Deals, growth, and financing decisions

Why companies buy, sell, borrow, raise equity, IPO, etc.

Why might a company acquire another company?

• Enter a new market or country

• Gain customers or market share

• Acquire technology, IP, or expertise

• Obtain valuable assets

• Increase scale

• Diversify into another product/industry

• Acquire talent

• Buy a company it believes is undervalued

What are synergies in an acquisition?

Synergies = benefits expected from combining two businesses that would not be achieved as effectively separately

Cost synergies = saving money by removing duplication e.g. combining offices or systems

Revenue synergies = generating more sales

The risk is that expected synergies may never materialise

Why might an acquisition destroy value?

• The buyer overpays

• Expected synergies fail

• Integration costs are higher than expected

• Customers leave

• Key employees leave

• Cultures/systems do not work together

• Buyer takes on excessive debt

• Regulation delays or blocks the deal

• Previously unknown liabilities emerge

Why might a company agree to be acquired?

• The buyer offers shareholders an attractive premium

• The company may struggle to achieve its growth plans independently

• Another owner may have more capital/resources

• The company is struggling financially

• Shareholder want to realise their investment

• The board believes the offer is better than remaining independent

Commercial tension between taking the money now and believing the company will be worth more later

Why might a target reject a takeover offer?

• The offer undervalues the company

• The board expectes stronger future growth

• Doubts about the bidder’s strategy

• Concerns about share consideration losing value (they are being paid in shares of the buyer’s business and are concerned these shares may lose value)

• The deal may face regulatory difficulties

• Management believes independence creates greater long-term value

What is a takeover premium and why does it matter?

Takover premium = the amount by which a takeover offer exceeds the target’s pre-offer share price

This matters because shareholders need an incentive to sell control of their company (the offer should be enough to persuade shareholders, but not su much as to overpay)

What is the difference between cash consideration and share consideration?

Cash consideration = target shareholders receive cash
Advantages - certainty of value and a clean exit for shareholders
Risks - requires access to signficant cash/financing for the buyer

Share consideration = target shareholders receive shares in the buyer
Advantages - the buyer does not need to fund the entire price in cash and the shareholders continue participating in the combined company’s future performance
Risks - the value of what the shareholders receive can change with the buyer’s share price

What is due diligence and its commercial purpose?

Due diligence = investigating the target before buying/investing

A buyer might investigate:

• Major customers/contracts

• Debt

• Litigation

• IP ownership

• Employees

• Property

• Regulation

• Supplies

• Tax liabilities

What might make something found in due diligence commercially significant?

• If it reduces revenue

• If it increases costs

• If it make an important asset unusable

• If it causes a customer/supplier to leave

• If it creates a major liability

• If it prevents the deal completing

• If it reduces what the buyer should be willing to pay

E.g. discovering that the technology target merely licenses its crucial IP could make the company less valuable than the buyer originally believed

How can a buyer respond to problems found in due diligence?

• Negotiate a lower price

• Require the seller to fix the problem

• Seek contractual protection (to protect the buyer if the problems cause financial damage later)

• Change the transaction structure (changing how the deal is paid for or organised to avoid the risk entirely e.g. only buying the safe assets of a company)

• Accept the risk if commercially worthwhile

• Walk away if the issue is severe enough

Lawyers often help clients manage and allocate risk, rather than eliminating every risk

What are warranties and indemnities, and why are they commercially useful?

Warranty = a contractual statement about the target/business e.g. a seller states that there is no undisclosed major litigation

Indemnity = an agreement to compensate the buyer for a particular identified loss e.g. the buyer discovers a specific tax issue and the seller agrees to cover losses arising from it

These help decide who bears the financial consequences if something goes wrong

Why do change-of-control clauses matter in acquisitions?

A contract may give another party rights if the company changes owner

This might allow termination, consent requirements, renegotiation because if the target’s biggest customer can leave after an acquisition, the business may suddenly be worth much less to the buyer

Why might singing and completion happen at different times?

Signing = parties legally agree the transaction

Completion = ownership actually transfers

Things need to happen between these processes such as competition approval, shareholder approval, financing arrangements, etc. (circumstances can change between singing and completion which pose commercial risks)

Why might a company expand into another country?

Potential opportunities:

• Access new customers

• Increase revenue

• Diversify away from one market

• Access talents/resources

• Exploit demand that is not available domestically

Potential risks:

• Unfamiliar regulation

• Political instability

• Currency movements

• Cultural differences

• Local competition

• Tax

Why might companies form a joint venture instead of one acquiring the other?

Joint venture = allows two businesses to cooperate on a project/business while remaining separate companies

Potential opportunities:

• Share costs and risk

• Combine complementary expertise

• Enter a new market with a local partner

• Pursue an opportunity neither could easily undertake alone

Potential risks:

• The partners may disagree about strategy, funding, or control

Why might a company sell/divest part of its business?

• It is not central to its strategy

• It is underperforming

• The buyer offers an attractive price

• The company wants cash to reduce debt

• The company wants to invest elsewhere

• The regulators require a sale

• Management wants to simplify/focus the business

Selling assets is not necessarily evidence that a company is struggling

How might a company fund an acquisition?

• Existing cash

• Borrowing/debt

• Issuing new shares

• Giving the seller shares

• Combination of the above

Potential questions that should be asked:

• How expensive is borrowing?

• How much debt can the company safely carry?

• Will issuing shares dilute existing shareholders?

• How confident is management in the acquisition?

How a deal is financed can materially change its risk

Why might a company refinance its debt?

Refinancing = replacing existing borrowing with new borrowing

• Debt is approaching maturity

• To obtain lower interest rates

• To change repayment schedule

• To loosen restrictive terms

• To raise additional money

• To reorganise finances after business circumstances change

Market interest rates and investor confidence can make refinancing much easier or harder

Why might a company IPO?

IPO = allows a private company to become publicly listed and sell shares to public investors

• Raise money for growth

• Allow founders/early investors to sell some holdings

• Create publicly tradable shares

• Raise profile

• Potentially use shares in future acquisitions

Potential downsides:

• Disclosure requirements

• Regulatory burden

• Costs

• Scrutiny from public shareholders

• Share-price pressure (pressure for share price to go up)

How does private equity make money?

PE firms raise investor capital, buy companies, increase their value, eventually sell/IPO them, and generate a return

PE firms may increase value through:

• Improving operations

• Growing revenue

• Entering new markets

• Making bolt-on acquisitions

• Reducing unecessary costs

• Changing strategy

Why do private equity deals often use debt?

Using debt means the PE fund does not have to fund the entire acquisition using its investors’ equity

If the company grows successfully, this can increase the return on the PE fund’s own money

Downsides of using debt:

• Interest must be paid

• Debt must eventually be repaid/refinanced

• Weak business performance becomes dangerous

This is why interest rates matter enormously to PE

What is a bolt-on acquisition and why might private equity use one?

Bolt-on acquisition = a portfolio company buys another, usually smaller, company

• To gain customers

• To enter new locations

• To acquire technology

• To increase scale

• To consolidate a fragmented industry

Instead of relying only on organic growth, the PE owner uses acquisitions to make its portfolio company bigger/more valuable

How can a private equity investor exit?

• Sell to another company (trade sale)

• Sell to another PE fund

• IPO the company

• Sometimes sell portions to other investors

PE ultimately needs a way to realise the increase in value of its investment

Why does timing matter in M&A and investment decisions?

A company may be attractive, but the market environment can make a deal more or less appealing

• Interest rates

• Valuations/share prices

• Economic growth

• Regulation

• Availability of financing

• Investor confidence

• Geopolitical uncertainty

Not only ‘why this deal?’, but also ‘why is the company doing it now?’