Questions and Answers to Help You Prepare For Your Mergers and Acquisition Exam
What role do lawyers play in mergers and acquisition?
- Heads of agreement
- Formal sales and purchase agreement
- Public offer
As the framework of an agreement emerges the lawyers may be involved in drawing up a preliminary summary of the transaction called a "heads of agreement'. Opinions vary as to whether it is helpful to reduce the main terms of an agreement in principle to a written form, which is signed or initialed even though it is not legally binding. Heads of agreement can serve to clarify and record the intentions of the parties and to bring into focus any major areas of dispute. Some vendors regard a head of agreement as a necessary stage before they are prepared to release sensitive information about their business.
Another view is that to sign an agreement that is not legally binding is to interpose an unnecessary step in the negotiations. Because the parties know the agreement is not binding there may be a tendency to fudge difficult issues so that the meeting of minds is more apparent than real. The parties may feel that there is a substantial measure of understanding between them when in fact there is not. Frustration may set in later because negotiations appear to be going backward. The transition from heads of agreement to a legally binding contract can be as difficult as arriving at the heads of agreement in the first place.
If the principals intend to sign a formal sale and purchase agreement, the lawyers for both sides will play a prominent part in drawing it up. Successive drafts of the agreement may be used as a vehicle for advancing the negotiations so the role of draughtsman and negotiator become mingled. At this stage, the person drafting can insert ideas of his own as well as reflect the results of discussions which can give rise to antagonism and accusations of bad faith. A lawyer may gain the trust of his opposite number as well as his own clients if he can fairly reflect in the documentation what has been agreed between the two principals. This approach is often ultimately more effective than a more adversarial style.
The lawyer's role in the formal stages of a public offer is pervasive. He will be closely involved in reviewing all aspects of the documentation with particular attention to the matters required to be disclosed by law and other regulations. The detailed terms of the consideration under the offer, its conditions, and the rights of the securities which form part of it will be carefully examined and precisely worded. If the takeover is by way of a scheme of the arrangement, the legal procedures will set the framework and timetable for the entire transaction.
A number of tactics, particularly in defense, are the province of the lawyer. Various provisions may be built into the company's articles of association, designed to repel an unwelcome bidder or make his bid prohibitively expensive. To be effective, such measures need to be introduced and worded with extreme care. The company's lawyer will be called upon to shepherd the directors through each step. Other defensive maneuvers may include appeals to anti-monopoly legislation and contact with the bodies which administer it. The company will look to its lawyers to take the lead in organising the necessary presentations and meetings.
Offers and defenses require a plethora of approvals by boards and individual directors. In a situation where their handling of affairs may come under close scrutiny, directors will seek such comfort as they can obtain that all the documents are accurate and complete. The lawyer will be responsible for organising the necessary verification procedures and documentation. They will also prepare detailed board minutes for use as an agenda for directors' meetings to ensure that all necessary areas have been covered. After documents have been approved, the lawyer will ensure that they have been cleared or filed with all the relevant authorities.
Which tax aspects must be put into consideration during mergers and acquisitions?
Advice on tax may be provided either by accountants or lawyers involved in the transaction or by specialist tax advisers.
The taxation aspects of acquisition are often the most technically complex part of it, particularly in countries such as the US and the UK. General guidelines can be misleading in particular circumstances but points which an acquirer should be alert to include:
- Transfer duty
- Capital duty
- Tax on income stream
- On the sale of investment
- Tax liabilities of the company being acquired
When shares are bought and sold, a duty is normally payable on the registration of the transfer. In a stock market transaction, the practice is for the buyer and seller to pay their own duty. This practice may be followed in the acquisition of a private company. In the case of a public company, the terms of the offer generally include a provision for the buyer to pay both buyer's and seller's transfer duty.
Various methods are available to eliminate or reduce the transfer duty payable. A scheme of the arrangement, which works by cancellation and reissue of shares. does not technically involve a transfer and therefore no duty is payable. If a scheme of arrangement cannot be used, it is sometimes possible to reduce the value of the shares being transferred for example by the issue of new shares. Existing shares are converted to deferred shares carrying inferior rights and therefore having a low value. Transfer duty, which is charged by reference to value, is reduced. However, tax regulations are subject to change to counter this type of reorganization.
Where shares are issued as part of the consideration, it is likely that capital duty will be payable. The duty is based on the value at which the shares are considered to have been issued. Loan capital does not normally attract such duty.
When calculating the return from an acquisition, it is important for a purchaser to determine what return he requires in cash and where it is to be received. In the case of acquisitions outside the acquirer's own tax domicile, the dividends, interest, management fees and the other components of the return may be subject to withholding and other taxes. The appropriate domicile of the ultimate holding company will be influenced by political stability, ease of communications and access, taxes on capital and income, and other expenses of operation.
In countries that permit grouping for tax purposes, it is likely to be advantageous if the immediate holding company for the investment is domiciled in the same jurisdiction as the investment. This may permit interest payable on loans used to finance the investment to be offset against the taxable profits of the acquisition. It is unlikely that the investment holding company will make profits on an unconsolidated basis if there is even a moderate amount of gearing in its capital structure.
Countries that levy a withholding tax on dividends normally have tax payments that may be made in place of dividends, such as interest on shareholders' loans, management fees and royalties.
The individual tax position of shareholders who receive an offer, particularly in cash, will be relevant. Shareholders may be subject to tax on disposal which will reduce the apparent attractiveness. A share-for-share exchange on the other hand is not normally treated as a disposal until the shares received in exchange are themselves disposed of.
Where an investment is likely to be sold again, it may be useful to place it in an intermediate holding company. The tax implications of the disposal require prior planning to enable the most suitable holding structure to be established. It may well be advantageous to sell an offshore company holding or controlling an investment rather than to sell the investment itself.
In countries where the depreciation bases for tax purposes and for accounting purposes vary, it will be necessary to ensure that any discrepancy between the tax written-down value and book cost of assets has been taken into account.
On occasions, a major item of value, or even the prime purpose of an acquisition, is a tax loss available to offset future profits earned by the company being acquired. There may be limitations on whether such tax losses can be fully utilized after a change of control of the business which requires careful examination. If the nature of the business also changes, the continued availability of tax losses will be further jeopardized. In the case of private companies, tax liabilities may arise through the tax position of their previous controlling shareholders. An indemnity from the vendor in the sale and purchase agreement is usually considered sufficient to cover this point.
Which Other Professionals Are Valuable And Must Be Considered During Mergers And Acquisitions?
Depending on the nature of the transaction various other professionals may be involved in one or more stages.
In a public company takeover, the firm of stockbrokers will have a particularly key role. They will normally handle the necessary liaison with the stock exchange authorities as regards public announcements, trading arrangements, and clearance of the offer documents.
The stockbroker is in a position to offer informed advice on what price may be acceptable to major stockholders and will liaise with stockholders who are their customers to obtain their views on the situation. Both the offeror and offeree companies may organize market operations to provide support for their respective share prices and sometimes to destabilize their opponents. This cut- and-thrust role in the market is very much the province of the stockbroker. If the offer requires financial support through underwriting, the stockbroker will play a leading role in lining up a syndicate of underwriting institutions.
If a substantial volume of commissions is generated through dealings in the market, the stockbroker may be prepared to handle other functions for a fairly low fee. On other occasions where a stockbroker has provided a corporate finance advisory service without handling a large volume of market transactions, a higher level of fee will be charged.
If the companies concerned in a takeover have a substantial amount of fixed assets it may be desirable (or required) to commission a revaluation. The valuer chosen should be independent of the board and of sufficient reputation that his opinion will stand up under any crossfire which may arise. He should be alive to the possibility of different valuations for different uses of the property and should present a 'best alternative use' value so that this can be considered in negotiations and communications with shareholders.
In the closing stages of an offer, the registrars or receiving bankers may be heavily involved in counting acceptances. There have been occasions where two parties have claimed to have received over 50% acceptances.
A measure of double-counting and other mistakes are likely to occur under pressure. Last-minute circulars and other documents may be required so that the less glamorous functions of proofing, printing, and getting documents dispatched can become highly critical. Merger and acquisition work requires a decisive hand. Behind the high-profile announcements and decisions, a great deal of teamwork and specialist support is required. Constant coordination is essential to ensure that the various professionals involved are not either treading on each other's toes or missing an important area on the assumption that someone else must be covering it.