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Basic Concepts of Mergers and Acquisitions

Merger and acquisition, these two words we often associate with the company laws. Thus from the six-lettered word merger, we may develop the presumption that it stresses on the fact that two entities come together and form their summation results into a new a better working organization. However, when we talk about acquisition the first thing which comes into our mind is that of assimilation of one entity into another, thus one company being in a better position has the power to acquire or overpower another entity.

Merger and acquisition, however, had not been defined in the Companies Act, 2013. Many of the scholars are of the view that they use lagged measures of industry merger and acquisition (M & A) activity to proxy for anticipated demand that potential targets face for their assets.

Research Gap
We often find a huge number of papers are there in this particular branch of Company's law, i.e Merger and Acquisitions having huge implications and understandings. However, it is an observation that most of the papers don't refer to the basic words or determination as to their meaning. Thus this research note basically focuses on the basic terms, concepts which are being used in the day-to-day activities of merger and acquisition, so as to help the young scholars to grasp a better foundation and knowledge in a simpler way in this heavily compliance-based field of Company Law.

Background
The term merger had not been defined in Companies Act, 2013. Thus when we are talking about merger, it may happen in two ways merger by absorption and merger by formation of a new entity. Acquisition on the other hand means taking over of one company by another. The origin of merger and acquisition could be traced back in U.S and U.K. The history of merger and acquisition can be traced back as per the times. The motivational force behind merger and acquisitions involves both technological, economic, political and social forces.

According it can be classified into 5 waves:
First Merger Wave ( 1897- 1904)
The first merger wave started in the 19th century and lasted till 1904. The rising amount of stock and the introduction of the Sherman Anti-trust Act, 1890, had brought dramatic changes in the market and the economy. Thus during this time the companies started to create monopolies, without any interferences of regulatory bodies. Thus during this period a high number of mergers started taking place due to the increasing monopolies in the market.

Thus period had undergone several mostly horizontal mergers, and its role for creating monopolies. Thus the main motivation behind this huge number of mergers taking place was the monopoly in the market, revival of the market that had fallen down, economy of scale, etc.

Second Merger Wave ( 1922- 1929)
The second wave of merger however, began in the year 1920 and ended with a huge economic slowdown in the year 1929. This period is also known as the Great Depression of the world in which the encouraged new business ideas and wanted to form a standardized system which would ultimately lead to the growth and development of the economy. Thus during this period merger was seen as remedial route to save and revive the economy. This period however gained vertical recognition horizon.

Third Merger Wave ( 1965 1969)
During this period the conglomerate mergers came into existence. During this period, the US economy also made a improved itself. Throughout this period, many of the deals with based on friendly arrangement which had ultimately being useful for the diversification and expansion of the business.

Fourth wave of merger
The fourth wave of merger is known as the mega merger. During this period hostile takeover started taking place in huge scale. The sectors which underwent such huge changes were the oil, gas, pharmaceuticals, medical equipments, etc. It was observed during this time that many non-US companies initiated the deal ir order to expand and diversify the companies. During this phase many of the deals were also in the form of leveraged buyouts.

Fifth Merger waves ( 1992 onwards)
This period was the time of the major economic waves in the country. This wave dealt with the biggest merger that broke all previous records. Thus during this phase, there was a shift from hostile takeovers to settled structured mergers.

Thus in this was the merger and acquisition had developed, which ultimately lead to the biggest development in the financial market and the economy of the country.

Objectives of merger and Acquisition
As already discussed previously for expansion of economy, market capitalization, higher valuation, increase in demand and supply the process of merger and acquisition was adopted. Management, philosophy and companies policies everything falls under the objectives of merger and acquisition. Acquirers may also actively seek out undervalued targets. In some cases, acquirers may have more accurate expectations about the future value of the target firm, allowing it to profit via the purchase of undervalued target.

So the main objectives for the same are as follows:
  1. Revenue maximization:
    If there is a loss making company, and in case if it merges with a profit making company. Thus, through the merger the target company can achieve a rise or growth in its business. However if we talk about the other company then through merger that other company would get the customer base, product and services that was being used by the loss making company.
  2. Security
    When two companies merge, or when one company is being acquired by another then the dual efforts of both result into a backup or a security to another company. Therefore if one company fails the other company will be there in order to support it. Thus it adds to the security of the to the company to deal with the market at a large.
  3. Customer recognition:
    When one company gets merged with the other then, loss making company protects it reputation , thus it customer base moves to the newly formed merged company, which ultimately results into customer's recognition.
  4. Diversification:
    it gives an opportunity to diversify.
  5. Tax benefits:
    When M & A takes place many tax benefits are also being enjoyed. For example when a loss making company is being merged or acquired by the profit making company, then surely it does save the loss making company by reducing the tax burden of them.

  6. Eliminating competition:
    When merger and acquisitions are taking place, it substantially reduces the competition in the market, which can prove beneficial for the economic growth of the country as a whole. Therefore they may have the freedom to keep their prices high and supply a variety of goods and services.
  7. Synergy effect:
    Synergy means that when two companies combine together to form a third company, the value of the created third company will be greater than the summation of first two companies. Thus operational synergies are also achieved by combining the functions such as distribution and production. Management synergies refers to the new management styles which are being created and established by the summation of both the previous companies which results into the efficient new working company.

The terms in use:
There are a number of technical terminology which are being used for understanding of the concept of merger and acquisitions at a very basic level.

The terms are as follows:
  1. Negotiations:
    Negotiations mean the understanding, cooperation and the terms of common grounds which the parties to the contract agrees upon, thereby fulfilling the need of corporate restructuring. These are preferences put by the parties in order to come to a common consensus before agreeing to the merger, acquisitions or for any kind of restructuring.
  2. Commercial intent:
    Commercial intent means the commercial motivation behind the merger, acquisitions or any kind of restructuring taking place in this regard. Thus it provides with a platform for motivating and negotiating the deal among the parties. It mostly focuses on the commercial or the financial aspect of the deal which is taking place between the parties. The commercial intent varies differently from both the sides of the parties.
  3. Pre- Contractual documents:
    These are the documents which are being decided at the negotiation stage as per the needs of the parties. When we talk about contracts, it emphasis on the terms, conditions and considerations that are being decided and agreed upon by the parties. Some of the precontractual documents hereby includes the term sheet, Letter of intent, Non Disclosure agreements, co-founders agreement, etc. Thus these are the valid documents in contract that finally result into final documents involved in the transactions.
  4. Term Sheet:
    Term sheet is one of the pre- contractual documents as are involved in the transactional works. It is mostly used for financial investments rather than for strategic investments. However, term sheets are mostly non-binding in nature, but they may be sometimes they may have the binding clause in it, which make the term sheet as binding.
  5. Letter of Intent:
    Letter of intent, as the word suggests, showcases the intention of the parties while entering into the contract. It lays down the foundation on which the deal is being made functional. It mostly used for the strategic investment, which are the long term investments. However, it is always binding in nature. Thus is the most important distinction between the letter of intent and the term sheet.
  6. Non- Disclosure agreements
    These are the agreements which are not to be disclosed or known to any other third parties except the parties themselves. It is usually a binding on both the parties. It may involve confidential informations can be intellectual property rights over design blueprint, data bases, client list, trade secrets, etc. Exceptions in this case includes statutory restrictions and court orders.
  7. Due diligence
    Due diligence mostly means proper care and attention. Thus while drafting the documents proper care and attention should be given to the minute detailing so that any kind of conflicts or confusions could be avoided. It can be exhaustive as well as limited. Therefore it the basic background check to see whether the proper regulatory compliances are seen are check or not. If certain flaws or loopholes are found in it, then the investee company is given time to fulfill in certain compliances.
  8. Co-founders agreement:
    Co-founders agreement are the agreement which are being entered upon by the partners or the co-founders in the initial stage of the business. These are the documents which specifies the duties, responsibilities and liabilities which exists between the co-founders. It also put forth the situations and circumstances which arises during a dispute between the co-founder. Thus it is the agreement which is being entered into when the business had not yet been incorporated and registered.
  9. Financial Investment:
    Financial investments are the short-term investments. In this, the investors can invest simultaneously together in a multiple companies. They don't ordinarily look for the controlling interest in the companies, thus their only concern is the returns which they derive out of their investments. They will normally invest for 4-5 years before the company goes for an initial public offer or in simple words before the company goes public. Some of these examples however, would include the venture capitalists, private equity investors, angel investors, etc.
  10. Strategic Investment:
    Strategic investments are the long term investment in which the investors invests for particularly for longer period of time. Business synergies, cutting cost, long term market, unnecessary expenses and economies of scale are to be included and taken due care while considering the strategic investment.
  11. Business synergies:
    It is the concept which primarily focuses on the topic that combined value and performance of two companies will be greater than the summation of the two individual parts. Synergy is a term which is most commonly used for the merger and acquisitions.

Types of Merger and acquisition
Horizontal Merger
Horizontal mergers are the form of mergers which operates in the same industry. Advantages of such a share involves increase in the market share and also for the creation of economies of scale. However, it also involves some of the disadvantages such as less flexibility, regulatory scrutiny etc. At the same time some of the scholarly authors find that a horizontal merger tends to reduce innovation incentives in the absence of efficiencies.

Vertical Merger
Vertical merger is a form of merger in which two different companies provide a different set of supply or production chain, for serving the common good or the customer. Thus it heightens the synergy, increases the control on the supply chain. However, vertical merger can cause market foreclosure, in the sense of raising a rival's cost and reducing the rival's output.The main motivation behind such an act is to lower the cost with an increase in the production.

Conglomerate Merger
Conglomerate merger is a merger between firms that are involved between firms that are totally unrelated business activities. Thus the merger is basically between different industries. There are two types of conglomerate which involves pure and mixed forms of conglomerate.

Acquisition by shares
This is a form of acquisition which only happens in terms of shares. This is the most common and the wide form of acquisition which happens in India. Share represents the true value of the company, thus this kind of acquisition splays a major role in corporate restructuring.

Asset acquisition
It is a kind of acquisition in which a significant part of the assets are acquired as per the needs of the company. Here the acquirer company gets an option to pick and choose whichever asset they want to choose, unlike slump sale. As a general rule, often it will be in the buyer's best interests to purchase assets but in the seller's best interests to sell stock or merge.

Slump sale
In slump sale the entire business undertaking is being acquired at a going concern basis. Here the acquirer company doesn't get an option to pick and choose. Rather they need to either acquire the business undertaking or the part of the business undertaking. As a general rule, often it will be in the buyer's best interests to purchase assets but in the seller's best interests to sell stock or merge.

Conclusion
Merger and acquisitions are a growing field of study at a present time in India. Therefore before understanding the process and the complications involved in it, we should know the basic foundation of the terminology involved in it. Merger and acquisitions gives a new scope for the loss making companies to merge and grow and diversify their company. In a similar way acquisition helps acquirer company to grow and develop by the acquisition of certain specific areas. Thus if the basic understanding of the concepts are clear then each and every restructuring would happen in an easy and a simpler way.

Thus, this basic concepts plays an extremely important part in understanding the ground cause or the roots of mergers and acquisitions.

Important Related Questions:
  1. How does merger takes place?
    Ans. Mergers mostly take by merger by creation of a new entity and merger by absorption
  2. What are the basic motivational forces behind the M & A taking place?
    Ans. The basic motivation forces behind M & A are technological, political, economic and social forces.
  3. How many waves of merger ?
    Ans. There are 5 waves of merger that had eventually led to its development.
  4. When did the first wave start?
    Ans. The first wave of merger start in the year 1897- 1904.
  5. When do you mean by slump sale?
    Ans: Slump sale is one of the methods of asset acquisition in which the entire business undertaking is taking place. Here the acquirer doesn't get an option to pick and choose.
  6. When did the 3rd wave of merger start?
    Ans. The third wave of merger started from 1965 to 1969.
  7. What are the basic objectives of M & A?
    Ans. The basic objectives of merger and acquisitions are corporate restructuring.
  8. What does synergy mean?
    Ans. Synergy means that when two companies combine together to form a third company, the value of the created third company will be greater than the summation of first two companies.
  9. Does this provide any tax benefits?
    Ans. In slump sale, there are certain tax benefits which one gets.
  10. How does customer recognition help?
    Ans. Customer recognition helps in the formation of a larger customer base, which would ultimately lead to better ground of development for the company.
  11. What do you mean by negotiation?
    Ans. Negotiations mean the understanding, cooperation and the terms of common grounds which the parties to the contract agrees upon, thereby fulfilling the need of corporate restructuring.
  12. Meaning of commercial intent?
    Ans. Commercial intent means the commercial motivation behind the merger, acquisitions or any kind of restructuring taking place in this regard.
  13. Name some pre-contractual documents?
    Ans. Some pre-contractual documents includes letter of intent, Term sheet, memorandum of understanding or Non-disclosure agreements.
  14. Is termsheet binding?
    Ans. Mostly a term sheet is not binding, however if there is some confidential clause involved in it then it certainly becomes binding.
  15. What are NDAs? Are they binding?
    Ans. The NDAs are non-disclosure agreements. Yes, they are binding.
  16. What is due diligence?
    Ans. Due diligence means proper attention and care that are given for the fulfilment of the documentations involved in merger and acquisitions.
  17. What are strategic investment?
    Ans. Strategic investments are the long-term investment.
  18. What are financial investment?
    Ans. Financial Investments are the short term investment.
  19. Why is acquisition of shares is one of the most common form of acquisition in India?
    Ans. Acquisition of shares is the most common form of acquisition in India, because shares represent the true values of the assets.
  20. Is slump sale more flexible than an asset acquisition?
    Ans. No slump sale is not flexible than that of an asset acquisition. In slump sale you don't get the opportunity to pick and choose, thus it centres round a particular amount of rigidity.

References:
  1. Nishith Desai Associate, Business Transfer, Why, How and When?, 2-5, 2020
  2. Giulio Federico, Horizontal Merger and Product Innovative, Electronic Journal, 2018.
  3. Yongmin Chen, Verticle mergers and their Competitive Effects, The RAND Journal Of Economics, 2001.
  4. Byron F. Egan, Asset Acquisitions: Assuming and Avoiding Liabilities, Penn State Law Review, 917-920.
  5. Racheal Calipha, et al. Merger and Acquisition: A review of phase, motives and success factors, Researchgate, 4-6 ( 2010).
  6. Paulina Junni & Satu Teerikangas, Mergers & Acquisition, Oxford Research Encyclopedia, Business And Management. (2019).
  7. Walter, G. A., & Barney, J. B. (1990). Management objectives in mergers and acquisitions. Strategic Management Journal, 11, 7986.
  8. Ellen R. Auster, The Dynamics of Merger and Acquisition Waves, The Journal For applied Behavioural Science, 222, 2002.
  9. Patrick A. Gaughan, Merger, Acquisition and Corporate Restructuring 30, 4 ed, 2007.
Written By: Prime Legal Law Firm
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