How to write your finance exam on mergers and acquisitions
What is the role of merchant banks in mergers and acquisitions?
- Preliminary stages
- Takeover code
- if a certain percentage holding (ranging from 20% to 35% in different markets) is acquired by one person or a group of persons acting together to obtain control, an offer must be made to all shareholders, essentially on the same terms on which control has been acquired.
- Up-to-date financial and other material information must be disclosed in time for shareholders to make an informed judgment of an offer. A detailed list of what is required is incorporated in the code, corresponding largely to the stock exchange's regulations for disclosure about significant acquisitions and disposals.
- The target company may not without shareholder approval at an extraordinary general meeting take any action which would effectively frustrate an offer or prevent shareholders from deciding on an offer on its merits.
- The contents of all documents and publications addressed to shareholders during the period of an offer must be prepared with the same standards of care which would apply if the document was a prospectus.
- Dealings for a period before and during the offer are subject to disclosure to the authorities and publication. If the offeror buys shares of the target company at above the offer price, it must raise its offer correspondingly.
- Guidelines are laid down for the initial and subsequent public announcements. Arrangements may be made for suspending market dealings in the shares briefly when critical new information is released. Any conditions to which the offer is subject must be announced from the outset.
- Directors of an offeror or offeree company have a responsibility to act solely in their capacity as directors, without regard to their own position.
- Other procedural aspects
Merchant banks actively go out seeking mandates to act for a buyer or a seller of a company. A mandate for a committed seller is preferred. All managements worth their salt wish to hear about opportunities. Few will say they are not interested in acquisitions. This is a far cry from actually concluding the deal. It is a simpler matter to determine whether a potential seller is serious about a sale. Once the parameters (price, terms, timing) have been established, one side of the transaction is firm. It should then not be too difficult a task to identify a buyer in the marketplace.
Acting for a seller also has advantages when it comes to fees. A firm mandate to act exclusively can be obtained from a seller whereas few buyers will wish to commit themselves in this way. In addition, a seller who has received a satisfactory price is normally quite willing to pay a reasonable fee out of the proceeds. A buyer who is already facing large payments for the acquisition may be unwilling to shoulder heavy professional fees as well.
Merchant banks will try to keep lists of current buyers and sellers in their files. However, the chances of arranging a transaction 'off the shelf in this manner are remote. Good deals tend to be done quickly. Deals that have been in the market for some time go stale. It is likely that a specific search will be needed to identify a target that is not being actively offered for sale. In a large market such as the US, an initial screening may be made by the computer to identify a range of suitable propositions.
Merchant banks will assist, if desired, in assessing the price which may have to be offered to bring an acquisition to a successful conclusion. A merchant bank's approach will tend to be market-orientated, concentrating on the price needed for success which is not necessarily the same as a valuation.
The merchant bank will often be involved in the negotiating process. Questions of price and negotiations tend to merge. If a buyer is willing to pay a high price, the negotiator need not be very skillful. A merchant bank will seek some room for manoeuvre in negotiations to improve the chances of bringing the discussions to a successful conclusion. As merchant banks are often paid substantially on a 'no foal, no fee basis, they have a strong interest in getting the deal done. This is not to say that they will not fight hard for their corner but they may also be inclined to feel that it is in their client's interest to show some flexibility.
Takeover codes operate in a number of markets where the practice is traditionally based on the UK system. In the UK, takeover activity has primarily been self-regulated through a voluntary code of practice. Such a code and its administrators rely heavily on the cooperation of the participants in the market and can be made to seem toothless when confronted by an operator determined to go his own way. On the other hand, since legal procedures are avoided action within the scope of the code can be taken swiftly and informally. Not all concepts need to be precisely defined, as considerable reliance is placed on the 'spirit' of the code. This discourages participants from exploiting loopholes in the rules which may be considered legitimate where regulation is by law alone. It can, however, lead to a considerable argument about whether an action, particularly when a new tactic first emerges, is within the spirit of the code or not. Voluntary codes are based on a core of general principles designed, among other things, to ensure equal treatment for all shareholders, proper provision of information and advice, and adequate time for response to an offer. The principle that all shareholders should be treated equally has gained particular prominence, although in some markets it is freely acknowledged that a block of shares that confers control should be valued more highly than a small holding.
Detailed rules are drawn up or amended in response to specific problems which arise. This approach can resound in the clang of stable doors being locked after the horse has bolted. Rules are designed to prevent perceived abuses. By the time new rules are introduced, the market conditions which generated those particular abuses may no longer exist.
A number of important provisions have proved relevant despite changes in the market and include the following:
As there is an element of vagueness in voluntary codes which rely on compliance with the spirit as well as the letter of the regulations, it is essential to have an informed and responsive body to administer the code. This body is constantly available for consultation and to give rulings on points of doubt. It is normally staffed by a combination of civil servants and practitioners. There may be a full-time secretariat plus a committee that can be convened at short notice to consider urgent questions. There will be a provision for appeal against the committee's decision. Practice notes supplementing the rules will be published regularly to provide up-to-date information about significant decisions made by the committee or the secretariat.
When negotiations have been concluded, the merchant bank will usually take the lead in coordinating documentation. Offer documents contain much legal and accounting information which the merchant bank will not have prepared. The merchant bank's role is to draw the various parts together into a consistent whole. This document will then be submitted to various regulatory authorities for their comments,
Once the document has been put together and cleared by the relevant regulatory agencies, the merchant bank oversees the process of distributing it to shareholders. The merchant bank will also monitor response, often drafting in numbers of people to assist in contacting shareholders or soliciting proxies. If a company meeting is involved and difficult questions are anticipated, a rehearsal may be held to prepare the executives involved for what may be ahead. A list of expected questions and model answers will be drawn up.
Throughout this period, the merchant bank will be monitoring the reaction in the market and watching for an opportunity to pick up shares in the target company at advantageous prices. In addition, it may organize some support for the shares of the offeror.
When necessary, the merchant bank may organize and provide finance for acquisitions. Although merchant banks rarely do much straightforward lending. They may be involved in identifying suitable lenders and negotiating terms with them. If the takeover is being financed by the issue of securities, the merchant bank, in conjunction with the company's stockbrokers, may assemble a syndicate to buy or underwrite the securities being issued.
Explain In Detail the Role of Accountants in Acquisition
- Accountant's report
- Impact on acquirer's accounts
It is prudent for a purchaser to seek a full accountant's report on the business he is buying. A seller is likely to oppose an accountant's investigation, at least until a late stage in the negotiations. Not only does the report represent a further substantial hurdle at which the deal may fall, but it also involves disruption to day-to-day business and can be damaging to the morale of existing staff.
The basic methodology of the accountant's report is to take each significant item in the financial statements and examine it to ensure that any unusual or doubtful aspects are brought to the attention of those deciding the offer price. Any items of potential under- or over-valuation will be highlighted, together with items that may not be directly reflected in the balance sheet but could have an impact on value such as guarantees, litigation and lease obligations. Comments may be made on the adequacy of systems and the general competency of management. The quality of earnings should be scrutinised by the accountants. It is normally possible for a company to produce better-than-average results for one year by including items that may previously have been held in reserve. Particularly in a private company, there is no incentive for the owners to increase their tax bill by showing a high level of profitability.
Companies may follow different policies in accounting for profits. Certain sales of assets may be included in profits before taxation by some companies and treated as extraordinary items by others. In general terms, it is only to be expected that the sellers will groom their company for sale and present the figures in the best possible light.
An accountant's report is a very useful reference point in the analysis. Often the seller refuses to allow it to be carried out. Where permission is given the buyer should regard the report as a thorough check but not a substitute for thought and analysis of their own. In the final reckoning, the acquirer must form their own view of value.
An acquisition can have a significant impact on the balance sheet, profit and loss account, and dividend-paying ability of the enlarged group. The acquirer's accountants are in the best position to assess this impact.
What factors do accountants consider during an acquisition?
- Cost of acquisition. The cost of acquisition is based on the consideration provided by the vendor. In the case of cash or loan stock, it is the amount paid or issued. In the case of shares, it is the market value at completion of the number of shares issued, unless some unusual factor makes the market price misleading, in which case some other measure such as net asset backing could be substituted. The expenses of the acquisition may also be added.
- Goodwill. The cost of acquisition is compared with the 'fair value' (based on open market value) of the assets acquired.