1. A merger occurs when one firm assumes all the assets and all the
liabilities of another.
2. The acquiring firm retains its identity, while the acquired firm
ceases to exist.
3. A majority vote of shareholders is generally required to approve a
4. A merger is just one type of acquisition. One company can acquire
another in several other ways, including purchasing some or all of
the company's assets or buying up its outstanding shares of stock
5. In general, mergers and other types of acquisitions are performed
in the hopes of realizing an economic gain.
6. Some of the potential advantages of mergers and acquisitions
include achieving economies of scale, combining complementary
resources, garnering tax advantages, and eliminating inefficiencies.
7. Other reasons for considering growth through acquisitions include
obtaining proprietary rights to products or services, increasing
market power by purchasing competitors, shoring up weaknesses
in key business areas, penetrating new geographic regions, or
providing managers with new opportunities for career growth and
1. When a small business owner chooses to merge with or sell out to another
company, it is sometimes called "harvesting" the small business.
2. In this situation, the transaction is intended to release the value locked up in
the small business for the benefit of its owners and investors
3. The impetus for a small business owner to pursue a sale or merger may
involve estate planning, a need to diversify his or her investments, an
inability to finance growth independently, or a simple need for change.
4. In principle, the decision to merge with or acquire another firm is a capital
budgeting decision much like any other But mergers differ from ordinary
investment decisions in at least five ways.:
• First, the value of a merger may depend on such things as strategic fits that
are difficult to measure.
• Second, the accounting, tax, and legal aspects of a merger can be complex.
• Third, mergers often involve issues of corporate control and are a means of
replacing existing management.
• Fourth, mergers obviously affect the value of the firm, but they also affect
the relative value of the stocks and bonds.
• Finally, mergers are often "unfriendly."
Horizontal mergers raise three basic competitive problems.
• The first is the elimination of competition between the merging
firms, which, depending on their size, may be significant.
• The second is that the unification of the merging firms'
operations may create substantial market power and could
enable the merged entity to raise prices by reducing output
• The third problem is that, by increasing concentration in the
relevant market, the transaction may strengthen the ability of
the market's remaining participants to coordinate their pricing
and output decisions.
• The fear is not that the entities will engage in secret
collaboration but that the reduction in the number of industry
members will enhance tacit coordination of behavior.
WHAT MERGER DOES ?.
• The guidelines prescribe five questions for identifying
hazards in proposed horizontal mergers:
• Does the merger cause a significant increase in
concentration and produce a concentrated market?
• Does the merger appear likely to cause adverse
• Would entry sufficient to frustrate anticompetitive
conduct be timely and likely to occur?
• Will the merger generate efficiencies that the parties
could not reasonably achieve through other means?
• Is either party likely to fail, and will its assets leave the
market if the merger does not occur?
TYPES OF MERGERS
1. In general, acquisitions can be horizontal, vertical, or conglomerate.
2. A horizontal acquisition takes place between two firms in the same line of
business. For example, one tool and die company might purchase another.
3. In contrast, a vertical merger entails expanding forward or backward in the
chain of distribution, toward the source of raw materials or toward the
ultimate consumer. For example, an auto parts manufacturer might
purchase a retail auto parts store.
4. A conglomerate is formed through the combination of unrelated businesses.
5. Another type of combination of two companies is a consolidation. In a
consolidation, an entirely new firm is created, and the two previous entities
cease to exist. Consolidated financial statements are prepared under the
assumption that two or more corporate entities are in actuality only one. The
consolidated statements are prepared by combining the account balances of
the individual firms after certain adjusting and eliminating entries are made.
6. Accretive mergers are those in which an acquiring company's earnings per
share (EPS) increase. An alternative way of calculating this is if a company
with a high price to earnings ratio (P/E) acquires one with a low P/E.
7. Dilutive mergers are the opposite of above, whereby a company's EPS
decreases. The company will be one with a low P/E acquiring one with a
TAXABLE VERSUS TAX-FREE TRANSACTIONS
• Mergers and acquisitions can be either tax-free or taxable
events. The tax status of a transaction may affect its value
from both the buyer's and the seller's viewpoints.
• In a taxable acquisition, the assets of the selling firm are
revalued or "written up." Therefore, the depreciation
deduction will rise (assets are not revalued in a tax-free
• But the selling shareholders will have to pay capital gains
taxes and thus will want more for their shares to
• This is known as the capital gains effect. The capital gains
and write-up effects tend to cancel each other out.
• Certain exchanges of stock are considered tax-free
reorganizations, which permit the owners of one company
to exchange their shares for the stock of the acquirer
without paying taxes. There are three basic types of tax-
free reorganizations. In order for a transaction to qualify as
a type A ,type B and type C tax-free reorganization, it must
be structured in certain ways.
DO ACQUISITIONS BENEFIT SHAREHOLDERS?
• There is substantial empirical evidence that the
shareholders in acquired firms benefit substantially. Gains
for this group typically amount to 20 percent in mergers
and 30 percent in tender offers above the market prices
prevailing a month prior to the merger announcement.
• The gains to acquiring firms are difficult to measure. The
best evidence suggests that shareholders in bidding firms
gain little. Losses in value subsequent to merger
announcements are not unusual. This seems to suggest
that overvaluation by bidding firms is common. Managers
may also have incentives to increase firm size at the
potential expense of shareholder wealth. If so, merger
activity may happen for non economic reasons, to the
detriment of shareholders.
Regulation of Mergers and
• Mergers and acquisitions are governed by both state and federal laws. State law sets the
procedures for the approval of mergers and establishes judicial oversight for the terms
of mergers to ensure shareholders of the target company receive fair value.
• State law also governs the extent to which the management of a target company can
protect itself from a hostile takeover through various financial and legal defenses.
• Generally, state law tends to be deferential to defenses as long as the target company is
not acting primarily to preserve its own positions. Courts tend to be skeptical of
defenses if the management of a target company has already decided to sell the
company or to bring about a change of control.
• Because of the fear that mergers will negatively affect employees or other company
stakeholders, most states allow directors at target companies to defend against
acquisitions. Because of the number of state defenses now available, the vast majority
of mergers and acquisitions are friendly, negotiated transactions.
• The federal government oversees corporate consolidations to ensure that the combined
size of the new corporation does not have such monopolistic power as to be unlawful
under the Sherman Antitrust Act. The federal government also regulates tender offers
through the Williams Act, which requires anyone purchasing more than 5 percent of a
company's shares to identify herself and make certain public disclosures, including an
announcement of the purpose of the share purchase and of any terms of a tender offer.
The act also requires that an acquirer who raises his or her price during the term of a
tender offer, raise it for any stock already tendered, that acquirers hold tender offers
open for twenty business days, and that acquirers not commit fraud.
• Vertical mergers take two basic forms: forward integration,
by which a firm buys a customer, and backward
integration, by which a firm acquires a supplier.
• Replacing market exchanges with internal transfers can
offer at least two major benefits.
• First, the vertical merger internalizes all transactions
between manufacturer and its supplier or dealer, thus
converting a potentially adversarial relationship into
something more like a partnership.
• Second, internalization can give management more
effective ways to monitor and improve performance.
• Vertical integration by merger does not reduce the total
number of economic entities operating at one level of the
market, but it may change patterns of industry behavior.
• Conglomerate transactions take many forms, ranging
from short-term joint ventures to complete mergers.
Whether a conglomerate merger is pure, geographical, or
a product line extension, it involves firms that operate in
separate markets. Therefore, a conglomerate transaction
ordinarily has no direct effect on competition. There is no
reduction or other change in the number of firms in either
the acquiring or acquired firm's market.
• Conglomerate mergers can supply a market or "demand"
for firms, thus giving entrepreneurs liquidity at an open
market price and with a key inducement to form new
enterprises. The threat of takeover may force existing
managers to increase efficiency in competitive markets.
Conglomerate mergers also provide opportunities for
firms to reduce capital costs and overhead and achieve
• An acquisition, also known as a takeover, is the
buying of one company (the ‘target’) by another.
• An acquisition may be friendly or hostile.
• In the former case, the companies cooperate in
• In the latter case, the takeover target is unwilling
to be bought or the target's board has no prior
knowledge of the offer.
• Acquisition usually refers to a purchase of a
smaller firm by a larger one.
• Sometimes, however, a smaller firm will acquire
management control of a larger or longer
established company and keep its name for the
combined entity. This is known as a reverse
Types Of Acquisition
1. The buyer buys the shares, and therefore control, of the target company being
2. Ownership control of the company in turn conveys effective control over the assets
of the company, but since the company is acquired intact as a going business, this
form of transaction carries with it all of the liabilities accrued by that business over
its past and all of the risks that company faces in its commercial environment.
The buyer buys the assets of the target company. The cash the target receives from
the sell-off is paid back to its shareholders by dividend or through liquidation.
This type of transaction leaves the target company as an empty shell, if the buyer
buys out the entire assets. A buyer often structures the transaction as an asset
purchase to "cherry-pick" the assets that it wants and leave out the assets and
liabilities that it does not.
This can be particularly important where foreseeable liabilities may include future,
unquantified damage awards such as those that could arise from litigation over
defective products, employee benefits or terminations, or environmental damage.
A disadvantage of this structure is the tax that many jurisdictions, particularly
outside the United States, impose on transfers of the individual assets, whereas
stock transactions can frequently be structured as like-kind exchanges or other
arrangements that are tax-free or tax-neutral, both to the buyer and to the seller's
The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a
situation where one company splits into two, generating a second company
separately listed on a stock exchange.
Motives Behind Mergers And
1. Economies of scale: This refers to the fact that the combined company can often
reduce duplicate departments or operations, lowering the costs of the company
relative to the same revenue stream, thus increasing profit.
2. Increased revenue/Increased Market Share: This motive assumes that the company
will be absorbing a major competitor and thus increase its power (by capturing
increased market share) to set prices.
3. Cross selling: For example, a bank buying a stock broker could then sell its
banking products to the stock broker's customers, while the broker can sign up
the bank's customers for brokerage accounts. Or, a manufacturer can acquire and
sell complementary products.
4. Synergy: Better use of complementary resources.
5. Taxes: A profitable company can buy a loss maker to use the target's loss as their
advantage by reducing their tax liability. In the United States and many other
countries, rules are in place to limit the ability of profitable companies to "shop"
for loss making companies, limiting the tax motive of an acquiring company.
6. Geographical or other diversification: This is designed to smooth the earnings
results of a company, which over the long term smoothens the stock price of a
company, giving conservative investors more confidence in investing in the
company. However, this does not always deliver value to shareholders (see
7. Resource transfer: resources are unevenly distributed across firms (Barney, 1991)
and the interaction of target and acquiring firm resources can create value through
either overcoming information asymmetry or by combining scarce resources.
8. Increased Market share, which can increase market power: In an oligopoly market,
increased market share generally allows companies to raise prices. Note that while
this may be in the shareholders' interest, it often raises antitrust concerns, and
may not be in the public interest.
Corporate Financial Restructuring
1. Corporate Financial restructuring entails any fundamental change in a
company's business or financial structure, designed to increase the
company's value to shareholders or creditor.
2. Corporate Financial restructuring is often divided into two parts:
• Financial restructuring : Financial restructuring relates to improvements in
the capital structure of the firm. An example of financial restructuring would
be to add debt to lower the corporation's overall cost of capital. For otherwise
viable firms under stress it may mean debt rescheduling or equity-for-debt
swaps based on the strength of the firm. If the firm is in bankruptcy, this
financial restructuring is laid out in the plan of reorganization.
• Operational restructuring : It is the process of increasing the economic
viability of the underlying business model. Examples include mergers, the
sale of divisions or abandonment of product lines, or cost-cutting measures
such as closing down unprofitable facilities. In most turnarounds and
bankruptcy situations, both financial and operational restructuring must
occur simultaneously to save the business.
• Corporate financial restructuring involves restructuring the assets and
liabilities of corporations, including their debt-to-equity structures, in line
with their cash-flow needs to promote efficiency, support growth, and
maximize the value to shareholders, creditors and other stakeholders. These
objectives make it sound like restructuring is done pro-actively, that it is
initiated by management or the board of directors. While that is sometimes
the case -- examples include share buybacks and leveraged recapitalizations
-- more often the existing structure remains in place until a crisis emerges.
Then the motives are defensive -- as in defenses against a hostile takeover --
or distress-induced, where creditors threaten to enforce their rights.
Corporate Financial Restructuring
• Financial restructuring may mean refinancing at every level of capital
• Securing asset-based loans (accounts receivable, inventory, and
• Securing mezzanine and subordinated debt financing
• Securing institutional private placements of equity
• Achieving strategic partnering
• Identifying potential merger candidates
• Just because a company needs restructuring -- financial or operational --
does not mean it will undertake the necessary reforms. Management and
controlling shareholders may prevail for an extended period, during which
time minority shareholders and/or creditors suffer an erosion of value. A
number of East Asian corporations, saddled with debt, nearly collapsed
during the financial crisis of 1997. Many have managed to avoid both
repayment and restructuring, however, and remain overly indebted and
invested in unprofitable businesses. How could this happen?
• Assignment: Identify a company in the news that is undergoing corporate
restructuring. Is the restructuring financial or operational? What methods are
being used? Will they produce fundamental improvements? What risks does
the company run in using these techniques
DIVESTITURES : STRATEGIC GAINS: SELL-OFFS.
1. We test a sample of divestitures defined as sell-offs of
either a complete operating division or a wholly owned
subsidiary of the divesting firm.
2. Analogous to the US studies, our tests show that the
market reacts positively to Australian sell-off
announcements, with average abnormal returns of 1.15%
over a two-day announcement period.
3. When the sample is segregated into strategic divestitures
(the disposal of units unrelated to the firm's core
activities) and non-strategic divestitures (the disposal of
related units) the strategic divestitures are associated
with a significant average abnormal return of 1.71%. In
contrast, returns accruing to the non-strategic group are
DIVESTITURES : STRATEGIC GAINS: SELL-OFFS.
1. Examination of the stated use of proceeds of the sell-off reveals that
higher and more significant abnormal returns (3.0%) are observed for
firms that intend to use the proceeds for strategic purposes, compared
with insignificant returns for firms that fail to disclose the intended
2. The market reaction to the latter may be driven by a fear that, without
public disclosure, opportunistic management is more likely to
misappropriate the proceeds (Jensen & Ruback 1983). A lower (1.8%),
and only marginally significant abnormal return accrues to firms
intending to use the proceeds to repay debt.
3. When strategic divestitures are grouped on the basis of the disclosed
use of proceeds, the largest abnormal return of 4.3% accrues to the
group in which the intended use of proceeds is also strategic, with
lower and insignificant returns recorded for the debt group, 1.93%, and
the undisclosed use group, 0.94%.
4. Of the non-strategic divestitures, no group on the basis of the
intended use of proceeds has significant announcement-period
returns. The study provides evidence that, on average, only strategic
sell-offs of unrelated units are positively valued by the Australian
Divestitures and Abnormal Returns
1. Divestitures classified as sell-offs occur when the parent (divesting)
company sells part of its assets for cash, securities or assets.
2. An act of divestiture is a major structural activity so that, for the purpose of
these definitions, the term 'assets' means both whole operating divisions or
3. US studies on the market reaction to the announcement of sell-offs
documents an average positive abnormal return of around 1% accruing to
the divesting firm over the two-day announcement period, day -1 and day in
event time, where day is the day of the reported divestiture announcement
in the Wall Street Journal.
4. Consistent evidence of positive abnormal returns associated with
announcements of sell-offs in the US and Europe suggests that sell-offs in
Australia will also result in positive abnormal returns to the divesting firm.
5. That divestitures are widely publicised events and that one of
management's primary motives for divesting is to increase the company's
share price (Hamilton & Chow 1993; Montgomery, Thomas & Kamath 1984)
further support the expectation of positive announcement returns. Our first
hypothesis is, therefore, that positive abnormal returns will accrue to
Australian firms upon the announcement of a sell-off.
• Typical Venture Investment Cycle ( BOSTON CAPITAL VENTURES ).
• STAGE 1 · Deal Origination
• Sources of deals include BCV portfolio companies, entrepreneurs, academic institutions,
research organizations, other venture firms, attorneys, investment bankers, business
associates, search firms, private investors and limited partners.
• STAGE 2 · Due Diligence
• The due diligence process includes business plan review, presentation by management
to BCV, site visits, market and competitive analysis, business model and financial
analysis, management team reference checks, corporate review including credit checks
as well as an examination of corporate structure and legal issues.
• STAGE 3 · Deal Structuring
• Deal structuring includes negotiating transaction terms, establishing anticipated capital
needs, finding sources of financing, as well as addressing accounting, tax and legal
• STAGE 4 · Management of the Investments
• Responsibilities at this stage include providing strategic guidance, working with
executive search firms to recruit senior management if necessary, establishing banking
and credit relationships, giving advice on strategy and marketing, as well as providing
board representation and/or leadership.
• STAGE 5 · Liquidation and Exit
• The final stage of the cycle involves establishing investment banking relationships,
identifying appropriate merger or sale candidates, facilitating "road shows" through the
selected underwriters and providing assistance during investor due diligence.
1. Entrepreneurs today are selecting venture 'partners' based on
2. Entrepreneurs seek out management, marketing and
operating experience from knowledgeable professionals who
understand their businesses as a result of first-hand operating
3. The BCV IV team's reputation for providing strategic guidance
as well as traditional financial expertise to early stage
companies gives BCV a significant advantage in sourcing
4. The most significant source of deal origination will be the
personal and professional networks and reputation of the
general partners and principals. These networks include
existing BCV portfolio companies, entrepreneurs, academic
institutions, research organizations, other venture firms,
attorneys, investment bankers, business associates, search
firms, corporate partners and private investors from around
• Business plan review: Key to evaluating business plans is the ability to assess the
risks and rewards of each opportunity. BCV carefully screens business plans, placing
the highest emphasis on the management, market analysis and business model
sections. In initial discussions with the company, BCV looks for management's ability
to answer detailed questions about their company and a strong sense of ownership
in the business.
• Management presentation: The next step in the process involves a presentation by
management to BCV so that a comprehensive profile of the management team can
be built. BCV looks for integrity, motivation, market orientation, industry experience
• Site visits: Site visits give the team the opportunity to meet employees, observe the
company dynamic, and see the facilities, products and manufacturing process. Often,
site visits reveal interesting aspects of the company that are not articulated in the
• Management team evaluation and reference checks: BCV places extraordinary
emphasis on the quality of the people who manage the portfolio companies. Market
conditions are constantly changing in the technology industry. Due to shorter product
cycles, new competitors emerge, services expand and products gain new
capabilities. In such an environment, the management of companies must effectively
manage change. BCV conducts thorough reference checks with customers,
suppliers, creditors, academic institutions, consultants, investors and acquaintances
to ensure that the management team is capable of executing its proposed strategy.
• Market and competitive analysis: BCV develops an assessment of market size
through research, industry sources and proprietary analysis. Potential portfolio
companies must operate in markets that represent a significant opportunity. If
markets meet this size criteria, we will examine the competitive environment to
identify individual strengths and weaknesses. Potential investments must have
business strategies that properly consider these forces.
• Business model and financial analysis: The business model and growth plan
analysis are important aspects of the due diligence process. To be considered,
portfolio companies must have the potential to reach $50 million in revenue within
five years. A detailed analysis of the corporate structure and growth plan allows BCV
to determine the viability of the plan and anticipated cash requirements.
• Corporate review: As a final step, BCV examines corporate records which reveal
important information about legal matters, debt and equity, and pending litigation, if
• Rapid decision-making: To participate in attractive investment opportunities, the
team can accelerate the data gathering and decision-making process. By engaging
senior advisors as needed to complement our industry and financial expertise, BCV
achieves high levels of certainty without compromising the quality of information
• Consensus-driven investment decisions: If potential investments pass BCV's
requirements, and if there is favorable rapport with the entrepreneur or management
team, the opportunity is presented to the general partners for evaluation. If there is
consensus among the general partners, BCV establishes a mutually agreeable
financial and operating plan with management. This plan will form the basis against
which future company performance is judged
• Successful investments require a long term approach.
After a financial and operating plan is developed, BCV
tries to anticipate the capital needs of the portfolio
company and provides assistance by identifying
suitable co-investor or debt partners, if needed.
• Preferred equity participation
• Simple deal structures facilitate current and follow-on
investments. Accordingly, investments are typically
structured as preferred stock with voting rights.
• Management incentives
• Employee equity participation has proven to be an
effective tool in building successful, profitable
companies. BCV requires that a pool of stock options,
which vest over a period of time, bet set aside for key
employees of portfolio companies.
MANAGEMENT OF INVESTMENTS
• Active board leadership role
• BCV will take a lead role in providing strategic guidance to portfolio companies thus
adding value that goes beyond the investment of capital. Areas where the BCV team
can provide guidance include but are not limited to:
• Experience-based guidance
• BCV's management team has broad worldwide operating experience that spans from
start-up to Fortune 100 companies. This knowledge base will allow the BCV team to
better assist portfolio companies in solving existing challenges as well as anticipating
and preventing future problems.
• Hiring senior management
• Access to a large network of professionals, entrepreneurs, and executive search
firms allows BCV to add value during the senior management recruiting process. The
operating experience of the BCV team contributes towards more accurate
assessments of potential candidates, compensation issues and ultimately, hiring a
motivated and more successful entrepreneurial management team.
• Advising on strategy and marketing
• BCV adds value on matters relating to company growth, acquisition, sale or merger
as a result of the broad experience of its team. The BCV team's expertise on matters
such as product pricing and positioning will help portfolio companies achieve their
market share objectives.
• Establishing banking and credit relationships
• BCV can provide the introduction to banks and financial institutions so that portfolio
companies can tap into larger sources of capital at lower cost.
INVESTMENT LIQUIDATION AND EXIT
• Liquidation and exit strategies
• U.S. capital markets provide the largest opportunity for liquidity
for venture type investments of any market in the world. BCV
will use liquidation and exit strategies that have been
successfully used in the past, including stock mergers, sale of
portfolio companies to other parties and initial public offerings
(IPOs). Liquidation and exit strategies will vary depending on
market conditions and the type of business being sold.
• Liquidity typically within 3 to 7 years
• Investment liquidation and exits generally occur within 3 to 7
years and are timed to maximize the rate of return for investors.
In some cases, BCV may decide to accelerate or delay the sale
or merger of a portfolio company if, in its judgement, doing so
will significantly increase the rate of return while maintaining or
reducing the level of risk. U.S. capital markets provide the
largest opportunity for liquidity for venture type investments of
any market in the world
• Mezzanine financing offers a way for publicly and privately held companies to attain financing without going public
and potentially ceding ownership of their company. It is a blend of traditional debt financing and equity financing,
reaping some benefits of both. Like equity financing, mezzanine financing is an unsecured debt, requiring no
collateral to be put up unlike traditional bank loans. Like debt financing, mezzanine financing is very fluid and does
not necessarily involve giving up an interest in the company.
• Mezzanine financing relies on very high interest rates in the 20-30% range to make it profitable. Unlike a bank
loan, mezzanine financing does not hold real assets of a company as collateral; instead, lenders offering
mezzanine financing have the right to convert their stake to an equity or ownership in the event of a default on the
• Mezzanine financing is a particularly appealing form of liquidity for owners of privately held companies. It is
traditionally understood that a privately held company simply cannot achieve the same sort of fluid capital flow as
a publicly held company, but mezzanine financing offers a way to balance that situation without going public. In
addition to the fact that mezzanine financers do not retain an interest in the company except in the event of a
default, there is also the important consideration that they actively do not want an interest in the company. While
traditional equity investors are often striving towards some level of control, a displeasing thought to many private
owners, with mezzanine financing one can rest assured that the financers will do what they can to ensure you pay
off your debt without resorting to default.
• Because of the lack of real collateral, as well as the high speed of lending, mezzanine financing is typically more
difficult to receive than a traditional bank loan or equity financing. A company must demonstrate an established
track record in its industry, show a profit or at the very least post no loss, and have a strong business plan for
future expansion. Because of these limitations, mezzanine financing is not for every business. For businesses
looking for a quick injection of capital to grow their already successful business, without giving up an interest,
mezzanine financing can be an ideal solution