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PART I1. Earn-out agreements
Earn-out agreements set a portion of the purchase price contingent upon the acquired company
reaching certain financial goals/ milestones during a specified period after the closing. 1 Under an
earn-out agreement the seller receives part of the purchase price up front, and additional
payments over time. Such an agreement is often reached in a business purchase agreement when
the buyer and seller significantly disagree about the value of the target company. For example, if
the buyer is unwilling to pay the full purchase price up front due to doubts about future
performance of the business, it might offer to pay 80 percent of the purchase price at the time of
sale, and pay the remaining 20 percent over a period of five years. An earn-out agreement thus
rewards the seller if its projections are accurate, while protecting the buyer from overpaying if
they are not. Furthermore, buyers can use earn-outs as a source from which they can offset
indemnification, and another rationale may be that the buyer wants to bridge a financing gap.
2. Leveraged buyout
A leveraged buyout is an acquisition of a corporation as a whole or a division of a corporation
that utilizes mainly debt to finance the buyout. Typically, the acquirer creates a new acquisition
vehicle in which the capital structure consist of debt sliced into different types of debt and
equity.2 Equity is provided by investors who invest in a “fund” raised by a specialist firm: “the
private equity firm” that locates suitable investment opportunities. The aim of leveraged buyouts
is that the return generated on the acquisition will more than outweigh the interest paid on debt.
Therefore, this acquisition vehicle allows companies to make large acquisitions with only a small
amount of financing, which is usually 10 percent where the remaining 90 percent of cost is
financed through debt. In other words it can be said that high returns can be achieved by
leveraged buyouts without having to commit a lot of capital.
3. Poison pill
The poison pill is a defensive strategy used by a target company in the attempt to make its stock
less attractive to the acquirer. In this way, the poison pill deters aggressors in corporate takeover
attempts. This defensive strategy allows existing shareholders to purchase shares in the target
company at a discount (flip-in), which imposes losses on the acquirer and dilutes his or her
equity position. 3 In turn, the flip-in pill dilutes the raider‟s voting percentage, its economic
interest will decline, and furthermore, triggering the pill makes the target shares more costly to
acquire. Therefore, the buyer will be deterred from crossing the ownership threshold that will
trigger the rights plan by confronting it with the prospect of dilution. In addition to the flip-in pill,
there is the flip-over pill which only applies in case of second step merger. This defensive
strategy namely allows stockholders to buy the acquirer‟s shares at a discounted price after the
merger.
1
Sherman, Andrew J., and Milledge A. Hart, Mergers and Acquisitions From A to Z, Amacom (New York), 2011,
3rd Ed., p.207-209
2
Sudarsanam, Sudi, Creating Value from Mergers and Acquisitions, The Challenges, Prentice-Hall International
(London), 2010, 2nd Ed., p. 307-308
3
Idem, p. 672-673
1
, 4. MAC clause
The MAC clause stands for “Material Adverse Change” clause. Such clauses typically include
that if, between signing and the closing of the transaction, the target company suffers a material
adverse effect (including events or changes that are detrimental to the target company, for which
the precise definition and terms is negotiated), the buyer is allowed to refuse to complete the
transaction and to walk away from the deal before it closes.4 The MAC clause thus serves to
protect the buyer from being forced to acquire the target when an extraordinary event has
occurred that affects the value of the target firm.
5. Spin-offs
A spin-off is a corporate restructuring where a small part of a parent company is carved out to
float off a subsidiary, which is to be a new business entity that is separately valued on the stock
market: the spin-off company.5 The parent company transfers a portion of its assets in exchange
for all of the spin-off company‟s capital stock, which is subsequently distributed to the
shareholders of the parent company. Typically, spun-off companies are expected to be worth
more as independent entities than if they were included as parts of larger businesses.
6. Warranties
In merger and acquisition transactions the seller typically gives the buyer warranties about the
business concerned. Warranties laid down in a merger or acquisition agreement are statements
made by the seller guaranteeing that certain facts in relation to the business or the company are
true.6 In the event it appears that a warranty was not true, a buyer can claim damages for breach
of warranty. Because the buyer usually is unable to gain a complete knowledge and
understanding of the target company or its affairs before committing the purchase, warranties
serve as a kind of protection for a buyer in a merger and acquisition transaction.
PART II
Subpart A
Question 1
Parties negotiating the sale of a company each have their own interests to the deal. While buyers
usually bargain for deal protection mechanisms to be included in the merger agreement in order
to protect their interest, sellers aim to fulfill their fiduciary responsibilities by obtaining the
highest price possible for the company under the Revlon duty. 7 Traditionally, sellers would
engage in a formal or informal auction, identifying serious bidders, and sign a deal with the
4
Sherman, Andrew J., and Milledge A. Hart, Mergers and Acquisitions From A to Z, Amacom (New York), 2011,
3rd Ed., p.206
5
Sudarsanam, Sudi, Creating Value from Mergers and Acquisitions, The Challenges, Prentice-Hall International
(London), 2010, 2nd Ed., p.282-287
6
Sherman, Andrew J., and Milledge A. Hart, Mergers and Acquisitions From A to Z, Amacom (New York), 2011,
3rd Ed., p.204-205
7
Subramanian, Guhan, Go-Shops vs. No-Shops in Private Equity Deals: Evidence and Implications. Business
Lawyer, May 2008; Harvard Public Law Working Paper No. 08-09, p.1
Available at SSRN: http://ssrn.com/abstract=1084586
2
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