Explaining the Procedures, Merits, and Demerits of M&A Used in Company Sales

Traditionally, the primary method of investment recovery in venture companies, commonly referred to as EXIT, was through an Initial Public Offering (IPO).

However, recently, there has been an increase in business owners who do not necessarily aim for an IPO, but instead choose to sell their companies through M&A while remaining unlisted.

Therefore, for business owners considering selling their companies, we will provide a detailed explanation of the merits and demerits of M&A, the process of M&A, and the procedures that should be entrusted to a lawyer.

What is a Company Sale through M&A?

M&A stands for Mergers and Acquisitions. In a direct translation, it means “mergers and acquisitions”. Therefore, M&A refers to the merger and acquisition of companies.

Methods of M&A include not only merger procedures, which are one of the organizational restructuring actions stipulated in the Japanese Companies Act, but also stock transfers and business transfers.

Merger procedures under the Japanese Companies Act are strictly defined, including procedures to protect creditors. Therefore, it tends to be used by large-scale companies with many creditors.

On the other hand, when venture companies sell their companies through M&A, stock transfers and business transfers are often used. For more detailed explanation on M&A through stock transfer, please refer to the following article.

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

Advantages and Disadvantages of Company Sales through M&A

For venture companies, the means of investment recovery are typically either an initial public offering (IPO) or a merger and acquisition (M&A). Here, we will explain the advantages and disadvantages of M&A compared to an IPO.

Advantages of Using M&A

The main advantages of a venture company selling its business through M&A include:

• Investment recovery can be achieved faster than with an IPO
• The founder can take on other business challenges

Investment Recovery Can Be Achieved Faster Than with an IPO

Generally, if you aim for an IPO, you need a preparation period of several years.

Also, the cost of hiring experts or consultants for the IPO and establishing internal management systems is very high.

In contrast, if you can find a buyer for a company sale through M&A, it is not uncommon to conclude a deal in about six months to a year.

While you may need to seek support from external experts when conducting an M&A, the cost is lower compared to an IPO.

The Founder Can Take on Other Business Challenges

In addition, in the case of M&A, it is easy for the representative of the selling company to resign at the same time as the company sale.

It is not uncommon for founders of venture companies who have found a new business area they want to focus on to want to start a new business in a separate company.

Moreover, if the company is not in the red and has potential for the future, the founder who owns the shares can obtain the sale price by selling the company through M&A, and this money can be invested in a new business.

Disadvantages of Using M&A

• There is a risk that the founder will lose control of the company
• The company’s value may be estimated lower than with an IPO

Risk of the Founder Losing Control of the Company

If the founder wants to resign at the same time as the company sale, there is no problem, but if they want to stay in the company as an executive, there is a risk with M&A.

If an M&A is conducted that transfers all of the company’s control to the buying company through a stock transfer, the appointment and dismissal of directors and other executives of the selling company can be done at the discretion of the buying company. Therefore, there is no guarantee that the founder and others can stay in the company after the company sale.

Company Value May Be Estimated Lower

Also, in the case of a company sale through M&A, the sale price is determined by negotiation with the buying company.

If the buying company highly evaluates the future potential of the selling company or expects a synergy effect, the company’s value may be estimated higher than with an IPO.

However, on the other hand, it is certainly possible to be bought out at a lower price than with an IPO. Therefore, when considering a company sale through M&A, it is better to set a standard in advance as to how much money would make the company sale economically rational.

How to Proceed with a Company Sale through M&A

We will explain the procedures for advancing a company sale through M&A, and how lawyers are involved in the process.

Contracts and Procedures Required for M&A

When selling a company through M&A, the process typically follows the steps outlined below.

Signing of Confidentiality Agreement

Once the seller and potential buyer have been identified and concrete discussions for the M&A begin, a confidentiality agreement is first signed between the two parties.

The fact that M&A discussions are underway is highly confidential information for both companies. Until a final agreement on the company sale is reached, the progress of the M&A discussions is usually only known to the management team and a select group of employees, and is kept secret from the general staff.

Especially when either the selling or buying company is a publicly listed company, this information becomes insider information, so it is absolutely necessary to prevent any leaks.

Furthermore, it is only after the confidentiality agreement is signed that the selling and buying companies disclose their company names to each other.

Signing of Letter of Intent

Once the buying company formally decides to proceed with the M&A, it issues a ‘Letter of Intent’ to the selling company.

Upon receiving this, if the selling company indicates its intention to negotiate the sale of the company, a Letter of Intent is signed between the two parties to proceed with the M&A discussions. The Letter of Intent explicitly states in writing that the selling and buying companies will proceed with the M&A discussions.

However, this agreement to proceed with the M&A discussions is generally considered a non-legally binding gentleman’s agreement. Therefore, even if the M&A agreement is not ultimately reached, the parties involved are not usually liable for damages or other responsibilities.

For examples of clauses in a Letter of Intent in M&A and their legal binding force, please refer to the following article.

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

Due Diligence to Signing of Final Contract

What is necessary for the buying company to decide whether or not to proceed with the M&A is a procedure called due diligence, which thoroughly examines the value and risks of the selling company. We will explain more about due diligence later.

Based on the due diligence, if the buying company makes a final decision to proceed with the M&A, a final contract regarding the company sale is signed between the selling and buying companies.

In the final contract, clauses such as the company’s selling price, the method of transferring shares and assets, and the treatment of the selling company’s representatives after the company sale, are usually provided.

Once the final contract is signed, the seller and buyer carry out the necessary procedures based on the contract content, and the company sale is executed. This execution procedure is sometimes referred to as ‘closing’.

Why Lawyers are Essential in M&A

When a company undertakes an M&A, it is common to seek support from external professionals such as lawyers and certified public accountants.

Lawyers primarily support companies in M&A in the following two scenarios:

• Contract negotiation and conclusion
• Legal due diligence

Contract Negotiation and Conclusion

Firstly, in M&A, the selling company and the buying company conclude contracts at several stages, such as when entering into specific discussions and at the stage of final agreement on company sale.

Generally, a company sale through M&A is a very important event that can determine the fate of the company for both the buyer and the seller. Therefore, it is unacceptable for the contract to be extremely disadvantageous to your company.

Furthermore, individual contract negotiations between the seller and the buyer must be conducted based on the results of the due diligence performed prior to the final agreement on the company sale.

Although it is possible to easily obtain a template for an M&A contract, it is essential to reflect the individual circumstances of each case when actually concluding a contract.

If there are risks or concerns in M&A for your company, there are often situations where it is necessary to devise ways to hedge risks, such as including clauses in the contract.

For such contract negotiations and contract drafting, specialized legal knowledge such as corporate law is required. Therefore, the involvement of a lawyer is necessary at the stage of contract negotiation and conclusion.

Legal Due Diligence

Secondly, the involvement of a lawyer is also necessary for legal due diligence conducted prior to the final agreement on the company sale.

Due diligence in M&A is a procedure for the buying company to scrutinize the value, profitability, etc., of the selling company.

If facts that could impair the value of the selling company are revealed in due diligence, M&A may even be aborted. Therefore, it is a very important procedure in the series of procedures for company sale by M&A.

Due diligence is conducted from various perspectives such as finance, legal, human resources, and systems, and it is not realistic in terms of time and cost to conduct due diligence on all items.

However, financial due diligence and legal due diligence significantly influence corporate value, so they are often uniformly conducted in M&A.

Among these, legal due diligence is usually conducted by an external lawyer.

Indeed, if the buying company has a legal department, it is technically possible for the in-house legal staff to conduct legal due diligence.

Despite this, external professionals are hired because if damage occurs to the buying company due to an obvious oversight in legal due diligence, there is a risk that the management team will be held accountable by shareholders and others.

At this time, if the lawyer has accumulated experience in legal due diligence in M&A, the risk of overlooking points to be confirmed in due diligence can be significantly reduced.

Summary

If you wish to sell your company through M&A, it is relatively common to first register with an intermediary company that provides M&A advisory services. In addition to this, there are also cases where professionals such as banks with transactions, certified public accountants, and tax accountants who conduct M&A advisory services act as intermediaries.

When you register with an M&A advisory company as a selling case, corporations and individuals who want to buy a company can view information about the company for sale. This information often includes some financial information such as the previous year’s sales, with the company name undisclosed.

In recent years, there has been an increase in companies wanting to buy promising venture companies as part of their strategy. Therefore, selling a company through M&A will likely continue to be a powerful EXIT strategy for founders in the future.