CS Professional:Corporate Restructuring,Insolvency,Liquidation and Winding Up [Ch-4 Process of Merger & Acquisition Transaction]

MERGER AND ACQUISITION (M&A)

involves corporate control,strategy,corporate finance and mgmt. it involves co. consolidation and requires various regulatory approvals/procedures as in co. act,2013.

A merger being strategy has to be object-oriented and dwells upon synergy.it could also be by purchase of business/share purchase agreement/sanction through court. Once the court sanctioned the scheme and the scheme filed with ROC,it was irreversible,carrying a stamp of final approval by judicial authority and acceptable by all stakeholders.

PREREQUISITES

1. due diligence: investigating effort to gather all relevant facts and info to influence decisions. not a privilege but an unsaid duty as it helps to avoid legal hassles due to insufficient knowledge.
2. business valuation: first step examines and evaluates present/future markets value along with thorough research on capital gains/org structure/ distribution channel/corporate structure/specific strengths/credibility in market.
3. planning exit: when and how evaluating all financial and business issues
4. structuring a business deal: after the above,a new entity initiates marketing/innovative strategies to enhance business and credibility
5. integration stage: preparing the doc,signing the agreement and negotiating the deal

KEY HIGHLIGHTS OF CO. ACT,2013 IMPACTING M&A

• treasury shares no longer permissible
• objections to schemes can be raised only by shareholders holding at least 10%stake/creditors holding 5% total outstanding debts
• regulators make representations within 30 days regarding, else deemed 'no objections'
• no tribunal approval required if merger between holding and 100% subsidiary or between small companies.
• merger of indian with foreign co. in certain jurisdictions subject to RBI/FDI guidelines
• option to vote through the postal ballot,e-voting in addition to physical voting

DUE DILIGENCE

 it means prudence,vigilance,attentiveness,assiduity or care of which there are infinite shades. also explained in People v. Hewitt, 78 Cal. App. 426, 248 P. 1021.

 properly exercised by a reasonable and prudent man and not by an absolute standard but depending on relative facts of special cases. also explained in Perry v. Cedar Falls, 87 Iowa, 315, 54 N.W. 225.

 refers to investigation/audit prior to signing contract,could be a legal obligation,but commonly applicable to voluntary investigations as it contributes to informed decision making by enhancing amount/quality of available info and ensuring systematic use in a reflexive manner.

 credential research/market valuation/status of accounts/products and brands involved/position in debt market/legal and statutory compliances/past performance/previous financial reports to general reputation and background/confirming all material facts and preventing unnecessary harm/hassles.

first used under US securities act,1933

PRACTICAL GUIDE TO DUE DILIGENCE

1. meaningful analysis of given info is a crucial task as both financial and non-financial info is to be collected to derive profitability.
2. successful diligence depends upon the proposed seller's cooperation which is only possible in "friendly takeovers"
3. gathered from internal/external sources incorporating following:

• INDUSTRY ANALYSIS
• competition/growth rate
• future projections/barriers to entry and exit
• industry M&A/brand evaluation
• MGMT ANALYSIS
• HR policies/mgmt. analysis
• summary plan/contracts/strike histories
• labor relations/workmen compensation
• personnel schemes/permanent employee profiles
• labor dues/compliances
• FINANCIAL ANALYSIS
• audited financial statements/letters and replies
• credit report/analyst report
• budgets/ratios/revenue v. cost
• description of depreciation/amortization methods/changes in accounting methods
• equipment leases
• analysis of expenses and margins
• ledger/valuation of assets and liabilities
• internal control procedures/internal audit reports
• insurance coverage
• IP RIGHTS
• domestic/foreign patents
• trademarks/copyrights
• technical know-how/protection methods
• docs/clearance agreements
• TAXES
• IT/VAT/GST returns
• assessment order/tax audits
• settlement docs
• filing statements/tax litigations
• MARKETING ANALYSIS
• past sales/future trend
• customer base/major agreements
• trends/distribution channels
• product profile/development/disclosures
• MANUFACTURING
• location/tech/process
• quality/R&D/raw material sourcing
• COMPLIANCE OF VARIOUS LAWS
• LITIGATIONS
• pending/threatened
• coverages/injunctions/decrees/settlements
• unsatisfied judgements
• DEBTOR'S/CREDITORS' ASPECTS
• MATERIAL CONTROL ASPECTS
• HUMAN ASPECT

MANAGING DUE DILIGENCE PROCESS

requires specialized knowledge,expertise and experience to complete in a time bound and effective manner,following are worth consideration:

1. constituting due diligence team with experts in various fields
2. assign tasks to each member and co-ordination supervised by a senior officer
3. collect data with reference to corporate records
4. analyse above info/stats,assess future prospects and benefits in acquiring
5. If a feasible proposal,follow regulatory requirements

CONTENTS OF DUE DILIGENCE REPORT

1. comments of mgmt and organization
2. details of personnel
3. details of marketing efforts taken
4. financial liabilities and commitments
5. deviations from generally accepted accounting policies/practices
6. analysis of major expenditure/costs, details of customers and suppliers
7. legal compliance
8. potential benefits 
9. adjustment to the latest financial statement
10. number/type of litigations
11. key assets/customer takeaways

FACTORS INFLUENCING VALUATIONS

The next step is deciding the swap ratio as the company will change ownership hand when fair market value is arrived and is within beneficial interest of seller and buyer. it depends upon the following factors:

• past dividend track/past earnings
• prices of share trading/bonus track record/past history of share price
• IPO/FPO
• voting strength in merged entity
• net worth/nest assets/liquidity
• underlying net tangible assets
• business conditions
• future earnings and projections
• ongoing/future projects
• cash flows/NPV/ERR

GENERAL PRINCIPLES

1. time-value principle
2. risk and return principle
3. substitution principle : competitive substitutes
4. alternatives principle
5. expectation principle : growth/performance
6. Reasonable Principle
7. various analysis including business/financial/forecasting and valuation/ assets based/earnings based and market based

OTHER ASPECTS TO VALUATIONS METHODS

• relative method : estimates value of an asset by looking at 'comparable assets' and relative to common variables such as:
• EBITDA
• EBIT
• PBT
• PAT
• super profit method based on going concern assumption
• contingent claim method using option pricing models on assets having share option characteristics
• accounting professional experts using various accounting ratios

REGULATORY ASPECTS OF VALUATION

Section 247 of companies act,2013

seeks that valuation of assets or net worth shall be valued by a person having such qualification and experience and registered as a valuer.

[247(1)] registered valuer (RV) appointed by audit committee or board in their absence

[247(2)] RV appointed under (1) shall:

1. make an impartial,true and fair valuation
2. exercise due diligence
3. make valuations according to rules
4. not undertake valuations in which he has direct/indirect interest during 3 years prior to appointment or 3 years after valuation

[247(3)] contravention, fined 50,000 to 1 lakh;; intention to defraud- imprisoned up to 1 year and fined 1l-3l.

[247(4)] if RV has been convicted,liable to:

• refund remuneration
• pay for damages caused

REGULATIONS BASED UPON PRICE

CO. (RVs and valuation) rules,2017 (Rule 3,4,5,6,8,10,12)

SEBI (ICDR) regulations,2018 (Regulation 27,28,29,30,164)

SEBI (share based employee benefits/sweat equity) regulations, 2021 w.e.f. 13/08/2021 (regulation 15,17,22,33)

SEBI (delisting) regulations, 2021 w.e.f. 10/06/2021 (regulation 20)

CO. (share cap and debentures) rules, 2014 (rule 8)

SEBI (SAST) regulations, 2011

CONSOLIDATED FDI POLICY 2020

MERGER VALUATION STRATEGIES

fair market value=estimate/opinion of a company's theoretical worth upon its underlying assets,income generating ability and comparable transactions. accepted procedures and formulas tested in tax,law and other contentious matters.

REGULATORY FRAMEWORK

1. co. act 2013
• Ch XV (section 230-240)
• 230-231: scheme of compromise or arrangements with creditors/members and tribunal's power to enforce such a scheme
• 232: M&As schemes including demergers
• 233: M&A of small co./between wholding and 100% owned subsidiary (fast track mergers)
• 234: amalgamations with foreign co. (cross border mergers)
• 235: acquisition of dissenting shares
• 236: purchase of minority shareholding
• 237: CGs power to provide amalgamations in public interest
• 238: registration of offer of schemes
• 239: preservation of books and papers of amalgamated co.
• 240: liability of officers for offences committed prior to M&A
2. NCLT rules,2016
3. co. (compromise,arrangements and amalgamations) rules, 2016 [rule 3-29]
4. Income tax Act, 1961
5. SEBI (LODR) regulations, 2015 [regulations 11,37,38]
6. competition act,2002
7. approval from industry specific regulators
8. Indian Stamp act,1899

 AMALGAMATION APPROVALS 

• authorisation
• pre-approval for appointment of intermediaries,advisors,etc.
• valuation report approval by audit committee
• board approval
• along with authorising a director/CS/other for applying to tribunal,sign app and other docs and necessary scheme changes 
• approval of shareholders/creditors from each class obtained at specially convened meetings per tribunal
• app to the tribunal w.r.t. RO includes:
• first motion petition
• scrutinizer report about shareholders/creditors approval
• second motion petition
• notices to stakeholders inviting objections
• stock exchange approval
• FI,trustees to debentureholders approval
• land holder approval
• tribunal approval
• by both companies
• except those involving sick industrial co.
• different tribunals,separate approvals
• notice of every tribunal filled app has to be given to the Central Govt. (RD)
• tribunal passes order sanctioning the scheme with modifications as it deems fit
• RBI approval according to FEMA regulations 2000
• CCI approvals for combos

FILING REQUIREMENTS IN M&A

1. object clause altered to provide M&A by passing Special Resolution
• authorized share cap increased
• authorise board to issue shares to holders of transferors
• authorizing transferee to commence transferor's business
• file with ROC within 30 days of passing above resolutions with:
• certified true copies of resolutions
• certified true copy of explanatory statement
• digitally signed and certified as prescribed
2. complying with listing regulations, transferee to give board meeting notice/result to exchanges for discussing and approving amalgamation before giving to shareholders and media.
3. transferee required to file with INC-28 along with certified tribunal's order copy digitally signed/certified directing convening/holding of meetings according to 230,failing which scheme won't be considered and legal action might be taken.
4. transferee to simultaneously furnish with exchanges copy of every notice,explanatory statements and minutes sent to members which approves scheme.
5. file with CG every app made to tribunal, no notice required to be given to CG once tribunal passes final order to dissolve transferor
6. file with ROC within 30 days of allotment the return of allotment digitally signed and certified.

STEPS INVOLVED IN MERGER

procedure commences with an application to stock exchange for NOC and then an application for seeking directions of the Tribunal for convening, holding and conducting meetings of creditors or class of creditors, members or class of members, as the case may be, to the stage of the Tribunal's order sanctioning the scheme.

1. To ensure the Memorandum of Association contain an enabling clause relating to authorisation of the companies to undertake the amalgamation/ merger/demerger of the companies.Place memorandum before the Board of Directors for in-principal approval of such merger/amalgamation.
2. Place a memorandum before the Board of Directors for in-principal approval of such merger/amalgamation.

3. Authorisation by the Board to appoint:appoint Registered Valuers'///Merchant Bankers for fairness opinion///Advocates, counsels, advisors, practicing company secretaries etc. to draft the Scheme, file petitions, plead before NCLT & other authorities.

4. Valuation Report by Independent Registered Values.

5. Working on the swap ratio by Valuers/Chartered Accountants/in-house Advisors/ in-house Counsels.

6. Drafting of the scheme of merger/amalgamation.
7. Convening of the Audit Committee/Board meeting and placement of valuation report, swap ratio, etc. for approval of the Board along with the information to the concerned stock exchanges (before and after conclusion of the meeting) where the shares of the companies are listed.

8. In principle approval by stock exchanges

9. No complaint report.

10. Approval of Scheme of Arrangement/Valuation Report/Swap ratio/ Fairness opinion by Audit Committee and Board.

11. Please refer to the checklist on the NSE/BSE website.

12. Application to the National Company Law Tribunal seeking direction to call General Meeting of shareholders/ for each type of shareholders as well as creditors/secured/unsecured/other classes of the company.

13. Order of NCLT to contain - time, venue, date, quorum approval - how obtained /majority type, e-voting/ postal ballot/physical meeting.

14. Filing of Scrutinizers' Report - timeline

15. Convening of General Meeting of the shareholders (inform the concerned Stock Exchanges - before and after the conclusion of the meeting).

16. Scrutinizers' Report.

17. Filing of Second Motion Petition.
18. Public Notices.
19. Notices to Central Govt., ROC, OL, RBI, etc.
20. Outcome of the General Meeting to be apprised of the Tribunal.
21. Obtaining the sanction of the Tribunal.
22. Filing the copy of the Order of the Tribunal to the Registrar of Companies.
23. Preparation of financial statements, approval by the Board indicating transfer of assets and liabilities
24. Listing of shares at stock exchanges
25. Post-merger integration.

REVISED ORGANIZATION CHART

planning and intensive analysis are vital to creating a decision-making and communication framework supporting post-merger objectives and will help the new business grow.

1. structural change in hierarchy,chain of command,mgmt.
2. pre-merger due diligence
3. three phases
• I-awareness
• II-acceptance
• III-full adoption
• imp case law=merger of the associate banks of SBI with that of the State Bank of India
4. EMPLOYEE COMPENSATION,BENEFITS AND WELFARE ACTIVITIES
5. aligning co. policies
6. aligning accounting and internal database mgmt. systems
7. INTEGRATION OF BUSINESS AND OPERATIONS
• assessment of future cash flow for organic growth after undergoing inorganic growth
• integration of software and policies
• customer retention
• satisfying human resources

POST-MERGER SUCCESS & VALUATION

• earning performance by return on total assets/net worth [arthur dewing]
• merged co. yields large net profit or high rate of return on total funds employed or ability to sustain increased earnings [arthur dewing]
• capitalisation of dividend rates and payouts [shaw l.]
• creating a larger business org which survives and provides a basis for growth [edith perirose]
• comparison with similar sized co.
• fair market value (generally made in pre-merger)
• financial data of comparable co. to determine ratios which indicate position
• gains to stakeholders along other factors
• cap base/market segments
• improvement in debtors realisation,reduction in Non-Performing Assets,Improvement due to economies of large scale production
• mgmt. in sources/resources
• human/cultural aspects must also be thoroughly considered

integration impact on key performance indicators?

hypothesized synergies realized?

activities/milestones on target?

major issues requiring considerable attention?

important facts emerged that can be used to improve subsequent M&As

KEY INDICATORS

1. financial performance
2. component measures
3. organisational indicators
4. continuous appraisal of all aspects based on benchmarks