MBA Week 2: Mergers and Acquisitions

This is part of my Eccentric MBA,  a self-paced self-taught online programme of study.

This week’s topic is mergers and acquisitions. This cropped up in corporate law, obviously, and being short of time last week I was aware I’d not looked at it properly, so that’s what I’m doing this week. I started posting an unorganised set of impressions of things that struck me in a rapid skate over a complex area, which is my baseline aim, but had enough time to tidy it up in to something slightly more coherent.

As with corporate law, it’s quickly obvious that there are technicalities here that can really matter, and require deep study and experience – certainly more than I’m giving it here.

Most treatments of the topic say that purchases of one entity by another are either for stock or for cash, including leveraged buyouts as cash, which struck me as odd, because to my mind they’re very different – the latter is purchasing it with debt, and I’m used to drawing a very sharp line in terms of evaluation and decision-making between cash transactions and debt transactions. I guess this is a textbook thing: if you’re planning an acquisition you absolutely will care about how you’re financing it. And also, as a practical matter, the shareholders of the target will either get cash for their shares or stock (or a mix), not debt, so in that sense it’s perfectly accurate.

It’s nice to have crystallised the distinction between acquiring a company’s assets and acquiring the company’s equity. The equity may well be cheaper, but that’s because the equity prices in the liabilities as well. Splitting this up is of course what happens in corporate insolvency (which I realise is yet another whole area): companies can acquire the assets in a company that’s being wound up by paying cash (possibly leveraged!) without taking on the liabilities, and the receiver uses the cash from asset sales to try to make the creditors good – but of course being insolvent means that the assets are worth less than the liabilities. And sometimes a company will take on (some) liabilities along with assets to acquire them more cheaply – e.g. when there’s a purchase for a nominal £1 – which is akin to an equity purchase.

The main thing I knew of but was not on top of was the Takeover Code, a 422-page document administered by the Takeover Panel. This was originally a City gentlemens’ agreement, made explicit and written down in the 1980s and then made statutory in 2006 under the Companies Act 2006. It regulates how takeovers happen. A fun rabbit-hole (I narrowly escaped) is the live list of changes made to disclosures under the code. There’s also a whole load of other relevant legislation, including stuff on insider trading, market abuse, the Listing Rules, and even more financial services stuff.

Not all M&A are governed by the Takeover Code. The main focus is on publicly-listed companies. (I think privately owned companies can make what deals they like, subject to fraud and so on.) SMEs are mostly right out.

As well as the Code, there’s competition law and the Competition and Markets Authority, and for big-ticket things the Government might well take an active interest. And of course there may be sector-specific regulatory issues. I’ll leave those aside for now. Except to note in passing that the threshold for CMA interest is 25% market share, or £70m UK turnover – but only £1m for AI, crypto, CPUs, quantum tech, advanced materials, and military kit.

Interesting in regulatory terms that four of the ways you can regulate things are in operation all at once. There are:

• broad principles whose spirit must be respected (all shareholders must be treated equally, etc),
• detailed technical rules about what you should and should not do,
• people (the Panel) who can provide rulings about what’s Ok and what’s not in specific circumstances, and
• controls on who is allowed to do it and how they do it, via professional regulation (e.g. lawyers, financial advisors), with conditions on their training, qualifications, conduct, etc.

(The other sorts of regulation I can think of that are not in play here are inspection – although some of the professional bodies might have aspects of that – and outcomes-based regulation, both of which seem to be anathema to UK corporate practice.)

The Panel itself has considerable powers of enforcement, including court orders to require compliance, requiring compensation be paid, and censure/cold-shouldering which is the reputational thing from the gentlemens’ agreement days put on a statutory footing. There’s also criminal liability, particularly around insider trading and fraud, and FCA penalties. And of course civil liability which I’m sure is great fun for everyone.

To summarise of a lot of detailed regulation, there are things you must disclose in very particular forms in certain circumstances, and otherwise you have to be very quiet about it. In some contexts it’s very strictly need-to-know, and only up to six people can know. That’d be a lot of pressure to deal with for people used to working closely with their broader teams. There is a strong ‘put up or shut up’ aspect to the rules: if you acquire more than 30% of shares, you must say so, and have 28 days to either formally announce a bid or say you won’t do so. Which I infer means you can’t for a year.

(Total aside, but this regulatory need for extreme confidentiality is one of the drivers for why senior executives and board members tend to be at least a bit hazy about how they spend their time. “The Chair of the Board has had four meetings with the chief exec of our main competitor in the last week” is exactly the sort of thing you need to take great care about disclosing. Radical diary openness is effectively illegal for people who might be involved in such discussions.)

There’s two main sorts of offer:

• A contractual offer, where the buyer offers the shareholders a deal, they decide individually, and it goes ahead if enough agree to reach the pre-set target ownership, in the range 50%-90%. (If more than 90% agree, the rest can be forced to sell.) The advantage here is that you don’t need as many of the shareholders to agree, and you don’t need the target company’s co-operation, so hostile takeovers will happen this way.
• A scheme of arrangement, where the offer is approved by the court and then voted on by the shareholders, and it goes ahead if a shareholder vote of at least 75% of the shares approves it. The advantage of this is that if almost everyone involved is happy with the deal, it can happen quite quickly and certainly, and the acquirer gets complete control.

Any time you have a quota arrangement in a voting system, there’s the possibility of shenanigans, where those wanting to stop something happening might seek to exert greater influence by abstaining than they would have by voting against. I don’t know if this happens in this context, or if there are rules that stop it. I do know that some mergers start as a scheme of arrangement and then switch to a contractual offer when it becomes clear that there may be difficulty with the scheme approach.

If you’re issuing shares or other securities as part of the deal, you’ll also need a proper prospectus, which is a whole other area of complexity. An actual merger is going to be structured on this sort of basis since two sets of shareholders are going to effectively sell their shares in exchange for shares in the new, merged entity. And, duh, this is part of why leveraged buyouts are popular, because there’s a lot less paperwork and legal overhead to take out a loan than there is to offer shares. And if you’re issuing your own shares, your existing shareholders are going to want to take a view on it.

How you value companies is an absolutely crucial part of all this – due diligence that must be exercised – and there are plenty of rules about it. That’s a whole other topic. Importantly, as an acquirer it’s very much caveat emptor and you have little protection if liabilities turn up that you hadn’t properly anticipated. As a target you mustn’t deliberately hide or misrepresent such things, but you don’t have to say what you’re not asked, and as an acquirer, you’re likely on the hook even if the target is guilty. For completeness, there’s corporate, financial, and legal due diligence to be done, and they’re much more easily (?and cheaply) done in a friendly takeover context.

There’s plenty of regulation around the pricing – basically you’re not allowed skulduggery and if you are trying to buy up a company you have to pay all the shareholders the same. This was not obvious to me as a teenager, when I thought the share price of a company was a single price for all its shares, so why ever would a bidder pay a premium? But of course it is only the marginal price at which shares change hands. By definition most of the existing shareholders think the shares are worth more than the current share price, or they’d sell them.

Interesting wrinkle here about piercing the corporate veil. The shareholders in that context are definitely only liable for their investment, no more. Executives and board members may have personal liabilities, both criminal and civil, if they are guilty of misconduct, but in practical terms there may be little point in pursuing them for a civil claim in that sort of context because their assets are likely to be tiny compared to those involved. Unless, of course, they were also substantial shareholders.

All this is about the shareholders. The other stakeholders (esp employees and pension trustees) get only the public announcements, although they can be consulted and might seek to influence shareholder and regulatory/Government opinion. Anything that is put in the formal offer in terms of future intentions (e.g. retaining all existing employees) is expected to be binding for a year.

That said, the TUPE regulations put some quite firm bounds on what an acquirer can do regarding employees. I know about those regs already from my trade union days. In that context they seemed like minimal protections that we always sought to improve on; in an M&A context I bet they can seem like frustrating obstacles. Employees’ rights – including to back pay and redundancy money – are, of course, a liability that in an insolvency context an acquirer may be reluctant to take on. Which again I’m familiar with from my trade union days.

Ha ha, even if the board of the bid target is on side, they may still limit what they tell the bidder about the business, because the Code specifies that anything they do say has to be made available to all potential bidders who ask – provided they are bona fide, but of course that may be tricky to establish, so you want to be careful about disclosing commercially sensitive stuff.

In terms of hostile takeovers, US practice is full of poison pill stuff to make it difficult, but this generally doesn’t happen in the UK, largely because it’s illegal under the Code but also because it’s just not what we do here (!). I knew about white knights (an alternative, welcome bidder where there is a hostile bid), but not about white squires, who are shareholders who support the board in resisting an acquisition.

And there’s a whole load of stuff about incentives and the principal-agent problem around the management and boards of both companies and their shareholders. Essentially the difference between ‘hostile’ and ‘friendly’ takeovers cashes out as whether the senior folk at the target think they’ll do really well out of the deal personally – and of course there are regulations about that. (It’s really not about whether the shareholders are in favour or not: if the majority of shareholders are not in favour, it simply doesn’t happen.) It strikes me that M&A is one of the key contexts where the difference between the board and management really matters.