You can’t have a much more important agreement than one involving mergers and acquisitions.
It can help your company reach new markets, eliminate the competition and gain new clients.
It can also turn into a complete nightmare, financially and operationally, if you don’t do your legal homework and protect yourself in the merger/acquisition agreement.
Our expert lawyer, Hugh Mulley, shares the key things you need to know about both Mergers and Acquisitions to avoid hidden risks.
What is the Difference Between a Merger and an Acquisition?
The term Mergers and Acquisitions is generally used to describe the amalgamation of two or more entities (generally, companies). The concepts are often used interchangeably and somewhat loosely and in some situations the differences between them can be slight, however, they tend to have different characteristics.
What is an Acquisition?
An acquisition will take place where one entity, usually a company (which we’ll call Company A) acquires the shares, or assets and often business, of another (let’s call it Company B). Where Company A acquires a majority of Company B’s shares, Company B will become its subsidiary, and where Company A acquires Company B’s assets and business, they’ll become part of Company A’s business to be used by it in its future operations. The dominant factor in each case is that Company A has acquired (or, if you like, taken over) Company B, or its assets and business.
It will also be a type of acquisition if someone (perhaps a private equity investor invited to invest in a private company) invests in a company, in this case they’ll be acquiring shares (often a minority stake).
What is a Merger?
A merger, on the other hand, suggests the coming together of 2 entities (again, generally companies) on a more ‘equal footing’. For instance, in a ‘pure’ merger, each proposed merger partner may agree to transfer their existing company or business into a new company, in return for a 50% stake in it, following which their only interests will be in the ‘merged’ company. Mergers are generally perceived as being of a more ‘friendly’ nature than acquisitions in that the parties join with a common purpose, rather than one acquiring something from the other.
In the case of private companies, acquisitions are far more common than mergers. Typically someone wants to sell their company or business, they find a willing buyer and the acquisition will be completed.
In some situations, whilst arguably an acquisition, a transaction may look a lot like a merger. If (using the same terms as above) Company A acquires Company B’s shares or assets, but under the terms of the transaction, Company B’s seller acquires a 50% shareholding in Company A, they’ll end up owning half of the overall combined business. Commercially speaking that looks very much like a merger.
Even if technically an acquisition, there may be presentational reasons why the parties prefer to loosely refer to a transaction as a merger (sounding a bit more ‘friendly’, inclusive and collaborative). For instance, they may be continuing to work together and prefer to give the impression that they do so as ‘equals’, or feel that it will be less unsettling to customers and staff to call it a merger.
Why undertake a Merger or Acquisition in the first place?
In an acquisition, one party is likely to be looking to sell their shares or business. There may be a variety of reasons for this, including retirement, a desire to realise a return or raise cash or exit a particular market, and so on.
That seller has to find a willing buyer and there may be a number of reasons why someone might be interested. They may believe that buying an existing operation will be a quicker and more cost-effective way of setting up in that market than starting from scratch and/or that it’s necessary to acquire the ‘target’ company or business, to prevent it from falling into the hands of a competitor. Perhaps that ‘target’ contains certain key assets that the buyer wants (maybe some important personnel, or some kind of licence, approval, or technology). Whatever happens; the buyer is likely to have identified key cost savings or advantages that it believes can be gained from the acquisition (e.g. the removal of duplicate or surplus overhead, operations, staff or assets).
In general terms, a buyer will need to assess (rightly or wrongly, time will tell!) whether the value that the acquisition will add to the combined operation will outweigh the time and cost involved in making it.
Rather than making a strategic acquisition of all or substantially all of a company or business with the intention of operating it themselves as referred to above, someone (for instance a private equity investor) may wish to invest in it. The investor will need to calculate whether, factoring in the available information, the risks involved and the legal protections that they’re able to obtain, the investment will generate an acceptable return over a projected period (often around 5 years).
Any buyer or investor should carry out as much due diligence as possible on the ‘target’ before completing the acquisition.
A merger will be driven by each merger partner’s expectation that the value of their interest in a merged operation will (in time) exceed the value of their existing business had they continued to operate it independently.
Perhaps they feel that their individual business is too small to succeed independently or that the risk and cost of following a separate path is too great, and that a combined operation will allow for the more effective pooling of resources, technology and overhead and the more acceptable sharing of risk. Prime candidates for a merger may be businesses in very capital intensive industries (for instance where continued operation requires substantial research and development costs), where the attractions for teaming up are great.
Each merger partner should carry out adequate due diligence on the business that their partner is proposing to introduce to the merged operation, as any unforeseen problems or liabilities may have an adverse effect on the merged value and therefore the value of the individual stakes in it.
Any Merger or Acquisition will raise legal, tax and accounting challenges.
The relevant transaction will be completed by way of an agreement, if it’s an acquisition this will normally be a sale (or purchase) agreement. Where the acquisition is made by way of an investment, the agreement will be an investment (or similar) agreement.
The agreement will set out the transaction terms, and generally include a number of protections (normally warranties and indemnities) for the acquiring party or investor. The drafting and negotiation of these is often a rigorous and contested process, as the buyer (or investor) seeks to make them as extensive as possible, and the seller or company aims to minimise them.
In a merger, there will be some kind of merger or transfer agreement transferring the respective parties’ assets into the merged operation. In this case, the agreement will contain protections in favour of that operation. Merger partners may also need advice on a shareholder’s or similar agreement setting out how the merged operation will be run.
How can we help?
Parties should take early legal advice on any merger or acquisition.
This will include initial advice on its overall structure, on the terms of the relevant documentation and, where appropriate, on any relevant due diligence process. Acquisitions or mergers having an appreciable effect on competition in the relevant market may also be subject to competition law. Timely legal advice should be sought if this is likely to be the case.
Make sure you work through all the commercial and legal issues associated with taking in investment (including share price, due diligence, warrantee, dilution and exit).
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The author of this article is expert LawBrief Hugh Mulley. Hugh Mulley is a City trained corporate and commercial solicitor with over 20 years’ experience acting for clients across the business spectrum. He has a background in major London Law Firms, including a period of 4 years working as a lawyer in the Middle East, and was head of the corporate commercial group at a leading Hertfordshire Law Firm.