Reading: Forms of Takeover

This section briefly deals with the question of how the acquirer can actually gain control over the target company or, more specifically, how a merger can actually be executed.

One step merger

One way to go is that the buyer and seller jointly negotiate a merger agreement. For the companies to then legally merge, usually only one additional step is required: target shareholder approval. This is why this form of merger is sometimes referred to as a "one step merger." More specifically, the logical sequence of a one-step merger roughly is:

• The parties negotiate a merger agreement
• The board of directors of the target company approves the agreement and issues a merger proxy that goes to a shareholder vote.
• In practice, all that is required is a simple majority (>50%) for the deal to pass, though some incorporation documents or state laws may require a supermajority vote.
• If the target shareholders approve the deal, the acquiring company directly obtains 100% of the target shares in exchange for the negotiated deal consideration. 
• The acquiring shareholders usually do not get to vote on such transactions. The general exception are stock deals in which the acquirer issues more than 20% of its own shares to acquire the target company.

The main advantage of the one step merger is that the acquiring company does not have to deal with the individual shareholders of the target company. It is the traditional form of merger. A case in point could be the acquisition of LinkedIn by Microsoft in June 2016 for more than $26 billion. The two companies signed a merger agreement and LinkedIn then issued a merger proxy, which the shareholders of LinkedIn approved on a special meeting. Since the transaction was all cash, Microsoft's shareholders did not get to vote on the deal.

Two Step Merger

Alternatively, the acquirer can engage in a so-called two step merger, where the acquirer first gains control over the target's shares and subsequently merges the companies.

Step 1: Gain control over the shares (Front end)

In a first step, the acquiring firm directly purchases shares from the target shareholders

• Privately negotiate purchases from large target shareholders
• Extend a tender offer to the target shareholders, in which the acquiring company offers to buy the shares of the target company at a specific price over a specific period (usually at least 20 days from the offer date), and usually conditional on a minimum threshold of tendered shares (50%).

Step 2: Merge the companies (Back end)

The second step then is to merge the companies. Depending on the fraction of shares acquired in the first step, this can generally take the form of a so-called long-form merger or a short-form merger:

• Long form merger:
  • If the acquiring company has acquired more than 50% but less than 90% of the shares, the target company is required to issue a proxy statement, call and hold a (special) meeting of its shareholders, and obtain the required shareholder votes.
  • Usually, a successful outcome of the vote is assured since the acquirer already controls the majority of the votes. The long-form merger therefore "simply" extends the time it takes to merge the companies.

• Short form merger:
  
  • If the acquirer controls more than 90% of the votes after the first step, it can merge the companies without a vote of the target shareholders (at least under Delaware law).
  • This process is much faster than the long form merger and can be executed in as few as 20 business days.
  • The remaining minority shareholders receive a compensation and are squeezed out of ownership in the target company (a so-called back end squeeze out).

It is often not easy to obtain a threshold of 90% to implement a short-form merger. This is especially the case when the target firm in question has a dispersed ownership structure. In recent years, so-called top-up options have been used to address this challenge:

• With a top-up option, the acquirer typically has to gain control over 50% of the shares of the target company (as before).
• Upon reaching that threshold, the target then grants the acquirer an option to purchase new shares such that, in aggregate, the acquirer will control at least 90% of the target's shares (the top-up option).
• After exercising the option and reaching the 90% threshold, the acquirer then proceeds with the short form merger.

Note that it takes a lot of new shares to increase the acquirer's ownership stake to 90%. The following example illustrates this.

Example:

The target company T currently has 80 shares outstanding, 70 of which have been purchased by the acquirer via tender offer. Moreover, A has a top-up option on T's authorized but unissued shares to reach the required threshold of 90%.

In the status quo, the acquirer already controls 87.5% of the shares (= 70/80). How many shares N_Top does the target firm have to sell to the acquirer to reach the required threshold of 90%? We can find the answer by solving the following equation for N_Top:

\( 0.9 = \frac{70 + N_{Top}}{80 + N_{Top}} \)

\( \longrightarrow N_{Top} = 20 \)

The firm has to sell 20 new shares to the acquirer, so that the acquirer then controls 90 shares (70 + 20) of the total number of 100 shares outstanding (80 + 20). Put differently, the number of shares outstanding has to increase by 25% (= 20/80) in order for the ownership stake of the acquirer to increase by 2.5%.