Exam 2

cash, shares of common stock, preferred stock, debt, assets, and contingent payments

Cash is king! It is the most desirable form of payment (liquid and clear value)
- sends a strong signal to the seller.
- less market risk
- buyer gets full benefit from synergies (and takes all of the risk)
How a buyer gets the cash is the most important question.
- most companies dont have huge amounts of cash on hand... so they have to raise cash by borrowing it via loans and or bonds.
- can also raise cash by issuing equity but its not common
Be careful... too much borrowing = high leverage; how much debt is safe to borrow without putting the company at risk?

In a stock deal, the shareholders of the company being sold become shareholders int he buyers company.
- The acquierer gives up some ownership and voting control in their company.
- sellers stay incentivized bc their financial gain depends on future performance.
- avoids taking on more debt to raise cash (sometimes this is the only option for highly leveraged companies)
- there are risks of synergies shared between acquirer and seller.
- stock deals are more complicated becuase they have to analyze two stocks.
Common stock deals are structured 2 different ways:
- Fixed share ratio: each shareholder of the target company will recieve a specific # of shares of the buyers company for every share they currently own (# shares fixed, value varies)
--> risky if buyers share price changes.
--> You can turn around and sell the new shares or keep them (taking on market and company risk)
- Fixed dollar amount: acquirer promises that the target companys shareholders will get a set dollar value worth of the acquirers shares (value fixed, # shares varies)
--> this protects targets shareholders becuase they always get the agreed upon dollar value.
--> good for when the transaction takes a while to approve
--> protects buyers if their share price rises and protects sellers if the buyers share price falls.

Instead of using cash or common stock, preferred stock can be used. This pays fixed dividends.
- not used often
Senior to common stock - get paid first (safer)
Convertible preferred is often used as it can be converted into common stock in the future.
Good: capture the upside if the buyers stock goes up, the sell can convert and profit
Risk: if there is financial risk the seller wouldn't convert into common (stay protected)

Buyer is borrowing from the seller.
- least preferred way.
Seller Note: seller issues debt to the buyer
- "IOU" from the buyer to the seller. (private debt)
- buyer agrees to pay the seller a certain amount of principal by a maturity date along with periodic interest payments.
- Used when a buyer is unable to come up with the cash at the time of the deal.
- only used in acquisitions of privately owned companies.
2 major disadvantages are:
1) default risk: seller never recieves final payment
2) TVM: PV is lower even if the future payment looks bigger and payment is delayed to a future date.

Assets are used sometimes when cash is not a practical option.
- the buyer cant borrow enough money.
- deal is done in a market with currency restrictions or a unstable currency.
Problems of using assets for both buyer and seller...
- some assets such as land, buildings, patents, etc. are hard to value.
- some assets such as gold and oil have to be transported from buyer to seller.
- seller has to convert the asset into cash by selling it which may or may not be hard to do (land and buildings)
Used more in emerging markets

The amount is dependent upon future performance (seller only receives value if the company does well)
Earnouts: sell gets a % of future profits above a certain minimum level
- buyer pays part of the money now and the rest later if the company hits a specific goal.
- helps the buyer not overpay & gives the seller a chance to earn more money.
- also prefequently used with sales of private companies.
- often called "seller notes"
Warrants/Options: long term options issued by the buyer that will become valuable if their company does well and its stock price rises.
- Heres a coupon to buy my stock for $10 anytime in the next 5 years. if the stock price rises to $20 yous ave $10. - not used as often as earnouts. Contingent payments bridge the differences between buyers and sellers on valuation of the company.

Synergies are the extra benefits that come from the acquisition.
"2+2 = 5"
The two main types are cost synergies and revenue synergies (cross-selling)

These are cost savings generated by elimiating duplicative people, assets, facilities, operations, and suppliers. (money saved after the merger or acquisiton by removing what they don't need twice of)
- Headcount synergies: elimination of duplicative jobs such as executive and administrative but also salespeople, engineers, and others.
--> they require firing employees which may be restricted by laws, union contracts, and other executive contracts.
--> the savings may be partially offset by severance costs.
--> Valued by using multiples.
- Manufacturing and distribution synergies: close duplicate manufacturing warehouses and using the most efficient facilities.
--> these often take lots of time and money to execute because equipment is moved/modified.
--> Risky because shutting down facilities could lead to lower quality, slower distribution, issues with CS
-->if the workers belong to a union they could strike casuing delays
--> valued using DCF
- Purchasing synergies: possible when the 2 companies share suppliers or purchase the same matierals or services.
--> becuase the two companies combined will be buyer larger volumes, they can negotiate better prices. if they have different suppliers have them bid for best price.
Risks are quality risk and dependcy.

these are additional sales generated by selling one companys products to the other companys customers.
- easier to achieve if the two companies serve different groups of customers or serve different products
- these synergies take time to achieve
- hard to estimate becuase it depends on the companys customers
- valued using a DCF

- some synergies are easier to acheive than others.
- cutting adminastrative jobs is the easiest and fastest (headcount)
- plant closing and revenue synergies are going to take longer to acheive
- revenue synergies are the hardest to estimate (forecast) and quantify

Synergies are not always fully achieved.
- customers object to closing facilities
- quality and product problems related to transfering manufacturing between facilities
- labor union and government objections to plant closing and layoffs (biggest problem in Europe)
- Unexpected implemenation costs
- the capital makrets can weaken resulting in it being harder to raise cash
- delays in getting the deal closed (rival bidders emerge)

They can cause problems such as drive up the cost of an acquisiton, cause the buyer to lose the opportunitiy, and delay the process.
You can minimize the possibility of a rival bidder emerginig by
- making a strong inital offer
- use as much cash as possible
- minimize the number of conditions attached to the offer

The rating agency may say if you continue to borrow, we will drop your rating. Also banks may be harder to work with if they see you trying to raise debt.

- Officers of the company who are responsible for the day to day operations of the company.
- CEO heads the management team (they report to the board of directors so the BoD gets their info from MGT team)
- other important officers are....
--> CFO
--> general counsel
--> business group presidents

Elected by shareholders to represent their best interest.
May have insiders and outsiders (independent directors) of the company.
- best to have majority independent so it reduces conflict of interest
- best to not have the CEO be the chairman of the board
Directors are required to be informed, avoid conflict of interest, use good business judgemet, and act honestly and in good faith.
Major decisions include:
- hiring and firing ceo, hiring and firing auditors, executive compensation, M&A, dividends, and issuance of shares of stock.

exectivies of other compannies, retired exectuives, lawyers, leaders of non-profits, and retired military officials.

Groupthink (no diversiity in experience/opinions), afraid of CEO, not enough experience in financial, accounting, and legal expeirence, and too many board memebers.

Fiduciary Duty: duty of the directors to always act in the best interest of the corporation
Business Judgement rule: board memebers have the right to make decsisions if they are well-informed, have no conflicts of interest, and act honestly and in good faith

Compensation committe: approve and monitor executive pay and incentive programs
Audit committe: select and review performance of the companys auditors.
Others include corporate governance, finance, and nominating

compenstion
control over major decisions (max shareholder value, M&A, direction of the company)
Board memebership (CEO may want a lot of friends on the board)

Shareholders own the business
Shakeholders include shareholders but also include employees and union, suppliers and customers, local committees and governments, and credits/lendersondholders
- directors typically consider the immpact of the stakeholders in addition ot the shareholders (degree varies per state)
- shareholders can ignore the boards recommendations (takeover)

State of Incorporation: every corporation must choose a state in which to incorporate
-> each state has different laws regarding corporations and transations
-> Delaware is the most common state for incorporation
Bylaws and certification of incorporation: documents that outline the rules for a corporation
- Includes... size of the board and election procedures, voting rules for major decisions, shareholder meetings, and procedures for amending bylaws (all can be changed by shareholder vote)

They make it harder for a corporation to be taken over.... examples
-> supermajority voting requirements (makes it harder to get approval need greater than 60%)
-> staggered board terms: directors are elected in staggered terms
- good because there is no mass exit and you must state how long someone has to stay on board
-> Poison pill: new shares are issued to dilute acquiers %

majority directors are independent, CEO is not the Chairman, Diversity in expeirence, alignment with shareholder interest, frequent meetings

evaluate the offer is it fair? (hire experts) , seek best value for shareholders, stay informed, act in good faith, consider defense strategies if necessary, and communicaate with shareholders (the shareholders ultimatley decided so the board just gives a recommendation)

Book value of equity can be negative becuase of share buybacks like the mcdonalds example buteven with having a negative book value their market value was positive as they were a profitable company so we say that we always use market value

increase shareholder value, achieve strategic goals, deal with legal or regulatory changes, or to satisfy needs or egos of founders, managers, and their families
(shareprice, strategy, EBIT)

synergies often require upfront costs to achieve cost savings later
one time expenses
Ex: severance payments, cost to move inventory, legal costs, cost to maintain idle facilities, etc.

Target standalone value = the minimum acceptable bid to the target
Target standalone value + synergy value that the acquirer expects to receieve = maximum bid
Final bid is usually below the max for potential upside for the acquier.

Total = $125 m Min = $100m
Max = $125m Inital offer = $110 m
Final Offer = $115 acquirer has potential for a $10m upside.

- how much to pay for the business being aquired?
- how to pay for the deal including how to raise money needed
- how to structure the deal
- how to deal with various legal requirements
- strateges to max. the chance of approval by shareholders

Key question: does the seller want to sell?
- are rival bidders likely to emerge?
- is the target business an entire company or part?
- is it publicly or privately owned?
- who owns the shares?
- how large are the synergies?
- does the acquierer require financing to do the deal?
- state/country of acquier and target incorporated
- are they in the same industry?

friendly = target company is willing to sell
hostile = target copany doesnt want to be acquireed but the acquirer proceeds anyway

These are thigns that must occur before a deal can be done
- due diligence (most important)
- shareholder approval
- governemnt and regulator approval
- finanancing if necessary
- contracts
shareholder and government are always a contingency
these allow acquirers to back out if they are not met

Used by acquirer
Acquirer approaches the targets directors and shareholders with the offer and bypasses managment
1) Toehold: a potential acquirer buys an inital block of the target companys shares (becoming a shareholder)
- any stake 5% or more must be reported to the SEC within 10 days
2) Litigation: the acquirer can commence or threaten to sue against the target directors (not doing their fiduicary duty)
3) Proxy fight: acquirer calls for a vote to reelect new directors to gain control over takeover
4) tender offer: acquierer makes an unsolicted offer to purchase the target companys common stock (buying at a premium)
- really expensive, buying votes, only do this if you think you can win, must be approved by SEC, shareholders get 20 business days to deicide
- issue: some people may not sell and you dont have majority

Used by targeted company
1) Convince shareholders this is not a good deal (disney example)
2) Litigation: sue or threaten to sue acquieer to delay/discourage them
3) Build allies with those who oppose the takeover (government officials, unions, customers, etc. )
4) White Knite: find a rival bidder to offer a higher.comparable price
5) Auction: seek multiple bidders for the company
- good: shareholders gets the highest offer
- bad: they may not like who buys it
6) modify target company bylaws to make it harder to acquier (poison pill, supermajoirty, staggered terms)
7) leveraged recapitalization: issue debt and use the proceeds to buy back stock or pay a large dividend (makes company risky)
8) pac man: start buying or make a hostile takeover offer for the other companys shares (rarely used)

1) Sole Proprietor: one own with unlimited liability
2) Partnership: multiple owners with unlimited liability
- MLP is a type of ownership that is traded publicly
3) Corporation: multiple owners with limited liability
- Owners have shares of common stock in the company
- shareholders are represented by board of directors

1) LLC and S-corp: are only used when the number of shareholders is small.
- provides tax advantages compared to c corp
2) C-corp: only used when the number of shareholders is large.
- most public companies are c corp
- taxes are paid at the shareholder and corporate level
3) REIT: special type of corporation that owns real estate assets.
- has special tax rules and requirements
4) Benefit corp: company must take into account the community and other stakeholders in the decision process.

most large companies are made up of a parent company and many smaller units called dividsions/subsidaries
Divisions: business unit of the parent company (or a piece of the subsidary) that is not separtely incorporated
- "department or business unit"
- part of the company
Subsidarie: separetly incorporated unit whose equity is 100% owned or partially owned by a parent company.
- used to separate business in other countries or risky business units
- separate company (beats is its own company but Apple owns it)

Separetely incorporated entitiy whose shares are owned by 2+ corporations or government entities.
- commonly used for overseas expansion
- most foriegn dels want a local partner involved

A loan is a private contract in which a company borrows money from a lender or group of lenders.
- the money must be repaid according to a schedule both parties agree on.
- interest is paid on the amount you still owe until its fully repaid.
Syndicated loan: large corporate loans involving multiple financial institutions that together lend money to a company.
- Agent Bank: primary lender --> they arrange the loan and then sell portions of it to other lenders (syndicated banks)
- this spreads the risk across all institutions
- reduces the amount of capital the agent bank needs to provide
- After the loan is placed, they still have jobs to do....
1) pass along informatoin from company to lenders
2) distribute money between borrowers and lenders
3) lead negotiations
4) keep records

most loans have floating interest rates (base rate + ____%/spread)
SOFR is the most common base rate for corporate loans
Loan interest is usually payable quarterly

Term loans and revolving credit facilities
- both can be traded in the secondary market
- borrowers can have more than 1 loan outstanding at a time.

Money is borrowed upfront and then repaid according to a set schedule.
- final principal is due on the maturity date.
- can be unsecured or secured by collateral
- most frequently traded (more common with borrowers below investment grade)
- most cna be called or repaid at any time by the borrower
- once the term is repaid, the principal cannot be reborrowed.
Principal Repayment Schedule
1) refular repayments each year
2) small payments each year, big payment at the end
3) Bullet maturity: all principal is paid at the end
Maturities usually 5-7 years
Instiutional investors will often invest in term loans because they have bond like trading characteristics

A loan that allows the borrower to borrow up to a certain amount of principa at any time while the loan is still active.
- like a credit card
- Matures in 1-5 years
- most common type of loan for companies
Uses for revolvers:
1)good for seasonal businesses (borrow when you need and pay when you dont)
2) backup funding if the company can't refinance its commercial paper.
3) backup in case of a recession
4) help fund acquisitons
Letters of Credit: contracts in which the lenders guarantee to make a payment if something goes wrong (3rd party usage)
- used in construction, waste disposal, and importing and exporting
Lenders get paid 3 ways on a revolver...
1) interest on borrowed funds
2) fees for letters of credit issued
3) fees for any unused availability

payment default: the company fails to make a principal or interest payments
Technical default: the company violates a covenant or another part of the credit agreement
Most credit agreements have a grace period

Most loans rated below investment grade are secured by liens against specific assets (collaterol)
Lien: gives the lender the right to seize the collateral if the borrower violates the terms in the agreement.
- a company can have more than 1 level of lien agaist an assets (1st and 2nd lien - 1st is senior)
- if a company has multiple loans, they can be backed by different collaterol.

group of assets that secure a loan.
Common assets are: cash, AR, inventory, PP&E, intangiable assets, contracts, equity, etc.

Unencumber assets: assets with no liens against them
Assets not used by collaterol are people, goodwill, and some foreign subsidary stock or assets becuase of tax laws

State what the borrow must do and can't do
- loans usually have more convenants than bonds
- they are usually stricter (more likely to be violated)
- at the end of each quarter, the borrower must send a statement to the agent bank detailing their compliance with the convenants (any calc.)

Affirmative: list of things the borrower must do
- file timely
- accurate financial statements
Negative: list of things the borrower can't do
- restricted payments
- limit of TD
- limit of asset sales
- limitation on liens
- change of control
- transactions with affiliates
Financial (maintence): rules in a loan agreement that say the company must meet certain financial targets every quarter to keep the loan in good standing (4 formulas)
Leverage is the most common convenant

These are loans with no significant financial covenants
- gives lenders less control
- lenders will demand higher interest rates

1) do nothing
2) demand immediate repayment (cause bankruptcy)
3) waivers: bank agrees to ignore a covenant violation for a period of time
- lenders usually get a fee for doing this and sometimes a higher interest rate
- require simple majority
4) Amendements: covenant or other part of the agreement is modified.
- majority vote or 2/3
- lenders usually get a fee for doing this and higher rates
- maturity and collateral are hard to amend (100% vote)

- Banks: dominate in the revolvers market but invest in term
- Hedge funds: most term
- mutual funds: mostly term
- CLOs: special purpose entity that has loans in its portfolio
- private credit funds: investment funds set up to lend money directly to companies

large, hostile investors who buy a block of shares and starts making demands to a company and its board.
- usually a hedge fund or wealthy individual
- Goal: force company to take actions that will increase the share price
- not trying to buy the whole company
- only interested in short term gain
typical demands:
- more aggressive cost cutting
- change in senior mangement team
- sale of company
- stock repurchases
- changes in company strategy
- a seat or seats on the board

Tools used by activists... same as takeover tactics except no tender offer
Defenses:
- ignore them
- convice the other shareholders that the activists strategies will hurt the compnay
- seat on board to prove strategies are going well (problem: give them more power)
- repurchase their shares at a premium

Are bonds that can be converted into shares of common stock
- bondholder has the option
- enables bondholder to share in upside
- bondholders are willing to accept a lower interest rate because of potential upside.
Conversion Ratio: _____ shares per $1000 bond principal Conversion price: $1000/conversion ratio
Conversion Premium: (Conversion price- current share price)/ current share price
- the higher it is the less likely for upside
- bondholders want low premiums but issuers want high
- investors are willing to accept a lower interest rate in exchange for lower conversion premium ("high premium = high interest rate")

Primary EPS: based on existing number of shares --> (NI-preferred dividends)/Common shaers outstanding
Fully Diluted EPS: assumes that all convertible and preferred stock converts and all stock options are exercised.
- convertible bonds dilute EPS when converted into common stock

Issued by comapnies with high risk of bankrupcy but significant stock price upside if they succeed.
Ex: biotech, tech, software, etc.

Positives:
- lower interest rate
- conversion into equity reduces company leverage and improve credit rating
Negatives:
- conversion into equity causes EPS dilution
- converstion into equity reduce voting power of existing owners

Adv:
- prferred has no maturiy
- preferred doesn't count as debt in leveraged calculations
Dis.:
- preferred dividends have higher rate than bond interest
- preferred dividends are not tax deductable