M&A: how corporate mergers and acquisitions work
The process of merging two or more companies and the acquisition of one company by another is called M&A Mergers & Acquisitions.
In the corporate world it is common for companies to be acquired by others or to merge to form a single corporation or to take part in other types of transactions, with the aim of gaining a greater share of the market in order to increase competitiveness and, consequently, achieve a greater volume of revenue.
In short, M&A is a financial operation, a business transaction involving the purchase of one company by another or the merger between two or more companies, or even a business spin-off, which can be from the same sector or the same business interest, or even from different sectors and interests.
People often confuse mergers with acquisitions, but they are not the same thing. There is a difference between the two operations. In the merger process, two or more companies come together to form a new company.
The companies that give rise to the merger disappear, cease to exist legally in order for a new company to emerge. They can be from the same sector or from different but complementary sectors.
With the emergence of the new society, there has been a reformulation of the structure of companies, aimed at innovation, improvement and reformulation of their operations in order to optimize productivity.
An acquisition, on the other hand, is an operation in which a larger company acquires a smaller company with the aim of controlling it. In an acquisition, one company is extinguished and the other remains, although in some cases the acquired company remains in the market under new management, depending on the type of operation.
The acquisition can be total or partial. In a total acquisition, the acquired company is bought in its entirety, while in a partial acquisition, the acquirer buys only part of the acquired company’s assets.
Types of Fusion
Mergers can take several forms: horizontal; vertical; conglomerate; market extension mergers and product extension mergers.
Horizontal merger
In a horizontal merger, companies in the same sector and with similar operations merge to create a company with greater market share and operations.
Vertical fusion
In vertical mergers, complementary, non-competing companies with different purposes for the same product come together to gain greater control over the production chain and optimize their products, with a view to increasing market share.
Merger by conglomerate
In a conglomerate merger, companies that have no market relationship with each other and have different solutions join forces in order to diversify their risks and invest in new investment options.
Merger by market extension
Market extension mergers correspond to those companies that merge because they have the same solutions in different markets, seeking to ensure that these companies participate in new, larger markets with more customers.
Product extension merger
Finally, in the Product Extension Merger, companies operating in the same field, with activities in the same market and similar solutions, come together to group their products and expand their customer portfolio
What the law says about M&A
According to Law 6.404/1976 in its article 228: “A merger is the operation by which two or more companies unite to form a new company, which will succeed them in all rights and obligations.”
Article 1.119 of the Brazilian Civil Code states the following: “A merger determines the extinction of the companies that are united to form a new company, which will succeed them in rights and obligations”.
The new company will assume all the burdens and bonuses of the companies that form the new company. In this sense, article 132 of the National Tax Code states that the legal entity resulting from the merger will be liable for the taxes due up to the date of the resulting act.
M&A processes
The M&A process is complex and requires certain stages to be followed. It is a set of decisions and careful assessments in conducting negotiations, with the aim of minimizing risks and probable losses.
In view of the importance of the operation, it is essential that the company planning the M&A is advised by a quality legal team with expertise in the process. The law firm Monteiro Verdasca Advogados, for example, has extensive experience in the area and can help the entrepreneur who intends to carry out the merger.
Execution plan
The first step is to draw up an Execution Plan. To do this, the entrepreneur must identify the companies, carry out a market study, assess risks, forecast deadlines, analyze people, interests and responsibilities.
To avoid future problems, it is essential to be covered with the necessary documentation: the Letter of Intent (LOI), the Memorandum of Understanding (MOU) and the Confidentiality Agreement. This legal security is provided by a trusted lawyer.
Valuation
The next step is company valuation. This consists of assessing the company’s market value using various methods to check the level of debt, market positioning, growth prospects and the impact of the brand on the market.
Valuation enables the market and investors to have an almost precise idea of the company’s financial health in order to carry out an operation with the greatest possible certainty in the merger or acquisition process, avoiding risks and losses.
Due Diligence (M&A/F&A)
The next step in the M&A process is an audit known in business circles as Due Diligence. Through Due Diligence it is possible to investigate in depth whether the company to be sold has legal liabilities that compromise its liquidity and assets.
At this stage, we check the judicial and administrative proceedings in the various legal fields such as labor, tax, environmental, social security, accounting, among others, and what the impacts of these proceedings are on the final results for the company’s assets, the possibilities of losses and compensation.
To this end, the company’s legal team thoroughly analyzes the results of the audit, assessing future risks by screening legal claims, classifying risks and probabilities of success and possible obstacles.
Corporate reorganization or restructuring
Corporate reorganization is another important step in mergers and acquisitions and consists of readjusting the corporate composition of a company, changing and adapting its performance in the market and the composition of its partners in the company’s articles of association.
It can occur by means of demerger (partial or total), incorporation or merger and it can occur by transforming the type of company, from a joint stock company to an LTDA, for example.
It can also occur with a change in the company’s share capital, reducing or increasing it, as well as the merger of shares between the partners and the companies involved.
Corporate reorganization, as well as being part of the M&A process, is important in adapting the company to changes in the market and the profile of consumers, and such adaptations are fundamental to remaining competitive and increasing profitability.
The way a company is taxed may also require a corporate reorganization aimed at reducing costs and improving tax compliance, according to the scenario in which it operates.
The change of tax regime should take place to the extent of your turnover and profit in the market, with the aim of paying taxes within the market reality in which you find yourself, but it is necessary to look at the operational adjustments to see if it is worthwhile.
This analysis requires specialized knowledge of Brazilian tax legislation, and is best carried out by a professional. Monteiro Verdasca Advogados has the necessary knowledge to deal with such demands, with extensive experience in the area.
Contract Negotiation Phase
Finally, we come to the Contract Negotiation phase, which precedes the Final Contract, the Closing and the Post-Closing. From here the negotiations begin, the negotiation of the main contract, which can take several forms:
Contract for the purchase and sale of quotas or shares
also known as (QPA) or (SPA). These are agreements stipulated in cases where the buyer acquires all or part of the seller’s shareholding.
Subscription agreement for quotas or shares
Also known as (QSA) or (SSA). Occurs in agreements in which the participation of the new partner is accepted through the subscription and payment of new quotas or shares issued by the brand.
Asset purchase agreement
This occurs when there is a direct acquisition of assets. In the case of the purchase of a shareholding in which the sellers do not hand over their entire stake in the business, the shareholders’ or quotaholders’ agreement has a similar relevance to the main contract.
The MAC Clause
During the contract negotiation phase, it is very likely that a lot of time will pass to adjust a series of details pertinent to the contract negotiation process. For this reason, some agreements include a “MAC” clause, which stands for Material Adverse Change.
In Portuguese, the “MAC” clause stands for “Material Adverse Events”. It is provided for in the event of withdrawal during the signing phase of Share or Share Purchase Agreements (SPA) and Closing. It has a legal basis in the Theory of Imprediction and is based on article 478 of the Civil Code.
Final Contract
This is the stage of the M&A process where the parties involved actually sign the main contract and the ancillary contracts. The contracts stipulate all the points discussed and agreed upon during the previous phases of the negotiation.
They set out the price conditions, payment terms and conditions, types of guarantees, compensation clauses, non-compete clauses and penalty clauses, compliance with deadlines, possible indemnities, responsibilities, among other constituent elements of the agreement.
Payment Guarantees
In order to guarantee the payment of the amounts during the course of the negotiations, payment guarantees are established, such as Bank Guarantee Letters, Mortgages, Fiduciary Alienation, Pledges, Credit Securities, Fidejussory Guarantees and Early Maturity.
Closing
Soon after the main and ancillary contracts have been signed, the closing takes place. This is the moment when the agreements made and the obligations committed to are fulfilled, in accordance with the terms of the contract.
The closing conditions of an M&A transaction can occur at the time the SPA is signed (Immediate Closing), or can be deferred, subject to the fulfillment of conditions precedent (Deferred Closing).
To summarize, this means that in Immediate Closing, the closing of the transaction takes place at the same time as the signing of the definitive contract, while in Deferred Closing the signing and closing take place at different times. The latter is more common in M&A transactions.
Closing takes place in the following stages:
- The delivery of the letters of resignation of the current directors;
- The delivery of negative certificates;
- The signing of the instruments and documents required to close the price;
- Noting changes in shareholdings in the share register and transfer books; and
- The payment of the purchase price in full or in part, depending on whether there are withholdings or a guarantee deposit, and, in the latter case, the deposit of the relevant amount in the escrow account.
Post-Closing
The last phase of the M&A process is Post-Closing. In this phase, the parties will implement the operation within the deadlines set. It is the completion of the entire process in which the main measure is to register the corporate changes in the Articles of Association with the Board of Trade.
Other post-closure measures are the administrative acts of updating and registering state registration, municipal registration, CNPJ, INSS and FGTS records with the relevant bodies.
The M&A Lawyer
When conducting an M&A process, the participation of a lawyer is essential. A lawyer is the best qualified professional to examine all the negotiation procedures technically and thoroughly, taking into account legal issues and possible risks, avoiding damage to the parties and the market.
Mergers and acquisitions are naturally complex operations, full of details and regulated by equally complex legislation. In addition to other professionals, M&As are conducted by firms with teams of lawyers from different fields of law.
M&As involve the application of civil, corporate, tax, social security, labor, environmental, special legislation, international law (in cases where companies and partners from other countries are involved), as well as administrative and registration acts.
The complexity of conducting M&A transactions requires well-prepared legal professionals with specific knowledge of the issues involved. Lawyers with extensive experience and expertise in this segment, which grew 143% in 2021, are imperative.
The legal professional plays a decisive role in all stages of the deal, from drafting documents such as the confidentiality agreement (LOI), the letter of intent (NDA) and the memorandum of understanding (MOU), to closing the agreements and post-closing.
He is also the one who carries out the due diligence, a delicate stage in the process because it involves issues that cannot leave the slightest room for future disputes, as well as removing risks and avoiding losses, especially for the acquirer.
Despite the importance of other professionals such as accountants, for example, it is impossible to carry out an M&A transaction without the advice of an experienced law firm.
Therefore, a quality law firm, such as Monteiro Verdasca, can be the difference between a well-structured M&A and avoiding any headaches that may arise from a poorly drafted document.
Venture Capital
There are companies that need to grow but don’t have the capital to expand their business. They turn to investors, who inject money and become partners in these companies like any other investment, and this is what the market calls Venture Capital.
Venture capital operations are carried out with small and medium-sized companies with the potential for rapid growth and high profitability. They are not loans, but investments aimed at making a profit.
Those who invest in this type of company aim to inject money to make it grow, gain market value and strength, interfere in its management and prepare it for the future sale of shareholdings. Some investors leave the business soon afterwards.
The investment rounds are classified as Seed, Series A, Series B and Series C, depending on the company’s development and the increasing value of the investment. Angel investors invest in the early stage of the company and Private Equity funds in more experienced companies, with a higher investment amount
Investment can take place through the acquisition of shares or participation rights in these companies, known as startups. It can also be through specialized investment funds, Private Equity funds.
Brazil is the largest venture capital market in Latin America, growing by 28% a year, and the CVM (Brazilian Securities and Exchange Commission) regulates and supervises these funds, such as FIP (Equity Investment Funds) and FMIEE (Mutual Funds for Investment in Emerging Companies).
When the investor injects money into these companies, he also provides administrative support and business advice, interfering in management in a more professional way, considering his expertise, which is valuable in a recently established enterprise.
The advantages for the company are: management support, the investors have a lot of experience; long-term partnership; greater professionalization in management with the possible creation of the Fiscal and Administrative Council and rapid evolution, with more structure the return comes faster.
The best lawyer for an M&A
A lawyer specializing in M&A must have in-depth knowledge of the business in which he will be working. They must know the market and understand whether or not an operation is profitable for the company.
In addition, this knowledge of the area is essential for the lawyer to understand the risks of the operation. Not understanding the process can result in the entrepreneur taking on far more risk than would be economically worthwhile.
There is one more detail that is essential in this type of operation: knowledge of tax legislation. Depending on how an operation is carried out, the incidence of tax can be much higher than necessary.
Furthermore, Brazilian tax legislation is not simple. Taxes have to be paid at the state, federal and municipal levels. Paying the wrong amount can lead to a series of difficulties, as the money is not easily recovered and the debt to the correct sphere continues to exist.
In other words, the saying goes: he who pays wrongly, pays twice. And that, for a company’s cash balance, especially when it involves large sums of money, is a huge loss.
Good advice from a lawyer is therefore essential. A firm that knows the business, understands the business environment and has extensive experience in government procedures, in order to understand tax legislation and show the entrepreneur the least costly way to operate.
Therefore, a law firm like Monteiro Verdasca is the key to a good negotiation. Risk-taking and the pursuit of results are much easier when accompanied by high-level professionals, such as those at the firm in question.
Conclusion
The M&A operation is an alternative for companies looking to boost their business. As with any operation involving large profits, there is a great deal of risk involved.
Therefore, the help of a specialized professional who understands the risks of the operation and acts in the best possible way to reduce or mitigate them is essential.
As has been explained throughout the text, the operation involves technical knowledge about the business environment and the country’s tax system. All this knowledge has to be used in the operation.
What’s more, an operation of this level requires a certain negotiating skill. The parties have to know how to allocate the risks. This prevents, for example, in the event of an eventuality, someone ending up paying much more than they should.
Every step, every word of the contract must be thought through. Every piece of information shared with the other party must have a guarantee of confidentiality. If all the steps are well tied together, the risks of a problem occurring are minimal.
Although you can’t control the future or prevent unforeseen events from happening, being well prepared in the event of eventualities makes all the difference. And one professional who works to protect entrepreneurs from these risks is a lawyer.
A competent law firm, such as Monteiro Verdasca, can be the difference between a well-executed M&A or a botched operation, which ends up generating more damage and headaches than the profits the entrepreneur dreams of making from the operation.
