Corporate Restructuring

Module - 1

Introduction
With Indian corporate houses showing sustained growth over the last decade, many have shown an interest in growing globally by choosing to acquire or merge with other companies outside India. One such example would be the acquisition of Britains orus by !ata an Indian conglomerate by way of a leveraged buy"out. !he !atas also acquired #aguar and $and %over in a significant cross border transaction. Whereas both transactions involved the acquisition of assets in a foreign &urisdiction, both transactions were also governed by Indian domestic law. Whether a merger or an acquisition is that of an Indian entity or it is an Indian entity acquiring a foreign entity, such a transaction would be governed by Indian domestic law. In the sections which follow, we touch up on different laws with a view to educate the reader of the broader areas of law which would be of significance. 'ergers and acquisitions are methods by which distinct businesses may combine. #oint ventures are another way for two businesses to wor( together to achieve growth as partners in progress, though a &oint venture is more of a contractual arrangement between two or more businesses.

Corporate Restructuring Classifications

A. MERGERS AND AMALGAMATIONS. The term merger is not defined under the Companies Act, 1956 (the Companies Act), the Income Ta Act, 1961 (the ITA) or an! other Indian "a#. $imp"! put, a merger is a com%ination of t#o or more distinct entities into one& the desired effect %eing not 'ust the accumu"ation of assets and "ia%i"ities of the distinct entities, %ut to achie(e se(era" other %enefits such as, economies of sca"e, ac)uisition of cutting edge techno"ogies, o%taining access into sectors * mar+ets #ith esta%"ished p"a!ers etc. ,enera""!, in a merger, the merging entities #ou"d cease to %e in e istence and #ou"d merge into a sing"e sur(i(ing entit!. -er! often, the t#o e pressions .merger. and .ama"gamation. are used s!non!mous"!. /ut there is, in fact, a difference. 0erger genera""! refers to a circumstance in #hich the assets and "ia%i"ities of a compan! (merging compan!) are (ested in another compan! (the merged compan!). The merging entit! "oses its identit! and its shareho"ders %ecome shareho"ders of the merged compan!. 1n the other hand, an

ama"gamation is an arrangement, #here%! the assets and "ia%i"ities of t#o or more companies (ama"gamating companies) %ecome (ested in another compan! (the ama"gamated compan!). The ama"gamating companies a"" "ose their identit! and emerge as the ama"gamated compan!& though in certain transaction structures the ama"gamated compan! ma! or ma! not %e one of the origina" companies. The shareho"ders of the ama"gamating companies %ecome shareho"ders of the ama"gamated compan!. 2hi"e the Companies Act does not define a merger or ama"gamation, $ections 394 to 395 of the Companies Act dea" #ith the ana"ogous concept of schemes of arrangement or compromise %et#een a compan!, it shareho"ders and*or its creditors. A merger of a compan! A #ith another compan! / #ou"d in(o"(e t#o schemes of arrangements, one %et#een A and its shareho"ders and the other %et#een / and its shareho"ders. 0ergers ma! %e of se(era" t!pes, depending on the re)uirements of the merging entities6 Horizontal Mergers. A"so referred to as a hori7onta" integration, this +ind of merger ta+es p"ace %et#een entities engaged in competing %usinesses #hich are at the same stage of the industria" process.8 A hori7onta" merger ta+es a compan! a step c"oser to#ards monopo"! %! e"iminating a competitor and esta%"ishing a stronger presence in the mar+et. The other %enefits of this form of merger are the ad(antages of economies of sca"e and economies of scope. Vertical Mergers. -ertica" mergers refer to the com%ination of t#o entities at different stages of the industria" or production process. 9or e amp"e, the merger of a compan! engaged in the construction %usiness #ith a compan! engaged in production of %ric+ or stee" #ou"d "ead to (ertica" integration. Companies stand to gain on account of "o#er transaction costs and s!nchroni7ation of demand and supp"!. 0oreo(er, (ertica" integration he"ps a compan! mo(e to#ards greater independence and se"f:sufficienc!. The do#nside of a (ertica" merger in(o"(es "arge in(estments in techno"og! in order to compete effecti(e"!. Congeneric Mergers. These are mergers %et#een entities engaged in the same genera" industr! and some#hat interre"ated, %ut ha(ing no common customer:supp"ier re"ationship. A compan! uses this t!pe of merger in order to use the resu"ting a%i"it! to use the same sa"es and distri%ution channe"s to reach the customers of %oth %usinesses.3 Conglomerate Mergers. A cong"omerate merger is a merger %et#een t#o entities in unre"ated industries. The principa" reason for a cong"omerate merger is uti"i7ation of financia" resources, en"argement of de%t capacit!, and increase in the (a"ue of outstanding shares %! increased "e(erage and earnings per share, and %! "o#ering the a(erage cost of capita".5 A merger #ith a di(erse %usiness a"so he"ps the compan! to fora! into (aried %usinesses #ithout ha(ing to incur "arge start:up costs norma""! associated #ith a ne# %usiness.

Cas Merger. In a t!pica" merger, the merged entit! com%ines the assets of the t#o companies and grants the shareho"ders of each origina" compan! shares in the ne# compan! %ased on the re"ati(e (a"uations of the t#o origina" companies. ;o#e(er, in the case of a cash merger, a"so +no#n as a cash:out merger, the shareho"ders of one entit! recei(e cash in p"ace of shares in the merged entit!. This is a common practice in cases #here the shareho"ders of one of the merging entities do not #ant to %e a part of the merged entit!. Triang!lar Merger. A triangu"ar merger is often resorted to for regu"ator! and ta reasons. As the name suggests, it is a tripartite arrangement in #hich the target merges #ith a su%sidiar! of the ac)uirer. /ased on #hich entit! is the sur(i(or after such merger, a triangu"ar merger ma! %e for#ard (#hen the target merges into the su%sidiar! and the su%sidiar! sur(i(es), or re(erse (#hen the su%sidiar! merges into the target and the target sur(i(es). /. AC"#ISITIONS. An ac)uisition or ta+eo(er is the purchase %! one compan! of contro""ing interest in the share capita", or a"" or su%stantia""! a"" of the assets and*or "ia%i"ities, of another compan!. A ta+eo(er ma! %e friend"! or hosti"e, depending on the offerer compan!s approach, and ma! %e effected through agreements %et#een the offerer and the ma'orit! shareho"ders, purchase of shares from the open mar+et, or %! ma+ing an offer for ac)uisition of the offerees shares to the entire %od! of shareho"ders. $rien%l& ta'eo(er. A"so common"! referred to as negotiated ta+eo(er, a friend"! ta+eo(er in(o"(es an ac)uisition of the target compan! through negotiations %et#een the e isting promoters and prospecti(e in(estors. This +ind of ta+eo(er is resorted to further some common o%'ecti(es of %oth the parties. Hostile Ta'eo(er. A hosti"e ta+eo(er can happen %! #a! of an! of the fo""o#ing actions6 if the %oard re'ects the offer, %ut the %idder continues to pursue it or the %idder ma+es the offer #ithout informing the %oard %eforehand. The ac)uisition of one compan! (ca""ed the target compan!) %! another (ca""ed the ac)uirer) that is accomp"ished not %! coming to an agreement #ith the target compan!<s management, %ut %! going direct"! to the compan!s shareho"ders or fighting to rep"ace management in order to get the ac)uisition appro(ed. A hosti"e ta+eo(er can %e accomp"ished through either a tender offer or a pro ! fight.

Le(erage% )!&o!ts. These are a form of ta+eo(ers #here the ac)uisition is funded %! %orro#ed mone!. 1ften the assets of the target compan! are used as co""atera" for the "oan. This is a common structure #hen ac)uirers #ish to ma+e "arge ac)uisitions #ithout ha(ing to commit too much capita", and hope to ma+e the ac)uired %usiness ser(ice the de%t so raised.

)ailo!t Ta'eo(ers. Another form of ta+eo(er is a %ai" out ta+eo(er in #hich a profit ma+ing compan! ac)uires a sic+ compan!. This +ind of ta+eo(er is usua""! pursuant to a scheme of reconstruction*reha%i"itation #ith the appro(a" of "ender %an+s*financia" institutions. 1ne of the primar! moti(es for a profit ma+ing compan! to ac)uire a sic+*"oss ma+ing compan! #ou"d %e to set off of the "osses of the sic+ compan! against the profits of the ac)uirer, there%! reducing the ta pa!a%"e %! the ac)uirer. This #ou"d %e true in the case of a merger %et#een such companies as #e"". C. STRATEGIC ALLIANCE A partnership #ith another %usiness in #hich !ou com%ine efforts in %usiness efforts in a %usiness effort in(o"(ing an!thing from getting a %etter price for goods %! %u!ing %u"+ together, to see+ing %usiness together, #ith each of !ou pro(iding part of the product. The %asic idea %ehind a""iances is to minimi7e ris+ #hi"e ma imising !our "e(erage. D. *OINT VENT#RES. A 'oint (enture is the coming together of t#o or more %usinesses for a specific purpose, #hich ma! or ma! not %e for a "imited duration. The purpose of the 'oint (enture ma! %e for the entr! of the 'oint (enture parties into a ne# %usiness, or the entr! into a ne# mar+et, #hich re)uires the specific s+i""s, e pertise, or the in(estment of each of the 'oint (enture parties. The e ecution of a 'oint (enture agreement setting out the rights and o%"igations of each of the parties is usua""! a norm for most 'oint (entures. The 'oint (enture parties ma! a"so incorporate a ne# compan! #hich #i"" engage in the proposed %usiness. In such a case, the %!e"a#s of the 'oint (enture compan! #ou"d incorporate the agreement %et#een the 'oint (enture parties. =. DEMERGERS. A demerger is the opposite of a merger, in(o"(ing the sp"itting up of one entit! into t#o or more entities. An entit! #hich has more than one %usiness, ma! decide to hi(e off or spin off one of its %usinesses into a ne# entit!. The shareho"ders of the origina" entit! #ou"d genera""! recei(e shares of the ne# entit!. If one of the %usinesses of a compan! is financia""! sic+ and the other %usiness is financia""! sound, the sic+ %usiness ma! %e demerged from the compan!. This faci"itates the restructuring or sa"e of the sic+ %usiness, #ithout affecting the assets of the hea"th! %usiness. Con(erse"!, a demerger ma! a"so %e underta+en for situating a "ucrati(e %usiness in a separate entit!. A demerger, ma! %e comp"eted through a court process under the 0erger >ro(isions, %ut cou"d a"so %e structured in a manner to a(oid attracting the 0erger >ro(isions. The terms .demerger., .spin:off. and .spin:out. are sometimes used to indicate a situation #here one compan! sp"its into t#o, generating a second compan! #hich ma! or ma! not %ecome separate"! "isted on a stoc+ e change.

$. DIVESTIT#RES

A ?i(estiture is the sa"e of part of a compan! to a third part!. Assets, product "ines, su%sidiaries, or di(isions are so"d for cash or securities or some com%ination thereof. The %u!ers are t!pica""! other corporations or, increasing"!, in(estor groups together #ith the current managers of the di(ested operation.

Reasons 6 ?ismant"ing Cong"omerates @estructuring acti(it! Adding -a"ue %! se""ing into a %etter fit Aarge additiona" in(estment re)uired ;ar(esting >ast in(estments successfu""! ?iscarding Bn#anted /usiness di(isions G. LEVERAGED )#+O#TS ,L)OA "e(eraged /u!out or C/ootstrapD transaction occurs #hen a financia" sponsor gains contro" of a ma'orit! of a target compan!s e)uit! through the use of %orro#ed mone! or de%t. A A/1 is essentia""! a strateg! in(o"(ing the ac)uisition of another compan! using a significant amount of %orro#ed mone! (%onds or "oans) to meet the cost of ac)uisition. 1ften, the assets of the compan! %eing ac)uired are used as co""atera" for the "oans in addition to the assets of the compan!. H. EM.LO+EE STOC/ O.TION .LAN ,ESO.=$1 p"ans are a""o#s emp"o!ees can %u! compan!s stoc+ after certain "ength of emp"o!ment or the! can %u! share at an! time. $ome corporations ha(e po"icies to compensate emp"o!ees #ith compan!s shares instead of other monetar! %enefits. This #i"" increase the accounta%i"it! and commitment of emp"o!ee #ith his #or+ and organi7ationa" gro#th. At the same time accumu"ation of shares to emp"o!ees hands a"so #ea+ens the po#er of top management. I. SELL0O$$S
A se"":off, a"so +no#n as a di(estiture, is the outright sa"e of a compan! su%sidiar!. Eorma""!, se"":offs are done %ecause the su%sidiar! doesn<t fit into the parent compan!<s core strateg!. The mar+et ma! %e under(a"uing the com%ined %usinesses due to a "ac+ of s!nerg! %et#een the parent and su%sidiar!. As a resu"t, management and the %oard decide that the su%sidiar! is %etter off under different o#nership.

*. E"#IT+ CARVE0O#TS 0ore and more companies are using e)uit! car(e:outs to %oost shareho"der (a"ue.
A parent firm ma+es a su%sidiar! pu%"ic through an initia" pu%"ic offering (I>1) of shares, amounting to a partia" se"":off. A ne# pu%"ic"!:"isted compan! is created, %ut the parent +eeps a contro""ing sta+e in the ne#"! traded su%sidiar!

/. S.INO$$S
A spinoff occurs #hen a su%sidiar! %ecomes an independent entit!. The parent firm distri%utes shares of the su%sidiar! to its shareho"ders through a stoc+ di(idend. $ince this transaction is a di(idend distri%ution, no cash is generated. Thus, spinoffs are un"i+e"! to %e used #hen a firm needs to finance gro#th or dea"s. Ai+e the car(e:out, the su%sidiar! %ecomes a separate "ega" entit! #ith a distinct management and %oard.

Merger & Acquisition

Basic Concepts
Mergers and acquisitions represent the ultimate in change for a business. No other event is more difficult, challenging, or chaotic as a merger and acquisition. It is imperative that everyone involved in the process has a clear understanding of how the process works. Hopefully this short course will provide you with a better appreciation of what is involved. You might be asking yourself, why do I need to learn the merger and acquisition M ! "# process$ %ell for starters, mergers and acquisitions are now a normal way of life within the business world. In today&s global, competitive environment, mergers are sometimes the only means for long'term survival. In other cases, such as (isco )ystems, mergers are a strategic component for generating long'term growth. "dditionally, many entrepreneurs no longer build companies for the long'term* they build companies for the short'term, hoping to sell the company for huge profits. In her book +he "rt of Merger and "cquisition Integration, "le,andra -eed .a/ou, puts it best0 1irtually every ma/or company in the 2nited )tates today has e,perienced a ma/or acquisition at some point in history.

M & A Defined
%hen we use the term 3merger3, we are referring to the merging of two companies where one new company will continue to e,ist. +he term 3acquisition3 refers to the acquisition of assets by one company from another company. In an acquisition, both companies may continue to e,ist. However, throughout this course we will loosely refer to mergers and acquisitions M ! " # as a business transaction where one company acquires

another company. +he acquiring company will remain in business and the acquired company which we will sometimes call the +arget (ompany# will be integrated into the acquiring company and thus, the acquired company ceases to e,ist after the merger.

Distinction 1et2een Mergers an% Ac3!isitions

A"though the! are often uttered in the same %reath and used as though the! #ere s!non!mous, the terms merger and ac)uisition mean s"ight"! different things. 2hen one compan! ta+es o(er another and c"ear"! esta%"ished itse"f as the ne# o#ner, the purchase is ca""ed an ac)uisition. 9rom a "ega" point of (ie#, the target compan! ceases to e ist, the %u!er .s#a""o#s. the %usiness and the %u!er<s stoc+ continues to %e traded. In the pure sense of the term, a merger happens #hen t#o firms, often of a%out the same si7e, agree to go for#ard as a sing"e ne# compan! rather than remain separate"! o#ned and operated. This +ind of action is more precise"! referred to as a .merger of e)ua"s.. /oth companies< stoc+s are surrendered and ne# compan! stoc+ is issued in its p"ace. 9or e amp"e, %oth ?aim"er:/en7 and Chr!s"er ceased to e ist #hen the t#o firms merged, and a ne# compan!, ?aim"erChr!s"er, #as created. In practice, ho#e(er, actua" mergers of e)ua"s don<t happen (er! often. Bsua""!, one compan! #i"" %u! another and, as part of the dea"<s terms, simp"! a""o# the ac)uired firm to proc"aim that the action is a merger of e)ua"s, e(en if it<s technica""! an ac)uisition. /eing %ought out often carries negati(e connotations, therefore, %! descri%ing the dea" as a merger,

Merger Theories Differential efficiency theory. Inefficient management theory. Synergy.

 Pure diversification. Strategic realignment to changing environment. Hubris hypothesis

Differential efficiency theory. ccording to this theory if the management of firm efficient than the firm ! and if the firm firm . The theory implies that some firms operate belo% their potential and as a result have belo% average efficiency. Such firms are most vulnerable to ac"uisition by other more efficient firms in the same industry. This is because firms %ith greater efficiency %ould be able to identify firms %ith good potential but operating at lo%er efficiency.
According to this theory, some firms operate below their potential and consequently have low efficiency. Such firms are likely to be acquired by other, more efficient firms in the same industry. This is because, firms with greater efficiency would be able to identify firms with good potential operating at lower efficiency. They would also have the managerial ability to improve the latters performance.

is more

ac"uires firm !# the

efficiency of firm ! is li$ely to be brought up to the level of the

 However, a difficulty would arise when the acquiring firm overestimates its impact on improving the performance of the acquired firm. This may result in the acquirer paying too much for the acquired firm. Alternatively, the acquirer may not be able to improve the acquired firms performance up to the level of the acquisition value given to it. The managerial synergy hypothesis is an e tension of the differential efficiency theory. !t states that a firm, whose management team has greater competency than is required by the current tasks in the firm, may seek to employ the surplus resources by acquiring and improving the efficiency of a firm, which is less efficient due to lack of adequate managerial resources. Thus, the merger will create a synergy, since the surplus managerial resources of the acquirer combine with the non"managerial organi#ational capital of the firm. $hen these surplus resources are indivisible and cannot be released, a merger enables them to be optimally utili#ed. %ven if the firm has no opportunity to e pand within its industry, it can diversify and enter into new areas. However, since it does not possess the relevant skills related to that business, it will attempt to gain a &toehold entry by acquiring a firm in that industry, which has organi#ational capital alongwith inadequate managerial capabilities.

Inefficient management theory. This is similar to the concept of managerial efficiency but it is different in that inefficient management means that the management of one company simply is not performing upto its potential. Inefficient management theory simply represents that is incompetent in the complete sense. Synergy. Synergy refers to the type of reactions that occur %hen t%o substances or factors combine to produce a greater effect together than that %hich the sum of the t%o operating independently could account for.

 The ability of a combination of t%o firms to be more profitable than the t%o firms individually. There are t%o types of synergy& 'inancial synergy. (perating synergy.

Pure diversification. Diversification provides numerous benefits to managers# employees# o%ners of the firms and to the firm itself. Diversification through mergers is commonly preferred to diversification through internal gro%th# given that the firm may lac$ internal resources or capabilities re"uires. Strategic realignment to changing environment. It suggests that the firms use the strategy of M) s as %ays to rapidly ad*ust to changes in their e+ternal environments. ,hen a company has an opportunity of gro%th available only for a limited period of time slo% internal gro%th may not be sufficient. Hubris hypothesis

 Hubris hypothesis implies that manager-s loo$ for ac"uisition of firms for their o%n potential motives and that the economic gains are not the only motivation for the ac"uisitions. This theory is particularly evident in case of competitive tender offer to ac"uire a target. The urge to %in the game often results in the %inners curse refers to the ironic hypothesis that states that the firm %hich overestimates the value of the target mostly %ins the contest.

Module . II /aluing synergy in M) deals A

4very merger has its own unique reasons why the combining of two companies is a good business decision. +he underlying principle behind mergers and acquisitions M ! " # is simple0 5 6 5 7 8. +he value of (ompany " is 9 5 billion and the value of (ompany : is 9 5 billion, but when we merge the two companies together, we have a total value of 9 8 billion. +he /oining or merging of the two companies creates additional value which we call 3synergy3 value. Synergy value can take three forms: 1. Revenues0 :y combining the two companies, we will reali;e higher revenues then if the two companies operate separately. 2. Expenses: :y combining the two companies, we will reali;e lower e,penses then if the two companies operate separately. 3. Cost of Capital: :y combining the two companies, we will e,perience a lower overall cost of capital.

Why Mergers?- Motives

+he dominant rationale used to e,plain M!" activity is that acquiring firms seek improved financial performance. +he following motives are considered to improve financial performance0

0conomy of scale6 This refers to the fact that the com%ined compan! can often reduce its fi ed costs %! remo(ing dup"icate departments or operations, "o#ering the costs of the compan! re"ati(e to the same re(enue stream, thus increasing profit margins. 0conomy of scope6 This refers to the efficiencies primari"! associated #ith demand:side changes, such as increasing or decreasing the scope of mar+eting and distri%ution, of different t!pes of products. Increased revenue or mar$et share6 This assumes that the %u!er #i"" %e a%sor%ing a ma'or competitor and thus increase its mar+et po#er (%! capturing increased mar+et share) to set prices. Cross.selling& 9or e amp"e, a %an+ %u!ing a stoc+ %ro+er cou"d then se"" its %an+ing products to the stoc+ %ro+er<s customers, #hi"e the %ro+er can sign up the %an+<s customers for %ro+erage accounts. 1r, a manufacturer can ac)uire and se"" comp"ementar! products. Synergy& 9or e amp"e, manageria" economies such as the increased opportunit! of manageria" specia"i7ation. Another e amp"e are purchasing economies due to increased order si7e and associated %u"+:%u!ing discounts. Ta+ation& A profita%"e compan! can %u! a "oss ma+er to use the target<s "oss as their ad(antage %! reducing their ta "ia%i"it!. In the Bnited $tates and man! other countries, ru"es are in p"ace to "imit the a%i"it! of profita%"e companies to .shop. for "oss ma+ing companies, "imiting the ta moti(e of an ac)uiring compan!.

1eographical or other diversification6 This is designed to smooth the earnings resu"ts of a compan!, #hich o(er the "ong term smoothens the stoc+ price of a compan!, gi(ing conser(ati(e in(estors more confidence in in(esting in the compan!. ;o#e(er, this does not a"#a!s de"i(er (a"ue to shareho"ders (see %e"o#). Resource transfer6 resources are une(en"! distri%uted across firms (/arne!, 1991) and the interaction of target and ac)uiring firm resources can create (a"ue through either o(ercoming information as!mmetr! or %! com%ining scarce resources. /ertical integration6 -ertica" integration occurs #hen an upstream and do#nstream firm merges (or one ac)uires the other). There are se(era" reasons for this to occur. 1ne reason is to interna"i7e an e terna"it! pro%"em. A common e amp"e of such an e terna"it! is dou%"e margina"i7ation. ?ou%"e margina"i7ation occurs #hen %oth the upstream and do#nstream firms ha(e monopo"! po#er and each firm reduces output from the competiti(e "e(e" to the monopo"! "e(e", creating t#o dead#eight "osses. 9o""o#ing a merger, the (ertica""! integrated firm can co""ect one dead#eight "oss %! setting the do#nstream firm<s output to the competiti(e "e(e". This increases profits and consumer surp"us. A merger that creates a (ertica""! integrated firm can %e profita%"e.FGH Hiring& some companies use ac)uisitions as an a"ternati(e to the norma" hiring process. This is especia""! common #hen the target is a sma"" pri(ate compan! or is in the startup phase. In this case, the ac)uiring compan! simp"! hires the staff of the target pri(ate compan!, there%! ac)uiring its ta"ent (if that is its main asset and appea"). The target pri(ate compan! simp"! disso"(es and "itt"e "ega" issues are in(o"(ed. bsorption of similar businesses under single management6 simi"ar portfo"io in(ested %! t#o different mutua" funds name"! united mone! mar+et fund and united gro#th and income fund, caused the management to a%sor% united mone! mar+et fund into united gro#th and income fund. ;o#e(er, on a(erage and across the most common"! studied (aria%"es, ac)uiring firms< financia"

performance does not positi(e"! change as a function of their ac)uisition acti(it!.F9H Therefore, additiona" moti(es for merger and ac)uisition that ma! not add shareho"der (a"ue inc"ude6

Diversification& 2hi"e this ma! hedge a compan! against a do#nturn in an indi(idua" industr! it fai"s to de"i(er (a"ue, since it is possi%"e for indi(idua" shareho"ders to achie(e the same hedge %! di(ersif!ing their portfo"ios at a much "o#er cost than those associated #ith a merger.

(b*ectives in a M) transaction2
An opportunit! for achie(ing faster gro#th 1%taining ta concessions ="iminating competition

 Achie(ing di(ersification #ith minimum cost Impro(ing corporate image and %usiness (a"ue ,aining access to management or technica" ta"ent

(b*ective for Companies to offer themselves for sale2

?ec"ining earnings and profita%i"it! To raise funds for more promising "ines of %usiness ?esire to ma imi7e gro#th ,i(e itse"f the %enefit of image of "arger compan! Aac+ of ade)uate management or technica" s+i""s

<or the most part, the biggest source of synergy value is lower e,penses. Many mergers are driven by the need to cut costs. (ost savings often come from the elimination of redundant services, such as Human -esources, "ccounting, Information +echnology, etc. However, the best mergers seem to have strategic reasons for the business combination. These strategic reasons include: Positioning ' +aking advantage of future opportunities that can be e,ploited when the two companies are combined. <or e,ample, a telecommunications company might improve its position for the future if it were to own a broad band service company. (ompanies need to position themselves to take advantage of emerging trends in the marketplace. Gap Filling ' =ne company may have a ma/or weakness such as poor distribution# whereas the other company has some significant strength. :y combining the two companies, each company fills'in strategic gaps that are essential for long'term survival. rgani!ational Co"petencies ' "cquiring human resources and intellectual capital can help improve innovative thinking and development within the company. #roader $ar%et &ccess ' "cquiring a foreign company can give a company quick access to emerging global markets. $ergers can also 'e driven '( 'asic 'usiness reasons) such as: #argain Purchase ' It may be cheaper to acquire another company then to invest internally. <or e,ample, suppose a company is considering e,pansion of fabrication facilities. "nother company has very similar facilities that are idle. It may be cheaper to /ust acquire the company with the unused facilities then to go out and build new facilities on your own.

 *iversification ' It may be necessary to smooth'out earnings and achieve more consistent long'term growth and profitability. +his is particularly true for companies in very mature industries where future growth is unlikely. It should be noted that traditional financial management does not always support diversification through mergers and acquisitions. It is widely held that investors are in the best position to diversify, not the management of companies since managing a steel company is not the same as running a software company. +hort Ter" Gro,th ' Management may be under pressure to turnaround sluggish growth and profitability. (onsequently, a merger and acquisition is made to boost poor performance. -ndervalued Target ' +he +arget (ompany may be undervalued and thus, it represents a good investment. )ome mergers are e,ecuted for 3financial3 reasons and not strategic reasons. <or e,ample, >ohlberg >ravis ! -oberts acquires poor performing companies and replaces the management team in hopes of increasing depressed values.

The Overall

rocess

The Merger & Acquisition Process can be broken o!n into five "hases:
Phase 1 - Pre Acquisition Review: +he first step is to assess your own situation and determine if a merger and acquisition strategy should be implemented. If a company e,pects difficulty in the future when it comes to maintaining core competencies, market share, return on capital, or other key performance drivers, then a merger and acquisition M ! "# program may be necessary. Phase 2 - Search & Screen Targets: +he second phase within the M ! " ?rocess is to search for possible takeover candidates. +arget companies must fulfill a set of criteria so that the +arget (ompany is a good strategic fit with the acquiring company. <or e,ample, the target&s drivers of performance should compliment the acquiring company. (ompatibility and fit should be assessed across a range of criteria ' relative si;e, type of business, capital structure, organi;ational strengths, core competencies, market channels, etc. It is worth noting that the search and screening process is performed in'house by the "cquiring (ompany. -eliance on outside investment firms is kept to a minimum since the preliminary stages of M ! " must be highly guarded and independent. Phase 3 - Investigate & Value the Target 0 +he third phase of M ! " is to perform a more detail analysis of the target company. You want to confirm that the +arget (ompany is truly a good fit with the acquiring company. +his will require a more thorough review of operations, strategies, financials, and other aspects of the +arget (ompany. +his detail review is called 3due diligence.3 )pecifically, ?hase I @ue @iligence is initiated once a target company has been selected. +he main ob/ective is to identify various synergy values that can be reali;ed through an M ! " of the +arget (ompany. Investment :ankers now enter into the M ! " process to assist with this evaluation.

Phase 4 - Acquire through

egotiation: Now that we have selected our target company, it&s time to start the

process of negotiating a M ! ". %e need to develop a negotiation plan based on several key questions0 How much resistance will we encounter from the +arget (ompany$ %hat are the benefits of the M ! " for the +arget (ompany$ %hat will be our bidding strategy$ How much do we offer in the first round of bidding$ +he most common approach to acquiring another company is for both companies to reach agreement concerning the M ! "* i.e. a negotiated merger will take place. +his negotiated arrangement is sometimes called a 3'ear hug.3 +he negotiated merger or bear hug is the preferred approach to a M ! " since having both sides agree to the deal will go a long way to making the M ! " work. Phase ! - Post "erger Integration0 If all goes well, the two companies will announce an agreement to merge the two companies. +he deal is finali;ed in a formal merger and acquisition agreement. +his leads us to the fifth and final phase within the M ! " ?rocess, the integration of the two companies. 4very company is different ' differences in culture, differences in information systems, differences in strategies, etc. "s a result, the ?ost Merger Integration ?hase is the most difficult phase within the M ! " ?rocess. Now all of a sudden we have to bring these two companies together and make the whole thing work. +his requires e,tensive planning and design throughout the entire organi;ation. +he integration process can take place at three levels0 1. Full: "ll functional areas operations, marketing, finance, human resources, etc.# will be merged into one new company. +he new company will use the 3best practices3 between the two companies. 2. $oderate: (ertain key functions or processes such as production# will be merged together. )trategic decisions will be centrali;ed within one company, but day to day operating decisions will remain autonomous. 3. $ini"al0 =nly selected personnel will be merged together in order to reduce redundancies. :oth strategic and operating decisions will remain decentrali;ed and autonomous. "s mentioned at the start of this course, mergers and acquisitions are e,tremely difficult. 4,pected synergy values may not be reali;ed and therefore, the merger is considered a failure.

)ome of the reasons behind failed mergers are0 Poor strategic fit ' +he two companies have strategies and ob/ectives that are too different and they conflict with one another. Cultural and +ocial *ifferences ' It has been said that most problems can be traced to 3people problems.3 If the two companies have wide differences in cultures, then synergy values can be very elusive. .nco"plete and .nade/uate *ue *iligence ' @ue diligence is the 3watchdog3 within the M! " ?rocess. If you fail to let the watchdog do his /ob, you are in for some serious problems within the M ! " ?rocess. Poorl( $anaged .ntegration ' +he integration of two companies requires a very high level of quality management. In the words of one (4=, 3give me some people who know the drill.3 Integration is often poorly managed with little planning and design. "s a result, implementation fails. Pa(ing too $uch ' In today&s merger fren;y world, it is not unusual for the acquiring company to pay a premium for the +arget (ompany. ?remiums are paid based on e,pectations of synergies. However, if synergies are not reali;ed, then the premium paid to acquire the target is never recouped. verl( pti"istic ' If the acquiring company is too optimistic in its pro/ections about the +arget

(ompany, then bad decisions will be made within the M ! " ?rocess. "n overly optimistic forecast or conclusion about a critical issue can lead to a failed merger.

' ( A )aluation approaches

Valuation of Target Company
The principa" incenti(e for a merger is that the %usiness (a"ue of the com%ined %usiness is e pected to %e greater than the sum of the independent %usiness (a"ues of the merging entities. The difference %et#een the com%ined (a"ue and the sum of the (a"ues of indi(idua" companies is the s!nerg! gain attri%uta%"e to the 0IA transaction. ;ence, -a"ue of ac)uirer J $tand a"one (a"ue of Target J -a"ue of $!nerg! K Com%ined -a"ue. There is a"so a cost attached to an ac)uisition. The cost of ac)uisition is the price premium paid o(er the mar+et (a"ue plus other costs of integration. Therefore, the net gain is the (a"ue of s!nerg! minus premium paid. $uppose -A K @s. 844 (0erging Compan!, or Ac)uirer)

-/ K @s. 54 (0erging Compan!, or Target) -A/ K @s. 344 (0erged or Ama"gamated =ntit!) Therefore, $!nerg! K -A/ L ( -A J -/ ) K @s. 54. If the premium paid for this merger is @s. 84, Eet gain from merger of A and / #i"" %e @s. 34 (i.e. @s. 54 L @s. 84). It is this 34, %ecause of #hich companies merge or ac)uire. 1ne of the essentia" steps in 0IA is the (a"uation of the Target Compan!. Ana"!sts use a #ide range of mode"s in practice for measuring the (a"ue of the Target firm. These mode"s often ma+e (er! different assumptions a%out pricing, %ut the! do share some common characteristics and can %e c"assified in %roader terms. There are se(era" ad(antages to such a c"assification6 it is easier to understand #here indi(idua" mode"s fit into the %igger picture, #h! the! pro(ide different resu"ts and #here the! ha(e fundamenta" errors in "ogic. There are on"! t ree approac es to (a"ue a %usiness or %usiness interest. ;o#e(er, there are numerous techni)ues #ithin each one of the approaches that the ana"!sts ma! consider in performing a (a"uation. The Approaches and Techni)ues are as fo""o#s6 :

3. Income pproach
The Income Approac is one of three ma'or groups of methodo"ogies, ca""ed (a"uation approaches, used %! appraisers. It is particu"ar"! common in commercia" rea" estate appraisa" and in %usiness appraisa". The fundamenta" math is simi"ar to the methods used for financia" (a"uation, securities ana"!sis, or %ond pricing. ;o#e(er, there are some significant and important modifications #hen used in rea" estate or %usiness (a"uation. Bnder this approach t#o primar! used methods to (a"ue a %usiness interest inc"ude6 a) ?iscounted Cash f"o# method %) Capita"i7ed Cash f"o# method =ach of these methods depends on the present (a"ue of an enterprises future cash f"o#s. Discounted Cash flo% Techni"ue The ?iscounted Cash f"o# (a"uation is %ased upon the notion that the (a"ue of an asset is the present (a"ue of the e pected cash f"o#s on that asset, discounted at a rate that ref"ects the ris+iness of those cash f"o#s. The nature of the cash f"o#s #i"" depend upon the asset, di(idends for an e)uit! share, coupons and redemption (a"ue for %onds and the post ta cash f"o#s for a pro'ect. The $teps in(o"(ed in (a"uation under this method are as under6

'C'0 Techni"ue 4'ree Cash 'lo% 'rom 0"uity5 The Capita"i7ed Cash f"o# techni)ue of income approach is the a%%re(iated (ersion of ?iscounted Cash f"o# techni)ue #here the gro#th rate (g) and the discount rate (+) are assumed to remain constant in perpetuit!. This mode" is represented as under6 -a"ue of 9irm K Eet Cash f"o# in !ear one ( + L g )

6. Mar$et pproach
The origin of mar'et approac o4 1!siness (al!ation is esta%"ished in the economic rationa"e of

competition. It states that in case of a free mar+et, the demand and supp"! effects direct the (a"ue of %usiness properties to a particu"ar %a"ance. The purchasers are not read! to pa! higher amounts for the %usiness and the (endors are not read! to recei(e an! amount, #hich is "o#er in comparison to the (a"ue of a corresponding commercia" entit!. It is the (a"ue of a firm %! performing a comparison %et#een the firms concerned #ith organi7ations in the simi"ar "ocation, of e)ua" (o"ume or operating in the simi"ar sector. It has a "arge num%er of resem%"ances #ith the compara%"e sa"es techni)ue, #hich is genera""! uti"i7ed in case of rea" estate estimation. The mar+et (a"ue of shares of companies that are traded pu%"ic"! and are in(o"(ed in identica" commercia" acti(ities ma! %e a "ogica" signa" of the (a"ue of commercia" operation. In this case the compan! shares are %ought and so"d in an open and free mar+et. This process a""o#s purposefu" comparison of the mar+et (a"ue of shares. The pro%"em e ists in distinguishing pu%"ic companies, #hich are ade)uate"! corresponding to the compan! concerned for this intention. In addition, in case of a pri(ate compan!, the "i)uidit! of the e)uit! is "o#er (put different"!, its shares are difficu"t to trade) in comparison to a pu%"ic compan!. The (a"ue is regarded as some#hat "esser in comparison to that a mar+et:%ased (a"uation #i"" render. E.g. : $uppose a compan! operating in the same industr! as A/C #ith compara%"e si7e and other situations has %een so"d at @s. 544 crores in "ast #ee+ pro(ides a good measurement for (a"uation of %usiness. Considering the circumstances, 14 (a"ue of the %usiness of A/C shou"d %e around @s. 544 crores under mar+et approach.

7.

ssets pproach

The first step in using the assets approach is to o%tain a /a"ance $heet as c"ose as possi%"e to the (a"uation date. =ach recorded asset inc"uding intangi%"e assets must %e identified, e amined and ad'usted to fair mar+et (a"ue. Eo# a"" "ia%i"ities are to %e su%tracted, again at fair mar+et (a"ue, from the (a"ue of assets deri(ed as a%o(e to reach at the fair mar+et (a"ue of e)uit! of the %usiness. It is important to note here that an! unrecorded assets or "ia%i"ities shou"d a"so %e considered #hi"e arri(ing at the (a"ue of %usiness %! the assets approach. Net Asset Val!e Approac Net asset (al!e (EA-) is a term used to descri%e the (a"ue of an entit!<s assets "ess the (a"ue of its "ia%i"ities. The term is most common"! used in re"ation to open:ended or mutua" funds due to the fact that shares of such funds are redeemed at their net asset (a"ue. Economic Val!e A%%e% ,EVA- Approac =conomic -a"ue Added or =-A is an estimate of economic profit, #hich can %e determined, among other #a!s, %! ma+ing correcti(e ad'ustments to ,AA> accounting, inc"uding deducting the opportunit! cost of e)uit! capita". =-A is simi"ar to @esidua" Income (@I), a"though under some definitions there ma! %e minor technica" differences %et#een =-A and @I (for e amp"e, ad'ustments that might %e made to E1>AT %efore it is suita%"e for the formu"a %e"o#). Mar'et Val!e A%%e% Approac ,MVA0ar+et -a"ue Added (0-A) is the difference %et#een the current mar+et (a"ue of a firm and the capita" contri%uted %! in(estors. If 0-A is positi(e, the firm has added (a"ue. If it is negati(e, the firm has destro!ed (a"ue. The amount of (a"ue added needs to %e greater than the firm<s in(estors cou"d ha(e achie(ed in(esting in the mar+et portfo"io, ad'usted for the "e(erage (%eta coefficient) of the firm re"ati(e to the mar+et. The formu"a for 0-A is6 MVA 5 V 6 / 2here6 0-A is mar+et (a"ue added, - is the mar+et (a"ue of the firm, inc"uding the (a"ue of the firm<s e)uit! and de%t M is the capita" in(ested in the firm The higher the 0-A the %etter it is. A high 0-A indicates the compan! has created su%stantia" #ea"th for the shareho"ders. A negati(e 0-A means that the (a"ue of management<s actions and in(estments are "ess than the (a"ue of the capita" contri%uted to the compan! %! the

capita" mar+et (or that #ea"th and (a"ue ha(e %een destro!ed).

!egal and Regulator" Considerations

Introduction

%hen one company decides to acquire another company, a series of negotiations will take place between the two companies. +he acquiring company will have a well'developed negotiating strategy and plan in place. If the +arget (ompany believes a merger is possible, the two companies will enter into a 3.etter of Intent.3 +he .etter of Intent outlines the terms for future negotiations and commits the +arget (ompany to giving serious consideration to the merger. " .etter of Intent also gives the acquiring company the green light to move into ?hase II @ue @iligence. +he .etter of Intent attempts to answer several issues concerning the proposed merger0 A. How will the acquisition price be determined$ 5. %hat e,actly are we acquiring$ Is it physical assets, is it a controlling interest in the target, is it intellectual capital, etc.$ B. How will the merger transaction be designed$ %ill it be an outright purchase of assets$ %ill it be an e,change of stock$ C. %hat is the form of payment$ %ill the acquiring company issue stock, pay cash, issue notes, or use a combination of stock, cash, andDor notes$ 8. %ill the acquiring company setup an escrow account and deposit part of the purchase price$ %ill the escrow account cover unrecorded liabilities discovered from due diligence$ E. %hat is the estimated time frame for the merger$ %hat law firms will be responsible for creating the M ! " "greement$ F. %ill there be any ad/ustment to the final purchase price due to anticipated losses or events prior to the closing of the merger$

M & M & A Agree#ent M & A Agree#ent

"s the negotiations continue, both companies will conduct e,tensive ?hase II @ue @iligence in an effort to identify issues that must be resolved for a successful merger. If significant issues can be resolved and both companies are convinced that a merger will be beneficial, then a formal merger and acquisition agreement will be formulated. +he basic outline for the M ! " "greement is rooted in the .etter of Intent. However, ?hase II @ue @iligence will uncover several additional issues not covered in the .etter of Intent. (onsequently, the M ! " "greement can be very lengthy based on the issues e,posed through ?hase II

@ue @iligence. "dditionally, both companies need to agree on the integration process. <or e,ample, a +ransition )ervice "greement is e,ecuted to cover certain types of services, such as payroll. +he +arget (ompany continues to handle payroll up through a certain date and once the integration process is complete, the acquiring company takes over payroll responsibilities. +he +ransition )ervice "greement will specify the types of services, timeframes, and fees associated with the integration process.

Inde#nification
"nother important element within the M ! " "greement is indemnification. +he M ! " "greement will specify the nature and e,tent to which each company can recover damages should a misrepresentation or breach of contract occur. " 3basket3 provision will stipulate that damages are not due until the indemnification amount has reached a certain threshold. If the basket amount is e,ceeded, the indemnification amount becomes payable at either the basket amount or an amount more than the basket amount. +he seller +arget (ompany# will insist on having a ceiling for basket amounts within the M ! " "greement. )ince both sides may not agree on indemnification, it is a good idea to include a provision on how disputes will be resolved such as binding arbitration#. <inally, indemnification provisions may include a 3right of sell off3 for the buyer since the buyer has deposited part of the purchase price into an escrow account. +he -ight to )ell =ff allows the buyer acquiring company# to offset any indemnification claims against amounts deferred within the purchase price of the merger. If the purchase price has been paid, then legal action may be necessary to resolve the indemnification.

&ccounting For $ 0 &

=ne last item that we should discuss is the application of accounting principles to mergers and acquisitions. (urrently, there are two methods that are used to account for mergers and acquisitions M ! "#0 Purchase0 +he M ! " is viewed prospectively restate everything and look forward# by treating the transaction as a purchase. "ssets of the +arget (ompany are restated to fair market value and the difference between the price paid and the fair market values are posted to the :alance )heet as goodwill. Pooling of .nterest0 +he M ! " is viewed historically refer back to e,isting values# by combining the book values of both companies. +here is no recognition of goodwill. It should be noted that ?ooling of Interest applies to M ! "&s that involve stock only. In the good old days when physical assets were important* the ?urchase Method was the leading method for M ! " accounting. However, as the importance of intellectual capital and other intangibles has grown, the ?ooling of Interest Method is now the dominant method for M ! " accounting. However, therein lies the problem. :ecause intangibles have become so important to businesses, the failure to recogni;e these assets from an M ! " can seriously distort the financial statements. "s a result, the <inancial "ccounting )tandards :oard has proposed the elimination of the ?ooling of Interest Method. If ?ooling is phased out, then it will become much more important to properly arrive at fair market values for the target&s assets.

Module 8 III

S0!I Ta$eover Code

SEC#RITIES AND E7CHANGE )OARD O$ INDIA. Ta'eo(er Co%e If an ac)uisition is contemp"ated %! #a! of issue of ne# shares 84, or the ac)uisition of e isting shares, of a Aisted compan!, to or %! an ac)uirer, the pro(isions of the Ta+eo(er Code ma! %e app"ica%"e. Bnder the Ta+eo(er Code, an ac)uirer, a"ong #ith persons acting in concert. cannot ac)uire shares or (oting rights #hich (ta+en together #ith shares or (oting rights, if an!, he"d %! him and %! persons acting in concert), entit"e such ac)uirer to e ercise 15N or more of the shares or (oting rights in the target, #ho has ac)uired, 15N or more %ut "ess than 55N of the shares or (oting rights in the target, cannot ac)uire, either %! himse"f or through persons acting in concert #ho ho"ds 55N or more %ut "ess than O5N of the shares or (oting rights in the target, cannot ac)uire either %! himse"f or through persons acting in concert, an! additiona" shares or (oting rights therein #ho ho"ds O5N of the shares or (oting rights in the target, cannot ac)uire either %! himse"f or through persons acting in concert, an! additiona" shares or (oting rights therein. un"ess the ac)uirer ma+es a pu%"ic announcement to ac)uire the shares or (oting rights of the target in accordance #ith the pro(isions of the Ta+eo(er Code. The term ac)uisition #ou"d inc"ude %oth, direct ac)uisition in an Indian "isted compan! as #e"" as indirect ac)uisition of an Indian "isted compan! %! (irtue of ac)uisition of companies, #hether "isted or un"isted, #hether in India or a%road. 9urther, the aforesaid "imit of 5N ac)uisition is ca"cu"ated aggregating a"" purchases, #ithout netting of sa"es. ;o#e(er, (ide a recent amendment, an! person ho"ding 55N or more (%ut "ess than O5N) shares is permitted to further increase his shareho"ding %! not more than 5N in the target #ithout ma+ing a pu%"ic announcement if the ac)uisition is through open mar+et purchase in norma" segment on the stoc+ e change %ut not through %u"+ dea" *%"oc+ dea"* negotiated dea"* preferentia" a""otment or the increase in the shareho"ding or (oting rights of the ac)uirer is pursuant to a %u!%ac+ of shares %! the target. Though there #ere certain am%iguities as to the period during #hich the 5N "imit can %e e hausted, $=/I has c"arified that the 5N "imit sha"" %e app"ica%"e during the "ifetime of the target #ithout an! "imitation as to financia" !ear or other#ise. ;o#e(er, 'ust "i+e the ac)uisition of 5N up to 55N, the ac)uisition is ca"cu"ated aggregating a"" purchases, #ithout netting of sa"es. The $=/I ma! a"so re)uire (a"uation of such infre)uent"! traded shares %! an independent (a"uer.

'ode of payment of offer price. The offer price ma! %e paid in cash, %! issue, e change or transfer of shares (1ther than preference shares) of the ac)uirer, if the ac)uirer is a "isted entit!, %! issue, e change or transfer of secured instruments of the ac)uirer #ith a minimum A grade rating from a credit rating agenc! registered #ith the $=/I, or a com%ination of a"" of the a%o(e *on"compete payments. >a!ments made to persons other than the target compan! under an! non:compete agreement e ceeding 85N of the offer price arri(ed at as per the re)uirements mentioned a%o(e, must %e added to the offer price. +ricing for indirect acquisition or control. The offer price for indirect ac)uisition or contro" sha"" %e determined #ith reference to the date of the pu%"ic announcement for the parent compan! and the date of the pu%"ic announcement for ac)uisition of shares of the target compan!, #hiche(er is higher, in accordance #ith re)uirements set out a%o(e. If the ac)uirer intends to dispose of * encum%er the assets in the target compan!, e cept in the ordinar! course of %usiness, then he must ma+e such a disc"osure in the pu%"ic announcement or in the "etter of offer to the shareho"ders, fai"ing #hich, the ac)uirer cannot dispose of or encum%er the assets of the target compan! for a period of 8 !ears from the date of c"osure of the pu%"ic offer @estrictions on the target compan!. After the pu%"ic announcement is made %! the ac)uirer, the target compan! is a"so su%'ect to certain restrictions. The target compan! cannot then (a) se"", transfer, encum%er or other#ise dispose off or enter into an agreement for sa"e, transfer, encum%rance or for disposa" of assets, e cept in the ordinar! course of %usiness of the target compan! and its su%sidiaries, (%) issue or a""ot an! securities carr!ing (oting rights during the offer period, e cept for an! su%sisting o%"igations, and (c) enter into an! materia" contracts.

The fo""o#ing ac)uisitions * transfers #ou"d %e e empt from the +e! pro(isions of the Ta+eo(er Code6 ac)uisition pursuant to a pu%"ic issue& ac)uisition %! a shareho"der pursuant to a rights issue to the e tent of his entit"ement and su%'ect to certain other restrictions& inter:se transfer of shares amongst6 o )ua"if!ing Indian promoters and foreign co""a%orators #ho are shareho"ders, o )ua"if!ing promoter, pro(ided that the parties ha(e %een ho"ding shares in the target compan! for a

period of at "east three !ears prior to the proposed ac)uisition, o the ac)uirer and >AC, #here the transfer of shares ta+es p"ace three !ears after the date of c"osure of the pu%"ic offer made %! them under the Ta+eo(er Code and the transfer is at a price not e ceeding 185N of the price determined as per the Ta+eo(er Code (as mentioned a%o(e)& ac)uisition of shares in the ordinar! course of %usiness %! (a) %an+s and pu%"ic financia" institutions as p"edgees, (%) the Internationa" 9inance Corporation, Asian ?e(e"opment /an+, Internationa" /an+ for @econstruction and ?e(e"opment, Common#ea"th ?e(e"opment Corporation and such other internationa" financia" institutions& ac)uisition of shares %! a person in e change of shares recei(ed under a pu%"ic offer made under the Ta+eo(er Code& ac)uisition of shares %! #a! of transmission on succession or inheritance& transfer of shares from (enture capita" funds or foreign (enture capita" in(estors registered #ith the $=/I to promoters of a (enture capita" underta+ing or to a (enture capita" underta+ing, pursuant to an agreement %et#een such (enture capita" fund or foreign (enture capita" in(estors, #ith such promoters or (enture capita" underta+ing& change in contro" %! ta+eo(er of management of the %orro#er target compan! %! the secured creditor or %! restoration of management to the said target compan! %! the said secured creditor in terms of the $ecuriti7ation and @econstruction of 9inancia" Assets and =nforcement of $ecurit! Interest Act, 8448& ac)uisition of shares in companies #hose shares are not "isted on an! stoc+ e change, un"ess it resu"ts in the ac)uisition shares*(oting rights*contro" of a compan! "isted in India& and ac)uisition of shares in terms of guide"ines or regu"ations regarding de"isting of securities framed %! the $=/I.

#inancing M&A $eals

0ergers are genera""! differentiated from ac)uisitions part"! %! the #a! in #hich the! are financed and part"! %! the re"ati(e si7e of the companies. -arious methods of financing an 0IA dea" e ist6

Cash
>a!ment %! cash. $uch transactions are usua""! termed ac)uisitions rather than mergers %ecause the shareho"ders of the target compan! are remo(ed from the picture and the target comes under the (indirect) contro" of the %idder<s shareho"ders.

+toc%
>a!ment in the form of the ac)uiring compan!<s stoc+, issued to the shareho"ders of the ac)uired compan! at a gi(en ratio proportiona" to the (a"uation of the "atter.

Financing options
There are some e"ements to thin+ a%out #hen choosing the form of pa!ment. 2hen su%mitting an offer, the ac)uiring firm shou"d consider other potentia" %idders and thin+ strategica""!. The form of pa!ment might %e decisi(e for the se""er. 2ith pure cash dea"s, there is no dou%t on the rea" (a"ue of the %id (#ithout considering an e(entua" earn out). The contingenc! of the share pa!ment is indeed remo(ed. Thus, a cash offer preempts competitors %etter than securities. Ta es are a second e"ement to consider and shou"d %e e(a"uated #ith the counse" of competent ta and accounting ad(isers. Third, #ith a share dea" the %u!ers capita" structure might %e affected and the contro" of the %u!er modified.

If the issuance of shares is necessar!, shareho"ders of the ac)uiring compan! might pre(ent such capita" increase at the genera" meeting of shareho"ders. The ris+ is remo(ed #ith a cash transaction. Then, the %a"ance sheet of the %u!er #i"" %e modified and the decision ma+er shou"d ta+e into account the effects on the reported financia" resu"ts. 9or e amp"e, in a pure cash dea" (financed from the compan!s current account), "i)uidit! ratios might decrease. 1n the other hand, in a pure stoc+ for stoc+ transaction (financed from the issuance of ne# shares), the compan! might sho# "o#er profita%i"it! ratios (e.g. @1A). ;o#e(er, economic di"ution must pre(ai" to#ards accounting di"ution #hen ma+ing the choice. The form of pa!ment and financing options are tight"! "in+ed. If the %u!er pa!s cash, there are three main financing options6

Cash on hand6 it consumes financia" s"ac+ (e cess cash or unused de%t capacit!) and ma! decrease It consumes financia" s"ac+, ma! decrease de%t rating and increase cost of de%t. Transaction costs inc"ude under#riting or c"osing costs of 1N to 3N of the face (a"ue. Issue of stoc+6 it increases financia" s"ac+, ma! impro(e de%t rating and reduce cost of de%t. Transaction costs inc"ude fees for preparation of a pro ! statement, an e traordinar! shareho"der meeting and registration.

de%t rating. There are no ma'or transaction costs.

If the %u!er pa!s #ith stoc+, the financing possi%i"ities are6

Issue of stoc+ (same effects and transaction costs as descri%ed a%o(e). $hares in treasur!6 it increases financia" s"ac+ (if the! dont ha(e to %e repurchased on the mar+et), ma! impro(e de%t rating and reduce cost of de%t. Transaction costs inc"ude %ro+erage fees if shares are repurchased in the mar+et other#ise there are no ma'or costs.

In genera", stoc+ #i"" create financia" f"e i%i"it!. Transaction costs must a"so %e considered %ut tend to ha(e a greater impact on the pa!ment decision for "arger transactions. 9ina""!, pa!ing cash or #ith shares is a #a! to signa" (a"ue to the other part!, e.g.6 %u!ers tend to offer stoc+ #hen the! %e"ie(e their shares are o(er(a"ued and cash #hen under(a"ued.F6H

S"ecialist M&A a visory firms

A"though at present the ma'orit! of 0IA ad(ice is pro(ided %! fu"":ser(ice in(estment %an+s, recent !ears ha(e seen a rise in the prominence of specia"ist 0IA ad(isers, #ho on"! pro(ide 0IA ad(ice (and not financing). These companies are sometimes referred to as Transition companies, assisting %usinesses often referred to as .companies in transition.. To perform these ser(ices in the B$, an ad(isor must %e a "icensed %ro+er dea"er, and su%'ect to $=C (9IE@A) regu"ation. 0ore information on 0IA ad(isor! firms is pro(ided at corporate ad(isor!

*E#T RE+TR-CT-R.1G
*e't restructuring is a process that allows a private or public company facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations. " debt restructuring is usually less e,pensive and a preferable alternative to bankruptcy. +he main costs associated with a business debt restructuring are the time and effort to negotiate with bankers, creditors, vendors and ta, authorities. @ebt restructurings typically involve a reduction of debt and an e,tension of payment terms

Definition of 'Debt Restructuring'

A method used by companies with outstanding debt obligations to alter the terms of the debt agreements in order to achieve some advantage.

Companies use de%t restructuring to a(oid defau"t on e isting de%t or to ta+e ad(antage of a "o#er interest rate. A compan! #i"" often issue ca""a%"e %onds to a""o# them to readi"! restructure de%t in the future. The e isting de%t is ca""ed and then rep"aced #ith ne# de%t at a "o#er interest rate. Companies can a"so restructure their de%t %! a"tering the terms and pro(isions of the e isting de%t issue.
Related ter#s
-eplacement of old debt by new debt when not under financial distress is referred to as %efinancing *e't consolidation entails taking out one loan to pay off many others. +his is often done to secure a lower interest rate, secure a fi,ed interest rate or for the convenience of servicing only one loan

+hare #u('ac% 2or3 +hare Repurchase

A program %! #hich a compan! %u!s %ac+ its o#n shares from the mar+etp"ace, reducing the num%er of outstanding shares. $hare repurchase is usua""! an indication that the compan!<s management thin+s the shares are under(a"ued. The compan! can %u! shares direct"! from the mar+et or offer its shareho"der the option to tender their shares direct"! to the compan! at a fi ed price. /ecause a share repurchase reduces the num%er of shares outstanding (i.e. supp"!), it increases earnings per share and tends to e"e(ate the mar+et (a"ue of the remaining shares. 2hen a compan! does repurchase shares, it #i"" usua""! sa! something a"ong the "ines of, .2e find no %etter in(estment than our o#n compan!..

1. $hareho"ders ma! %e presented #ith a tender offer #here%! the! ha(e the option to su%mit (or tender) a portion or a"" of their shares #ithin a certain time frame and at a premium to the current mar+et price. This premium compensates in(estors for tendering their shares rather than ho"ding on to them. 8. Companies %u! %ac+ shares on the open mar+et o(er an e tended period of time.

S are Rep!rc ase

)lternative to the payment of cash dividends, the company may purchase the shares bac(. *urchase of shares outstanding can be done through the secondary mar(et +toc( ,xchange. +hares purchased are included in treasury stoc( account. !heoretically, the value of the company before and after the purchase of shares will be the same again. The Advantages of Stock Repurchases

Buying back shares could save on taxes. Announcement of buy-back could be considered a positive signal by investors, because Stock repurchases often driven by the motivation of managers who assume that the undervalued stock price (lower than they should .

!ayment of dividends is usually done with a stable pattern. Shareholders have the option to Stock "epurchases. #hen need cash, they can sell the shares they ac$uire. %onversely, if do not need cash, or evading taxes, they can invest back into the company stock. &n some specific situations, Stock "epurchases done selectively

The Disadvantages of Stock Repurchases

'he shareholders may have different preferences between cash dividends and Stock "epurchases (profits derived from capital gains . %ash dividends tend to be (unreliable) because it gives a clear income (cash received , and relatively stable.

'he %ompany may pay the repurchase price is too high, to the detriment of current shareholders (who still holds the shares . Shareholders who sell their shares may not know exactly the implications and the Stock "epurchases program effects. &f it turns out to feel aggrieved, they can sue the company.

PMerits o4 S

are Rep!rc ase

Re%!ce ta'eo(er c ances8 /u!ing %ac+ stoc+ uses up e cess cash. There turns on e cess cash in mone! mar+et a c c o u n t s c a n d r a g d o # n o ( e r a " " compan! performance. Cash rich companies are a"so (er! attracti(e ta+eo(er t a r g e t s . / u ! i n g % a c + s t o c + a " " o # s t h e c o m p a n ! t o e a r n a % e t t e r r e t u r n o n e cess cash and +eep itse"f from %ecoming a ta+eo(er target. PIncrease ROE8 /u!ing %ac+ stoc+ can increase the return on e)uit! (@1=). T h i s e f f e c t i s g r e a t e r t h e m o r e u n d e r ( a " u e d t h e s h a r e s a r e # h e n t h e ! a r e repurchased. If shares are under(a"ued, this ma! %e the most profita%"e course of action for the compan!. P .s&c ological E44ect8 2 h e n a c o m p a n ! p u r c h a s e s i t s o # n s t o c + i t i s essentia""! te""ing the mar+ e t t h a t t h e ! t h i n + t h a t t h e c o m p a n ! s s t o c + i s under(a"ued. This can ha(e a ps!cho"ogica" effect on the mar+et. P /u!ing %ac+ stoc+ a""o#s a compan! to pass on e tra cash to shareho"ders #ithout raising the di(idend. If the cash is temporar! in nature it ma! pro(e more %eneficia" to pass on (a"ue to shareho"ders through %u!%ac+s rather than raising the di(idend. P E9cellent Tool 4or $inancial Reengineering8 In the case of profit ma+ing, h i g h d i ( i d e n d : p a ! i n g c o m p a n i e s # h o s e s h a r e p r i c e s a r e " a n g u i s h i n g , %u!%ac+s can actua""! %oost their %ottom "ines since di(idends attract ta es. A % u ! % a c + a n d t h e s u % s e ) u e n t n e u t r a " i s a t i o n o f s h a r e s c a n r e d u c e d i ( i d e n d outf"o#s, and if the opportunit! cost of funds used is "o#er than the di(idend sa(ings, the compan! can "augh a"" the #a! to the %an+. P Ta9 Implication8

= e m p t i o n i s a ( a i " a % " e o n " ! i f t h e s h a r e s a r e s o " d o n a recognised stoc+ e change and if securities transaction ta ($TT) on the sa"e h a s % e e n p a i d . I n a % u ! % a c + s c h e m e , n e i t h e r d o e s t h e s a " e t a + e p " a c e o n a recognised e change nor is the $TT paid. $o, !ou #i"" ha(e to pa! income ta on !our "ong:term capita" gain on the %u!%ac+ after deducting the ac)uisition cost of !our shares p"us the %enefit of inde ation from the !ear of purchase to the !ear of %u!%ac+. 1n the resu"tant gain, the ta #ou"d %e 84 per cent p"us the app"ica%"e surcharge, if an!, p"us 8 per cent education cess. Qou ma! a"so #or+ out the ta at 14 per cent of the gain #ithout considering inde ation. Qour ta "ia%i"it! #i"" %e "imited to the "o#er of the t#o ca"cu"ations. P $toc+ %u!%ac+s a"so raise the demand for the stoc+ on the open mar+et. This point is rather se"f e p"anator! as the compan! is competing against other in(estors to purchase shares of its o#n stoc+.

Demerits o4 S are Rep!rc ase

6 P Sen%ing Negati(e Signals8 A %u!%ac+ announcement can send a negati(e signa" i n t h e s e s i t u a t i o n s . A t ! p i c a " e a m p " e i s t h e ; > c a s e 6 9 r o m E o ( e m % e r 1 9 9 G through 1cto%er 8444, the computer giant ;e#"ett: >ac+ard spent RG.8 %i""ion to %u! %ac+ 18G mi""ion of its shares. The aim #as to ma+e opportunistic purchases of ;> stoc+ at attracti(e pricesSin other #ords, at prices the! fe"t under(a"ued the compan!. Instead of signa""ing good operating prospects to the mar+et, the %u!%ac+ signa" #as comp"ete"! dro#ned out more po#erfu" contradictor! signa"s a%out the compan!s future #hich are an a%orted ac)uisition, a protracted %usiness r e s t r u c t u r i n g , s " i p p i n g f i n a n c i a " r e s u " t s , a n d a d e c a ! i n t h e g e n e r a " profita%i"it! of +e! mar+ets. /! "ast Tanuar!, ;>s shares #ere trading at around ha"f the a(erage R65 per share paid to repurchase the stoc+. P )ac'4ire8 /u!%ac+s can a"so %ac+fire for a compan! competing in a high:gro#th industr! %ecause the! ma! %e read as an admission that the compan! has fe# i m p o r t a n t n e # o p p o r t u n i t i e s o n # h i c h t o o t h e r # i s e s p e n d i t s m o n e ! . I n s u c h cases, "ong:term in(estors #i"" respond to a %u!%ac+ announcement %! se""ing the compan!s shares The share %u!%ac+ scheme might %ecome a %ig disad(antage to the compan! #hen it p a ! s t o o m u c h f o r i t s o # n s h a r e s . I n d e e d , i t i s f o o " i s h t o % u ! i n a n o(erpriced mar+et. Instead, the compan! shou"d put the mone! into assets that can %e easi"! con(erted %ac+ into cash. This

#a!, #hen the mar+et s#ings the other #a! and is trading %e"o# its true (a"ue, shares of the compan! can %e %ought %ac+ at a discount, ensuring current shareho"ders recei(e ma imum %enefit. $trict"!, acompan! shou"d repurchase its shares on"! #hen its stoc+ is trading %e"o# its e pected (a"ue and #hen no %etter in(estment opportunities are a(ai"a%"e.

.ROVISIONS : CONDITIONS RELATING TO )#+)AC/. The restrictions #ere imposed to restrict the companies from using the stoc+ mar+ets as short term mone! pro(ider apart from protecting interests of sma"" in(estors. $ec OOA6 >o#er of a compan! to purchase its o#n securities. $ection OOA #as introduced %! the Companies (Amendment) Act, 1999, pursuant to the report of the #or+ing group #hich #as set up to suggest reforms to the Companies Act. $ection OOA(8) of the Companies Act, 19566 1)Authorised %! Artic"es of Association and a $pecia" @es o"ution 8)/u!%ac+ shou"d %e e)ua" to or "ess than 85Nof the tota" paid up c a p i t a " a n d f r e e reser(es 3)$hares to %e %ought %ac+ shou"d %e fu""! paid up 5)?e%t =)uit! ratio shou"d not e ceed 861 post %u!%ac+ 5)Eotice of meeting to the shareho"ders shou"d ha(e a"" the detai"s necessar! 6)/u!%ac+ of shares "isted on an! recognised stoc+ e change shou"d %e in accordance #ith $=/I guide"ines O)= p"anator! statement stating the fo""o#ing shou"d %e prepared: a)A fu"" and comp"ete disc"osure of a"" materia" facts& %)The necessit! for the %u!:%ac+ c)The c"ass of securit! intended to %e purchased under the %u!:%ac+& d)The amount to %e in(ested under the %u!:%ac+& and e)The time "imit for comp"etion of %u!:%ac+ G)A dec"aration of so"(enc! has to %e fi"ed #ith $=/I and @egistrar 1f Companies

9)Comp"etion of the %u!%ac+ shou"d %e #ithin 18 months 14) The shares %ought %ac+ shou"d %e e tinguished and ph!sica""! destro!ed& 11) The compan! shou"d not ma+e an! further issue of securities #ithin 8 !ears, e cept %onus, con(ersion of #arrants, etc.

?=T=@0IEATI1E 19 $2A> @ATI1 0IA ?=AA$

Definition of 'Swap Ratio'

'he ratio in which an ac$uiring company will offer its own shares in exchange for the target company*s shares during a merger or ac$uisition. 'o calculate the swap ratio, companies analy+e financial ratios such as book value, earnings per share, profits after tax and dividends paid, as well as other factors, such as the reasons for the merger or ac$uisition. ,or example, if a company offers a swap ratio of -.-./, it will provide one share of its own company for every -./ shares of the company being ac$uired. 'his can also be applied as a debt0e$uity swap, when a company wants investors to trade their bonds with the company being ac$uired for the ac$uiring company*s own shares.

$#ap @atio (or = change @atio)

The shareho"ders of the ama"gamating compan! are gi(en the shares of the ama"gamated compan! in e change for the shares he"d %! them in the ama"gamating compan!. 9or e amp"e #hen T10C1 #as emerged #ith ;industan Ae(er Aimited, shareho"ders of T10C1 #ere gi(en the shares of ;industan Ae(er Aimited in the ratio of 8615& that means 8 shares of ;industan "e(er Aimited #ere gi(en in "ieu of 15 shares of T10C1 . ;o# is the e change ratio determinedU The common"! used %ases for esta%"ishing the e change ratio are6 earnings per share, mar+et price per share, and %oo+ (a"ue per share. Earnings per s are6 $uppose the earnings per share of the ac)uiring firm are @s 5.44 and the earnings per share of the target firm @s 8.44. An e change ratio %ased on earnings per share #i"" %e 4.5 that is (8*5). This means 8 shares of the ac)uiring firms #i"" %e e changed for 5 shares of the target firm.

2hi"e earnings per share ref"ect prime facie the earnings po#er, there are some pro%"ems in an e change ratio %ased so"e"! on current earnings per share of the merging companies %ecause it fai"s to ta+e into account the fo""o#ing6 V The difference in the gro#th rates of earnings of the t#o companies V The gains in earnings arising out of merger V The differentia" ris+s associated #ith the earnings of the t#o companies 0oreo(er, there is the measurement pro%"em of defining the norma" "e(e" of current earnings. The current earnings per share ma! %e inf"uenced %! certain transient factors "i+e a #indfa"" profit, or an a%norma" "a%or pro%"em, or a "arge ta re"ief. 9ina""!, ho# can earnings per share, #hen the! are negati(e, %e usedU Mar'et .rice per s are6 The e change ratio ma! %e %ased on the re"ati(e mar+et prices of the shares of the ac)uiring firm and the target firm. 9or e amp"e, if the ac)uiring firms e)uit! share se""s for @s 54 and the target firms e)uit! share se""s for @s 14 the e change ratio %ased on the mar+et price is 4.8 that is (14*54). This means that 1 share of the ac)uiring firm #i"" %e e changed for 5 shares of the target firm. 2hen the shares of the ac)uiring firm and the target firm are acti(e"! traded in a competiti(e mar+et, mar+et prices ha(e considera%"e merit. The! ref"ect current earnings, gro#th prospects and ris+ characteristics. 2hen the trading is meagre mar+et prices, ho#e(er, ma! not %e (er! re"ia%"e. In the e treme case mar+et prices ma! not %e a(ai"a%"e if the shares are not traded. Another pro%"em #ith mar+et prices is that the! ma! %e manipu"ated %! those #ho ha(e a (ested interest. )oo' (al!e per s are6 The re"ati(e %oo+ (a"ues of the t#o firms ma! %e used to determine the e change rate. 9or e amp"e, if the %oo+ (a"ue per share of the ac)uiring compan! is @s 85 and the %oo+ (a"ue per share of the target compan! is @s 15, the %oo+ (a"ue %ased e change ratio is 4.6 K(15*85). The proponents of %oo+ (a"ue contend that it pro(ides a (er! o%'ecti(es %asis. This ho#e(er is not con(incing argument %ecause %oo+ (a"ues are inf"uenced %! accounting po"icies #hich ref"ect su%'ecti(e 'udgments. There are sti"" serious o%'ections against the use of the %oo+ (a"ue. 1. /oo+ (a"ues do not ref"ect changes in purchasing po#er of mone!. 8. /oo+ (a"ues often are high"! different from true economic (a"ues

SHARE )#+)AC/ IN REG#LATED IND#STRIES The regu"ation is app"ica%"e to %u!%ac+ of shares or other specified securities of a compan! "isted on a $toc+ = change. The %u!%ac+ of shares can-t ta$e place for delisting of shares 4rom t e Stoc' E9c ange. 2hen the compan! is %u!ing %ac+ shares it cant %u! %ac+ through negotiated dea"s #ith an! person or through spot transactions or through an! pri(ate arrangement. Special Reg!lation In case the 1ffer si7e is greater than 85N of its =)uit! share capita" I free reser(es, the compan! can go ahead #ith the %u! %ac+ on"! if a specia" reso"ution is passed at the genera" meeting. 2hen the notice is %eing sent to the shareho"ders an = p"anator! $tatement must %e anne ed to the notice containing (arious disc"osures T h e c o m p a n ! c a n a " s o c o m p a n ! c a n g o a h e a d # i t h t h e % u ! % a c + o n " ! if a specia" reso"ution is through the posta"%a""ot route as per The Companies (>assing of the @eso"ution %! >osta" /a""ot) @u"es, 8441.C>osta" /a""otD inc"udes (oting %! share ho"ders %! posta" or e"ectronic mode instead of (oting persona""! %! presenting for transacting %usinesses in a genera" meeting of the compan!, 0ethod for sending notice6(a) The compan! ma! issue notices either,:(i) Bnder @egistered >ost Ac+no#"edgement ?ue& or (ii) Bnder certificate of posting& and( % ) 2 i t h a n a d ( e r t i s e m e n t p u % " i s h e d i n a " e a d i n g = n g " i s h E e # s p a p e r a n d i n o n e (ernacu"ar Ee#spaper circu"ating in the $tate in #hich the registered o f f i c e o f t h e compan! is situated, a%out ha(ing despatched the %a""ot papers.D

E9planator& Statement The compan! needs to ma+e the fo""o#ing disc"osures in the statement 1. The date of the /oard meeting at #hich the proposa" for %u! %ac+ #as appro(ed %! the /1?. 8. The necessit! for the %u! %ac+ 3. The compan! ma! specif! one reason to %e adopted for %u!:%ac+ so that the shareho"ders authori7e the /1? for the same. 5. The ma imum amount re)uired under the %u! %ac+ and the sources of funds fr om #hich the %u! %ac+ #ou"d %e financed. 5. The %asis of arri(ing at the %u!:%ac+ price. 6. The num%er of securities that the compan! proposes to %u! %ac+.

O. a. The aggregate shareho"ding of the promoter and of the directors of the promoters, as on the date of the notice con(ening the ,enera" 0eeting. %. Aggregate num%er of shares purchased or so"d %! such persons during a period of si months preceding the date of the /oard 0eeting c. The ma imum and minimum price at #hich purchases and sa"es #ere made a"ong #ith the re"e(ant dates. G. Intention of the promoters and persons in contro" of the compan! to tender their shares for %u!:%ac+ indicating the num%er of shares and detai"s of ac)uisition #ith dates and price. 9. A confirmation that there are no defau"ts su%sisting in repa!ment of deposits, redemption of de%entures or preference shares or repa!ment of term "oans to an! financia" institutions or %an+s. 14. A confirmation that the /1? has made a fu"" en)uir! into the affairs and prospects of the compan! and is of the opinion. a. that there #i"" %e no grounds on #hich the compan! cou"d %e found una%"e to pa! its de%ts& %.The compan! during that !ear, the compan! #i"" %e a%"e to meet its "ia%i"ities as and #hen the! fa"" due and #i"" not %e rendered inso"(ent #ithin a period of one !ear from that ,enera" 0eeting date & and c. In forming their opinion for the a%o(e purposes, the directors ha(e ta+en into account the "ia%i"ities as if the compan! #ere %eing #ound up under the pro(isions of the Companies Act, 1956 ; o Is Merc ant )an'er< A merchant %an+er, according to $=/I (0erchant /an+ers) @egu"ations, 1998 C is a person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory services in relation to such issue management, 0erchant %an+ers render ser(ices to meet the needs of trade, industr! and a"so in(estors %! performing as intermediar!, consu"tant and a "iaison. 0erchant %an+ing is a ser(ice oriented industr! specia"i7ing in in(estment and financia" decision ma+ing, assisting in ma+ing corporate strategies, assessing capita" needs andhe"ping in procuring the e)uit! and de%t funds for corporate sectors and u"timate"! he"ping in esta%"ishing fa(oura%"e economic en(ironment.

S;EAT E"#IT+ = COR.ORATE .ER$ORMANCE What is 'Sweat Equity'?

+,eat e/uit( is a party&s contribution to a pro/ect in the form of effort '' as opposed to financial equity, which is a contribution in the form of capital. In a partnership, some partners may contribute to the firm only capital and others only sweat equity

%ontribution to a pro1ect or enterprise in the form of effort and toil. Sweat e$uity is the ownership interest, or increase in value, that is created as a direct result of hard work by the owner(s . &t is the preferred mode of building e$uity for cash-strapped entrepreneurs in their start-up ventures, since they may be unable to contribute much financial capital to their enterprise. &n the context of real estate, sweat e$uity refers to value-enhancing improvements made by homeowners themselves to their properties. 'he term is probably derived from the fact that such e$uity is considered to be generated from the 2sweat of one*s brow.2 ,or example, consider an entrepreneur who has invested 3-44,444 in her start-up. After a year of developing the business and getting it off the ground, she sells a 5/6 stake to an angel investor for 3/44,444. 'his gives the business a valuation of 35 million (i.e. 3/44,44404.5/ , of which the entrepreneur*s share is 3-./ million. Subtracting her initial investment of 3-44,444, the sweat e$uity she has built up is 3-.7 million. 8aluation of sweat e$uity can become a contentious issue when there are multiple owners in an enterprise, especially when they are performing different functions. 'o avoid disputes and complications at a later stage, it may be advisable to arrive at an understanding of how sweat e$uity will be valued at the outset or initial stage itself.

,mployee +toc( Option -,+O*. and +weat ,quity -+,. are new tools, which are in use by a lot of multinational companies and consulting companies coming to India and engaging the real brain of Indian professionals who are offered ,+O*/+, by such companies as an incentive to them. In absence of any set law or precedent about its

legality, taxation and accounting, a great deal of confusion is prevailing and an attempt is made to resolve the same.

Why ESO

or SE !

!he employee stoc( option plan is a good management tool for retention of human talent and guarding against poaching of staff of a running organisa"tion by a rival company. When a company is newly formed or starts a new line of business, the company engages the best executives and employees available, who bring in their I*% -Intellectual *roperty %ights. and (now"how, s(ill and expertise with them, which ma(e a value addition for the company. ertain (ey professionals would li(e to invest in the companys capital and would li(e to ris( their own contribution to the capital of the company along with their own I*%, (now"how, s(ill and expertise. +uch employees would li(e to be a strategic part of the promoter group and would li(e to ma(e value addition to their capital invested in the company. +uch an employee is awarded with +weat ,quity as an incentive to &oin the company. )s the company grows, the management would li(e to see that all its core management team remains with them and further, such core management team is given additional incentive as a reward for the efforts put in by them in managing the company. +uch employees are offered ,+O* at a price which is less than the real value of the share.

E"plo(ee +toc%

,nership Plan 2E+ P3

"n employee stock ownership plan 4)=?# is a defined contribution plan that provides a company&s workers with an ownership interest in the company. In an 4)=?, companies provide their employees with stock ownership, typically at no cost to the employees. )hares are given to employees and are held in the 4)=? trust until the employee retires or leaves the company, or earlier diversification opportunities arise. #SES O$ AN =$1> A Rea%il& A(aila1le Mar'et 4or Controlling S are ol%ers 9re)uent"!, contro""ing shareho"ders desire to se"" a part of their shares in order to di(ersit! their ho"dings, or to pro(ide "i)uidit! for in(estment or estate p"anning purposes. Bsua""!, ho#e(er, there is no mar+et for the sa"e of a minorit! interest in a c"ose"!:he"d compan!.

A great dea" of f"e i%i"it! is a(ai"a%"e in structuring sa"es to the =$1>. If a shareho"der desires immediate "i)uidit!, the p"an ma! o%tain a %an+ "oan and purchase the shares for cash. If a shareho"der does not need immediate "i)uidit!, he ma! defer the ta on the sa"e %! se""ing his shares to the trust on an insta"ment sa"e %asis, or %! se""ing on"! a portion of his shares to the trust on a !ear:%!:!ear %asis. A Rea%il& A(aila1le Mar'et 4or Minorit& S are ol%ers an% O!tsi%e In(estors The =$1> a"so pro(ides a readi"! a(ai"a%"e mar+et for the minorit! shareho"ders and other CoutsideD in(estors #ho desire to rea"i7e their gain or to "i)uidate a part or a"" of their in(estment for rein(estment in other companies. If the =$1> ac)uires at "east 34N o#nership, a minorit! shareho"der ma! a"so e"ect ta :free ro""o(er treatment under W1458 of the Interna" @e(enue Code. A Ta90A%(antage% Alternati(e to Sale or Merger >urchase of an o#ners stoc+ %! an =$1> #i"" a"most a"#a!s %e more %eneficia" to the o#ner than sa"e or merger. 9or e amp"e, in the case of a sa"e, the se""er #i"" incur an income ta , #i"" "ose contro", #i"" usua""! "ose his sa"ar! and fringe %enefits, and #i"" se"dom %e a%"e to +eep an! retained e)uit!. In comparison, there #i"" %e no ta to the se""er if he se""s stoc+ to the =$1> under the ta :free ro""o(er pro(ision of the 19G5 Ta @eform Act. In addition, under an =$1>, the se""er can +eep contro", can continue to recei(e his sa"ar! and fringe %enefits, and can +eep as much or as "itt"e of the stoc+ as he desires. An E44ecti(e Tool 4or Increasing Cas $lo2 an% Net ;ort A compan! can reduce its corporate income ta es and increase its cash f"o# and net #orth %! simp"! issuing treasur! stoc+ or ne#"! issued stoc+ to an =$1> in an! amount up to 85N of e"igi%"e annua" pa!ro"". Bsing this approach, a compan! ma! drastica""! reduce or e(en e"iminate its corporate ta "ia%i"it!. The cash f"o# impact can %e dramatic. If the contri%ution to the =$1> is made in "ieu of cash contri%utions to a profit sharing p"an, the cash f"o# sa(ings are e(en more dramatic. 1f course, the o#ners must consider that these contri%utions of stoc+ #i"" resu"t in some di"ution of their o#nership interest. A S!perior Emplo&ee Incenti(e De(ice An =mp"o!ee $toc+ 1#nership >"an is designed to pro(ide emp"o!ees #ith the incenti(e of a Cpiece of the action,D and to ena%"e emp"o!ees to share in the capital growth of the compan!. =mp"o!ee stoc+ o#nership gi(es emp"o!ees a direct and (ested interest in the success of their compan!, ena%"es emp"o!ees to share in the profits of their o#n "a%or, and creates an identit! of interest %et#een management and "a%or. As an emp"o!ee incenti(e de(ice, the =$1> is usua""! superior to other incenti(e p"ans. In an ordinar! profit sharing p"an, for e amp"e, the funds are in(ested in stoc+s of unre"ated companies, and the incenti(e effects are minima". In an =$1>, on the other hand, the emp"o!ees ac)uire an o#nership interest in their o#n compan!, and the incenti(e e"ement is ma imi7ed.

The =$1> is a f"e i%"e p"an that can %e used either in "ieu of or in com%ination #ith other emp"o!ee %enefits p"ans. /ecause of its man! ad(antages, the =$1> is %ecoming an increasing"! popu"ar form of emp"o!ee %enefit. The =$1> is particu"ar"! ad(antageous for companies #hose rapid gro#th has re)uired the rein(estment of profits, resu"ting in a shortage of cash a(ai"a%"e for emp"o!ee %enefits. A co""atera" %enefit is that the =$1> often ser(es to diminish emp"o!ee interest in unioni7ation. A Ne2 ;a& to $inance De1t Re%!ction Companies fre)uent"! find it necessar! to %orro# mone! in order to finance corporate gro#th. 1ne disad(antage of de%t financing is that repa!ment of the "oan principa" is not a deducti%"e e pense. An =$1> can %e used to mitigate this pro%"em %! ha(ing the compan! issue ne#"! issued stoc+ or treasur! stoc+ to an =$1>. The resu"ting ta sa(ings can then %e app"ied against the principa" pa!ments so that ta :deducti%"e do""ars are used to pa! part, or a"", of the "oan principa". Ho2 t e .lan is Designe% An =$1> is a p"an )ua"ified %! the Interna" @e(enue $er(ice as an e)uit!:%ased deferred compensation p"an. As such, it is in the same fami"! as profit sharing p"ans and stoc+ %onus p"ans. An =$1>, ho#e(er, differs from a profit sharing p"an in that an =$1> is re)uired to in(est primari"! in emp"o!er securities, #hi"e a profit sharing p"an is usua""! prohi%ited from in(esting primari"! in emp"o!er securities. An =$1> a"so differs from profit sharing p"ans and from stoc+ %onus p"ans in that an =$1> is permitted and authori7ed to engage in "e(eraged purchases of compan! stoc+. Conse)uent"!, an =$1> re)uired different accounting procedures and a different method of a""ocating stoc+s and other in(estments among the emp"o!ees than other t!pes of p"ans. 9or this reason, the p"an shou"d %e designed %! an =$1> specia"ist in order to a(oid Interna" @e(enue $er(ice difficu"ties. The =$1>, "i+e a profit sharing p"an, must co(er a"" non:union emp"o!ees #ho are at "east age 81 and ha(e one !ear of ser(ice. An =$1> ma! either inc"ude or e c"ude union emp"o!ees. In practica" effect, share o#nership under the p"an is usua""! proportionate to the re"ati(e sa"aries of the participants in the p"an. Ho2 %o Stoc' .!rc ase .lans 2or'< #n%er a t&pical Stoc' .!rc ase .lan> emplo&ees are gi(en an option to p!rc ase t eir emplo&er?s stoc' generall& at a %isco!nte% price at t e en% o4 an o44ering perio%. .rior to eac o44ering perio%> eligi1le emplo&ees in%icate i4 t e& 2is to participate in t e plan. I4 t e emplo&ee 2is es to participate> e:s e in%icates t e percentage or %ollar amo!nt o4 compensation to 1e %e%!cte% 4rom t eir pa&roll t ro!g o!t t e o44ering perio%. T e percentage or

%ollar amo!nt emplo&ees are allo2e% to contri1!te (aries 1& plan> o2e(er> t e IRS limits t e total p!rc ase to @AB>CCC ann!all&. #n%er most stoc' p!rc ase plans> t e p!rc ase price is set at a %isco!nt 4rom t e 4air mar'et (al!e. ; ile some plans pro(i%e t at t e %isco!nt is applie% to t e (al!e on t e stoc' on t e p!rc ase %ate ,e.g.> DBE o4 t e 4air mar'et (al!e on t at %ate-> it is more common to appl& t e %isco!nt to t e (al!e o4 t e stoc' on t e 4irst or last %a& o4 t e o44ering perio%> 2 ic e(er is lo2er. Most plans allo2 emplo&ees to increase or %ecrease t eir pa&roll %e%!ction percentage at an& time %!ring t e o44ering perio%. Eac plan is !ni3!e> &o!r plan materials 2ill %etail o2 a speci4ic plan 2or's. Top T2o T&pes o4 Emplo&ee Stoc' .!rc ase .lans T ere are t2o t&pes o4 Emplo&ee Stoc' .!rc ase .lans> classi4ie% 1& t eir ta9 stat!s8 "!ali4ie% Emplo&ee Stoc' .!rc ase .lans ,Section FAG"!ali4ie% Emplo&ee Stoc' .!rc ase .lans meet con%itions %escri1e% 1& Section FAG o4 t e Internal Re(en!e Co%e. T ere is special ta9 treatment 4or s ares t at are el% 4or more t an a &ear. A 3!ali4ie% plan m!st meet t e 4ollo2ing re3!irements8

Onl& emplo&ees o4 t e compan& ,or its parent or s!1si%iar& corporations- ma& participate in t e plan T e p!rc ase plan m!st 1e appro(e% 1& t e s are ol%ers o4 t e compan& 2it in t e HA mont s 1e4ore it is a%opte% 1& t e 1oar%. An& emplo&ee o2ning more t an BE o4 t e compan& stoc' ma& not participate in t e plan All eligi1le emplo&ees m!st 1e allo2e% to participate in t e plan> alt o!g certain categories o4 emplo&ees ma& 1e e9cl!%e% ,e.g. emplo&ees emplo&e% less t an t2o &earsAll emplo&ees m!st enIo& t e same rig ts an% pri(ileges !n%er t e plan> e9pect t at t e amo!nt o4 stoc' t at ma& 1e p!rc ase% ma& 1e 1ase% on compensation %i44erences T e p!rc ase price ma& not 1e less t an t e lesser o4 DBE o4 t e 4air mar'et (al!e o4 t e stoc' H- at t e 1eginning o4 t e o44ering perio%> or A- on t e p!rc ase %ate T e ma9im!m o44ering perio% cannot e9cee% AJ mont s !nless t e p!rc ase price is 1ase% solel& on t e 4air mar'et (al!e at time o4 p!rc ase> in 2 ic case t e o44ering perio% ma& 1e as long as B &ears

An emplo&ee ma& not p!rc ase more t an @AB>CCC 2ort o4 stoc' ,1ase% on 4air mar'et (al!e on t e 4irst %a& o4 t e o44ering perio%- 4or eac calen%ar &ear in 2 ic t e o44ering perio% is in e44ect

Non0"!ali4ie% Emplo&ee Stoc' .!rc ase .lans Non0Section FAG Emplo&ee Stoc' .!rc ase .lans are simple pa&roll %e%!ction plans t at allo2 emplo&ees to p!rc ase compan& stoc'> sometimes at a %isco!nt. T ere is no special ta9 treatment o4 an& procee%s> an% t e plan is not necessaril& a(aila1le to all emplo&ees.