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Important M&A Transaction Aspects - Apohan Corporate Consultants Pvt. Ltd.

Important M&A Transaction Aspects

Apohan Corporate Consultants Pvt. Ltd. > Mergers & acquisitions > Important M&A Transaction Aspects

Before going for equity funding:

The banks require you to provide security in the form of your property two to three times the amount of loan. You must pay instalments of these loans on time. If you don’t pay, the bank will treat it as default, it will sell your business, it will sell your personal property, and also it will sell the property of the persons and companies who have stood guarantors to the loan. The banks are like good weather friends. They will bring misery to you in the bad times.

On the other hand, an equity partnership is like a marriage. There is a lot of checking, enquiry and due diligence before making an alliance. But then, once an alliance is made, it is carried out with full loyalty and it is very difficult to get out of it.

But why do these equity investors take an extra risk? Because they expect a business to perform and to make more money than any alternative investment avenues for their money. They trust in your ability, your business, your technical capability, your promises, etc upon the due diligence possible for them. They provide all kind of assistance, participation, their abilities in financial management; they may provide additional capital, participation in additional growth ventures, etc. If they are strategic business investors then they will provide all their network and business strengths to your business. Your benefit is their benefit. Traditional saturated businesses are very well proven and there is not much risk associated with them. There is huge competition as well as a huge investment in them. The riskier businesses have more dangers associated with it, but they also stand chance of making exceptional returns. Such risky projects are not funded by traditional lenders.

Also, equity investment is not possible in very small businesses. Apohan expects a typical investment size of around rupees 50 crores of investment requirement. As a rule, we do not entertain any equity investment requirement below rupees 10 crores in our consulting assignments. The very complex and rigorous process of mergers and acquisitions is not economical, feasible and practical for small businesses.

So in nutshell, getting a loan is very easy and paying back it is very difficult. As against this, getting equity is very difficult, and there is no question of paying it back under force, it is all about sharing good & bad fortunes. So remember that you are sharing all your business skills, your efforts, your ownership, your control, your decision making along all business risks with the equity investors.

See: Checklist of questions in equity funding

Importance of synergy in mergers & acquisitions

The value of a merged company is much more than the sum of values of the two individual merging companies. And equity transaction should be focused on achieving maximum synergies. There are various types of synergies: Operational, marketing-related, financial, technical, etc. Apohan has prepared a comprehensive list of synergies and you should study which synergies are possible in an association.

See: Benefits of mergers and acquisitions

Investor perspective:

The perspective of the investors is very important in equity financing transactions. Strategic investor are businesses (that buy another businesses) and they want to explore more out of the synergies by absorption of a smaller company or by acquisition of substantial equity control. But most of the investors are financial investors. They may have a certain sector preference or segment preference. They may have a working knowledge of the business. But they themselves are not businessmen. They expect that the businessman has all the technical knowledge, operational knowledge, knowledge of products and processes, product certifications, knowledge of markets and a network of clients. They themselves cannot bring and should not be expected to bring these things to the table. They like to see that the segment in which the company works has a good market and good growth potential. They like to see that the management of the company has the capability to undertake new projects and has already worked on some plans.

See: Investor perspective in merger and acquisition transactions

Cost of M&A transaction

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 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:

Broker’s charges:

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 a 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 the 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 fee.

See: Brokers role in mergers and acquisition

Cost of M&A consultants

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 crores. 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 a 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 advertising of what kind of business they want to buy. There is no standard definition of a 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.

See: Apohan’s payment structure for M&A consulting

Cost of due diligence professionals:

The due diligence of buyer or investor is relatively easy. However, the due diligence of a business is a 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, the validity of certificates and approvals, intellectual property, etc.

The financial investor makes 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.

See: Due diligence in M&A process

ROC fees

When the control is diluted by an issue of additional shares in a certain proportion of the existing number of shares, a ROC fee 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 have 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.

Angel tax or overvaluation tax:

For a company that 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.

Stamp duty

A company requires to pay stamp duty for the 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.

Compliance costs:

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 with technical standards.

See: Apohan’s expert network

Cost of internal manpower:

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.

Sharing of the M&A costs:

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.

See: Details of M&A transaction costs

Time-frame of M&A

Completion of a merger and acquisition transaction takes around 6 to 9 months but it can be completed in 3-4 months as well. If there is a lack of clarity on what should be the profile of the business investor, what are the expected terms and conditions of the investment contract, what is the expected valuation of the business, how much control is to be diluted, etc, it takes even more amount of time to complete the transaction. If the profile of the investor that is expected to make investment is not made clear at the beginning, a lot of time is wasted in communicating with unwanted people. If the terms and conditions off the investment contract are not made clear in the beginning itself, the negotiations fail at a later stage and all the work has to be initiated again with another investor. Apohan has a wide network of associated investors, investment professionals, financial intermediaries. Apohan makes wide use of social media & is part of many online & physical investors forum. Apohan has a perfect screening process and does not waste time pursuing fruitless entities. Also, Apohan has a huge template database which makes the process of documentation very fast.

See: Timeline of a merger and acquisition transaction

M&A Process flow

The M&A process is carried out in a few chronological phases. Appointment of consultants, inception, identification of investors, deal structure, due diligence, closure, & integration is these phases.

See: The phases & activities in a merger and acquisition transaction

M&A documentation

There are two types of documents involved in a merger and acquisition transaction: 1. Existing documents of a company & 2. Documents prepared for the transaction.

Existing documents:

All the parties, including the consultants, whether new is old, how to study the existing documents of the company. Many of these documents are confidential. The company has to prepare an anonymous version of these documents advanced stage of negotiation is reached.

See: The list of company documents required at various stages

New documents prepared for the transaction:

Apart from the study of the existing documents, the main consultants and the management of the company have to prepare new set of documents as per the specific requirement of the transaction. Various kinds of reports, presentation, communication templates, apart from the financial model in excel and the business transfer agreement or the investment contract have to be prepared.

See: Documents to be prepared for merger and acquisition transactions

1. Consulting proposal, agreement
2. Inception report
3. Client presentation
4. Profile of the client
5. Profile of target company/investor
6. Teaser, Pitch book
7. Information memorandum
8. Data sheet
9. Business plan
10. Schedule of investment requirement
11. Financial model
12. Amendments in MOA/AOA
13. Board resolutions
14. Advertisements for online media
15. Advertisements for physical media
16. Mutual NDA
17. Investor presentation
18. Investor proposal analysis report
19. Investor’s due diligence report
20. Valuation reports
21. Document list of data room
22. New documents & reports for specific needs
23. Term-sheet
24. Business Transfer agreement
25. Corporate documents
26. Legal documents
27. Disclosure schedule
28. Due diligence agency appointments
29. Due-diligence report
30. Handholding report
31. Monthly Status Report

Deal structure:

An equity funding transaction (or a merger and acquisition transaction) finally result in the funding of a company. If there is the purchase of shares from the existing shareholders, then there is a change in the management and the control structure of the company without involving any inflow of money in the company. If there is an issue of additional equity, there is a cash inflow.

There are several parameters on which decisions have to be taken and an agreement has to be reached between the parties. These parameters are The amount of investment, schedule of investment, the type of security issued, the corporate process followed for allocation of share, a combination of debt if any, securities and guarantees to be provided by the shareholders, repayment of the existing loan, regularization of the existing loan in case of default, the structure of the board of directors, rights and liabilities of the partners, etc. The permutations and combinations of these parameters give rise to several formats of mergers and acquisitions. The most important types of M&A on various bases are listed in our service portfolio.

See: Apohan’s M&A service portfolio

Structuring an M&A deal

Business valuation

The business valuation is computed before the investment and after the investment. The equation is not as simple as
Valuation before investment + investment = valuation after investment. When to businesses combine, their joint potential is much more than the sum of individual potentials.

The valuation also depends upon whether it is the investors’ market or the market of the businessmen. Who is able to dictate the terms? If the investor has many more opportunities with better profiles, he will try to bargain the value of the business to a lower price. If there are many investors seeking a good investment opportunity, it will be the business that will dictate the terms. If a business does not appoint good merger and acquisition consultants with the large network of investors, a business is bound to realise very less value. It is not that there are fewer investors, but that the opportunity is not widely (but anonymously) publicized. The private limited businesses are very illiquid assets, but that does not mean that lack of a network of M&A consultants should lower their value!

Also, business valuation should be carried out by the DCF method using a full-fledged MS Excel-based financial model.

See link:

Aspects of business valuation

How to get higher valuation for your business?

Financial modelling

Dilemma between growth and control

Growth is not a compulsion for every businessman. Also, the internal accruals, reserves, profits, borrowings from banks may be sufficient to drive a certain degree of growth without diluting the control at all. But when there are huge opportunities for growth and they require a large amount of capital, many businesses choose to let the opportunities pass by rather than undertaking growth initiatives with an equity investment. Many times it happens that a businessman who is completely “intolerant” towards a dilution of his control, loses all the control and wealth only because the bank didn’t come to is rescue when the going became difficult.

There is no point in remaining a small company for a very long period of time despite having great operational strength and market opportunities. It is wiser to be a part of a large family of investors, owners, capable people in a very large business than being the nearly 100% owner of a very small business.

See: Dilemma between growth and control.

Why business alliances fail?

The business partnerships fail mainly because they are not designed to sustain the common failures in the journey of a going concern. When two friends or two businessmen start a new venture, they are in very good spirits. The activity they are going to do is highly uncertain and a very high degree of cooperation is necessary between them. There is not much wealth in the business in the beginning and whatever it is there, is brought from one’s own pockets. There is hardly anything to fight for or fight about. Hardly any complex aspects of the business are known at the beginning as it is very simple in size, form and nature.

As the businesses progress, it generates more wealth, new aspects of a business manifest themselves. These aspects bring wealth, reputation, assets, profits, rights, duties, obligations, liabilities, risks, people, stress, egos, complex communications, events, etc. as the organization matures every coming year. There is no pre-written explicit written documentation taking care of how these new aspects of a business are going to be handled. If written at all, they were only for statutory compliance purposes!

When the differences arise for the first time, they start getting handled randomly, casually, haphazardly and without much thought between the otherwise well-meaning partners. However, this cannot go on for a long time. Differences prop-up. There are no pre-decided, pre-negotiated amendable principles in place! These partners are hesitant to talk to each other “in the negotiation mode” as they were very less used to that mode. But, it is a human tendency to retain benefits & pass on the liabilities. And soon they find it impossible to negotiate how to share these new benefits and risks from new complex business situations. And this is why equity alliances, ownership partnerships, joint ventures fail.

To avoid this, alliance partners or members should evolve well-written, well-thought documentation for management of future complexities jotting down treatment of foreseeable events & principles of treatment of unforeseen events. It is the absence of such agreement & the presence of only compliance documents that breaks up the business alliance.

See: Why business alliances fail?

Role of brokers:

The brokers shouldn’t be taken as M&A consultants!!!

They don’t know M&A process details and may reveal your M&A intent to the wrong entities. A company rumoured to be sold risks business relations

They don’t know many investors & even if they know, no professional investor invests crores of rupees on their personal recommendation.
They make it difficult to get an investor as the investor requires a direct mandate from the business/seller to the M&A consultants.
The investor gets put off by higher brokerage charges as they are ultimately paid by the company.
Brokers increase the cost of acquisition of finance without much contribution in deal-making, documentation, trust-building,
They delay M&A closure as it takes them a lot of time to make an agreement, decide payment sharing, etc as they don’t do this full time.
They accept any terms & conditions & that is why they are wrongly perceived as a very lucrative M&A.
A decent broker would charge a nominal referral fee.
A private limited business is highly illiquid but that doesn’t mean a broker should take away your wealth!

See: Role of deal brokers in mergers and acquisitions

M&A is Joint Work of Business & Consultants:

A merger and transaction acquisition transaction activity is not the sole work or responsibility of the consultants. It is not a compliance work that can be delegated to a professional and then forgotten. Mergers and acquisitions require the intense engagement of the topmost management of a company. It is desirable that the company forms a committee of senior directors to provide complete support to the transaction. The top management, especially the Managing Director, needs to be available to review the outputs and take a call on the key recommendations. The committee of directors should review the output of all the submissions of the consultants from time to time. The investor expects the senior-most authority from the business to be reasonably available to create the notion of credibility and seriousness. To take the decisions in mergers and acquisition deal with deal with the most important matters of the company, the top management is expected to be present in all the key meetings. The chartered accountant, company secretary and the head of the finance department is expected to keep all the documents ready. They are expected to know all the explanations of the numbers.

Merger and acquisition being a very serious and confidential matter, the information should be divulged gradually. The confidence-building process should be also taken up simultaneously with the investor. It is an art of fine balance! Personal behaviour, manners, etiquette may lead to unnecessary, pre-mature conclusions, and hence, so far as possible, a formal environment should be kept. A record of the documents provided and received from the investor should be kept. All the contracts, agreements, MOUs, NDAs, etc should be prepared and kept carefully. Adequate preparation should be done for going before the investor meeting. A formal, written, meaningful, logical offer should be made in line with the market practices & market values. All the necessary communication should be made to extinguish the doubts and clarifications in the mind of the investor. If necessary, raw data is needed to be converted into meaningful reports and presentations to be prepared to address the concerns put forth by the investors. In the same fashion, documents and data should be made available to the consultants to prepare the basic documents of the transaction.

One of the major reasons why the transactions take so much time is because the management gives the appointment of the next meeting after a couple of weeks (even to consultants). Equity transactions require lot many meetings and delaying meeting results in delay in obtaining equity funding. The role of consultants is to analyse the situation, analyse the problems, analyse the possible solutions and put forth them to the management. Many of these decisions are intrinsically subjective. The choice and opinion of the management matters and the consultants cannot make any objective recommendation. In such cases, the management should listen to the various pros and cons of the options from the consultants and take the decisions.

It can be said that the more time spent by the management, and the more involvement in analysing the transaction, the faster the closer of the assignment and faster the realisation of disbursement of the equity fund.

See: Cooperation between M&A consultants & the top management in equity deals

Consulting structure:

First of all, no chartered accountants or company secretaries or business lawyers should not be appointed as merger and acquisition consultants only because they know about it a bit more than you as an SME business. No professional without prior experience in merger and acquisition transactions can bring it to success. Being from the finance field & being an M&A expert is not one and the same! Also, an M&A transaction is more of a business transaction than a financial transaction!! The past credentials in the M&A field of the consultants must be checked before giving the consulting assignment. Brokers or business deal-makers or people claiming to be close to a couple of investor or HNIs should not be treated as a consultant. While all these people are important in carrying out one or the other activity, they cannot be assigned the role of integration of all the activities going in equity funding process. Individuals should not be engaged. Firms or companies should be engaged.

The chartered accounts and company secretaries can not advertise in any way. This limits their ability to access an investor!!! M&A consultants & investment banks are the best resources! Many businessmen don’t believe in getting equity investment, and many times the reason is they have given the task to completely wrong people.

The main consultants should be experienced merger and acquisition advisors or investment bankers. They are costly but the advantage is that they know the process in and out and they have a wide network of investors which results in getting a quick deal and a better valuation for the business.

Distinction should be made from the firms that have an end-to-end experience of merger and acquisition transactions and those that have worked on only a few specific components of the transactions such as accounting, taxation, corporate process, drafting of contracts, taking legal approvals, merger integration, etc. The company doing only one component of the entire merger acquisition process cannot do justice to the whole process. Hence, a company should be preferred which has all the types of professionals in it: s chartered accountants, company secretaries, taxation experts, business lawyers, engineers, strategy experts, market experts, technology experts, operations experts, valuation experts, etc.

In India, engaging wrong consultants for merger and acquisition and also earned a bad name for equity investment. These people are never able to locate appropriate investors nor they are able to make a proper business deal, resulting in wastage of time of a business. It has been observed that many businesses prefer to award the consulting work for merger and acquisition only on a success fees basis. This is affordable only to very large, cash-rich investment banks who are confident of getting investment for you (after the initial screening). Mostly this kind of investment banks deals with transactions greater than rupees 500 crores. If a consultant is agreeing to do all the work for a relatively small company where there is no transaction documentation prepared, this consulting offer should be taken with a pinch of salt. This consulting firm is not going to invest its time and resources in a risky M&A deal and where no decision is in its hand. The buyer and seller are going to decide whether to do a transaction or not, on what terms, at what value. Mostly this kind of consultants are not going to prepare any documentation and they have no interest more than catching hold of an M&A consultant down the line and earning a brokerage out of it. This delays the transaction increases the cost.

The typical audit, accounting, taxation & compliance chartered accountants, company secretaries and business lawyers should be able to carry out their respective statutory roles in the merger and acquisition transaction at least after a bit of basic induction and orientation. However, they will not be able to carry out this strategic documentation, strategic decision making, investor identification, business pitching for investment, negotiations, etc. A professional, experienced merger and acquisition consulting firm should be appointed for coordinating all the related professionals activities.

See: Role of M&A consultants
Role and engagement of consultants in equity transactions

Models of engagement of Consultants:

An SME business is typically not expert in identifying all these types of professionals involved in a merger and acquisition transaction. A company needs to identify qualified, experienced professionals in the respective domains. It needs to give a clear scope of work to them. This is a major area where the scope of work given in the beginning is very different from what is required at the end. This typically results in the professionals asking for more fees in between the process. Further, the company should be able to review the output from the professionals. A company may not be in a position to manage the multiple contracts and integrate their output.

Apohan has all of these capabilities in a single company. Apohan can take the responsibility of appointing all the types of consultants and professionals if the business desires to. Once Apohan is engaged, the company need not worry about the roles of various professionals.

See: Model’s of consultants’ engagement

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