M&A transactions as a building block of corporate strategy

"Dr. Axel Wahl LL.M. is the National Partner at the Frankfurt office of the international law firm Willkie, Farr & Gallagher LLP. He advises companies on corporate law issues as well as in connection with domestic and international M&A transactions."

The significance of acquisitions and divestitures of corporate holdings as well as the formation of joint ventures has increased considerably in recent years as part of corporate strategy for medium-sized businesses. Given the complexity of these transactions, it is essential to avoid pitfalls.

A.  Introduction

The term M&A, short for Mergers & Acquisitions, originates from English and stands for mergers and acquisitions. It refers to changes in ownership structure through the merger of two previously independent companies (Merger) or the (partial) acquisition of a company by a competitor or a financial investor (Acquisition). The formation of joint ventures (so-called Joint Ventures) is also classified within this legal area.

The importance of M&A transactions for the mid-sized sector has increased significantly in recent years. From the perspective of a medium-sized company, an M&A transaction is particularly considered to achieve the following strategic goals:

• Generation of equity capital for further company development
• Bundling of know-how in a joint venture
• Sale of a business division as part of a strategic realignment
• Company growth
• Business succession

Due to the legal complexity, high transaction volumes, and associated risks, careful planning and support of the M&A process are crucial. The article presents potential pitfalls and structuring alternatives through specific examples.

B.  Equity Financing

Company financing through equity can be an interesting alternative to financing via loans or corporate bonds for medium-sized businesses. This can involve issuing new shares in the company to one or more investors as part of a capital increase. This is especially relevant when the costs of borrowing or financing on the capital market are high and the associated restrictions on corporate management (e.g., via key performance indicators, etc.) are undesirable.

The participation of an investor as a co-shareholder requires a comprehensive regulation of mutual rights and obligations to ensure successful company management in the future. In addition to possible amendments to the articles of association, a shareholder agreement (Shareholders’ Agreement) is typically concluded. The purpose of this separate agreement is to regulate management and the relationship among shareholders. Compared to incorporating such provisions into the articles of association, a shareholder agreement is generally not subject to mandatory disclosure in the commercial register.

Primarily, financial investors are considered for such participations. They usually hold their stake for about 3 to 7 years before selling their shares. To prevent the remaining shareholder from facing an unwelcome new partner after the exit of the financial investor, the exit must be thoroughly contractually structured, e.g., through call/put options or pre-emptive rights. Additionally, conflict resolution mechanisms among shareholders should be detailed, with proven mechanisms available for this purpose.

C.  Joint Ventures

A good way to access new markets or utilize business opportunities can be the establishment of a joint venture with one or more partners. Forming a joint venture can be suitable, for example, to combine various expertise or to generate funds for an anticipated investment.

Here, too, comprehensive contractual regulation within a shareholder agreement is necessary. Compared to an investment by a financial investor, collaboration among competitors primarily raises questions regarding the protection of know-how or the use of developed patents, etc. Furthermore, it must be carefully regulated how competition can be effectively and legally compliantly prevented or at least limited by the parties.

D.  Strategic Acquisitions and Divestitures

The development of a company may reach a point where it makes sense to focus on the core business activities. Conversely, the company may have reached the limits of organic growth or expect advantages (especially synergies) through acquiring another company. In the first case, divestment of parts of the company can be considered; in the latter, strategic acquisitions may be pursued.

I.  Sale Situation

If the seller decides on a partial sale (or, due to the lack of a suitable successor, a complete sale), many questions arise that make comprehensive process management indispensable. For example, the part of the company to be sold may need to be separated from the rest of the business through a so-called carve-out to isolate risk areas. This process can raise very complex legal issues. If both parts of the company share patents or services, arrangements must be made on how to continue or substitute their use after separation.

Protecting know-how during the sale process is especially sensitive—particularly for companies in high-tech sectors. Confidentiality agreements should be used to ensure maximum protection for the seller, e.g., against poaching key employees. Additionally, the buyer's due diligence—financial and legal review of the company—must be prepared. It is important to carefully consider what information is disclosed, when, and to whom. For highly sensitive data, special protective measures, such as restricting access to certain individuals or only allowing review, can be considered.

Finally, liability risks can be minimized through the disclosure of liability-relevant documents and a carefully drafted purchase agreement. Particular attention should be paid to the warranty regime and liability limitations in the purchase contract. Industry knowledge is valuable here to enforce effective liability limitation mechanisms and exclude liable facts from warranties.

II.  Purchase Situation

In a purchase scenario, the primary goal is to ensure that the buyer receives the promised consideration in exchange for the purchase price. Correspondingly, the buyer must identify financial and legal risks associated with the transaction during due diligence. If the buyer intends to acquire a company to secure know-how for a novel process, the advisor must evaluate whether the seller holds the necessary patents and approvals and determine their scope and duration. Additionally, the transfer of these rights and licenses must be secured as part of the purchase. During this phase, potential liability risks should be identified, and the interests of both parties properly considered, without delaying or preventing a economically viable transaction. Negotiating the various aspects of the purchase agreement plays a particularly important role here.

E.  Conclusion

M&A transactions can be a valuable aspect of corporate development. They offer many opportunities for repositioning and generating liquidity. The downside includes risks that could threaten the existence of a functioning company. Therefore, good advice is expensive, but bad advice can be significantly more costly. Engaging an experienced advisor unquestionably pays off in risk reduction and also has a direct positive impact on the smooth and swift execution of a transaction, thereby contributing to its economic success. Experienced advisors can especially offer solutions to reconcile diverging interests and facilitate a quick and seamless process, minimizing the (negative) impact on the company's business.

"Dr. Axel Wahl LL.M. is a national partner at the Frankfurt office of the international law firm Willkie, Farr & Gallagher LLP. He advises companies on corporate law issues as well as in connection with national and international M&A transactions."