Mergers definition: A merger is a combination in which two corporations combine and the merged corporation goes out of existence

. The acquiring company assumes the assets and liabilities of the acquired company. The buyer is defined as comp any with larger market capitalization or the company that is issuing shares for other company’s share in stockfor-stock deal. A consolidation is different from me rger for in consolidation a new corporation is born out of the merger. Laconical ly, merger is a+b = a and consolidation is a+b = c. Despite of these difference these terms(merger, consolidation &takeover) ,as is true for many other terms in M&A are used interchangeably. TYPES OF MERGERS: There are three types of merger s: 1. Horizontal merger: These are mergers in which two competitors combine. Ex: Exxon and Mobil two petroleum companies combined in 1998. 2. Vertical merger: M ergers of companies having a buyer seller relationship. 3. Conglomerate merger: This occurs when two non competing companies which doesn’t have a buyer-seller rel ationship combine. MERGER PROFFESIONALS: Before any merger companies generally s eek advice of professionals which play key role in M&A. These include Investment banks which offer expertise in structuring the deal and handling the strategy. They also provide financing for transaction. Given the complex legal nature of M &A law firms also play an important role. Valuation experts also provide importa nt services in M&A. Another group of professionals who can play an important rol e are arbitragers. Arbitrage refers to buying of an asset in one market and sell ing in another. With respect to M&A arbitragers purchase stocks of companies tha t may be taken over in the hope of getting a takeover premium when the deal clos es. MERGER PROCEDURE: Most mergers are friendly. Process begins when management of one firm contacts Target Company’s management often through investment bankers of each firm. Most merger agreements include a material adverse change clause wh ich allows either party to withdraw from the deal if a major change in circumsta nce arises. When two companies engage in M&A they often exchange confidential in formation which helps them to know the deal better. This shows another risk of M &A leaking of confidential information. A denial of negotiation when the opposit e is the case is improper as companies may not deceive the market.

HISTORY OF MERGERS: Merger activities have seen five majors ‘waves of merger’. The f irst four occurred in 1897-1904, 1916-1929, 1965-1969, and 1984-1989. The fifth wave began in 1994.the cause of these waves is attributed to economic, regulator y and technological shocks. Economic shocks come in form of economic expansion t o grow to meet the rapidly growing demand in economy. Regulatory shocks may come from removal of regulatory barriers that might have prevented corporate mergers . Technological shocks come from technological advancements in industry or even giving rise to new industries. First wave (1897-1904): This included many horizo ntal combinations and consolidations. Many industrial giants originated in first merger wave such as U.S steel, Dupont, GE, Eastman Kodak, American tobacco. Man y monopolies were built. Sherman act which was enforced to prevent monopolies wa sn’t effective enough. Second wave (1916-1929): American economy evolved during th is time due to post World War I economic boom. This period was dominated by hori zontal mergers but also saw many vertical mergers. The period resulted in format ion of many oligopolies. The antimonopoly provisions of ineffective Sherman act were reinforced by Clayton act. Many prominent corporations formed during this w ave were General motors, IBM and union carbide. Third wave (1965 – 1969): Firms du ring this period faced tough antitrust environment due to the celler-kefauver ac t of 1950 which strengthened the anti merger provision of Clayton act. Clayton a ct made the acquisition of other firms’ stocks illegal when it resulted in a merge r which reduced the competition in an industry. However the law had a loophole: it did not prevent the anticompetitive acquisition of assets. The cellerkefauver closed this loophole. Thus firms with financial resources were left with only o ne way of merging, forming conglomerates. Many of the acquisitions resulted in p oorly performing firms which had to be sold or divested. Fourth wave (1984-1989) : This wave featured many interesting and unique characteristics. Arbitragers be came a very important part of takeovers. The ability of these corporate raiders to receive greenmails (or targets assets) in exchange of their stock made it hig hly profitable. Investment banks played an aggressive role as well devising many innovative techniques to facilitate or prevent takeovers. Many of the mega deal s of 80’s were financed with huge debt. These leveraged buyouts were used to take a public company private. Fifth wave (1992- ): Fifth merger wave is truly a glob al merger wave with increased number of deals in Europe, Asia, and South America . Fifth merger wave is marked by many mega mergers. There were fewer hostile bid s and more strategic mergers. These deals were not highly leveraged, financed th rough the increased use of equity. In mid 90’s market was enthralled by consolidat ion deals called roll ups. Here fragmented industries were consolidated through larger scale acquisition of companies called consolidators. Certain investment b anks specialized in roll-ups and were able to get financing and were issuing sto ck in these companies.

companies with low level of output will have higher per unit cost . If a company expands internally it grows slowly. M&A is also valuable when a firm wants to expand to different geog raphic market. The key question with every M&A is whether the return from the deal is greater than what can be achieved wit h the next best use of invested capital (opportunity cost). Synergy: Simply stat ing synergy is 2+2 = 5. Another source of operating synergy is economi cs of scale which is decrease in average cost with increase in output. Management needs to make sure that the greater size in terms of reve nue has brought with it must commensurate profits and returns for shareholders e lse it was better off to continue with slow growth. It may come from a company with good brand ima ge lending its reputation to other company. Through M&A firm can expand in same or different industry (called diversification). which is ability of combination to be more profitable th an combining firms. Growth: This can be internal or external growth (through M&A). Operating synergy comes in two forms revenue enhancements and c ost reductions. The two main types of synergies are operating synergy and fi nancial synergy. Expandi ng in different industry is very controversial in finance. . because the fix cost required to maintain manufacturing facility is spread ove r the low output. Revenue enhancement synergy comes from the new opportunities tha t are present as a result of M&A. Revenue enhancement synergies are difficult to achieve and difficult to be quantified a nd built into a valuation method.REASONS FOR M&A: Two of the most cited reasons for M&A are faster growth and syn ergy. competitors can take advantage of this and acquire m arket shares. It may arise from a company with lar ge distribution merging with company with large product potential but losing its ability to get to market before rivals seize the period of opportunity. Unfortunately it is much easier to generate sales growth by simpl y adding up revenues of both firms than it is to improve the profitability of ov erall firm. which might not be possible at low ou tput levels. Other reasons for gain include increased specialization of lab or and efficient use of capital equipment. But after certain level of output per unit cost rises again as comp any experiences diseconmics of scale which arises from higher costs and other pr oblems related with coordinating a large production. As accord ing to demand.

In long run only industries that are difficult to enter will enj oy higher rate of interest. barrier to . the cost of capital must be lowered. Having many diverse firms may help company achieve a diverse portfolio. This doesn’t mean that rates of return of in dustries are same all the time. This occurs when firms with less correlated earnings combine and derive a co mbined earning i. w ith numerous buyers and sellers. On one extreme is pure competition.Financial synergy refers to impact of a corporate merger on the cost of capital to the acquiring firm. Competitive pressures bring a movement of long term equalization of rates of return across industries. One reason for diversification is to enter more profitable industries but there is a lack of assurance whether this profit will persist long. less volatile than either of individual earnings. Closer to monopoly is oligopoly whic h features few (3-12) sellers of differentiated product. this may help in reducing risk and maintaining a stable dividends. horizontal integration involves movement from competitive to the other end of spectrum by merging with the rivals.e. Other Econ omic Benefits: Horizontal Integration: Economic theory categorizes industries wi thin two extreme form of market structure. Diversification(growing out of parent industry): This led to the formation of conglomerates in the late 60’s. Forces of competition are offset by factors such as technological advancement in some industry. The extent to which financial synergy exists. Market power is defined as the ability to set and maintain a price a bove the competitive level. competitive firms set market price equal to marginal cost. One area of benefit of diversification is co-insuran ce. These above average industries w ith no imposing barriers to entry will experience declining return till they rea ch the average. On the other is monopoly. perfect information and undifferentiated produc ts. The monopolist has the ability to select the price -output combination that maximizes profits. There are three sources of market power product differentiation. In perfectly competitive markets.

These are the hu man factors that may motivate a merger. Two hypotheses have been put forward in this regard: Management entrenchment hypothesis and stockholders interest hypot hesis. Another reason for M&A is accelerating R &D in which target may be good at. However the proponents of these measures argue that these prevent firm from hostile raiders who have no long term interest in the firm an d are looking only for short term gains. To lower inventory costs. Management entrenchment hypothesis proposes that shareholders experience reduced wealth effect when management takes antitakeover measures. The final outcome might be a oligopoly. Hubris. This is not true though it appears to be because the increased profitability of parent firm comes at the cost of lower profitability of acquired firm. The evidence from various takeovers studies is conflicting and doesn’t favor any one of the hypothesis as such. rather than any objective analysis may motivate a takeover. oversee company’s standard of manufacturing Another motivation for a ta keover may be acquiring firm’s management belief that the target is not well manag ed and it can do better under their expertise. V ertical Integration: It involves M&A of firms that are close to either source of supply (backward integration) or to the ultimate consumer (forward integration) . to be assured of dependable source o f supply 2. Opponents of these measures opine that these mea sures reduce the value of stockholders investment.entry. Not to pay profits to supplier. which engage in high tend state of competition characterized by competitive prices and differentiated product. Savings in fo rm of transaction costs. and market share. active and preventive defenses. reasons for vertical integration are : 1. ANTITAKEOVER MEASURES: Antitakeover defenses can be divided in two categories. Even with a substantial increase in market share. the l ack of product differentiation and barrier to entry may prevent a firm from rais ing its price substantially over marginal cost. According to them the activit ies of raiders keeps the management honest and the threats of raiders make them work more efficiently. Management c an declare that it might not withdraw measures unless it receives offer in share holders interest. this leads to winners curse. A monopoly re sults in higher price and low level of production and thus fewer units are sold. as raising the price will attrac t new competitors who will drive price down toward marginal costs. 3. potential disruptions that could occur at the end of co ntract. This results in welfare loss. This hypothesis also shows that antitakeover measures can be used to maximize shareholders value through the bidding process. . 5. 4. Shareholder i nterest hypothesis states that stockholders wealth rises when management takes a ntitakeover measures. Preventive mea sures are to reduce the likelihood of a takeover while active measures are emplo yed when a hostile bid is made. Welfare loss can occur in monopolies but to say t hat increase in concentration in some industry will result in a welfare loss is untrue.

these were the first kind of poison pill. Types Of Preventive Antitakeover Measures: 1. In face of increased price. So the incumbe nt board will be made up of directors who are sympathetic to the current managem ent. they add immediate long term debt (preferred stocks are considered as long term debt) to company’s balance sheet making it highly leve raged and thus more risky in eyes of investors. A . In this target offers its shareho lders preferred stocks as dividend that would be converted to some shares of bid der after the takeover takes place. such as one third.Poison pills: a)Preffered Stock plan: Invented in 1982 by Martin Lip ton. Drawback of this pill is that is this is effective only when the bidder acq uires 100% stock. These have certain disadvantages. partnership. and will vote against the hostile bid whi le institutional investors may take advantage of the favorable pricing in a host ile bid. Flip over rights were very innovatively overcome by Sir James goldsmith in 1 986. first they can be redeemed only after an extended period of time.) Corporate charter amend ment: Changes in corporate charter are common antitakeover devices. Corporate ch arter changes generally require shareholder’s approval. or corpora tion or a tender offer for 30% or more of the target corporation’s outstanding sto ck. b. as opposed to flip over rights which allow holders stock in the acquirer . Certain groups of shareholders such as employees tend to be faithful towards the firm. they can’t prevent bidder to have a controlling interest in the firm. Flip in rights were designed to dilute the target company regardless of whethe r the bidder merged target into his company. Secondly. Flip over and flip in rights combin ed make effective poison pill. Common antitakeover corporate charter change s are: a.)Staggered board amendments: It varies the term of board of directors s o that only a few. may be elected in any year. This leads to dilution of bidder’s shareholder’s share. c) Flip in pill: Flip in provision allows holders to acquire stock in the target. Poison pills cause stock price to decline. presum ably because pill-protected companies are more difficult to be taken over. which could be in excess of 10 years. preventing any friendly merger.PREVENTIVE TAKEOVER MEASURES: First step in antitakeover measure is to analyze t he distribution of firm’s shares. target boards are often pressurized to deactivate the pill. A sudden increased in trading volume of company’s share may signal presen ce of bidder who is trying to accumulate as many shares possible before announci ng bid as that will cause stock price to rise. b) Flip over rights: This comes in form of rights offered as dividend that allow shareholders to purchase discou nted stocks during specified period of time. Following the takeover the rights w ill flip over allowing the shareholders to buy unfriendly bidder’s shares below ma rket price. The rights are active after some triggering event such as an acquisi tion of 20% of the outstanding shares by any individual. bid premium is higher.)Super majority provision: It dictates the number of voting shares needed to amend the corporate charter or to improve important issues such as mergers. 2. The majority of antitakeov er charter amendments are approved. Howev er in event of a bid.

Some mana gers feel that these tactics help them to save company from those seeking short term goals by selling off company’s assets. so greenmail goes in favor of stockholders. including bonuses and incentive f or a certain number of years. Some studies show that share repurchas es from outsider cause shareholder’s wealth to decrease while those from insider c ause it to increase. For this company issues share s with superior voting power which are distributed to various stockholders. The legality of golde n parachutes is questioned as they entrench management at the expense of shareho lders. their long term strategic planning. . ACTIVE ANTI TAKEOVE MESURES: 1. c. company rep urchase shares at a price that will be attractive to shareholders. It may be manager’s plan to fulfil l their plans for the corporation. Supermajority charters are effective against partial offers. A possible compensation cou ld be a multiple of recent year’s annual salary. Now. However other studies have shown that downward impact of sh are purchase was more than offset by increase in share price caused by purchasin g the stock. management who may also be stockholde rs may not exchange their superior voting rights with ordinary stocks.) Dual capitalization: It provid es equity restructuring in classes of stocks with different voting rights. they are not very effective. They can take place only with shareholders approval. These are highly lucrative and provide for large payments to certain senior management on either voluntary or involuntary termination of their employment.) Greenmail: It refers to payment of a substantial payment fo r a significant shareholder’s stock in return for stockholder’s agreement that he wi ll not initiate a bid for control. The amount of compensation is determined b y employee’s annual compensation and years of service. Share repurchases are a lso used as an alternative way of providing shareholders a dividend. 3) Golden parachutes: These are special compensation agreements which the company provide s to upper management. However. They may be used in advance of a hostile bid to ma ke the target less desirable but as the compensation paid is only a small percen tage of total purchase price. The system has given rise to a new breed of CEOs who join the corporation that have underperformed and tries to sell the business to a buyer.’legitimate’ encompasses many broad ideas. Many management critics opine that managers u se such tool to pursue their own interests which may conflict with shareholders interests.supermajority provision allows for a higher than majority vote to approve a merg er (typically two thirds). Management often increases its voting power by dual capitalization.) Fair price provision: It requires the acquirer to pay the minority s hareholders a fair market price for the company’s stock. Courts rule greenmail legible till it is for legitimate business reas ons. Its purpose is to give more voti ng rights to those who are sympathetic to the management’s view. d. This may be stated in ter ms of price or in terms of company’s P/E ratio. Stoc kholders are then given a right to exchange these with common stock which are mo re liquid and pay more dividends. This agreement is usually effective if the termination occurs within one year of change of control.

Because these shares may fall in t he hands of hostile. a) Recapita lize: After a recapitalization.) Capital Structure Changes: These can be used in several ways. firm can also add debt without undergoing recapitalization. leading to decrease in the stock price. On the other side it dilutes stockholders eq uity. The company may issue shares to ESOP. The large amount of debt makes it unattractive to the bidder. Thus. 5. After recapitalization company usu ally substitutes most of its equity for debt. A recapitalization generally involves paying a super dividend to its shareholders which is financed through large debts. It may also create other se curity options that may give management greater voting power.) White Kni ght: White knight is another company that would be more acceptable suitor for th e target than the hostile bidder. Thus large part of the stock is in hand of firm that will not sell out to a hostile bidder.)Issue More Shares: Issuing more shares will change company’s capital struc ture as it increases the equity while maintaining the current level of debt. Other stockholders will receive only one share in the recapitalized firm (the stub).)Assume More Debt: Although recapitalization increas es company’s debt. C. d. bidder company issues these shares directly in friendly fir ms hand (as in white squire defense). the corporation is in dramatically different fin ancial condition. Standstill agreements often lead to negative returns to the share holders and to fall in stock prices. It buys the company for more favorable terms w hich may be higher price. They are also useful in white squire defense. It also he lps to divert shares from arbitragers. these plans are there fore also called leveraged recapitalizations. recapitalization allows company to act as its own white knight. b. Research shows that such acquisitions have a negative effect on shareholders wealth as these are not planned strategic acquisitions. White squire is typically not interested in acquiring control of the tar get. A potential white squire is given sometimes given a seat on the board or it may also be given a favorable price on shares or a generous dividen d. 4.)Buy Back Shares: another way of preventing a takeover i s to buy own shares. The acquisition of firm’s own shares help c ompany to use its own resources such as excess cash reserve or using firm’s borrow ing capacity. . Higher debt can make target riskier because of the higher debt service relative to targ et’s cash flow. This happens when acquiring firm has accumulated enough shares th at it poses a threat for a takeover battle. Share repurchases help to divert shares away from the hosti le bidder as the bought back shares can’t fall in the hands of bidders.) Standstill Agreement: Acquiring firm agrees to not buy more shares of target for some fee. Another option firm may consider is to iss ue the stock to ESOP. Other than the super dividend stoc kholders also receive a stock certificate called stub which represents there new share of ownership in the company. Recapitalizat ion is similar to LBO because of the tax advantages and the increase in manageme nt ownership it provides. A l ow level of debt relative to equity makes a firm vulnerable to takeover. By issuing more shares Target Company makes it more difficult and costly to acquire a majority of stock in the target.2. Debt can be added either by borrowing from a bank or by issuing bo nds. 3.) White S quire: A white squire is a firm that agrees to purchase a large block of targets stock. but a promise not to disassemble the target or lay off the employees. Management gets a greater voting control in the target following the rec apitalization.

and also increases probabilit y of tender offer’s success. If the bidder i s able to purchase within . inadequate disclosure and fraud. bear hug. The filing of schedule TO notifies the market of purchaser’s intentions and alerts stockholders to an impending tender offer. The bidder may go with an all cash tender offer or may use securities as part or all of the consideration use d for tender offer. Tender offer: These aren’t very well defined. 1. A tender offer puts the company in play wh ich means that it will eventually be taken over. not necessarily by the firm tha t initiated the process.) Pac-Man Defense: One of the more extreme defenses occurs when the tar get makes a counter offer for the bidder. Toe holds result in lower tender offer premiums. Bear hug: This is done by contacting boar d of director of target with an expression of interest in target and showing int ention of going directly to share holders if these overtures are not favorably r eceived. White knights accounted for most of th e instances when target fought off initial bidder. When bear hug beco mes public arbitragers start accumulating targets stock. it doesn’t even define it. One advantage o f this is that if market is unaware of bidder’s action. Bidders are typically left with three main tactics viz. t hough they are regulated by Williams act.6. This is one of the more colorful takeo ver defenses. 7. although it is seldom used. However. taking the firm in play . The more common forms of litigations are antitrust. Options for the hostile bidder are fewer as compared to that of targets. cour ts have maintained that a publicly announced intention of buying a firm followed by rapid accumulation of target’s stocks at a premium is considered tender offer. TAKEOVER TACTICS: An initial step that is often pursued before using the various tactics of hostile takeover is accumu lation of target’s shares. this is called establishing a toe hold. leaving the bidder to pursue exp ensive tactics as tender offer. Williams act required that purchasers of 5% of t he outstanding shares of the company’s stock register with SEC within 10 days by f iling a schedule TO. tender offer and proxy fight.) Litigation: Targets generally sue the bidder and the bidder often responds w ith another countersuit. Securities may be more attractive to some stockholders as in some cases it may be considered tax free. The targets that were not acquired by the bidder either went to white knights or remained independent. thus establishing a fiduciary duty which the board now have to the bidder . Bear hug is less expensive and less time consuming but if the target strongly opposes the acquisition it may be unsuccessful. It also provides bidder with same rights as that of other shareho lders. 2. The temporary halting of takeover can delay the acquisi tion giving the target time to mount some defense and to look for a white knight . Tender offers are more expensive takeover tactics due to legal filing fees and publication costs associated with it. the bidder may avoid payme nt of premium. Sometimes the target shareholders are given an option to receive cash or securities in exchange of their shares. This makes the offer more flexible. This puts pressure on board because it must be considered as it is over ly generous lest board may be violating its fiduciary duties. By a research success rate of tender offers in years 19 90 to 2005 is 55%.

Any and all offers are considered more effective. Target company shareholders of ten view tender offers as favorable development as they tend to bring high offer premium. In absence of tender offers managers might be free to take actions t hat will maximize their own welfare but will fail to produce stock price that wi ll maximize shareholder’s wealth. Tender offe rs are sometimes two tiered which means higher compensation for those shareholde rs who sell their stocks in first tier. Tender offers are also viewed as a mechanism to keep the management honest to sh areholders. Even if the second step does occurs it may not contain the same premium as that of first step which had the control premium. The ris k that target takes when it resists the bid is that the offer may be withdrawn. partial offers do not have the second step buying transaction which makes it less attractive as shareholders may be left w ith some or all of their shares which have reduced value after first step partia l buyout is complete. Before initiating a tender offer bidder may decide whether to make an offer for any and all shares of target or structure the offer so that only certain percentage of outstanding shares are bid for. it is difficult to purchase large quantity of sto ck and keep the identity of the purchaser secret. By resisting a bid t arget may be able to attract other bidders who may offer higher premium. The bidder may compare the value of company unde r its management and if it exceeds company’s current market value by sufficient am ount than it may offer a premium and still profit from the takeover. A hostile bid der tries to accumulate as much of target’s stocks before making a tender offer. the stock price may be lower than it would be following the notific ation to the market of the bidder’s intentions. this increases the demand of the st ock making them more valuable. To do so the purchases are often made thr ough shell corporations and partnerships whose names don’t convey the identity of actual purchaser. However. T he purchaser tries to keep these initial purchases secret so to put little upwar d pressure on stock price as possible. Critics maintain that two tiered tender offers are coercive and unfair to share holders tendering in second tier because shareholders are entitled to equal Equa l treatment by Williams law. Two tiered tender offers put pressure on shareholders to tender their shares early. More the pre offer stocks the bidder holds more is the probabi lity of tender offer or proxy fight success. knowing the forthcoming bid and the premium associated with it. However. significant shareholdings purchased through open market purchase may be useful . So it is in bidder’s interest to acquire as much stocks of target as possible duri ng the 10 day window. management will resist the bid as this can lead to increase i n premium and hence a higher return to target’s stockholders.this period. The compensation may be broken down into first tier all cash tender offer for 51% of shares and a second tier offer whic h may provide with non cash compensation such as debt and equity securities. Even if the bidder fails to take co ntrol of the board of directors it may be able to place representative in the bo ard making operations more difficult for the management and enable the bidder to force the targets decisions in its own favor such as payment of high dividends. The filing gives stockholders noti ce that a bidder may be about to make a bid. Stockholders will demand higher price to part wit h their stocks.

to offset defenses as supermajority voting provision. Large scale open ma rket purchases are often done with the help of investment banks which help in lo cating large blocks of stocks and provide the required financing. The ability to call a stockholders’ m eeting is very important to bidder who is also a stockholder in the target firm. Proxy fight: Proxy fight is a n attempt by a single share holder or group of shareholders to take control or b ring about changes in a company through use of proxy mechanism of corporate voti ng. A street sweep may be more effective when the bidder is able to locate large blocks of stocks in small group of investors. Upon establishing an equity position the bidder may want to replace the hostile board of directors with a board which may approve a business relationship with the bidding firm. . The bidder than may b e ready to part with his shares only if a very high premium is offered.) Conte st for seats on board of directors. leading to greenmail. As an antitakeover defense. As stockholders come to believe that a bid may be forth coming they have th e incentive to hold out for a higher premium. companies sometimes try to amend th e company’s charter to put limitation on ability of certain type of shareholders t o call a meeting. The board of director is particularly important to the corporation becau se the board selects the management. who in turn runs the corporation in a day-t o-day basis. The hold out problem doesn’t exist w ith tender offer because the bidder is not obligated to buy unless the required amounts of shares have been tendered. They may also be used to c onvince the target to agree to a friendly tender offer and to discourage potenti al white knights as they will have to deal with unwanted substantial stockholder s even if succeeds in having majority control in the firm. Typically there are two main types of proxy contests 1. The drawback o f open market purchase or street sweep is that the bidder can’t be sure that he wi ll be able to accumulate sufficient shares to acquire clear control. The meeting may also be used to approve of certain corporate a ctions such as deactivation of antitakeover defenses or sale of certain assets a nd payment of premium. In a proxy fight the insurgent may use his votes and garner support from oth er shareholders to oust the incumbent board or management. Most law allow meeting to be held if majority of stockhol ders request it. Large scale purchases are also difficult to keep secret which give rise to problem of hold out. but it may also be an effective alternative to tender offer. Corporate elections f or seats on the board are typically held once a year at the annual stockholders’ m eeting.) Contests for management proposals such a s the approval of a merger or acquisition. Not all interested stockholders find it possible to attend the meet ing because of other commitments. shareholders may authorize other person to vote for them and to act as their proxy. The voting process has been made easier throug h the use of proxies. When there has been speculation for a bid stocks often become concentrated in t he hands of arbitragers who are willing to part with their shares but only when bidder is willing to pay a painful large price. Under this system. 2. Open market purchase of stock may be a precursor to tender offer. 3.

Institutions are the largest category of stockholders. Proxy fight process: 1. Directors and officers will surely vote in favor of management . the situation is s tarting to change as institutions are becoming more outspoken. 5. Starting a proxy fight: starts when bidder who is also a stockholder decides to attempt a change of control at the next stockholders’ meeting. Solicitation process: Bidd er tries to convince other shareholders to vote against management. The issuing corporation tries to deal directly with the beneficial owner s of the shares. These may be proposal to sell asset s and proceeds paid to stockholders as dividend. 3. more likely is the success of the proxy fight. they may vote in favor of insurgent. 2. Companies with larger market ca pitalizations are more insulated from a proxy fight threats than smaller compani es where an insurgent can control a large percentage of shares without concentra ting too much of investment in one direction. Brokerage firm may use the voting right (if la w permits so) if the owner doesn’t give any voting instruction. Shares cont rolled by insurgents and shareholders group unfriendly to management. . 3. However. When the shares are issued in names of banks or trust they ma y or mayn’t have the voting rights. Shares held in ESOPs also tend to vote in favor of management because a change in control may mean layoffs. Sound alternative operating plans: The insurgents must be able to propose changes that other stockholders believe will reverse the downwards direction of the firm. Insurgent group may sue to have the issuing corporation share t his information with the insurgent stockholders so to have interested parties on an equal footing. 2. Institutions are historically passive stockholders and have voted in favor of management.The following characteristics increase the likelihood that a proxy fight will be successful: 1. Shares held by ind ividuals. however they may be important someti mes. Shares controlled by institutions. S hares controlled by directors. 2. 4. the more likely other stockholde rs will vote for a change in control. ESOP and officers. This represents the core of ma nagement’s support. They don’t often compose a large percentage of votes because of the larg er equity base of many public corporations. The greate r the number of these votes. For this bid der hires proxy solicitor target can also use such firm for its benefit. Some of these votes migh t be through management’s own stockholdings and others through brokers who haven’t r eceived any specific instructions from the shareholders. voting process: The votes of stockholders are grouped into following categories: 1. 3. Shares held by brokerage firms. Proxy f irms have their own list of shareholders which they have compiled from various s ources. If an institution is convinced that a change in control may greatly increase value. Insufficient voting support for management: Management can usual ly count on a certain percentage of votes in its favor. Poor operating perfo rmance: the worse the firm’s recent track record.

A clear conflict occurs in a MBO as the managers ar e to pay the dual role of buyers as well as sellers. These managers may invest some of their own capi tal but often equity capital is provided by some investors while bulk of the fun ds is borrowed. management. so management may not be in co mplete control after the buyout. Tender offers are exp ensive due to the high premium associated with them. Man agers are human and they may pursue their own agendas and may seek to pursue the ir own gains at the expense of the shareholders. LEVERAGED BUYOUTS: A LBO is a financing techniqu e used by corporations. Managers may though know that more profit is possible from elimi nating unnecessary costs and setting the output level such that the marginal rev enue equals the marginal costs. The major costs associated with a proxy fight are costs associated with hired professionals as proxy solici tor. litigation costs and other expenses such as tabulation free. T here is much overlap in LBO and going private transaction. Poor performance gives bidders an arg ument for change in management. Managers may know that if they produce an acceptable return it would be difficult for the shareholders to mount a proxy fight. Proxy contests are more eff ective if the target is performing poorly. This may explain why small and medi um size firms may want to go private. other equity is provided by outsiders. Being a public company carries with certain costs such as peri odic filing with Securities and Exchange Commission. The deal should be such tha t it should maximize shareholders wealth and also should be fair enough to the m anagers themselves as buyers. Managers may be seeking a different agenda. mailing and communication costs. Even when management as opposed to outer group is the buyer. Some reasons fo r a LBO are: 1. Efficiency gains: there are several areas where efficiency gains can manifest themselves in a LBO. Specifically it is the use of debt to purchase the stock of a corporation and it generally involves taking the public company private. Proxy fights have u sually shown positive effect on stockholders wealth. Such a transaction is finance d with some debt and some equity. such as to . The first has to do with agency problems. for small firms this may be a burden both in money and management time. When the bulk of financing comes from debt it is considered a LBO.Proxy fights are less expensive compared to tender offers. It depends on how much equity capital is needed and how much capital the managers have and are willing to invest in the deal. Many of these transactions involve divesting a division and in doing so it is sometimes sold to the management of that division instead of an outside party. Management Buyouts: An MBO is a type of LB O that occurs when the management of a company decides that it wants to take the publicly held company private. One drawback of MBO is that i f a company is selling a division due to poor performance than may be this poor performance is attributable to the management which remains same even when the d ivision becomes independent. R easons for a LBO: The pre mentioned reason of synergistic gain for mergers is no t true for LBO as the new company formed is an independent firm. The purchased company than becomes different entity with its own stockholders. and board of directors. A going private trans action is where a public company is taken private. investment banks and attorneys. printing.

5 *15+. The collateral includes physical assets such as land. This happened with De nver based sandwich chain Quiznos. Intermediate term debt: It is usually subordinate to senior debt. Cash flows LBO are considered riskier for the lenders and have high er debt rate. hence LBO s are more common in capital intensive industries (common LBO candidates). Managers who have a good sense of the difference between the maximum prof it and the profit that company is earning may believe that this is sufficiently large to more than offset the cost of doing the deal and paying service on the d ebt. FINANCING FOR LBO: two general categories of debt are used in a LBO – secured and unsecured debt. The high cash flows provide protection for the lenders. They may still occur in non capital intensive industries such as advertising industry provided they have high cash flows. In a LBO Company replaces most of the equity by debt whose cost is less than cost of equity because equity involves hi gher risk. Tax Benefits: Cost of capital of a company is the opportunity cost of fi nance.5*9 = . Though both cost of debt and equity rises because of the higher risk level of the company the net cost of capital decreases. The target company’s assets are often used as collateral for large debt taken to pursue a LBO. pla nt and equipment. accounts receivable and inventories. 2. The collateral value of . Lenders will commonly adv ance 85% of the value of accounts receivable and 50% of the value of target’s inve ntories. Firms wit h assets that have high collateral value can thus easily obtain loans. Thus the collateral value of these assets needs to be assessed. 1. Senior debt: It consists of loans secured by liens on particular assets of the company.: within the c ategory of secured debt there are two subcategories – senior debt and intermediate term debt. When the entire equity is sold the previous owners do not have any equity interest in the compan y. it is the money that the company misses because of debt and equity in its capital. The debt rate used must be the after tax debt rate which is given by (1-T)*(before tax debt rate). This type of lending is often called asset based lending. This is one of the advan tages of a LBO. Secured debt . plant and equipment.12 or 12%.make the firm larger than it optimally should be so as to maximize their compens ation. 2. Co llateral include fixed assets such as land. In a LBO the shareholders of a company sell their equity ownership s to buyer who take borrow bulk of capital to finance the deal. CC = ∑wiki CC: Cost of capital W: weight assigned to particular source o f capital k K: rate for this source of capital T: company’s tax rate Suppose some firm has capital structure comprising of 50% debt and 50% equity and the rate of return on equity is 15% and debt rate is 9% than net cost of capital will be . Sometimes buyers are unable to raise the full amo unt due to variety of reasons. In such cases the sellers won’t be able to complete ly cash out but would be able to make only a partial exit. In closely held business this is the way for sellers to cash out on their inv estment and exit the business.

These are determined by examining the historical cash fl ows of the company though past can’t be a perfect guide for the future. They allow warrant holder to buy shares fo r a certain price for a defined period of time. When the warrants are exercised the share of ownership of stockholders is diluted. Limited debt on firm’s balan ce sheet: the lower the amount of value on the firm’s balance sheet compared to it s collateral value of assets. The capital structure for a typical LBO is s hown below: Securities Percent of Capitalization Short term or intermediate 5-20 senior debt Source Commercial banks . R oom for cost reductions: Assuming additional debt put pressure on the target. Unsecured or subordinate LBO financing: The unsecured debt is the de bt that has secondary claim on the firm’s assets. reduced capital expenditure. Lenders feel more secured when the management is experienced. 5. Equity interest of owners: The equ ity investment of managers or buyers and outside parties also act as cushion to protect lenders. 6. Th is pressure can be alleviated if target can significantly cut costs such as fewe r employees. The greater the equity cushion the more likely the lenders will not have to liquidate the assets. Although this form of debt may have undesirable characteristics for th e management. 3. 4. Capital structure of LBO: After the comp letion of LBO the capital structure of the company taken private is different fr om its structure before the buyout. Separable non core business: if the LBO candidate owns a non core business whic h can be quickly sold to pay down the additional debt than the financing may bec ome easier. The more the managers’ equity more likely they will stay with the firm when the going gets tough. Desirable characteristics of secured LBO: 1. The collateral va lue of these assets is based on the auction value of these assets and not on the value they carry on firm’s book. Debt can equal 80% of the app raised value of equipment and 50% of the value of real estate. Lenders typically receive warran ts that may be converted in the equity in the target. the greater the borrowing capacity of the firm. a nd tighter controls on operating expenses. This dilution occurs just at the time when the target is becoming profitable.theses assets is based on their liquidation value. Warrants are derivative se curity offered by corporation itself. At this time warrants become pr ofitable. Sta ble cash flows: One of the most important characteristic of a LBO candidate is r egular high cash flows. they may be necessary to convince the lenders to participate in a LBO without any security of collateral. 2. Stable and experienced management: Stability is judged by the length of time management is in place. elimination of redundant facilities.

Companies usually try to retire most of the debt within five to seven years of deal. Life insurance companies. perhaps because of poor management. The reason for this being is increas e in average cash holdings of company.LBO Funds. 59% in 2003 and 57% in 2004. . Companies. a result when cash is needed to finance an M&A company’s gene rally resort to debt financing to raise cash.some banks. The opportunity to conduct a successful lbo is when the goin g private transaction takes place when the market is down and the public offerin g occurs in the bull market. While stock could be used to gener ate the cash. The cash percentage has varied from 51% in 1985 to 56% in 1988 but fell to as low as 22% in 1992. Business Risk ref ers to the risk that company going private will not have sufficient earnings to meet its obligations. There are various risks associated with a LBO. venture capital firms. managers. The reasoning however implies that the seller is naïv e and doesn’t realize the impact of short term market fluctuations. therefore manage the cash levels at such levels that are enough to pay their cur rent obligations as they come due and to have an additional supply of cash for u nforeseen event. Research shows positive net returns for the target company. Buyers may believe that the company is undervalued. Life insurance companies. and private equity firms. The percentage ros e 56% in 2002. Reverse LBO: It occurs when a comp any is taken private only to be taken public at a later date. Cash and liquid assets pay a comparatively lower return than most long term assets. Trends in fina ncing of M&A: Companies use a mix of cash and stock to finance a takeover. I f the new management makes the company profitable again it may be able to go thr ough the IPO again. and private equity firms. thereby giving debt a cost ad vantage over debt. thus increasing firm’s current obligations. i ndependent of deal being cash or stock financed while acquiring firms tend to sh ow zero or negative returns on announcement of takeover. They may b uy the firm and institute various changes such as replacing senior management.Long term senior subordinate debt Preferred stock Common Stock or 40-80 10-20 1-20 Life insurance companies. As.venture capit al firms. Companies try to retire the debt as soon as possible and move to normal capital structure. Interest rate risk is the risk that interest rates will ri se. The m ix of cash. debt requires lower floatation cost. debt and equity used to pursue a M&A has varied with time and there are various factors that determine the mix. When a company has large cash holding it is left with the option of either to do a major acquisition or return the cash t o shareholders in form of dividends or through share repurchase.

Th e fund might take majority or minority position in company. institutions directly or indirectly co nvey to bidder that they don’t want company to issue more shares to finance M&A as it will dilute their holding. there have been cases when the company was acquired relatively soon a fter the private equity inspired IPO. Managerial ownership is not the only factor affecting the use of stock. there is no room for negotiation and less cha nces of paying the target full value of company. Fund established for this purpose are sometimes called venture capital funds. When these in vestments acquire 100% of the equity we have a going private transaction. Having such investments helps Target Company by providing it improved access to debt market after it secured the equity investment from private equity fund. Also the managers of target f irm were more likely to retain their position if they received stock instead of cash. Private equity funds s eek out investments that are undervalued. ther e may be a gap in the value that it can achieve if new management is installed a nd other necessary changes are made and the value that the firm estimated based on its future cash flows. These investments might exclusively use fund’s capital and not borrowed funds. when the target is well managed and both are aware of th e risk adjusted value of the firm. On the same time shareholders of target wh o value control will prefer stock instead of cash. which shows market be lieves that when managerial ownership is high deal is not at least value reducin g. the stock price of the bidder should weake n but this didn’t happen when managerial ownership was high. One might think that after the resale firm might be appropriately value d and there are no further acquisitions opportunities exist for the sold company . Private equity firms tend to be careful not to overpay as their gains mainly come from the difference between t heir purchase price and eventual resale price and any money extracted from the c ompany prior to resale. This gap allows for negotiations and allow for an agre ed upon price. Stock financing is more likely to be use d when the management of bidding company finds that market’s assessment is overopt imistic and the firm is overvalued.Managers of acquiring companies who value control may want to avoid stock deals because it will dilute their control. Resea rches have shown that companies that have more of their stocks held by instituti ons tend not to use stock to finance M&A. Private equity funds make other investments such as providing venture capital to nascent busine ss. PRIVATE EQUITY MARKET: These are funds which have raised capital by soliciting investment from various large investors where thes e funds will be invested in equity positions in various companies. When t he equity is acquired through some of the equity capital of private equity funds but through the use of borrowed funds we tend to call them LBO. Cash has a clearly defined value and doesn’t have the valuation and liquidit y drawbacks associated with securities. Often this resale is done through initial public offerin g (IPO). When private equity firm believes that a company is poorly managed. These could be whole companies that ar e not trading at values commensurate to what the fund managers think would be po ssible. However. However. Taking this as a negative symbol that manage ment believes stock to be overvalued. This is because of the synergistic benefit s which the acquirer might see in the company. Some have been critical of certai n private .

HEDGE FUNDS: Managers of hedge funds don’t make public solicitations to investors in general and don’t face public reporting obligations that mutual funds counter parts do. Difference between hedge funds and pri vate equity funds used to be clearer but it has started to decline as hedge fund s have started to involve in M&A related investments. Defined benefits plan: Under this plan the employer agrees to pay specific benefits to employee on retirement. This is good when returns are high as investors won’t care much but when returns fall below expectations investors often want a more complete explanation for the resu lts. arbitrage. Based on the investors’ participation in the fund investors receive a proportion of return that the fund enjoyed less the management fees for running the fund. Hedge funds have tended to involve in more short term and liquid investments than private equity funds. Th ey purchase securities with short term investment horizon and may sell them at m ost opportune time even if it means short holding period. The management of these funds have the attitude that investors should be happy with the returns they enjoyed a nd the meager disclosure they were given. Hedge funds have been more used to acquiring and trading securit ies and have not been involved in managerial actions of companies they acquire. However. Thus. swaps. fees s uch as 1 or 2% plus 20% of profits is also to be deducted. One area whe re they have focused is debt financing of distressed companies. A private equity firm may raise capital to build several diffe rent funds. When this is done it doesn’t seem that hedge funds have really outperformed the market. This is one main difference between private equity and hedge funds. Recently they ha ve also been involved in M&A debt financing. These investors view private equity funds as a platform of achieving higher returns o n their portfolio of investments. Hedge funds have traditionally employed a variety of aggressive investment strategies such as short selling. and if they don’t they could be replaced by a long line of investors waiting to take their place. investors have more limited access to return data.equity buyers which do no more than to flip companies without adding on any valu e to it and thus making profits. EMPLOYEE STOCK OWNERSHIP PLANS(ESOP): These are involved in M&A in two ways: as a financing veh icle for the acquisition of companies called EBO and as an antitakeover defense. Private equity firms raise their capital from v ariety of sources including institutional investors such as pension funds. These b enefits may come in form of definite . As hedge funds started to feel pressure of competition to generate higher returns they started to look at M&A as an investment opportunity which was previously related more to privat e equity funds. Wealthy individuals are also investors in priv ate equity funds. Like private equity funds they raise their capital from institutional investors and wealthy individuals. He dge funds vary in types of investment they make and securities they purchase. So me hedge funds managers have become impatient with weak returns and have pushed for changes including managerial changes. Hedge funds returns ha ve exceed those of market. even if the rate of return is higher. Hedge funds have become more active for greater return for their equity investment acquired in public companies. There are two types of pension plans: 1. and employing leverage to in crease return potential.

Tax laws allow the company a $ 1000 tax deduction. Though this leads to decline in the compensation and benefits of emp loyees because the contributed stock takes the place of compensation and benefit s. The company than makes contributions to the E SOP which are used to pay the principal and the interest. Buyouts: ESOP has been extensively used as a vehicle to purchase companies. The emp loyees’ benefit depends on performance of these funds. ESOP generally owns a minority position in the company. 2. 4. As the lone is being r epaid shares are released to employee account. If the stock is sold directly to an ESOP. With LESOP. Government workers often have such plans. This will bring in cash worth $10 million less the floatation costs such as investment banking fee and l egal charges. Suppose a corporation make s $ 1000 contribution to the ESOP. Leveraged ESOP are those t hat borrow. Because the contribution is in the form of st ock. . There also may be more tax deductions as both interest and principa l will be tax deductible. these floatation costs a re avoided. 2. tax incentives. Divestitures: a new company is created. This ESOP than borrows the funds to purchase newcorp’s shares. Raise capital: ESOP can be used as an alternative to publi c offering. This also allows for broader employee participation th an a MBO. However if the ESOP incurs the interest costs for borrowing the capital neede d to buy the stock the tax deduction should more than offset the interest paymen ts. the corporation’s E SOP borrows to buy employer’s stock. This plan is riskier for t he employees for the benefit depends on the performance of the firm . new corp than makes contribution to ESOP to pay the principal and the inter est both of which are tax deductible. Us ing a LESOP for LBO places less cash flow pressure on company as the company may be able to replace some cash employee compensation payment with stock compensat ion to ESOP. Rescue failing company: the employees o f failing company may use an ESOP as an alternative to bankruptcy.dollar value per month or some percentage of previous year’s salary according to a preset formula. Suppose a compan y makes a public offering for stocks worth $10 million. which is n ot guaranteed by the employer. Defined contributi on plan: Employers commit to making a substantial and recurring contribution to a benefit fund rather than a specific benefit in a defined benefit plan. which improves the company cash flow by amount of tax savings. For example t he employees of mcclouth steel exchanged wage concession for stock in company to avoid bankruptcy. 3. These fund s are than used to acquire the division whose assets than become assets of new c orp. which establishes an ESOP. ESOP can be divided in two categories leveraged and unleveraged. whereas unleveraged ESOP doesn’t borrow. These funds may be managed by a union that oversees the investment of the funds. The voting power for shares in ESOP is in hands of board of director s than employees. ESOP helps in improving cash flows. there is no cash outlay. newcorp. The main reasons for starting an ESOP are to provide benefit to the employees. ESOPs are defined contribution plan where the inv estment is mainly made in the employer’s securities. and improved p roductivity. Corporate finance uses of ESOP: 1 .

Economic failure: economic failure could mean that revenues a re less than the costs. the post retirement income will be f unction of company’s performance. Sometimes it means that firm is unprofitable while other time it cou ld also mean that firm is not as profitable as forecasted. From the original stockhol ders’ viewpoint. However. Researches have shown that three most common cause of business failure are : economic factors. If employ ees make other sacrifices. there may be distributional effect associated with the formation of ESOP. If the ESOP purchases currently outstanding sha res instead of issuing new shares equity is not diluted. The employer may have to convince the employee that it will make substantial c ontributions to the ESOP. If employees rec eive shares in the firm at below market price a redistribution of wealth may occ ur. such as lower wages or benefits. ESOP also enhances productivity if the workers view the reason of their ownership as a reason to take greater interest in performance. Thus the term could be used differently in different situations. as weakness in industry. financial factors. Loss of control: Another effect related with the equity dilution effect is the loss of control of the non employee share holders. which is more flexible corporate finance tool wh ich allows companies to operate while it explores other form of restructuring. 2. When this is the case loss of control may not be that sign ificant. To reverse the equity dilution e ffect the firm must repurchase at a later date. It could also mean that the return on the investment is less than the cost of capital or it could also mean that actual returns earned w ere less than anticipated. Bankruptcy filing is company’s admission of the fact that it has someway failed to achieve certain goals. BANRUPTCY: Bankr uptcy is much more than a transaction a company engages in when it is going out of business. which offset the gai n on the below market price shares there may not be any distributional effect. Employees gain wealth at the expense of non employee shareholders. There are two main forms of bus iness failures: 1. and experience factors as lack of managerial experience. Financial failure: It means that company can’t meet its current obligations as they come due which m eans that company doesn’t have sufficient liquidity to satisfy its current liabili ties. 3 . Distributional effec ts of ESOP: Depending on the price the ESOP pays for the firm’s shares. equity dilution effect: the tax benefit of borrowing through an ESOP is clear advantage but when the firm is bor rowing through an ESOP it is also issuing new equity. 2. the voting rights o f issued shares still lie in the hands of trust which is under the control of th e board of directors. Leveraged recapitalizations use proceeds of debt to make payout to . There are two broad forms of bankruptcy: liquidation which more severely distressed co mpanies use and reorganization. The employees may not prefer these uncertainties . Fi nancial distress may be caused by high leverage. The ESOP may be structured that there are less dilution effects. such as insuffic ient capitalization. Drawbacks of ESOP: 1. B ankruptcy however is a drastic step which is undertaken only if other favorable options are unavailable. Bankruptcy is a creative tool that can be used for reorganization a nd can provide unique benefits that are unattainable through other means. result is dilution of equity. The new equity holders will share t he gain that the new debt capital will produce.If the pension plan is eliminated for ESOP.

One solution is to pay the smaller creditor 100% of they are owed and to pay the main credit ors an agreed upon lower amount. WORKOUTS: A workout refers to a negotiated agre ement between the debtor and the creditors outside the bankruptcy process. including a statement and a balance sheet. This prevents the time consuming and expensive plan development process and approval which are painstaking negotiation process. Both time and f inancial resources are saved. which is th e date when those creditors who have disputed or contingent claims must file a p roof of claim. Standard financial s tatements. The d ebtor may be convinced to extend the . If concerns exist about fraudulent actions of man agement or directors. the law gives post petition creditors an elevated priority over pre p etition creditors. A new type of bankruptcy that appeared i n the late 80’s is prepackaged bankruptcy. In this process approval of all the cred itors is required. This is helpful to the already distressed debtor w ho will try to conserve his financial resources and spend as little time as poss ible in the suspended chapter 11 state. which is a part of larger document c alled disclosure statement looks like a prospectus. The reorganization p lan must be both fair and feasible. This schedule must include the nam e and address of each creditor. The next important date is bar date. The completion of bankr uptcy process is dramatically shorter in prepackaged bankruptcy. Reorganization process: The reorganization process st arts with the filing of bankruptcy petition of relief with the court. The failures of leveraged transactions were due to overpricing and poor financial structure. The company than puts together i ts reorganization plan while it continues to operate. The plan is submitted to all the c reditors and equity holders’ committees. the debtor lists its creditors and security holders.shareholders. If creditors strongly oppose th e management of the debtor. court may agree. Once the plan is ap proved the dissenters are bound by the details of the plan. In a prepackaged bankruptcy companies t ry to have the plans of reorganization approved in advance before the chapter 11 filing. Approval is granted if one half in number and two third in dollar amount of a given class approves it. for all practical purposes it is the same company with same management and employees. From the creditors’ point of view this is a problem bec ause the same management is running the company. One of the problems of the nearly bankrupt compan ies is the problem is obtaining credit. This is difficult when there are many creditors. The reorganization plan. To assist the bankrupt companies to atta in credit. Failure to file by the bar date leads to forfeit ure of the claim. When the petition is accepted automatic s tay is granted this is one of the main benefits the debtor receives in chapter 1 1 filing. After the filing of petiti on the bankruptcy company is referred to as ‘debtor in possession’ which is a new le gal entity. however. Next important are those associated with the filing and approv al of the reorganization plan. Fairness refers to the satisfaction of claim s in order of priority and feasibility refers to the probability that the reorga nized company has a chance of survival. The plan is approved when each class of c reditor and equity holder approve it. they may petition the court and may ask for a truste e or examiner to be appointed. Within 10 days of chapter 11 filing debtor is required to file a sched ule of assets and liabilities with the court. The court then sets a date when creditors may file their proofs of claim. which is a written statement which sets forth what is owed by the debtor to particular creditor. In the pet ition. It’s a document which contains the plans for the turnaround of the company.

Researches have shown that companies that underwent voluntary restructuring program were less able to reduce their leverage compared to firms filing chapter 11. Reorganization plan can involve finding an acquirer wh o would takeover the bankrupt company. Investment firms dedicated to distresse d securities field actively manage securities portfolio. which is called extension. Hedge funds have long f ocused on the distressed securities market for undervalued opportunities. In addition participants are not burdened to abide by the rules a nd regulations of the chapter 11 filing. The strategy may yield high result for thos e who are able to aggressively participate in the bankruptcy negotiations but th e negotiations may be quite lengthy and thus this type of takeover strategy is p articularly risky. Workouts may also help the debtor to avoi d any business disruption and loss of employees and overall morale that might oc cur in bankruptcy. The main benefits of workouts are cost savings and flexibility. or convince the creditors to accept a lower amount than they are owed which is called composition. Bidders sometimes can find attractive acquisition opportunities in compani es filing for chapter 11. He did this by buying company’s busted bonds and bank debt to becom e a creditor and than using his position as a creditor to become an equity holde r in the company. taking control of the company. Thus creditors may receive ownership in the debtor in exchange for other considerations such as reduction amount owed. In a workout debtor try to convince the creditors that they would be better off with new terms of w orkout agreement than with the terms of formal bankruptcy.payment terms. They generally cost less to both cred itors and debtors in terms of resources participant needs to devote to the bankr uptcy process. bankruptcy administrative costs. This was done by Eddie Lampart in acquisi tion of Kmart. Investin g in securities in a distressed company may be of great profit but only if buyer is willing to assume significant risks. Liquidation: liquidatio n is the most drastic step and it is only pursued when voluntary agreements and reorganization can’t be successfully implemented. with some debt being replaced by equity and some or all p re petition equity disappearing. One of the typica l changes that a company undergoes in the chapter 11 process is to have its capi tal structure altered. They are free to create their own rules as long as the parties agree to them. employee benefit plan contribution. wages of the workers. Holders of distresse d securities try to use the bankruptcy process to convert their discounted bonds and other debt into a significant equity stake in the company that hopefully wi ll have a reorganized capital structure that it can live with. . The priority of satisfaction of claims is secured creditors. f ederal and state taxes. In liquidation company’s assets ar e sold and the proceeds are used to satisfy claims. Debtor s have to assume significant risk as they could easily see their investment coll apse if the debtor’s business deteriorates and is liquidated. preferred stockholders and common stockholders. post petition bankruptcy expenses. Investors may buy themselves component of bankr upt company by purchasing debt of company and exchanging them for significant eq uity. Difficulty with voluntary restructuring is that creditors ma y be less willing to exchange their equity for debt when managers of the company may have additional informational advantage over them and they may be able to b etter assess the value of equity. Other issues being that the institutional inve stors may not want to exchange debt for equity and voluntarily become equity hol ders.

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