What is a Takeover and Why Do Takeovers Happen?
A takeover is the purchase of a company (the target) by another company (the acquirer or bidder). Whether the takeover is friendly or hostile, the resulting transaction results in the merging of the two companies into one. A takeover happens for several reasons, including:
1. To realize operational efficiencies and economies of scale
By creating a larger company through the merger of two smaller companies, the resulting company is able to realize operational efficiencies and economies of scale (assuming that they operate in a similar industry and/or use similar resources).
2. To eliminate competition
Takeovers can be used to eliminate smaller companies that compete with the bidder. Instead of competing with the target company to acquire market share, the bidder can simply take over the target company to eliminate competition and gain the target’s market share.
3. To acquire a company in a unique niche market
A takeover may happen when the bidder wants to acquire proprietary technology that the target company owns. This may be the case when the bidder lacks a strong research and development (R&D) team or does not want to expend time and resources developing new technology.
For example, a data management company may want to take over a target company that possesses proprietary AI technology so that it can incorporate the AI technology into its data management platform instead of spending resources and time to develop its own AI technology.
4. Empire building by management
Takeovers may happen due to management wanting to “empire build.” This is the act of increasing the size, scope, and influence of a company through acquiring other companies. Empire building as a business rationale for a takeover is typically unwelcomed by shareholders of the acquiring company, as it may indicate that the management team is more concerned with resource control rather than with efficiently allocating resources.
If the company is acquiring companies in unrelated industries, it could increase the overall business risk of the company. Empire building as a business rationale for takeovers may not ultimately benefit shareholders.
The Takeover Process
A takeover Starts with a proposal by the acquiring company to take over the target company. The proposal must be filed with the relevant regulatory bodies where the companies are headquartered. Next, the target company’s board of directors can approve the proposal and advise shareholders to vote in favor of the takeover (friendly takeover) or reject the proposal and advise shareholders to vote against the takeover (hostile takeover). The acquirer company employs different strategies depending on whether the target board approves or rejects the takeover.
Friendly Takeover Strategies Employed
In a friendly takeover, the management and board of directors approve of the takeover and advises shareholders to vote in favor of the deal, in a hostile takeover the board of directors disapprove.
In M&A transactions, a friendly takeover is the acquisition of a target company by an acquirer/bidder with the consent or approval of the management and board of directors of the target company.
Components of a Friendly Takeover
1. Public offer of cash or stock
Generally, a friendly takeover is a public offer of cash or stock made by a bidding company, that is given to the board of directors of the target company for approval.
2. Premium per share
The per share stock price paid by the acquirer to the shareholders of the target company is often a key determinant of the success of the deal. In most cases, the acquirer must pay a significant premium per share to secure the approval of the target company’s shareholders.
3. Shareholders’ approval
When an offer is received by the target company’s board of directors, shareholders with voting rights vote for the approval of the transaction. Typically, the approval requires a simple majority vote (i.e., more than 50%).
However, some companies include supermajority provisions in their corporate charters that require a larger percentage of shareholders to approve the transaction (the number may vary between 70% to 90%).
4. Regulatory approval
Even if the shareholders of the target company approve the acquisition, the deal is still subject to the approval of a regulatory body (e.g., Department of Justice). The government regulator may disapprove of a friendly takeover if the deal violates competition (also known as antitrust or anti-monopoly) laws. Other buyout terms also play a crucial role since the offer is a comprehensive legal document that includes several provisions and clauses. For example, the buyout terms may include provisions regarding the brand and operations of the target company, as well as the inclusion of key shareholders of the target company in the board of directors of the acquirer.
Advantages of a Friendly Takeover
Generally, friendly takeover deals deliver substantial advantages to both bidders and target companies, as compared to a hostile takeover. Some of the advantages include the following:
- The involvement of both parties (bidder and target company) ensures better design of the deal and value delivery to the participating parties.
- The target company does not incur costs or erase its value due to employing defense mechanisms to prevent a hostile takeover.
- The bidder incurs reasonable costs to acquire the target company. The per share premium is primarily based on the growth prospects of the target company and potential synergies created as a result of a deal.
Reverse Takeover (RTO)
A Reverse Takeover (RTO), often known as a reverse IPO, is the process in which a small private company goes public by acquiring a larger, already publicly listed company. The practice is contrary to the norm because the smaller company is taking over the larger company – thus, the merger is in “reverse” order.
In a typical public listing, a private company must undergo an initial public offering (IPO). The process is not only time-consuming, but it is also exceedingly costly. To bypass the expensive and laborious process, a private company can go public more simply by acquiring a public company.
The process of reverse takeover usually involves two simple steps:
1. Mass buying of shares
At the start, the acquirer conducting a reverse takeover commissions the mass-buying of the publicly listed company’s shares. The goal is to gain control of the target company by acquiring 50%+ of the outstanding voting shares.
2. Shareholders-shares-buy activities
It is the next phase that leads to the merger and public listing. The process involves the private company’s shareholders engaging actively in the exchange of its shares with those of the public company. The public company – which is now effectively a shell company – cedes a large majority of its stock shares to the private company’s shareholders, along with control of the board of directors. They pay for the shell company with their shares in the private company.
a) No need for registration
Since the private company will acquire the public listed company through the mass buying of shares in the shell companies, the company will not need any registration, unlike in the case of IPO.
b) Less expensive
Choosing to go public through the issue of an Initial Public Offering is not an easy task for a small private company. It can be prohibitively expensive. The reverse takeover route typically costs only a fraction of what the average IPO costs.
c) RTO saves time
The IPO process of registration and listing can take several months to even years. A reverse takeover reduces the length of the process of going public from several months to just a few weeks.
d) Gaining entry to a foreign country
If a foreign private company wants to become a publicly listed firm in the United States, it needs to meet strict trade regulations, such as meeting the US Internal Revenue Service requirements, and incur exorbitant expenses such as company registration, legal fees, and other expenses. However, a private company can easily gain access to a foreign country’s financial market by executing a reverse takeover.
A reverse takeover presents the following potential drawbacks:
a) Masquerading public shell companies
Some public shell companies present themselves as possible vehicles that private companies can use to gain a public listing. However, some are not reputable firms and may entangle the private company in liabilities and litigation.
b) Liquidation mayhem
A private company willing to go public using reverse takeover should ask itself, “After the merger, will we still have enough liquidity?” The company may have to deal with a possible stock slump when the merger unfolds. It’s critical that the new company has adequate cash flow to navigate the transition period.
In mergers and acquisitions (M&A) a Creeping Takeover, also known as Creeping Tender Offer, is the gradual purchase of the target company’s shares. The strategy of a creeping takeover is to gradually acquire shares of the target through the open market, with the goal of gaining a controlling interest.
A creeping takeover involves purchasing shares of the target company on the open market. Through the creeping takeover method, the acquirer can obtain a portion of the shares at current market prices rather than needing to pay a premium price through a formal tender offer. The purpose of a creeping tender offer is to obtain a portion of the target company’s shares more cheaply than one can through an ordinary tender offer. In some countries, however, there are regulations governing this process that require the bidder to offer a formal bid upon holding a certain amount of shares.
Rationale Behind a Creeping Takeover
In the US, a creeping takeover is used to get around the provisions of the Williams Act.
Key provisions of the Williams Act:
- In a tender offer, all shareholders must be offered the same price for their shares.
- An investor or a group attempting to acquire a large block of shares must file all relevant details of their tender offer with the SEC.
Therefore, with a creeping tender offer, the bidder is able to circumvent all of these provisions and purchase shares from different shareholders on the open market. Usually, only when a substantial number of shares have already been acquired through a creeping takeover strategy will the bidder file the necessary documents and offer a formal bid.
Risks in a Creeping Takeover
A failure in the takeover of the target company will leave the acquirer with a large block of shares that it may need to liquidate, possibly at a loss, in the future. However, there are ways to minimize this risk. Pressure can be applied to the target company to force them to repurchase the shares at a high price.
A bailout takeover refers to a scenario where the government or a financially stable company takes over control of a weak company with the goal of helping the latter regain its financial strength. The acquiring entity takes over the weak company, usually by means of purchasing a controlling amount of the company’s stock shares. Share exchange programs may also be used.
The goal of the bailout takeover is to help turn around the operations of the company without liquidating its assets. The acquiring entity achieves this by developing a rescue plan and appointing a manager to spearhead the recovery while protecting the interests of the investors and shareholders.
Companies considered for a bailout takeover are typically those whose collapse or bankruptcy would be detrimental to the industry they are a part of and/or to the country’s economy as a whole. For example, a company that employs a very large number of individuals, especially if the company is a major employer for the geographical area it is located in, may be considered “too big to fail”.
The bailout comes in the form of stock, bonds, loans, and cash that may require reimbursement in the future. In the case of stock shares, the struggling company would need to re-purchase the shares from the acquiring entity once it regains its financial strength.
Legislative and Executive Efforts on Bailout Takeovers
The Dodd-Frank Act was signed into law by President Barack Obama in July 2010. The act was a response to the financial crisis of 2007/2008 when many major US companies were facing collapse due to the financial crisis. While the government moved in to rescue the troubled companies, the Dodd-Frank Act also sought to protect consumers from bearing the cost of bailouts when rescuing mismanaged companies. The law established regulatory bodies such as the Financial Stability Oversight Council, the Office of Financial Research, and the Bureau of Consumer Financial Protection.
The Dodd-Frank Act was aimed at promoting the financial stability of the United States financial system by requiring accountability and transparency among US companies. Title II of the Dodd-Frank Act legislates bailout procedures for struggling companies. It requires shareholders and creditors to bear the losses of a failed company.
The 2008 bailout takeover of numerous financial institutions by the United States Government was the largest in history. The government moved in to rescue financial institutions that suffered large losses from the collapse of the subprime mortgage market.
At the time, financial institutions had provided mortgage loans to borrowers with low credit scores, and when large numbers of these mortgages went into default, the lending companies were unable to absorb the massive losses.
Troubled Asset Relief Program (TARP)
The Emergency Economic Stabilization Act (2008) authorized the creation of the Troubled Asset Relief Program (TARP) to provide a bailout fund of $700 billion distributed to large US companies that qualified for the program. It was one of the measures that the government took to address the subprime mortgage crisis.
Authorities used the TARP to purchase toxic assets from financial institutions as a way of strengthening their financial position and helping to stabilize the balance sheets of struggling companies. In the end, the TARP disbursed more than $426.4 billion to financial institutions and recovered approximately $441.7 billion in repayments.
A hostile takeover, in mergers and acquisitions (M&A), is the acquisition of a target company by another company (referred to as the acquirer) by going directly to the target company’s shareholders, either by making a tender offer or through a proxy vote. The difference between a hostile and a friendly takeover is that, in a hostile takeover, the target company’s board of directors do not approve of the transaction.
Example of a Hostile Takeover
For example, Company A is looking to pursue a corporate-level strategy and expand into a new geographical market.
- Company A approaches Company B with a bid offer to purchase Company B.
- The board of directors of Company B concludes that this would not be in the best interest of shareholders in Company B and rejects the bid offer.
- Despite seeing the bid offer denied, Company A continues to push for an attempted acquisition of Company B.
In the scenario above, despite the rejection of its bid, Company A is still attempting an acquisition of Company B. This situation would then be referred to as a hostile takeover attempt.
Hostile Takeover Strategies
There are two commonly-used hostile takeover strategies: a tender offer or a proxy vote.
1. Tender offer
A tender offer is an offer to purchase stock shares from Company B shareholders at a premium to the market price or at a fixed price. Often, the fixed price is much higher than the amount the company’s share would sell for on the market. The higher price serves as an incentive so that the shareholders can agree to sell their stock.
The tender bid is made formally, and it may highlight the specifications proposed by the acquirer. For example, the acquiring entity can choose to set a timeframe for the stocks’ purchase. Once the window closes, they may resort to other measures to acquire the company.
The acquiring company is required to file acquisition documents for instance in the USA with the Securities and Exchange Commission (SEC). They must also explain their objectives for the target company – an aspect that helps the target company make a final decision.
While it sounds easy, a tender offer is one of the more difficult takeover strategies. Most companies put measures in place to protect their ventures from such a takeover. For this reason, the acquiring entities often resort to a proxy fight.
For example, if Company B’s current market price of shares is $10, Company A could make a tender offer to purchase shares of company B at $15 (50% premium). The goal of a tender offer is to acquire enough voting shares to have a controlling equity interest in the target company. Ordinarily, this means the acquirer needs to own more than 50% of the voting stock. In fact, most tender offers are made conditional on the acquirer being able to obtain a specified amount of shares. If not enough shareholders are willing to sell their stock to Company A to provide it with a controlling interest, then it will cancel its $15 a share tender offer.
2. Proxy vote, Proxy Fight, Proxy Battle
A proxy vote is the act of the acquirer company persuading existing shareholders to vote out the management of the target company so it will be easier to take over. Also known as a proxy battle, a proxy fight is another strategy for taking over a company’s operations. It involves removing board members who do not support the acquisition bid and replacing them with new members who would.
For a proxy fight to be successful, the acquiring entity must persuade the current shareholders that a change in management is necessary. The acquiring company can achieve this by pinpointing faults in the present administration. For instance, if the company has underperforming assets or faces a financial crisis, the shareholders may support the idea. If they are convinced, they will permit the acquiring entity to vote their shares by proxy.
If the proxy fight is a success, the company can appoint new board members. Usually, the acquirer will propose members who will vote in favor of the acquisition.
For example, Company A could persuade shareholders of Company B to use their proxy votes to make changes to the company’s board of directors. The goal of such a proxy vote is to remove the board members opposing the takeover and to install new board members who are more receptive to a change in ownership and who, therefore, will vote to approve the takeover.
3. Purchasing Shares
If neither the proxy fight nor the tender offer work, the last solution for an acquirer is to gain a controlling share of the target company’s stock. It entails purchasing a considerable number of shares in the open market.The more shares the acquiring entity has, the more say they have in the decision-making process. For instance, if the acquirer has three-quarters of the company’s shares, it means they always have the highest number of votes; hence, a great deal of control.
Defenses against a Hostile Takeover
There are several defenses that the management of the target company can employ to deter a hostile takeover. They include the following:
- Poison pill: Making the stocks of the target company less attractive by allowing current shareholders of the target company to purchase new shares at a discount. This will dilute the equity interest represented by each share and, thus, increase the number of shares the acquirer company needs to buy in order to obtain a controlling interest. The hope is that by making the acquisition more difficult and more expensive, the would-be acquirer will abandon their takeover attempt.
- Crown jewels defense: Selling the most valuable parts of the company in the event of a hostile takeover attempt. This obviously makes the target company less desirable and deters a hostile takeover.
- Supermajority amendment: An amendment to the company’s charter requiring a substantial majority (67%-90%) of the shares to vote to approve a merger.
- Golden parachute: An employment contract that guarantees expensive benefits be paid to key management if they are removed from the company following a takeover. The idea here is, again, to make the acquisition prohibitively expensive.
- Greenmail: The target company repurchasing shares that the acquirer has already purchased, at a higher premium, in order to prevent the shares from being in the hands of the acquirer. For example, Company A purchases shares of Company B at a premium price of $15; the target, Company B, then offers to purchase shares at $20 a share. Hopefully, it can repurchase enough shares to keep Company A from obtaining a controlling interest.
- Pac-Man defense: The target company purchasing shares of the acquiring company and attempting a takeover of their own. The acquirer will abandon its takeover attempt if it believes it is in danger of losing control of its own business. This strategy obviously requires Company B to have a lot of money to buy a lot of shares in Company A. Therefore, the Pac-Man defense usually isn’t workable for a small company with limited capital resources.
Do you want to read more?
Corporate Takeover Law and Management Discipline
Corporate Takeover Targets