holding 75% or more of voting rights/ shareholding in the target
 company and has deposited in the escrow account in cash a sum of 50% of the consideration
payable under the public offer.

The Acquirer is required to appoint a Merchant Banker registered with SEBI before making a PA
and is also required to make the PA within four working days of the entering into an agreement
to acquire shares, which has led to the triggering of the takeover, through such Merchant Banker.

 The other disclosures in this announcement would inter alia include

 The offer price,
 The number of shares to be acquired from the public,
 The identity of the acquirer,
 The purposes of acquisition,
 The future plans of the acquirer, if any, regarding the target company,
 The change in control over the target company, if any
 The procedure to be followed by acquirer in accepting the shares tendered by the shareholders and the
period within which all the formalities pertaining to the offer would be completed.

The basic objective behind the PA being made is to ensure that the shareholders of the target
company are aware of the exit opportunity available to them in case of a takeover / substantial
acquisition of shares of the target company. They may, on the basis of the disclosures contained
therein and in the letter of offer, either continue with the target company or decide to exit from it.

4. Procedure to be followed after the Public Announcement

In pursuance of the provisions of Reg. 18 of the said Regulations, the Acquirer is required to file
a draft Offer Document with SEBI within 14 days of the PA through its Merchant Banker, along
with filing fees of Rs.50,000/- per offer Document (payable by Banker’s Cheque / Demand
Draft). Along with the draft offer document, the Merchant Banker also has to submit a due
diligence certificate as well as certain registration details.

The filing of the draft offer document is a joint responsibility of both the Acquirer as well as the
Merchant Banker

Thereafter, the acquirer through its Merchant Banker sends the offer document as well as the
blank acceptance form within 45 days from the date of PA, to all the shareholders whose names
appear in the register of the company on a particular date.

The offer remains open for 30 days. The shareholders are required to send their Share
certificate(s) / related documents to the Registrar or Merchant Banker as specified in the PA and
offer document.

The acquirer is obligated to offer a minimum offer price as is required to be paid by him to all
those shareholders whose shares are accepted under the offer, within 30 days from the closure of
offer.
 5. Exemptions

The following transactions are however exempted from making an offer and are not required to
be reported to SEBI:

 Allotment to underwriter pursuant to any underwriting agreement;

 Acquisition of shares in ordinary course of business by;
 Regd. Stock brokers on behalf of clients;
 Regd. Market makers;
 Public financial institutions on their own account;
 Banks & FIs as pledges;
 Acquisition of shares by way of transmission on succession or by inheritance;
 Aquisition of shares by Govt. companies;
 Acquisition pursuant to a scheme framed under section 18 of SICA 1985;
 Of arrangement/ restructuring including amalgamation or merger or de-merger under any law or
Regulation Indian or Foreign;
 Acquisition of shares in companies whose shares are not listed;
 However, if by virtue of acquisition of shares of unlisted company, the acquirer acquires shares or voting
rights (over the limits specified) in the listed company, acquirer is required to make an open offer in
accordance with the Regulations.

6. Minimum Offer Price and Payments made

It is not the duty of SEBI to approve the offer price, however it ensures that all the relevant
parameters are taken in to consideration for fixing the offer price and that the justification for the
same is disclosed in the offer document. The offer price shall be the highest of:

 Negotiated price under the agreement, which triggered the open offer.
 Price paid by the acquirer or PAC with him for acquisition if any, including by way of public rights/
preferential issue during the 26-week period prior to the date of the PA.
 Average of weekly high & low of the closing prices of shares as quoted on the Stock exchanges, where
shares of Target company are most frequently traded during 26 weeks prior to the date of the Public
Announcement

In case the shares of target company are not frequently traded, then the offer price shall be
determined by reliance on the following parameters, viz: the negotiated price under the
agreement, highest price paid by the acquirer or PAC with him for acquisition if any, including
by way of public rights/ preferential issue during the 26-week period prior to the date of the PA
and other parameters including return on net worth, book value of the shares of the target
company, earning per share, price earning multiple vis a vis the industry average.

Acquirers are required to complete the payment of consideration to shareholders who have
accepted the offer within 30 days from the date of closure of the offer. In case the delay in
payment is on account of non-receipt of statutory approvals and if the same is not due to willful
default or neglect on part of the acquirer, the acquirers would be liable to pay interest to the
 shareholders for the delayed period in accordance with Regulations. Acquirer(s) are however not
to be made accountable for postal delays.

If the delay in payment of consideration is not due to the above reasons, it would be treated as a
violation of the Regulations.

7. Safeguards incorporated so as to ensure that the Shareholders get their payments

Before making the Public Announcement the acquirer has to create an escrow account having
25% of total consideration payable under the offer of size Rs. 100 crores (Additional 10% if
offer size more than 100 crores). The Escrow could be in the form of cash deposited with a
scheduled commercial bank, bank guarantee in favor of the Merchant Banker or deposit of
acceptable securities with appropriate margin with the Merchant Banker. The Merchant Banker
is also required to confirm that firm financial arrangements are in place for fulfilling the offer
obligations. In case, the acquirer fails to make payment, Merchant Banker has a right to forfeit
the escrow account and distribute the proceeds in the following way.

 1/3 of amount to target company

 1/3 to regional Stock Exchanges, for credit to investor protection fund etc.
 1/3 to be distributed on pro rata basis among the shareholders who have accepted the offer.

The Merchant Banker advised by SEBI is required to ensure that the rejected documents which
are kept in the custody of the Registrar / Merchant Banker are sent back to the shareholder
through Registered Post.

Besides forfeiture of escrow account, SEBI can take separate action against the acquirer which
may include prosecution / barring the acquirer from entering the capital market for a period etc.

8. Penalties

The Regulations have laid down the general obligations of the acquirer, target company and the
Merchant Banker. For failure to carry out these obligations as well as for failure / non-
compliance of other provisions of the Regulations, Reg. 45 provides for penalties. Any person
violating any provisions of the Regulations shall be liable for action in terms of the Regulations
and the SEBI Act.

If the acquirer or any person acting in concert with him, fails to carry out the obligations under
the Regulations, the entire or part of the sum in the escrow amount shall be liable to be forfeited
and the acquirer or such a person shall also be liable for action in terms of the Regulations and
the Act.

The board of directors of the target company failing to carry out the obligations under the
Regulations shall be liable for action in terms of the Regulations and SEBI Act.
 The Board may, for failure to carry out the requirements of the Regulations by an intermediary,
initiate action for suspension or cancellation of registration of an intermediary holding a
certificate of registration under section 12 of the Act. Provided that no such certificate of
registration shall be suspended or cancelled unless the procedure specified in the Regulations
applicable to such intermediary is complied with.

For any mis-statement to the shareholders or for concealment of material information required to
be disclosed to the shareholders, the acquirers or the directors where he acquirer is a body
corporate, the directors of the target company, the merchant banker to the public offer and the
merchant banker engaged by the target company for independent advice would be liable for
action in terms of the Regulations and the SEBI Act.

The penalties referred to in sub-regulation (1) to (5) may include

 Criminal prosecution under section 24 of the SEBI Act;

 Monetary penalties under section 15 H of the SEBI Act;
 Directions under the provisions of Section 11B of the SEBI Act.

Regulations have laid down the penalties for non-compliance. These penalties may include
forfeiture of the escrow account, directing the person concerned to sell the shares acquired in
violation of the regulations, directing the person concerned not to further deal in securities,
monetary penalties, prosecution etc., which may even extend to the barring of the acquirer from
entering and participating in the Capital Market. Action can also be initiated for suspension,
cancellation of registration against an intermediary such as the Merchant Banker to the offer.

The provisions dealt with in this paper are some of the important provisions, which are required
to be complied with when dealing with the procedure to be complied with in order to take over a
company.

Valuation of a Business
There are many reasons to have an up-to-date business valuation. For example:

 You may need to sell the business due to retirement, health, divorce, or for family reasons.
 You may need debt or equity financing for expansion or due to cash flow problems. Potential financiers
or investors will want to see that the business has sufficient worth.
 You may be adding shareholders (or one or more shareholders may wish a buyout). In this case, share
value will need to be determined.

Regardless of the reason, how much your business is worth depends on many factors, from the
current state of the economy through your business’s balance sheet. If for example, similar
businesses in your area have recently sold, the value of your business will be determined in large
part by the selling price of the previous sales.
 Get It Done Right

Business owners should not do their own business valuation. This is too much like asking a
mother how talented her child is. Neither the business owner nor the mother has the necessary
distance to step back and answer the question objectively.

So to ensure that you set and get the best price when you’re selling a business, get a business
valuation done by a professional, such as a Chartered Business Valuator (CBV). In the U.S., you
can find Business Valuators through the website of the American Society of Appraisers
(ASA) while in Canada you can find them through the Canadian Institute of Chartered Business
Valuators.

A Business Valuator (or anyone valuating your business such as an accountant) will use a variety
of business valuation methods to determine a fair price for your business, such as:

Three Business Valuation Methods

1. Asset-Based Approaches

Basically, these business valuation methods total up all the investments in the business.

Asset-based business valuations can be done on a going concern or on a liquidation basis.

 A going concern asset-based approach lists the business’s net balance sheet value of its assets and
subtracts the value of its liabilities.

 A liquidation asset-based approach determines the net cash that would be received if all assets were
sold and liabilities paid off.

Using the asset-based approach to value a sole proprietorship is more difficult. In a corporation,
all assets are owned by the company and would normally be included in a sale of the business.
Assets in a sole proprietorship exist in the name of the owner and separating assets from business
and personal use can be difficult.

For instance, a sole proprietor in a lawn care business may use various pieces of lawn care
equipment for both business and personal use. A potential purchaser of the business would need
to sort out which assets the owner intends to sell as part of the business.

2. Earning Value Approaches

These business valuation methods are predicated on the idea that a business’s true value lies in
its ability to produce wealth in the future. The most common earning value approach is
Capitalizing Past Earning.
With this approach, a valuator determines an expected level of cash flow for the company using
a company’s record of past earnings, normalizes them for unusual revenue or expenses, and
multiplies the expected normalized cash flows by a capitalization factor.

The capitalization factor is a reflection of what rate of return a reasonable purchaser would
expect on the investment, as well as a measure of the risk that the expected earnings will not be
achieved.

Discounted Future Earnings is another earning value approach to business valuation where
instead of an average of past earnings, an average of the trend of predicted future earnings is
used and divided by the capitalization factor.

What might such capitalization rates be? In a Management Issues paper discussing “How Much
Is Your Business Worth?”, law firm Grant Thornton LLP suggests:

“Well established businesses with a history of strong earnings and good market share might
often trade with a capitalization rate of, say 12% to 20%. Unproven businesses in a fluctuating
and volatile market tend to trade at much higher capitalization rates, say 25% to 50%.”

Valuation of a sole proprietorship in terms of past earnings can be tricky, as customer loyalty is
directly tied to the identity of the business owner. Whether the business involves plumbing
or management consulting, will existing customers automatically expect that a new owner
delivers the same degree of service and professionalism?

Any valuation of a service oriented sole proprietorship needs to involve an estimate of the
percentage of business that might be lost under a change of ownership. Note that this can be
mitigated in many cases, such as when a trusted family member (who may already be familiar
with the client list) takes over the business.

3. Market Value Approaches

Market value approaches to business valuation attempt to establish the value of your business by
comparing your business to similar businesses that have recently sold. Obviously, this method is
only going to work well if there are a sufficient number of similar businesses to compare.

Assigning a value to a sole proprietorship based on market value is particularly difficult. By

definition, sole proprietorships are individually owned so attempting to find public information
on prior sales of like businesses is not an easy task.

Although the Earning Value Approach is the most popular business valuation method, for most
businesses, some combination of business valuation methods will be the fairest way to set a
selling price.

Non-Competition Clauses Can Affect Valuation

 Non-competition clauses are frequently included in agreements for the sale of a business,
particularly in cases where goodwill forms a significant part of the valuation. No one wants to
purchase a business on the assumption that current customers will continue to patronize the
business only to have the previous owner immediately join a competitor or open a similar
business in the same area.

Non-competition clauses typically contain restrictions such as:

 Forbidding the seller from opening up a competing business in the same geographical area
 Attaching a time limit to competing activity – for example the buyer may request that the seller not
engage in direct competition for a period of five years

Non-competition agreements can be a thorny legal issue and are often the subject of court cases
between buyers and sellers after a business is sold. From a legal standpoint, to be enforceable the
restrictions placed in a non-competition clause must be clearly defined and ‘reasonable’. Non-
competition covenants can be nullified by the courts if it is determined that enforcement places
overly broad and/or unreasonable restrictions on the seller’s ability to continue his/her trade and
earn a living. Non-competition clauses should be reviewed by the legal representatives of the
buyer and seller prior to the sale of the business.

What About Franchise Businesses?

Franchise agreements generally define how a franchise can be sold, and these vary by franchise
vendor — check your franchise contract. Some contracts stipulate that the franchisors will buy
back your franchise directly for a fixed price. Others provide assistance with valuation and
locating a buyer, as it is in their best interest to make sure that the business continues
uninterrupted.

The Best Choice May Be a Combination

Although the Earning Value Approach is the most popular business valuation method, for most
businesses, some combination of business valuation methods will be the fairest way to set a
selling price. The first step is to hire a professional Business Valuator; he or she will be able to
advise you on the best method or methods to use to set your price so you can successfully sell
your business.
UNIT 3

Cash flow Basis, Earning Potential Basis, Growth Rate,

Market price etc.
When a Business or Shares are transferred from one party to another, it becomes very important
for both buyer as well as seller to know what is the worth of that particular asset which is being
transferred. The process which is undertaken to know the worth is nothing but “Valuation”. It is
popularly said that “Price” is what you pay and “Value” is what you get. “Value” refers to the
worth of an asset, whereas “Price” is the result of a negotiation process between a willing but not
an overeager buyer and a willing but not an overeager seller. In simple terms, valuation is a
process of determining value of a company or an asset. Valuation is an art and not exact science.
What the buyer thinks is whether the product is “worth the price” he has paid, this “worth” itself
is the value of the product. Depending on the structure of the transaction, the management may
want to value the entire business or a component of a business – such as division, a brand,
distribution network, etc. The importance of intangible assets such as brands, patents, intellectual
property rights, human resources, etc. is increasing and the valuation of such assets is also
becoming a more common phenomenon. Some of the instances for which valuation is called for
are listed below:
 Purchase/Sale of Business / Shares
 Corporate Restructuring such as Merger / Demerger
 Purchase/Sale of Equity stake by joint venture partners
 Family Settlement
 To comply with the requirements of Accounting Standards issued by the ICAI – Impairment testing
 Purchase price allocation
 Determining the Portfolio Value of investments
 To comply with certain statutory requirements e.g. Transfer Pricing, Reserve Bank of India
 Other instances as required under the Companies Act, 2013

It is important to understand the purpose for which the valuation is being attempted before
commencement of any valuation exercise. The structure of the transaction also plays a very
important role in determining the value. The ‘general purpose’ value may have to be suitably
modified for the special purpose for which the valuation is done. The factors affecting that value
with reference to the special purpose must be judged and brought into final assessment in a
sound and reasonable manner.

VALUATION METHODOLOGIES
 There are many methodologies that a valuer may use/consider to value the shares of a Company /
Business. Though different values are arrived under various methods, it is necessary for a valuer
to arrive at a fair value. In practice, the valuer normally, uses several methodologies of valuation,
and arrives at a fair price for the entire business. As mentioned earlier, selection of appropriate
valuation methods also depends on the purpose of valuation. If the valuation is for the purpose of
liquidation, the valuer would want to use the Realisable Value of the Net Assets of the Company
and not the Earnings Capacity since; in this case the Company will not exist and the share
holders will be left with the Net Assets. Similarly, during a Merger, the valuer would want to
value the companies involved in a similar manner to arrive at a relative value. Following are
generally accepted methodologies for valuation of shares / business:

 Net Asset Method

 Discounted Cash Flow Method
 Earnings Capitalisation Method
 EV/EBIDTA Multiple Method
 Comparable Transaction Method
 Market Price Method

Each method proceeds on different fundamental assumptions, which have greater or lesser
relevance, and at times even no relevance to a given situation. Thus, the methods to be adopted
for a particular valuation must be judiciously chosen.

NET ASSET VALUE (“NAV”) METHOD

The Net Assets Method represents the value of the business with reference to the asset base of
the entity and the attached liabilities on the valuation date. The Net Assets Value can be
calculated using one of the following approaches, viz.:

 At Book Value While valuing the Shares/Business of a Company, the valuer takes into consideration the
last audited financial statements and works out the net asset value. This method would only give the
historical cost of the assets and may not be indicative of the true worth of the assets in terms of income
generating potential. Also, in case of businesses which are not capital intensive viz. service sector
companies or trading companies this method may not be relevant.

The shortcomings of this method may be partly overcome by applying the Price to Book multiple
of a listed company to derive market price of a business with given underlying value of assets.

 At Intrinsic Value At times, when a transaction is in the nature of transfer of asset from one entity to
another, or when the intrinsic value of the assets is easily available, the valuer would like to consider the
intrinsic value of the underlying assets. The intrinsic value of assets is worked out by considering current
market/replacement value of the assets.

Some of the common adjustments that the valuer takes into account while valuing the
Shares/Business of a Company are contingent liabilities, appreciation/depreciation in the value of
investments, surplus assets, etc. In case of revaluation of surplus assets, the effect of tax outgo in
the event of transfer of the assets should also be considered.
EARNINGS CAPITALISATION METHOD

This method is used while valuing a going concern business with a good profitability history. It
involves determining the future maintainable earning level of the entity from its normal
operations. It is essential for the valuer to understand the business of the entity and take into
account the normal business profits after adjusting the non-recurring/extraordinary items of
income and expense. E.g. a one-time Voluntary Retirement Scheme (VRS) expense borne by the
entity or an award won in monetary terms. It is important to remove all non-recurring expenses
and incomes as the valuer is calculating the future maintainable profits of the entity with normal
operations. The valuer must give optimal weights to each financial year considering the profit
trend and cyclical nature of business. This maintainable profit, considered on a post tax basis, is
then capitalised at a rate, which in the opinion of the valuer, combines an adequate expectation of
reward from enterprise and risk, to arrive at the business value. While arriving at such factor,
valuer may also consider the market data available for comparable companies, which reflects the
fair expectation of the price by the market for the given earnings of those companies. The
selection of the Capitalisation Rate, inverse of the Price Earning (‘PE’) Multiple, is a judgment
of the valuer taking into account strengths and weaknesses of the company as well as market
situations prevailing at the time of valuation. It would be essential for the valuer to know the PE
Multiple of other companies in the same business and market advantages of the company subject
to valuation to give it a fair multiple. Value of assets viz. Investments, Surplus Assets, etc. which
do not contribute to the operating profits of the business, after considering the impact of notional
tax, if any needs to be added to the earnings capitalisation value.

EV/EBIDTA MULTIPLE METHOD

This method is also called the “price-to-EBIDTA multiple” or “Comparable Companies Multiple
Method”. The EBITDA multiple is the ratio of the value of capital employed (enterprise value)
to EBITDA. This method is similar to Earnings Capitalisation Method, only difference being
EBITDA of the company needs to be capitalised to arrive at the Enterprise Value. While
considering the EV/EBITDA Multiple of comparable companies, the valuer needs to keep in
mind that EBITDA multiple does not capture the differences in depreciation methods and also
the debt funding that one company may have taken vis-a-vis another. EV/EBIDTA multiple is
calculated as:

Enterprise Value

EV/ EBITDA Multiple = ———————–

EBITDA
Enterprise Value = Market Value of Equity + Market Value of Debt

COMPARABLE TRANSACTION METHOD

The Comparable Transaction Method is a relative valuation method, wherein the details of recent
transactions of similar business/ companies are considered to estimate the business/ company
value. This method is seldom used in practice since, there may not be enough transactions of
similar business/ company or the details of relevant transactions may not be available in the
public domain. It is more used as a cross check. Adequate care is to be exercised by the valuer
when carrying out valuation since, the comparable transaction value may include control
premium or liquidity discount which needs to be adjusted.

MARKET PRICE METHOD

This method evaluates the value on the basis of prices quoted on the stock exchange. Average of
quoted price is considered as indicative of the value perception of the company by investors
operating under free market conditions. The average for such Market Prices could be taken on a
Weighted Average method taking into consideration the value and the volumes of the
transactions taken place on the stock exchange. Since the Secondary Equity Market is not only a
reflection of the fair value of the company, but also of other market information it is important
for a valuer to know the perception of the market prevailing during the span of time for which he
evaluates the price of the share. At times, the valuer may also want to ignore this value, if
according to the valuer, the market price is not a fair reflection of the company’s underlying
asset or profitability status.

DISCOUNTED CASH FLOW (DCF) METHOD

In today’s scenario, it is essential for valuers to not only take into consideration the past profits
of the company, but also look at its future profitability. With the increase of the knowledge
sector, where the asset base of the company is much smaller than its future profitability, this
method has become very popular. The DCF method values the business by discounting its free
cash flows for the explicit forecast period and the perpetuity value thereafter. The free cash flows
represent the cash available for distribution to both the owners and the creditors of the business.
The perpetuity value of the entity is calculated to fully capture the growth capacity of the entity
to infinity, after the explicit period. It is important for the valuer to take into consideration the
past growth rate of the concern as well as the future projections for the explicit period, while
determining the perpetuity growth rate. The free cash flows and perpetuity are discounted by a
Weighted Average Cost of Capital (WACC). WACC is an appropriate rate of discount to
calculate the present value of the cash flows as it considers equity-business risk and the debt-
equity ratio of the company. The Cost of Equity is worked out by taking into consideration the
risk-free rate of return and adjusting the same for the equity risk premium and the Beta factor.
The risk free rate of return is taken based on the current return on Government Treasury Bills.
Beta the sensitivity of a particular stock vis-a-vis Market or Index. Equity Risk Premium is the
expectation of the investor over and above the risk free return. On the other hand, net of tax long-
term cost of debt is taken after considering the existing cost for the debt raised by the entity. The
Debt-Equity ratio is applied and a WACC can be calculated in a manner shown by the formula
below:

(Cost of Equity x Equity Weight) +

(After Tax Cost of Debt x Debt weight)

WAC
= ——————————————-
C

(Debt weight + Equity weight)

After discounting the future cash flows and the perpetuity value, the present value calculated is a
fair indicator of the value of the business.

Computation of impact on EPS and Market Price

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share
of common stock. Earnings per share serves as an indicator of a company’s profitability. EPS is
calculated as:

EPS = (Net Income – Dividends on Preferred Stock) / Average Outstanding Shares

How to Calculate ‘Earnings Per Share – EPS’

To calculate the EPS of a company, the balance sheet and income statement should be used to
find the total number of shares outstanding, dividends on preferred stock (if any), and the net
income or profit value. When calculating, it is more accurate to use a weighted average number
of shares outstanding over the reporting term, because the number of shares outstanding can
change over time. Any stock dividends or splits that occur must be reflected in the calculation of
the weighted average number of shares outstanding. However, data sources sometimes simplify
the calculation by using the number of shares outstanding at the end of a period.

Let’s calculate the EPS for a couple of companies for fiscal year ended 2016:

Earnings (Net Preferred Weighted Shares

Company Basic EPS
Income) Dividends Outstanding
 Ford Motors $1.23/3.97 =
$1.23 billion 0 3.97 billion
Company $0.31

$13.64/3.1 =
Wal-Mart Inc. $13.64 billion 0 3.1 billion
$4.40

NVIDIA $1.67/0.541 =
$1.67 billion 0 541 million
Corporation $3.08

McDonald’s $4.69/0.854 =
$4.69 billion 0 854 million
Corporation $5.49

Basic vs. Diluted EPS

The formula used in the table above calculates the basic EPS of each of these select companies.
Basic EPS does not factor in the dilutive effect of additional securities. When the capital
structure of a company includes stock options, warrants, restricted stock units (RSU), etc. these
investments, if exercised, could increase the total number of shares outstanding in the market. To
better show the effects of additional securities on per share earnings, companies also report
the diluted EPS, which expands on basic EPS by including convertible securities in the
outstanding shares number. The diluted EPS is the worst-case scenario for the earnings per share
if certain securities were converted to common stock.

For example, the total number of NVIDIA’s convertible instruments for the fiscal year ended
2016 is 108 million. If this number is added to its total shares outstanding, its diluted weighted
average shares outstanding will be 541 million + 108 million = 649 million shares. The
company’s diluted EPS is, therefore, $1.67 billion / 649 million = $2.57.

Importance of Earnings Per Share – EPS

Earnings per share (EPS) is generally considered to be the single most important variable in
determining a share’s price. It is also a major component used to calculate the price-to-
earnings (P/E) valuation ratio, where the ‘E’ in P/E refers to EPS. By dividing a company’s share
price by its earnings per share, an investor can understand the fair market value of a stock in
terms of what the market is willing to pay based on a company’s current earnings.

The EPS is an important fundamental used in valuing a company because it breaks down a firm’s
profits on a per share basis. This is especially important as the number of shares outstanding
could change, and the total earnings of a company might not be a real measure of profitability for
investors. If Ford’s total earnings were to increase in a subsequent year to $1.8 billion, this might
seem like great news to an investor until they consider the fact that the company’s total shares
outstanding increased to 4.5 billion. In this case, EPS would have only gone up to $0.40.

An important aspect of EPS that’s often ignored is the capital that is required to generate the
earnings (net income) in the calculation. Two companies could generate the same EPS number,
but one could do so with less equity (investment) – that company would be more efficient at
using its capital to generate income and, all other things being equal, would be a “better”
company. Investors also need to be aware of earnings manipulation that will affect the quality of
the earnings number. It is important not to rely on any one financial measure, but to use it in
conjunction with statement analysis and other measures.

Market Price

Impact cost is the cost that a buyer or seller of stocks incurs while executing a transaction due to
the prevailing liquidity condition on the counter. In other words, it represents the cost of
executing a transaction of a given security, with a specific predefined order size, at any given
point in time.

Description: It is a realistic measure of liquidity of the stock or security and is deemed to be

closer to the true cost of execution faced by a trader in comparison to the bid-ask spread
(difference between the best buy and the best sell orders). It is the percentage markup observed
while buying or selling a desired quantity of shares with reference to its ideal price.

The ideal price can be illustrated by an example.

Suppose a buyer wants to purchase 3,000 shares of, say, ABC. If the best buy order for 1,000
shares is placed at Rs 237 and the best sell order for 1,500 shares is placed at Rs 239, the ideal
price for the deal should be:

(239+237)/2 = Rs 238

At this price, one can expect the buyer to ideally get the desired quantity of ABC shares.
But suppose that the buyer was able to buy 3,000 ABC shares at an average cost of Rs 239.67
(see the above table)

Average cost: [(1500x 239) + (1000 x 240) + (500 x 241)]/3000

Or (3,58,500+ 2,40,000+ 1,20,500)/3000 = 239.83

The impact cost, therefore, would be 0.70 per cent. To find the impact cost, the formula is:

(Actual cost – ideal cost)/ideal cost*100 (#)

In our example, the ideal price is Rs 238, but the average acquisition price for that buyer is Rs
239.67.

By formula (#), the impact cost should thus be:

(239.67 – 238)/239.67*100 = 0.70

This is a cost that the buyers incur due to lack of market liquidity. The importance of impact cost
can be judged from the fact that it is one of the criteria to select a stock for inclusion in the
NSE’s benchmark index Nifty50.

For a stock to qualify for possible inclusion into Nifty50, it has to have traded at an average
impact cost of 0.50 per cent or less during the last six months for 90 per cent of the observations
for a basket size of Rs 2 crore.

It must be note that impact cost does vary for different transaction sizes. It is dynamic in nature
and depends on the outstanding orders. Lastly, a penal impact cost is applicable if a stock is not
sufficiently liquid.

Determination of Exchange Ratio

THEINTACTFRONT23 APR 20181 COMMENT

In mergers and acquisitions (M&A), the share exchange ratio measures the number of shares
the acquiring company has to issue for each individual share of the target firm. For M&A deals
that include shares as part of the consideration (compensation) for the deal, the share exchange
ratio is an important metric. Deals can be all cash, all shares, or a mix of the two.

Formula

Exchange Ratio = Offer Price for the Target’s Shares / Acquirer’s Share Price
Exchange Ratio example

Assume Firm A is the acquirer and Firm B is the target firm. Firm B has 10,000 outstanding
shares and is trading at a current price of $17.30 and Firm A is willing to pay a 25% takeover
premium. This means the Offer Price for Firm B is $21.63. Firm A is currently trading at $11.75
per share.

To calculate the exchange ratio we take the offer price of $21.63 and divide it by Firm A’s share
price of $11.75.

The result is 1.84x. This means Firm A has to issue 1.84 of its own shares for every 1 share of
the Target it plans to acquire.

Importance of the Exchange Ratio

In the event of an all-cash merger transaction, the exchange ratio is not a useful metric. In fact, in
this situation, it would be fine to exclude the ratio from the analysis. Often times, M&A
valuation models will note the ratio as “0.000” or blank, when it comes to a full cash transaction.
Alternatively, the model may display a theoretical exchange ratio, if the same value of the cash
transaction were instead to be carried out by a stock transaction.

However, in the event of a 100% stock deal, the exchange ratio becomes a powerful metric. It
becomes virtually essential and allows the analyst to view the relative value of the offer between
the two firms.

In the event of a split deal, where a portion of the transaction involves cash and a portion
involves a stock deal, the percentage of stock involved in the transaction must be considered.
Excluding any cash effects, what is the actual exchange ratio based on the stock. Additionally,
M&A models may want to also show what this transaction would look like if there was a 100%
stock deal.
 Impact of variation in Growth of
the firms
THEINTACTFRONT23 APR 20181 COMMENT

Variation in business performance

1. Variation in profit ratios

An examination of the degree of variation in the ratio of ordinary profit to sales in different
sectors of the economy shows that the standard deviation (a measure of dispersion) is especially
high in the case of the service industry, and that the retail sector too has a high standard deviation
despite a low mean, indicating that there is considerable variation in profit ratios in these sectors.

It is also apparent that the degree of variation in profit ratios varies according to firm size among
firms in the same sector. Taking manufacturing as an example, it can be seen that the average
profit ratio increases the greater the size of the workforce. There is no major difference in the
average profit ratios of the top 10% of firms in each size category, however; indeed, the top
firms with fewer than 10 employees have extremely high profit ratios. The average profit ratio of
the bottom 10%, on the other hand, is increasingly negative the smaller the size of the company.
Looking at the standard deviation, it can be seen that while the variation in the performance of
individual firms increases among smaller firms and some small firms are in dire financial straits,
some SMEs perform slightly better than the average large firm.

2. Variation in sales growth rates

As in the case of the ratio of ordinary profit to sales, the average sales growth rate increases with
the size of a business establishment, but there is greater variation among smaller establishments.

3. Increasing variation in business performance

A study of trends over time reveals that the variation in business performance is changing. The
standard deviation of returns on sales among manufacturing business establishments has
increased since 1986, and there is growing variation in performance irrespective of size. As the
standard deviation grew particularly noticeably between 1990 and 1994, it may be surmised that
it was the collapse of the economic bubble that caused the performance of individual firms to
become so much more disparate. Although business performances are growing increasingly
varied in all size categories, the degree of variation is greater among smaller firms.

Moreover, as has already been noted, variation is relatively greater in the service sector, which
suggests that with services playing an increasingly important economic role, variance in the
 performances of individual firms as economic entities is growing.
(Year)

Causes of variation in business performance

1. Relationship between new activities and business performance

The small business environment is changing tremendously, and it is crucial that SMEs seize the
opportunities that such change offers and aggressively engage in new business activities.

An examination of the relationship between new business activities and the ratio of ordinary
profit to sales shows that SMEs that upgraded existing products and services and made
technological improvements saw their ratio of ordinary profit to sales increase from 2.0% in
fiscal 1994 to 2.9% in fiscal 1996, and that profit ratios are higher at SMEs engaged in some
form of new business activities than at those not so engaged. Moreover, SMEs that engaged in
new activities also had relatively higher sales growth rates.

2. Relationship between networks and business performance

In order for SMEs to respond to the changing business environment and maintain and improve
their performance, it is important that they develop their own unique strengths. However, it is
difficult for individual SMEs to possess all the necessary managerial resources to enable them to
do so, and attempting to acquire all these resources could on the contrary reduce efficiency.
Building networks with other firms and relevant organizations to procure the necessary
managerial resources externally thus forms an important part of management strategy.

Evidence of the effectiveness of joint R&D with other firms and especially firms in other sectors
is the fact that the ratio of ordinary profit to sales of companies involved in joint R&D with firms
in other sectors rose significantly between fiscal 1994 and fiscal 1996, and that firms engaged in
joint R&D with firms in the same sector, meanwhile, succeeded in maintaining high profitability
in both fiscal 1994 and fiscal 1996.

Looking next at the relationship between taking orders and marketing jointly and sales growth
rates, it can be seen that SMEs that engage in such joint activities have higher sales growth rates
than SMEs as a whole. And as in the case of joint R&D, the effects on profits are even greater if
firms take orders and market jointly with firms in other sectors. Moreover, the effectiveness of
such activities is significantly greater among SMEs.

3. Relationship between outsourcing and business performance

Outsourcing has attracted attention in recent years as an important part of corporate business
strategy. The term outsourcing is used here to refer to outsourcing using services, i.e. the external
procurement of services traditionally provided within the firm and new services, and it is on the
basis of this definition that we will consider the relationship between outsourcing and business
performance.
 In fiscal 1994, the average ratio of ordinary profit to sales was 1.8% in the case of both SMEs
that outsourced and those that did not. By fiscal 1996, however, the gap between the two had
grown. Furthermore, outsourcing raised profit ratios more at SMEs than at large firms.

The most commonly cited advantages of outsourcing were related to using outside sources in a
firm’s weak areas and making up for shortages of managerial resources (enabling firms to utilize
specialties outside the firm and concentrate managerial resources on a firm’s own strengths),
reducing costs (enabling firms to cut the size of their workforces and reduce personnel
expenses), and speeding up business activities (such as by speeding up provision of services).

4. Other factors related to business performance

In addition to the above, a variety of other factors impact on business performance. A regression
equation was therefore estimated to explain the ratio of ordinary profit to sales in manufacturing
and the wholesale sector.

The results show that in manufacturing, workforce size, capital investment, the specialization
ratio, overseas sales ratio, overseas purchases ratio, sales growth rate and patents all have a
positive effect on the ratio of ordinary profit to sales. The fact that the number of patents owned
by a firm has a positive effect shows that firms that put more resources into R&D perform better,
while the fact that the overseas sales and overseas purchases ratios also have a positive effect
suggests how important it is that SMEs adopt an international approach in their business
strategies.

In the wholesale sector, capital investment, the overseas purchases ratio, changes to main
products and the sales growth rate were found to have a positive effect. The positive effect of
changing main products suggests that it is important that firms change their product lineups
flexibly to meet customer and consumer needs.

MBO, LBO, Boot Strapping

Management Buyout (MBO)

A management buyout (MBO) is a transaction where a company’s management team purchases

the assets and operations of the business they manage. A management buyout (MBO) is
appealing to professional managers because of the greater potential rewards from being owners
of the business rather than employees. MBOs are favored exit strategies for large corporations
who wish to pursue the sale of divisions that are not part of their core business, or by private
businesses where the owners wish to retire. The financing required for an MBO is often quite
substantial, and is usually a combination of debt and equity that is derived from the buyers,
financiers and sometimes the seller.

BREAKING DOWN ‘Management Buyout – MBO’

In a management buyout (MBO), a management team pools resources to acquire all or part of a
business they manage. Funding usually comes from a mix of personal resources, private equity
financiers, and seller financing. An MBO is different from a management buy-in (MBI), in
which an external management team acquires a company and replaces the existing management
team. It also differs from a leveraged management buyout (LMBO), where the buyers use the
company assets as collateral to obtain debt financing. The advantage of an MBO over an LMBO
is that the company’s debt load may be lower, giving it more financial flexibility.

An MBO’s advantage over an MBI is that as the existing managers are acquiring the business,
they have a much better understanding of it and there is no learning curve involved, which would
be the case if it were being run by a new set of managers. Management buyouts are conducted by
management teams that want to get the financial reward for the future development of the
company more directly than they would do as employees only.

However, there are several drawbacks to the MBO structure as well. While the management
team can reap the rewards of ownership, they have to make the transition from being employees
to owners, which requires a change in mindset from managerial to entrepreneurial. Not all
managers may be successful in making this transition.

Also, the seller may not realize the best price for the asset sale in an MBO. If the existing
management team is a serious bidder for the assets or operations being divested, the managers
have a potential conflict of interest. That is, they could downplay or deliberately sabotage the
future prospects of the assets that are for sale to buy them at a relatively low price.

Leveraged buyout (LBO)

Diagram of the basic structure of a generic leveraged buyout transaction

A leveraged buyout (LBO) is a financial transaction in which a company is purchased with a

combination of equity and debt, such that the company’s cash flow is the collateral used to
secure and repay the borrowed money. The use of debt, which has a lower cost of capital than
equity, serves to reduce the overall cost of financing the acquisition. The cost of debt is lower
 because interest payments reduce corporate income tax liability, whereas dividend payments do
not. This reduced cost of financing allows greater gains to accrue to the equity, and, as a result,
the debt serves as a lever to increase the returns to the equity.

The term LBO is usually employed when a financial sponsor acquires a company. However,
many corporate transactions are partially funded by bank debt, thus effectively also representing
an LBO. LBOs can have many different forms such as management buyout (MBO), management
buy-in (MBI), secondary buyout and tertiary buyout, among others, and can occur in growth
situations, restructuring situations, and insolvencies. LBOs mostly occur in private companies,
but can also be employed with public companies (in a so-called PtP transaction – Public to
Private).

As financial sponsors increase their returns by employing a very high leverage (i.e., a high ratio
of debt to equity), they have an incentive to employ as much debt as possible to finance an
acquisition. This has, in many cases, led to situations in which companies were “over-
leveraged”, meaning that they did not generate sufficient cash flows to service their debt, which
in turn led to insolvency or to debt-to-equity swaps in which the equity owners lose control over
the business to the lenders

Characteristics

LBOs have become attractive as they usually represent a win-win situation for the financial
sponsor and the banks: the financial sponsor can increase the rate of returns on his equity by
employing the leverage; banks can make substantially higher margins when supporting the
financing of LBOs as compared to usual corporate lending, because the interest chargeable is
that much higher. Banks can increase their likelihood of being repaid by obtaining collateral or
security.

The amount of debt that banks are willing to provide to support an LBO varies greatly and
depends, among other things, on:

 The quality of the asset to be acquired (stability of cash flows, history, growth, prospects, hard assets,
etc.)
 The amount of equity supplied by the financial sponsor
 The history and experience of the financial sponsor
 The overall economic environment

Boot Strapping

Bootstrap is a situation in which an entrepreneur starts a company with little capital. An

individual is said to be bootstrapping when he or she attempts to found and build a company
from personal finances or from the operating revenues of the new company.

Compared to using venture capital, boot strapping can be beneficial, as the entrepreneur is able
to maintain control over all decisions. On the downside, however, this form of financing may
place unnecessary financial risk on the entrepreneur. Furthermore, boot strapping may not
provide enough investment for the company to become successful at a reasonable rate.

BREAKING DOWN ‘Bootstrap’

The term boostrap itself originates from the phrase “pulling oneself up by one’s bootstraps,” and
professionals who engage in bootstrapping are known as bootstrappers. These individuals
typically rely on personal savings and the earliest instances of revenue to begin funding their
own startup companies. This contrasts with other entrepreneurial actions, which may include
contacting external investors and other business professionals to begin funding their
operations. Studies show that more than 80% of new startup operations are funded through the
founders’ personal finances. The recorded median in start-up capital is reported at approximately
$10,000.

Pros & Cons of Bootstrapping

Though not as quick in turning profits, bootstrapping is a steady way to begin compiling revenue
and to support future investments by providing the business with a safety net for long-term cost
management. Bootstrapping provides professionals with the peace of mind they need to focus on
building relations with customers and other professionals.

Because the business does not have to rely on other sources of funding, initial business owners
do not have to worry about diluting ownership between investors. Entrepreneurs do not need to
issue equity, and they can focus debt on personal sources. Bootstrapping allows business owners
to experiment with their brand more, as there is not as much pressure for them to get their
product right the first time. With personal startup funds, they can experiment with focus groups
until they are satisfied with the results of their venture.

However, this also increases the degree of risk for the starter, because they may need
to micromanage their source of income as well as their business venture. When a startup is
launched with the starter’s own funds, generating revenue is essential in order to keep the
business afloat. A successful profit plan must be operational early, which can lead to growth
models that weren’t part of the original plan. Additionally, without large amounts of money from
outside investors, some startups might not be able to develop and expand as quickly as desired.
For instance, a certain amount of revenue is essential for expanding the team and for adequate
marketing. Milestone could take longer to reach.

Another downside to bootstrapping could be a lack of credibility. Not having outside investors
could hurt a company’s credibility in the beginning, because it could seem as though no investors
were interested, even if that isn’t case. Being backed by well-respected investors can give
potential customers the reassurance to buy in, which self-funding could potentially highlight a
company’s lack of resources and experience.

Examples of Successfully Bootstrapped Businesses

One example of a successfully bootstrapped business is Electronic Data Systems. Ross Perot first
started EDS, an information technology equipment and services company, in 1962 with $1,000
he saved up in personal funds from previous employment arrangements. Through persistence and
careful networking, he turned his small startup operation into a multi-billion-dollar company.

Another example of a successfully bootstrapped business is Spanx. Founded by Sara Blakely,

Spanx was launched out of Atlanta with $5,000 of Blakley’s personal savings; she even wrote
a patent application for the now-famous women’s undergarment and filed it herself to save on
legal fees. Blakely still owns 100 percent of Spanx, which has an estimated $400 million in sales,
and has never taken money from outside investors.

Criteria for Negotiating Friendly

Takeover
THEINTACTFRONT23 APR 20181 COMMENT

A recent study on M&A turned up a surprising statistic. Between 1984 and 1994, some 80% of
LBO firms reported that their fund investors had received a return that matched or exceeded their
cost of capital, even though in many cases the prices paid for the companies those funds acquired
were pushed up by competing bidders. That figure stands in stark contrast to the overall record of
M&A investments, which from the corporate acquirer’s perspective has been dismal, at times
disastrous.

The fact that financial acquirers are so much more successful than most corporate acquirers may
come as a shock to some managers. After all, financial investors don’t bring synergies to their
acquisitions, and they often have relatively little operational experience in the industries
involved. Indeed, it’s highly likely that the target’s management team will initially view potential
acquirers with substantial skepticism. 1

Why, then, are financial acquirers so successful? Based on our experience advising companies
on both acquisitions and negotiation strategy, we believe the answer lies in their approach to the
acquisition process. Most corporate managers treat acquisitions as a direct-march-up-the-hill
kind of exercise: “I want to buy this company. Let’s find out what it’s worth, offer less, and see
if we get it.” The actual deal-management process is often delegated to outside experts—to
investment bankers and lawyers.

But senior managers at financial investors—and the more successful corporate acquirers—treat
deal management as a core part of their business. They approach potential acquisitions with
sensitivity and a well-established process. They adjust their negotiating postures and objectives
as the deal evolves. And they take the trouble to carefully coordinate the different actors—senior
managers, lawyers, investment bankers, and so on—throughout the process. It is this care and
effort that enables successful acquirers to create the value they do.
In this article, we’ll describe how successful acquirers manage their deals. Our focus is primarily
on friendly deals, but much of what we found is applicable in a hostile context as well because
even a hostile bid has to end in an agreement to work together. All friendly M&A deals pass
through five distinct stages: screening potential deals, reaching an initial agreement, conducting
due diligence, setting the final agreement, and ultimately closing. We’ll walk you through that
process, comparing good practice with bad, and then we’ll suggest ways companies can turn
their deal-making experiences into organizational learning.

Screening Potential Deals

Acquisition possibilities can pop up without warning and usually need to be evaluated quickly. A
core challenge in sizing up potential acquisitions, therefore, is to balance the need to think
strategically with the need to react opportunistically. Experienced acquirers follow two simple
rules in screening deals.

Look at everything.

Successful acquirers are always on the lookout for deals. An LBO shop such as the New York
City-based Cypress Group might complete only two or three deals a year, but it will have
explored as many as 500 possibilities and have closely examined perhaps 25 of them. Successful
corporate acquirers do much the same, albeit on a smaller scale. Cisco Systems, for example,
typically evaluates three potential markets for each one it decides to enter and then takes a hard
look at five to ten candidates for each deal it does. Assessing a large volume of opportunities
confers two main benefits. It gives Cisco an overall sense of what kinds of strategic acquisition
opportunities exist and at what price, making the company better able to assess the value of each
prospect relative to the others. On a more basic level, it forces managers to bring discipline and
speed to the screening process.

Keep a strategic focus.

A common mistake for novice acquirers is to cast strategy aside in the face of an exciting
opportunity. “The failure starts right at the beginning,” one senior financial professional
explained to us.” Someone at the top falls in love, and the word comes down, ’We are going to
do that deal.’ Once the decision gets made, the guys doing the deal just want to get it done. They
start stretching the operating assumptions to make it work.” Senior executives at LBO firms,
however, are strict about sticking to guidelines. Joe Nolan, a partner at GTCR Golder Rauner, is
very clear about his firm’s focus: “We look for businesses where acquisition will be a core part
of the growth strategy. We back people who know how to both operate and acquire companies,
which is a rare combination. We invest in service companies and not manufacturing.”

From Talking to Planning

Initial negotiations can take place in a variety of ways. Some cases occur through a structured
process, such as an auction; others happen less formally through conversations between senior
executives. Either way, the challenge at this second stage is for the senior management of both
companies to agree that the potential for a deal is sufficient to justify investing resources in
further exploration. Successful friendly acquirers follow much the same rules of thumb in
nursing potential transactions through this phase.

Don’t get bogged down over price.

It is usually unwise to try to establish a firm agreement on price this early. The parties simply
don’t have enough information. As Bob End, one of the founding partners at Stonington
Partners, puts it: “You have to do some preliminary feeling out, but if you focus on price at the
beginning, you are setting yourself up for failure. People start staking out positions and end up
souring on the deal. I’d rather get some momentum around the business possibilities, to get
people nodding their heads.”

Identify must-haves.

Although acquirers cannot afford to get tied up with too much detail at this stage, it is essential to
pin down certain issues. Many of these are driven by the acquisition’s strategic rationale. GTCR
Golder Rauner, for example, focuses on the management team’s experience and its incentive
structure. Cisco insists that the management of target companies believes in employee
ownership. It’s also important to clarify the roles that the target’s top executives will play in the
combined organization: who will be retained, and what will they do? American Home Products’
merger with Monsanto foundered, for example, because the two CEOs could not agree on which
of them would be number one. Finally, it is essential that the acquirer be comfortable at this
stage with any potential liabilities—such as environmental exposures, retiree health-care
liabilities, or class action suits—that could materially affect the price of the transaction.

Financing of Merger
THEINTACTFRONT23 APR 20181 COMMENT

Financing a Merger: Form # 1. Cash Offer:

After the value of the firm to be acquired has been determined, the most straight forward method
of making the payment could be by way of offer for cash payment. The major advantage of cash
offer is that it will not cause any dilution in the ownership as well as earnings per share of the
company.
However, the shareholders of the acquired company will be liable to pay tax on any gains made
by them. Another important consideration could be the adverse effect on liquidity position of the
company. Thus, only a company having very sound liquidity position may offer cash for
financing a merger.

Financing a Merger: Form # 2. Equity Share Financing:

It is one of the most commonly used methods of financing mergers. Under this method
shareholders of the acquired company are given shares of the acquiring company. It results into
sharing of benefits and earnings of merger between the shareholders of the acquired companies
and the acquiring company.

The determination of a rational exchange ratio is the most important factor in this form of
financing a merger. The actual net benefits to the shareholders of the two companies depend
upon the exchange ratio and the price-earning ratio of the companies.

Usually, it is an ideal method of financing a merger in case the price-earning ratio of the
acquiring company is comparatively high as compared to that of the acquired company.
When the shareholders of the acquired company receive shares in exchange in the acquiring
company, they are not liable to any immediate tax liability.

Financing a Merger: Form # 3. Debt and Preference Share Financing:

A company may also finance a merger through issue of fixed interest bearing convertible
debentures and convertible preference shares bearing a fixed rate of dividend. The shareholders
of the acquired company sometimes prefer such a mode of payment because of security of
income along with an option of conversion into equity within a stated period.

The acquiring company is also benefited on account of lesser or no dilution of earnings per share
as well as voting/controlling power of its existing shareholders.

Financing a Merger: Form # 4. Deferred Payment:

Deferred payment also known as earn-out plan is a method of making payment to the target firm
which is being acquired in such a manner that only a part of the payment is made initially either
in cash or securities. In addition to the initial payment, the acquiring company undertakes to
make additional payment in future years if it is able of increase the earnings after the merger or
acquisition.

It is known as earn -out plan because the future payments are linked with the firm’s future
earnings. This method enables the acquiring company to negotiate successfully with the target
company and also helps in increasing the earning per share because of lesser number of shares
being issued in the initial years.

However, to make it successful, the acquiring company should be prepared to co-operate towards
the growth and success of the target firm.

Financing a Merger: Form # 5. Leveraged Buy – Out:

A merger of a company which is substantially financed through debt is known as leveraged buy-
out. Debt, usually, forms more than 70 percent of the purchase price. The shares of such a firm
are concentrated in the hands of a few investors and are not generally, traded in the stock,
exchange.

It is known as leveraged buy out because of the leverage provided by debt source of financing
over equity. A leveraged buy-out is also called Management Buy-Out (MBO). However, a
leveraged buy-out may be possible only in case of a financially sound acquiring company which
is viewed by the lenders as risk free.

Financing a Merger: Form # 6. Tender Offer:

Under this method, the purchaser, who is interested in acquisition of some company, approaches
the shareholders of the target firm directly and offers them a price (which is usually more than
the market price) to encourage them sell their shares to him. It is a method that results into
hostile or forced take-over.

The management of the target firm may also tender a counter offer at still a higher price to avoid
the take over. It may also educate the shareholders by informing them that the acquisition offer is
not in the interest of the shareholders in the long-run.
 UNIT 4
Poisson Pill
A poison pill is a tactic utilized by companies to prevent or discourage hostile takeovers. A
company targeted for a takeover uses a poison pill strategy to make shares of the
company’s stock unfavorable to the acquiring firm.

What is a ‘Poison Pill’

A poison pill is a tactic utilized by companies to prevent or discourage hostile takeovers. A

company targeted for a takeover uses a poison pill strategy to make shares of the
company’s stock unfavorable to the acquiring firm.

BREAKING DOWN ‘Poison Pill’

The term poison pill is the common colloquial expression referring to a specially
designed shareholder rights plan.

There are two types of poison pills:

1. A “flip-in” permits shareholders, except for the acquirer, to purchase additional shares at a
discount. This provides investors with instantaneous profits. Using this type of poison pill
also dilutes shares held by the acquiring company, making the takeover attempt more
expensive and more difficult.
2. A “flip-over” enables stockholders to purchase the acquirer’s shares after the merger at a
discounted rate. For example, a shareholder may gain the right to buy the stock of
its acquirer, in subsequent mergers, at a two-for-one rate.

History and Functionality of Poison Pill

In regard to mergers and acquisitions, poison pills were initially constructed in the early
1980s. They were devised as a way to stop bidding takeover companies from directly
negotiating a price for the sale of shares with shareholders and instead force bidders to
negotiate with the board of directors.

Shareholder rights plans are typically issued by the board of directors in the form of
a warrant or an option attached to existing shares. These plans, or poison pills, can only be
revoked by the board. Of the two types, the flip-in variety is the most common.

Poison Pill Example

Flip-in poison pills may hold an attached option that permits shareholders to buy additional
discounted shares if any one shareholder buys more than a certain percentage, or more, of
the company’s shares. For example, a flip-in poison pill plan is triggered when a
shareholder buys 25% of the company’s shares. When it is triggered, every shareholder,
excluding the holder who purchased 25%, is entitled to buy a new issue of shares at a
discounted rate. The greater the number of shareholders who buy additional shares, the
more diluted the bidder’s interest becomes and the higher the cost of the bid. If a bidder is
aware such a plan could be activated, it may be inclined not to pursue a takeover without
board approval.

Bear Hug
A bear hug is an offer made by one company to buy the shares of another for a much
higher per-share price than what that company is worth. A bear hug offer is usually made
when there is doubt that the target company’s management is willing to sell.

The name “bear hug” reflects the persuasiveness of the offering company’s overly generous
offer to the target company.

By offering a price far in excess of the target company’s current value, the offering party can
usually obtain an agreement. The target company’s management is essentially forced to
accept such a generous offer because it is legally obligated to look out for the best interests
of its shareholders.

A bear hug can be interpreted as a hostile takeover attempt by the company making the
offer, as it is designed to put the target company in a position where it is unable to refuse
being acquired. Unlike some other forms of hostile takeovers, a bear hug often leaves
shareholders in a positive financial situation. The acquiring company may offer additional
incentives to the target company to increase the likelihood that it will take the offer.

To qualify as a bear hug, the acquiring company must make an offer well above market
value for a large number of a company’s shares. Since the target company is required to
look out for the best interest of their shareholders, it is often required to take the offer
seriously even if there was no previous intention to change the business model or previous
announcement of looking for a buyer.

At times, bear hug offers may be made to struggling companies or startups in hopes of
acquiring assets that will have stronger values in the future, though companies that do not
demonstrate any financial needs or difficulties may be targeted as well.

Refusal of a Bear Hug Offer

Refusal to take the bear hug offer can potentially lead to a lawsuit being filed on behalf of
the shareholders if the target company cannot properly justify the refusal. Since the
business has a responsibility to the shareholders, refusing an offer that otherwise may
seem too good to be true could be considered a poor decision.

Why Attempt a Bear Hug ?

A business may attempt a bear hug in an effort to avoid a more confrontational form of
takeover attempt, or one that would require significantly more time to complete.

The offer, though financially favorable, is generally unsolicited by the target company. The
acquiring company may use a bear hug to limit competition or acquire goods or services
that complement its current offerings.

Greenmail
Greenmail
Definition: The Greenmail is the anti-takeover tactic undertaken when the target firm buys back
its own shares at an inflated price from the unfriendly firm which possesses a large stock of the
target company and is threatening a hostile takeover.

In other words, the money given by the target firm to another company, called as a corporate
raider to buy back its own shares in order to prevent the takeover bid is called as a greenmail.
The target company is forced to pay a substantial premium to get the control over its own shares.
This strategy is also called as “bon voyage bonus” or a “goodbye kiss”.

Greenmail is like blackmail, wherein the corporate raider demands a ransom amount to release
the control over the target company’s stock. Actually, the corporate raider has no intention of
buying the target company; it just wants to make a profit from the costly buy backs.

Greenmail Outlawed

Although it still occurs in various forms, federal and state regulations have made it much
more difficult for companies to repurchase shares from short-term investors above market
price. In 1987, the Internal Revenue Service introduced an excise tax of 50% on any
greenmail profits. In addition, companies have introduced various defense mechanisms
referred to as poison pills to deter activist investors from making hostile takeover bids.

Pacman
A high-risk hostile takeover defense in which the target firm tries to take over the company
that has made the hostile bid by purchasing large amounts of the would-be acquirer’s stock.
The Pac-Man defense is supposed to scare off the would-be acquirer, which doesn’t want to
be taken over itself. The target may sell off its own assets or borrow heavily in order to
acquire enough of the acquirer’s stock to prevent the takeover.

The Pac-Man defense does not always work, but it was first successfully used in 1982 by
Martin Marietta to prevent a takeover by Bendix Corp. In 1988, American Brands used it
successfully against E-II, and TotalFina used it in 1999 to prevent a takeover by Elf
Aquitaine. Some analysts speculated that Cadbury would try to use the Pac-Man defense
against Kraft in 2009.

The Pac-Man defense may be used alone or in conjunction with other takeover defenses,
such as the white knight.

Post Merger HR and

Cultural Issue
HR Role in Merger & Acquisition: Success of merger and acquisitions depends on the
people who drive the business, their ability to drive, lead, and formulate strategy, execution
 and implementation. It is very important to involve HR professionals in merger & acquisition
as it involves people and has an impact on key people issues. HR professionals play an
active role in the change process by offering their interventions to help ensure a successful
merger and acquisition.

HR plays a vital role in

 Employees coping up with change and culture

 Organizational hierarchy structure,
 Maintaining the productivity by placing of right people at right place
 Alignment of compensation, benefits and welfare schemes
 Job security


 Relocation
 Compliance of local labour laws
 Employee communication
 Taking care of personal records

Best practices to be followed by HR during and after merger & acquisition:

 Identify leaders from both the companies for effective implementation, transition and
communication of the same to employees.
 Train managers on the nature of change
 Explain new roles to the people
 Orientation programs on policies and procedures
 Orientation programs on performance management, compensation, benefits and welfare
schemes
 Identify the skills of people and mapping them appropriately
 Town halls & Team building activities

Basic HRM practices such as recruitment, selection, training, etc. affect the performance
and stability of an organization. Thus these practices have the ability to influence employee
behavior and create values that develop organizational culture. Since the behavior change
refers to how one acts or conducts oneself, if HR practices could positively affect the
behavior, developing positive thinking about Organizational initiatives towards the
employees can help in creating value for the strategies and would result in positive results
for the business.