Modes of Effecting M&As, Factors to consider

Before the entrepreneur decides upon a particular mode to effect the M&A transaction, there are some factors that influence it and must be considered seriously to reach a sound business decision. Once these factors are considered, he will be faced with the choice of selecting the mode of effecting the M&A transaction. Different factors influence the mode of effecting M&A such as:

Factors to consider while choosing the mode:

-???????The Consideration

The buyer has to decide how to finance i.e., pay for the M&A transaction, this is known as the consideration for acquiring or merging with the other business. The consideration can be either in cash, shares or equity, promissory notes or through debt financing, movable property such as the raw materials, goods and other stock of the company, immovable property such as land, buildings, factory premises or intangible property such as patents, trademarks, copyrights, trade secrets etc.

The choice of consideration can have an immense impact on the financials of the merged or acquired company. Post the acquisition or merger, the company’s Earnings Per Share (EPS) values may increase (known as Accretion) or decrease (known as Dilution). A pre-transaction analysis using a merger model shows how the EPS Ratio is affected post the transaction and if it is beneficial to the buyer’s bottom line.

Another significant consideration is what the company’s credit structure will look like after the transaction. If a promissory note or a form of debt finance is used as consideration, whether wholly or partly, the company will acquire debt in its balance sheet which may also lower its credit rating and financial stability in the market. Therefore, the choice of consideration greatly influences the business performance of the company post the M&A transaction.

-???????The Accounting Method

Many accounting entries need to be entered into the company’s books of accounts before the transaction is complete. Some of these entries are:

·??????Purchase Price Allocation

This entry reflects the amount that is paid in consideration of the assets or liabilities that are acquired during the transaction. This entry is important as it is used to determine the amount the goodwill which balances the entry.

Assets + Goodwill – Liabilities = Purchase Price

·??????New Depreciation and Amortization from Write-ups

The intangible and tangible assets that are acquired need to be depreciated and amortized in the books of the new company and reflected in the Profit and Loss Account i.e., Income Statement of the company.

·??????Creation of Goodwill

Goodwill is an intangible asset i.e., it has no physical existence and cannot be felt, touched or otherwise perceived by the senses. However, it is a huge part of the business’ success and includes items like the company’s brand name, patents, trademark, technology, customer base, client lists, a stable workplace, business processes, efficiency, etc.

Goodwill = Purchase Price – (Assets – Liabilities)

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-???????The Tax Implications

Taxes on cash, asset and stock sales are calculated differently, with different tax benefits given for each. There is a higher incidence of tax liability on cash sales compared to an asset or stock sales. Asset sales are beneficial to the buyer because he can deduct depreciation from the taxes payable in future as depreciation is a non-cash liability. On the other hand, stock sales have lesser taxability as they are not subject to gains taxes.

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-???????Synergies

Synergies are also called economies of scale and the reason why companies merge or acquire other companies in the first place. It is to increase their capacities for production and achieve greater efficiency and opportunities for themselves that they would not have had individually. It is a method to increase their profits and EPS.

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-???????Strategic Rationale

There should be some value added to the company that makes sense for it to undertake an M&A transaction. This strategic advantage to the company’s business can be any of the following forms or some other form also:

i.??????Financial synergy

ii.????Operational synergy

iii.??Growth

iv.??Increased power in the market

v.????Greater Corporate Tax Savings

vi.??Retirement

vii.?Tax Incentives

viii.???????????????????Resolving Market/Business/Product Line issues

ix.??Acquire needed resources such as labor, machinery, technology, access to customers, raw materials, supply chains, etc.

x.????For the purpose of Diversification

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?-???????Intangible Property

These properties do not have a physical existence except in law but can bring immense business and competitive advantages for the company. They may be in the form of customer lists, clients, patents, trademarks, copyrights, designs, etc. They may also include goodwill, brand value, employee non-compete agreements, trade secrets, technology, business processes and techniques, business strategy, etc. that give a competitive advantage but are not capable of protection as intellectual property rights.

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The Modes of Effecting M&A:

1.????Vertical

The transaction is vertical in nature if two companies providing the same goods or services but in different stages of production come together. For example, if a retail store takes over a textile manufacturer, it is a vertical acquisition. They are both in the same industry i.e., the clothing industry but are at different stages across the supply chain because the retailer is in the tertiary sector and the textile manufacturer is in the secondary sector.

This type of transaction is usually undertaken to maintain greater control over and reduce disruptions in the supply chain as in this example, the retailer has greater control over the manner of sales and is guaranteed the supply of the clothes and can reduce the costs of the manufacturer and other middlemen. It also has the advantage of restricting supply to competitors and giving greater shares of profits and revenues.

2.????Horizontal

Horizontal M&A happens when a company merges or takes over a company operating in the same industry, produces the same product and is at the same stage of production. Often, this company will be its direct competitor in the market. For example, if a company manufacturing cars acquires another company that also manufactures cars. The advantage of this mode of M&A is that it removes competition from the market, helps to achieve operations of scale and reduces costs because many repetitive procedures and multiple departments such as the sales, advertising and marketing departments are eliminated as wasteful, repetitive and redundant activities are removed from operations.

3.????Concentric

These types of mergers are usually between companies having complementary products with common customers in a common industry, but which do not offer the same products or services. Let’s take the example of a company selling smartphones merging or acquiring a company that sells phone covers or screen guard protection for phones. These two products go hand-in-hand as customers will invariably buy the phone covers or the screen guards, the same time they buy a new phone. Therefore, the products are complements of each other and this will be known as a conglomerate transaction.

The benefits of such a transaction are many. They are usually undertaken to facilitate customers as it is easier to sell these products together. It helps the company to diversify, thereby increasing its profits and reducing risk in its product portfolio. Thus, the company can manage to create a one-stop-shop facility for its customers and provide an attractive product mix. In this way, the sale of one product invariably increases the sale of the other and the sale of even one product can double the company’s revenues.

The two companies involved in the M&A usually have some association with each other. They may either have the production process, business markets or basic technology in common. It may also entail the expansion of product lines. This type of M&A transaction opens up new opportunities for the company to enter into another industry or explore previously inaccessible markets.

4.????Conglomerate

If two companies from entirely different industries, irrespective of the markets they’re in, their customer base, or their stage of production, enter into an M&A transaction with each other, it is a conglomerate merger. It is usually undertaken to enter new industries and to diversify risks.

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Forms of M&A:

·???????Statutory Mergers

This form of a merger is said to occur when the acquirer is a much larger company than the target company and takes over all of its assets and liabilities in such a manner that the target company ceases to exist after the transaction is complete.

·???????Subsidiary Mergers

In a subsidiary merger the target company i.e., the company that is acquired, becomes the subsidiary of the acquiring company and continues its operations as a subsidiary. Thus, its existence continues post the transaction as well, albeit under the control of the acquirer company.

·???????Consolidation

In a consolidation form of merger, both the companies involved in the transaction consolidate i.e., come together to merge into a completely new entity having separate legal existence or identity and the companies involved in the transaction cease to exist after the deal.

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This is sixth article in the series on M&A by our student researchers Swasti Patoria, Annapurna Prabhu, Astha Agarwal, Aayomi Sharma, Amrutha Alapati and Aradhya Singh, students of Jindal Global Law School, Symbiosis Law School, Pune and Noida