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The power of two? Weighing up mergers

The power of two? Weighing up mergers

Whether you operate in the independent or the multiple sector, if you’re considering a merger or an acquisition, considering the following points will help the deal go smoothly, says Adam Bernstein

Although they are often used interchangeably, the words mergers and acquisitions have different legal meanings. In a merger, two companies of a similar size combine to form a new single entity. An acquisition occurs when a larger company acquires a smaller business and absorbs it.

Merger and acquisition deals can be friendly or hostile, depending on the approval of the target company’s board. Paul Taylor, a partner in the corporate department at Fox Williams LLP, says success hinges on understanding what the deal seeks to achieve.

Deciding on the goals at the outset and communicating these to a potential buyer upfront makes it more likely that the desired outcome will be achieved.

Payment Considerations

Many sales take the form of a share sale rather than an asset sale. In essence, the former transfers ownership interests in the company, whereas the latter means the sale of assets and business to another company. Taylor says there are benefits and drawbacks to each, but a key driver is tax: “A share sale may give rise to capital gains tax on the profits made,” he says.

“An asset sale will result in corporation tax on the proceeds of the sale made by the company. Once the company has paid corporation tax, the proceeds of the sale can then be distributed, but if the owners are individuals, they will be charged income tax on the proceeds.”

In effect, he warns that there can be double taxation on an asset sale.

An issue for private limited companies is that they have no open market for their shares, making it difficult to determine a valuation – at least not without external advisers. Here, Taylor recommends that “a valuation is obtained from a reputable corporate finance adviser early on in the process”.

He explains, however, that there are options for sellers: “With a ‘locked box’, the price is locked on a particular date and any leakage out of the company to the sellers and connected persons from that date is owed to the buyer,” he says.

“But with completion accounts, the price is subject to adjustment once accounts have been prepared and finalised following the completion date to reflect the true position at the date the buyer acquired the company.” Taylor sees the ‘locked box’ route as preferable for sellers.

Regardless of the route chosen, key terms that are important to the seller should, says Taylor, be documented in a letter of intent or heads of terms. While this generally won’t be legally binding, it will record that the parties agreed to proceed with the deal on a certain basis.

Naturally, centre-stage of any transaction is the payment. Those looking to make a clean exit will likely be looking for the buyer to make a single cash payment upon completion. However, the buyer may suggest a different structure. In fact, Taylor often sees “provisions that link a target – say profit or revenue – to the price that is payable at a future date… there are a myriad of other potential consideration structures that may be proposed, depending on the motivations and finances of the buyer.”

One example is where the buyer expects sellers to stay on with the business and must reinvest a portion of their proceeds into shares or loan notes within the buyer’s organisation.

Managing the process

The process takes time because buyers want to conduct due diligence. As Taylor highlights: “The timing of this exercise will depend on the buyer’s level of urgency, the amount of information to review and the materiality thresholds the buyer might have set for such review.”

Another consideration, says Taylor, is the high likelihood of the need to give warranties in the sale documentation relating to the company and its business operations “against which a seller can disclose any untrue or misleading information to limit their liability”.

It should be said that due diligence does open up a company’s innermost secrets. It also risks the public, customers or suppliers learning of the deal before it completes. On top of this are worries if the potential buyer is a competitor.

It’s because of these risks that Taylor recommends that sellers enter into a confidentiality or non-disclosure agreement at the outset to “provide some comfort that potential buyers will keep the information they learn during the deal process, and the existence of the potential deal itself, confidential.”

That said, there are other ways to protect sensitive information disclosed during the transaction. Two options that Taylor mentions are to “only upload data once it has been established that the buyer is sufficiently serious about the deal, and to apply permissions to documents so that they cannot be printed or downloaded”.

Personal tax implications

While proceeds from a share sale should be taxed as capital gains, there is also business asset disposal relief (BADR), formerly known as entrepreneurs’ relief, to consider.

Taylor puts great store in BADR since it “currently entitles the seller to a 10 per cent tax rate rather than the otherwise applicable capital gains tax rate.”

He adds that, broadly speaking, “this relief should also be available on asset sales and share sales, but there are various qualifying conditions and sellers should definitely take advice from a tax advisor before structuring the sale transaction.”

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