A merger refers to the combination of two or more companies into a single company. This combination may be either through absorption or consolidation. In legal parlance mergers are also referred to as amalgamations.
Mergers may occur in four ways i.e.:
(i) By purchase of assets
(ii) By purchase of common stock
(iii) By exchange of stock for assets i.e. acquiring company give its shares to the stockholders of acquired company
(iv) By exchange of stock for stock i.e. acquiring company gives its shares to the shareholders of acquired company
2. Types of Mergers
Mergers may be classified into 3 main types:
A horizontal merger is one that takes place between two companies in the same line of business.
A Vertical merger is one in which the buyer expands backwards and merges with the company supplying raw materials or expands forward in the direction of the ultimate consumer. Thus in a vertical merger there is merging of companies engaged at different stages of production cycle within the industry.
In conglomerate merger the merging companies are in totally unrelated lines of business.
3. Acquisitions or Takeovers
A takeover generally involves the acquisition of a certain block of equity capital of a company which enables the acquirers to exercise control over the affairs of the company. In theory the acquirer (must) buy more than 50 per cent, of paid-up equity of the acquired company to enjoy complete control.
In practice however effective control can be exercised with smaller holding usually between 10 and 40 percent because the remaining shareholders scattered and ill-organized are not likely to challenge the control of the acquirer.
The main objective of a takeover bid is to obtain legal control of the company. The company taken over remains in existence as a separate entity unless from a merger in that under a takeover the company taken over maintains its separate existence while under a merger both the companies merge to form a single corporate entitle and at least one of the companies loses its identity.
According to Charles A Scharf, the element of willingness on the part of the buyer and seller distinguishes an acquisition from a takeover. If there exists willingness of the company being acquired it is known as acquisition. If the willingness is absent it is known as take over.
SEBI Guidelines (on Nov. – 4 1994) regarding Take-over:
i. Any acquirer whose aggregate share-holding exceeds 5% of the shares in a company shall disclose within 4 weeks his stake to each stock Exchange where the shares are listed.
ii. Similar disclosures should be made if shares of at least 5% of the shares in a company are held.
iii. Acquires holding more than 10% of shares in a company have to make half yearly disclosures to stock-exchanges.
iv. In a negotiated takeover the acquirer should make a public announcement to acquire another 20% (this 20% is exceeding 10% held by the acquirer) for not less than the market price.
v. In an open market takeover the acquirer should make a public announcement to acquire another 20% at highest market price.
vi. In addition to this the raiders should reveal their intentions and avoid clandestine or secrete deals.
vii. The financial Institutions cannot sell 1% stake to the raider without public notice.
viii. The directors cannot refuse to register shares without the approval & consent of the shareholder. All these guidelines are issued to make takeovers as transparent as possible in order to protect target companies and individual shareholders.
4. Motives behind Mergers and Acquisitions
(1) Economies of Scale:
When 2 or more companies combine the larger volume of operations of the merged entity results in various economies of scale. These economics arise because of greater intensive utilization of combined production capacities, data processing system etc.
It is found that economies of scale are more predominate in horizontal mergers as the same kinds of resources are available in the merging companies which can be utilized intensively.
In vertical mergers the principal economics are increased efficiency and control over the production process better coordination so activities lower inventory levels and greater marketing strength. Even conglomerate mergers result in economics due to reduction of overhead expenses.
But it is to be observed that there is an optimal size to the volume of operations and the size of the organization. Beyond this optimal scale any further increase will lead to diseconomies of scale and cost per unit will increase.
(2) Financial Economies:
A Principal reason for mergers and acquisitions is to avail oneself on financial economics in one or more of the following forms:
i. Utilization of tax shields
ii. Higher debt capacity
iii. Reduction in notation cost
iv. Lower rate of borrowing.
Growth normally is a very corporate objective. If a firm has decided to enter or expand in a particular industry, acquisition of a firm in that industry rather than dependence on internal expansion may offer several strategic advantages –
(i) As a per emotive move it can prevent a competitor from establishing a similar position in the industry.
(ii) If offers a special ‘timing ‘ advantage because the merger alternative enables a firm to ‘leap frog’ several stages in the process of expansion.
(iii) It may entail less risk and even less cost
(iv) In a ‘saturated’ market, simultaneous expansion and replacement (through a merger) makes more sense than creation of additional capacity through internal expansion.
If two companies X and Y are merging and the shares of X are not traded in the stock exchange after the merger when company XY is formed X’s shares also get traded along with the shares of company Y Investors can thus automatically diversity their portfolio of shares by buying the shares of merged company
5. Legal Procedure for Merger and Acquisition
The companies Act, 1956 provides the following procedure for merger or acquisition:
(a) The first step is to verify the ‘object clause’ of Memorandum of Association of all the amalgamated companies. The acquiring company should have the power to acquire the business of the acquired company as per the object clause.
In the same way the acquired company should have the power to amalgamate into the acquiring company. If these powers are not given as per the object clause it will have to be amended to acquire these powers.
(b) If the concerned companies are listed on the stock exchanges intimation will have to be given to the concerned stock-exchange.
(c) Approval of the Board of Directors of both the companies is required for the amalgamation scheme.
(d) Sanction of the High court is also necessary for the scheme of amalgamation. Therefore an application to the court is required. On this application the High Court will convene the meeting of die creditors and shareholders.
(e) In this meeting (at least 75% of) creditors and shareholders must give their approval for the scheme of merger of acquisition.
(f) After the approval of creditors and shareholders the High court will approve the scheme if it is fair and just. After the court’s order the copies of the order will be filed with the registrar of companies.
The assets and liabilities of the acquired company will be transferred to the acquiring company from a particular date. The purchase consideration will be paid to the acquired company as per the agreements.