M&A deals & the extent of acquisition of control:
When one company invests in the other, or buys the equity stake in the other company, or subscribes to the fresh issue of shares it need not be always 100%. When it comes to small and medium enterprises, Apohan has observed that, it is the personal strength of the founder/ promoter/ director that keeps the enterprise going on. He has the highest quality of relations and network with all the the stakeholders of the business. Hence, it would be kind of unwise to remove off this original promoter and put in place a completely new management. It depends on the circumstances, but the original management should continue at least for couple of years for hand holding, or for integration of the merger, or as independent directors, or on salary basis, or till the demonstration of potential performance promised at the time of the deal even in case a business is completely bought out.
The functioning of the board of directors and the General Body of members (shareholders) requires a specific percentage of the ownership or the control to be able to take a specific type of decisions. On one side, the importance of ability to lead the decisions (or importance of the power and authority to be able to take important company decisions without interference of the other shareholders) is very critical and on the other side, the available cash for purchase of adequate percentage of total holding is a serious limitation.
When it comes to listed companies, the degree of compliance for acquisition of control requires larger compliances including open offer to retail investors according to the takeover code. The companies also have to see that the cross holding of certain shareholders does not result in conflict of interest for tenders. If a company has more than 5% equity in another company and if both of them bid for a tender, both of them may be disqualified for conflict of interest. Increased acquisition of equity stake also results in requirement of compliance of related party transactions, the regulations also called transfer pricing regulations.
Following is the classification of the merger and acquisition activity based on the extent of acquisition of control:
Buyout or sellout deals:
It means the acquirer acquires 100% stake of the original shareholders. The basic objective behind a buyout deal is the complete flexibility in the new management and no interference from the legacy management in key decision making.
Absolute majority deals:
In the deals for absolute majority, the acquirer acquires 90% or more stake in the target company. With 90% stake, the number of corporate process complexities in terms of taking care of the minority shareholder reduce drastically.
Concept of majority stake:
Majority stake means more than 50% shares. Having more than 50% shares is as good as having veto power. Without the consent of the majority, not even a small decision can be taken in a company. However, it is to be noted that majority stake is not sufficient, it gives the shareholder the power to veto out the decisions that disapprove but it doesn’t give them the power to execute all the decisions that they want to undertake. For the special type of decisions, the board must pass special resolution which require minimum 75% holding in case there is friction or difference of opinion in the board.
Control deal are the merger and acquisition deals in which investors’ preference is to acquire more than 50% equity and replace the existing management or board of directors with new one or at least to substantially reconstitute it. Typically, the valuation of shareholding for 49% stake, 50% state, and 51% stake is not in the proportion 49: 50: 51. There is control premium for exercising equal control on the company and there is even more control premium for handing over the control at 51% stake. Control premium is the amount over and above the mathematically proportional valuation.
Minority stake deals:
Any state less than 50% of the total equity is called minority stake. While the financial benefits are proportionately available, the majority shareholders may oppress the minority shareholders as they have the control over the management of the company. There are several statutory provisions for the protection of interest of the minority shareholders.
Representation stake deals:
If a shareholder for a group of shareholders have more than 25% equity in the company, they have the right to nominate one director on the board of directors. The presence on board of directors does not help in leading any decision making, does not help much in avoiding adverse (to the group) corporate decisions. It provides a comfort that they are being treated fairly. Every director has access to critical company information and the shareholder group can rest assured that no siphoning of funds is happening.
Material stake deals:
When the stakeholding of a single shareholder or a single company or a single group of companies exceeds 5%, or exceeds 10% but is lesser than 25%, depending upon the domestic or foreign origin of the company, several reporting, declaration, disclosure, compliance, etc norms shoot in.
Marginal stake deals:
Marginal stake means very small equity shareholding (0 to less than 5%) in a company. It cannot exercise any kind of control but can be part of the financial benefits exactly on the same lines and in the same proportion as any other shareholder. In India, technically, ownership of a single share gives the right the to the shareholder to attend the Annual General Meeting of a company with even having the largest market capitalisation.
Some mergers and acquisitions take place in which both the companies continue their legal existence but they acquire shareholding in each other. This may be done by the shareholders as well in place of being done by the companies. If the companies have cross holding in each other, subject to compliance of transfer pricing and conflict of interest rules, they would not undertake any commercial decisions that will cause adverse effect on one another.
Differential voting rights (DVR):
Differential voting right is one of the key tools for retention of the financial benefits in proportion of (or more than) the proportion of financial investment. This is achieved by tweaking the control management with differential voting rights for different classes of shareholders. There are examples of 200 votes for one share (in the General Meeting) in some companies and also there are examples of 200 shares for one vote in some other companies. Dilution of control rights in a company results in lower valuation of DVR shares.
Apohan very well understands the various sensitivities around control management in the M&A deals. Apohan helps its clients in the proper management of the control of the merged entity in the right hands so that no destruction of value happens. Apohan carries out professional, end-to-end, customized consultancy services by understanding how to allocate various control functions in the board of directors. Apohan manages the transaction right from the problem identification phase, to the closure of deal with perfection.