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M&A Life cycle, due Diligence and

transaction structure
An overview

Abhijit Sen
OCTOBER 2014

Contents
1. Understanding Transaction Lifecycle
2. Enterprise value and purchase price formulae
3. What is due diligence
4. Types of due diligence
5. Tools for transferring business

Understanding Buy-Side transaction lifecycle

Strategic
Analysis

Identify Deals

Opportunity
Analysis

Opportunity
Analysis

Transaction
Development

Negotiation
advice &
Execution

Transaction
Effectiveness

Indicative/
Evaluating the deal Making the deal
Conditional bid
Executing the deal successful
Evaluating the deal Completion & post Exit the deal
( Private Equity)
completion

Stage:1 Strategic Analysis (Buy Side)

Strategic
Analysis

Identify Deals

Opportunity
Analysis

Opportunity
Analysis

Transaction
Development

Negotiation
advice &
Execution

Indicative/
Evaluating the
Conditional bid
deal
Evaluating the deal Executing the deal
Completion & post
completion

Buyer activity

Confirm strategy
Identify potential targets
Preliminary desktop evaluation

(public info)
Industry assessment (key for
private equity
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Transaction
Effectiveness

Making the deal


successful
Exiting the deal
( Private Equity)

Stage:2 Opportunity Analysis (Buy Side)

Strategic
Analysis

Opportunity
Analysis

Opportunity
Analysis

Identify Deals

Transaction
Development

Indicative/
Conditional bid
Evaluating the deal

Buyer activity

Review teaser
Confirm strategic fit or

purchase rationale
Preliminary internal
discussions
Preliminary valuation
Preliminary bid or expression
of intent
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Negotiation
advice &
Execution

Transaction
Effectiveness

Making the deal


Evaluating the
successful
deal
Executing the deal Exiting the deal
Completion & post ( Private Equity)
completion

Stage:3 Transaction Development (Buy Side)

Strategic
Analysis

Identify Deals

Opportunity
Analysis

Transaction
Development

Indicative/
Conditional bid
Evaluating the deal

Opportunity
Analysis

Negotiation
advice &
Execution

Transaction
Effectiveness

Evaluating the
Making the deal
deal
successful
Executing the deal Exiting the deal
Completion & post ( Private Equity)
completion

Buyer activity

Short-listed
Agree on confidentiality

agreement
Review IM
Re-confirm strategic fit
First valuation

Submit a conditional bid/ LOI


Access to data room
Negotiate exclusivity agreement, if

possible
Management presentation

Access to target

management
Conduct comprehensive
due diligence
Submit offer (form of letter
and marked-up SPA)

Stage:3 Transaction Development (Buy Side)

Strategic
Analysis

Identify Deals

Opportunity
Analysis

Transaction
Development

Negotiation
advice &
Execution

Transaction
Effectiveness

Making the deal


Evaluating the
Indicative/
successful
deal
Conditional bid
Evaluating the deal Executing the deal Exiting the deal
Completion & post ( Private Equity)
completion

Opportunity
Analysis

Buyer activity

Valuation (Financial & Tax

Modelling)
Due Diligence (Market,
Financial, Tax, Human
Resource, Real Estate,
Technology, Operations)
SPA Advice
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Stage:4 Negotiation Advice & Execution

Strategic
Analysis

Identify Deals

Opportunity
Analysis

Opportunity
Analysis

Transaction
Development

Negotiation
advice &
Execution

Transaction
Effectiveness

Indicative/
Evaluating the deal Making the deal
Conditional bid
Executing the deal successful
Evaluating the deal Completion & post Exiting the deal
completion
( Private Equity

Buyer activity

Agree on terms with seller


Agree on financing with vendor
Price
Sign the deal
Structure
Legal title passes to buyer and
funds change hands
Warranties and indemnities
Transition
Post-acquisition arrangements
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Preparation of financial

information for purchase


price true-ups
Exhibits and appendices to
SPA finalized

Stage:5 Transaction Effectiveness

Strategic
Analysis

Identify Deals

Opportunity
Analysis

Opportunity
Analysis

Transaction
Development

Negotiation
advice &
Execution

Transaction
Effectiveness

Indicative/
Evaluating the deal Making the deal
Conditional bid
Executing the deal successful
Evaluating the deal Completion & post Exiting the deal
completion

Buyer activity

Integration
Restructuring
Consideration of exit options
Sale of business
IPO
MBO
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Ways to sell a business


Auction
Number of potential buyers are given opportunity to evaluate a business
being sold based on limited information
Post evaluation the buyers submit their bids
Exclusive arrangement
A seller and a buyer enter into an agreement on a selling price or price
range contingent upon certain parameters, including the results of due
diligence
Generally, more information and more access to target management is
made available by the seller

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The Transaction Lifecycle: Sell Side

Strategic
Analysis

Strategic Analysis

Opportunity
Analysis

Opportunity
Analysis

Transaction
Development

Disposal
preparation
Marketing

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Negotiation
advice &
Execution

Executing the deal

Transaction
Effectiveness

Completion

Post completion

Contents
1. Understanding Transaction Lifecycle
2. Enterprise value and purchase price formulae
3. What is due diligence
4. Types of due diligence
5. Tools for transferring business

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Enterprise Value

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Enterprise Value

The following methods are typically used to assess the enterprise value of a
business to be purchased:
DCF-entity approach
Projected free cash flows are discounted to the date of valuation
Free cash flows are a gross figure, not accounting for financing structure (equity vs. financial
debt)
Discount rate applied accounts for risk premiums and cost of capital
Multiples on EBITDA/ EBIT figures
An approximation for DCF methods
Applied to normalized EBITDA/ EBIT for either the current year (forecast) or next budget year
Considers multiples paid for comparable transactions
Magnitude of the multiple depends on buyers desire to complete the transaction

Both valuation methods are interrelated and result in a value for the business
The result is a business value, which is a gross value, independent of the
financing structure of the business

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Enterprise Value vs. Purchase Price Consideration


Paid to Equity Shareholders

In order to arrive at the purchase price consideration paid to equity


shareholders, certain adjustments are made to enterprise value.

These adjustments reflect the difference between enterprise value and the
consideration paid to equity shareholders at the date when the economic
ownership is transferred from the seller to the buyer (closing date).

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Purchase Price
Consideration Formula

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Purchase Price Consideration Formula


Enterprise Value
+/Cash/ Debt (Net Debt)
+/Working capital adjustment
+/Capital expenditure adjustments
+/Non-Operating assets and liabilities
=
Purchase price consideration paid to equity shareholders

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How DD Impacts the Purchase Price


Consideration Formula
Enterprise value

Are reported earnings acceptable to use in arriving


at enterprise value (quality of earnings analysis)?
Any non-recurring items?

Any out-of-period items?


Any under accruals?

Cash/ Debt

Which balance sheet and off-balance sheet items


should be included in definition of cash or debt?

Working Capital

What are the trailing twelve (12) months (TTM)


average and minimum levels of normalized
working capital?

Capex

What is the amount of any deferred/ postponed


capex?

Non-operating assets
and liabilities

Appropriately classified?
Are any overstated/ understated?
Any unrecorded significant commitments or
contingencies?
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Signing Date vs. Closing/


Effective Date

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Closing date

Closing date is the date when the economic and legal power over the business
assets and liabilities is transferred from the seller to the buyer.

Closing date is different from the date when the sale and purchase agreement
(SPA) is signed as a result of several factors. Some of them are preconditions:

Conditions to the legal effectiveness of the transaction; for example, payment of the purchase
price
Conclusion of supportive contracts/ agreements
Allowance from anti-trust agreements/Competition Commission of India
Approval of FIPB
Other business related condition precedents

The balances used to determine net debt and working capital adjustments are
typically measured as of the transaction closing date based on the closing
balance sheet or completion accounts.

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Summary

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Summary

Concepts of enterprise value and purchase price consideration paid to equity


shareholders:

Enterprise value is typically a gross value, independent of the financing structure of the
business.
Purchase price consideration paid to equity shareholders is based on enterprise value after any
necessary adjustments.

DD team should be aware of implications of their due diligence work on


purchase price consideration.

Concept of closing date vs. signing date:

Signing date is the date when the agreement is signed by both parties.
Closing date is the date when the economic and legal power over the business's assets and
liabilities are transferred from the seller to the buyer.

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Questions?

23

Contents
1. Understanding Transaction Lifecycle
2. Enterprise value and purchase price formulae
3. What is due diligence
4. Types of due diligence
5. Tools for transferring business

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What is due diligence?

?
A measure of
prudence or
assiduity, as is
properly to be
expected from,
and ordinarily
exercised by, a
reasonable and
prudent man
under the
particular
circumstance.

Defined as an investigation into the affairs of an entity prior to


its acquisition, flotation, restructuring or other similar
transaction.
The process by which information is gathered about:

a target company
its business; and
the environment in which a target company operates.

The objective is to ensure that prospective investors make an


informed investment decision.

Blacks law
dictionary

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What is financial due diligence?


A business oriented analysis and not an accounting
analysis.
A fact gathering exercise with a focused analysis of
information.
It is not just:
Checking the
facts

Reciting them
Its about:
Evaluation
Interpretation

Communication

Understanding the industry of the target.


Reasonable level of enquiry into the affairs having a
material impact on the prospects of the business.
Evaluation of the business model and key business
practices.
Examination of relevant aspects of the past, present and
near future of the business.
Assessment of the benefits and liabilities of the proposed
transaction.

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Purpose of due diligence


Our findings assist buyer in
identifying deal stoppers

determining future financing

structuring and valuing the transaction

strategies

preparing financing strategies and

identifying operational areas upon

documents (including projections)

which to concentrate after the deal

negotiating purchase price and purchase

closes
assessing the financial statement

agreements
negotiating financial covenants in credit
agreements
determining future financing strategies

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impact of the transaction


conforming accounting principles

Contents
1. Understanding Transaction Lifecycle
2. Enterprise value and purchase price formulae
3. What is due diligence
4. Types of due diligence
5. Tools for transferring business

28

Types of due diligence


Types

Financial and Accounting


Taxation
Operations

Information technology
Human resources / employee benefits
Commercial
Insurance/ risk management
Legal
Environmental
Regulatory

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Focus areas
Quality of
earnings,
gross margin
& cash flows

Quality of
assets &
working
capital

Separation/
structuring/
integration Issues

Potential
liabilities &
commitments

Net debt

Other matters

Co-ordination with other work streams is very important. It is an iterative


process requiring prompt communication of and acting on findings.
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Focus areas
Deal fundamentals
Business environment - markets, competition, regulations
Public listed company

Third party interests - ROFR


Sale of business < > sale of shares of the target
Carve out of financial statements
Carve out of assets and liabilities
Tax considerations

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Key benefits
Inputs for making Go/No go decision, valuation, risk mitigation in
transaction documents and matters to be addressed post acquisition.
Those issues which would impede
the consummation of the
proposed transaction

Those issues which would be


necessary to consider in the
valuation of business/negotiation
of bid price

Deal Breakers

Valuation and Negotiation points

Those issues which would need


indemnities and identify conditions
precedent for consummation of
the transaction

Those risks and issues which are


knowingly taken over as a
calculated commercial decision.

Issues for agreements

Commercial override

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Questions?

33

Contents
1. Understanding Transaction Lifecycle
2. Enterprise value and purchase price formulae
3. What is due diligence
4. Types of due diligence
5. Tools for transferring business

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Tools for transfer of business

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Tools for transfer of business

Tools for transfer of business

Merger

Demerger

Acquisition

Asset Purchase

Slump Sale

Asset sale

Share Acquisition

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1. Merger
Meaning

Merger involves the combination of two or more


distinct entities into one through a court approved
scheme, resulting in accumulation of their assets and
liabilities.

Pre-merger scenario
Shareholders A Co

Shareholders B Co

A Co

B Co

Certain key considerations

Transfer of all properties, liabilities and employees by


merging company (A Co) to the Transferee company
(B Co)
Shares to be issued by B Co to shareholders of A Co,
as consideration (a pre-requisite for achieving tax
efficiency)

Share swap on merger to be determined by valuation


based on asset and cash flow criteria etc., as
appropriate

Shares issued could be either preference or equity,


depending on commercial considerations

Approval of specified majority of creditors/ shareholders


of both companies as well as from regulators and
judicial authorities i.e. High courts where registered
offices of companies are situated

Merger is tax neutral subject to fulfillment of certain


conditions

Merging entity would cease to exist post-merger

Post-merger scenario
Shareholders A Co

Shareholders B Co

Company A+B

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2. Demerger
Transaction

Meaning

Demerger involves transfer of identified business from


one company to another and in consideration, the
company which acquires the business issues shares to
shareholders of the selling company

Shareholders of A Co
Consideration in the form of
shares of buyer company

100%

Certain key considerations

Demerger involves transfer of identified business


(Undertaking/ Business Y) from one company (A Co)
to another (B Co)

Transfer of all properties and liabilities of the


Undertaking at book values on going concern basis

A Co

Business
X

Discharge of consideration by issue of shares on


proportionate basis

Demerger is a Court approved process similar to


merger

Demerger is tax neutral subject to fulfillment of certain


conditions

Demerger of
Business Y

B Co

The resultant structure

In consideration, the company which acquires the


business (B Co) issues shares to shareholders of the
selling company (A Co)

Business
Y

Shareholders
100%

X%

A Co

B Co

Business X

Business Y

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3. Slump sale
Meaning

Pre-slump sale scenario and transaction

Slump sale means the transfer of one or more


undertakings as a result of the sale for a lump sum

Shareholders of A Co

consideration without values being assigned to the

Consideration in form of
cash/ shares

individual assets and liabilities in such sales.

Certain key considerations

Transfer of identified business ('Undertaking/ Business Y)


comprising of assets and liabilities on going concern basis

Business X

Business Y

by transferor company (A Co') to transferee company (B

Slump sale of
Business Y

Co') for lump sum consideration without assigning value to


individual assets and liabilities

B Co

A Co

Resultant structure

In consideration, the transferor company (B Co) may pay


cash / issue shares to the transferor company (A Co) and

Shareholders of A Co

not its shareholders

Can be achieved through shareholder resolution and a


business transfer agreement

No court approval required

Recognition of purchase consideration in value of assets

A Co

B Co

Business X

Business Y

in buyers books

Transaction chargeable to capital gains tax


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4. Asset sale
Certain key considerations

Any acquisition of business which does not satisfy the


conditions of slump sale is likely to be classified as
asset sale
Sale of assets is liable to capital gains tax depending
upon following factors:

The nature of capital assets (i.e. depreciable or nondepreciable assets)

Pre-slump sale scenario and transaction

Shareholders of A Co
Consideration in form of
cash/ shares

B Co

A Co

Business X
Sale of certain
assets of
Business X

In case of non-depreciable assets - the period of


holding of assets

Resultant structure

Shareholders of A Co

A Co

B Co

Business X

Certain assets
of Business X

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5. Share acquisition
Certain key considerations

In case of share acquisition, the Buyer (B Co) acquires


the shares of the target company (Target Co) from its
present shareholder

The consideration is discharged by the Buyer (B Co) to


the shareholder of the Target Co (i.e. A Co)
The acquisition of shares is a taxable transaction giving
rise to tax implications

Pre-acquisition scenario

Flow of Consideration

Shareholders (A
Co)

Buyer (B Co)

X
Target Co

Post-acquisition scenario

A Co

Shareholders (B
Co)

Target Co

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THANK YOU