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Investment banking terms and expressions

Change of control clause


A contractual provision which gives a party to an agreement enhanced protection
if the controlling shareholding of the other party is transferred. In commercial
contracts a change of control clause will often give the party who is not subject to
a change in ownership the right to terminate the agreement in the event of a
change of control of the other party. In employment contracts, a change of
control clause entitles the employee to a specified payment or enhanced notice
period if their employer is taken over and the takeover results in dismissal by
their employer or a material reduction in the employee's responsibilities leading
to constructive dismissal within a specified time. In finance contracts a change of
control clause will enable the bank to declare an event of default or a mandatory
prepayment event and therefore cancel any obligation to make further loans and
require the repayment of existing loans.

Exclusivity agreement
Also known as lock-out, shut-out or no-shop agreements. Agreements which are
used to try to ensure that the other party to a prospective deal negotiates solely
with the client for a period of time. They aim to give the client some protection
from another party outbidding him.

Exclusivity agreement: private equity (favouring seller)


A sample exclusivity agreement providing only the most limited protection for a
buyer.
It is drafted from the perspective of a seller and provides only the most limited
protection to a buyer. The seller agrees only not to solicit interest from or enter
into any negotiations relating to a sale of the target. Standard document,
Exclusivity agreement: private equity (favouring buyer) is much wider in scope
and includes a restriction on making information available to any other person in
connection with a competing offer.

Exclusivity agreement: private equity (favouring buyer)


A sample exclusivity agreement which imposes a wide range of restrictions on
the seller.
This agreement prohibits a range of acts by the seller, which would prejudice the
exclusivity arrangements. The seller agrees to observe the exclusivity restrictions
and to procure that its directors, employees, agents and advisors do likewise.
It is important that "Competing Offer" is defined carefully so as to include a sale
(save in the ordinary course of trading) of any part of the target business or any
of its material assets.

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Paragraph 1.1(e) provides for the reimbursement of the buyer's costs in the event
that a legally binding sale and purchase agreement is not completed by a
specified date. It is worth noting that in Radiant Shipping Co. Limited v Sea
Containers [1995] CLC 977 an undertaking by a party for good consideration to
reimburse costs is only enforceable if it applies to "reasonable fees". The court's
view was that "the court has to make a common sense judgement upon the
evidence in all the circumstances" as to whether or not the fees incurred were
reasonable.

Information memorandum
Also known as an Info. Memo. This term has a number of meanings depending on
the context in which it is used.
In a syndicated loan, it is a document put together by the arranger who circulates
it to potential lenders to provide information on the borrower and the proposed
loan. The borrower provides much of the information for the document. The
document typically includes:

A sample term sheet.


General information and forecasts about the borrower.
Details of the borrower's business and related markets.
A statement from the arranger limiting, as far as possible, its liability for
the content of the information contained in the document.
In the context of a bond issue, it is also known as a "prospectus" or "offering
circular". It is a legal and regulatory disclosure document designed to prevent
investors from claiming that they were not given all material information or that
they were misled by the issuer. The document typically includes:

A description of the bonds and their terms and conditions.


A negative pledge and events of default in the terms and conditions.
A description of the issuer's (and, if applicable, the guarantor's) business
and operations.
Financial information about the issuer (and guarantor).
A summary of the selling restrictions and tax provisions relating to the
bonds.
If the issue is listed, the content of the information memorandum will need to
conform to the rules of the relevant stock exchange or listing authority and, if
applicable, the requirements of the Prospectus Directive.
In the context of a Euro commercial paper (ECP) programme, the information
memorandum is the legal and regulatory document and is the equivalent of the
prospectus in a bond issue. It looks like a short-form version of a standard bond
prospectus but also contains the forms of notes to be issued (that contain the
terms and conditions). The document typically includes:

A summary of the terms and conditions of the ECP.


A brief description of the issuer's (and if applicable, the guarantor's)
business and operations.
A summary of the selling restrictions.
The form of the notes.
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In the context of a private company acquisition where there is a controlled
auction process (that is, the sale of a company or business where the seller seeks
competing bids for the target), a selling document which give bidders a
reasonable amount of information about the target in order to elicit meaningful
bids. It will usually contain:

A description of the target's business and its history.


Its principal assets.
Up-to-date and historical financial information.
Projections for the future.
Information about employees and, depending on sensitivity, about major
customers and contracts.
Formal verification of the information memorandum may be undertaken. The
information memorandum will invariably contain a disclaimer. In some cases,
bidders may be asked to pay a fee to receive the information memorandum to
defray the costs of the process and to discourage bidders who are not serious.

What is 'Private Equity?


Private equity is equity capital that is not quoted on a public exchange. Private
equity consists of investors and funds that make investments directly into private
companies or conduct buyouts of public companies that result in a delisting of
public equity. Capital for private equity is raised from retail and institutional
investors, and can be used to fund new technologies, expand working capital
within an owned company, make acquisitions, or to strengthen a balance sheet.
The majority of private equity consists of institutional investors and accredited
investors who can commit large sums of money for long periods of time. Private
equity investments often demand long holding periods to allow for a turnaround
of a distressed company or a liquidity event such as an IPO or sale to a public
company.
The size of the private equity market has grown steadily since the 1970s. Private
equity firms will sometimes pool funds together to take very large public
companies private. Many private equity firms conduct what are known as
leveraged buyouts (LBOs), where large amounts of debt are issued to fund a
large purchase. Private equity firms will then try to improve the financial results
and prospects of the company in the hope of reselling the company to another
firm or cashing out via an IPO.

What is a 'Leveraged Buyout - LBO'?


A leveraged buyout (LBO) is the acquisition of another company using a
significant amount of borrowed money (bonds or loans) to meet the cost of
acquisition. Often, the assets of the company being acquired are used as
collateral for the loans in addition to the assets of the acquiring company. The
purpose of leveraged buyouts is to allow companies to make large acquisitions
without having to commit a lot of capital.
In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high
debt/equity ratio, the bonds usually are not investment grade and are referred to
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as junk bonds. Leveraged buyouts have had a notorious history, especially in the
1980s when several prominent buyouts led to the eventual bankruptcy of the
acquired companies. This was mainly due to the fact that the leverage ratio was
nearly 100% and the interest payments were so large that the company's
operating cash flows were unable to meet the obligation.
One of the largest LBOs on record was the acquisition of HCA Inc. in 2006 by
Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch. The three
companies paid around $33 billion for the acquisition.
It can be considered ironic that a company's success (in the form of assets on the
balance sheet) can be used against it as collateral by a hostile company that
acquires it. For this reason, some regard LBOs as an especially ruthless,
predatory tactic.
What is a 'Management Buyout - MBO'
A transaction where a companys management team purchases the assets and
operations of the business they manage. A management buyout (MBO) is
appealing to professional managers because of the greater potential rewards
from being owners of the business rather than employees. MBOs are favored exit
strategies for large corporations who wish to pursue the sale of divisions that are
not part of their core business, or by private businesses where the owners wish to
retire. The financing required for an MBO is often quite substantial, and is usually
a combination of debt and equity that is derived from the buyers, financiers and
sometimes the seller.
An MBO is different from a management buy-in (MBI), in which an external
management team acquires a company and replaces the existing management
team. It also differs from a leveraged management buyout (LMBO), where the
buyers use the company assets as collateral to obtain debt financing.
An MBOs advantage over an MBI is that as the existing managers are acquiring
the business, they have a much better understanding of it and there is no
learning curve involved, which would be the case if it were being run by a new
set of managers. The advantage of an MBO over an LMBO is that the companys
debt load may be lower, giving it more financial flexibility.
However, there are several drawbacks to the MBO structure as well. While the
management team can reap the rewards of ownership, they have to make the
transition from being employees to owners, which requires a change in mind set
from managerial to entrepreneurial. Not all managers may be successful in
making this transition.
Also, the seller may not realize the best price for the asset sale in an MBO. If the
existing management team is a serious bidder for the assets or operations being
divested, the managers have a potential conflict of interest. That is, they could
downplay or deliberately sabotage the future prospects of the assets that are for
sale to buy them at a relatively low price.
MBOs are viewed as good investment opportunities by hedge funds and large
financiers, who usually encourage the company to go private so that it can
streamline operations and improve profitability away from the public eye, and
then take it public at a much higher valuation down the road. While private equity
funds may also participate in MBOs, their preference may be for MBIs, where the

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companies are run by managers they know rather than the incumbent
management team.

What is the 'Run Rate'?


The run rate is how the financial performance of a company would look if you
were to extrapolate current results out over a certain period of time.
The run rate is how the financial performance of a company would look if you
were to extrapolate current results out over a certain period of time.
In the context of extrapolating future performance (the first definition), the run
rate helps to put the company's latest results in perspective. For example, if a
company has revenues of $100 million in its latest quarter, the CEO might say:
"Our latest quarter puts us at a $400 million run rate." All this is saying is that if
the company were to perform at the same level for the next year, they'd have
annual revenues of $400 million.
The run rate can be a very deceiving metric, especially in seasonal industries. A
great example of this is a retailer after Christmas. Almost all retailers experience
higher sales during the holiday season. It is very unlikely that the coming
quarters will have sales as strong as in the 4th quarter, and so the run rate will
likely overstate next year's revenue.

Potential Focus Areas of a Financial Client


Where is the opportunity?
The key for every PE house is to understand what added values can they bring to
a deal and harvest upon exit. This can come from financial engineering and more
focus on cash and working capital management. However, more PE houses are
looking for a specific angle to add value to a Target. Even before the financial
crisis in 2009, the investment strategy of many Private Equity houses was
focussed on investing in distressed businesses. In today's environment, investing
in distressed businesses becomes an increasingly attractive market for PE
houses. The level of return depends on solving a multitude of a Target's
operational and strategic variables, which the Vendor (often a corporate) may not
have the expertise or the appetite to do so. Funding and liquidity constraints,
financial reporting issues, high turnover of staff and the lack of formal controls
are often associated with distressed companies. Therefore, interested PE players
must have the proper turnaround know-how to evaluate, plan, and manage such
investments.
What is the growth story for this business?
A growth story tells how a business will grow by identifying and exploiting new
growth opportunities. Looking to maximise the return, PE houses seek to invest in
companies with a solid growth plan supported by good market prospects. What
cash flows does the business generate? And what are its funding requirements?
In preparing the business valuation model, PE houses seek to quantify the
company's potential to generate cash and assess the achievability of the
investment criteria. The free cash flow generated by the business shows the
company's ability to develop new products and service the acquisition debt.
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What are the working capital and capital expenditure requirements?
Determining the working capital requirements of the Target is essential in
defining the funding requirements post-closing. The PE house may need to
arrange the availability of a credit line post acquisition to address the short-term
operating needs, but does not have the opportunity to get additional funding post
acquisition in case there are surprises.
What is the best tax structure?
Understanding the tax implications of the proposed deal and determining the
optimal tax structure is critical to creating deal value. Each transaction brings its
own set of potential exposures to buyers.
How can I exit?
A Financial buyer will look to exit the investment in three to seven years so as to
realise a return on the initial investment. Financial buyers may exit either
through:
Sale to a strategic buyer, or
Sale to another Financial buyer, resulting in a so-called secondary or
Even tertiary buy-out, or
An IPO.
In addition they may take cash out of the business though a recapitalisation and
subsequent payment of dividend.

What is 'Earnout'?
Earnout is a contractual provision stating that the seller of a business is to obtain
additional future compensation based on the business achieving certain future
financial goals.
The financial goals are usually stated as a percentage of gross sales or earnings.
Say an entrepreneur selling a business is asking $2,000,000 based on projected
earnings, but the buyer is willing to pay only $1,000,000 based on historical
performance. An earn out provision structures the deal so that the entrepreneur
receives more than the buyer's offer only if the business achieves a certain level
of earnings. The exact numbers would depend upon the business, but in this
example a simplified provision might set the purchase price at $1,000,000 plus
5% of gross sales over the next three years. The earn out thereby helps eliminate
uncertainty for the buyer.

Key Facts about private equity

How do private equity and buy-out funds differ from venture capital funds?
Venture capital firms have similar business models as those found in private
equity. However, their focus varies: venture funds largely invest capital in start-
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up and young companies with little or no track record. Private equity and buy-out
funds focus on investing capital in more mature businesses that demonstrate the
potential for growth in value and enhancing their performance over a prolonged
period through structural, strategic management and operational improvements.

How do private equity funds and hedge funds differ?


A very important point to understand about private equity is that all investments
centre on improving the business and ultimately increasing its value over the
long-term. Private equity investors succeed only when the companies they own
succeed. If a private equity company fails to succeed, it not only loses its own
money, but also that of its investors, ultimately damaging its ability to raise
future funds.
In contrast, hedge funds typically have a much shorter time horizon. They act as
pools of capital that usually invest in stocks, bonds or commodities and aim to
capitalise on short-term gains, using complicated trading strategies and
derivative financial instruments. Hedge funds usually have holding periods of
weeks or months, not years.

Why is debt involved if the ownership structure is referred to as private equity?


Virtually every company, public or private, has a capital structure made up of
equity (stock) and debt (bank loans, bonds, etc.). When a private equity firm
looks to acquire a company, the financing will comprise the equity (capital) raised
from investors as well as loans or 'leverage' from a number of other sources,
primarily banks.

How do private equity firms improve company performance?


To succeed in improving the performance of a portfolio company a private equity
firm needs to supply a great deal more than just financial creativity. Developing
organic revenue growth is key to securing increased value within a company. To
further enhance a company's performance it is also crucial to undertake
substantial operational improvements, cost and waste reductions, improving the
company's competitiveness, product repositioning and ability to enter new
markets, as well as the development and execution of a sound business strategy.

How does private equity benefit portfolio companies and the broader economy
and society?
In today's globalised world, private equity investment activity is increasing
substantially. CVC's success in investing in some of the world's most prominent
companies and developing their long-term value has helped to fuel the economy,
create wealth and drive innovation. Empirical evidence shows that private equity
portfolio companies create economic value by operating more efficiently.
Academic studies have shown that private equity investment and leverage has

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an overall positive impact on the financial performance and efficiency of
companies, especially since the transitional capital invested fills a critical gap
when capital markets are fragile.
Ultimately, leveraged buy-outs of portfolio companies generate greater
productivity, promote employment and salary growth, and have a positive effect
on employee relations within the company. Superior returns from private equity
investments strengthen pension funds that provide benefits for millions of
employees. According to research carried out by Preqin, by 2008, the total net
profits distributed to investors worldwide by private equity funds raised
throughout 2007 were over US$1.1 trillion.

What happens when private equity-owned companies reach the end of their
holding period?
At the end of the holding period, an exit from a portfolio company is usually
sought through: an initial public offering (IPO) or flotation of the portfolio
company on the stock market; a 'trade sale' of the company to a strategic
acquirer through a merger or acquisition (M&A); or a 'secondary sale' to another
private equity house.

What is 'Mezzanine Financing'

Mezzanine financing is a hybrid of debt and equity financing that is typically used
to finance the expansion of existing companies. Mezzanine financing is basically
debt capital that gives the lender the rights to convert to an ownership or equity
interest in the company if the loan is not paid back in time and in full. It is
generally subordinated to debt provided by senior lenders such as banks and
venture capital companies.

Since mezzanine financing is usually provided to the borrower very quickly with
little due diligence on the part of the lender and little or no collateral on the part
of the borrower, this type of financing is aggressively priced with the lender
seeking a return in the 20-30% range.
Mezzanine financing is advantageous because it is treated like equity on a
company's balance sheet and may make it easier to obtain standard bank
financing. To attract mezzanine financing, a company usually must demonstrate a
track record in the industry with an established reputation and product, a history
of profitability and a viable expansion plan for the business (e.g. expansions,
acquisitions, IPO).

What is 'Contango'?

A situation where the futures price of a commodity is above the expected future
spot price. Contango refers to a situation where the future spot price is below the
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current price, and people are willing to pay more for a commodity at some point
in the future than the actual expected price of the commodity. This may be due to
people's desire to pay a premium to have the commodity in the future rather
than paying the costs of storage and carry costs of buying the commodity today.
When a market is "in contango" when the delivery price of a particular futures
contract has to converge downward to meet the futures price. If prices did not
converge, it would set up an opportunity for investors to profit from arbitrage.
Contango situations can be costly to investors holding net long positions since
futures prices are falling. For example, assume an investor goes long a futures
contract today at $100. The contract is due in one year. If the expected future
spot price is $70, the market is in contango, and the futures price will have to fall
(unless the future spot price changes) to converge with the expected future spot
price.
The opposite of contango is known as normal backwardation. A market is "in
backwardation" when the futures price is below the expected future spot price for
a particular commodity. This is favourable for investors who have long positions
since they want the futures price to rise.

Contango Vs. Normal Backwardation

The shape of the futures curve is important to commodity hedgers and


speculators. Both care about whether commodity futures markets are contango
markets or normal backwardation markets. This isn't semantic: in 1993 the
German company Metallgesellschaft famously lost more than $1 billion dollars -
mostly because management deployed a hedging system that profited from
normal backwardation markets but did not anticipate a shift to contango markets.
In this article, we'll lay out the difference between contango and backwardation
and show you how to avoid serious losses.

A contango market is often confused with a normal futures curve; and a normal
backwardation market is confused with an inverted futures curve.
Let's start by getting an understanding of the difference between the two. Start
with a static picture of a futures curve. A static picture of the futures curve plots
futures prices (y-axis) against contract maturities (i.e., terms to maturity). This is
analogous to a plot of the term structure of interest rates: we are looking at
prices for many different maturities as they extend into the horizon. The chart
below plots a normal market in green and an inverted market in red:

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Copyright spot price. In the chart above, the spot price is $60. In the normal
(green line) market, a one-year futures contract is priced at $90. Therefore, if you
take a long position in the one-year contract, you promise to purchase one
contract for $90 in one year. Our long position is not an option in the future - it is
an obligation in the future.
Supply/Demand Determines the Shape
The red line in Figure 1, on the other hand, depicts an inverted market. In an
inverted market, the futures price for faraway deliveries is less than the spot
price. Why would a futures curve invert? Because, in the case of a physical asset,
there may be some benefit to owning the asset (called the convenience yield) or,
in the case of a financial asset, ownership may confer a dividend to the owner.
SEE: Why Dividends Matter
A few fundamental factors (i.e., the cost to carry a physical asset or finance a
financial asset) inform supply/demand for the commodity, which ultimately
determines the shape of the futures curve. If we really want to be precise, we
could say that fundamentals like storage cost, financing cost (cost to carry) and
convenience yield inform supply and demand. Supply meets demand where
market participants are willing to agree about the expected future spot price.
Their consensus view sets the futures price. And that's why a futures price
changes over time: market participants update their views about the future
expected spot price.
The traditional crude oil futures curve, for example, is typically humped: it is
normal in the short-term but gives way to an inverted market for longer
maturities.
Contango and Normal Backwardation: Patterns over Time
We have established that a futures market is normal if futures prices are higher at
longer maturities and inverted if futures prices are lower at distant maturities.
This is where the concept gets a little tricky, so we'll start with two key ideas:
As we approach contract maturity (we might be long or short the futures
contract, it doesn't matter), the futures price must converge toward the spot
price. The difference is called the basis. That's because, on the maturity date, the
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futures price must equal the spot price. If they don't converge on maturity,
anybody could make free money with an easy arbitrage.
The most rational futures price is the expected future spot price. For example, if
you and your counterparty both could foresee that the spot price in crude oil
would be $80 in one year, you would rationally settle on an $80 futures price.
Anything above or below would represent a loss for one of you!
Now we can define contango and normal backwardation. The difference is that
normal/inverted refers to the shape of the curve as we take a snapshot in time.
Contango and normal backwardation refer to the pattern of prices over time.
Specifically, is the price of our contract rising or falling?
Suppose we entered into a December 2012 futures contract, today, for $100.
Now go forward one month. The same December 2012 future contract could still
be $100, but it might also have increased to $110 (this implies normal
backwardation) or it might have decreased to $90 (implies contango). The
definitions are as follows:
Contango is when the futures price is above the expected future spot price.
Because the futures price must converge on the expected future spot price,
contango implies that futures prices are falling over time as new information
brings them into line with the expected future spot price.
Normal backwardation is when the futures price is below the expected future spot
price. This is desirable for speculators who are "net long" in their positions: they
want the futures price to increase. So, normal backwardation is when the futures
prices are increasing.
Consider a futures contract that we purchase today, due in exactly one year.
Assume the expected future spot price is $60 (see the blue flat line in Figure 2
below). If today's cost for the one-year futures contract is $90 (the red line), the
futures price is above the expected future spot price. This is a contango scenario.
Unless the expected future spot price changes, the contract price must drop. If
we go forward in time one month, note that we will be referring to an 11-month
contract; in six months, it will be a six-month contract.

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What is a 'Lock-Up Agreement?'
A
A lock-up agreement is a legally binding contract between the underwriters and
insiders of a company prohibiting these individuals from selling any shares of
stock for a specified period of time. Lock-up periods typically last 180 days (six
months) but can on occasion last for as little as 120 days or as long as 365 days
(one year).

Underwriters will have company executives, managers, employees and venture


capitalists sign lock-up agreements to ensure an element of stability in the
stock's price in the first few months of trading. When lock-ups expire, restricted
people are permitted to sell their stock, which sometimes (if these insiders are
looking to sell their stock) results in a drastic drop in share price due to the huge
increase in supply of stock.
B

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Debt push-down an acquisition structure leading to a tax effective
interest deduction?

The typical structure of a Swiss target company acquired through an acquisition


vehicle with subsequent merger and debt push-down is subject to income tax
limitations set by the Swiss tax authorities. The authorities often take the view
that interest expenses incurred after such merger cannot be deducted from
taxable income. This newsletter outlines structuring options to minimize
disadvantages resulting from the strict practice of the tax authorities.

1. STR UCTURE OF A DEBT PUSH-DOW N ACQUISITION


1.1 Introduction

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One of the factors of the success of M&A transactions is an appropriate
acquisition and financing structure. Using maximum leverage in an acquisition, in
which the return on assets exceeds the interest expenses, leads to a substantially
higher return on equity. For this reason, investors (for instance in an LBO or MBO)
wish to obtain maximum debt financing, also considering an increased risk of
insolvency and strategically reduced business opportunities due to lower financial
flexibility.

1.2 Debt Push-Down Structure


The basic acquisition structure for a debt push-down is implemented as follows:
The investor as a first step incorporates an acquisition vehicle in the form of a
separate legal entity. The investor contributes the equity necessary to finance the
acquisition and grants the vehicle additional shareholder loans, if required.
Furthermore, the acquisition vehicle usually borrows funds from banks to finance
the acquisition. Such funded acquisition vehicle acquires the shares of the target
company. This structure in principle excludes any liability risk for the investors, as
funding is non-recourse.
Now the financial means needed for repayment of the funding and interest
payments must be generated by the target company, which - contrary to the
acquisition company - conducts an operating business.
Ideally, the acquisition company and the target company merge following the
acquisition whereby the operating cash flow of the target company may be used
for interest payments and repayments of funding received by the acquisition
vehicle. From a Swiss corporate income tax point of view the question arises
whether the Swiss tax authorities allow such interest deduction by the merged
company as an income tax deductible item.

2. TAX CONSEQUENCES OF A DEBT PUSH-DOWN

2.1 Tax Effect of Interest Deduction before Debt Push-Down


Interest expenses incurred by the acquisition vehicle are generally tax-
deductible. Some hurdles, however, are embodied in the Swiss thin capitalization
rules. Interest on the part of a related partners debt that is qualified as hidden
equity under the published practice of the tax authorities is not deductible for
corporate income tax purposes and is subject to withholding tax.
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Regardless of the thin capitalization rules, a deduction of interest expenses by
the acquisition vehicle in most cases has no tax effect. This is based on the fact
that such company meets the requirements for the participation relief with regard
to qualifying dividends and capital gains for federal as well as for cantonal tax
purposes. In addition, such company usually benefits from the holding company
privilege and hence is exempt from any cantonal income taxes. Investors often
try to solve this ineffective interest expense by merging the acquisition vehicle
with the target company.

2.2 Tax Consequences of a Merger with Debt Push-Down


A merger is a transaction whereby all assets and liabilities of a company are
absorbed by another company and, as a result, the absorbed company ceases to
exist. Under corporate law, the target companys requirements in case of such an
upstream merger are not strict. Generally the merger neither results in a share-
for-share exchange nor in compensation payments for existing shareholders.
Under Swiss tax law, a merger of the acquisition company with the target
company can generally be done in a tax-neutral way, provided
the assets and liabilities remain liable for the same Swiss income taxation; and
the tax values are assumed by the absorbing entity (here the acquisition
vehicle).
In most cases, these requirements are met. Other transaction- specific
prerequisites are not required. In addition, the acquisition company may claim
unused tax-loss carry-forwards of the target company and offset such losses with
future profits.
In addition, in the course of such absorption a merger gain or loss may arise if the
tax value of target company shares on the books of the acquisition company
does not match the net asset value of the target company as reported in its own
books.
The absorption of the target company after being acquired typically results in a
merger loss for the acquisition company. This is based on the fact that the price
paid for the target company is usually higher than its net asset value. In most
cases, such merger loss is referred to as "unreal", as it is compensated by the
goodwill of the target company and other hidden reserves not shown in its
balance sheet. Although from a commercial law perspective such unreal merger
loss at the level of the acquisition vehicle qualifies as goodwill which can be
amortized, the authorities will not accept such amortization for income tax
purposes. Hence, the tax balance sheet is amended accordingly.

Regarding deductibility of interest expenses, the statements made in section 2.1


should also hold true after the merger. Also, any borrowing costs should then be
qualified as justified business expenses to the extent that the merged company is
not thinly capitalized. However, the vast majority of the cantonal tax authorities
deny the deduction of interest expenses after a merger in cases where the
acquisition vehicle has been specifically incorporated for the purpose of acquiring
the target company. Some cantons refuse a tax deduction entirely until the debt
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required for the acquisition has been paid off. Other cantons deny tax-effective
interest deductions for a period of five years following the merger. The cantonal
tax authorities all base their argument against deductibility of the interest
expenses on the concept of tax avoidance.

2.3 Tax Avoidance


According to established case law of the Swiss Federal Supreme Court, there is
generally tax avoidance if
the structure chosen by the taxpayer is uncommon, inappropriate or strange (if
the structure does not make sense from an economical point of view);
it appears that the structure has been chosen only in order to save taxes which
would normally be due; and
the structure would result in a substantial tax saving if accepted by the tax
authorities.
If all three conditions are met, according to settled federal case law the taxpayer
is taxed based on the structure that should have been adopted, i.e. the structure
that corresponds to their economic goals. The concept of tax avoidance is based
on the prohibition of abuse of rights. Considering its open description which
conflicts with the principles of legality and legal certainty, tax avoidance can
apply only in extraordinary cases. Such cases must contravene the sense of
fairness.
In many cases, an acquisition followed by a merger of the acquisition vehicle with
debt push-down is not tax-driven at all. The primary reason for the use of a new
acquisition vehicle is without doubt the isolation of the liability for the total
investment. A comparison of acquisition financing on an international scale
reveals that a direct financing without using means of the target is highly
unusual. Once the acquisition is completed, the acquisition company is no longer
of use. To limit the liability of the investor it is sufficient that the target company
remains a separate legal entity. It is therefore obvious to merge the acquisition
vehicle with the target company.
By merging the acquisition company with the target company, costs for
maintaining the acquisition company can be saved. Furthermore, a simplification
of corporate governance can be achieved. The investor is closer to the operating
cash flow. Finally and this is also an important reason for a merger the so-
called structural subordination is eliminated, i.e. the fact that according to
applicable capital protection provisions stated in Swiss corporate law, the
creditors of the acquisition company are no longer subordinated to the creditors
of the target company. The merger therefore eliminates any financial assistance
issues which arise if the creditors of the acquisition company receive securities
from the target company.

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2.4 Tax Consequences for the Seller

The tax consequences of the acquisition for the seller can of course not be
neglected in a transaction either. Especially in cases where the seller had held
the shares in the target company in his personal property, an indirect partial
liquidation provision must be observed. A merger of the acquisition company with
the target company within five years after the acquisition of the target company
may trigger income taxes for the seller. This is the reason why share purchase
agreements often limit a debt push-down to cases where it does not lead to an
indirect partial liquidation taxation of the seller.

3. ALTERNATIVE STRUCTURES
It appears that the Swiss Federal Supreme Court has never decided on debt push-
down structures. This can be explained by the long duration of court case
proceedings. Tax advisors have developed several viable alternatives which
depending on the specific starting point allow at least a partial tax deduction of
interest expenses. The most common structural alternatives are the following:

3.1 Cascade Purchase


The structuring alternative of a cascade purchase can be applied in cases where
the target consists of several companies. In such instance, acquisition debt can
be allocated to the different companies acquired during the cascade acquisition,
whereby one company buys another of the targets companies. This has the
effect that interest payments at the level of the acquired companies which in turn
have acquired further companies are tax deductible. If necessary, a target
company may even be split prior to the cascade acquisition in order to achieve
an optimal structure.

3.2 Equity Debt Swaps


Alternatively, the target company is not merged but reduces its capital whereby
the acquisition company converts its claim, resulting from the repayment of
reduced share capital, in an interest-bearing loan. The same result can be
achieved by means of a dividend distribution with a subsequent conversion of the
dividend claim into a loan. Subsequent interest, resulting from such new debt and
paid by the target company to the acquisition company, is income tax-deductible
as long as the companies are at arms length and the target company is not
thinly capitalized. The acquisition company receives taxable interest income
which at least for cantonal corporate income tax purposes is not taxable if the
acquisition company still qualifies as a holding company.

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3.3 Transfer of Assets to the Acquisition Company
Depending on the initial situation, further structuring alternatives may be
considered. It is for example possible to transfer income-generating assets from
the target company to the acquisition company by means of a tax-neutral
intragroup transfer (also called asset push-up). It must be noted, however, that in
certain cases the tax authorities have not only qualified such transaction
structure as tax avoidance but also refused the deduction of interest expenses for
tax purposes.

4. CONCLUSION
These alternative structures are helpful, but usually do not lead to a complete
tax-effective interest deduction. Therefore it is important to determine all non-tax
purposes leading to a debt push-down in a merger of the acquisition company
with the target company. Such determination allows discussions with the tax
authorities to demonstrate that the case at hand does not qualify as a tax
avoidance.

What's the difference between working capital and net working capital?

While both focus on obligations due within a year, thus exclude fixed assets/PP&E
(which together make up total capital) they actually have two almost opposite
meanings and implications.
From a strict accounting standpoint, basic working capital is current assets (cash,
inventory, a/r) minus current liabilities (a/p, short term debt). This essentially
represents a company's liquidity, or ability to meet short term demands. The
higher the working capital, the better / more liquid.
Net working capital is similar but removes the cash and debt consideration and
simplifies the formula to a/r and inventory minus a/p. This represents how much
capital is required run the operations of the business. In this case, the lower the
number the better as that means it takes up less capital (ie money) to run the
daily operations, ie the company is being more efficient. Less capital required =
less shareholders and creditors to pay. This definition has become much more
prominent in the last decade with companies and often when they talk working
capital they are actually referring to this definition, not the former.
For further comparison, in the first example having higher a/r is a good thing as
that means you have more money coming your way in the near term. In the latter
example it's a bad thing as that means your customers are taking too long to pay
you. (Vice versa for a/p) In the former example, higher inventory is good as that
means you're holding onto higher value, in the latter example high inventory is
bad as that means the company is not managing inventory effectively by
purchasing too much, and thus tying up capital in the process.

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Pitchbook
A pitchbook is a sales book created by an investment bank or firm that details the
main attributes of the firm, and it is used by the firm's sales force to help sell
products and services and generate new clients. Pitchbooks are helpful guides for
the sales force to remember important benefits and to provide visual aids when
presenting to clients.
There are two main types of pitchbooks. There is the main pitchbook, which
contains all of the main attributes of the firm, and one that contains details about
a specific deal, such as a company's IPO or investment product.
The main pitchbook provides general overview about the firm. For an investment
bank, it would show information like the number of analysts, its prior IPO success
and the number of deals it completes per year. For an investment firm, it will
show information such as the financial strength of the company, and the many
resources and services available for its clients. If the pitchbook is being used by a
team or individual financial advisor, there could be biographical information as
well. All the details displayed in the pitchbook are points that the sales team
should focus on when selling the benefits of the firm to potential clients.

Product Pitchbook
For an investment bank, this form of pitchbook focuses on all of the benefits of
the issue, helping brokers and investment bankers demonstrate how the firm can
service the specific needs of their potential clients. It would have more detailed
information about how the potential IPO process could play out for the potential
client. It would also show comparable IPOs within the same industry that the
investment bank has had success in the past.

In 2011, the company Autonomy the acquisition target of several larger


competitors. Hewlett Packard and Oracle were interested, but HP eventually
became the victor and acquired the software infrastructure company. Oracle
decided to post the IPO pitchbook, which was developed by the firm Qatalyst
Partners, on its website. In the pitchbook, Qatalyst shows examples of how Oracle
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would benefit from acquiring Autonomy, showing it will increase its competitive
advantage in areas where Oracle has no footing. It also shows the key financial
metrics of the company and how it has both positive revenue and margin growth.
The book also shows the partners and customers that Oracle will immediate
acquire once it purchases the company. It also goes into detail about Automony's
management team and directors

For an investment firm, the pitchbook would be more product-oriented. It could


show the track record of an investment portfolio, using charts and comparisons to
an appropriate benchmark. If the investment strategy is more advanced, it would
display the method of selecting stocks and other informational data that would
help the potential client understand the strategy.

Envy ratio

Envy ratio, in finance, is the ratio of the price paid by investors to that paid by
the management team for their respective shares of the equity. It is used to
consider an opportunity for a management buyout. Managers are often allowed
to invest at a lower valuation to make their ownership possible and to create a
personal financial incentive for them to approve the buyout and to work diligently
towards the success of the investment. The envy ratio is somewhat similar to the
concept of financial leverage; managers can increase returns on their
investments by using other investors' money.

If private equity investors paid $500M for 80% of a company's equity, and a
management team paid $60M for 20%, then ER=(500/80)/(60/20)=2.08x. This
means that the investors paid for a share 2.08 times more than did the
managers. The ratio demonstrates how generous institutional investors are to a
management teamthe higher the ratio is, the better is the deal for
management.[2]
As a rule of thumb, management should be expected to invest anywhere from six
months to one years gross salary to demonstrate commitment and have some
"skin in the game".[3] In any transaction, the envy ratio is affected by how keen
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the investors are to do the deal; the competition they are facing; and economic
factors.[4]

What is a 'Hire Purchase'

A hire purchase is a method of buying goods through making installment


payments over time. The term "hire purchase" originated in the United Kingdom
and is similar to rent-to-own arrangements in the United States. Under a hire
purchase contract, the buyer is leasing the goods and does not obtain ownership
until the full amount of the contract is paid.
To begin a hire purchase, a payment is often required up front. The rest of the
amount due is submitted through scheduled payments, similar to an installment
loan or a vehicle lease. The ownership of the good purchased through a hire
purchase is not officially transferred to the buyer until all required payments have
been submitted. Companies offering hire purchase options earn a profit by
applying additional costs to the monthly payment which serves as interest
charges for the purchase.

Businesses commonly employ this manner of leasing goods to enhance the


appearance of earnings metrics. For instance, by leasing assets, it may be
possible to keep the debt used to pay for the assets and the asset itself off the
balance sheet, resulting in higher operational and return-on-asset (ROA) figures.
In circumstances where a buyer either cannot continue to make the required
payments or is no longer interested in purchasing the item, it can be returned to
the company at which the hire purchase arrangement was made. This may
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render the original agreement void, as the associated asset has been returned to
the store that currently maintains ownership rights on the asset in question.
Risks of Using a Hire Purchase
In the United States, consumer rent-to-own arrangements are controversial
because they can be used in an attempt to circumvent proper accounting
standards. This can include the lack of credit checks as well as payment amounts
that result in higher-than-average amounts of interest effectively being paid.

There have been allegations that U.S. rent-to-own businesses bypass certain
consumer protection laws by referring to the purchase contracts as rental
agreements instead as an extension of credit. Rental agreements are exempt
from the Truth in Lending Act that requires the clear disclosure of interest rates
on consumer loan products. This allows rent-to-own businesses to refrain from
explicitly stating the associated interest rate paid based on the product's price
compared to the monthly payment amounts.
Additionally, if a buyer using a hire purchase fails to make the required payments,
the company sponsoring the purchase can repossess the item. Whether a
repossession is voluntary or involuntary, the buyer is generally not eligible to
receive any funds back that have already been placed toward the purchase.

'Shadow Market'

An unregulated private market in which investors can purchase shares in


companies that are not currently publicly traded. Shadow markets in stocks give
investors an opportunity to invest in companies prior to their initial public
offerings (IPO). However, the SEC requires investors to have a net worth greater
than $1 million in order to participate in this non-transparent market. These
people are what the SEC refers to as "accredited investors".
The main benefit of using the shadow market to purchase shares is that the
accredited investor can get exposure to certain companies much earlier than
most other investors. This greatly increases the potential profit for the investor if
the stock goes public and demand from average investors drives the stock price
up. Some of the downsides of the shadow market include lack of liquidity, lack of
disclosure from the company, and a greater degree of uncertainty and risk.

Add-On Acquisition
An add-on acquisition refers to a company that is added by a private equity firm
to one of its platform companies, or by a strategic buyer pursuing a consolidation
investment strategy. Typically, the acquirer will already have the management
capabilities, infrastructure, and systems that allows for organic or acquisitions
growth. The add-on acquisitions can provide complimentary services, technology,
or expansion into the existing geographic footprint that can be quickly integrated
into the existing infrastructure. A larger add-on target might also bring some
diversification of products, geographies, and customers which would further
extend the reach of the buyer.

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Similar to a bolt-on or tuck-in, an add-on acquisition can refer to acquisitions of
smaller companies with very little financial and administrative infrastructure.
Given the lack of infrastructure, acquirers will usually pay lower end valuation
multiples for add-on acquisitions.
Unlike a bolt-on or a tuck-in, an add-on acquisition can also refer to the
acquisition of a larger company that provides diversification to an existing
business. The add-on business could have strong infrastructure and management
teams, and in some instances might be seen as a synergistic purchase by an
acquirer. In this case, an add-on acquisition could fetch a premium valuation in
the marketplace.

Bolt-on Acquisition
A bolt-on acquisition refers to a company that is added by a private equity (PE)
firm to one of its platform companies. Typically, a PE firm will partner with a
larger company that has a position in a particular market. This larger company
becomes a platform to expand into the market because it has the management
capabilities, infrastructure and systems that allows for organic or acquisition
growth.

The platform company will look for bolt-on acquisitions that provide
complementary services, technology or geographic footprint diversification and
can be quickly integrated into the existing management infrastructure.

Bolt-on acquisitions are usually smaller companies with very little financial and
administrative infrastructure. They are typically operated by the company owner
and have hit a tipping point where they can't grow anymore due to lack of
capital, scale or management expertise. They may have unsophisticated financial
systems, IT and internal controls, but are usually excellent operating companies
with good customer relationships.
The owners of bolt-on acquisitions are usually looking to move the administration
and corporate management so they can focus on operations and customers. This
is why private equity-backed platform companies or corporate buyers with the
infrastructure in place can be a perfect fit. Given the lack of infrastructure at
these companies, buyers will usually pay a lower valuation multiple for a bolt-on
acquisition than they would for a platform company.

Hostile Takeover

A hostile takeover is the acquisition of one company (called the target company)
by another (called the acquirer) that is accomplished by going directly to the
company's shareholders or fighting to replace management to get the acquisition
approved. A hostile takeover can be accomplished through either a tender offer
or a proxy fight.

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The key characteristic of a hostile takeover is that the target company's
management does not want the deal to go through. Sometimes a company's
management will defend against unwanted hostile takeovers by using several
controversial strategies, such as the poison pill, the crown-jewel defense, a
golden parachute or the Pac-Man defense.

Tender Offer or Proxy Fight

When a company, an investor or a group of investors makes a tender offer to


purchase the shares of another company at a premium above the current market
value, the board of directors might reject the offer. The acquiring company can
take that offer directly to the shareholders, who may choose to accept it if it is at
a sufficient premium to market value or if they are unhappy with current
management. The sale of the stock only takes place if a sufficient number of
stockholders agree to accept the offer.
In a proxy fight, opposing groups of stockholders persuade other stockholders to
allow them to vote their shares. If a company that makes a hostile takeover bid
acquires enough proxies, it can use those proxies to vote to accept the offer.

Preemptive Takeover Defenses

A company can establish stocks with differential voting rights (DVR); a stock with
less voting rights pays a higher dividend. This makes it an attractive investment
but it becomes harder to generate the votes needed for a hostile takeover.
Another defense is to establish an employee stock ownership program (ESOP),
which is a tax-qualified plan in which employees own substantial interest in the
company. They are more likely to vote with management, which is why this can
be a successful defense. In a crown jewel defense, a provision of the company's
bylaws requires the sale of the most valuable assets if there is a hostile takeover.

Reactive Defenses

Officially known as a shareholder rights plan , a poison pill defense allows existing
shareholders to buy newly issued stock at a discount if one shareholder has
bought more than a stipulated percentage of the stock; the buyer who triggered

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the defense is excluded from the discount. The term is often used broadly to
include a range of defenses, including issuing both additional debt to make the
target less attractive and stock options to employees that vest upon a merger. A
people pill provides for the resignation of key personnel in the case of a hostile
takeover, while the Pac-Man defense has the target company aggressively buy
stock in the company attempting the takeover.

Poison Pill

A poison pill is a tactic utilized by companies to prevent or discourage hostile


takeovers. A company targeted for a takeover uses a poison pill strategy to make
shares of the companys stock look unattractive or less desirable to the acquiring
firm.
There are two types of poison pills:
1. A flip-in permits shareholders, except for the acquirer, to purchase additional
shares at a discount. This provides investors with instantaneous profits. Using this
type of poison pill also dilutes shares held by the acquiring company, making the
takeover attempt more expensive and more difficult.

2. A flip-over enables stockholders to purchase the acquirers shares after the


merger at a discounted rate. For example, a shareholder may gain the right to
buy the stock of its acquirer, in subsequent mergers, at a two-for-one rate.
The term poison pill is the common colloquial expression referring to a specially
designed shareholder rights plan. A defensive tactic enacted by a companys
board of directors, poison pills, at least, cause an aggressive takeover plot to be
rethought. At most, a poison pill may deter a takeover altogether.

History and Functionality

In regard to mergers and acquisitions, poison pills were initially constructed in the
early 1980s. They were devised as a way to stop bidding takeover companies
from directly negotiating a price for the sale of shares with shareholders and
instead force bidders to negotiate with the board of directors.

Shareholder rights plans are typically issued by the board of directors in the form
of a warrant or an option attached to existing shares. These plans, or poison pills,
can only be revoked by the board. Since their inception, poison pills have
formulated into two types with the flip-in variety being the most common.

An Example
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Flip-in poison pills may hold an attached option that permits shareholders to buy
additional discounted shares if any one shareholder buys more than a certain
percentage, or more, of the companys shares. For example, a flip-in poison pill
plan is triggered when a shareholder buys 25% of the companys shares. When it
is triggered, every shareholder, minus the holder who purchased 25%, is entitled
to buy a new issue of shares at a discounted rate. The greater the number of
shareholders who buy additional shares, the more diluted the bidders interest
becomes and the higher the cost of the bid. If a bidder is aware such a plan could
be activated, it may be inclined not to pursue a takeover without board approval.

Golden Parachute

A golden parachute consists of substantial benefits given to top executives if the


company is taken over by another firm and the executives are terminated as a
result of the merger or takeover. Golden parachutes are contracts given to key
executives and can be used as a type of anti-takeover measure, often collectively
referred to as poison pills, taken by a firm to discourage an unwanted takeover
attempt. Benefits may include stock options, cash bonuses and generous
severance pay.
Golden parachute clauses can be used to define the lucrative benefits that an
employee would receive if he is terminated. The term often relates to the
terminations that result from a takeover or merger.

Controversy Surrounding Golden Parachutes


The use of golden parachutes is controversial. Supporters believe that golden
parachutes make it easier to hire and retain top executives, particularly in
merger-prone industries. In addition, proponents believe that these lucrative
benefit packages allow executives to remain objective if the company is involved
in a takeover or merger, and that they can discourage takeovers because of the
costs that are associated with the golden parachute contracts.

Opponents of golden parachutes argue that executives are already well-


compensated and should not be rewarded for being terminated. Opponents may
further argue that executives have an inherent fiduciary responsibility to act in
the best interest of the company, so they should not need additional financial
incentive to remain objective and act in the manner that best benefits the
company. In addition, many people who disagree with golden parachutes cite that
the associated costs are minuscule compared to the takeover costs and, as a
result, can have little to no impact on the outcome of the takeover attempt.

Examples of Golden Parachutes

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Some examples of golden parachutes that have been reported in the press
include:
Meg Whitman, chief executive officer (CEO) of Hewlett-Packard Enterprise,
stands to receive almost $9 million if there is a change of control at the company
and more than $51 million if she is terminated.
Until a federal court blocked it in May 2016, Staples Inc. and Office Depot Inc.
were looking to merge. If they had done so, the CEO of Office Depot would have
collected $39 million under his golden parachute.
Dell Inc. is in the process of merging with storage giant EMC Corporation. By
virtue of his golden parachute, EMC's CEO will receive compensation worth $27
million.

What is the 'Pac-Man Defense'

The Pac-Man defense is a defensive tactic used by a targeted firm in a hostile


takeover situation. In a Pac-Man defense, the target firm then tries to acquire the
company that has made the hostile takeover attempt. In an attempt to scare off
the would-be acquirers, the takeover target may use any method to acquire the
other company, including dipping into its war chest for cash to buy a majority
stake in the other company.
A smaller or equivalent company may avoid a hostile takeover by using the Pac-
Man defense.

Pac-Man Game Strategy


In the Pac-Man game, the player has several ghosts chasing and trying to
eliminate it. If the player eats a power pellet, he may turn around and eat the
ghosts.
Companies may use a similar approach as a means of avoiding a hostile takeover.
During the acquiring phase, the takeover company begins a large-scale purchase
of the target companys stocks for gaining control of the target company. As a
counter-strategy, the target company may begin buying back its shares and
purchasing shares of the takeover company.

War Chest

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A companys war chest is the buffer of cash kept aside for uncertain adverse
events, such as taking over a company. A war chest is typically invested in liquid
assets such as Treasury bills and bank deposits that are available on demand.

Disadvantages of the Pac-Man Defense


The Pac-Man defense is an expensive strategy that may increase debts for the
target company. Shareholders may suffer losses or lower dividends in future
years.

Examples of the Pac-Man Defense


In 1982, Bendix Corporation attempted to overtake Martin Marietta by purchasing
a controlling amount of its stocks. Bendix Corporation became the owner of the
company on paper. However, Martin Mariettas management reacted by selling
off its chemical, cement and aluminum divisions and borrowing over $1 billion to
counter the acquisition. The conflict resulted in Allied Corporation acquiring
Bendix Corporation.
In February 1988, after a month-long takeover fight that began when E-II
Holdings Inc. made an offer for American Brands Inc., American Brands bought E-
II for $2.7 billion. American Brands financed the merger through existing lines of
credit and a private placement of commercial paper.
In October 2013, Jos. A. Bank launched a bid to take over Mens Wearhouse.
Mens Wearhouse rejected the bid and countered with its own offers. During
negotiations, Jos. A. Bank bought Eddie Bauer to gain more control in the
marketplace. Mens Wearhouse ended up buying Jos. A. Bank for $1.8 billion.

Transitional Service Agreement (TSA)

Definition - What does Transitional Service Agreement (TSA) mean?


A transitional service agreement (TSA) is made between a buyer and seller and
contemplates having the seller provide infrastructure support such as accounting,
IT, and HR after the transaction closes. The TSA is common in situations where
the buyer does not have the management or systems in place to absorb the
acquisition, and the seller can offer them for a fee.
Transitional service agreements are common when a large company sells one of
its divisions or certain non-core assets to a less sophisticated buyer or a newly
incorporated company where the senior management is in place, but the back
office infrastructure has not yet been assembled. They can also be used during
"carve-outs" where a large company spins out a division into a separate public
company, and then offers the infrastructure services for a defined period of time.

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Transitional service agreements can be extremely difficult to manage if they are
not properly defined. Usually, poorly drafted TSA's result in disputes between the
buyer and the seller centred on the scope of services to be provided.
TSA's should ensure the following key points are fully defined:
The fee for the general scope of services and additional charges for services
beyond the scope;
The term of the agreement and any available renewal terms;
The dispute resolution mechanism to deal with discrepancies between the buyer
and seller; and
How the TSA will be transitioned once the buyer is able to assume the
administrative responsibilities

Stock Purchase Agreement (SPA)


Definition - What does Stock Purchase Agreement (SPA) mean?
The Stock Purchase Agreement ("SPA") is the definitive agreement that finalizes
all terms and conditions related to the purchase and sale of the shares of a
company. It is different from an Asset Purchase Agreement ("APA") where the
assets (not the shares) of a company are being bought/sold.

The stock purchase agreement covers the following sections:


Interpretation - provides the definitions for all the major terms used in the
overall body of the agreement;
Purchase and sale of stock - itemizes the purchase price, any purchase price
adjustments, the purchase price allocation for tax purposes between the seller
and the buyer, and dispute resolution mechanisms;
Representations and warranties of the seller and buyer - provides all the
statements that the seller and buyer are signing off to be true;
Matters related to employees - provides terms on how employee benefits and
any accrued bonuses are to be handled post transaction;
Indemnifications - provides details on all indemnifications to be provided by
either the seller or buyer to each other for any costs that may arise post
transaction resulting from conditions that existed prior to the deal closing;
and Tax matters - specifies any special tax treatment that either the seller or the
buyer may be entitled to.
While the entire SPA should be reviewed, a seller should focus specifically on two
sections: the purchase and sale section and the representations and warranties.
The purchase/sale section should match exactly to the terms stipulated on the
letter of intent (LOI). If there are any differences, they likely resulted from the
buyer due diligence, and should have been formally negotiated prior to the
completion of the SPA.

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The representations and warranties need to be fully scrutinized to ensure there is
no statement that is believed to be untrue. There is usually recourse and
potential legal action if it is later found out that the representations and
warranties provided were untrue. Even post-transaction, this may result in a
purchase price adjustment where the seller is required by the legal courts to
reimburse the buyer for any misrepresentations.

'Reverse Takeover - RTO'

A reverse takeover (RTO) is a type of merger that private companies use become
publicly traded without resorting to an initial public offering (IPO). Initially, the
private company buys enough shares to control a publicly traded company. The
private company's shareholder then uses its shares in the private company to
exchange for shares in the public company. At this point, the private company
has effectively become a publicly traded company. An RTO is also known as a
reverse merger or a reverse IPO.
With this type of merger, the private company does not need to pay the
expensive fees associated with arranging an IPO. However, the company does not
acquire any additional funds through the merger, and it must have enough funds
to complete the transaction on its own.
While not a requirement of an RTO, the name of the publicly traded company
involved is often changed as part of the process. Additionally, the corporate
restructuring of one or both of the merging companies are adjusted to meet the
new business design.
It is not uncommon for the publicly traded company to have had little, if any,
recent activity, existing as more of a shell corporation. This allows the private
company to shift its operations into the shell of the public entity with relative
ease, all while avoiding the costs, regulatory requirements and time constraints
associated with an IPO. While a traditional IPO may require months or years to
complete, an RTO may be complete within weeks.
Using a Reverse Takeover to Access U.S. Markets
A foreign company may use an RTO as a mechanism to gain entry into the U.S.
marketplace. If a business with operations based outside of the U.S. purchases
enough shares to become a controlling interest in the U.S. company, it can move
to merge the foreign-based business with the U.S.-based one, giving access to a
new market without the costs traditionally involved.
To complete the process, the final resulting company must be able to meet all
Securities Exchange Commission (SEC) reporting requirements and other
regulatory standards, including the filing of an SEC Form 8-K to disclose the
transaction.
Alternate Definition

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A reverse takeover can also refer to an instance where a smaller company takes
over a larger one. It is so named due to the fact that it is the lesser expected
arrangement of the traditional takeover of a smaller business by a larger one.

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