Merger Process 1

Acquisition:

Acquisition is a corporate action in which a company buys most, if not all, of the target company's
ownership stakes in order to assume control of the target firm. Acquisitions are often made as part of a
company's growth strategy whereby it is more beneficial to take over an existing firm's operations and
niche compared to expanding on its own. Acquisitions are often paid in cash, the acquiring company's
stock or a combination of both.

Acquisitions can be either friendly or hostile. Friendly acquisitions occur when the target firm
expresses its agreement to be acquired, whereas hostile acquisitions don't have the same agreement from
the target firm and the acquiring firm needs to actively purchase large stakes of
the target company in order to have a majority stake.

In either case, the acquiring company often offers a premium on the market price of the target
company's shares in order to entice shareholders to sell.

For example, News Corp.'s bid to acquire Dow Jones was equal to a 65% premium over the
stock's market price.

Acquisition Process:

1. Screening and investigation of merger proposal:

When there is an intention of acquisition or merger ,the primary step is that of screening. The motives and
the needs are to be adjusted against 3 strategic criteria i.e., business fit, management and financial
strength.

Once the proposal fits into the strategic motive of the acquirer ,then the proposal acquirer will collect
all relevant information relating to the target company about share price movements , earnings , dividends
,market share, shareholding patterns, gearing ,financial position ,benefits from proposed acquisition etc.,

This form of investigation will bring out the strengths and weaknesses of both one’s own co.,
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and the prospective merger candidate. The acquirer co., should not only consider the benefits to be
obtained but also be careful about the attendant risks. If the proposal is viable after thorough analysis
from all angles , then the matter will be carried further.

2. Negotiation stage:

It’s the stage in which the bargain is made in order to secure the highest price by the seller and the
acquirer keep to limit the price of the bid.
Before the negotiations start , the seller needs to decide the minimum price acceptable and the buyer
needs to decide the maximum he is prepared to pay.
After the consideration is decided then the payment terms and exchange ratio of shares will be
decided , which has to be worked out by valuing the shares of both as per norms and methods of valuation
of shares.
Approved valuer or a firm of chartered accountants will evaluate the shares on the basis of audited
accounts as on the transfer date.

3. Approval of proposal by board of directors:

Deciding upon the considerations of the deal and terms of payments, the proposal will be put for the
board of directors approval.

4. Approval of share holders :

As per the provisions of the companies Act 1956 the shareholders of both seller and the acquirer
companies hold meeting under the directors of the national co., law tribunal and consider the scheme of
amalgamation .A separate meeting for both preference and equity shareholder is convened for this
purpose.
5. Approval of creditors/financial institutions/banks:

Approvals from all these are to be sought for as per the respective agreement with each of them and their
interest are considered in drawing up the scheme of merger.

6. Tribunal’s approval:
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Is required for confirming the scheme of amalgamation .The tribunal shall issue orders for winding up of
the amalgamating co., without dissolution on receipt of the reports from the official liquidator and
regional director that the affairs of the amalgamating co., have not been conducted in a manner prejudicial
to the interest of its members or to public interest.

7. Approval of central government :

Is required on the recommendation made by the specified authority under sec 72A of the income tax Act .

8. Integration stage:

The structural and cultural aspects of the 2 organizations ,if carefully integrated in the new
organization ,will lead to successful merger and ensure that expected benefits of the merger are realized.

9. Closing:

Closing the legal procedures where the co., changes hands. It consists of all necessary shareholder ,
regulatory and third party consent.

Stages of merger process under 5-S model:

Stages of merger process under 5-S model can be divided as follows:

1. Corporate strategy development

2. Organizing for acquisitions
3. Deal structuring and negotiation
4. Post-acquisition integration
5. Post acquisition audit and organizational learning

The brief explanation of the above stages of merger is given below:

Stage 1: Corporate strategy development

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Corporate strategy is concerned with the ways of optimizing the portfolios of businesses that a firm
currently owns and with how this portfolio can be changed to serve the interests of the corporation’s stake
holders. Merger and acquisition can serve the objectives of both corporate and business strategies despite
their being the only one of several instruments. Effectiveness of merger and acquisition in achieving these
objectives depends on the conceptual and empirical validity of the models upon which the corporate
strategy is based. Given an appropriate corporate strategy model, mergers and acquisition is likely to fail
to deliver sustainable competitive advantage. Corporate strategy analysis involves has evolved in recent
years through several paradigms-industry structure-driven strategy, competition among strategic group,
competence or resource based competition etc.

Stage 2: Organizing for acquisitions

One of the major reasons for the observed failure of many acquisitions may be that firms lack the
organizational resources and capabilities for making acquisitions. It is also likely that the acquisition
decision-making processes within firms are far from the models of economic rationality that one may
assume. Thus a pre condition for a successful acquisition is that the firm organizes itself for effective
acquisition making. An understanding of the acquisition decision making process is important, since it
has a bearing on the quality of the acquisition decision and its value creation logic. At this stage the firm
lays down the criteria for potential targets of acquisitions consistent with the strategic objectives and
value creation logic of the firm’s corporate strategy and business model.

Stage 3: Deal structuring and negotiation

This stage consists of:

 Valuing target companies
 Choice of advisers (investment banker, lawyers, accountants etc) to the deal
 Obtaining and evaluating about the target from the target as well as from other sources.
 Performing due diligence
 Determining the range of negotiation parameters
 Negotiating the positions of senior management of both firms in the post-merger dispensation
 Developing the appropriate bid and defense strategies and tactics within the parameters set by the
relevant regulatory regime etc.
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Stage 4: Post-acquisition integration

At his stage, the objective is to put in place a managed organization that can deliver the strategic and
value expectations that drove the merger in the first place. The integration process also has to be viewed
as a project and the firm must have the necessary project management capabilities and programmed with
well defined goals, teams, deadlines, performance benchmarks etc. Such a methodical process can unearth
problems and provide solutions so that integration achieves the strategic and value creation goals. One of
the major problems in post-merger integration is the integration of the merging firm’s information
systems. This is particularly important in mergers that seek to leverage each company’s information on
customers, markets or processes with that of the other company.

Stage 5: Post-acquisition audit and organizational learning

The importance of organizational to the success of future acquisitions needs much greater recognition,
given the failure rate of acquisitions. Post-merger audit by internal auditors can be acquisition specific as
well as being part of an annual audit. Internal auditor has a significant role in ensuring organizational
learning and its dissemination.

Due Diligence:

Definition:

An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in
regards to a sale.
Generally, due diligence refers to the care a reasonable person should take before entering into an
agreement or a transaction with another party.

Components Due Diligence:

1. Financial Due Diligence:

 Defined as “an investigation into the affairs of an entity prior to its acquisition, flotation
restructuring or other similar transaction.”

 The process by which information is gathered about:

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• a target company
• its business; and
• The environment in which a target company operates.

 The objective is to ensure that prospective investors make an informed investment decision

Key benefits:

 Inputs for making go / No go decision, valuation, risk mitigation in transaction documents and
matters to be addressed post acquisition.
 However the benefits of financial due diligence reviews are not limited to merger and acquisition
decisions.
 They can also be useful in assessing the merits of disposing of certain existing business divisions
within an organization.
 A financial due diligence review is also an essential component of assessing investment
requirements for venture capital arrangements.

Limitations:

 Not equivalent to an audit conducted in accordance with generally accepted auditing standards,
 Not an examination of internal controls,
 Not attestation or review services or services to perform agreed upon procedures in accordance
with standards established by the ICAI.
 Dependency on Target
(a) Information and explanations provided (verbal or written) are materially correct.
(b) Financial information, details and other documents provided for analysis are
materially correct and complete.
(c) Various documents furnished are genuine

2. Legal Due Diligence

Business transactions such as mergers, acquisitions and EPO´s often require the performance of a legal
due diligence investigation.
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 A legal due diligence consists of a scrutiny of all, or specific parts, of the legal affairs of the
target company with a view of uncovering any legal risks and provide the buyer with an extensive
insight into the company’s legal matters. Additionally, a legal due diligence often improves the
buyer’s bargaining position and ensures that necessary precautions in relation to the transaction
be taken.

 Venture capitalists having their lawyers conduct a legal due diligence prior to investing in a
company. For this legal due diligence, the lawyers check that the company doesn't have
significant legal problems and is being properly operated. You should expect to receive a Due
Diligence Checklist from the venture capitalists' lawyers asking for a bulk of documents and
information about the company.

Here are some of the main documents that should be expected to hand over quickly:

 Key contracts
 Employment agreements
 Minutes and consents of the board of directors and shareholders
 Confidentiality and Invention Assignment Agreements with employees
 Corporate charter and bylaws
 Litigation-related documents
 Patents, copyrights, and other intellectual property-related documents
 Tax and financial documents

Scope of Legal Due Diligence:

The objectives of a legal due diligence exercise may vary from case to case. Some of the basic objectives
may, however, be summarized as follows:

• Gathering of information from the target company,

• Uncovering of the target company’s strong and weak sides, relevant risks and advantages in
connection with the transaction,
• Minimizing the risk of unexpected situations,
• Improvement of the seller’s bargaining position,
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• Identification of areas where representations and warranties from the seller

• Should be obtained in the acquisition agreement.

Extent of the Legal Due Diligence:

The precise extent of a legal due diligence depends on the activities of the target company and the nature
of the transaction.

3. Strategic Due Diligence

 Strategic due diligence explores whether that potential — however enticing — is realistic.

 It tests the strategic rationale behind a proposed transaction with two broad questions.

 Is the deal commercially attractive?

 And are we capable of realizing the targeted value? T

 The first question requires external inquiry; the second demands an internal focus.

 Each question partially informs the other, reinforcing an inquiry that thoroughly plumbs the
wisdom of the deal.

 Above all, strategic due diligence ensures that no two transactions are treated the same way; each
deal has its own value drivers, and thus the composition of each due diligence team must change.

 Executives should determine which areas of the organization will produce value in the merger,
and draw members of the due diligence team from those areas.

 Strategic due diligence counterbalances the danger of institutionalizing and replicating a diligence
capability ill-suited for the task at hand.

Strategic Due Diligence Methodology:

y

Building the Diligence Team

The value of strategic due diligence relies heavily on the quality of the team in charge of the process.
Building a strong team is important both to ensure proper assessment of the deal and to facilitate the
actual integration.
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Eight best practices for organizing a due diligence team:

1. Choose the right people who have time to lead the project and serve as team members.

Time constraints and confidentiality will make it difficult to replace these people later in the
process. Dedicate specific team resources for the due diligence period.

2. Diligence will naturally focus on certain functional areas.

Human resources, information technology, finance, operations, and even R&D and marketing
may all be involved. Be sure to draw team members from all of these areas of the organization.
This adds valuable expertise, and it helps the team attain the buy-in from line management that
can be hard to get if a key functional area is shut out of the integration process.

3. Ensure that the diligence team is co-located within a secure environment, such as a
corporate headquarters.

Sometimes it makes more sense to locate the team near the target.

4. Communicate to the due diligence team the strategic and financial rationale behind the
acquisition.

They should understand enough detail to be able to identify critical diligence issues.

5. Train the team to identify and home in on specific issues, including the analysis and data
required.

This ongoing checklist keeps the diligence on track and brings it to a conclusion. It thus helps to
avoid the “analysis paralysis” that can result from an undirected data search.

6. Develop and communicate rules of engagement between the diligence team and the target
company.

This avoids cultural conflicts and ensures that the team acts in a manner that reflects the
acquirer’s intentions.

7. Make available analytical tools and techniques so the team can rapidly get its arms around
potential synergies and integration challenges.

This helps the team complete its task within the allotted time and budget.

8. There must be a healthy flow of information from the due diligence team to the integration
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team.

Therefore, include diligence team members in the integration planning team to ensure that
diligence rationale and data are properly leveraged.

Three Common Themes of Failure

Strategic due diligence is a challenging task, to put it mildly, and there are any number of ways to veer off
course if careful attention is not paid to the work

1. Failure to Focus on Key Issues:

• Fools Rush In:

Time will be tight, but don’t rush through the necessary step of clarifying the rationale for the
deal and sources of expected value. This step determines which hypotheses need to be tested and
avoids wasting time gathering irrelevant data.

• Reinventing the Wheel:

Don’t be so distracted by the process that the analysis suffers. When possible, use a common
diligence methodology, standardized formats, and simple project management software to
manage and share relevant diligence data. This will save time, keep the process focused, and thus
permit a higher level of analysis.

• Reluctance to Share:
When diligence information is not shared adequately among all diligence teams, it’s impossible
to focus effectively on the larger issues at hand. A clear flow of data through the use of regular
(as frequent as daily) updates can quickly identify “deal killers”; it can also help the team allocate
resources more effectively, and it will lead to a richer and more nuanced view of the diligence
issues.

• Analysis Paralysis:
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Inevitably, some issues will remain in doubt, but the team must be rigorous about defining an end
point for the analysis. Part of being focused is knowing when to check something off the list,
when to report it to management, and when to move on.

2. Failure to Identify New Opportunities and Risks:

• The Unquestioned Assumption:

Although time constraints prevent any major recasting of a company’s strategy, a quick stress test
of management’s key assumptions about its business may show opportunities for growth or a
strategic refocus that may create significant value.

• Being Afraid to Rock the Boat:

Even when a deal seems imminent, it is not too late to probe deeply into its merits. Ask the target
company’s management both broad and specific questions to gain a deeper understanding of
value drivers and key risks. Also, identify and interview customers and the competition. This is
all part of reaching sound conclusions on possible trends (such as the emergence of a substitute
product or service) and risks (such as the market entry of a new competitor).

• “It’s Just an Audit”:

Due diligence is more than an audit. By validating the assumptions that underpin the business
plan and detecting risks or inconsistencies early, diligence aids management’s long-term
stewardship of the company.

3 Failure to Allocate Adequate Resources

• Choosing the Wrong People:

The best people for the due diligence team are probably also the company’s most valuable
managers. Find a way to put them on the job rather than choosing people who happen to have
time available. Also, make sure to choose people with the right expertise; don’t overlook
managers from the functional areas of the firm that will be affected by the deal.

• Insufficient Time:
The due diligence process will be a time-crunch affair, but don’t make the problem worse than it
is. Give the team as much time as possible, and don’t be trapped by artificial or arbitrary
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deadlines.

• Insufficient Resources:
Support the due diligence teams with the resources of the firm. This includes space to work,
equipment, software, staff, and access to the right data and people. And, as much as possible,
relieve them of their daily responsibilities so they can focus on the task at hand.

Aspects of Due Diligence:

 Detailed examination of preliminary information of target company

 Firm should make sure that there are no problems with prospective partners
 No legal problems or suit
 No difficulties or complications regarding pension plan or provident fund
 No environmental problems
 No other contingent liabilities
 Reliability of accounting records
 Physical inspection of property and asset possessed by target company
 Scope for product improvement and superiority
 Merger should fill gaps in managerial capabilities and enhance it
 Integration between management
 Target should be more worth than the acquired
(a) Integration of cultural factors
(b) Management by formal paperwork
(c) Individual versus group discussion
(d) Risk taking is encouraged versus for one mistake you are out
(e) Post performance evaluation versus long term relationship
 Valuation
 Negotiation
 Implementation and review

Process of Due Diligence:

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A business which wants to attract foreign investments must present a business plan. But a business plan is
the equivalent of a visit card. The introduction is very important - but, once the foreign investor has
expressed interest, a second, more serious, more onerous and more tedious process commences: Due
Diligence.

"Due Diligence" is a legal term (borrowed from the securities industry). It means, essentially, to make
sure that all the facts regarding the firm are available and have been independently verified. In some
respects, it is very similar to an audit. All the documents of the firm are assembled and reviewed, the
management is interviewed and a team of financial experts, lawyers and accountants descends on the firm
to analyze it.

First Rule:

The firm must appoint ONE due diligence coordinator. This person interfaces with all outside due
diligence teams. He collects all the materials requested and oversees all the activities which make up the
due diligence process.
The firm must have ONE VOICE. Only one person represents the company, answers questions, makes
presentations and serves as a coordinator when the DD teams wish to interview people connected to the
firm.

Second Rule:

Brief your workers. Give them the big picture. Why are the company raising funds, who are the investors,
how will the future of the firm (and their personal future) look if the investor comes in. Both employees
and management must realize that this is a top priority. They must be instructed not to lie. They must
know the Due Diligence coordinator and the company's spokesman in the Due Diligence process.
The Due Diligence is a process which is more structured than the preparation of a Business Plan. It is
confined both in time and in subjects: Legal, Financial, Technical, Marketing, Controls.

The Marketing Plan:

Must include the following elements:

• A brief history of the business (to show its track performance and growth).
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• Points regarding the political, legal (licenses) and competitive environment.

• A vision of the business in the future.
• Products and services and their uses.
• Comparison of the firm's products and services to those of the competitors.
• Warranties, guarantees and after-sales service.
• Development of new products or services.
• A general overview of the market and market segmentation.
• Is the market rising or falling (the trend: past and future).
• What customer needs do the products / services satisfy.
• Which markets segments do we concentrate on and why?
• What factors are important in the customer's decision to buy (or not to buy)?
• A list of the direct competitors and a short description of each.
• The strengths and weaknesses of the competitors relative to the firm.
• Missing information regarding the markets, the clients and the competitors.
• Planned market research.
• A sales forecast by product group.
• The pricing strategy (how is pricing decided).
• Promotion of the sales of the products (including a description of the sales force, sales-related
incentives, sales targets, training of the sales personnel, special offers, dealerships, telemarketing
and sales support). Attach a flow chart of the purchasing process from the moment that the client
is approached by the sales force until he buys the product.
• Marketing and advertising campaigns (including cost estimates) - broken by market and by
media.
• Distribution of the products.
• A flow chart describing the receipt of orders, invoicing, shipping.
• Customer after-sales service (hotline, support, maintenance, complaints, upgrades, etc.).
• Customer loyalty (example: churn rate and how is it monitored and controlled).

Legal Details:

• Full name of the firm.

• Ownership of the firm.
• Court registration documents.
• Copies of all protocols of the Board of Directors and the General Assembly of Shareholders.
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• Signatory rights backed by the appropriate decisions.

• The charter (statute) of the firm and other incorporation documents.
• Copies of licenses granted to the firm.
• A legal opinion regarding the above licenses.
• A list of lawsuit that were filed against the firm and that the firm filed against third parties
(litigation) plus a list of disputes which are likely to reach the courts.
• Legal opinions regarding the possible outcomes of all the lawsuits and disputes including their
potential influence on the firm.

Financial Due Diligence:

Last 3 years income statements of the firm or of constituents of the firm, if the firm is the result of a
merger. The statements have to include:
• Balance Sheets;
• Income Statements;
• Cash Flow statements;
• Audit reports (preferably done according to the International Accounting Standards, or, if the firm
is looking to raise money in the USA, in accordance with FASB);
• Cash Flow Projections and the assumptions underlying them.

Controls:

• Accounting systems used;

• Methods to price products and services;
• Payment terms, collections of debts and ageing of receivables;
• Introduction of international accounting standards;
• Monitoring of sales;
• Monitoring of orders and shipments;
• Keeping of records, filing, archives;
• Cost accounting system;
• Budgeting and budget monitoring and controls;
• Internal audits (frequency and procedures);
• External audits (frequency and procedures);
• The banks that the firm is working with: history, references, balances.
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Technical Plan:

• Description of manufacturing processes (hardware, software, communications, other);

• Need for know-how, technological transfer and licensing required;
• Suppliers of equipment, software, services (including offers);
• Manpower (skilled and unskilled);
• Infrastructure (power, water, etc.);
• Transport and communications (example: satellites, lines, receivers, transmitters);
• Raw materials: sources, cost and quality;
• Relations with suppliers and support industries;
• Import restrictions or licensing (where applicable);
• Sites, technical specification;
• Environmental issues and how they are addressed;
• Leases, special arrangements;
• Integration of new operations into existing ones (protocols, etc.).

A successful due diligence is the key to an eventual investment. This is a process much more serious and
important than the preparation of the Business Plan.

Human resource aspects in merger and acquisition process:

 Changing the board of directors

 The senior job to be done
 Head count reduction
 Key people retention
 Aligning performance measurement
 Reward system
 Managing conflicts and expectation

HR should be involved in every part of an M&A process, particularly in the early stages. HRM should
play a more strategic role in the organization. The new role from them is to offer distinctive value to
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every part of the business process so that the unique capabilities of employees can be harnessed by the
Organization. Similarly, this applies to each part of the M&A process. Be proactive. Be a coach. Be there.

Looking at the steps involved in an M&A process, let us see how HR can add value at each step.

Pre-deal:

• Spotting problems that may be overlooked by other members of the management team
• Assessing people, organization and cultural fit.
• Educating executives about possible risks

Due diligence:

• Recognizing that there is more to due diligence that the bottom line issues, such as benefits and
employee pay
• Looking at the impact of learning and development
• Advising on organization design and development and
• Recruitment and retention in the integration process

Integration:

• Determining the culture/vision of the new company

• Contracts of employment
• Performance management issues
• Looking at leadership commitment and talent
• Confirming people's expectations - retention, cost and cultural fit
• Looking at techniques that work well in both operations and selecting the most effective ones that
will work across the board

Implementation:

• Alignment of HR policies and practices

• Advising senior management on people issues
• Reward schemes
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• Education
• Recruitment

Questions:

3 marks:

(1) What is due diligence? Write a brief note on its components.

(2) What are the five stages of M and A process?
(3) What are the different aspects needed to be covered by ‘due diligence’?

7 marks:

(1) Describe the five stages in the merger and acquisition process.
(2) What is due diligence? Who is required to undertake it?
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10 marks:

(1) What are organizational and human aspects that one should consider during merger
integration?
(2) Explain the human resource management issues during integration process of merger.
(3) Describe the five stage model of merger process.