M&A Deal Structuring

Process: Payment &

Legal Considerations
If you can’t convince them,
confuse them.

—Harry S. Truman
 Course Layout: M&A & Other
Restructuring Activities

Part I: M&A Part II: M&A Part III: M&A Part IV: Deal Part V:
Environment Process Valuation & Structuring & Alternative Bus.
Modeling Financing Strategies

Motivations for Business & Public Company Payment & Business

M&A Acquisition Valuation Legal Alliances
Plans Considerations

Regulatory Search through Private Accounting & Divestitures,

Considerations Closing Company Tax Spin-Offs &
Activities Valuation Considerations Carve-Outs

Takeover Tactics M&A Integration Financial Financing Bankruptcy &

and Defenses Modeling Strategies Liquidation
Techniques

Cross-Border
Transactions
 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
– Satisfies as many of the primary objectives of the
parties involved 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 control Corporate (C or S) or
Facilitating postclosing divisional structure
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 Corporate or divisional
Centralize control in parent structure
Facilitate future funding
Implement earn-out Holding company
Preserve target’s culture
Exit business in 5-7 years
Assume minority position
Minimize risk Partnerships
Minimize taxes Limited liability companies
Pass through losses
 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)
– Collar arrangements (Often used when acquirer’s share price
has a history of volatility)
 Collar Arrangements Based on a Floating Share
Exchange Ratio (SER) to Protect Target Shareholders1,2
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 floating share exchange ratio, 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. Floating exchange ratios are used most often when the acquirer’s share price
is volatile. Fixed share exchange ratios 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 prior to closing provides time to calculate the
appropriate acquirer share price and incorporate into legal documents.
 Case Study: Alternative Collar Arrangements Based on Fixed
Value 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 was calculated using an exchange ratio floating inside
a 10% collar above and below a Flextronics share price of $11.73 and a fixed purchase price of
$6.55 per share for each share of IDW 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 calculated using a fixed exchange ratio
inside a collar 11% and 15% above and below $11.73 resulting in a floating purchase 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 more than
15% below $11.73. If Flextronics' share price increases 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 agreement

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.
Flextronics-IDW Share Exchange Using Fixed Value (SER Floats)
and Fixed Share Exchange 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

Floating SER 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. A3.ll changes in the offer price based on percent change from $11.73
 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 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

Key Point: Each form represents an alternative means of transferring

ownership.
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 voting
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.
• Procedure for statutory mergers: Assume Firm B is merged into Firm A 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
majority of outstanding shares. Dissenting shareholders must sell their shares.
• Voting rule exceptions: 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) .
• Advantages/disadvantages: All target assets and liabilities (known/unknown) transfer to
acquirer as a “matter of law,” flexible payment terms, 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 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 (a limited partnership)
creates shell corporation funded with sponsor equity.
– Stage 1: Shell corporation raises cash by borrowing from banks
and selling debt to institutional investors
– 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.
– 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?
 Determining Purchase Price and Control
Premium: The NBC Universal (NBCU) Case

• Comcast and General Electric (GE) announced on

12/2/09 that they had agreed to form a JV that will be
51% owned by Comcast, with the remainder owned by
GE.
• GE was to contribute NBC Universal (NBCU) valued at
$30 billion and Comcast was to contribute TV networks
valued at $7.25 billion.
• Comcast also was to pay GE $6.5 billion in cash. In
addition, NBCU was to borrow $9.1 billion and distribute
the cash to GE.
NBC Universal (NBCU) JV Valuation, Purchase Price
Determination, and Resulting Control Premium
NBC Universal Joint Venture Valuation1 $37.25 billion
Comcast Purchase Price for 51% of NBC Universal JV
Cash from Comcast paid to GE $6.50
Cash proceeds paid to GE from NBCU borrowings2 9.10
Contributed assets (Comcast network) 7.25
Total $22.85 billion
GE Purchase Price for 49% of NBC Universal JV
Contributed assets (NBC Universal) $30.00
Cash from Comcast Paid to GE (6.50)
Cash proceeds paid to GE from NBCU borrowings (9.10)
Total $14.40 billion
Implied Control / Purchase Price Premium (%)3 20.3
Implied Minority/Liquidity Discount (%)4 (21.1)
1Equals the sum of NBCU ($30 billion) plus the fair market value of contributed Comcast properties ($7.25 billion)
and assumes no incremental value due to synergy. These values were agreed to during negotiation.
2The $9.1 billion borrowed by NBCU and paid to GE will be carried on the consolidated books of Comcast, since it

has the controlling interest in the JV. In theory, it reduces Comcast’s borrowing capacity by that amount and should
be viewed as a portion of the purchase price. In practice, it may reduce borrowing capacity by less if lenders view
the JV cash flow as sufficient to satisfy debt service requirements.
3The control premium represents the excess of the purchase price paid over the book value of the net acquired

assets and is calculated as follows: [$22.85 / (.51 x $37.25] -1.

4The minority/liquidity discount represents the excess of the fair market value of the net acquired assets over the

purchase price and is calculated as follows: [$14.40/(.49 x $37.25)] -1.

 Discussion Questions

1. Suppose two firms, each of which was generating

operating losses, wanted to create a joint venture. The
potential partners believed that significant operating
synergies could be created by combining the two
businesses resulting in a marked improvement in
operating performance. How should the ownership
distribution of the JV be determined?
2. Discuss the advantages and disadvantages of your
answer to question one.
3. Should the majority owner always be the one
managing the daily operations of the business? Why?
Why not?
 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.