M

1
MA Deal Structuring Process Payment Legal
Considerations
2
If you cant convince them, confuse them.

Harry S.
Truman
3
Cross-Border Transactions
4
Learning Objectives

• Primary Learning Objective To provide students
  with a knowledge of the MA deal structuring
  process
• Secondary Learning Objectives To enable students
  to understand
• the primary components of the process,
• payment considerations, and
• legal considerations.

5
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?

6
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

7
Factors Affecting Alternative Forms of Legal
Entities

• Control by owners
• Management autonomy
• Continuity of ownership
• Duration or life of entity
• Ease of transferring ownership
• Limitation on ownership liability
• Ease of raising capital
• Tax Status
• Question Of these factors, which do you believe
  is often the most important? Explain your answer.

8
Acquisition Vehicle
Acquirers Objective (s) Potential Organization
Maximizing control Facilitating postclosing integration Corporate (C or S) or divisional structure
Minimizing or sharing risk Partnership/joint venture Holding company
Gaining control while limiting investment Holding company
Transferring ownership interest to employees Employee stock ownership plan
9
Post-Closing Organization
Acquirers Objective (s) Potential Organization
Integrate target immediately Centralize control in parent Facilitate future funding Corporate or divisional structure
Implement earn-out Preserve targets culture Exit business in 5-7 years Assume minority position Holding company
Minimize risk Minimize taxes Pass through losses Partnerships Limited liability companies
10
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?

11
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 acquirers
  share price has a history of volatility)

12
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 Acquirers Share Price (ASP)
• Offer Price Per Target Share x
  Acquirers Share Price
• 
  Acquirers 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 acquirers 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
• 1For a floating share exchange ratio, the dollar
  offer price per share is fixed and the number of
  shares exchanged varies with the value of the
  acquirers share price. Acquirer share price
  changes require re-estimating the share exchange
  ratio. Floating exchange ratios are used most
  often when the acquirers 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.

13
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
  followsa
• 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.

14
Multiple Price Collars Around Acquirer
Flextronics Share Price to Introduce Some
Predictability
Price Increase Above Acquirer Share Price of
11.73
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 acquirers share price.
15
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 lt1gt (6.55/11.61) x 11.61 6.55
2 (6.55/11.96) x 11.96 6.55 lt2gt (6.55/11.50) x 11.50 6.55
3 (6.55/12.08) x 12.08 6.55 lt3gt (6.55/11.38) x 11.38 6.55
4 (6.55/12.20) x 12.20 6.55 lt4gt (6.55/11.26) x 11.26 6.55
5 (6.55/12.32) x 12.32 6.55 lt5gt (6.55/11.14) x 11.14 6.55
6 (6.55/12.43) x 12.43 6.55 lt6gt (6.55/11.03) x 11.03 6.55
7 (6.55/12.55) x 12.55 6.55 lt7gt (6.55/10.91) x 10.91 6.55
8 (6.55/12.67) x 12.67 6.55 lt8gt (6.55/10.79) x 10.79 6.55
9 (6.55/12.79) x 12.79 6.55 lt9gt (6.55/10.67) x 10.67 6.55
10 (6.55/12.90) x 12.90 6.55 lt10gt (6.55/10.56) x 10.56 6.55
Fixed SER 11 (6.55/12.90) x 13.02 6.61 lt11gt (6.55/10.56) x 10.44 6.48
12 (6.55/12.90) x 13.14 6.67 lt12gt (6.55/10.56) x 10.32 6.40
13 (6.55/12.90) x 13.25 6.73 lt13gt (6.55/10.56) x 10.21 6.33
14 (6.55/12.90) x 13.37 6.79 lt14gt (6.55/10.56) x 10.09 6.26
15 (6.55/12.90) x 13.49 6.85 lt15gt (6.55/10.56) x 9.97 6.18
gt15 SER floats based on fixed 6.85 offer SER floats based on fixed 6.85 offer gtlt15gt IDW may terminate agreement IDW may terminate agreement
1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73 1Percent change in Flextronics share price. A3.ll changes in the offer price based on percent change from 11.73
16
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.

17
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 Bs 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
  firms voting shares following closing. (Small
  scale merger exception)1
• Parent firm holds over 90 of a subsidiarys
  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.
18
Asset Aquisitions1

• Cash for assets acquisition Acquiring firm pays
  cash for target firms assets, accepting some,
  all, or none of targets 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 targets assets, accepting some, all,
  or none of targets liabilities.
• If acquirer buys all of targets 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 firms outstanding shares
• Targets 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 targets operating
  assets and may assume some or all of the targets
  liabilities. In some cases, courts have ruled
  that acquirer is responsible for target
  liabilities as effectively liquidating or merging
  with the target.

19
Stock Acquisitions

• Cash for stock acquisitions Acquirer buys
  targets stock with cash directly from targets
  shareholders and operates target as a wholly- or
  partially-owned (if lt 100 of target shares
  acquired) subsidiary
• Stock for stock acquisitions Acquirer buys
  targets stock directly from targets
  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

20
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

21
Special Applications of Basic Structures Contd

• 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.

22
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?

23
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.

24
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 Cash proceeds paid to GE from NBCU borrowings2 Contributed assets (Comcast network) Total 6.50 9.10 7.25 22.85 billion
GE Purchase Price for 49 of NBC Universal JV Contributed assets (NBC Universal) Cash from Comcast Paid to GE Cash proceeds paid to GE from NBCU borrowings Total 30.00 (6.50) (9.10) 14.40 billion
Implied Control / Purchase Price Premium ()3 Implied Minority/Liquidity Discount ()4 20.3 (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 Comcasts 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.
25
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?

26
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.