Introduction to M&A | Holger Spamann | December 10, 2017


Introduction to M&A

by Holger Spamann Show/Hide


Importance for the firm

Acquisitions are the single most important event in most corporations’ existences. On a formal level, the corporation may cease to exist after the acquisition (see transactional technique below).

More importantly, however, most acquisitions profoundly affect the substantive organization of the business. This is especially so for the acquired firm (the “target”). The target’s management will usually leave (or be made to leave) following the acquisition. Often, business units are sold or shut down. But acquisitions tend to be major events for the acquirer as well, because the acquirer’s business may grow and change dramatically through the transaction.

Acquisitions are routine events only if the acquirer is much bigger than the target. (For example, big pharmaceutical companies frequently buy small biotechs or other startups to add to their technology portfolio.)

Importance for the social allocation of productive capacity

In a broader social perspective, acquisitions reallocate large pools of assets to different management and possibly different economic tasks (e.g., Google’s acquisition of Motorola; Facebook’s acquisition of Instagram).

Oftentimes, the capital structure of the corporation changes dramatically as well. This is particularly so in acquisitions or divestitures by so called “financial acquirers” — mainly private equity funds (acquirers who do not have a stand-alone line of business but specialize in acquiring and then improving existing companies).

Importance for corporate governance

From the perspective of corporate governance, the most important aspect of acquisitions may be their role as a governance device.

Takeovers have a direct effect on governance when a better-governed firm takes over a worse-governed firm. After the takeover, both firms’ assets will be managed under the former’s better governance structure.

But takeovers also have an indirect effect on governance. The threat of a takeover may incentivize boards to do a better job. If they don’t, the corporation’s stock price may fall below potential. This may create an opportunity for a potential acquirer to take over the firm at a profit. While this indirect effect is hard to measure, it may well be more important than the direct effect.

Hostile takeovers and takeover defenses

To be sure, the threat of a takeover would be empty if takeovers only occurred with the approval of the current management (so-called “friendly takeovers”). This is why “hostile takeovers”—  takeovers without the approval of current management — deserve special attention as a potentially potent governance device.

By definition, target management opposes hostile takeovers. Over time, target managers and their advisers have devised various “takeover defenses” to fend off such “attacks.” The defenses may be justified because hostile takeovers and the threat thereof can be abused to disrupt the target’s business. The defenses can also be an important bargaining tool to get a better price for target shareholders. At the same time, target management may use defenses merely to perpetuate itself in office and to blunt the governance mechanism of hostile takeovers. We will study an important string of cases struggling with the double-edged nature of takeover defenses— “entrenchment” on the one hand and legitimate protection of corporate interests on the other.

Transactional technique: mergers in a technical sense

Most acquisitions are structured to involve a “merger” in a technical legal sense. In this sense, it would be more accurate to speak of “acquisitions by way of merger” instead of “mergers and acquisitions.”

A merger in this legal sense is the fusion of two corporations into one (cf. DGCL subchapter 9, especially sections 251, 259-261). The target merges with the acquirer or, more frequently, a wholly-owned subsidiary of the acquirer. The acquirer thus obtains control over the target’s assets directly (if the target merges with the acquirer) or indirectly (if the target merges into the acquirer’s subsidiary). The target shareholders obtain the merger consideration for their shares, if they have not already sold them earlier.

Because a merger tends to be such an important transaction, it generally requires approval by the board and a majority of the shareholders (DGCL 251(b)/©). Furthermore, shareholders can request to receive the “fair value” of their shares as appraised by the Chancery Court rather than the merger consideration (appraisal, cf. DGCL 262). There are, however, numerous exceptions and conditions – see Delaware Merger ABC below.

The shareholder approval requirement has major implications for deal structure and timing even if a clear majority of shareholders approves of the deal when it is signed. Properly calling a shareholder meeting and soliciting proxies takes time – usually several months. (You wouldn’t know this from DGCL 213(a) and 222 alone, but you need to factor in the time it takes to clear the proxy statement with the SEC [again, not a statutory or regulatory requirement but everybody does it] and then to solicit the proxies – at least 50% of the shareholder need to approve, DGCL 251©.) Many things can happen between signing and shareholder vote. Most importantly, a new bidder may arrive on the scene—usually to the (then) delight of the seller and dismay of the buyer

Question: Why do buyers tend to like the appearance of other bidders whereas sellers dread them?

A partial alternative is to structure the deal as a tender offer, i.e., an offer to all shareholders to sell (“tender”) their shares to the bidder at the price announced by the offeror (and, in a friendly deal, agreed by the target corporation’s board). Under SEC rules, a tender offer must be open for at least 20 business days (rule 14e-1, see below), but it can still be quicker than calling a shareholder meeting. The tender offer is only a partial alternative because not all of the shares will be tendered, and so the offeror will have to conduct a follow-up merger to “squeeze out” (see below) the remaining shareholders. (But see now DGCL 251(h), which greatly facilitates the post-tender squeeze-out – more on this below.)

Mergers vs. asset sales

The use of the merger technique is a choice of convenience (and possibly tax and accounting considerations, but those are beyond this course). The alternative to a merger is an asset sale, as in Hariton v. Arco Electronics below.

The hassles of asset sales

In an asset sale, the target transfers its assets individually to the acquirer. The sales contract must carefully describe all assets and employ transfer mechanisms compliant with the applicable transfer rules, which differ by asset type (e.g., personal property, real property, contracts, negotiable instruments, etc.). If the sales contract fails to do so, the acquirer will not obtain ownership rights in all the assets. Moreover, some assets cannot be transferred in this way without the affirmative approval of some third party. In particular, by default, contracts cannot be transferred without the approval of the contract counterparty. All of this makes asset sales extremely cumbersome. (Unless, of course, the assets are shares in one or more subsidiaries. That sort of asset sale would be very simple.)

An asset sale does have two potential advantages. First, dissenting shareholders do not get appraisal rights (cf. DGCL 262 and Hariton v. Arco Electronics below). Second, the acquirer does not automatically assume all the liabilities of the target. In practice, however, a variety of rules limit the importance of this second point. Some liabilities automatically transfer with ownership of the asset (such as environmental cleanup obligations). Further, a variety of rules covered later in the class protect creditors against opportunistic asset transfers. Last but not least, major debt contracts usually restrict a debtor’s ability to sell off a substantial part of its assets.

To be sure, a contract might also require approval for a merger, and many important ones do. In general, as always, contractual arrangements, including charter arrangements, can add or efface distinctions between asset sales and mergers. What will usually remain, however, is the hassle of transferring assets individually in an asset sale.

The ease of mergers

The merger, on the other hand, is easy. It usually requires only an agreement between the two corporations, and approval by both boards and shareholder meetings, usually by simple majority vote. Unanimous approval is not required.

In addition, the merger agreement can freely determine just about anything in the organization of the joint entity: its charter, its ownership, and its management. For example, there is no requirement that the shareholders of both merging corporations remain shareholders in the joint entity.

A warning: Don’t be misled by expressions such as “surviving entity.” They are merely naming conventions. In particular, the shareholders, board, management, and charter of the “surviving entity” could all be eliminated in the merger (in the case of shareholders, for due compensation) and replaced by those of the other entity.

A side note: Because the merger is so easy and flexible, it is a versatile device with many uses outside of M&A. For example, it can be used for internal rearrangements inside a corporate group (cf. DGCL 253, 267), reincorporation from one state to another (by merging the corporation into a shell company incorporated in the destination state; this can also be achieved directly by “conversion” under DGCL 265, 266), and so on.

Other steps in the acquisition process

To be sure, the merger is not the only step in many acquisitions. This is most obvious in a hostile takeover. A merger requires approval by the target board. By definition, the hostile takeover is a situation in which the target board is unwilling to approve a merger. So how can a merger happen in a hostile takeover?

The answer is that the merger will come last in a chain of hostile acquisition steps. In a standard hostile takeover, the acquirer would first acquire a majority of the target stock through a “tender offer” (i.e., an offer addressed to all target shareholders to purchase their stock) and then replace the resisting target board. The new board would then cause the target to enter into a merger agreement with the acquirer.

Friendly acquisitions can also involve more than just the merger step. In these cases, however, the merger agreement may act as a road map containing the earlier steps. The 3G / Burger King agreement below provides an example of such a structure.

Sources of law

M&A involves a complicated mix of statutes, rules, and precedents, from many areas of law, including corporate law, securities law, and antitrust.

Securities laws

The securities laws and rules not only regulate disclosure, but also set important timing requirements. In particular, the Williams Act of 1968 requires an acquirer of 5% or more of a corporation’s voting stock to disclose this fact within ten days of crossing the 5% threshold (SEA §13(d)). This means that an acquirer cannot gain control of the target secretly and slowly.

The Williams Act also regulates tender offers (SEA §14(d)/(e)). Among other things, the SEC rules require that any tender offer remain open for at least 20 business days (rule 14e-1). This prevents quick acquisitions by way of a tender offer. Moreover, while the offer remains open, shareholders who already tendered may reverse their decision and withdraw their shares (rule 14d-7(1)).

Other Williams Act rules of particular importance for deal structure are:

• “All holders, best price:” the tender offer must be open to all shareholders, and all must be paid the same consideration (rule 14d-10);
• Conversely, the tender offeror may not buy stock in side deals between public announcement and expiry of the offer (rule 14e-5: “Prohibiting purchases outside of a tender offer”);
• Pro-rata allocation: if the tender offer is oversubscribed — the tender offer is for less than all of the corporation’s outstanding stock, and more shares are tendered — the offeror must take up tendered shares pro rata (SEA §14(d)(6), rule 14d-8).

Stock exchange listing rules

The listing rules of the stock exchanges can play an important role as well. For example, rule 312.03 of the New York Stock Exchange’s Listed Company Manual requires stockholder approval for certain stock issuances, including those of a certain size (≥20%) or leading to a change in control. Rule 402.04 requires active proxy solicitation for any stockholder meeting, triggering the SEC’s proxy rules and associated delay.

Corporate law

Within corporate law, the statutory provisions relating to mergers are of obvious importance for M&A (e.g., DGCL 251, 253, 262, 271). But as we have already seen (Blasius), many general and perhaps deceivingly innocuous provisions of the DGCL, such as those governing director removal and appointment (DGCL 141, 223), can also play an important role in M&A.

Fiduciary duties play a major role in M&A as well. In fact, most of the cases that we will read will deal with the shaping of fiduciary duties in the M&A context. Nevertheless, this should not lead you to think that the statute is unimportant. Fiduciary duties only become important to the extent that the statute has not preempted a particular question. In other words, the statute demarcates the field on which the game is played, and fiduciary duties regulate the behavior of the players on the field. Both are important to understand the game.

Other law

Depending on the industry, various other areas of law may come into play. For example, banks require approval from the banking regulator for acquisitions.

One area of law that is always important in M&A is antitrust. It is covered in a separate course. Here you just need to know that the Hart-Scott-Rodino Act requires that certain antitrust filings be made fifteen or thirty days before the closing of an acquisition. This may be an additional source of delay — and, in the case of “hostile” acquisitions, an early warning to the corporation's management.


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  1. 2 Show/Hide More Hariton v. Arco Electronics, Inc. (Del. 1963)
    Original Creator: Holger Spamann
    This case addresses the question whether an asset sale that achieves the same purpose as a merger should be subjected to the rules applicable to mergers as a “de facto merger.”

    1. Why did the defendant structure the deal as an asset sale rather than a merger?
    2. What is the Delaware Supreme Court’s position on the de facto merger theory? (NB: This position is still good law in Delaware.)
    3. How does that answer relate to the court’s opinion in Schnell (which was decided eight years later but did not purport to break new ground)?

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December 17, 2017

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