Deal Structuring Process-II

Presented by Prof. (Dr.) Manish Popli

Form of Acquisition

1
 Form of Acquisition

• Slump Sale and Asset purchases1 :

– Sale of all or a portion of the assets of the target to the buyer or its subsidiary in
exchange for buyer stock , cash or debt. The buyer may assume all, some, or
none of the target’s liabilities.

• Stock purchases:
– Involves the sale of the outstanding stock of the target to the buyer or its
subsidiary by the target’s shareholders.

– The target’s shareholders may receive acquirer stock, cash, or both for their
shares.

1: Section 180 (1) of the companies act require board of Directors of a company to exercise the slump sale/ Asset sale only with the consent of
the company by a special resolution

M&A Course by Prof. Manish Popli 2

 Form of Acquisition

• Merger

– A merger involves the combination of the target with the buyer or a subsidiary
formed to complete the merger.

M&A Course by Prof. Manish Popli 3

Instruments for managing risks post closing

4
 Escrow accounts

• In a all cash transaction , the risks accrue entirely to the buyer. Despite exhaustive
due diligence there is no assurance that the buyer will have uncovered all the risks
associated with the target.

• Post-closing adjustment price mechanisms include

• Holdback or escrow account: Both mechanism rely on an audit of the target firms .

• Example:
– ABRY and F+W Publications case

– Google’s purchase of YouTube involved a holdback of a portion of the

purchase price because of the potential for copyright infringement litigations.

M&A Course by Prof. Manish Popli 5

 Managing Risk: Earn out Agreements (1)

• Earn-out agreements : Used whenever the buyer and the seller cannot agree
on the probable performance of the seller’s business over some future period.

– Essentially, it is a financial contract in which a portion of the purchase price of a

company is to be paid in the future, contingent on the realization of a previously
agreed-on future earnings level or some other performance measure.

M&A Course by Prof. Manish Popli 6

 Managing Risk: Earn out Agreements (2)

• Earn out can take many forms:

• Some earn outs are payable only if a certain performance threshold is achieved;
others depend on average performance over a number of periods.

• Earn-outs are common in high-tech industries.

M&A Course by Prof. Manish Popli 7

 Managing Risk: Earn out Agreements (3)

• Cautions:

– Acquired firm management may take only those actions which can improve
short-term profits as the expense of profits in the long-term.

– Management motivation may be lost if the acquired firm does not perform well
to achieve the targets.

M&A Course by Prof. Manish Popli 8

 Managing Risk: Earn out Agreements (4)

In what situations would you suggest to have a earn-out kind of instrument?

• Situations of Asymmetric information

– as a way of reducing downside risk

• Significant Intangibles involved

– Retain the human capital in the target firm

• Core vs Non-core Acquisitions (Related vs unrelated Acquisition)

• No experience of prior Acquisitions

M&A Course by Prof. Manish Popli 9

 Managing Risk: Earn out Agreements (5)

In what situations would you suggest to have a earn-out kind of instrument?

• Equity Stake purchased

• High-tech or Service Industries

– Greater uncertainty concerning the value of the target

– Proprietary Assets

• Resource are Sticky! (non-Fungibility)

• These problems are magnified in an international environment because tacit

resources are more difficult to assimilate.

M&A Course by Prof. Manish Popli 10

 Research
Gap & Earn out Payments : Indian Scenario
Objectives

• Patni acquired Cymbal (a US firm) In 2004

– Total consideration of: $68 million

– Cymbal would be paid $35 million upfront and
– the balance of $33 million would be paid over three years based on meeting
projected revenue and profit targets.

• Likewise, Cognizant's acquisition of Fathom (in April 2005) was structured as $19 million
payment in cash and stock upfront with a $16 million earn out.

• Satyam's acquisition of Citisoft was structured as $23 million guaranteed cash payment
(of which $10 million would be paid upfront) and $16 million as earn out.

• http://economictimes.indiatimes.com/tech/ites/tech-mahindra-to-buy-uk-based-digital-
firm-as-buyout-spree-continues/articleshow/52862136.cms

M&A Course by Prof. Manish Popli

11
 Managing Risk: CVR

• Contingent Value Rights (CVRs)

• CVRs are commitments by the issuing company to pay additional cash or securities
to the holder of the CVR if the share price of the issuing company falls below a
specified level at some date in the future.

– Or reverse as well.

• While relatively rare, such rights are sometimes granted in deals in which there are
large disagreements between the buyer and seller with respect to the purchase
price.

M&A Course by Prof. Manish Popli 12

Tax Concerns

13
 Tax Concerns (1)

• In order to mitigate some of the tax risks, parties have in the past

– negotiated specific tax indemnities in the deal documents and/or

– held back a certain portion of deal consideration in escrow and/or

– have taken tax insurance to cover potential tax risk.

M&A Course by Prof. Manish Popli 14

 Tax Concerns (2)

• Indemnity and R&W Insurance

– Given, the tax concerns in India, tax indemnity has also occupied a central theme
in the negotiations.

– R&W Insurance (representation and warranties insurance)

M&A Course by Prof. Manish Popli

15
Thanks!

16