Corporate Financial Strategy
4th edition
Dr Ruth Bender
Chapter 16
Acquisitions and selling a business
Corporate Financial Strategy
Acquisitions: contents
 Learning objectives
 Some reasons for making an
acquisition
 Relating synergies to value drivers
 Synergy checklist
 Adding value in an acquisition
 Classifying synergies
 Illustrative due diligence
 Financing the acquisition with cash
 Financing the acquisition with
shares
 Buying a company for shares –
some issues
 Buying a company for cash – some
issues
Corporate Financial Strategy
 Acquisition strategies to enhance
eps
 Financing the deal – who gets
what?
 Financing strategy – regardless of
the acquisition
 Earn-outs and deferred
consideration
 Some defence strategies
 Indicative sales process
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Acquisitions: learning objectives
1. Understand how and why companies make acquisitions.
2. Critically evaluate the synergies claimed for an acquisition, and how
they affect the valuation of the target business.
3. Explain the different ways in which an acquisition can be financed,
and understand how to select the most appropriate funding strategy.
4. Appreciate the governance and finance issues surrounding hostile
bids.
5. Identify situations where an earn-out might be of use, and explain the
advantages and disadvantages of this deal structure.
6. Outline some key areas of consideration in the sale of a business.
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Some reasons for making an acquisition
 Support strategy
Complement strategy by adding in:
products, markets, risk reduction, supply
of raw materials, geographic expansion,
etc.
 Grow the business
Support growth that can’t be achieved
organically
 Frustrate competitors
Make an acquisition in order to prevent a
competitor doing so
 Show better profits
Manipulating published financial results
can improve appearance but does not
add shareholder value
 Managerial utility
Acquisitions are quite good fun!
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Relating synergies to value drivers
Value driver
Increase sales growth
Examples of some possible synergies
Use Target distribution network for Bidder products, or vice
versa.
Complementary products can increase volumes for both.
Increase operating profit Cost efficiencies (e.g. economies of scale or scope, or better
procurement practices).
margin
Increase selling prices, e.g. due to economies of scope.
Reduce cash tax rate
Reduce incremental
investment in capital
expenditure
Reduce investment in
working capital
Increase time period of
competitive advantage
Reduce cost of capital
Corporate Financial Strategy
More tax-efficient location of operations.
Combine operations and sell off surplus assets.
Combine operations and reduce inventories.
Strengthened branding or R&D from the business combination.
Should only occur if one of the companies is not already
financed in the most efficient manner.
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Synergy checklist
Strategic
1. Which of the value drivers will be affected by this transaction?
2. In which direction?
3. Why?
Financial
4. By how much will it change?
5. When will this happen?
Operational
6. What critical success factors need to be in place to ensure this
happens?
7. What needs to be measured?
8. Who is responsible for making it happen?
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Adding value in an acquisition
Deal costs
Working capital
Cost efficiencies
Zone of
negotiation
Increased sales
Value to
Vendor
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Value to
Acquirer
Maximum
to pay
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Classifying synergies
 Synergies that any bidder could realize
(E.g., arising through better management)
 Synergies that any bidder within the industry could realize
(E.g. arising through consolidation of manufacturing, or
distribution chains)
 Synergies unique to this bidder
(E.g., involving the application of a particular brand or R&D
capability)
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Illustrative due diligence
Financial performance
−
−
−
−
historical information
systems of internal control
accounting policies
review of forecasts
Taxation
− existing and potential liabilities
− arrangements (intra-group)
− transaction
Economic and commercial
−
−
−
−
−
−
industry analysis and key players
PESTLE
competitive position
strategic assets
order book
contracts
Production and operations
− technologies and systems
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Information systems
− IT systems and integration
People and culture
− who’s who – management and lower tiers
− capabilities
− cultural fit
Environmental and social
− potential liabilities
− legal & regulatory impact
− CR stance
Intellectual property
− existence and ownership
Legal and governance
− review of contracts
− potential problems and contingencies
− competition issues?
Pensions
− scheme details
− deficit? (And assumptions)
− powers of trustees
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Financing the acquisition with cash
Cash paid to
shareholders
Bidder
Bidder
Shareholders in
Target
Shareholders in
Target
Target’s
shareholders have
no stake in the
business after the
acquisition
Target
Before the acquisition
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Target
After the acquisition
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Financing the acquisition with shares
Shareholders in
Target
Bidder
Bidder
Shareholders in
Target
Target’s
shareholders own
shares in an
enlarged Bidder
after the acquisition
Target
Before the acquisition
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Target
After the acquisition
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Buying a company for shares – some issues
1. If the consideration is shares, who is buying whom?
2. Issuing new shares may dilute the voting control of a dominant
shareholder – especially if the target has a block-holder
3. Selling shareholders share the risk of the transaction
4. Selling shareholders share the synergies
5. Both companies need to be valued
6. Offer a fixed number of shares, or fixed value?
7. Tax implications – sellers can defer a gain
8. May not be possible to offer shares in a cross-border transaction
9. Cash resources may not be available
10. Buying for shares may increase eps if acquirer has higher p/e
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Buying a company for cash – some issues
1. Can we afford it?
2. How much will be bridge financing, how much will be longer term?
3. If bridging, when and how will a refinancing be effected?
4. Effect on the company’s credit rating, banking covenants, etc.
5. Where to raise the debt? (Banks or capital markets?)
6. Additional considerations for cross-border acquisitions
– where do we raise the money?
– in what currency?
– tax issues, etc.
7. Buying for cash might increase eps if interest rates are less than inverse of
target P/E
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Acquisition strategies to enhance eps
‘Rule’ 1
Buy companies with a higher p/e using debt or an earn-out, to avoid
dilution of eps in the short term
Buy companies with a lower p/e using equity
‘Rule’ 2
Use debt if after-tax cost of debt is less than inverse of target p/e
Enhancing eps is not the same as increasing shareholder value
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Funding the deal – who gets what?
Cash
Seller gets
Shares
Cash/
debt
Deal may also be structured
so that seller gets loan stock –
still has some exposure to the
buyer
Buyer raises
Need to consider raising funds
conditionally
Initial funding may not be the
final structure. Borrow to do
the deal, and then refinance.
The refinancing may be with
new debt (on better terms) or
with convertibles, or with
equity. Alternatively, the
refinancing may be from
selling assets.
Shares
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Deal may not be structured as
all cash or all debt – could be
a mixture
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Financing strategies – regardless of the acquisition
GROWTH
business risk – high
financial risk – low
funding – equity
divi pay-out – nominal
p/e high
MATURITY
business risk – med
financial risk – medium
funding – debt
divi pay-out – high
p/e – med
LAUNCH
business risk – v. high
financial risk – v. low
funding – equity
divi pay-out – nil
p/e v. high
DECLINE
business risk – low
financial risk – high
funding – debt
divi pay-out – total
p/e v. low

X
X

Gearing
The financial strategy for
the acquisition should be
in line with the company’s
overall financing strategy
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H
L
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Business risk
H
Earn-outs and deferred consideration
BUYER CONSIDERATIONS
SELLER CONSIDERATIONS
Delays payment, or delays issue of new
shares
Limits eps dilution if share eventually issued at
higher price
Limits dilution of control, ditto
Useful if future results of target are uncertain
Retain managers’ commitment in handover
period
Gives possibility of more consideration at a
later date
May wish to earn salary in handover period
Retains their involvement in their business
But…
 Is it sloppy negotiating?
 Can be difficult to combine businesses
 Who runs the business?
 Short termism. What happens after the earnout?
 What if own share price falls before the end of
the period?
But…
 Is it sloppy negotiating?
 May not want to stay on
 Protect against buyer changing the business
model
 Will buyer have sufficient funds to meet the
eventual liability?
 Fixed value or fixed number of shares for
additional consideration?
 Will we be able to sell the shares?
 Tax issues need to be considered
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Some defence tactics
1. Make sure company is priced correctly
2. Strategic issues and profit forecast
3. Good relations with City
4. Friendly shareholders
5. Buy another company
6. Sell/demerge units
7. Look for a white knight
8. Referral to competition authorities
9. Joint ventures
10. Poison pills
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Indicative sales process
1. In the pre-sale period you need to choose advisers, undertake pre-sale
grooming, review the alternatives
2. Information memorandum to be prepared
3. Identify potential purchasers and make contact. (Use confidentiality
letters?)
4. Initial meetings are likely to be off-site; after receiving indicative
valuations, preferred bidders can have site visits
5. Negotiations around price (often P/E-based), deal structure and
conditions will lead to Heads of Agreement with preferred bidder
6. Due diligence is done. (May use a data room)
7. Legals completed – contracts, warranties, etc.
Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009
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