Payment and Legal Considerations

8/13/2019 Payment and Legal Considerations

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M&A Deal StructuringProcess: Payment &Legal Considerations



If you can’t convince them,

confuse them.

—Harry S. Truman





Learning Objectives

• Primary Learning Objective: To providestudents with a knowledge of the M&Adeal structuring process

• Secondary Learning Objectives: To enablestudents to understand

– the primary components of the process,

– payment considerations, and – legal considerations.



Deal Structuring Process• Deal structuring involves identifying

– The primary goals of the parties involved in thetransaction;

– Alternatives to achieve these goals; and

– How to share risks.

• The appropriate deal structure is that which – Satisfies as many of the primary objectives of the

parties involved as necessary to reach agreement

– Subject to an acceptable level of risk

Questions: 1. What are common high priority needs of public companyshareholders? Private/family owned firm shareholders?

2. How would you determine the highest priority needs of the

parties involved?



Major Components ofDeal Structuring Process

1. Acquisition vehicle

2. Post-closing organization

3. Form of payment4. Form of acquisition

5. Legal form of selling entity

6. Accounting Considerations7. Tax considerations





Acquisition Vehicle

Acquirer’s Objective (s) Potential Organization

Maximizing controlFacilitating postclosing

integration

Corporate (C or S) ordivisional structure

Minimizing or sharing risk Partnership/joint ventureHolding company

Gaining control while limiting

investment

Holding company

Transferring ownershipinterest to employees

Employee stock ownershipplan



Post-Closing Organization

Acquirer’s Objective (s) Potential Organization

Integrate target immediatelyCentralize control in parentFacilitate future funding

Corporate or divisionalstructure

Implement earn-outPreserve target’s culture Exit business in 5-7 years

Assume minority position

Holding company

Minimize risk

Minimize taxesPass through losses

Partnerships

Limited liability companies



Discussion Questions

1. What is an acquisition vehicle? What aresome of the reasons an acquirer maychoose a particular form of acquisition

vehicle?2. What is a post-closing organization?

What are some of the reasons an

acquirer may choose a particular form ofpost-closing organization?



Form of Payment

• Cash (Simple but creates immediate seller tax liability)

• Non-cash forms of payment – Common equity (Possible EPS dilution but defers tax liability) – Preferred equity (Lower shareholder risk in liquidation) – Convertible preferred stock (Incl. attributes of common & pref.) – Debt (secured and unsecured) (Lower risk in liquidation)

– Real property (May be tax advantaged through 1031 exchange) – Some combination (Meets needs of multiple constituencies)• Closing the gap on price and risk mitigation

– Balance sheet adjustments (Ignores off-balance sheet value) – Earn-outs or contingent payments (May shift risk to seller) – Rights, royalties, and fees (May create competitor & seller tax

liability) – Collar arrangements (Often used when acquirer’s share price

has a history of volatility)

C S



Collar Arrangements Based on a Floating ShareExchange Ratio (SER) to Protect Target Shareholders1,2

Objective: To guarantee an offer price per share (OPPS) within a range for target firmshareholders.

Offer Price Per Share = Share Exchange Ratio (SER) x Acquirer’s Share Price (ASP) = Offer Price Per Target Share x Acquirer’s Share Price

Acquirer’s Share Price

Collar Arrangement: Defines the maximum and minimum price range within which theOPPS varies.

SER x ASP (lower limit) ≤ Offer Price Per Share ≤ SER x ASP (upper limit)

Example: A target agrees to a $50 purchase price based on a share exchange ratio of 1.25acquirer shares for each target share. The value of the each acquirer share at the timeof the agreement is $40 per share. The target shareholder is guaranteed to receive $50per share as long as the acquirer’s share price stays within a range of $35 to $45 pershare. The share exchange ratio floats within the $35 to $45 range in order to maintain

the $50 purchase price.($50/$35) x $35 ≤ ($50/$40) x $40 ≤ ($50/$45) x $45

1.4286 x $35 ≤ 1.25 x $40 ≤ 1.1111 x $45

1For a floating share exchange ratio, the dollar offer price per share is fixed and the number of shares exchanged varies with the value of the acquirer’s share price. Acquirer share price changes require re-estimating the share exchange ratio. Floating exchange ratios are used most often when the acquirer’s share priceis volatile. Fixed share exchange ratios are more common since they involve both firms’ share prices and allow both parties t o share in the risk or benefit offluctuating share prices.

2SER generally calculated based on the 10 to 20 trading day period ending 5 days prior to closing. The 5-day period prior to closing provides time to calculate theappropriate acquirer share price and incorporate into legal documents.

C St d Alt ti C ll A t B d Fi d



Case Study: Alternative Collar Arrangements Based on FixedValue and Fixed Share Exchange Ratios

On 9/5/2009, Flextronics agreed to acquire IDW in a stock- for-stock merger with an aggregate value ofapproximately $300 million. The share exchange ratio used at closing was calculated using theFlextronics average daily closing share price for the 20 trading days ending on the fifth trading dayimmediately preceding the closing. Transaction terms identified the following three collars:

1. Fixed Value Agreement (SER floats): Offer price was calculated using an exchange ratio floating insidea 10% collar above and below a Flextronics share price of $11.73 and a fixed purchase price of$6.55 per share for each share of IDW common stock. The range in which the exchange ratio floatscan be expressed as follows:a

[$6.55/$10.55] x $10.55 ≤ [$6.55/$11.73] x $11.73 ≤ [$6.55 /$12.90] x $12.90.6209 x $10.55 ≤ .5584 x $11.73 ≤ .5078 x $12.90

.6209 shares of Flextronics stock issued for each IDW share (i.e., $6.55/$10.55) if Flextronics declinesby up to 10%

.5078 shares of Flextronics stock issued for each IDW share (i.e., $6.55 /$12.90) if Flextronicsincreases by up to 10%

2. Fixed Share Exchange Agreement (SER fixed): Offer price calculated using a fixed exchange ratioinside a collar 11% and 15% above and below $11.73 resulting in a floating purchase price if theaverage Flextronics' stock price increases or decreases between 11% and 15% from $11.73 pershare. (See the next slide.)

3. The target, IDW, has the right to terminate the agreement if Flextronics' share price falls more than15% below $11.73. If Flextronics' share price increases more than 15% above $11.73, theexchange ratio floats based on a fixed purchase price of $6.85 per share.b (See the next slide.)

aThe share exchange ratio varies within a range of plus or minus 10% of the Flextronics’ $11.73 share price. bIDW is protected against a potential “free fall” in Flextronics share price, while the purchase price paid by Flextronics is capped at $6.85.



Multiple Price Collars Around Acquirer FlextronicsShare Price to Introduce Some Predictability

$11.73 increases more than 15%,

offer price capped at $6.85$11.73 falls by more than 15%,IDW may terminate agreement

$11.73 increases (decreases) from 11%15% (Offer price floats up to $6.85 ordown to $6.18)

$11.73 increases (decreases) from1% to 10% (Offer price fixed at $6.55)

$11.73 Flextronics Share Price

Price Increase Above Acquirer Share Price of$11.73

Price Decrease Below Acquirer Share Price of$11.73

Fixed Share Exchange Agreement: Allows Purchase Price to ChangeWithin a Range1

Fixed Value Agreement: AllowsFloating Share Exchange Ratio toHold Purchase Price Constant2

1Fixed share exchange agreement represents range in which acquirer and target shareholders share risk of fluctuations inacquirer share price.

2Fixed value agreement represents range in which the target shareholders are protected from fluctuations in the acquirer’sshare price.

Fl t i IDW Sh E h U i Fi d V l (SER Fl t )



Flextronics-IDW Share Exchange Using Fixed Value (SER Floats)and Fixed Share Exchange Agreements

Offer Price Offer Price %Chg.1. ($6.55/$11.73) x $11.73 = $6.55 %Chg.1 $(6.55/$11.73) x $11.73 = $6.55

Floating SER 1 ($6.55/$11.85) x $11.85 = $6.55 <1> ($6.55/$11.61) x $11.61 = $6.55

2 ($6.55/$11.96) x $11.96 = $6.55 <2> ($6.55/$11.50) x $11.50 = $6.55

3 ($6.55/$12.08) x $12.08 = $6.55 <3> ($6.55/$11.38) x $11.38 = $6.55

4 ($6.55/$12.20) x $12.20 = $6.55 <4> ($6.55/$11.26) x $11.26 = $6.55

5 ($6.55/$12.32) x $12.32 = $6.55 <5> ($6.55/$11.14) x $11.14 = $6.55

6 ($6.55/$12.43) x $12.43 = $6.55 <6> ($6.55/$11.03) x $11.03 = $6.55

7 ($6.55/$12.55) x $12.55 = $6.55 <7> ($6.55/$10.91) x $10.91 = $6.55

8 ($6.55/$12.67) x $12.67 = $6.55 <8> ($6.55/$10.79) x $10.79 = $6.55

9 ($6.55/$12.79) x $12.79 = $6.55 <9> ($6.55/$10.67) x $10.67 = $6.55

10 ($6.55/$12.90) x $12.90 = $6.55 <10> ($6.55/$10.56) x $10.56 = $6.55Fixed SER 11 ($6.55/$12.90) x $13.02 = $6.61 <11> ($6.55/$10.56) x $10.44 = $6.48

12 ($6.55/$12.90) x $13.14 = $6.67 <12> ($6.55/$10.56) x $10.32 = $6.40

13 ($6.55/$12.90) x $13.25 = $6.73 <13> ($6.55/$10.56) x $10.21 = $6.33

14 ($6.55/$12.90) x $13.37 = $6.79 <14> ($6.55/$10.56) x $10.09 = $6.26

15 ($6.55/$12.90) x $13.49 = $6.85 <15> ($6.55/$10.56) x $9.97 = $6.18

>15 SER floats based on fixed $6.85 offer ><15> IDW may terminate agreement 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from $11.73

t



orm o cqu s t on eans o rans err ngOwnership): Governed by State Statutes

• Statutory one-stage (compulsory) merger or consolidation: – Stock swap statutory merger by majority vote of both firms’ shareholders – Cash out statutory merger (form of payment something other than common

stock)• Asset acquisitions (buying target assets)

– Stock for assets – Cash for assets

• Stock acquisitions (buying target stock via tender offer) – Stock for stock – Cash for stock

• Special applications of basic structures – 2-stage stock acquisitions (Obtain control & implement backend merger) – Triangular acquisitions – Leveraged buyouts – Single firm recapitalizations

Key Point: Each form represents an alternative means of transferringownership.

St t t O St M d C lid ti



Statutory One-Stage Mergers and Consolidations

• Stock swap statutory merger : Two legally separate and roughly comparable in sizefirms merge with only one surviving. Shareholders of target (selling) firm receive votingshares in the surviving firm in exchange for their shares.

• Cash-out statutory merger : Selling firm shareholders receive cash, non-voting preferred

or common shares, or debt issued by the purchasing company.• Procedure for statutory mergers: Assume Firm B is merged into Firm A with Firm Asurviving: – Firm A absorbs Firm B’s assets and liabilities as a “matter of law.” – Boards of directors of both firms must approve merger agreement – Shareholders of both firms must then approve the merger agreement, usually by a

majority of outstanding shares. Dissenting shareholders must sell their shares.

• Voting rule exceptions: Parent firm shareholder votes not required when – Acquiring firm shareholders cannot vote unless their ownership in the acquiring firmis diluted by more than one-sixth or 16.67%, i.e., Firm A shareholders must own atleast 83.33% of the firm’s voting shares following closing. (Small scale mergerexception)1

– Parent firm holds over 90% of a subsidiary’s stock. (Parent-sub merger exception;also called a short-form merger)

– Certain holding company structures are created (Holding company exception) .• Advantages/disadvantages: All target assets and liabilities (known/unknown) transfer to

acquirer as a “matter of law,” flexible payment terms, and no minority shareholders ortransfer taxes but responsible for all liabilities and subject to shareholder approval.

1This effectively limits the acquirer to issuing no more than 20% of its total shares outstanding. For example, if the acquirer has 80 million sharesoutstanding and issues 16 million new shares (.2 x 80), its current shareholders are not diluted by more than one-sixth, since 16/(16 + 80) equalsone-sixth or 16.67%. More than 16 million new shares would violate the small merger exception.



Asset Aquisitions1

• Cash for assets acquisition: Acquiring firm pays cash for target firm’sassets, accepting some, all, or none of target’s liabilities. – If substantially all of its assets are acquired, target firm dissolves after

paying off any liabilities not assumed by acquirer and distributing anyremaining assets and cash to its shareholders2

– Shareholders do not vote but are “cashed out” • Stock for assets acquisition: Acquirer issues shares for target’s assets,

accepting some, all, or none of target’s liabilities. – If acquirer buys all of target’s assets and assumes all of its liabilities, the

acquisition is equivalent to a merger. – Listing requirements on major stock exchanges require acquiring firmshareholders to approve such acquisitions if the issuance of new sharesis more than 20% of the firm’s outstanding shares

– Target’s shareholders must approve the transaction if substantially all ofits assets are to be sold

• Advantages/disadvantages: Allows acquirer to select only certain target

assets and liabilities; asset write-up & no minority shareholders but lose taxattributes and assets not specified in contract and incur transfer taxes

1In acquisitions, acquiring firms usually larger than target f irms.2Usually, acquirer purchases 80% or more of the fair market value of the target’s operating assets and may

assume some or all of the target’s liabilities. In some cases, courts have ruled that acquirer is responsible fortarget liabilities as effectively liquidating or merging with the target.



S i l A li ti f B i St t



Special Applications of Basic Structures

• Two stage stock transactions:

– First stage: Acquirer buys target stock via a tender offer to gain

controlling interest and owns target as a partially owned subsidiary – Second stage (backend merger): Acquirer merges a partially owned

subsidiary into a wholly owned subsidiary giving minorityshareholders cash or debt for their cancelled shares. Also known asa freeze out or squeeze out.

– Advantages/disadvantages: Very popular as acquirers gain control

more rapidly than if they attempted a one-step statutory mergerwhich requires boards and shareholders to approve mergeragreement but may require substantial premium to gain initialcontrol.

• Triangular acquisitions: Acquirer creates wholly owned sub which

merges with target, with either the target or the sub surviving – Advantages: Avoids acquirer shareholder vote as parent sole ownerof sub and limits parent exposure to target liabilities; however,acquirer shareholder vote may be required in some states if newstock issued dilutes current shareholders by more than one-sixth



Special Applications of Basic Structures Cont’d

• Leveraged buyout (LBO): LBO sponsor (a limited partnership)creates shell corporation funded with sponsor equity.

– Stage 1: Shell corporation raises cash by borrowing from banksand selling debt to institutional investors

– Stage 2: Shell buys 50.1% of target stock, squeezing outminority shareholders with a back end merger in which

remaining shareholders receive debt or preferred stock.• Single firm recapitalization: Enables firm to squeeze out minority

shareholders.

– Firm with minority shareholders creates a wholly-owned shelland merges itself into the shell through a statutory merger.

– All stock in the original firm is cancelled with the majorityshareholders in the original firm receiving stock in the survivingfirm and minority shareholders receiving cash or debt.




1. What is the difference between the formof payment and form of acquisition?

2. What factors influence the determinationof form of payment?

3. What factors influence the form of

acquisition?



Determining Purchase Price and ControlPremium: The NBC Universal (NBCU) Case

• Comcast and General Electric (GE) announced on12/2/09 that they had agreed to form a JV that will be51% owned by Comcast, with the remainder owned byGE.

• GE was to contribute NBC Universal (NBCU) valued at$30 billion and Comcast was to contribute TV networksvalued at $7.25 billion.

• Comcast also was to pay GE $6.5 billion in cash. In

addition, NBCU was to borrow $9.1 billion and distributethe cash to GE.

NBC Universal (NBCU) JV Valuation Purchase Price



NBC Universal (NBCU) JV Valuation, Purchase PriceDetermination, and Resulting Control Premium

NBC Universal Joint Venture Valuation1 $37.25 billion

Comcast Purchase Price for 51% of NBC Universal JV

Cash from Comcast paid to GECash proceeds paid to GE from NBCU borrowings2

Contributed assets (Comcast network)Total

$6.509.10

7.25$22.85 billion

GE Purchase Price for 49% of NBC Universal JV

Contributed assets (NBC Universal)Cash from Comcast Paid to GE

Cash proceeds paid to GE from NBCU borrowingsTotal

$30.00(6.50)

(9.10)$14.40 billion

Implied Control / Purchase Price Premium (%)3

Implied Minority/Liquidity Discount (%)4

20.3

(21.1)1Equals the sum of NBCU ($30 billion) plus the fair market value of contributed Comcast properties ($7.25 billion)and assumes no incremental value due to synergy. These values were agreed to during negotiation.2The $9.1 billion borrowed by NBCU and paid to GE will be carried on the consolidated books of Comcast, since ithas the controlling interest in the JV. In theory, it reduces Comcast’s borrowing capacity by that amount and shouldbe viewed as a portion of the purchase price. In practice, it may reduce borrowing capacity by less if lenders viewthe JV cash flow as sufficient to satisfy debt service requirements.3The control premium represents the excess of the purchase price paid over the book value of the net acquiredassets and is calculated as follows: [$22.85 / (.51 x $37.25] -1.4

The minority/liquidity discount represents the excess of the fair market value of the net acquired assets over thepurchase price and is calculated as follows: [$14.40/(.49 x $37.25)] -1.




1. Suppose two firms, each of which was generatingoperating losses, wanted to create a joint venture. Thepotential partners believed that significant operatingsynergies could be created by combining the twobusinesses resulting in a marked improvement in

operating performance. How should the ownershipdistribution of the JV be determined?

2. Discuss the advantages and disadvantages of youranswer to question one.

3. Should the majority owner always be the onemanaging the daily operations of the business? Why?Why not?



Things to Remember…

• Deal structuring addresses identifying andsatisfying as many of the primary objectives ofthe parties involved and determining how riskwill be shared.

• Deal structuring consists of determining theacquisition vehicle, post-closing organization,the form of payment, the form of acquisition,legal form of selling entity, and accounting and

tax considerations.• Choices made in one area of the “deal” are likely

to impact other aspects of the transaction.

Documents

Payment and Legal Considerations