Understanding the Basics and Procedures of Corporate Acquisitions

Changes in the business environment, such as advancements in IT technology, digitalization, globalization, and issues of succession, have made M&A a critical management choice for the survival of small and medium-sized enterprises (SMEs).

Common methods used in M&A to acquire a company include:

• Share transfer
• Business transfer
• Share exchange
• Third-party allotment
• TOB (Takeover Bid)

According to a commissioned survey report on business reorganization, consolidation, and inter-company collaboration among SMEs conducted by the Ministry of Economy, Trade and Industry (Japanese METI) in December 2017, share transfers (40.8%) and business transfers (41.0%) alone account for over 80% of M&A implementations. However, various methods can be considered when actually acquiring a company.

In this article, we will provide a detailed explanation of the basic knowledge and necessary procedures for M&A related to the transfer of company management rights, not limited to “share transfers”.

Advantages and Disadvantages of Corporate Acquisitions

Corporate acquisitions are a method of transferring management rights by acquiring more than half of the issued shares of the target company.

While share transfers are suitable for minority shareholders of unlisted companies, there has been a recent increase in corporate acquisitions through TOB for listed companies.

While corporate acquisitions offer various benefits to the buyer, such as the ability to expand the business in a short period of time, there are also disadvantages that require caution.

Advantages of Corporate Acquisitions

Enhancing the competitiveness of the company

By utilizing the management resources of the acquired company, such as technology, know-how, personnel, and sales information, you can strengthen the technology and product development capabilities and sales capabilities that your company lacks, thereby enhancing your competitiveness against rival companies.

Possible to enter new fields

While it requires a large amount of money and a long time for your company to enter a new field on its own, by acquiring a company that is operating in the new field you are targeting, you can enter the field in a short period of time.

Possible to reduce costs

It is also possible to reduce costs by jointly using business bases owned by your company and the acquired company, or by jointly ordering products and supplies.

Disadvantages of Corporate Acquisitions

You will also inherit the risks

Unlike ‘business transfers’ where you can selectively buy and sell assets and rights, in corporate acquisitions you inherit the entire company, so you will also inherit liabilities along with assets.

There is also the risk of off-balance-sheet liabilities that may arise in the future if you have debt guarantees or lawsuits.

Possibility of not achieving the expected synergy effect

There is a possibility that you may overestimate the management resources of the acquired company and as a result of various initiatives, you may not achieve the synergy effect that matches the investment.

Risk of losing excellent personnel

If the management team changes due to a corporate acquisition, there will be employees who cannot agree with the new management policy. Therefore, there is a possibility that key personnel in technology and sales may flow out to rival companies or be poached.

If you want to know more about the central method of corporate acquisitions, ‘share transfer’, please refer to the following article.

https://monolith.law/corporate/share-transfer-ma[ja]

The Four Stages of Corporate Acquisition

Here, we will explain in detail the procedures for actually carrying out a corporate acquisition, as well as the documents and contracts required at each stage.

Preparation Stage

• Formulating a Strategy

Since M&A is a means to achieve the future goals that your company aims for, it is necessary to clarify what you expect from the M&A based on your company’s vision and medium-to-long term business policy, and how much funds you can invest for it.

• Selecting an Intermediary Company

There are two types of M&A advisors: a Financial Advisor (FA) who is exclusive to either the seller or the buyer, and an intermediary company that contracts with both parties and advances negotiations.

For small and medium-sized enterprises, it is common to choose an intermediary company that can facilitate early negotiations. Once the intermediary company is decided, a confidentiality agreement and advisory contract are concluded.

• Determining the Form of M&A

Considering the purpose of the corporate acquisition and the funds available for investment, you will choose the most suitable method from various M&A techniques. It is advisable to refer to the advice of intermediary companies and experts in making this decision, as it requires specialized knowledge.

Selection Stage

• Consideration with a Non-Name Sheet

In the initial stage of selecting a negotiation partner, you will consider using an anonymous document called a “Non-Name Sheet” created by the seller. This document contains only a summary of information, taking care not to identify the company name.

• Name Clear

If there is a company that interests you in the Non-Name Sheet, the buyer will confirm with the seller through the intermediary company whether it is possible to disclose the company name and detailed management information.

• Presentation of the Company Overview Document

If the seller confirms the Name Clear, the intermediary company will present the buyer with a company overview document detailing the business content and financial situation, and the buyer will proceed with a full-scale examination.

• Company Value Evaluation

The buyer will estimate the value of the target company in monetary terms based on the contents of the company overview document. This amount will be stated in the “Letter of Intent” mentioned later.

The methods of company value evaluation include the “Cost Approach” based on net assets, the “Income Approach” based on future earnings, and the “Market Approach” based on the value of similar companies.

Negotiation Stage

• Top-Level Meeting

In the case of corporate acquisition, it is an important process for the top executives of the seller and the buyer to meet before proceeding with specific negotiations to deepen mutual understanding. Especially if there are any questions about the buyer’s management or the target company, they will ask the other party directly and resolve each other’s anxieties and doubts.

• Submission of Letter of Intent

If both parties are satisfied with the top-level meeting, the buyer will submit a Letter of Intent to the seller stating the company overview, the form of M&A, and the purchase price to express their intention to purchase the shares.

• Conclusion of Basic Agreement

When the seller and the buyer can agree on the basic matters such as the conditions of transfer, transfer price, and schedule, they will create a basic agreement.

This is not the final contract, but a record of the agreement so far.

For more details on the “Legal Effect of the Basic Agreement in M&A Contracts”, please refer to the article below.

https://monolith.law/corporate/ma-lawyer-basic-agreement[ja]

• Conducting Due Diligence

After concluding the basic agreement, the buyer will thoroughly examine the contents of the documents submitted so far by a team of experts such as lawyers and certified public accountants.

The points are:

1. Proper value of the target company
2. Future issues
3. Potential and apparent risks
4. Future prospects
5. Synergy effect with own business

to analyze and evaluate from various perspectives such as business, finance, personnel, and legal affairs.

Final Stage

• Conclusion of Final Transfer Contract

Based on the results of due diligence, the final corporate value evaluation is calculated, and the final transfer contract is concluded based on the agreement with the seller.

The particularly important clauses here are:

1. Transfer date
2. Transfer amount
3. Closing
4. Representation and warranty
5. Approval of share transfer (in case of restricted transfer shares)
6. Prior approval of trading partners (if there is a change of control clause)

.

• Closing

Based on the final contract, the buyer pays the transfer price to the seller, the seller transfers the management rights to the buyer, and the corporate acquisition procedure is completed. Depending on the method of M&A, closing may take several months due to the transfer of assets and liabilities and prior approval of trading partners.

• PMI (Integration Process)

Integrate the management policies and management systems of the buyer company and the acquired company, prevent conflicts among employees, and ensure that the expected synergy effects can be smoothly demonstrated.

The Role of Lawyers in Stock Transfers

Lawyers play a crucial role in M&A transactions aimed at transferring management rights. Not only do they check various contracts, but they also conduct ‘legal due diligence’ to assess hidden risks through checking contracts and internal regulations of the target company, as well as compliance violations. This is a task that can only be performed by lawyers with specialized knowledge and experience.

In addition to this, they also check whether the stock transfer does not violate the ‘Japanese Antimonopoly Act’, or whether the procedures are being carried out in accordance with various laws and regulations. They are also important as advisors who sometimes provide advice for problem-solving.

Summary

We have discussed the “Merits and Demerits of Corporate Acquisitions,” the “Four Stages of Corporate Acquisitions,” and “The Role of Lawyers in Stock Transfers.”

Corporate acquisitions through M&A are increasing year by year due to succession issues and changes in the business environment. However, corporate acquisitions require substantial funds and various procedures, and there are risks involved. Therefore, it is necessary to proceed safely and smoothly in accordance with the procedures.

For this purpose, we recommend consulting with a law firm that is also an experienced M&A advisor with specialized legal knowledge from the initial stage, and receiving advice on how to proceed.

If you want to know more about the “Secrets to Successful Corporate Acquisitions,” please refer to the detailed article below.