An equity is the most costly resource of fund available in the market for a business – a business has to share all the fortunes in the agreed proportion! Moreover, a merger and acquisition transaction is much more costlier than availing any other type of fund. A lot depends upon the financial awareness of the companies and readiness of the documentation in its various departments. Companies with a dedicated individual or department looking after financial affairs can close the transactions faster and with lesser costs.
Following are the major Costs:
The small businesses engage brokers mistaking them as merger and acquisition consultants. In order to grab the opportunity quickly, they do not seek any retention fees and promise to work on only success fee. However, they increase the cost of transaction and delay the time frame by first making the investment bankers and the merger and acquisition consultants agree to their terms. Rather than advertising the opportunity more, they keep it close to chest. An attempt should be made to directly engage the M&A consultants, investment bankers or investors themselves.
When a business seeking equity investment or a sellout (100% sale) approaches & engages brokers who don’t know M&A process & also don’t know investors, they create a chain of interested parties who charge both the seller & buyer. Sometimes the chain between the buyer and the seller becomes as long as 10 intermediaries. This leaves hardly any money for the people who actually work. The role of all the people connecting the buyer and the seller cannot be undermined, but they should not be paid any success fee as a percentage of the transaction amount. They should be paid a fixed finder fees.
The merger and acquisition consultants typically charge upfront fees, milestone based fees and success fees. For the assignment to be purely success based, the transaction value needs to be around more than rupees 500 crore. If the investor is already identified, the major parameters of the deal are already frozen, the success fees would be a lesser percentage of the transaction value. For an end-to-end equity transaction advisory, the total cost of merger and acquisition consultants forms substantial cost of the transaction.
The merger and acquisition process is not as standard as processing a bank loan. The perspectives, the interested parties, their documentation requirements, their terms and conditions, the number of parties required to be approached, are highly customised for each M&A assignment. They is no market where investors are sitting with advertise of what kind of business they want to buy. There is no standard definition of good equity investment opportunity that anyone can convey perfectly & widely. Also, the decision making power is in the hands of buyer (investor) and seller (business), leaving the consultants with the risk of success.
Many investment banks charge a part of their success fee as a percentage of the diluted (post-investment) equity of the company as well.
The due diligence of buyer or investor is relatively easy. However, the due diligence of a business is very complex process. It requires checking all the claims made by the business. The investor has to verify the real estate assets, plant and machinery, intellectual property, designs and tools, inventory, brand value, etc. Since the investor is going to on the business as if it is his own after the investment, he goes to the depth of financial matters, contractual matters, corporate matters, legal matters, conflicts of interest, operations, human resources, litigations, competition, validity of certificates and approvals, intellectual property, etc.
The financial investor make carry out the due diligence with his own manpower at his own cost and risk. Or, he may require the businessman to do his own due diligence with the costs borne by the company which is called reverse due diligence. Alternately, the parties may agree to appoint third party professionals, experts, etc. The cost of due diligence is one of the major costs in an M&A transaction. If all the company’s departments are well organised, well documented and compliant with laws, the cost of due diligence can be reduced substantially.
When the control is diluted by an issue of additional shares in a certain proportion of existing number of shares, an ROC fees is required to be paid to the Government of India. Generally, there is an element of premium on the face value of a share for the new investor. The ROC fees has to be paid on the face value of the new equity issued. The approximate cost of ROC fees is around 2% of the face value of all the newly issued shares.
For a company which is not a startup, if the valuation of the share issued to the investor happens to be more than the valuation made by a certified business valuer (valuer certified by IBBI, a CA or an investment banker), then the additional value over the certified value is treated as the income of the company and income tax at applicable corporate income tax rate has to be paid on it.
A company requires to pay stamp duty for allotment of the new shares. The cost is around 0.2% of the face value of the shares. The stamp duty is collected by the state government and is different in each state.
For completion of merger and acquisition transaction, certified professionals are required to be engaged. Their charges are nominal if they are not involved in any strategic decision making and risk taking involvement.
Following are the various professionals that may be required to engage:
Company secretary – Corporate process charges
Chartered accountants, Accounting – Consolidation of statements
Chartered accountants, Taxation – Various direct & indirect taxes on the company, investors, sellers, etc
Business lawyers – Court approval, litigation, NCLT matters, contract & legal due diligence, vetting of investment contract
Valuation expert – Value for tax & compliance purposes (business valuation is done by the M & A consultant)
Technical expert – they are the technical and operational matters. They can inspect the plant and machinery. They can validate the process. They can check the technical certifications and compliance of technical standards.
During the merger and acquisition process, the top management of company has to spend substantial amount of time in attending consultants’ meetings, reviewing the submissions of the consultants, meeting with the investors, negotiating with the investors, studying various strategic options, decision making, etc. Other key staff is involved in providing documentation and support to the consultants. There is a value attached to their time involvement.
Another important area is sharing of the transaction costs between the business and the investor. The transaction cost incurred by the investor including the cost of due diligence should be borne by the investor. In case the transaction succeeds, it will be an indirect pass- through cost. If the transaction fails, it will be the risk of the investor. It should be made clear between the investor and company how the cost of the transaction will be shared, accounted, etc. The success fee payable to the merger and acquisition consultants is the liability of the company and it makes impact on the the valuation of the company before investment (pre-money valuation). Hence, the investor should be informed of the structure of consultant fees at the advanced stages of negotiation.