UK Business Information / Principles of the deal

PRINCIPLES OF THE DEAL

Below is an overview of the key elements of a deal and an examination of two important issues in any M&A deal: what is being acquired, and how is the acquisition to be financed?

Structure of the deal

A key start point in any M&A deal is deciding on the structure. Are the shares of the company or only individual assets of that company being acquired? Both options have their positives and negatives which are summarised below.

Share Purchase

A share purchase gives the acquirer ownership of all the assets and liabilities owned by the company at the time of the transaction. However, there is a potential risk as the acquirer is taking on all the liabilities of the target, some of which may be unknown or undisclosed. The benefit to the vendor is that it allows a full exit, with the proceeds received by the vendor shareholders. A share deal is usually the preferred option for most vendors who wish to have a clean break, or are looking for maximum proceeds on sale after managing and building up a business for many years.

Asset Purchase

The principal advantage of an asset purchase is that it allows the acquirer to cherry pick the best assets of the target. Individual assets can then be put into “clean” companies without any other liabilities being assigned across, unlike a share purchase transaction. An asset purchase therefore generally carries less risk for the purchaser than a share deal, removing the need for many of the warranties and indemnities in the sale agreement. However, asset purchase deals are often less popular with vendors who may want a full exit and who do not want to be left with a company stripped of its core assets which would likely need to be liquidated, with the vendor incurring additional costs.

Financing the deal

The next element is to consider how the deal is to be financed. The consideration paid for the target (whether this is the target company’s shares or assets) can be all cash, or shares or loan notes or a mixture. Vendors prefer all cash consideration for their equity (without any earn-out based, deferred or contingent consideration, which is discussed further below) as this gives them a clean exit from the business. The main disadvantage for the acquirer in an all cash consideration is principally the immediate cash outlay.

Conversely, where shares are the consideration, the acquirer will usually issue new shares which will then be given, as consideration, for the shares or assets of the target. This then ties the vendor with the fortunes of the acquirer and does not give the vendor a full exit from the business. It also ties management to the acquiring business going forward. A key advantage for the acquirer however is that there is no immediate cash payment at the point of completion.

Loan note consideration is arguably the least favoured type of consideration for a vendor as there is no immediate cash benefit, with this being delayed until the maturity date of the loan notes. The vendor will receive only accrued interest income from the interest on the loan notes but has no equity in the acquiring company.  The obvious advantage with loan note consideration from the acquirer’s perspective, however, is that it delays any capital payment until the maturity of the loan note.

Other types of M&A

It is worthwhile noting that “M&A” encompasses a large variety of different types of deals. For example, various “buyout” type acquisitions exist. These include management buyouts (MBOs), where existing management buy out the current shareholders of the business (often backed by private equity); management buy-ins where the acquisition is led by a new, external, management team; leveraged buyouts or buy-ins where the deal is financed with high levels of debt (which are less common in the current economic climate).

With regard to the financing structure for the deal, for example, private equity backed buyouts are often financed with a significant element of debt. Debt is usually cheaper than equity, with equity investors requiring higher rates of return than the cost of financing debt. However it is important to structure the debt efficiently if it is used to finance an acquisition, ascertaining the right mix and size of debt for the deal. Can cheaper long term credit be obtained or is shorter term and higher cost mezzanine debt required? Can the acquiring company finance the additional debt burden and what is the optimum gearing for the business post acquisition? It is worth noting that, given the current economic climate, the greater restrictions on available bank debt means that leveraged buyouts are more difficult and the levels of leverage seen a few years ago are unlikely, generally, to be seen for some time.