Mergers and acquisitions

Sep, 15 2020

Every year, many legal entities either appear or cease to exist on the business market. However, it quite often happens that this or that company wishes to expand its scope of activities, and in this regard, decides to “connect” with another company, pursuing various goals. This is why the role of the transactions known as “mergers and acquisitions” has become much more important recently. Below, we shall consider this phenomenon in detail.

Broadly speaking, the term “merger and acquisition” refers to a whole range of civil and corporate processes aimed at bringing together and combining two or more companies into a single company. The result is the reorganization and restructuring of commercial enterprises, with their capital also merged. 

The Civil Code of the Russian Federation does not provide for the legal interpretation of such a concept as the reorganization of a legal entity. However, the same Civil Code does have provisions that lead to understanding the concept of reorganization of a legal entity as one of the ways to terminate a legal entity’s activities while preserving its rights and obligations. The result of this reorganization is termination of that legal entity’s existence, with the transfer of its rights and obligations to another legal entity already existing at the time of reorganization or created as a result of such reorganization.

The provisions of the Civil Code clarify that reorganization of a legal entity can be carried out in the following forms:

  • merger;
  • accession;
  • separation;
  • spin out;
  • transformation.

Therefore, in this article, we will consider only two forms of reorganization, namely merger and accession. This is because in the sense of Russian legislation, merger and accession are analogous to the processes called mergers and acquisitions in countries governed by English law or countries in the Commonwealth of Nations.

Mergers and acquisitions can be classified according to the following characteristics:

1. Nature of integration:

  • horizontal;
  • vertical;

2. Consistency of the integration:

  • friendly;
  • hostile.

Horizontal mergers and acquisitions take place when two or more organizations are merged into a single legal entity, provided that the merging companies operate in the same area of production of goods or services. Such an association is usually set up to increase competitiveness in a particular area of commercial activity.

However, we should not forget that these types of processes are of great interest to state executive bodies overseeing antimonopoly regulation. In the Russian Federation, the responsible authority is the Russian Federal Antimonopoly Service (FAS). The FAS ensures that the principles of free competition are observed and applied in practice. Its activities are also aimed at ensuring equal access by economic entities to goods or services, which leads to the formation and cultivation of a favorable competitive environment.

Vertical mergers and acquisitions take place in cases where one company acts as the supplier, and the other as the manufacturer. The supplying company provides raw materials to the manufacturing company, which then creates products using the supplied raw materials. This M&A process offers several benefits.

A vertical merger or acquisition of two or more legal entities can reduce the cost of production, thereby increasing the manufacturer’s profit and increasing the profitability of production.

Therefore, the main purpose of entering into an M&A deal (M&A is the abbreviation for the English “mergers and acquisitions”) is usually a desire to increase a company’s profit through complementary cooperation of two or more companies. However, the reasons for concluding these types of deals are not only economic. There are many other reasons that push companies to unite (for example, improving the company’s image attractiveness).

It often happens that people interested in concluding M&A deals consider the two concepts of mergers and acquisitions as equivalent. However, it is worth distinguishing between the two. Below, we will briefly analyze some of the differences between the two concepts.

Acquisition is a process that results in the establishment of comprehensive, one-hundred-percent control of the main legal entity over the target company (the legal entity being absorbed), carried out by acquiring more than 30% of the authorized capital.

It is appropriate now to consider the classification of mergers and acquisitions into friendly and hostile as previously mentioned. For example, a company’s share price may be rapidly decreasing as a result of decrease in its growth rate, and it becomes profitable for absorption / acquisition.

In this situation, the takeover of the company may be made by prior agreement with the shareholders and the executive body of the company being acquired. In this case, the takeover / acquisition will be friendly, since the takeover decision would have been reached by consensus and considering the views and interests of all the stakeholders.

However, there are also cases when the takeover / acquisition is hostile. In such situations, the acquired company is absorbed by the main company against the interests of the former’s shareholders. It is obvious that such a takeover causes significant damage to the acquired company and its shareholders, since their interests are not considered or respected.

This is why several strategies have been developed to protect companies from hostile takeovers by other companies. Here are some examples of these techniques:

  • creation of various classes of shares by shareholders of the target company. These shares provide for a different number of votes per share, which allows shareholders to retain control of the company while owning a small number of particular shares;
  • amendments to the Articles of Association of the target company that make it difficult to carry out M&A transactions. The Articles of Association, for example, may provide that such a transaction can only be carried out if it is approved by a qualified majority of shareholders;
  • performance of actions that will make the opportunity of a company’s takeover less attractive. Such actions include the sale of the target company’s assets.

A merger is the creation of a new legal entity to which all rights and liabilities of the merging companies are transferred, with termination of  merging companies’ operations. 

Thus, the fundamental difference between an acquisition and a merger is that an acquisition establishes control over the company being acquired in order to subsequently join the main company. In a merger, both companies cease to exist, and a new legal entity is created.

M&A deals have their benefits and drawbacks. The benefits of entering into a merger and acquisition deal include:

  • greater competitive performance;
  • improvement of production indicators;
  • acquisition of a well-established and streamlined sales system;
  • expansion of areas of activity, the possibility of entering new markets;
  • increased profitability.

The disadvantages of these types of deals include:

  • M&A deals are rather complex and resource-intensive;
  • there is need to carry out a variety of preliminary procedures (financial due diligence, risk assessment, etc.);
  • significant financial costs;
  • complexity of integration (especially in vertical mergers and acquisitions);
  • possible problems within the company (disagreement with new internal policy).

Thus, bringing the topic of mergers and acquisitions of legal entities to its conclusion, we will consider the process itself, namely the actions and procedures that must be carried out for the successful conclusion of an M&A deal.

First, there is need to find a legal entity that will be a participant in the reorganization. It is important to keep in mind that such a legal entity should meet all legal requirements and not raise suspicions about its legitimacy.

In addition, it is necessary to develop a strategy for conducting the mergers and acquisitions, which will include a clear step-by-step description of all procedures for conducting the merger and acquisition.

Once a strategy for conducting the merger and acquisition has been developed, and a legal entity has been found that will act directly as the object of the transaction, it is necessary to conduct a thorough assessment of the possible risks that the companies may face. As part of this procedure, it is necessary to conduct the so-called due diligence of the company, which will identify the legal and financial risks associated with concluding the deal.

Due diligence is a comprehensive assessment of a company that is the subject an M&A deal. Due diligence prior to the deal allows to obtain reliable financial and legal data about feasibility of investment and possible legal risks, as well as to make effective strategic decisions.

Legal and financial due diligence includes analysis of information about a company’s assets, legal grounds for their acquisition, the risks of third-party claims, management risks, availability of necessary licenses, as well as the company’s liabilities to counterparties, financial accounting organization, and insolvency risks.

Based on the results of due diligence, the expert draws a conclusion on the feasibility / advisability of entering into the deal, which reflects all the identified risks and drawbacks of the target company.

The next stage of entering into an M&A deal is preparation of all necessary documents, which may include an application for registration of a new legal entity, constituent documents, namely a merger or acquisition agreement, etc.

To sum up, an M&A is quite an extensive procedure. The key to its successful implementation is careful preparation and professional execution of each stage of the M&A transaction. Otherwise, a company planning to carry out a merger or acquisition bears risk of negative consequences, which may result in the decrease of its production volumes and profitability.

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