Mergers and Acquisitions: A Legal Guide

Many people use mergers and acquisitions as interchangeable terms, when in fact they are not:

• Merger is when two companies join to become one, usually through an exchange of shares

• Acquisition is when one company buys the assets or shares of another company.

Typically, the net result is the same: two previously separately owned companies now operate under the same roof.

But the structure of a particular transaction can mean that one merger or acquisition may have a very different strategic, financial or even cultural impact from another.

A merger is a form of legal consolidation, where two (or more) companies form a single entity that supersedes the previously existing companies. But in an acquisition, where one company purchases another, the buyer company continues to exist.

In some acquisitions, the buyer can decide to keep the name of the other company, if the name has a degree of goodwill attached to it.

The distinction between mergers and acquisitions have become increasingly blurred, as more companies have entered into joint ventures.

This is where two or more parties pool their resources to achieve a specific objective. The difference between this and M&A is that the joint venture is separate from either party’s other business interests.

Just as mergers and acquisitions are different from each other, so there are also different types of M&A:

• Private mergers and acquisitions
• Public mergers and acquisitions

In private mergers and acquisitions, the shares of the companies involved are not traded on a public stock exchange. Instead, individuals or other companies own them privately.

Private M&A transactions have fewer rules and regulations governing them.

What tends to happen is that one private company buys another by buying all its share capital that has been issued or is to be issued.

The advantage of acquiring another company in this way is that it means the buyer acquires all the assets of the seller, usually without a need for consulting third parties.

It does mean, however, that the buyer also takes on any liabilities that the seller has.

An alternative is where one company acquires most or all of the assets of the seller, without the automatic transfer that applies to buying all share capital. If this does not specifically include certain assets, then these remain with the seller as liabilities and the buyer does not acquire their titles.

Another form of private M&A is when private equity firms acquire private companies.

Private equity covers a wide range of transactions, but private equity firms tend to buy businesses that are well-established. Alternatively, there are venture capital firms, which mostly invest in startups.

Private mergers and acquisitions involve a management buy-out (MBO) or management buy-in (MBI):

• MBO is the acquisition of a company by its own management team, with the support of either private equity or debt financing.

• MBI is where a management group outside the company leads an acquisition of it, replacing the existing management team.

These are mergers and acquisitions involving companies that have shares traded on public stock exchanges, and have various shareholders.

There are two main markets that the London Stock Exchange operates:

• The Main Market – made up of standard and premium listings, and

• The Alternative Investment Market (AIM) – for smaller and growing enterprises and organisations.

To protect investors, there is a large number of rules and regulations that govern companies that are publicly listed.

Of these rules, the Takeover Code is the major regulation that governs the takeover of public companies in the UK.

The aims of the code are to make sure that shareholders receive fair and equal treatment; and that they should have adequate information to make a decision about a takeover.

When a takeover bid is made, the code applies from the moment that the target actively considers it.

The Takeover Code regulates the terms of an offer, its timetable and dealings in the target’s securities. It also has rules about documentation, public statements and disclosures associated with the takeover.

All companies that the London Stock Exchange lists must issue a prospectus, which acts as an offer document for their listed securities.

There are also rules that determine the obligations of listed companies regarding the disclosure of information to the market. These are the Disclosure and Transparency Rules. These, and other important details, are in the FCA Handbook.

There can be a whole range of motives that drive mergers and acquisitions. They can be for growth purposes, or as a defensive manoeuvre. Companies may merge with or acquire others for strategic reasons, to spread risk or to adapt to changing industry trends.

Mergers and acquisitions can take place to gain unique capabilities or resources, such as innovative technology, or a specific patent or licence. It can be a means of transferring technology, where one company has a unique technological asset.

Combining two companies can unlock hidden value, combining resources and experiences.

Taking over another enterprise, or merging with it, can enable more effective exploitation of the market, giving a company an edge over its competitors.

M&A transactions provide the means for companies to grow significantly, by combining their expertise, assets and market share. This sort of increase in market power can drive sales and build greater revenue and profitability.

Where a company wants to diversify into new areas of business, mergers or acquisitions provide the means of doing this, spreading risk and providing more opportunities for sales, profits and greater market recognition.

In the service industry especially, mergers and acquisitions enable merged firms to handle larger clients than they would be capable of handling on their own as individual companies.

The concept of synergy can be very important in a merger or an acquisition. This is a way of improving a company’s performance for its shareholders.

The principle behind synergy is that the value and performance you achieve by combining two companies will be greater than the sum of the individual parts.

Often, therefore, the potential synergy of a merger or acquisition is the first thing people will want to evaluate.

There are several main parties involved in a mergers and acquisitons:

• Buyer – this is the party that is making the acquisition, who will go on to own or control the company’s shares or assets

• Seller – the party that is selling the shares or assets

• Target – this is a company that is the subject of a merger or acquisition attempt

• Management – in private equity transactions, this refers to directors or key senior employees

• Advisers – there will be key advisers on both the buying and selling side of the M&A transaction, normally lawyers, but there may also be specialist financial and tax advisers involved.

There are different ways to carry out mergers and acquisitions. The type of transaction can be:

• Horizontal
• Vertical
• Conglomerate
• Market extension
• Product extension

In a horizontal merger, one company acquires or merges with a direct competitor.

In a vertical merger, a company merges with or acquires another company that operates in a different part of the supply chain.

Conglomerate transactions involve two or more companies merging that are completely different and unrelated businesses.

Market extension transactions involve a company acquiring or merging with another that operates in a different geographical market.

Product extension is where a company acquires or merges with another company that sells different products, but to the same customer base.

M&A transactions come under the common law system in the UK.

Unlike civil law, common law places greater emphasis and importance on judicial decisions. It also applies the doctrine of precedent to cases. This means it looks at similar cases and previous decisions made in higher courts.

There are various conventions and principles that work alongside common law and an important one is caveat emptor.

Caveat emptor is a Latin phrase that translates as:

Let the buyer beware.

This forms a core part of the UK law on commercial contracts, including M&A.

When a buyer purchases a business or company, they have very limited statutory protection. Going on the principle of caveat emptor, the buyer is responsible for finding out all they need to about the company they intend to buy.

This does not mean the seller can conceal any liabilities deliberately, or misrepresent the state of their company. But they will not be held at fault if they have made an innocent mistake, or, importantly, if the buyer has not asked them about a particular issue.

This is why it is important for the buyer to carry out due diligence.

Due diligence (DD) is a detailed process that the buyer should carry out before going ahead with a transaction.

It is not a legal requirement, but at its core is a legal investigation. Without this legal aspect, due diligence is unlikely to be thorough or sufficient enough to give the buyer the essential details they need.

There are three parts to due diligence:

• Commercial
• Financial, and
• Legal.

The buyer, or their employees, would normally carry out commercial DD, finding and sharing broad information about the target company and its operations in the market.

Financial DD focuses on the target’s financial affairs that are relevant to the prospective purpose, and it is normally something an accountant would deal with.

Legal DD is the most critical aspect of the whole process. It will look in-depth at issues uncovered by commercial DD, scrutinising areas that might be of most risk to the buyer.

Due diligence should identify key strengths and weaknesses, to give the buyer the right information to then weigh up assets against risks and to determine what the correct purchase price of the target company should be.

M&A transactions are often very complex. They can also have a huge impact on businesses.

Expert legal support is therefore essential to ensure that parties involved in M&A achieve the best possible outcome, and it is an important aspect of the company and commercial law services.

Merger and acquisitions solicitors will:

• Carry out due diligence
• Advise and negotiate
• Draft legal documents and letters, and
• Provide expert support and advice throughout the process.

Preparation is key to getting a good deal. This includes gathering all the necessary intelligence, working to timescales that allow enough time to check and finalise all the details, and understanding the implications of a particular merger or acquisition.