Merger and acquisition

Section A

Meaning of merger: A merger is an agreement that unites two existing companies into one
new company.

A merger is a corporate strategy of combining different companies into a single company in

order to enhance the financial and operational strengths of both organizations.

Forms of Merger

1. Merger through Absorption: When two or more entities are combined, into an
existing company, it is known as merger through absorption. In this type of merger, only
one entity survive after the merger, while the rest of all cease to exist as they lose their
identity. E.g. Tata Chemicals Limited (TCL) absorbed Tata Fertilizers Limited (TFL).

2. Merger through Consolidation: When two or more companies fuse to give birth to a
new company, it is known as merger through consolidation. This implies that all the
companies to the merger are dissolved, i.e. they lose their identity and a new company is
created. E.g. Consolidation of Hindustan Computers Limited, Indian Reprographics
Limited, Indian Software Company Limited Hindustan Instruments Limited, to form a new
company HCL Limited.

Motives behind
M&A

Operational Financial Buying

Diversificatoon
synergy synergy undrlying firm

 Operational synergy: Operating synergy is when the value and performance of two firms
combined is greater than the sum of the separate firms apart and, as such, allows for the
firms to increase their operating income and achieve higher growth.
 Synergy can be mathematically expressed as follows:

Value of A + value of B = value of (AB) + C (where c is synergy)

Operational synergy refers to the synergy that is derived from a M&A activity based on the
following factors:

operational
synergies

Economies of Greater combination of Increased

scale pricing power different functional market share
strengths

Operational synergy affects operating profit, operating expenses, return on capital and
eventually return on equity.

Operational synergy can be obtained by increasing operating profit or decreasing operating

expenses. Operating profit can be enhanced by an optimum usage of the firm’s assets which
will eventually improve the return on assets.

 Economies of scale: economies of scale can be achieved when two large capital firms of
almost same scale with similar products merge. As the size of the firms is alike, it is
possible to cut down operational costs so that the combined firm can become more cost
efficient and profitable. Ex: if ICICI bank and Axis bank merge with each other,
economies of scale can be achieved.

 Greater pricing power: the merger not only reduce the number of competitors but also
enable the combined firm to command pricing on its products. Pricing power increase the
overall revenue which in turn will increase the operating income and return on capital and
ultimately increase return on equity and return to stake holders. Ex: If bharti Airtel and
reliance communication merge, a big telecommunication firm will be formed and the
number of major players in telecom industry will be reduced. This will give the combined
firm a greater pricing power. Ex2: pepsi and coke

 Combination of different functional strength: Combination of different functional

strength can eventually increase the total market share and total profit of the combined
firm. For example If one firm has high quality products and another firm has strong sales
 and marketing team, then high quality products can be easily sold in the market to increase
profitability.

 Increased market share: combined firm can increase its market share through M&A
which eventually increase the profitability and return on capital and return on equity.

 Financial synergies: it includes lowering the cost of capital and tax benefits.
 Lowering cost of capital: if company rise capital through debt, combined firm can
raise debt or the cost of debt goes down and eventually the cost of capital reduces.
 Tax benefits: if the acquirer has bought a loss making firm, the financials of the
target will be reported in the financial statement of the acquirer, which will cut
down the tax to be paid by the acquirer. Ex: ICICI bank bought sangli bank which
was loss making bank and reported heavy loss in 2006 and 2007. ICICI received tax
benefit out of it.
 Buying undervalued firm: firms that are undervalued can be targeted for acquisition by
acquirer to get the benefit of the difference between the potential value and the purchase
price.
 Diversification: it is the process of buying firms outside of a firm’s current core business.
Diversification helps in reducing risk. Ex: Tata group comprises a large number of firms
such as tata steel, tata motors, tata communications, tata power, tata tele services etc is a
good example of diversification.

Reasons for merger and acquisition

 Synergies
 Economies of Scale
 Accelerated Growth
 Increased Market Power
 Increasing efficiency
 Firing incompetent management: the removal of incompetent managers and
introduction of a new management team can improve the performance and
profitability.

 Expanding business
 Increased External Financial Capability: Many mergers, particularly those of
relatively small firms into large ones, occur when the acquired firm simply cannot
finance its operations. This situation is typical in a small growing firm with
expanding financial requirements. The firm has exhausted its bank credit and has
virtually no access to long term debt or equity markets.

 Increase Supply-Chain Pricing Power: By buying out one of its suppliers or

distributors, a business can eliminate an entire tier of costs. Specifically, buying out a
supplier, which is known as a vertical merger, lets a company save on the margins
the supplier was previously adding to its costs. Any by buying out a distributor, a
company often gains the ability to ship out products at a lower cost.

 Eliminate Competition: Many M&A deals allow the acquirer to eliminate

future competition and gain a larger market share.

 Cutting costs: When two companies have similar products or services,

combining can create a large opportunity to reduce costs.

 Diversification: Two or more companies operating in different lines can

diversify their activities through amalgamation. Since different companies are
already dealing in their respective lines there will be less risk in
diversification. When a company tries to enter new lines of activities then it
may face a number of problems in production, marketing etc.

 Survival: Sometimes, companies opt for a merger or acquisition deal in order

to survive, especially during the period of global financial crisis.

 Increase in Value: One of the main reasons of merger or amalgamation is the

increase in value of the merged company. The value of the merged company is
greater than the sum of the independent values of the merged companies. For
example, if X Ld. and Y Ltd. merge and form Z Ltd., the value of Z Ltd. is
expected to be greater than the sum of the independent values of X Ltd. and Y
Ltd.
 Classification of merger

Classification on the basis of Integration:

 STATUTORY MERGER: A statutory merger is one in which all the assets and
liabilities of the smaller company is acquired by the bigger (acquiring) company. As
a result, the smaller target company loses its existence as a separate entity.
Company A + Company B = Company A

 SUBSIDIARY MERGER: A subsidiary merger is one in which the target company

becomes a subsidiary of the bigger acquiring company. This happens because the
target company may have a known brand or a strong image which would make sense
for the acquiring company to retain.
Company A + Company B = (Company A + Company B)

 CONSOLIDATION MERGER: A consolidation merger is one in which both the

companies lose their identity as separate entities and become a part of a bigger new
company. This is generally the case with both the companies being of the same size.
Company A + Company B = Company C

Classification on the basis of relatedness of the business activities

HORIZONTAL MERGER: A merger that happens between companies belonging to the
same industry. The companies have businesses in the same space and are generally
competitors to each other offering the same good or service.

Example: A merger between Coca-Cola and the Pepsi beverage division, for example,
would be horizontal in nature. The goal of a horizontal merger is to create a new, larger
organization with more market share. Because the merging companies' business operations
may be very similar, there may be opportunities to join certain operations, such as
manufacturing, and reduce costs.
EX: Google inc and Motorola mobility

Vertical Merger: A merger between two companies producing different goods or services
for one specific finished product. A vertical merger occurs when two or more firms,
operating at different levels within an industry's supply chain, merge operations.
A vertical merger can happen in two ways. One is when a firm acquires another firm which
produces raw materials used by it. For e.g., a tyre manufacturer acquires a rubber
manufacturer, a car manufacturer acquires a steel company, a textile company acquires a
cotton yarn manufacturer etc.
Another form of vertical merger happens when a firm acquires another firm which would
help it get closer to the customer. For e.g., a consumer durable manufacturer acquiring a
consumer durable dealer, an FMCG company acquiring m advertising company or a
retailing outlet etc.

Conglomerate merger: A merger between companies in unrelated business activities

(e.g., a clothing company buys a software company) The main objective of a conglomerate
merger is to achieve i big size or market or product extensions. There are three types of
Conglomerate merger:

 MARKET EXTENSION MERGERS: Mergers between companies that have

same products to offer but the markets are different. The reason behind such mergers
is access to bigger markets and an increase in client base.

 PRODUCT EXTENSION MERGERS: A merger between companies that have

different but related products but the markets are same. Such mergers allow the
companies to bundle their product offerings and approach more consumers. EX: IN
2012 Sun pharmaceutical industries limited acquired DUSA pharmaceuticals.

 Pure conglomerate merger: it refers to a merger involving unrelated business

activities

ACCRETIVE MERGER: is a merger that increases the acquirer's earnings per share. A
merger is said to be accretive if the acquiring firm's earnings per share (EPS) increase after
the deal goes through.

Dilutive merger: A dilutive merger is a transaction that decreases the acquirer's earnings
per share (EPS). A dilutive merger can decrease shareholder value temporarily, but if the
deal has strategic value, it can potentially lead to a sufficient increase in EPS in later years.
Reverse Merger: A reverse takeover or reverse merger takeover (reverse IPO) is the
acquisition of a public company by a private company so that the private company can
bypass the lengthy and complex process of going public.

When a weaker or smaller company acquires a bigger company, it is a reverse merger. In

addition, when a parent company merges into its subsidiary or a loss-making company
acquires a profit-making company, it is also termed as a reverse merger.

Process of reverse merger

Stage 1: Identifying a suitable shell: identification of suitable shell company which

must comply with all the reporting requirements mandatory by sebi. The publicly traded
corporation is called a “shell”

Stage ii: financial staff: Right people to ensure the flawless execution of the reverse
merge process are crucial to find.

Stage iii: transaction documents:

 LETTER OF INTENT: it is a document that formalizes the interest of both parties

in a deal.
 THE CONTRACTUAL AGREEMENT: It is the most essential document of the
reverse merger process. It translates the plan on paper into reality once affixed by the
signature of both parties. Its major content includes:

• Consideration and mode of settlement (cash, stocks or a combination thereof).

• Changes in management control.
• Representations and Warranties
• Termination clauses and breakup fees applicable.

STAGE iv: Shareholders-shares-buy activities/ Mass buying of shares: It is the final

phase that leads to the merger and public listing. The process involves the private
company’s shareholders engaging actively in the exchange of its shares with those of the
public company. shareholders of the private company purchase control of the public shell
company and then merge it with the private company. The private company shareholders
receive a substantial majority of the shares of the public company and the control of its
board of directors. The business of the private Company does not go through an expensive
and time-consuming review with state and federal regulators because this process was
completed beforehand with the public company. One other advantage is that the private
company does not need to raise equity from public at this stage either because it does not
 need finance at this stage of business. The implication is that it becomes a publicly traded
company, which eventually leads to a merger.

Myths about reverse merger

 Reverse Mergers are Inexpensive and Fast: Stock promoters often compare the price of
an initial public offering (“IPO”) with that of a Reverse Merger. This is misleading
because with an IPO, a company pays an underwriter to sell securities to the public and
develop an active market after the company becomes public. A Reverse Merger is not a
capital raising transaction. A private company can go public and file their own
Registration Statement less than the cost of a reverse merger transaction.

Acquisition

Meaning: An acquisition is when one company purchases most or all of another

company's shares to gain control of that company. Purchasing more than 50% of
a target firm's stock and other assets allows the acquirer to make decisions about
the newly acquired assets without the approval of the company’s
shareholders. For example, if Corporation A buys 51% or more of Corporation B,

Then Corporation B becomes a subsidiary of Corporation A, and the activity is call

ed an acquisition.

Types of acquisition
 Asset purchase/ Acquisition: An asset acquisition is the purchase of a company by
buying its assets instead of its stock. The acquirer buys some or all of the target's
assets/liabilities directly from the seller. If all assets are acquired, the target is liquidated.
In an asset sale, individually identified assets and liabilities of the seller are sold to the
acquirer. The acquirer can choose ("cherry pick") which specific assets and liabilities it
wants to purchase, avoiding unwanted assets and liabilities for which it does not want to
assume responsibility. The asset purchase agreement between the buyer and seller will list
or describe and assign values to each asset (or liability) to be acquired, including every
asset from office supplies to goodwill.

 Stock acquisition/purchase: The acquirer buys the target's stock of from the selling
shareholders. In a stock purchase, all of the assets and liabilities of the seller are sold upon
transfer of the seller's stock to the acquirer. As such, no tedious valuation of the seller's
individual assets and liabilities is required and the transaction is mechanically simple.
 Difference between merger and acquisition
Basis Merger Acquisition
Meaning Merger is a process in which two or Is a process in which one company takes
more companies come forward to work the control of another company
as one
Presence Generally The companies involved in While in an acquisition, both the
the merger dissolve to form a new companies do not lose their existence.
entity.
Size of operations Two or more companies having the Whereas, in an acquisition, the larger
same scale of operations opt for a company takes over the smaller company.
merger.
Legalities The process of merger involves a time As opposed to an acquisition which can be
consuming procedure owing to the done faster as the legal
high number of legal formalities.
formalities are minimal.
Stocks The stocks of both the companies are While in an acquisition, no new stocks are
surrendered, while new stocks are issued.
issued afresh.
Formation of a Yes No
new company
Purpose To decrease competition and increase For Instantaneous growth
operational efficiency.

Title A new name is given The acquired company comes under the
name of acquiring company

Power Both companies have almost similar Acquiring company has more power
power

Motives behind M&A

 Economies of scale:
 Increased revenue/ Market Share:
 Synergy:
 Taxes: A profitable company can buy a loss maker to use the target's loss as their
advantage by reducing their tax liability.
 Geographical or other diversification:
 Vertical integration:
 Acquiring new technology
 Competition
 Improved profitability
 Value drivers in M&A
The value drivers do not only maximize the chances of business owners to sell at attractive exit
multiples in the mid- to long-term, but also to benefit in the short-term from running a
successful company.

 Projected future cash flow and earnings.

 Growth Rate
 Sustainability of Earnings
 Financial Performance
 Strong competitive advantages — Does your company have a USP, or unique selling
proposition? Is there something unique about your business that makes you stand out? For
example, this might be exceptionally high quality, superior customer service or the lowest price.
If not, you should identify and refine a competitive advantage now.

Reasons for failure of merger and acquisition

 Improper valuation:
 Cultural differences: One of the major reasons behind the failure of mergers and acquisitions
is the cultural difference between the organizations. It often becomes very tough to integrate the
cultures of two different companies, who often have been the competitors. The mismatch of
culture leads to deterring working environment, which in turn ensure the downturn of the
organization.

 Inadequate due diligence: inaccurate due diligence and inaccurate risk estimation leads to
failure of M&A.

 HR issues: job losses, restructuring etc.

 Over estimated synergies
 Limited or no involvement from the owners: Appointing M&A advisors at high costs for
various services is almost mandatory for any mid to large size deal. But leaving everything to
them just because they get a high fee is a clear sign leading to failure.

 Negotiations errors: Cases of overpaying for an acquisition (with high advisory fee) are also
rampant in executing M&A deals, leading to financial losses and hence failures.

 Regulatory issues:
 Integration difficulties: the combined entity has to adopt a new set of policies and procedures.
 Poor business fit: M&A also fails when the products and services of the merging entities do
not fit into acquirer’s over all business plans.

 Unexpected Economic Factors: Even the best laid plans can go awry if the economy
experiences sudden, drastic changes that affect stock prices and interest rates. A negative
economic climate will undoubtedly interfere with the success of mergers and acquisitions,
regardless of how well they were expected to perform.

 Backup plan: With more than 50% of M&A deals failing, it’s always better to keep a backup
plan to disengage in a timely manner (with/without a loss), to avoid further losses.

Merger and acquisition process

1. Develop an acquisition strategy – Developing a good acquisition strategy revolves around the
acquirer having a clear idea of what they expect to gain from making the acquisition – what
their business purpose is for acquiring the target company (e.g., expand product lines or gain
access to new markets)

2. Set the M&A search criteria – Determining the key criteria for identifying potential target
companies (e.g., profit margins, geographic location, or customer base)

3. Search for potential acquisition targets – The acquirer uses their identified search criteria to
look for and then evaluate potential target companies

4. Begin acquisition planning – The acquirer makes contact with one or more companies that
meet its search criteria and appear to offer good value; the purpose of initial conversations is to
get more information and to see how amenable to a merger or acquisition the target company is

5. Perform valuation analysis – Assuming initial contact and conversations go well, the acquirer
asks the target company to provide substantial information (current financials, etc.) that will
enable the acquirer to further evaluate the target, both as a business on its own and as a suitable
acquisition target

6. Negotiations – After producing several valuation models of the target company, the acquirer
should have sufficient information to enable it to construct a reasonable offer; Once the initial
offer has been presented, the two companies can negotiate terms in more detail

7. M&A due diligence – Due diligence is an exhaustive process that begins when the offer has
been accepted; due diligence aims to confirm or correct the acquirer’s assessment of the value
 of the target company by conducting a detailed examination and analysis of every aspect of the
target company’s operations – its financial metrics, assets and liabilities, customers, human
resources, etc.

8. Purchase and sale contracts – Assuming due diligence is completed with no major problems
or concerns arising, the next step forward is executing a final contract for sale; the parties will
make a final decision on the type of purchase agreement, whether it is to be an asset purchase
or share purchase

9. Closing and integration of the acquisition – The acquisition deal closes, and management
teams of the target and acquirer work together on the process of merging the two firms

Synergy
Synergy is the concept that the combined value and performance of two companies will be
greater than the sum of the separate individual parts.

Types of
synergy

Operational Financial

Financing of merger and acquisition

Debt financing: A company may also finance a merger through issue of fixed convertible
debentures and convertible preference share being a fixed rate of dividend. The shareholders of
the acquired company sometimes prefer such a mode of payment because of security of income
along with an option of conversion into equity within a stated period.
 Equity share Financing or exchange of shares: It is one of the most commonly used
methods of financing mergers. Under this method shareholders of the acquired company are
given shares of the acquiring company. It results into sharing of benefits and earnings of
merger between the shareholders of the acquired companies and the acquiring company.

 Cash financing: Shares are exchanged for cash. In case of an all-cash deal, the equity

synergy value
drivers

Cost based Revenue based

drivers drivers
portion of the parent company’s balance sheet is unchanged. This kind of transaction mostly
takes place when the acquiring company is much larger than the target company and it has
substantial cash reserves.

Synergy value drivers

A. Revenue based drivers

 New customers: if acquirer and target firms do not sell same products, the can sell their
products to each others’ customers.
 Cross selling: synergy can be created by selling products of the acquirer to the existing
customers of the target firm.
 Sales force efficiency: sales force of both firms work with each other.
 Access to new distribution channels
 Customer service
 New product development
 Marketing
 New markets: cross border merger helps the acquirer to sell its products and services in new
markets.
B. Cost based drivers
 Research and development: the acquirer can cut down its R&D cost by
acquiring a firm that produce those products for which the acquirer running
R&D. in addition the acquirer can cut down R&D projects of the target firms
that are not in line with the business plan of the acquirer.
 Supply chain: cost can be reduced in different stages of supply chain such as buying,
producing, assembling, moving, storing, or selling goods and services.

 Outsourcing

 Head count reduction: for example of two commercial banks merge with each other, there is
a possibility that they have too many employees working in one division. So there is a
possibility of cost by head count reduction.

FINANCING MERGER AND ACQUISITION

 Debt financing: rising capital by various types of debts and debt instruments such as

 Senior secured debt: this type of debt is raised by mortgaging the assets of the firm. The
debt holders are the first one to be paid in case of bankruptcy.
 Secured loan: it is also raised by mortgaging the assets of the firm but the debt holders
come second in claim to assets of the firm in case of default.
 High yield debt: it is raised without mortgaging the assets of the firm and so the cost of
this kind of debt is highest.
 Loan syndications: in loan syndications, firms hire a syndicator or group of syndicators
who help rising debt financing. The syndicators bring together a group of lenders where
each lender funds certain % of the debt capital. Syndicator charge fee for raising capital
and credit rating analysis.
 Bonds: it is a debt security issued for a period of more than one year with the purpose of
raising capital by borrowing.

 Equity financing: raising capital for M&A by issuing equity shares. Equity financing
includes:
 Common equity
 Private investment in public equity: it involves selling of publically traded shares to
private investors. It is a fast way of raising capital.
  Private equity: raising capital from private equity firms.
 Equity warrants: it is a contractual agreement that give the holder the right but not the
obligation to enter into a transaction involving an underlying security at a predetermined
price on a predetermined future date. It can be call or put warrant.

 Cash financing: cash rich firms can afford to buy other firms by paying cash. The cash based
transactions are termed as acquisition rather than merger because the shareholders of the
target firm are removed from the picture and the target comes under the control of the
acquirer.

Section B
Valuation
Meaning of valuation: Valuation is the analytical process of determining the current
(or projected) worth of an asset or a company.

A valuation is the process of determining the fair market value of a company.

Valuations are highly subjective calculations that aim to determine the fair market value of a
company.

Valuation refers to the process of determining the present value of a company or an asset. It can
be done using a number of techniques. Analysts that want to place value on a company
normally look at the management of the business, the prospective future earnings, the market
value of the company’s assets, and its capital structure composition.

Factors to be considered for valuation

1) Growth Prospects: This factor looks at how much potential the business has to grow in the
future. Thus, if you have a business model with high growth potential, or if you are in an
industry that will likely see significant growth, these factors could increase the value of the
business.

2) Earnings history: Income is a major factor in the valuation of any business. Particularly,
someone appraising the value of a business will look at historical trends in your income. For
example, an increase in gross income over the past five years will have a positive impact on the
valuation, while a downward trend in income may serve to devalue the business.

3) Location: Your company’s location is a major factor in its value. If you have an incredibly
innovative idea and a fantastic business model, it may not mean much if you are in a location
with little potential to grow or succeed. Conversely, if your business isn’t that successful, but
you are in a prime location, this can be a major positive when it comes to valuation.

4) Staff and Management: What kinds of employees will a buyer be inheriting if they
purchase your business? A skilled staff and effective, reliable management team can have a
strong impact on the value of your company.

5) Reputation: Your company’s reputation and goodwill within your community can be
incredibly valuable. An overwhelmingly positive reputation could significantly boost the value
of your company, while a negative reputation could be detrimental to your prospects for selling
your business.

6) Industry growth prospects: Firms operating in rapidly growing industry sectors are more
valuable.

7) Customer concentration: Most successful companies try to reduce dependence on a few

large customers. Should any one customer be lost, the effect on business earnings is minimal.
The more loyal customers a company has, the higher its value.

8) Business competitive advantages: Sustained competitive advantages such as great

technology, exclusive distribution rights or highly loyal customer following are sure value
creators for any business.

9) Regulations: No company can be free of regulations. And when you attempt to evaluate a
business, you need to see the regulatory factors as well.

10) Cash flows

11) Management strength and structure

12) The book values of assets and liabilities, and the financial condition of the business,

13) Dividend paying capacity,

14) The marketability of shares,

15) Intellectual property

16) Assets and liabilities

 Types of values in business valuation

 Book Value: Book value is the amount at which an asset or liability is recorded on the
entities books of accounts.

 Depreciated Value: Depreciated value or written down value is the net amount after
deducting depreciation or amortisation.

 Going Concern Value: The going concern value definition is the value of a company under
the assumption that it will continue to operate for the foreseeable future. The going-concern
value of a company is a value that assumes the company will remain in business indefinitely
and continue to be profitable. This differs from the value that would be realized if its assets
were liquidated because an ongoing operation has the ability to continue to earn profit, which
contributes to its value.

 Liquidation Value: Liquidation valuation is the value of a company that is bankrupt or

going out of business. It is the value of the company’s assets, according to what they would
be worth if they are sold off in order to repay creditors. This is in contrast to going concern
value, which assumes the company will continue to operate for the foreseeable future. The
liquidation value is the value of company real estate, fixtures, equipment, and inventory.
Intangible assets are excluded from a company's liquidation value. The difference
between going concern value and liquidation value consists of intangible assets and goodwill.

For example, if a well-known apparel company is a going concern, it can continue to sell
its brand-name clothing at a markup for a profit. It would then be valued according to its
going concern value. However, if the company is going out of business, it would have to sell
off its assets – sewing machines, fabric, etc. – to pay creditors. The company would probably
have to sell off its assets at a discount. In this case, the company would be valued according
to its liquidation value.

 Fire Sale Value: Fire sale value is the price at which an asset could be sold in the shortest
possible time regardless of how low a price is obtained.

 Market value: based on current market value

Methods of valuation

2. Asset base valuation: An asset-based approach is a type of business valuation that focuses
on the net asset value of a company. The net asset value is identified by subtracting total
liabilities from total assets. Asset-based valuation is a form of valuation in business that
focuses on the value of a company’s assets or the fair market value of its total assets after
 deducting liabilities. Assets are evaluated, and the fair market value is obtained. For example,
landowners may collaborate with appraisers to work out a property’s market worth. Over
time, property values increase, and a proprietor may realize a piece of property is worth more
today than it was five years ago. The new value is quoted and is used in the asset-based
approach.

Asset base value = Total value of assets – total value of liabilities

3. Earning based valuation: Business value under this approach is based on of future cash
flows of one's business. This method calculates a business’s future profitability based on its
cash flow. With this approach, a valuator determines an expected level of cash flow for the
company using a company's record of past earnings.

There are two income-based approaches that are primarily used when valuing a business, the
Capitalization of Cash Flow Method and the Discounted Cash Flow Method. These methods
are used to value a company based on the amount of income the company is expected to
generate in the future.

 Capitalization of Earnings: This method calculates a business’s future profitability based

on its cash flow, annual ROI, and its expected value. The Capitalization of Cash Flow
Method is most often used when a company is expected to have a relatively stable level of
margins and growth in the future.
 Discounted Cash Flow (DCF): Also known as the income approach, the DCF
method values a business based on its projected cash flow, adjusted (or discounted) to its
present value. The Discounted Cash Flow Method is used when future growth rates or
margins are expected to vary.

4. Market Value Approaches: Market value approaches to business valuation attempt to

establish the value of your business by comparing your business to similar businesses that
have recently sold. Obviously, this method is only going to work well if there are a sufficient
number of similar businesses to compare. The market approach is a valuation method used to
determine the appraisal value of a business, intangible asset, business ownership interest,
or security by considering the market prices of comparable assets or businesses that have
been sold recently or those that are still available.

5. Book Value approach: under this method the value the business’s equity (or total assets
minus total liabilities), is calculated as per the business’s balance sheet. An asset's book value
is equal to its carrying value on the balance sheet, and companies calculate it netting the asset
against its accumulated depreciation.
The book value represents the value of the company based upon the financial statement. It
concerns the total value of the company’s Assets minus the total value of the company’s
liabilities.This amount will equal to the owner’s equity in the firm and likewise equal to the
value of the firm.
6. Stock and debt approach of valuation:

Direct comparison approach: The logic of a direct comparison approach lies in the idea
that similar assets should sell for similar price. for example, the market value of a house could
be estimated by finding recent selling prices for substantially similar houses in comparable
neighborhoods. Finding sales of comparable businesses, however, is difficult. Transactions are
few, and comprehensive data sources do not exist. Thus, a true direct comparison approach
cannot generally be used in business valuation.

Cross border Acquisition

Post merger integration

Integration of various aspects such as HR, sales and marketing, Accounting and finance,
information technology etc is important to achieve synergies.

Proper plan should be made for post merger integration. Activities of post merger
integration should be properly prioritized. Timely completion of post merger integration
is the to the success of a M&A.

Post merger integration involves at different levels such as:

Leadership level

Human resource Sales and

level marketing level
post merger
integration

Information Accounting and

technology level finance level
 Leadership level: integration of leadership of two firms to achieve synergies and work
towards goal and vision of the firm.
 HR level integration: developing proper HR policies
 IT level: integration information and technology of both firms.
 Accounting and finance level: financial integration is a long process that can be from six
months to 1 year depending on the nature of the business.
 Sales and marketing level: the retention of the sales staff depends on the past performance of
the staff and nature of the products that combined firm offers.

Failure in post mergers integration

post merger integration fails due to:

strategic
conflicts

cultural PMI team

conflicts failure conflicts

poor
communication

 Strategic conflict: two firms may be very different in terms of goals, and strategies.
 Poor communication: some firms prefer formal way of communication and some prefer
informal way. If the leader of the acquirer firm is unable to communicate effectively with the
leader of the target firm, combined firm will not effectively achieve the goals.
 Team conflicts: the conflict between the management team of the acquirer and target firms
leads to failure of merger.
 Cultural conflicts: culture may be different because of different leadership style or because
the firms are in different countries or businesses are different in nature. When two firms merge,
they have to each other’s culture.

Successful of post merger integration

 Effective communication: it helps in communicating the goals, vision and model of the
business to the employees of the target firm.
 Strong management team: the best managers should be picked from acquirer and target
firms.
 Customer retention: the combined firm should work on retaining of the customers of both
firms.
 Shared vision: when two firms merge, the range of products/services increases, the
management and operation team increase, operational capacity increases , etc. therefore the
management should work on common goals, vision, mission statement and business model. A
successful identification of the shared vision helps in growth of the company.
 Employee retention: top performing employees of the target firm should be retained.
 Cultural integration:
 Products/service integration: synergy can be achieved by increasing the range of
products/services offered by combined firm

Section C

Corporate restructuring

Corporate restructuring is an action taken by the corporate entity to modify its capital structure
or its operations significantly.

The Corporate Restructuring is the process of making changes in the composition of a firm’s
one or more business portfolios in order to have a more profitable enterprise. Simply,
reorganizing the structure of the organization to fetch more profits from its operations or is best
suited to the present situation.

Restructuring is an action taken by a company to significantly modify the financial and

operational aspects of the company, usually when the business is facing financial pressures.

Types of corporate restructuring

1. Financial Restructuring: The Financial Restructuring may take place due to a drastic fall in
the sales because of the adverse economic conditions. Here, the firm may change the equity
 pattern, cross-holding pattern, debt-servicing schedule and the equity holdings. All this is done
to sustain the profitability of the firm and sustain in the market.
Portfolio restructuring involves the sale of assets no longer needed or wanted and the purchase o
f different ones.

2. Organizational Restructuring: The Organizational Restructuring means changing the structure

of an organization, such as reducing the hierarchical levels, downsizing the employees,
redesigning the job positions and changing the reporting relationships. This is done to cut the
cost and pay off the outstanding debt to continue with the business operations in some manner.

Forms of corporate restructuring

 Mergers / Amalgamation
 Acquisition and Takeover
 Divestiture
 Demerger (spin off / split up / split off)
 Reduction of Capital
 Joint Ventures
 Buy back of Securities
 Slump Sale: Under this strategy, an entity transfers its one or more undertaking for
lump sum consideration. Under Slump Sale, an undertaking is sold for a consideration
irrespective of the individual values of the assets or liabilities of the undertaking.

McKinsey 7S Model
The model was developed in the late 1970s by Tom Peters and Robert Waterman, former
consultants at McKinsey & Company. They identified seven internal elements of an
organization that need to align for it to be successful. It's useful to examine how the various
parts of your organization work together. The framework can be used to examine the likely
effects of future changes in the organization, or to align departments and processes during a
merger or acquisition.

The 7S Model specifies seven factors that are classified as "hard" and "soft" elements. Hard
elements are easily identified and influenced by management, while soft elements are fuzzier,
more intangible and influenced by corporate culture. The hard elements are as follows:

 Strategy: this is your organization's plan for building and maintaining a competitive
advantage over its competitors.
 Structure: this how your company is organized (that is, how departments and teams are
structured, including who reports to whom).
 Systems: the daily activities and procedures that staff use to get the job done.

The soft elements are as follows:

 Shared values: these are the core values of the organization, as shown in its corporate
culture and general work ethic. They were called "superordinate goals" when the model was
first developed.
 Style: the style of leadership adopted.
 Staff: the employees and their general capabilities.
 Skills: the actual skills and competencies of the organization's employees.
The model diagram represents the interdependency of all seven elements. Shared values are
placed in the middle of the model to emphasize that they are central to the development of all
the other critical elements. The ideas behind why the organization was created will influence the
other six elements.

Reasons for restructuring

 Change in the Strategy: The management of the troubled company attempts to improve the
company’s performance by eliminating certain subsidiaries or divisions which do not align
with the core focus of the company. The division may not seem to fit strategically with the
long-term vision of the company. Thus, the company decides to focus on its core strategy
and sell such assets to the buyers that can use them more effectively.
 Lack of Profits: The division may not be profitable enough to cover the firm’s cost of
capital and cause economic losses to the firm.
 Reverse Synergy: This concept is in contrast to the M&A principles of synergy, where a
combined unit is worth more than the individual parts together. According to reverse
synergy, the individual parts may be worth more than the combined unit. This is a common
 reasoning for divesting the assets. The company may decide that more value can be
unlocked from a division by divesting it off to a third party rather than owning it.
 Cash Flow Requirement: A sale of the division can help in creating a considerable cash
inflow for the company. If the company is facing some difficulty in obtaining finance,
selling an asset is a quick approach to raising money and reduces debt.

 Downsizing: One common reason for restructuring a company is to downsize the

workforce. The changing nature of economy may force the business to adopt new strategies
or alter their product mix, making staff redundant.

 Mergers and Acquisitions

 Statutory and Legal Compliance: At times, restructuring may be a forced exercise, to

conform to some legal or statutory requirements.

 Changing nature of business

 New Technology: Innovations in technology that influence businesses may require

organizational transformation to keep up with the times. Changes that result from the
adoption of new technology is common in most organizations. Leveraging the power of IT
may initially require a complete redo of the current systems and practices. However, new
technologies are more efficient and provide economical methods to perform work.

 External Pressure: External pressures can come from many areas, including customers,
competition, changing government regulations, and other environmental factors. At
times, these pressures may force an organizational transformation exercise in order to
meet some legal or statutory requirements.

Barriers to corporate restructuring



Key elements of corporate restructuring

1. Leadership/Vision: Solid leadership is an absolute prerequisite to even considering a

restructuring effort, for two reasons:

First, an effective leader with a clear, well-defined, and realistic vision will help to define the
ultimate goal of the restructuring and keep it on track. This requires clarity and conviction to
ensure that the restructuring both starts with and maintains its focus.
Second, an effective leader who possesses the respect and support of their peers and
subordinates can ensure that the majority stakeholders (i.e. major lenders, major suppliers,
customers, and employees) do not lose confidence through the restructuring process.

2. Timing: Identifying the need for restructuring before it is too late is extremely important.
Often the timeframe between when problems are first identified and when they are beyond
repair can be quite small.

3. Planning/Execution: It’s important to fully consider all the details of your current situation,
and to determine precisely what sort of restructuring would be best suited to your unique
circumstances.

4. Publicity: How will your restructuring be announced or presented to your investors? Or to

the world at large? Will they think that you’re grasping on to something obsolete? Or shifting to
the cutting edge?

Hardware and Software Restructuring

Hardware Restructuring: This involves redefining, dismantling, or modification of the

existing structure of the organization.
The major areas of the ‘hardware’ restructuring are as follows:

1. Identification of Core Competency: This involves a detailed analysis of the inherent

strengths of the company in area vis-a-vis the competitors, as the competitors will not take long
time to enter into the area of another weak competitor.

2. Flattening of Organizational Layer: To have the desired responsiveness of the company

towards company policies or strategies, the organizational layers should be as less as possible.

3. Downsizing: Over the years many organizations have accumulated fat in terms of
overstaffing. A lean organization is the need of the hour to stay competitive in the market.

4. Creation of Self-Directed Teams: These teams should be such that they will not wait for the
direction from the higher-ups. They will have a kind of autonomy in functioning.

5. Benchmarking: This is a continuous process of measuring the products, services and

business practices of a company against the toughest competitors or those companies
recognized as the industry leaders. It is the search for industry best practices that lead to
superior performance.
Software Restructuring:
This involves cultural and process changes required to create the more collaborative
environment needed for the renewal and growth of the company.

1. Communication: By creating transparency in the organization and convincing each

employee about the need for the restructuring exercise the same can be carried out in an
effective way otherwise it will run into all kinds of problems.

2. Organizational Support: The vertical and horizontal relationships through coaching,

guiding rather than control. Competition and contention is a must for renewal.

3. Trust: It provides confidence necessary for someone to let go of the security of business as
usual and take a leap in the belief that he will get a supportive hand in the organization.

4. Stretch: Stretch is the liberating and energizing element of managerial context that raises
individual aspiration levels and encourages people to lift their expectations of themselves and
others.

5. Empowering People: The top-down decision-making practice has to give way to ideas from
the bottom and decentralized decision-making. Replace the very concept of orders from the top
with ideas from the bottom.

6. Industry Foresight: This is different from vision of the company. Vision is generally very
narrowly held by one or two people and the rest of the organization has to carry it. Foresight
comes from a lot of hard work to understand what is changing such as a technology,
demographics, regulations etc.

7. Training: To weed-out the outdated ideas from the minds of people, a continuous training
program has to be adhered to.

Restructuring through Joint Venture

Joint Venture (JV) is an agreement between two or more parties to combine their resources
(generally: capital, know-how, execution capability, local network) in achieving the common
business goal. Joint Venture is a business preparation in which more than two organizations or
parties share the ownership, expense, return of investments, profit, governance, etc. To gain a
positive synergy from their competitors, various organizations expand either by infusing more capital
or by the medium of Joint Ventures with organizations. Ex: Google and NASA developing Google
Earth, Star Alliance and One World, etc.

Characteristics of joint venture

1. Specific Purposes: Parties create joint ventures keeping pre-determined purposes in mind.
They generally state this purpose clearly in their agreement.

2. Agreement: The parties to a joint venture, i.e. the co-venturers, generally execute a written
agreement between them. This agreement states details like their obligations, profit/loss sharing
ratios, their rights and liabilities, etc.

3. Specific Duration: Since all joint ventures are created for a specific purpose, they generally
come to an end once that purpose is fulfilled. The parties can, however, continue working together
as well if they mutually agree to do so.

4. Structure of the Venture: Parties can create a joint venture by exercising control on any of the
following aspects:

 Assets,

 Operations, or

 Entity itself.

5. Profit Sharing: The parties always agree on the ratio in which they will share their profits and
losses. If there is no agreement to this effect, they have to share profits equally or according to the
contribution they made during their admission into the joint venture.

Objectives of Joint Venture

 To enter foreign market and even new or emerging market.

 To reduce the risk factor for heavy investment.
 To make optimum utilisation of resources.
 To gain economies of scale.
 To achieve synergy.
 Creates Synergy
 Diversification
 Expansion
 Rationales/reasons for joint venture
Internal Reasons to Form a JV

 Spreading Costs – You and a JV partner can share costs associated with marketing, product
development, and other expenses, reducing your financial burden.

 Opening Access to Financial Resources – Together you and a JV partner might have better
credit or more assets to access bigger resources for loans and grants than you could obtain
on your own.

 Connection to Technological Resources – You might want access to technological

resources you couldn’t afford on your own, or vice versa. Sharing innovative and proprietary
technology can improve products, as well as your own understanding of technological
processes.

 Improving Access to New Markets – You and a JV partner can combine customer contacts
and together even form a joint product that accesses new markets.

 Help Economies of Scale – Together you and a JV partner can develop products or services
that reduce total overall production expenses. Bring your product to market cheaper where
the customer can enjoy the cost savings.

External Reasons to Form a JV

 Develop Stronger Innovative Product – Together you and a JV partner may be able to
share ideas to develop a product that is more competitive in your industry.

 Improve Speed to Market – With shared access to financial, technological, and distribution
resources, you and a JV partner can get your joint product to market faster and more
efficiently.

 Strategic Move Against Competition – A JV may be able to better compete against

another industry leader through the combination of markets, technology, and innovation.

Strategic Reasons

 Synergistic Reasons – You may find a JV partner with whom you can create synergy,
which produces a greater result together than doing it on your own.

 Share and Improve Technology and Skills – Two innovative companies can share
technology to improve upon each other’s ideas and skills.

 Diversification – There could be many diversification reasons: access to diverse markets,

development of diverse products, diversify the innovative working force, etc.
 Reasons for failure of Joint Venture

Research indicates that 50 to 70% of all joint ventures fail.

 Cultural differences
 Poor or unclear leadership
 Poor integration process
 Lack of a proper Joint Venture Agreement: The importance of a proper JV Agreement
cannot be emphasized enough. Ensure that you have a proper contract in place that covers
the entire foundation of your JV.
 Lack of finance. If one of the parties to the Joint Venture is struggling financially it can
be the downfall.
 conflicts on strategic objectives
 parent failure

Leverage buy outs

LBO refers to the acquisition of a firm by another firm with the help of high amount of
borrowed capital. In LBO the ratio of debt capital can be as high as 90%. The property, plant
and equipment (PPE) of the target company are used as collateral to finance full or part of the
acquisition value.

Sources for LBO

Term loan (generally secured)

Private equity firms

Preferred equity

Criteria for LBO

Specific criteria for a good LBO candidate include:

• Steady and predictable cash flow

• Divestible assets

• Minimum debt on the balance sheet of the target firm

• Strong management team

• Strong, defensible market position

 • High quality products with strong customer base

• Minimal capital expenditure required

• Minimum working capital requirements

• Enough PPE to rise secured debt

Strategic analysis of LBO investment/divestment.

Strategic analysis involves identification of retention and disinvestment analysis of each of the
product/divisions. Going forward post leverage buyout, only those products/divisions should be
retained that fall in the retention areas of the matrix.

Following steps are involved in the strategic analysis of LBO:

Step 1: understanding the nature of the business of the candidate: including factors such
quality of products, capital expenditure, debt on balance sheet, working capital requirements,
and amount of PPE. These factors are studied to determine how much each of them contributes
to the survival of the firm.

Step 2: business unit analysis by rating each product/division: each product/division is rated
on a specific scale such as 1-9, where 9 is highest and 1 is lowest.

Step 3: industry attractiveness analysis by rating each product’s industry: rate should be given
on the basis of industry attractiveness factors.

Step 4: divest and retain:

Fig (merger and acquisition book, by manu Sharma)

Management Buyouts

A management buyout (MBO) is a transaction where a company’s management team purchases

the assets and operations of the business they manage. In its simplest form, a management
buyout (MBO) involves the management team of a company combining resources to acquire all
or part of the company they manage.

Characteristics of Management buyouts:

 Transition: employees are becoming the owners.

 Ownership and control
 Expertise
 Capital
 Job security

Benefits of management buyouts

 Familiarity: As mentioned before, the MBO team is already familiar and involved in
the business and is most likely to perform better than an external team. Starting a
business from scratch is harder, riskier and time consuming. It is also a great opportunity
to gather a team of professionals who are interested in the business they run. The history
they have working together and dealing with the same issues provides them with a
similar solid background of the challenges of their market.

 Financial Rewards: Making the transition from an employee to a manager will have a
huge impact on the compensation of the management team members, if the MBO is
successful.

 Job Security: An MBO team eliminates the uncertainty of the job market by simply
appointing themselves managers of the company.

 Taking Business Private: In many cases, an MBO team will privatize the target
company. This saves the business a lot of paper work, legislation, and unnecessary
procedures that ought to be invested elsewhere.

 Expertise

 Management Buyouts Are Simple And Easy To Arrange: Rather than having to
invest significant amounts of time and energy (not to mention money) into marketing
your business in the hopes of finding a suitable third party buyer, with a MBO your
buyers are already on your doorstep. This means that MBO’s are usually quicker,
cheaper and easier.

 Confidentiality Can Be Maintained

 High Chance Of Success

 Disadvantages of a Management Buyout

 Difficulties of Raising Funding: In many cases the current management team are not able to
raise enough capital to fund an MBO themselves.

 Lack of Business Ownership Experience: In many cases the incumbent management team
may be highly experienced in running a business, but less so in the very different field of
owning one. It is often difficult to quantify exactly what qualities are required to be a
successful business owner

 Price: The price which is offered, or can be afforded, by the management team is usually
lower than what can be achieved on the open market.

Section D

Due diligence for merger and acquisition: in simple words due diligence refers to the process
in which an investor collects and evaluate information from different sources before making an
investment.

In other words due means having in depth knowledge of all aspects of the potential acquisition
target be in the business aspects, legal aspects or functional aspects of the firm from all view
points.

Due diligence of involves the study of target firm’s business plan, organizational structure,
operating history, all the financial documents, contractual relationships etc.

Due diligence is a process of verification, investigation, or audit of a potential deal or

investment opportunity to confirm all facts, financial information, and to verify anything else
that was brought up during an M&A deal or investment process. Due diligence is completed
before a deal closes to provide the buyer with an assurance of what they’re getting.

Need of due diligence

 To confirm and verify information that was brought up during the deal or investment
process
 To identify potential defects in the deal or investment opportunity and thus avoid a bad
business transaction
 To obtain information that would be useful in valuing the deal
  To make sure that the deal or investment opportunity complies with the investment or
deal criteria
 To Assist the buyer maximise his return on the deal
 To Assist the Vendor / Seller get the best value on the deal

Process of due diligence

Step 1: Due diligence team: The first step of the process involves gathering a team who will be
responsible for conducting the due diligence. To ensure that the process is executed properly,
the buyer will need a team of legal and financial experts with special knowledge in M&A. A
due diligence team typically consists of investors, accountants, lawyers, personal consultants,
and possibly other service providers based on the industry your business is in.

Step 2: gathering of important documents: The next step in the process involves the
gathering of important documents. The due diligence team will create a detailed checklist of
what documents are needed and in what time scale the documents are due. the due diligence
team can then request this information from the target company. In some instances, the buyer
and target company will arrange a meeting or series of meetings to discuss the M&A process
and document requirements. During these meetings, both parties are better able to determine
their compatibility and the buyer can make sure that the investment is sound.

Step 3: reviewing information: The next step of the due diligence process involves reviewing
all of the information provided by the target company. If the buyer has any questions regarding
the documents, now is the time for the target company to address their concerns. If for whatever
reason the buyer is unable to find certain answers based on the information provided by the
target company, then the buyer can request additional information.

Step 4: Due diligence report: This report will include a summary of any problems that were
discovered during the due diligence process, as well as any areas that were found to be
satisfactory. At the end of the report, the buyer will conclude with a final assessment of the deal.
In many cases, the buyer will see the acquisition as a sound investment and the transaction will
continue as planned. However, in some instances the buyer will request for the deal to be
adjusted based on their findings during the due diligence process. If the problems are found to
be too challenging to overcome, the buyer may abandon the deal.

Types/Aspects of due diligence

A. Corporate due diligence:

 MOA and AOA of the target firm and its subsidiaries.
 All written consent of the board of directors and stakeholders.
 Stock books, stock ledgers, and other records of stock issuance of the firm
  A list of the states and countries in which the firm is operating

B. Stockholder information:
 Information related to issuances of stock, options and shares of the Company including
amounts issued or granted mentioning the dates of the issuances.
 Detailed information of owners holding stock of the Company, including addresses, tax
identification numbers and number of shares owned.
 Detailed information of all holders of options and warrants holders including the number of
options/warrants held by each holder. Also check the exercise prices and vesting schedules.
Including the fact that if vesting of any options/warrants will accelerate in connection with a
merger or change of control of the Company.
 All written communications including any press release with stockholders in the last three
years.

C. Debt schedule:
 Detailed summary of short-term and long-term debt and capital lease obligations of the
Company including the loan amount of each type of debt (like secured, unsecured, high
yield, and mezzanine) and time to maturity of each debt instruments.
 All agreements and other documents where Company may be a surety or guarantor or any
kind of future obligation that might show up as debt on company on later state.
 All agreements in regard to total and outstanding line of credit of the company.

D. Legal issues:
 Detailed information in regard to any lawsuit (‫ (دعوی‬on the company, including names and
addresses of all law firms handling the litigation.
 Detailed information of any dispute, court case with employee, distributor, suppliers and/or
manufacturer for the company.
 Detailed information of any pending litigation, claims or assessments on the company.
 Detailed information of all the correspondence between company and state government as
well as national government.
 Detailed information of all the legal paper work related to compliance with health, safety and
labor laws.
 Detailed information of all reports, notices or correspondence relating to any violation by the
Company of government regulations, including any regulations relating to occupational
safety and health and the transportation of dangerous goods.

E. Operational/customers and suppliers Due Diligence

 Detailed information of Company’s ten largest customers, including the amount sold
annually, a description of discounts, promotional allowances, payment terms and rebates.
  Detailed information in regard to operations including number of shifts, number of hours per
shift, number of days operation per month. Also included in this information should be
capacity in terms of sales, given current organizational, human resource and facility
constraints.
 Detailed information in regard to current customers by geography and type of customer.
 Detailed information of the relationships with major suppliers and vendors, including a
description of any supplier quality issues.
 Detailed information in regard to Company’s five largest suppliers and vendors, setting forth
annual amounts purchased.
 Check for any written agreement between suppliers and company in regard to deliver of
goods to the company.
 Detailed information of major production materials required by the Company in the operation
of its business.
 Information about all products created, manufactured, licensed, sold, pr distributed by the
firm
 Detailed information on sales of all products in the last five years
 Detailed information about new products, which are expected to be introduced in the next
one to three years and forecast of revenue for these products

F. Intellectual Due Diligence:

 Detailed information of all technologies, inventions, patents, patent applications, designs,
trademarks, trade names and copyrights , whether registered, unregistered or the subject of a
pending application owned by the Company or in which the Company holds any right,
license.
 Detailed information in regard to list and copies of all agreements involving the licensing of
ownership interest to the Company in any given company’s intellectual property rights.
 Detailed information of all documents related to any charges of intellectual property dispute
made against the Company.
 Detailed analysis of any royalty agreements where the company either receives or pays
royalty.
 Detailed information of expenditure done on research and development in the past five years.
Also expenditure that is planned for future years.
 Detailed information of new technologies being developed by the company.
 Detailed report on nondisclosure agreements restricting disclosure, sharing or other
dissemination of intellectual property.

G. Financial due diligence:

 Audited financial statements (balance sheets, income statements, cash flow statements and
statement of change in position) of the firm for last five years.
  List of banks/lenders with whom the firm has financial relationship with respect to short term
and/or long term borrowings.
 What amount of working capital is required to run the company
 Current capital expenditure and investments
 Amount of outstanding debts and its terms

H. Human resources due diligence:

 Retirement plans and the benefits plans provided to the employees of the firm including any
employee profit sharing, bonus, stock options, or any other incentive plans
 Detailed information on compensation paid to officers, directors and key employees (salaries,
benefits, bonus, and non cash compensation)
 All polices and rules related to employees benefits
 Detailed information about any strikes and other labor disruptions at any of the firm facilities
and any claim of unfair labor practices or petitions filed with the ministry of labor with
respect to workers at any facility

I. Tax issues
J. Environmental issues
K. Insurance information

Strategic Alliance

A strategic alliance is an arrangement between two companies to undertake a mutually

beneficial project while each retains its independence. A company may enter into a strategic
alliance to expand into a new market, improve its product line, or develop an edge over a
competitor. The arrangement allows two businesses to work toward a common goal that will
benefit both.

Strategic alliances are agreements between two or more independent companies to cooperate in
the manufacturing, development, or sale of products and services or other business objectives.
For example, in a strategic alliance, Company A and Company B combine their respective
resources, capabilities, and core competencies to generate mutual interests in designing,
manufacturing, or distributing of goods or services. Ex: Spotify and Uber, Starbucks and
Barnes & Noble (With a Starbucks location in most (if not all) Barnes & Noble bookstores,
customers have twice the reason to shop there. Coffee break, and browse the latest bestsellers
shelf all in one stop.

Types of strategic alliance

1. Joint Venture: A joint venture is established when the parent companies establish a
new child company. For example, Company A and Company B (parent companies) can form a
joint venture by creating Company C (child company). In addition, if Company A and Company
B each own 50% of the child company, it is defined as a 50-50 Joint Venture. If Company A
owns 70% and Company B owns 30%, the joint venture is classified as a Majority-owned
Venture.

2 Equity Strategic Alliance: An equity strategic alliance is created when one company
purchases a certain equity percentage of the other company. If Company A purchases 40% of
the equity in Company B, an equity strategic alliance would be formed.

3 Non-equity Strategic Alliance: A non-equity strategic alliance is created when two or more
companies sign a contractual relationship to pool their resources and capabilities together.

The strategists Yoshino and Rangan have classified the strategic alliance based on two

dimensions: Extent of organizational interaction and conflict potential among the alliance
partners.
1. Procompetitive Alliances: The procompetitive alliance is characterized by low interaction
and low conflict. Such alliances offer the benefits of vertical integration, i.e. a relationship
between the manufacturer and its suppliers or distributors, without the firms actually investing
the resources in the manufacturing firm or distributing the semi-finished or finished goods.

2. Noncompetitive Alliances: Such alliances are characterized by high interaction and low
conflict. The noncompetitive alliances are formed between the companies that operate in the
same industry but do not consider each other as rivals. Their business operations do not coincide
and are quite distinctive due to which the feeling of competitiveness does not emerge. Often, the
companies that have expanded geographically within the industry adopt the noncompetitive
alliance.
3. Competitive Alliances: As the name suggests, these alliances are characterized by high
interaction and high conflict. Here, two competing firms that perceive each other as rivals
come together to form an alliance and. Therefore, the intense interaction between the two is
necessary. Such alliances could be intra- or inter-industry. Often, the foreign companies
operating in India forms a competitive alliance with the local rival companies for specific
purposes.

4. Precompetitive Alliance: The precompetitive alliance is characterized by low interaction and

high conflict. Such partnership brings two firms from different, most often unrelated industries
to work towards a specific activity, such as new product development, new technology
development, or creating awareness among the potential customers about the use of new
product or idea. The joint R&D activities and advertising campaigns are the examples of a
precompetitive alliance.

Based on relatedness of business:

1. Horizontal strategic alliances are created by businesses that are involved in the same business
area. This means that the partners in the alliance used to be competitors and come together In
order to boost their position in the marketplace and improve market power compared to other
business rivals.

Example: Alliance between Microsoft and Yahoo. The intent of the alliance was to use
Microsoft’s Bing search engine as a search engine on Yahoo’s website.

2. A vertical strategic alliance is a partnership between a firm and its distributors. Some
companies make use of vertical alliances to produce their products and services.
 Example: The close bond between an auto manufacturer and its suppliers is an example.

Reasons for strategic alliance

1. Acquiring new skills and resources: Often, when companies co-operate on a project, they
exchange skills that are not for sale. Typically, one partner possesses technological expertise
and the ability to keep abreast of rapidly evolving technological developments. What that
partner needs from the other partner or partners is capital, large distribution systems, marketing
expertise, service networks and credibility in the marketplace. Each partner therefore provides
the other with vital resources and uses the partnership to extend its skill set into new areas.

2. Forming economies of scale:

3. Enhancing competitiveness
4. Dividing risks
5. Setting new standards for technology
6. Entering new markets
7. Overcoming the competition in a market
8. Improve production efficiency
9. Build credibility and brand awareness in the industry

Divestitures

A divestiture is the partial or full disposal of a business unit through sale, exchange, closure, or
bankruptcy. A divestiture most commonly results from a management decision to cease
operating a business unit because it is not part of a core competency.

Business divestiture is the process of getting rid of business assets for a variety of reasons. In
other words A divestiture or divestment is the reduction of an asset or business
through sale, liquidation, exchange, closure, or any other means for financial or ethical reasons.
It is the opposite of investment.

Example:

Let's assume Company XYZ is the parent of a food company, a car company, and a clothing
company. If for some reason Company XYZ wants out of the car business, it might divest the
business by selling it to another company, exchanging it for another asset, or closing down the
car company.

Tata Steel continues with its divestment efforts of its loss-making European operations
 Reasons for Divestiture

1. To sell off redundant business units: Most companies decide to sell off a part of their core
operations if they are not performing in order to place more focus on the units that are
performing well and are profitable.

2. To generate funds: Selling a business unit for cash is a source of income without a binding
financial obligation.

3. To increase resale value: The sum of a company’s individual asset liquidation value exceeds
that of the market value of its combined assets, meaning there is more gain realized in
liquidation than there is in retaining existing assets.

4. To ensure business survival or stability: Sometimes, companies face financial difficulties;

therefore, instead of closing down or declaring bankruptcy, selling a business unit will provide a
solution.

5. To comply with regulators: A court order requires the sale of a business to improve market
competition.
6. Huge divisional losses
7. Continuous negative cash flows from a particular division
8. Difficulty in integrating the business within the company
9. Unable to meet the competition
10. Better alternatives of investment
11. Lack of technological upgradations due to non-affordability
12. Lack of integration between the divisions

Types of divestures

Spin-off: A business strategy wherein a company’s division or unit is separated and made into
an independent company. A company creates a subsidiary company. The shares of the new
entity are distributed to the shareholders of the parent company on a pro-rata basis. However,
the parent company also retains ownership in the spun-off entity. Spin-offs have two approaches
that can be followed.
 SPLITS: Splits involve dividing the company into two or more parts. This is done with an aim
to maximize profitability by removing stagnant units from the mainstream business. Splits can
be of two types, Split-ups and Split-offs.
When a company splits itself into two or more entities, it is termed as split-ups. In such cases,
the parent company loses its existence.

Split-offs is when the shareholders of a parent company surrender their shares in exchange for
shares in a subsidiary company. This concept is mainly followed for family businesses when all
members cross hold shares in all subsidiaries of the entity. Exchange and conversation of the
shares are done to separate the different family streams.

EQUITY CARVE-OUTS: A corporate approach wherein the company sells a portion of its
wholly-owned subsidiary through initial public offerings or IPOs and still retains full
management and control. Equity carve-outs are referred to a percentage of shares of the
subsidiary company being issued to the public. This method leads to a separation of the assets
of the parent company and the subsidiary entity. Equity carve outs result in publicly trading the
shares of the subsidiary entity.

Partial sell-offs: Selling a business subsidiary to another company to raise capital and apply the
funds to more productive core units instead.

DISINVESTMENT: Disinvestment occurs when a company boycotts or liquidates stocks. The

aim of disinvestment is to pressurize a government for a change in rules. Another aim is to
pressurize a company or industry for a change in policy.

Benefits of divesture

 Strategic Focus: Companies often divest assets and business units that no longer fit with the
company's core business. Divesting therefore helps companies maintain their strategic focus.
 Raise Cash or Reduce Debt: Companies that find themselves short of cash may elect to sell
one or more assets to restore the cash position to the desired level.

 Pursue of better opportunities. Divestiture permits a company to gain financial resources

needed for compelling investment opportunities – strengthening core business areas and higher
ROI.
Disadvantage: Costs No Longer Shared
One potential disadvantage of divestitures is the negative impact on a company's cost structure.
If a company has spread its fixed costs – including rent, maintenance, personnel allocation and
administrative support – over two or more business units, the remaining business units must
now absorb those costs.