At the end of the day, however, no matter how a stock offer is made, selling shareholders should never assume that the announced value is the value they will realize before or after closing. Selling early may limit exposure, but that strategy carries costs because the shares of target companies almost invariably trade below the offer price during the preclosing period. Of course, shareholders who wait until after the closing date to sell their shares of the merged company have no way of knowing what those shares will be worth at that time.
The questions we have discussed here—How much is the acquirer worth? How likely is it that the expected synergies will be realized? But those concerns should not play a key role in the acquisition decision. The actual impact of tax and accounting treatments on value and its distribution is not as great as it may seem. The way an acquisition is paid for affects the tax bills of the shareholders involved.
On the face of it, a cash purchase of shares is the most tax-favorable way for the acquirer to make an acquisition because it offers the opportunity to revalue assets and thereby increase the depreciation expense for tax purposes.
Conversely, shareholders in the selling company will face a tax bill for capital gains if they accept cash. After all, if the selling shareholders suffer losses on their shares, or if their shares are in tax-exempt pension funds, they may favor cash rather than stock.
But if sellers are to realize the deferred tax benefit, they must be long-term shareholders and consequently must assume their full share of the postclosing synergy risk. Some managers claim that stock deals are better for earnings than cash deals. But this focus on reported earnings flies in the face of economic sense and is purely a consequence of accounting convention.
In the United States, cash deals must be accounted for through the purchase-accounting method. This approach, which is widespread in the developed world, records the assets and liabilities of the acquired company at their fair market value and classifies the difference between the acquisition price and that fair value as goodwill. The goodwill must then be amortized, which causes a reduction in reported earnings after the merger is completed. This approach requires companies simply to combine their book values, creating no goodwill to be amortized.
Therefore, better earnings results are reported. Although it can dramatically affect the reported earnings of the acquiring company, it does not affect operating cash flows. Goodwill amortization is a noncash item and should not affect value. Managers are well aware of this, but many of them contend that investors are myopically addicted to short-term earnings and cannot see through the cosmetic differences between the two accounting methods. Research evidence does not support that claim, however.
Studies consistently show that the market does not reward companies for using pooling-of-interests accounting. Nor do goodwill charges from purchase accounting adversely affect stock prices. In fact, the market reacts more favorably to purchase transactions than to pooling transactions. The message for management is clear: value acquisitions on the basis of their economic substance—their future cash flows—not on the basis of short-term earnings generated by accounting conventions.
We present two simple tools for measuring synergy risk, one for the acquirer and the other for the seller. A useful tool for assessing the relative magnitude of synergy risk for the acquirer is a straightforward calculation we call shareholder value at risk. SVAR is simply the premium paid for the acquisition divided by the market value of the acquiring company before the announcement is made. The index can also be calculated as the premium percentage multiplied by the market value of the seller relative to the market value of the buyer.
The greater the premium percentage paid to sellers and the greater their market value relative to the acquiring company, the higher the SVAR. In those cases, SVAR underestimates risk.
Buyer Inc. In a cash deal, its SVAR would therefore be 1. But if Seller Inc. To calculate Buyer Inc. The question for sellers is, What percentage of the premium is at risk in a stock offer?
The answer is the percentage of ownership the seller will have in the combined company. In our hypothetical deal, therefore, the premium at risk for Seller Inc. Once again, the premium-at-risk calculation is actually a rather conservative measure of risk, as it assumes that the value of the independent businesses is safe and only the premium is at risk. The cash SVAR percentage is calculated as the premium percentage multiplied by the relative size of the seller to the acquirer.
If Buyer Inc. Since no synergy expectations are built into the price of those shares now, Seller Inc. In other words, Seller Inc. But in a fixed-share transaction, Seller Inc. Although we have taken a cautionary tone in this article, we are not advocating that companies should always avoid using stock to pay for acquisitions. Accordingly, a reasonable counter-offer on price ordinarily should not be poorly received.
If you never ask, you will never know. Most mergers and acquisitions can take a long period of time from inception through consummation; a period of 4 to 6 months is not uncommon. The time frame will depend on the urgency of the buyer to perform due diligence and complete the transaction, and whether the selling company is able to run a competitive process to sell the company, generating interest from multiple bidders. There are some things, however, that can be done to shorten the time frame:.
Mergers and acquisitions typically involve a substantial amount of due diligence by the buyer. This is particularly true in private company acquisitions, where the selling company has not been subject to the scrutiny of the public markets, and where the buyer has little ability to obtain the information it requires from public sources.
Sophisticated strategic and private equity buyers usually follow strict due diligence procedures that will entail an intensive and thorough investigation of the selling company by multiple buyer employee and advisory teams.
To more efficiently deal with the due diligence process, selling companies should set up an online data room. An online data room is an electronic warehouse of key company documents.
The online data room allows the selling company to provide valuable information in a controlled manner and in a way that helps preserve confidentiality.
Importantly, the online data room can be established to allow access to all documents or only to a subset of documents which can vary over time , and only to pre-approved individuals. Most online data rooms include a feature that allows the seller or its investment bankers to review who has been in the data room, how often that party has been in the data room, and the dates of entry into the data room.
This information can be very useful to sellers as an indication of the level of interest of each potential bidder for the selling company, and helps the selling company understand what is most important to each buyer. Selling companies need to understand that populating an online data room will take a substantial amount of time and require devotion of significant company resources. The selling company should not grant access to the data room until the site has been fully populated, unless it is clearly understood that the buyer is initially being granted access only to a subset of documents.
If the selling company allows access before all material documents have been included, adding documents on a rolling basis, potential buyers may become skeptical about whether the selling company has fully disclosed all information and documents that potential buyers deem material. Access to the online data room is made via the Internet, through a secured process involving a user ID and a protected password.
Typically, two-factor authentication will be required to access the data room. Below is a list of additional best practices, in approximate chronological order:.
Throughout the process, issues are bound to arise on both the buy and sell sides. Both parties should resist the urge to get too emotional or latch onto highs and lows — instead, solicit help when you need it, and keep communication open and honest. Once you progress to the integration phase, be sure to perform periodic reviews on personnel, products, and operations.
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Report on key metrics and get real-time visibility into work as it happens with roll-up reports, dashboards, and automated workflows built to keep your team connected and informed. Try Smartsheet for free, today. In This Article. What Is a Merger and Acquisition Process? See how Smartsheet can help you be more effective. Acquisition: In contrast to a merger, an acquisition occurs when one company purchases another company and its assets. Acquired Company: Also called the target company , this is the company that is purchased by another.
Acquiring Company: This is the company that purchases another company. Friendly vs. This is also called a tender offer. Conglomeration: This is a merger between companies that are completely unrelated in the market i.
Leveraged Buyout LBO : This is an acquisition in which the acquiring company purchases the target company using a large amount of borrowed money. Statutory Merger vs. Statutory Consolidation: In a statutory merger, one of the merging companies remains in existence as a legal entity. In a statutory consolidation, both merging companies cease to exist legally and instead form a new, combined entity. Forward Merger: This is the most straightforward deal, in which the target company becomes part of the acquiring company and ceases to exist as an independent entity.
Triangular Merger: A triangular merger involves a third party typically a subsidiary of the buyer. In a forward triangular merger , the target company becomes part of the subsidiary company; in a reverse triangular merger , the subsidiary becomes part of the target company, and this new entity continues as a new subsidiary under the parent buyer.
So, the wording of the agreement and the actions of both parties play a huge role in the classification of a purchasing deal as a merger or an acquisition. The success of mergers and acquisitions often depends on the ability of the bigger company to convince shareholders of the target to merge or sell their shares. In the investment banking industry, news of mergers and acquisitions can cause sudden spikes or dips in the value of a company's stocks.
Related: What Is a Shareholder? Here are examples of transactions that can be categorized as mergers and acquisitions:. Related: What Is a Stockholder? Mergers and acquisitions involve lengthy and often secret negotiations between two companies. The larger of the two firms often take the first step, followed by deliberations between their boards.
Here are steps involved in merging or acquiring companies:. This document will outline the purpose of the transaction, the potential gains for the parties, how to convince stakeholders and how to raise funding.
The next step is to determine the criteria for identifying target companies. These requirements can depend on the smaller company's market share, customer base, product lines, supply chain or geographic spread. Next, the acquirer identifies firms that satisfy their search criteria. These can depend on the market share, financial status, prospects and other factors that can help the acquiring company achieve its objectives.
Once the acquirer identifies potential targets, it contacts them with an initial offer. The target company's response is often what distinguishes a merger from an acquisition. If the reply is friendly, the relationship can take on a mutual tone from the start. An unfriendly response can cause a hostile takeover of the smaller company. If the target company is amenable to a merger or acquisition, the acquirer requests information about its health.
This provides deep insights into the company's finances, product performance and other vital metrics that will help the larger company make informed decisions going forward.
If the acquirer is satisfied with the target company's valuation, the two sides can start negotiations. This involves a comprehensive analysis of the acquirer's valuation of the target company.
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