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In general a purchaser and a vendor will need to agree on three basic issues in regard to an acquisition:
(a) Whether shares or assets are to be purchased.
(b) Financial value.
(c) Type of consideration.
The ‘shares or asset’ issue does not generally arise when public companies are acquired, but with the purchase of private companies it will usually turn on the following points:
(a) An asset purchase will enable the purchaser to claim tax allowances on certain assets acquired, principally fixed assets other than land. The vendor, on the other hand, will probably have certain tax ‘claw-backs’ or ‘balancing charges’ to pay arising from tax allowances he has taken earlier, again principally on fixed assets other than land. The consequence is that, at least so far as tax efficiency is concerned, vendors do not generally favour this route, whilst acquirers seek it wherever possible.
(b) A share purchase is much more complicated, principally because of all the actual and contingent liabilities attaching to a company, as opposed to the underlying assets in the business, which can be sold separately from such liabilities. The documentation is much more lengthy and the cost of professional advisors far greater. In addition, stamp duty may be payable on the entire share transfer (as opposed to only on the property element of an asset sale). Where the vendor can be persuaded that his tax position is not prejudiced, therefore, this argues for an asset purchase.
A technique commonly used to mitigate the disadvantages of a share purchase is the hivedown. This is generally applied to a company only part of whose business is wanted by the purchaser. The part required is transferred to a clean ‘off the shelf or new company owned by the vendor; such a transfer can be accomplished without adverse tax consequences. The clean company, containing the business, is then sold without the documentary negotiation and complications which normally accompany the sale of a company which has been in existence for some time.
The financial value of the business is clearly a matter for bargaining between the vendor and the acquirer. In so doing the following points should be taken into account:
(a) If the acquisition is for shares, any borrowings within the company would need to be added to the cost of the shares in computing the final consideration for the company. The combined consideration would then represent the financial value of the underlying assets concerned, and would normally be the price on which the investment appraisal for the acquisition would be based. Thus, total consideration for a company whose shares are valued at 200, and whose internal borrowings are 100, is in reality 300.
(b) Tax liabilities or advantages to the vendor or acquirer. The structure of the acquisition clearly affects the tax position of both parties, and there may be other tax assets or liabilities (eg, tax losses carried forward) which are additions to the commercial value of the business. These would affect the overall value of the business.
(c) Debt consideration bearing below market interest. Either by way of consideration (see
below) for shares, or existing internal borrowings acquired with the business. The present value of the difference over the life of the borrowings between the going market inter rate and the actual rate on the bon concerned is generally deducted from the total consideration.
Thus, where the total consideration is nominally 500, of which 300 is a loan, the inter rate on which is 7% (when the market rate is 10%) and the after-tax present value of t difference between the two interest rates is 10, the total consideration could be taken to 490.
(d) Conventional methods of valuing shares include earnings-based models, dividend valuation models and asset-based models. 4.4 Type of consideration
The means of transferring the financial value of the shares or assets of the business, ti consideration, can be satisfied in a combination of several alternatives:
(a) Cash.
(b) Debt.
(c) Preference shares.
(d) Ordinary shares.
In addition, debt and preference share consideration can be convertible into ordinary shares.
The value of ordinary shares issued is, generally speaking, based on their market value at the tin of issue. In principle, too, the issue of shares is no more expensive to the purchaser than cash debt consideration, despite the implicit difference in the cost of equity and debt. The reason for ti is that, in general, projects, whether internal or external (ie, acquisitions) should be considered to financed from a ‘pool’ of financial resources based on the optimum relationship between debt a equity, and basing the appropriate hurdle on the ‘blended’ cost of such a pool. If equity is issued consideration for a project, the change in the debt/equity ratio resulting is usually considered to temporary, and the group will subsequently make appropriate adjustments in the level of debt order to optimise the ratio. Adjustments would equally have to be made where debt rather ti equity is issued.
There are, however, certain complicating factors which require to be borne in mind and may against the use of such shares:
(a) Temporary depression of share price
The acquirer may feel the then current share price might rise in the future, either bec the share market as a whole is depressed, or because the value of the acquiring comp shares are temporarily depressed. Thus, the vendor may be getting the shares ‘cheap’.
(b) Dilution of existing shareholders’ interests
This will be a problem where the acquirer has a limited number of major shareholders may not, for control or other reasons, wish to see their interests diluted.
(c) Difficulty in valuing shares
Unquoted companies may have difficulty in establishing an appropriate price.
(d) Maintenance of debt/equity ratio
If the change in the equity base is large in relation to the pre-acquisition level of equity, it may be difficult to get back to an optimum debt/equity ratio. Under these circumstances, the ordinary shares issue may indeed have a higher cost, closer to the cost of equity rather than to the ‘blended cost of capital’.
The type, cost and term/redemption arrangement of debt or preference shares to be issued is a matter for negotiation. However, the vendor’s capital gains tax may be deferred by the issue of either debt or shares of any type, the deferral being until repayment date/redemption date/date of sale of ordinary shares.
Where debt or preference shares are concerned, there is often a quid pro quo exacted by the acquirer in the form of a lower interest and dividend rate than the going market, in return for the tax advantage conveyed.
The acquisition of quoted companies is circumscribed by the City Code on Takeovers and Mergers (‘the City Code’), which is the responsibility of the Panel on Takeovers and Mergers. This code does not have the force of law, but it is enforced by the various City regulatory authorities, including the Stock Exchange, and specifically by the Panel on Takeovers and Mergers (the ‘Takeover Panel’). Its basic principle is that of equity between one shareholder and another, and it sets out rules for the conduct of such acquisitions.
The Stock Exchange Yellow Book also has certain points to make in these circumstances:
(a) Details of documents to be issued during bids for quoted companies.
(b) Such documents to be cleared by the Stock Exchange.
(c) Timely announcement of all price sensitive information.
The Office of Fair Trading (OFT) regulates the monopoly aspects of bids. Many bids, because of their size, will require review by the OFT, and a limited number will subsequently be referred to the Monopolies Commission. In addition, if the offer gives rises to a concentration (ie, a potential monopoly) within the EC, the European Commission may initiate proceedings. This can result in considerable delay, and constitutes grounds for abandoning a bid.
In considering a public bid, a group will generally have the following advisors:
(a) Merchant bank – acting as general financial advisors.
(b) Legal advisors – to ensure compliance with the law, particularly in preparation of documents.
(c) Accountants – to provide any necessary support for financial information in documents.
(d) Stockbrokers – to assist with Stock Exchange requirements and underwriting, where appropriate.
Such a group would generally examine the publicly available information on the target company, and then would make a decision with its merchant bankers as to whether or not to approach the target’s board/management in advance of a bid. It would be normal to do this in the following circumstances:
(a) Where the target has a significant board/management shareholding.
(b) Where there appears to be a good chance of making an offer for the target ‘agreed’ management before the bid is announced.
(c) Where the bidding group does not wish to appear ‘hostile’ or ‘predatorial’.
The purpose of these preliminary discussions would be to discuss the purpose of the would- bidder, and to ascertain whether a price acceptable to both parties can be struck. A further bon might be the acceptance of a significant block of shareholders for such a bid.
If an acquirer does not approach management in advance, the subsequent bid will almost certair be taken to be ‘hostile’ or ‘predatorial’ and will result in a spirited defence by that managemei However, such an approach does have the disadvantage that it alerts the management to the possi bid, and gives them more time to prepare a suitable defence.
In either event, the would-be acquirer may decide, with the help of his advisors, to combine his b with the acquisition of shares in the market. Such action is governed by detailed rules set out in ti City Code and in the Companies Act 1985. The basic points are:
(a) 3% disclosure
A would-be bidder, together with related parties, can build up a stake of 3% without at obligations to disclose this to the target company. Over 3% the stake must be disclosed the target company under the statutory rules for disclosure of substantial interests, th? giving warning to the management of a possible bid.
(b) Limits on purchases when shareholding is between 15% and 30%
A shareholder cannot within any seven day period acquire a further block of shares of mo
than 10% if, after this additional purchase, his aggregate holding will be in the range of 15% to 30%.
This is designed to limit the speed at which a bidder can acquire a significant stake, so ti the target’s management have a fair chance to comment and prepare for a possible bid. T exceptions to this rule are acquisitions:
(i) from a single shareholder, or
(ii) pursuant to a tender offer, or
(iii) immediately preceding, and conditional upon, an announcement of an offer which is to be recommended by the board of the target company.
There are also provisions for disclosing the acquisition of such an interest to the target company much more quickly than required under the Companies Act.
The significance of this rule is that it limits to 15% of the total available the number shares that can be bought in a ‘dawn raid’ – a quick, organized share-buying operation usually over in a few minutes, which is often a prelude to a full bid. Such raids considered by many to be inequitable to non-institutional shareholders who will not hear the operation until it is over; but in any event, they are much rarer than in the past, since institutional shareholders have found in general that they obtain more for their shares by waiting for a full bid.
It is worth noting that it will, in general, take a minimum of fifteen days to build up a 30% stake as a result of this rule.
(c) Compulsory offer if shareholding exceeds 30%
If a shareholding exceeds 30% a bidder must make an offer conditional on a minimum acceptance of 50%, no Monopolies and Mergers Commission reference and no European Commission reference.
(d) Offer period
The offer period starts when an announcement is made of a proposed or possible offer.
This date is significant in determining the value of the offer to shareholders. If the offeror has purchased shares in the offered company within three months prior to the commencement of the offer period, the offer to shareholders must not be on less favorable terms.
(e) ‘Unconditional as to acceptances’
When an offer receives acceptances from shareholders, the offer and acceptance are conditional upon:
(i) a minimum percentage of share capital being acquired by the offeror;
(ii) a time period within which the shareholder can withdraw his acceptance.
The term ‘unconditional as to acceptances’ means that the offeror has obtained the minimum percentage and declares that accepting shareholders can no longer withdraw their acceptance.
If a would-be bidder decides to make an offer, the City Code is specific about the information it must contain. Furthermore, it cannot be withdrawn without the Takeover Panel’s consent, unless it lapses or certain conditions are not met. Two conditions are common to most offers:
(a) No reference to the Monopolies and Mergers Commission.
(b) Acceptances in excess of 50% and, at the option of the bidder, 90% of the shareholding are received.
If acceptances exceed 90%, the offer can in general be enforced compulsorily for 100% of the shares.
It is difficult to be precise about the course of a bid, and later in the text the section on Defence gives an example of what might be involved. However, there are certain deadlines and rules which the Code specifies:
(a) Offer document
This must be posted within twenty-eight days of the announcement of a bid, and is subject to the provisions of the Yellow Book. It will also generally contain a profit forecast (with merchant banker’s and accountant’s reports), and often a property revaluation.
(b) Closing date
An offer must generally stay open for twenty-one days after posting. If revised, it must stay open for a further fourteen days.
(c) Withdrawal of acceptances
A shareholder may withdraw his acceptance forty-two days after the offer document has been posted, if the offer has not gone ‘unconditional’.
(d) Revision
No offer may be revised longer than forty-six days after posting.
(e) Lapsing
An offer must go unconditional, or will lapse sixty days after posting. An extension may, however, be granted if another bidder has made an offer.
Offers may be for cash or, in principle, for any of the alternative forms of consideration set out above. If for cash, the bidder may use its existing cash or borrowing facilities, or, where shares are available as an alternative, such shares may be underwritten, so that acceptors can accept cash if they desire.
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