After valuation of the target firm, the acquiring firm must engage in the important task of negotiation. Negotiation involves implementing several essential tasks. These tasks include securing approval for merger and acquisition (M&A), due diligence, refining valuation, deal structuring, identifying sources of financing, regulatory considerations, and postacquisition integration planning. Next, we will discuss all, but the integration task. Due to the importance of postacquisition integration, we will discuss it in the following chapter.
Strategies to Secure Approval and Approaching the Target
Acquisition of a target firm requires approval from the owners, consent of management of the target firm if it is a public company, the shareholders’ agreement in a hostile takeover attempt, and approval from government regulatory agencies.
A formal offer to buy the shares of another firm, for cash or stocks, or both, is called a tender offer. In a friendly tender offer, the members of the boards of directors of acquiring and target firms enter formal negotiations. In some instances, if the board of directors of the target firm rejects such an offer, the acquiring firm may persist on its attempt to acquire the target by approaching the stockholders of the target directly. Such an action is called a hostile tender offer or a hostile takeover.
Some questions should be answered by the acquiring firm when it decides to approach a target firm. These questions include, who should make the initial contact with the target, how the contact should be made, what should be the content of message to the target, which person in the target company should be contacted, and how should the acquiring firm react to the target firm’s negative response to engage in M&A negotiations. Generally, the highest-ranking executive at the target company should be contacted via an intermediary.
Early in M&A transactions, writing a confidentiality agreement and letter of intent is a prudent practice.
A critical phase of negotiations in an M&A transaction is the conduct of due diligence as soon as the target firm agrees to allow it to begin. Due diligence refers to a set of activities with the aim of making sure that a potential acquirer obtains what the seller has promised to deliver.
By performing due diligence, the acquiring company will learn about the target company’s obligations such as debts, pending and potential lawsuits, leases, warranties, long-term customer agreements, employment contracts, distribution agreements, compensation arrangements, among other financial, technological, personnel, and cultural attributes of the target firm.
Refining Valuation of the Target Company
After the start of the negotiation, the task of updating the valuation of the target based on new information and data should begin. The acquirer should request the target’s financial data for 3 to 5 years. Based on the internal data of the company that are not available otherwise, the acquiring firm should identify nonrecurring revenues, losses, and expenses.
Initial deal structuring is the next step after a preliminary agreement is secured from the target management team. A deal structure is an arrangement between the acquiring and the target firm that defines the rights and responsibilities of both parties.
Deal structuring begins with each party stipulating its initial negotiating position, identifying potential risks, describing methods of mitigating the identified risks, stating the level of tolerance for risk, and articulating the conditions that permit either party to end the negotiations without reaching an agreement.
Deal structuring processes include tasks such as organizing the acquisition vehicle, designing the postclosing organization, specifying the method of payment, defining the legal form of the selling enterprise, and deciding the form of acquisition, as well as accounting and tax considerations. We next briefly define the components of deal structuring.
The acquisition vehicle is the legal structure created for the acquisition of the target. The postclosing organization refers to the organizational and legal framework used for management of the combined business after the successful conclusion of the deal. The organizational forms of a postmerger entity include a corporation, division, holding company, joint venture, partnership, limited liability company, and employee stock ownership plan.
The form of payment involves cash, stocks, debt, or a combination of three methods. The form of acquisition refers to the acquisition of stocks or assets of the target firm. Accounting considerations involve assessment of postmerger entity’s impact on the financial statements of the acquiring and the acquired enterprises. Finally, tax considerations refer to determining whether the transaction is taxable or nontaxable.1
In this phase of the negotiation, the acquiring concern must realistically assess the maximum amount it can finance for investment in the target firm. In financing the transaction of acquiring the target firm, the acquiring firm has the option of using cash in hand, borrowing, issuing equity, and having the seller to finance part of the deal.
Borrowing can take several forms including cash-flow lending, long-term financing, and leveraged bank loans.
In the cash-flow form of financing, the borrowing is short term, usually less than 1 year in maturity, and the borrowing firm uses certain near liquid assets such as inventory and accounts receivable as the collateral for the loan.
Long-term financing involves issuing of bonds, and leveraged loans, which are noninvestment-grade bank loans. These bank loans have adjustable interest rates, which are usually at least equal to the London Interbank Offer Rate (LIBOR) plus 1.5 percent. Finally, seller financing usually involves the seller agreeing to receive a portion of the purchase price later.
Governments play prominent roles in regulating cross-border foreign direct investment both in M&A and greenfield forms, as well as regulating business conducts to enhance competition and protect consumers. For example, in the United States, Department of Justice and Federal Trade Commission have the responsibility of promoting competition by enforcing antitrust laws of the United States. The Committee on Foreign Investment in the United States (CFIUS) has the responsibility of reviewing M&As of foreign enterprises in the United States, and report to the president of the United States those mergers or acquisitions that are potential threats to the national security of the United States (see Part III of this book in Volume II for the case studies involving the Chinese firm’s acquisition attempts and CFIUS). The Security and Exchange Commission of the United States has strict rules and regulations concerning competitive conduct and governance of publicly traded companies.
In 2007, Congress of the United States of America passed the Foreign Investment and National Security Act (FINSA). FINSA broadened the definition of “national security” in cases involving CFIUS review by including transactions in “critical infrastructure” and “critical technologies.” FINSA mandates investigation by CFIUS of all mergers and acquisition transactions involving a foreign government-controlled investor.
Of course, government regulations of corporate M&A, either domestically or cross-border, are present in many other countries. Accordingly, the in-depth due diligence of regulatory environment of the nation where merger or acquisition is to take place is pivotally important. A superficial review of the regulatory environment of the host country could result in massive losses after the conclusion of acquisition.
By way of illustration of deal structuring, we discuss a USD 4.7 billion acquisition of Smithfield Foods, a U.S. company, by Shuanghui International Holding Ltd, China’s largest pork producer, in September 2013 as a case study in Part III of this book in Volume II.
This chapter discussed negotiation, deal structuring, financing options, due diligence, and regulatory consideration for M&As. After defining these terminologies, strategies for securing approval from the target company’s management, shareholders, and government regulatory agencies responsible for domestic and cross-border M&As were examined. It was pointed out that detailed regulatory due diligence, especially in cross-border M&As is very important and is instrumental in preventing massive losses after completion of the deal. As an illustrative example of negotiation and deal structuring, the chapter presented a case study of Shuanghui International Ltd acquisition of Smithfield Foods in the United States.