Table Of Contents
- Walk me through a standard M&A process
- What is the difference between an asset deal and a share deal?
- In which cases would an investor prefer an asset deal over a share deal?
- What is a letter of intent?
- What are financial buyers? What are strategic buyers?
- What is a management buyout (“MBO”)?
- Why are strategic bidders usually able to pay higher purchase prices?
- What is a due diligence?
- Which are the three ways of structuring a company sale?
- What is the difference between signing and closing of a transaction?
- What is the advantage of a closing accounts mechanism?
- What is the difference between closing accounts and locked box mechanism?
- What is a fairness opinion?
Walk me through a standard M&A process
What is the difference between an asset and a share deal?
A share deal relates to the purchase of company shares while an asset deal is the purchase of individual assets.
In a share deal, buyers acquire the company by purchasing an individual amount of the shares of a partnership or corporation – this could be a minority stake or full ownership.
In the case of an asset deal, the buyer purchases the assets belonging to the company and have the individual assets transferred: production facilities, land, real estate, equipment, inventories etc, as well as contracts, receivables and liabilities of the company. An asset deal allows for “cherry picking” while excluding certain liabilities.
In which cases would an investor prefer an asset deal over a share deal?
There are numerous reasons for that. Let’s name a few:
- Goodwill amortization – In some countries and tax jurisdictions it is possible to amortize the goodwill over a certain period of time and that way reduce taxable income.
- Sometimes investors only want to buy certain assets. Sellers could carve-out the assets into a new entity and sell the respective shares, or, without the hassle for the seller, just sell the assets via an asset purchase agreement.
- “Cherry Picking” – An asset deal allows for investors to only pick, what they really want
- Excluding liabilities – through an asset deal it is possible to exclude unwanted liabilities
What is a letter of intent?
The letter of intent is a non-binding agreement between seller and buyer to purchase a company or assets. The non-binding character is a consequence of the timing of that agreement – usually after having received the information memorandum, but before the data room phase and the possibility to conduct a due diligence. Subsequently, no buyer would enter into a binding agreement without having thoroughly analysed every aspect of the company and confirming what the seller stated in the information memorandum.
What are financial buyers? What are strategic buyers?
A strategic buyer is a party, usually a corporation, that intents to buy another operation due to strategic reasons. These reasons can for example be to eliminate a competitor, consolidate the market to increase market share and margins through synergies, expand the current product or service portfolio to diversify revenue streams, etc. Strategic buyers generally assess an acquisition based on the impact it has on their current business.
As opposed to strategic buyers, financial buyers usually view a target as a stand-alone investment, which they can improve operationally, recapitalize the financial structure and at the end ideally sell at a much higher purchase price. There are many investor types which fall under the category financial buyers, who focus on companies in different stages of their lifetime, business sizes, shareholding stakes, sectors etc. At the end, these investors want to realize a return on their investment by increasing cash flows and through cashing out by way of selling their shareholdings at the end of the holding period.
Financial investors are for example leveraged buyout (“LBO”) funds, venture capital funds and growth equity funds.
What is a Management Buyout ("MBO")?
A management buyout is an acquisition of a company by the current management of the to be acquired company.
This can take place in the form of a takeover of an entire company or a part of a company that is spun off. As opposed to LBOs where management often gets a little share of equity to keep them involved in the company and motivate them to go on, MBOs give the management at least a controlling shareholding. MBOs are similar to other acquisition forms, with the exception that the buyers usually know the company already in-depths and no due diligence and only limited reps and warranties are required. This can speed up the acquisitions process and tremendously reduce costs on both sides. However, managers often don’t possess the funds necessary to finance the deal, so they must take on a loan by either a bank or finance the deal through a vendor loan, where the seller is not receiving the full purchase price as of closing but out of the cash flow of the business over the upcoming years. Further to the aforementioned methods, the management buyers can also look into private equity (a high proportion of MBOs are financed this way) or private debt financing. These however impose specific terms and conditions on the management and on how the company has to be run, which often is not in the interest of the management, but might be the only way of financing, if bank and a vendor loans are out of question.
Why are strategic bidders usually able to pay higher purchase prices?
The keyword here is synergies.
Imagine a strategic and a financial player bidding for an asset that has a fair purchase price (based on future cash flows to be generated) of €10m, so both parties would usually be able to pay a price of up to €10m. However, as the strategic buyer can generate synergies, let’s assume 30%, he would be able to pay up to €13m. In normal circumstances a strategic buyer would only partially pay for possible synergies, but nevertheless has the possibility to pay beyond what is possible for financial investors. For the sake of completion, it should be mentioned that through financial investors that make a bolt-on purchase to their current holdings and therefore realize synergies themselves, as well as through a large portion of dry powder available (at least pre-Corona), the margin of what’s possible in terms of purchase price between strategic and financial investors keeps shrinking.
What is a Due Diligence?
One of the most important assessments of the target company is the so-called due diligence (“DD”). There is a large information asymmetry between the buyer and the seller that the DD aims to reduce, while assessing opportunities, risks, deal breakers etc. of the target company. There are generally two types of DD processes: (i) the buy-side DD, where the provider analyses the target company, and (ii) the sell-side or vendor due diligence (“VDD”), which are detailed reports prepared on behalf of the seller that will be send to potential buyers, amongst other things, to reduce the workload in case of multiple buyers. There are a wide range of areas which DDs can cover, the most common being financial, tax, legal, commercial, operational as well as IT/technical DD.
Which are the three ways of structuring a company sale?
- A broad auction, in which a large number of potential investors are addressed,
- A targeted auction, where only a few selected players are invited into the process, or
- A negotiated sale, which usually takes place with only one, maximum two parties. For more information, please refer to our article about The M&A Process Steps.
What is the difference between signing and closing of a transaction?
Signing relates to the process of agreeing on the terms and conditions of a transaction and contractually manifest them by setting forth the rights and obligations of the parties involved. The signing itself does not necessarily result in the actual transfer of assets, as there might be certain conditions to be met (e.g. informing employees, carve-out of assets, regulatory approval) before the actual transfer can occur and, hence, the transaction is fully completed. The acquirer can generally only reap the fruits of the business, respectively the share in net profit, once all closing conditions are met and closing has occurred. It should be noted, though, that parties can agree that the acquirer shall already receive the benefits of the acquired assets (and also bear related risks) from a date prior to signing, i.e. the economic transfer can occur at a point in time prior to signing (example: locked box). In case of no closing conditions, signing and closing can fall on the same date.
Closing refers to the completion of a transaction. It is the starting date from which on the acquirer has actual control over the assets resp. the business. In case the parties have agreed on an economic transfer date prior to closing, the acquirer is entitled to the fruits of the business already from this point in time Closing happens when all relevant conditions precedent of the contract are fulfilled and all relevant closing actions have been undertaken by the parties. The conditions precedent can be defined by both parties and, sometimes rely on the regulations in each country. In many cases, the obtaining of an antitrust clearance is the sole – or at least most relevant – condition which needs to be fulfilled before an effective completion. It should be noted that, in some countries such, e.g. the UK, the antitrust ruling will not stand against an effective completion.
What is the advantage of a closing accounts mechanism?
In case a transactions includes conditions precedent which need to be fulfilled before an effective completion, signing and closing do not take place at the same point of time. This would give the seller the opportunity to optimize his cash flow by not paying his short-term payables but collecting all receivables to the disadvantage of the buyer (remember: the economical transfer of the business takes place as of closing). Therefore, parties agree on a working capital target (e.g. the average of last twelve months working capital), which will lead to purchase price adjustments if the working capital as of closing differs from the target working capital.
What is the difference between closing accounts and locked box mechanism?
In short: Both are pricing mechanisms – the key difference is the point of time of the economical transfer and the working capital adjustments related thereto.
By way of using a closing accounts mechanism, buyer and seller agree on a target working capital at the moment of singing – for example the average of the last twelve months – and will adjust the purchase price if the actual working capital as of closing differs from the target working capital. In order to do so, the company that was sold will create a new balance sheet as of closing (“closing accounts”). This is used, as the seller could deliberately manipulate the cash balance of the company by delaying payments until after closing as well as aggressively pushing for receivables to be paid.
In a locked box mechanism, the buyer acquires a company based on a historic balance sheet (the “locked box date”). That means that both parties are already aware of the working capital as of signing and there will subsequently be no adjustments as of closing. There is however the possibility for the seller to leak out some assets – the so called “leakage” – which must be defined in the purchase agreement. This mechanism has the advantage that it gives seller and acquirer a certain price certainty.
What is a fairness opinion?
A fairness opinion is a professional evaluation of a transaction by a third party, mainly in relation to whether the terms and conditions are fair. Often, a fairness opinion is required in the sale of public companies and appointed by senior executives involved in the deal, as the external opinion reduces the risk of potential errors of individual decisions and to some extend protects the decision makers should something go the wrong way.
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