FINA 4050A

Class 7: M&A Deal Structuring

Process: Payment & Legal
Considerations

Prof. Chew Seen Meng

4 Nov, 2020
If you can’t convince them,
confuse them.

—Harry S. Truman
 Exhibit 1: Course Layout: Mergers,
Acquisitions, and Other
Restructuring Activities

Part I: M&A Part II: M&A Process Part III: M&A Part IV: Deal Part V: Alternative
Environment Valuation and Structuring and Business and
Modeling Financing Restructuring
Strategies

Ch. 1: Motivations for Ch. 4: Business and Ch. 7: Discounted Ch. 11: Payment and Ch. 15: Business
M&A Acquisition Plans Cash Flow Valuation Legal Considerations Alliances

Ch. 2: Regulatory Ch. 5: Search through Ch. 8: Relative Ch. 12: Accounting & Ch. 16: Divestitures,
Considerations Closing Activities Valuation Tax Considerations Spin-Offs, Split-Offs,
Methodologies and Equity Carve-Outs

Ch. 3: Takeover Ch. 6: M&A Ch. 9: Financial Ch. 13: Financing the Ch. 17: Bankruptcy
Tactics, Defenses, and Postclosing Integration Modeling Basics Deal and Liquidation
Corporate Governance

Ch. 10: Private Ch. 14: Applying Ch. 18: Cross-Border

Company Valuation Financial Models to Transactions
Deal Structuring
 Learning Objectives

• Primary Learning Objective: To provide

students with a knowledge of the M&A
deal structuring process
• Secondary Learning Objectives: To enable
students to understand
– the primary components of the process,
– payment considerations, and
– legal considerations
 Deal Structuring Process
• Deal structuring involves identifying
– The primary goals of the parties involved in the
transaction;
– Alternatives to achieve these goals; and
– How to share risks.
• The appropriate deal structure is that which
– Clearly defines the rights and obligations of the
parties involved and satisfies as many of their primary
objectives as necessary to reach agreement
– Subject to an acceptable level of risk
Questions: 1. What are common high priority needs of public company
shareholders? Private/family owned firm shareholders?
2. How would you determine the highest priority needs of the
parties involved?
 Major Components of
Deal Structuring Process

1. Acquisition vehicle
2. Post-closing
organization
3. Form of payment
4. Form of acquisition
5. Legal form of selling
entity
6. Accounting
Considerations
7. Tax considerations
 Factors Affecting Alternative Forms
of Legal Entities

1. Control by owners
2. Management autonomy
3. Continuity of ownership
4. Duration or life of entity
5. Ease of transferring ownership
6. Limitation on ownership liability
7. Ease of raising capital
8. Tax Status
Question: Of these factors, which do you believe is often the most
important? Explain your answer.
 Acquisition Vehicle
Acquirer’s Objective (s) Potential Organization

Maximizing management Corporate (C or S) or

control divisional structure
Facilitating postclosing
integration
Minimizing or sharing risk Partnership/joint venture
Holding company
Gaining control while limiting Holding company
investment
Transferring ownership Employee stock ownership
interest to employees plan
 Post-Closing Organization

Acquirer’s Objective (s) Potential Organization

Integrate target immediately
Centralize control in parent
Facilitate future funding
Implement earn-out
Preserve target’s culture
Exit business in 5-7 years
Assume minority position
Minimize risk
Minimize taxes
Pass through losses
Corporate or divisional
structure
Holding company
Partnerships
Limited liability companies
Sub-Chapter S corporations
 Discussion Questions
1. What is an acquisition vehicle? What are
some of the reasons an acquirer may
choose a particular form of acquisition
vehicle?
2. What is a post-closing organization?
What are some of the reasons an
acquirer may choose a particular form of
post-closing organization?
 Form of Payment
• Cash (Simple but creates immediate seller tax liability)
• Non-cash forms of payment
– Common equity (Possible EPS dilution but defers tax liability)
– Preferred equity (Lower shareholder risk in liquidation)
– Convertible preferred stock (Incl. attributes of common & pref.)
– Debt (secured and unsecured; lower risk in liquidation)
– Real property (May be tax advantaged through 1031 exchange)
– Some combination (Meets needs of multiple constituencies)
• Closing the gap on price and risk mitigation
– Balance sheet adjustments (Ignores off-balance sheet value)
– Earn-outs or contingent payments (May shift risk to seller)
– Rights, royalties, and fees (May create competitor & seller tax
liability)
– Seller’s notes
– Collar arrangements (Often used if acquirer’s share price has a
history of volatility)
 Collar Arrangements1,2
Objective: To guarantee an offer price per share (OPPS) within a range for target firm
shareholders.

Offer Price Per Share = Share Exchange Ratio (SER) x Acquirer’s Share Price (ASP)
= Offer Price Per Target Share x Acquirer’s Share Price
Acquirer’s Share Price

Collar Arrangement: Defines the maximum and minimum price range within which the
OPPS varies.

SER x ASP (lower limit) ≤ Offer Price Per Share ≤ SER x ASP (upper limit)

Example: A target agrees to a $50 purchase price based on a share exchange ratio of 1.25
acquirer shares for each target share. The value of the each acquirer share at the time
of the agreement is $40 per share. The target shareholder is guaranteed to receive $50
per share as long as the acquirer’s share price stays within a range of $35 to $45 per
share. The share exchange ratio floats within the $35 to $45 range in order to maintain
the $50 purchase price.
($50/$35) x $35 ≤ ($50/$40) x $40 ≤ ($50/$45) x $45
1.4286 x $35 ≤ 1.25 x $40 ≤ 1.1111 x $45
1Fora fixed value agreement the dollar offer price per share is fixed and the number of shares exchanged varies with the value of the acquirer’s share price.
Acquirer share price changes require re-estimating the share exchange ratio. Variable or floating exchange ratios are used most often when the acquirer’s
share price is volatile. Fixed share exchange agreements, in which the SER does not vary, are more common since they involve both firms’ share prices and
allow both parties to share in the risk or benefit of fluctuating share prices.
2SER generally calculated based on the 10 to 20 trading day period ending 5 days prior to closing. The 5-day period provides time to calculate the appropriate
acquirer share price and to incorporate into legal documents.
Case Study: Alternative Collar Arrangements Based on Fixed
Value (SER Floats) and Fixed Share Exchange Ratios
On 9/5/2009, Flextronics agreed to acquire IDW in a stock- for-stock merger with an aggregate value of
approximately $300 million. The share exchange ratio used at closing was calculated using the
Flextronics average daily closing share price for the 20 trading days ending on the fifth trading day
immediately preceding the closing. Transaction terms identified the following three collars:

1. Fixed Value Agreement (SER floats-offer price fixed within a range): Offer price was calculated using
an exchange ratio floating inside a 10% collar above and below a Flextronics (acquirer) share
price of $11.73 and a fixed purchase (offer) price of $6.55 per share for each share of IDW (target)
common stock. The range in which the exchange ratio floats can be expressed as follows:a

[$6.55/$10.55] x $10.55 ≤ [$6.55/$11.73] x $11.73 ≤ [$6.55 /$12.90] x $12.90

.6209 x $10.55 ≤ .5584 x $11.73 ≤ .5078 x $12.90

.6209 shares of Flextronics stock issued for each IDW share (i.e., $6.55/$10.55) if Flextronics declines
by up to 10%
.5078 shares of Flextronics stock issued for each IDW share (i.e., $6.55 /$12.90) if Flextronics
increases by up to 10%

2. Fixed Share Exchange Agreement (SER fixed-offer price floats within a range): Offer price calculated
using a fixed exchange ratio inside a collar 11% and 15% above and below $11.73 resulting in a
floating purchase (offer) price if the average Flextronics' stock price increases or decreases
between 11% and 15% from $11.73 per share. (See the next slide.)

3. The target, IDW, has the right to terminate the agreement if Flextronics' share price falls by more than
15% below $11.73. If Flextronics' share price increases by more than 15% above $11.73, the
exchange ratio floats based on a fixed purchase price of $6.85 per share.b (See the next slide.)

aThe share exchange ratio varies within a range of plus or minus 10% of the Flextronics’ $11.73 share price.
bIDW is protected against a potential “free fall” in Flextronics share price, while the purchase price paid by Flextronics is capped at $6.85.
 Multiple Price Collars Around Acquirer Flextronics
Share Price to Introduce Some Predictability

$11.73 Flextronics Share Price

Price Increase Above $11.73 increases (decreases) from

Acquirer Share Price of 1% to 10% (Offer price fixed at $6.55)
$11.73 $11.73 increases (decreases) from 11%
15% (Offer price floats up to $6.85 or
down to $6.18)
$11.73 increases more than 15%,
offer price capped at $6.85
$11.73 falls by more than 15%,
IDW may terminate agreement3

Fixed Share Exchange Agreement:

Allows Purchase Price to Change
Within a Range1
Fixed Value Agreement: Allows
Floating Share Exchange Ratio to
Hold Purchase Price Constant2
Price Decrease Below
Acquirer Share Price of
$11.73

1Fixed share exchange agreement represents range in which acquirer and target shareholders share risk of fluctuations in acquirer share price.
2Fixed value agreement represents range in which the target shareholders are protected from fluctuations in the acquirer’s share price. Risk is borne by
acquirer, as declining SER would result in more acquirer shares being issued and potential acquirer EPS dilution.
3Risk capped for both acquirer and target firms.
Flextronics-IDW Share Exchange Using Fixed Value (SER Floats)
and Fixed Share Exchange Ratio Agreements
Offer Price Offer Price

%Chg.1. ($6.55/$11.73) x $11.73 = $6.55 %Chg.1 $(6.55/$11.73) x $11.73 = $6.55

Fixed Value 1 ($6.55/$11.85) x $11.85 = $6.55 <1> ($6.55/$11.61) x $11.61 = $6.55

2 ($6.55/$11.96) x $11.96 = $6.55 <2> ($6.55/$11.50) x $11.50 = $6.55

3 ($6.55/$12.08) x $12.08 = $6.55 <3> ($6.55/$11.38) x $11.38 = $6.55

4 ($6.55/$12.20) x $12.20 = $6.55 <4> ($6.55/$11.26) x $11.26 = $6.55

5 ($6.55/$12.32) x $12.32 = $6.55 <5> ($6.55/$11.14) x $11.14 = $6.55

6 ($6.55/$12.43) x $12.43 = $6.55 <6> ($6.55/$11.03) x $11.03 = $6.55

7 ($6.55/$12.55) x $12.55 = $6.55 <7> ($6.55/$10.91) x $10.91 = $6.55

8 ($6.55/$12.67) x $12.67 = $6.55 <8> ($6.55/$10.79) x $10.79 = $6.55

9 ($6.55/$12.79) x $12.79 = $6.55 <9> ($6.55/$10.67) x $10.67 = $6.55

10 ($6.55/$12.90) x $12.90 = $6.55 <10> ($6.55/$10.56) x $10.56 = $6.55

Fixed SER 11 ($6.55/$12.90) x $13.02 = $6.61 <11> ($6.55/$10.56) x $10.44 = $6.48

12 ($6.55/$12.90) x $13.14 = $6.67 <12> ($6.55/$10.56) x $10.32 = $6.40

13 ($6.55/$12.90) x $13.25 = $6.73 <13> ($6.55/$10.56) x $10.21 = $6.33

14 ($6.55/$12.90) x $13.37 = $6.79 <14> ($6.55/$10.56) x $10.09 = $6.26

15 ($6.55/$12.90) x $13.49 = $6.85 <15> ($6.55/$10.56) x $9.97 = $6.18

>15 SER floats based on fixed $6.85 offer ><15> IDW may terminate agreement
1Percent change in Flextronics share price. All changes in the offer price based on percent change from $11.73.
 Practice Exercise: Constructing a Collar
Arrangement
Northrop Grumman initiated a tender offer for 100% of TRW’s common
shares by offering to exchange $47 worth of Northrop Grumman common
stock, whose market value at that time was $108, for each share of TRW
common stock. The $47 offer price would be allowed to fluctuate between
the signing of the purchase agreement and closing within a narrow range by
placing a collar of plus 5% or minus 5% around the $108 Northrop Grumman
share price on the tender offer announcement date.

1. What is the share exchange ratio implied by the Northrop Grumman

tender offer?
2. What are the lower limit and upper limit share exchange ratios Northrop
Grumman used in constructing the collar arrangement?
3. How does the collar arrangement protect TRW shareholders? Northrop
Grumman shareholders?
 Form of Acquisition (Means of Transferring
Ownership): Governed by State Statutes
• Statutory one-stage (compulsory) merger or consolidation:
– Stock swap statutory merger by majority vote of both firms’ shareholders
– Cash out statutory merger (form of payment something other than acquirer
common stock)
• Asset acquisitions (buying target assets)
– Stock for assets
– Cash for assets
• Stock acquisitions (buying target stock via tender offer)
– Stock for stock
– Cash for stock
• Special applications of basic structures
– 2-stage stock acquisitions (Obtain control & implement backend merger)
– Triangular acquisitions
– Leveraged buyouts
– Single firm recapitalizations (Minority shareholder “squeeze out”)1

Key Point: Each form represents an alternative means of transferring

ownership.

1Analagous to a backend merger.

Statutory One-Stage Mergers and Consolidations
• Stock swap statutory merger: Two legally separate and roughly comparable in size firms
merge with only one surviving. Shareholders of target (selling) firm receive shares in the
surviving firm in exchange for their shares.
• Cash-out statutory merger: Selling firm shareholders receive cash, non-voting preferred or
common shares, or debt issued by the purchasing company; no acquirer shareholder vote
required.
• Procedure for statutory mergers: Assume Firm B is merged into Firm A in a share for share
exchange with Firm A surviving:
– Firm A absorbs Firm B’s assets and liabilities as a “matter of law.”
– Boards of directors of both firms must approve merger agreement
– Shareholders of both firms must then approve the merger agreement, usually by a simple
majority of outstanding shares. Dissenting shareholders must sell their shares.
• Exceptions for share exchanges: Parent firm shareholder votes not required when
– Acquiring firm shareholders cannot vote unless their ownership in the acquiring firm is
diluted by more than one-sixth or 16.67%, i.e., Firm A shareholders must own at least
83.33% of the firm’s voting shares following closing. (Small scale merger exception)1
– Parent firm holds over 90% of a subsidiary’s stock. (Parent-sub merger exception; also
called a short-form merger)
– Certain holding company structures are created (Holding company exception)
– No new acquirer shares must be issued to complete the deal
• Advantages/disadvantages: All target assets and liabilities (known/unknown) transfer to
acquirer as a “matter of law,” flexible payment terms (cash/stock), and no minority
shareholders or transfer taxes but responsible for all liabilities and subject to shareholder
approval.
1This effectively limits the acquirer to issuing no more than 20% of its total shares outstanding. For example, if the acquirer has 80 million shares
outstanding and issues 16 million new shares (.2 x 80), its current shareholders are not diluted by more than one-sixth, since 16/(16 + 80) equals
one-sixth or 16.67%. More than 16 million new shares would violate the small merger exception.
 Asset Aquisitions1
• Cash for assets acquisition: Acquiring firm pays cash for target firm’s
assets, accepting some, all, or none of target’s liabilities.
– If substantially all of its assets are acquired, target firm dissolves after
paying off any liabilities not assumed by acquirer and distributing any
remaining assets and cash to its shareholders2
– Shareholders do not vote but are “cashed out”
• Stock for assets acquisition: Acquirer issues shares for target’s assets,
accepting some, all, or none of target’s liabilities.
– If acquirer buys all of target’s assets and assumes all of its liabilities, the
acquisition is equivalent to a merger.
– Listing requirements on major stock exchanges require acquiring firm
shareholders to approve such acquisitions if the issuance of new shares
is more than 20% of the firm’s outstanding shares
– Target’s shareholders must approve the transaction if substantially all of
its assets are to be sold
• Advantages/disadvantages: Allows acquirer to select only certain target
assets and liabilities; asset write-up & no minority shareholders but lose tax
attributes and assets not specified in contract and incur transfer taxes
1In acquisitions, acquiring firms usually larger than target firms.
2Usually, acquirer purchases 80% or more of the fair market value of the target’s operating assets and may
assume some or all of the target’s liabilities. In some cases, courts have ruled that the acquirer is
responsible for target liabilities as effectively liquidating or merging with the target.
 Stock Acquisitions

• Cash for stock acquisitions: Acquirer buys target’s

stock with cash directly from target’s shareholders and
operates target as a wholly- or partially-owned (if <
100% of target shares acquired) subsidiary
• Stock for stock acquisitions: Acquirer buys target’s
stock directly from target’s shareholders, generally
operating target in a parent/subsidiary structure
• Advantages/disadvantages: Eliminates need for target
shareholder vote (buying from target shareholders); tax
attributes, licenses, and contracts transfer to acquirer;
and may insulate parent from subsidiary creditors but
responsible for all liabilities and have minority
shareholders
 Special Applications of Basic Structures
• Two stage stock transactions:
– First stage: Acquirer buys target stock via a tender offer to gain
controlling interest and owns target as a partially owned subsidiary
– Second stage (backend merger): Acquirer merges a partially owned
subsidiary into a wholly owned subsidiary giving minority
shareholders cash or debt for their cancelled shares. Also known as
a “freeze out” or “squeeze out.”
– Advantages/disadvantages: Very popular as acquirers gain control
more rapidly than if they attempted a one-step statutory merger
which requires boards and shareholders to approve merger
agreement but may require substantial premium to gain initial
control.
• Triangular acquisitions: Acquirer creates wholly owned sub which
merges with target, with either the target or the sub surviving
– Advantages: Avoids acquirer shareholder vote as parent sole owner
of sub and limits parent exposure to target liabilities; however,
acquirer shareholder vote may be required in some states if new
stock issued dilutes current shareholders by more than one-sixth
Special Applications of Basic Structures Cont’d

• Leveraged buyout (LBO): LBO sponsor (often a limited

partnership) creates shell corporation funded with sponsor equity.
– Stage 1: Shell corporation raises cash by borrowing from banks,
selling debt to institutional investors, and receives equity
contribution from financial sponsor
– Stage 2: Shell buys 50.1% of target stock, squeezing out
minority shareholders with a back end merger in which
remaining shareholders receive debt or preferred stock.
• Single firm recapitalization: Enables firm to squeeze out minority
shareholders.
– Firm with minority shareholders creates a wholly-owned shell
and merges itself into the shell through a statutory merger with
shell surviving.
– All stock in the original firm is cancelled with the majority
shareholders in the original firm receiving stock in the surviving
firm and minority shareholders receiving cash or debt.
 Discussion Questions

1. What is the difference between the form

of payment and form of acquisition?
2. What factors influence the determination
of form of payment?
3. What factors influence the form of
acquisition?
 Quick Quiz

In a statutory merger, which of the following are true

a. Only known assets and liabilities are automatically
transferred to the buyer.
b. Only known and unknown assets are transferred to
the buyer.
c. All known and unknown assets and liabilities are
automatically transferred to the buyer except for
those the seller agrees to retain.
d. The total consideration received by the target’s
shareholders is automatically taxable.
e. None of the above.
 Things to Remember…
• Deal structuring addresses identifying and
satisfying as many of the primary objectives of
the parties involved and determining how risk
will be shared.
• Deal structuring consists of determining the
acquisition vehicle, post-closing organization,
the form of payment, the form of acquisition,
legal form of selling entity, and accounting and
tax considerations.
• Choices made in one area of the “deal” are likely
to impact other aspects of the transaction.