M&A transactions– one step after another with no slips (part 1)

Katarzyna BUDA
Transaction Advisory Manager at RSM Poland

Mergers and acquisitions have been the basis of corporate development for the past one hundred years. An increase in trust and an improvement of the company situation, as well as access to sources of stable funding have contributed to a significant expansion of the global perspective within the area of M&A. An economic crisis is also conducive to the processes of company consolidation.  

Acquiring a company might take on different forms - it might be buying stocks or shares, as well as acquiring parts of the assets or of the organised part of the company. However, a merger, or, in different words, combining, takes place when entities of identical or comparable size, out of which each has a 50% share in the company, and the shareholders of the merging companies have 50% of votes at the AGM of the merged company. In every other case, we are talking about acquiring one company by another.

It needs to be noted that a merger is a special case of acquiring. According to the Commercial Companies Code, there are two models: combining by means of acquiring as well as combining by means of founding a new company. Combining by acquiring consists of transferring all the assets of the acquired company onto the acquiring company in exchange for the stocks or shares which the acquiring company issues to partners of the acquired company. Merging by unifying takes place by founding a new corporation, the latter getting all the assets of the merged companies in exchange for the stocks or shares of the new company. Irrespective of the choice of the merging model, the going concern acquires all the rights and liabilities of the merged companies.

One ought to remember acquiring a company is not the goal in and of itself, but rather a means to achieving a strategic goal. If the choice is made to acquire, the investor creates a profile of a perfect company meeting the pre-established conditions. Constructing such a profile allows for the conducting of active search of an attractive company, i.e. such that meets as many requirements as possible included in the said profile. Having prepared the candidate profile, the company has a choice of either conducting the search, identification and selection themselves, or hiring an expert.

Companies managing such services are usually investment banks or consulting companies and advising companies. After having identified an appropriate candidate, the management is contacted in order to commence talks on the possibility of carrying out a closer analysis of the company. The information gathered allow for the assessment of the pros and cons as well as for a preliminary candidate assessment. The list of critical elements which shall be researched closely at a later stage includes:

• too low or too high remuneration of the owners/shareholders/the management;
• investment written off too slowly or too fast;
• non-moving goods;
• bad debt;
• too low or too high cost of funding;
• off-balance liabilities;
• overestimated and underestimated property as well as other asset components;
• product lifecycle;
• technological advancement;
• no development cost (high current profit that can disappear in the future)

The above mentioned attests to the fact that the acquiring company conducts a lot of analytical activities, aimed at preliminary research of the prospective candidates. Such analyses are labelled as preliminary due diligence by the experts, the latter aimed at obtaining superficial knowledge of the potential candidate based on which the investor shall be able to carry out preliminary selection. Preliminary due diligence usually comprises the analysis of the widely available financial data, the prospectuses, yearly reports, review of the company agreement as well as the information on the management. The analysis is usually confidential.

After having carried out the preliminary due diligence, the investor - if they are still interested - signals their interest. Irrespective of what form the notifying takes place in, the investor should prepare a short memorandum describing:

• The subject-matter of the application;
• the profile of the notifying party;
• the benefits and drawbacks for the company being notified;
• the representative of the notifying party.

If the initial stage is successful, it should conclude in arrangements constituting the basis for further acquiring of the selected company. The arrangements of the sort shall be included in documents such as a letter of intent as well as the confidentiality clause.

The obligatory elements of a letter of intent:

• parties to the agreement;
• the subject matter of the prospective transaction (shares or asset components to be taken over);
• specification of the assets and liabilities excluded from the transaction;
• value (price, price bracket);
• the requirements that have to be met in order for the transaction to be concluded (due diligence, supervisory board resolutions, general assembly resolutions, authority consent - UOKiK or The Financial Services Authority, the opinion of the Revenue concerning the tax effects of the transaction, the exclusivity of the transaction - the duration).

In case the offerers are in the same industry as the acquired company (but not limited to such a situation), we have to remember the obtained information has important commercial value - it enables us to understand the structure of cost, revenue, the material condition, the profitability of the respective ranges of products, the pricing and staffing policy, the recipient and supplier lists, the plans connected with the future of the company. Therefore the confidentiality contract is a necessary element in the talks conducted between the buyer and the seller. It has to be concluded in such a way as to give the opportunity to impose certain financial sanctions in case of breach of trust.

Upon having the letter of intent as well as the confidentiality clause signed, the investor has an opportunity to carry out a more thorough analysis of the company in order to measure the extent of the potential, elements of risk as well as the financial situation of the candidate to be acquired. The process is informally called due diligence. The information gathered during the analytical stage allow us also to calculate the value of the company and to take the decision whether there is any basis for commencing the negotiations concerning the takeover or merger, and if so, on what terms. Let us stop here.

The upside and the downside of due diligence as well as what it is carried out by shall be discussed in further parts.