Acquisition Process

Madan Mohan

Richi Buru TutiB.F.Tech(Semester-6)

4/15/2014

National Institute of Fashion Technology, Hyderabad

Business Acquisition

A corporate action in which a company buys most, if not all, of the target company's ownership stakes in order to assume control of the target firm. Acquisitions are often made as part of a company's growth strategy whereby it is more beneficial to take over an existing firm's operations and niche compared to expanding on its own. Acquisitions are often paid in cash, the acquiring company's stock or a combination of both.

Acquisitions can be either friendly or hostile. Friendly acquisitions occur when the target firm expresses its agreement to be acquired, whereas hostile acquisitions don't have the same agreement from the target firm and the acquiring firm needs to actively purchase large stakes of the target company in order to have a majority stake.

In either case, the acquiring company often offers a premium on the market price of the target company's shares in order to entice shareholders to sell. For example, News Corp.'s bid to acquire Dow Jones was equal to a 65% premium over the stock's market price.

Acquisition Process

The acquisition of companies should not be a scattershot approach, since the acquiring entity will end up with a jumble of unrelated businesses. Instead, a serial acquirer typically builds a database of the companies competing in the market in which it has an interest. This may be organized as a matrix, with each company categorized by such factors as revenue, profitability, cash flow, and growth rate, number of employees, products, intellectual property, and so forth. The database will never be complete, since privately-held companies in particular are not willing to reveal information about them.

There are many sources of information that can be used to continually improve the database, such as public company filings, personal contacts, third party reports, and patent analysis. The acquirer should also maintain a listing of the acquisitions that have taken place in the industry recently, with particular attention to the market niches in which they are most common. This is useful for discerning the prices at which other sellers might expect to be sold, since everyone in the industry reads the same press releases, and so is aware of the acquisitions. A recent upsurge in prices might indicate to an acquirer that

the market is overheated, and so is not worth participating in during the near term.

This section is an overview of the buy-sell process that is detailed in the book. Of course, every business acquisition deal is different and no deal will follow these steps to the letter. However, most strategic acquisitions do follow most of the stages outlined here.

Non-Disclosure Agreement

If the target company concludes that it may have an interest in selling to the acquirer, the parties sign a non-disclosure agreement (NDA). This document states that all information stamped as confidential will be treated as such, that the information will not be issued to other parties, and that it will be returned upon request. These agreements can be difficult to enforce, but are nonetheless necessary.

Initial Negotiation

The initial question in any acquisition is whether the transaction should be structured as an asset purchase or share purchase. The answer depends upon a number of factors, including: timing, risk allocation (i.e. the liabilities, claims and encumbrances associated with the business), ease of implementation and tax consideration.

In a share purchase transaction, the purchaser acquires the corporation itself, with all of the underlying assets and liabilities. A share purchase is generally faster to complete and less complex than an asset acquisition – and it avoids many of the practical problems associated with a transfer of particular assets (such as the common requirement to obtain consent from third parties - although this may be required in certain cases - or to have the assets re-titled in the purchaser’s name). From a vendor’s perspective, a share transaction may be more tax advantageous than an asset purchase. This is because no GST or PST is payable on the sale of shares: tax liability is limited solely to taxes on any applicable capital gains (which in itself receive favourable tax treatment in comparison to tax on income). Moreover, taxes paid on capital gains may be minimized further if the business qualifies for a capital gains exemption as a Small Business Corporation. On the other hand, the vendor in a share transaction is unable to retain any existing losses (if any) in the corporation in order to off-set against future income.

In an asset purchase transaction, the purchaser selects which assets of the business (and accompanying liabilities) it wishes to purchase: it also gets to decide which assets and liabilities it wishes to exclude. Liabilities not assumed by the purchaser, particularly unknown liabilities, will remain the responsibility of the vendor. An asset purchase is often the more favourable structure for a purchaser or if the vendor is selling one division of a corporation while maintaining another. A sale of assets will generally be less favourable to the vendor from a tax perspective. This is because the sale is taxed at two levels: to the corporation when it sells its assets; and, to the shareholder (i.e. vendor) when the profits are distributed by the corporation. In an asset purchase, however, the vendor retains the ability to use existing tax losses in the corporation.

Letter of Intent

In many transactions, the purchaser and the vendor will execute a letter of intent. A letter of intent (which is sometimes called a memorandum of understanding) is a written agreement between two or more parties which is meant to confirm fundamental terms or indicate interest by a potential purchaser, as well as to open a dialogue for negotiations. It is a relatively straightforward document setting out the proposed terms of the transaction. If a deal is eventually consummated, the letter of intent may memorialize the major terms upon which a definitive agreement will be based.

A letter of intent may be binding or non-binding or a combination of both. In most cases, the letter of intent will contain binding provisions – for example, terms with respect to non-disclosure, covenants to negotiate in good faith or “no-shop” provisions granting the proposed purchaser with an exclusive right to negotiate for a specified term – even if the other sections of a letter of intent are non-binding. The purposes of a letter of intent include:

1 Clarifying the key points of a complex transaction for the convenience of the parties

2 Declaring officially that the parties are currently negotiating

3 Preventing the vendor from dealing with third parties while a transaction is being negotiated

4 Providing safeguards in case a deal collapses during negotiation

5 Binding a party to the terms of a proposed transaction even prior to the completion of all applicable conditions (in the case of a binding letter of intent).

Due Diligence

Regardless of the structure of the transaction, a purchaser will ultimately be most concerned with the condition of the business it is purchasing and the liabilities it is inheriting. As a result, in addition to obtaining appropriate representations, warranties and covenants from the vendor in the purchase agreement, a purchaser will seek to protect itself by conducting a due diligence review of the business and its assets.

Final Negotiation

The due diligence process can require a number of weeks to complete, with a few stray documents being located well after the main body of information has been analyzed. Once the bulk of the information has been reviewed, the due diligence team leader can advise the senior management of the acquirer regarding issues found and any remaining areas of uncertainty, which can be used to adjust the initial calculation of the price that the acquirer is willing to offer. The usual result is a decrease in the price offered.

If the acquirer wants to continue with the acquisition, it presents the seller with the first draft of a purchase agreement. Since the acquirer is controlling the document, it usually begins with a draft that contains terms more favorable to it. The attorney working for the seller must bring any unsatisfactory terms to the attention of the seller, for decisions regarding how they can be adjusted. If the seller does not retain an attorney who specializes in purchase agreements, the seller will likely agree to terms that favour the acquirer.

The parties may not agree to a deal. A serial acquirer should have considerable experience with which types of target companies it can successfully integrate into its operations, as well as the maximum price beyond which a deal is no longer economically viable. Thus, the acquirer should compare any proposed deal to its internal list of success criteria, and walk away if need be. Similarly, since the acquirer likely has a hard cap above which it will not increase its price, the seller must decide if the proposed price is adequate, and may elect to terminate the discussions.

Definitive Agreement

In parallel with DD above, buyer’s attorney, in support of the LOI, tenders definitive agreement and all support documents. Reservation is made to amend based on due diligence review. This is the formal document detailing the terms of the sale as agreed to by the parties. Loose ends from the LoI are tied up in this document. It is also called as “Purchase and Sales Agreement”.

Often, the lawyers are working on the P&S while due diligence is underway. Typically, there is a good deal of back and forth between the buyer's lawyer and seller's lawyer as the details are hammered out.

Closing

The closing is the final step in the acquisition process when papers are signed, money changes hands, and the company becomes yours. Traditionally, closings take place in a lawyer's office or conference room with all the parties sitting around a table and signing lots of forms. However, many closings now are largely done using fax and email such that the principles to the deal and their legal advisors are many miles apart.

Post-Closing

Now that you own your target company, it's time to operate it to make sure it achieves the intended goals.

Your first order of business is to keep your new company's employees and customers happy. Make especially sure you keep the former owner(s), who is probably now your employee, happy.

Press release, presentation with questions and answers for employees, strategy for communication to all relevant parties – employees, customers, suppliers, bankers, and service providers, this process is a ‘blitz’ effort to maximize everyone’s awareness and to do so in the shortest period possible so that minimal disruption of the business occurs.

Execution of first wave of post closing activities to implement agreed actions, designed to preserve the business and then to achieve the controls, growth, and synergies forming the basis for the “deal"