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Handbook of coping: Theory, research and applications. New York: John Wiley. HR know-how in mergers and acquisitions. London: Institute of Personnel and Development. Charman, A. Global mergers and acquisitions: The human resource challenge. Daniel, T. The management of people in mergers and acquisitions. Deal, T. The new corporate cultures: Revitalizing the workplace after downsizing, mergers and reengineering.

Cambridge, MA: Perseus Publishing. Corporate culture: The rights and rituals of corporate life. Dixon, I. SHRM case study: Culture management and merger acquisitions. Dooney, J. The morale and satisfaction of midlevel administrators: Differentiating the constructs and their impact on intent to leave. Feldman, M. New York: HarperCollins. Fisher, A. How to make a merger work. Fortune, 2 , Frank, R. Where have the masters of the big mergers gone? The Wall Street Journal, p. Gaughan, P. Mergers: What can go wrong and how to prevent it. Habeck, M. After the merger. London: Prentice Hall.

Haspeslagh, P. Managing acquisitions: Creating value through corporate renewal. New York: Free Press. Huselid, M. The impact of human resource management practices on turnover, productivity and corporate financial performance. Academy of Management Journal, 38 3 , — Jansen, S. Mergers and acquisitions 4th ed. Wiesbaden, England: Gabler. King, D. Meta-analyses of post-acquisition performance: Indications of unidentified moderators. Strategic Management Journal, 25 2 , — Leedy, P.

Practical research: Planning and design 8th ed. Luecke, R. Managing change and transition. Boston: Harvard Business School. Machiraju, H. Mergers, acquisitions and takeovers. Rend cultural management. Human Relations, 50 2 , — Munck, B. Changing a culture of face time. Boston: Harvard Business School Publishing. Nguyen, H. The effective management of mergers. Sample Provision During the Exclusivity Period, the Target shall not, and shall cause all of its Representatives not to, directly or indirectly, i solicit or [knowingly] induce or encourage the submission of any Acquisition Proposal, ii enter into any agreement or understanding whether or not binding with respect to any Acquisition Proposal, iii other than informing persons of the existence of this letter agreement but not the identity of the Buyer to the extent necessary in response to another Acquisition Proposal, provide any confidential information regarding the Target to any third party, or iv otherwise engage in any negotiations or discussions with any third party in connection with any Acquisition Proposal.

Exclusivity agreements, in contrast, do not usually contain those escape clauses as a matter of practice. Targets wanting to avoid exclusivity restrictions they regret signing up to have sometimes asked courts to read fiduciary out exceptions into the agreement. An exclusivity agreement does not commit a target to a deal, but instead commits it to not negotiate or sign up a deal with a third party during a relatively short period.

Accordingly, buyers argue, there is no need for related fiduciary out exceptions. The target is usually willing to accept an exclusivity agreement that does not contain a fiduciary out. The exclusivity period is typically short, and the. In addition, if a target informs the potential buyer that the target no longer wishes to pursue a transaction with that buyer—for instance, because the target believes it can obtain better terms from a third party—then the potential buyer will frequently not want to waste its resources continuing to negotiate.

The parties simply terminate exclusivity by mutual agreement in most such cases, so the target is not kept out of the market unnecessarily. Breaching exclusivity may give the potential buyer a damages claim, but it may be worth it to the target in some cases. For a public company target, the damages would, in effect, be paid by the interloper buyer. The interloper buyer would acquire a target that is burdened by potential liability claims against it. War Story The target was in dire straits.

Desperate for a deal, it finalized a letter of intent and agreed to exclusivity with the potential buyer. The full purchase agreement was expected to follow promptly but had not been drafted yet. As a public company, the target normally would not have announced an unfinished deal, but it felt the need to convey to the market and its customers that it had found a path to survival.

When the handshake deal was announced, a competing bidder decided to jump in. The target was caught in a bind. It wanted to accept the better price, of course, but was bound by exclusivity to just sit by and ignore it. The target had not asked for a fiduciary out, or even thought about the issue.

It was not bound to sign the first deal, but it felt it could not wait long enough to let the exclusivity period simply run its course and expire—in the meantime, the better bid could be lost. The target could even lose both deals in the process, which could mean financial disaster. The target took a leap of faith. The target told the original buyer that an unwritten fiduciary out implied by law had excused its breach of exclusivity. The first bidder was incensed. It asked the court to enjoin the new deal, but the court refused.

So it sought damages. Months after the target closed the new deal, the damages claim was settled. The target paid a substantial sum to the original bidder. Since at that point the target was percent owned by the buyer and the target shareholders had already collected their money , the settlement was effectively paid by the new buyer. Exclusivity period Exclusivity expires at the end of a short, defined period. The exclusivity period is designed to be long enough to complete the process of negotiating a deal, while not locking up the target for unnecessary periods of time.

The period will often range from two weeks to two months, but it can also be as short as a few days. Targets may also use tight periods to put pressure on the buyer to complete diligence and negotiations in a timely manner. Usually exclusivity terminates at the end of the exclusivity period. If the parties want to extend it, they can sign an amendment to extend it. Sample Provision The Exclusivity Period shall be automatically extended for [10 business days] following the end of the Exclusivity Period or any such extension period, unless no later than p.

The requirement for an affirmative termination can easily be fulfilled as a legal matter, but has practical significance. If the buyer and target decide that they cannot move forward because of a disagreement over terms, in most cases the parties will mutually agree to go ahead and terminate exclusivity. Although a buyer contractually has the power to keep the target out of the market in most deals even after the buyer. Nevertheless, a target may be wise to provide for this case up front.

To that end, a target may add a provision that exclusivity expires if the buyer stops actively negotiating a deal or if the buyer changes the deal e. Obligation to negotiate in good faith Some exclusivity agreements obligate the parties to negotiate in good faith during the exclusivity period.

This is more likely when the parties have already reached a basic agreement on the economic terms of the deal. The seller may be concerned that, if it decides not to go forward with a transaction, it could have liability to the buyer for failure to keep negotiating. Sample Provision During the Exclusivity Period, each of the parties hereto shall negotiate in good faith definitive documents regarding the Proposed Transaction.

Even if it is binding, enforcing an obligation to negotiate in good faith is difficult. How could the buyer show that the target rejected compromise positions out of bad faith? Is the target not justified in sticking to its economic positions? In some deals, all the material terms have already been agreed in a term sheet.

Since most all term sheets are nonbinding, even if there is a term sheet that forms the backdrop for negotiating in good faith, the target can always change its mind on what economic terms it is willing to accept.

Emerging Trends In Mergers & Acquisitions: Q&A With Rusty Wiley, CEO, Merrill Corporation

Specific performance would also be difficult to pursue for breach of an obligation to negotiate in good faith. No obligation to execute definitive documentation Even when the target is obligated to negotiate in good faith, it is not obligated to take the final step and actually sign the definitive documentation that it negotiates. In other words, an exclusivity agreement may require the parties to negotiate toward acceptable terms, but does not require the parties to actually agree to those terms, even if they are generally acceptable.

In most cases, there is an express provision confirming that the parties are not obligated to enter into definitive agreements, thus avoiding any risk that a court will interpret the obligation to negotiate as implying an obligation to sign the finalized arrangements. Scope of damages Some say that an agreement is only as good as its enforceability. When it comes to exclusivity, it is hard to measure damages for breach, which limits to some extent the legal value of the contract. It may still have significant practical value because the target will want to avoid any disruptive lawsuits.

Since the buyer is not entitled to a signed deal, what has it actually lost if the target walks away from negotiations? The amount of damages is not obvious. In some cases buyers have asked for expectation damages calculated based on the profits that the buyer would have earned if it had bought the target,10 claiming that their damages are the lost value of the deal to the buyer, but that argument seems difficult to sustain. Realistically, if the target was never obligated to sign a deal, the most that the buyer could ask for may be reimbursement of its deal expenses, such as legal and accounting diligence fees.

Even then, targets may feel that much of the expense was incurred before exclusivity was signed, and may have been incurred even if exclusivity had not been agreed or breached. Some buyers will add an explicit remedy to the exclusivity agreement to avoid this type of dispute over a relatively small amount of damages. Mutual exclusivity Sometimes a target will also ask the buyer for exclusivity. Usually, the buyer could pursue multiple deals at once without harm to the target so buyer exclusivity is not an issue. In other cases, though, the target fills a particular niche for the buyer.

If buying a competitor of the target would mean that. Mutual exclusivity could be used by the target to prevent the buyer from filling that need through another acquisition while negotiating with the target. Short of asking for mutual exclusivity, the target could also ask the buyer for notice of disruptive events. For instance, the target could require the buyer to provide notice of another deal that could, for instance, create antitrust problems for the buyer to acquire the target.

Term Sheets. Establishing those terms in a shorthand form reduces drafting time, and allows the back and forth of negotiations to proceed faster. They have the benefit of reducing legal costs at a point when it is not clear whether the parties can reach agreement on the fundamental terms of a deal.

They are also written in a form that is easier for the business teams to understand, so they facilitate greater participation by the business teams in negotiations. As a matter of custom, LOIs and MOUs tend to be drafted in a more narrative format, and tend to have less detail on the specific terms of the deal. Term sheets tend to be more specific as to terms. Term sheets are most common in complex and unique deals. In transactions with ordinary provisions, using a term sheet may not bring speed or efficiency.

If not drafted precisely enough, term sheets can gloss over the level of detail that actually tends to present the most difficulty. The parties may build momentum towards a deal without having to work through all the nuances that may in the end not be resolvable. Assuming that is the case, it is critical to explicitly state that the parties do not. Absent clarity on this issue, whether the parties intend to be bound would be a matter of fact to be determined through litigation. Some courts have enforced term sheets that one party argued were never intended to constitute binding contracts.

Most of those cases present unusual facts, such as the parties publicly announcing the deal on the basis of a term sheet,11 or one party signing a new deal with a different buyer just before the other party could approve the transaction,12 or one party appearing not to act in good faith. War Story The seller was ready to get rid of one of its underperforming divisions. Management wanted to refocus the division on growth areas.

After a multiround auction, the seller was disappointed with the final price. But it had selected its winner and moved forward to negotiate the final documents. The auction resulted in an agreed term sheet, which was, of course, nonbinding by its own terms. In the middle of negotiating the full deal documents, a new bidder emerged.

It was unclear why that new bidder had not participated in the auction. In addition, it somehow knew enough about the pricing to slightly outbid the best price of the auction. The new bidder made very minor edits to the contract, and was ready to sign. In the meantime, the auction winner was also close to finishing its deal. The auction winner expected its final agreement to be distributed overnight.

The next morning, the auction winner was stunned to read a press release from the seller: it had signed with the new bidder overnight! The court decided that it was a matter of fact to be determined at trial. The seller refused to settle. It could not avoid a jury trial. Ironically, because there was no signed contract with the auction winner, there was no agreement containing the standard waiver of the right to a jury trial. The seller slowly recognized that it was in for a long trial or a big settlement.

Eventually the seller settled for an amount that made it wish it had just sold at the slightly lower price to the auction winner. Even more ironic: the target business ended up performing poorly. The auction winner wound up much better off economically with the settlement than it would have if it had actually bought the target.

Merger valuation: Time to jettison EPS

Required public disclosure For a public company, agreed deal terms in a term sheet, LOI or MOU can exacerbate difficult disclosure issues under federal securities laws and the rules of the stock exchange on which its securities are listed. Generally speaking, disclosure is required if there is a duty to disclose and failure to disclose the deal would be material to shareholders of the target. Unlike many jurisdictions, in the United States all material information does not have to be disclosed on a current basis.

Instead, only a limited array of specific events have to be disclosed on a current basis. For instance, the duty to disclose can arise from affirmative Securities and Exchange Commission SEC filing obligations. Depending on the context, failing to disclose a potential deal that is. The two primary factors to consider are the size of the deal and the probability of the deal.

For example, if the parties negotiate an LOI, it becomes more difficult to take the position that substantial uncertainty remains as to whether the parties will ultimately come to an agreement. The parties may also be concerned that an agreed term sheet increases the likelihood of a leak. If the deal team members believe that transaction terms are agreed in principal, they may feel more comfortable talking to friends in the industry or members of the press. In In re Complete Genomics, Inc. The court enjoined enforcement of the provision.

But see In re Ancestry. The court ruled against the buyer, finding that the confidentiality agreement contemplated the use of confidential information only in connection with a mutually negotiated merger between the parties, not a hostile transaction. Thus, the use of the information in connection with the hostile transaction was a prohibited use under the confidentiality agreement. The court effectively read a standstill provision into the restriction on use.

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See also Certicom Corp. Research In Motion Ltd. Certicom involved a buyer that signed a confidentiality agreement allowing use of confidential information only to evaluate a friendly deal. The buyer proceeded to launch a hostile offer using the confidential information, which the court enjoined as violating the confidentiality agreement.

Portland, Inc. LaFarge Coppee S. A potential buyer, unable to come to a deal with the target, unilaterally made a hostile offer to the board of the target in violation of the confidentiality agreement, and publicized it. Exploration v. Rubicon U. REIT, Inc. The court noted that the existence of a fiduciary duty does not give rise to an inherent fiduciary out; instead, fiduciary outs must be bargained for to ensure that a contract does not restrict the exercise of fiduciary duties.

Millennium Digital Media Sys. LLC, No. In coming up with a formula for expectation damages, the court in Wavedivision reasoned that the original buyer was entitled to the value it expected to realize from the agreement, minus i any cost avoided by having to perform such as the purchase price , and ii any mitigation that the original buyer was able to achieve by purchasing another target.

See Texaco, Inc. Pennzoil, Co. Cyanamid Co. Elizabeth Arden Sales Corp. In addition to federal securities laws, state laws can also impose a duty of disclosure. Beracha, A. See 17 C. This occurred in Weiner v. Quaker Oats Co. Of course, doing so would have been difficult without disclosing the pending deal. But see Levie v. See Basic Inc. Levinson, U. See id. Acquisition agreements are made up of several core building blocks or components. In a typical acquisition agreement each is segregated into its own article. Complex deal components—such as financing contingencies and breakup fees—are implemented through multiple provisions that cut across several different parts of the agreement.

The first part of this chapter provides an overview of those key components and how they work together. It shows all pieces of the puzzle at once. The second part of this chapter compares and contrasts how they operate and when they are most or least useful in a deal. After that, each component is discussed in detail in its own chapter.

Structure The acquisition structure is defined in an initial section of the acquisition agreement. In a stock sale, the buyer acquires the stock of the target company. If the target is a small, privately held company or a wholly owned subsidiary of a larger company, the stock can be purchased in a simple, private sale directly from the shareholders. If the target is a public company and its shares are widely held, the stock sale would take the form of a public tender offer to buy shares from all those shareholders and would be subject to the tender offer rules under the federal securities laws.

In a merger, two companies join together to form a single entity with combined assets and liabilities. In practice, it is another mechanism for the buyer to acquire the stock of the target and own it as a subsidiary. Among other things, the target is required to obtain shareholder approval. If the target is a public company, the shareholder vote takes the form of a public proxy solicitation subject to proxy rules under the federal securities laws.

In an asset sale, the assets and liabilities of the target business may have to be teased apart from the other business activities of the target before they are sold to the buyer. If the target is selling all or substantially all of its assets, approval by its shareholders will be required. These structures can also be combined into more complicated, multistep transactions. Initially, it may appear that different structures should lead to fundamentally different types of acquisition agreements. However, acquisition structures can be thought of as simply one among many deal components. Perhaps surprisingly, most of the other components do not change significantly across the key types of structures.

Public and private deals will usually have some different key components. For instance, a family may be selling its wholly owned business, or a corporation may sell one of its divisions. In a typical private transaction, the contract typically is negotiated directly with the owners of the target and no subsequent shareholder vote is required.

That eliminates the uncertainty of public transactions arising from the need for a shareholder vote or shareholder acceptance of a tender offer. In a public transaction, ownership of the target entity is usually widely dispersed, and there is no readily identifiable party to stand behind the obligations of the target after closing.

As previously noted, in a public transaction shareholder support is still needed after the deal is signed, which creates a level of uncertainty not present in private transactions. A public company. Deal consideration How the buyer pays for the target business can take different forms.

In a public transaction, equity or other securities issued as deal consideration would have to be registered under the securities laws. Alternatively, the buyer can issue a note payable to the seller over time. Cash, equity, and notes can also be combined. Regardless of its form, the purchase price may be fixed at the time of signing or may be subject to adjustments measured at the time of closing. For example, the purchase price may fluctuate depending on the amount of working capital left in the target business on the closing date or based on the market value of any securities issued as consideration.

They are usually written in an affirmative form, often subject to knowledge and materiality qualifications. The process of working through and reviewing the disclosure schedule is an important part of buyer diligence. Other components of the acquisition agreement provide the buyer with two key remedies for breaches of representations. A closing condition and related termination right gives a buyer the right to walk away from.

This right usually exists if representations were not sufficiently accurate at signing or became inaccurate by the time of closing. If the target is privately held, the seller usually backstops the representations with an indemnity that allows the buyer to close and then sue to collect damages for breaches of representations. As a practical matter, if the target is a publicly held company with a large number of shareholders, an indemnity is difficult to implement and requires holding back part of the deal consideration.

Public company deal indemnities have not been done in practice outside of a couple of various instances. Covenants Affirmative covenants require a party to take actions. The covenants include an obligation to operate the target business in the ordinary course between signing and closing. Negative covenants prohibit the target business from taking specific types of actions before the closing, such as incurring debt, making material acquisitions, or selling material assets. Closing conditions For a variety of reasons, most transactions cannot be completed on the date the acquisition agreement is signed.

For instance, after signing the parties may need to secure shareholder votes or governmental approvals. Conditions describe the events that must occur and facts that must exist before a party is required to close the transaction. In addition, buyers usually have the benefit of a condition that there has been no material adverse effect on the target business. In other words, if a condition for the benefit of the buyer has not been satisfied, the buyer is not required to close the transaction—and the buyer is not required to pay any fees or damages to the target company when the buyer refuses to close on that basis.

This stands in contrast to some termination rights that require payment of a reverse breakup fee before they can be exercised. Termination rights Termination rights permit one or both parties to terminate the transaction agreement. Early termination rights reflect the fact that parties normally do not expect to be required to comply with covenants, including the covenant to try to satisfy the conditions, for an indefinite period of time. Early termination rights mirror closing conditions. If a party is not required to close because a particular condition has not been satisfied, that party may want to terminate early if it is no longer feasible to satisfy that condition.

For instance, if the representations are not sufficiently true to meet the closing condition standard, and have not or cannot be brought into compliance during a cure period, the buyer can terminate. If a public target holds a shareholder vote and shareholders vote down the deal, then the buyer can go ahead and terminate. This applies to terminating for breaches of representations or covenants, or, because the target has suffered a material adverse effect MAE. If the target in a public company merger terminates to accept a better deal, the target usually has to pay a breakup fee.

No material adverse effect protection Almost all acquisition agreements have a condition that allows the buyer to refuse to close if a material adverse effect on the target has occurred. Some buyers use quantitative measures to obtain more definitive protection against a downturn in the target business. The thresholds for triggering a quantitative MAC normally provide some buffer zone below the base case expected results. Quantitative MAC clauses usually do not contain all the various exclusions for adverse effects such as those attributable to changes in the industry or the economy that general MAE clauses contain.

Financing risk What happens if a buyer cannot obtain the debt financing it needs to pay the purchase price? This can be addressed in several ways. Financing conditions are extremely rare, though they are occasionally still used in tender offers. A reverse breakup fee is the most common alternative, under which the buyer is permitted to terminate the transaction upon payment of a negotiated fee if it is unable to obtain its debt financing despite having used sufficient efforts to do so.

Financing contingencies and related breakup fees are accomplished through several components, including conditions if there is a related condition , termination rights to permit termination that triggers the reverse breakup fee , remedies that determine whether the buyer is subject to specific performance i. These provisions must work together seamlessly to obtain the desired result.

The fiduciary out also allows the target company to terminate the acquisition agreement with the initial buyer in order to sign a transaction with a competing bidder offering superior terms. Indemnities In public deals where public stockholders receive the sale consideration , the buyer is not entitled to an indemnity in practice. In private deals where the target is a private company , the acquisition agreement normally includes an indemnity. Indemnities for breach of representations mostly protect the buyer against the unexpected or unknown; any known issues would be disclosed by the target in the disclosure schedules and, thus, would not constitute a breach.

The seller may separately indemnify the buyer through a special indemnity for a risk or liability that is known and fully disclosed. An indemnity typically includes the right to recover actual losses as well as related expenses e. If the indemnity is based on such a hypothetical reading of the representations, it will often, in exchange, give the target the benefit of a deductible before the buyer can recover damages. For example, if the target faces a potential liability, the parties may adjust the purchase price for the risk, draft closing conditions or related termination rights tied to successfully fixing those matters, or provide a special indemnity to protect the buyer from losses related to that liability.

If a risk triggers termination of a deal, the termination can be without cost, or the parties may agree to a breakup fee payable by the target company, or a reverse breakup fee payable by the buyer, in order to align incentives to avoid the termination. For instance, as discussed below, these tools vary in the timing of the protection and underlying loss e. Some techniques provide economic recovery for a loss, while others do not. The questions below illustrate how these provisions function. Is the buyer compensated for its losses? Indemnity is, by nature, designed to make the buyer whole for damages it has suffered.

A purchase price adjustment is also designed to make the buyer whole, though the adjustment may not, in fact, compensate for all related losses. For example, a working capital adjustment compensates a buyer for a shortfall in working capital at closing. If the shortfall is due to a general decline in the business, the buyer is not compensated for the shortfalls it will experience in the future. Closing conditions and termination rights provide no compensation for losses.

Instead, by allowing the buyer to refuse to close or to terminate the deal, it. Breakup fees and reverse breakup fees provide some compensation, but the amount may or may not match the scope of actual losses. The amount of the fee is fixed in the acquisition agreement at signing and does not adjust for the actual amount of the damages. Does the buyer have to close? Some provisions apply only if a deal closes; others let the buyer avoid closing. Indemnity protection only applies after closing, requiring the buyer to close in the face of the problem, and then seek recovery.

A purchase price adjustment also requires the buyer to close the transaction in order to benefit from its protection. Breakup fees apply only in the event of a termination. Does the buyer have to continue to work toward closing? Between signing and closing a deal, the parties are usually required to use reasonable best efforts to satisfy the closing conditions. Closing conditions do not permit the buyer to stop working toward closing. Although the buyer may refuse to close once the time for closing otherwise arises, the buyer is, perhaps paradoxically, not excused from continuing to use its efforts to achieve closing in the meantime.

Termination rights, in contrast, allow the buyer to stop complying with its covenants once the provision is exercised, so they excuse the buyer from continuing to work toward closing the deal. Termination rights often, but not always, mirror key closing conditions, allowing the buyer to terminate the deal early when it would not be required to close the transaction in any event.

As noted above, indemnities and purchase price adjustments only provide benefits if the buyer closes despite the problem. Breakup fees and reverse breakup fees apply only in the event of termination, but they have no effect on the obligation to work toward closing in advance of a termination. Does the buyer take risk in exercising its protections? For some solutions, the buyer takes risk if it tries to exercise its remedy and the target shows that the buyer was not entitled to the protection it claimed.

For others, the only risk to pursuing a claim is wasted effort and legal cost. Making an indemnity claim poses no risk to the buyer other than perhaps damaging the ongoing relationship with the other side. If the claim is too high, the parties will work through the dispute resolution process and arrive at a final amount for the loss. The purchase price adjustment, likewise, does not put the buyer at risk for claiming an adjustment, even if it ultimately does not prevail.

Exercising a closing condition or termination right, in contrast, presents risk. If a buyer claims that it is not required to close or permitted to terminate— and refuses to close or tries to terminate on that basis—the seller can challenge its conclusion. If the challenge is successful, then in retrospect the buyer may be shown to have breached its obligation to close.

That breach can subject the buyer to significant damages. Breakup fees and reverse breakup fees themselves do not present risk although the related termination may be challenged, as discussed above. Rough justice or a refined solution? Some solutions are intended to measure and make the buyer whole for its actual losses. It compensates the buyer for its losses, subject to limitations on recovery such as deductibles and caps.

A purchase price adjustment is also designed to make a party whole for the actual amount of shortfall or loss as measured as of the closing date. This mechanism does not compensate for future losses. A failed condition or a termination right can be the basis for the parties to negotiate a revised deal that better reflects economic reality which may be a more refined solution , but repricing the deal is not required by the condition itself. What is the timing of the protection? Indemnity for breaches of representations usually protects a party from breaches that occur at signing.

Although payment on the indemnity occurs after closing, the indemnity does not cover breaches that arise after closing. However, a special indemnity can be negotiated to cover losses that arise before or after closing. If an event happens before closing, a party may terminate or refuse to close.


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If the same event happens the day after closing, no protection is provided. For instance, the closing condition could cover a specified event, and be triggered by a reasonable expectation or likelihood of that even occurring in the future i. In a sense, no term of the transaction is more important to the buyer and the seller than the price to be paid. This chapter introduces the forms of consideration that may be offered and paid in a deal, and how those payments can vary or be adjusted based on facts that exist at closing or even performance that occurs after closing. Typically synergy is defined in such a way that the value of the combined firm C exceeds the collective values of the sepa- rate entities.

Expressions like mutualism, win-win situations, critical mass, co-evolution, threshold effects, and non-zerosumness are used as synonyms. Compare, Corning, , p. Selecting the market capitalization of a company as a benchmark for corporate value, the acquisition price per share is in many cases 60 percent higher than the actual share price.

Merger Model: Cash, Debt, and Stock Mix

Therefore the premium given to shareholders can be seen as an incentive to part with their existing stock. The acquiring company is willing to pay this requested premium to shareholders as a much greater return on synergy is expected to result from the merger. As primary risk taker in the merger, share holder A should receive at least the equivalent synergy premium as share holder B. Taking such a fair value criteria into account the total synergy outcome from a merger for a given time period, should be twice as high as the premium paid for the acquisition of firm B.

An interest rate to reflect the time value of money and the risk that the expected synergy would not crystallize in the future should also be applied to the total synergy premium. The post merger value of the integrated firm has to be equal to or greater then the sum of the firm values A and B and the total 4 Moeller, Schlingemann, Stulz, , p. The value of a merger can be measured either in the present or the future, as long as both figures are taken at the same point in time.

Hence the benchmark of success could be formalized at the time when the merger happens like in equation 8 or at certain point in the Future like in equation 9. Consequently, throughout the pricing process, it is essential corporate C be treated as a new economic system. Given this logic, the precise value of C can not be determined by the sum of A and B plus some synergy.

System theory provides a holistic view of what transpires during the merger process, and may be used as a guideline. According to this approach, a corporation should be observed as a complex economic system of elements and relations which are dependent upon each other. A company is an open system, insofar as it exists in mutual relation in- and output relations to its environment. Merg- ers disrupt this harmonic balance through the removal and addition of certain elements and corporate functions.

As a direct result of this modification, the measurable output in the form of sales, revenue, and turnover will also vary significantly. The merger of two intricate systems leads to the creation of a new corporate system; firm C, with its own distinctive elements and relations. Any valuation of such a system, given its uniqueness and individuality, requires a separate pricing process. Output categories such as sales, turnover, profit or EBIT are completely intertwined within corporate systems which frequently interact with one another.

Relationships 5 Gupta, Ross, , p. Subsequently the expected profit of the new entity C is the outcome of the corporate system function of C with its merged corporate functions of system A and system B. Relations between variables within the system function are not linked by value additiv- ity. Pricing firms A and B is made slightly easier given their existing systems and assuming the elements and relations within the systems will not be modified or split. With the process of performance unaltered, valuation of A and B can be found in various sources of codified and publicly available information, such as turnover, EBIT etc.

No additional knowledge of the corporate system function is required for the valuation of A and B. Contrary to this, firm C constitutes a unique corporate system; hence its valuation requires additional internal information concerning the relations and elements within the system. With- out an existing system in place, a performance projection of system C could only be derived from internal and system specific knowledge about elements and relations of system A and system B.

Codified knowledge about the performance of firm C in the form of balance sheets or business reports seizes to exist. Codified knowledge pertain- ing to A and B is less resourceful due to an absence of value additivity. This new approach to valuation of mergers refers to the theory of knowledge man- agement, which distinguishes between two forms of knowledge: implicit and explicit knowledge. Infor- mation concerning the relationships between the single elements within a corporate system could be called the tacit or implicit knowledge. Explicit and implicit elements of knowledge are complimentary to each other and are not considered mutually ex- clusive.

Rec- ognizing tacit knowledge contributes as well to the identification of synergy. To determine a fair value for the potential acquisition candidate, a wide range of valuation techniques and methods are used, ranging from simple to sophisticated. These methods, with their unique assumptions often produce differing values, despite sharing common characteristics. Book values of assets and liabilities reported on the balance sheet rarely reflect their current market values; therefore investors often make neces- sary adjustments toward current market prices.

The obvious weakness of the asset-oriented approach is its backward orienta- tion. Hence, book values of a balance sheet reflect only past performance based on historical revenues and costs. But valuation of any investment requests a projection of future cost or revenue evaluation. The asset oriented approach is incapable of deriving such information. This technique is future-oriented and calculates the current value of the firm based on projected earnings or cash flows.

The most 6 Polanyi, , p. FCF measures the cash generated by a business regardless of the fi- nancial structure. Future free cash flow for the planned period is then discounted by a risk-adjusted rate. The estimated value of the target company is obtained by summing up all discounted free cash flows, plus the discounted terminal value.

The terminal value or horizon value defines the value of the company by the end of the analyzed period. Certain key assumptions, such as the discount rate, the growth rate, and capital requirements can widely alter DCF values. Equally critical is the forecasted terminal value, as it often contributes in excess of 50 percent to the total net present value.


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The market multiple analysis is often used in financial markets. The basic principle underlying these methods is the "Law of one price", which states in general, that in competitive markets free of transportation costs and official barriers to trade, identical goods sold in differ- ent countries must sell for the same price. Applied to the valuation problem, it states that corporations which operate in the same industry segment, with identi- cal sales revenues, earnings, and equal assets should have the same value.

Based on this principle, a relation between corporate value and some corporate perfor- mance variable like earnings, turnover, or cash flow can be calculated for firms within a specific industry segment. Industry benchmarks or standards should allow for differences in the magnitude of corporations. Multiples define a standard for the observed market segment and serve as an adjustment for differences in sales, assets, or earnings of the firm. In spite of this, reality often depicts subtle differences to be a major significance.

One would then expect value estimations based on multiples to lack accuracy, when individual firms differ significantly from the market average. Empirical studies confirm this assessment. However traditional methods of evaluation are justifiable if firms continue to maintain existing corporate structures, while operating independently after the merger. Apparently the difference is that synergies are the chance or the positive result of an uncertain definite event. Synergy and operational risk could be seen as two sides of the same medal as the risk of a merger is that expected synergies fail to materialize.

The task of corporate risk management is to identify the risks inherent in the different steps of a business process, selecting a set of variables, providing an estimate for the likelihood and severity of operational risk and designing a control mechanism. Adopting this general structure for the process of risk management allows the valuation process of synergies to be divided into the three phases: identification, documentation and integration planning and evaluation. Synergy is neither given by posses- sion of resources nor inherent in tangible or intangible corporate assets.

Emerging Trends In Mergers & Acquisitions: Q&A With Rusty Wiley, CEO, Merrill Corporation

Synergy is the end result of amalgamating existing resources in a uniquely redesigned combination. The unification of resources to maximize value is a business process. Consequently identification of synergy has to observe a corporation in a new perspective as an orga- nized system of business processes. The primary focus must be on business processes as a key indicator for the ability of an organization to deliver its products or services in a timely and efficient manner. Any business process contains three key dimensions: 1.

Human resources; the most important intangible corporate asset. Due to special- ization, only a few key personnel have specific knowledge regarding business processes and its interactions with other people and systems within the firm.