An acquisition is a corporate transaction wherein a company purchases the majority or all another company’s shares or assets.
Acquisitions can be a great way to redirect and reshape corporate strategy. Purchasing a business may enhance access to markets, products, technology, and resources more promptly and efficiently than gaining the same objectives through internal efforts. With new competencies and resources, a company may gain a competitive edge in the marketplace and improve its long-term financial position. Moreover, an acquisition might be particularly advantageous as it encourages a company to enter into new markets and product lines with a brand that is already recognized, with a good reputation and an existing client base. In addition, acquisitions could enhance expansion, diversity and the scope for a fresh perspective.
Nevertheless, the process of conducting an acquisition might be complex, as it involves numerous activities, such as defining an acquisition strategy, establishing contact with target firm managers and owners, valuing and pricing targets, structuring deals, and negotiating with targets and other stakeholders.
This article portraits and explains the procedure of making an acquisition from a legal point of view and seeks to provide a comprehensive and practical guide on this matter.
Asset Deal v Share Deal
To start with, an acquisition can be structured either as an asset transaction or as a stock transaction.
Both these methods have various advantages and disadvantages that may lead a company to prefer the one over the other.
With an asset acquisition, the buyer only acquires the assets and liabilities it agrees to acquire, and thus an asset acquisition is a flexible option for the buyer. This is the biggest advantage of an asset acquisition over a shares acquisition, where the buyer acquires all the assets and liabilities (including unknown or undisclosed liabilities). An asset acquisition could be an attractive option for a company that wishes to gain control of assets owned by another company but is not interested in acquiring the entire business operation, due to the financial state of that company or for other reasons.
On the other hand, an asset acquisition might be time-consuming as the buyer would need to identify and investigate each of the assets that it desires to acquire. Furthermore, the fact that each asset must be transferred individually usually causes more complexity, especially when dealing with a large number of assets. The inclusion of business contracts might become particularly challenging as these may require third party consent, which would lead to delays and frustrations for all parties involved. In addition, when considering tax disadvantages and employment protection issues, asset acquisitions might not be the ideal option for the buyer.
Share acquisitions might be simpler and time saving in nature, as they achieve continuity of trade with minimum disruption and with little effect on third party dealings with the target and its business. Moreover, the due diligence is more thorough and thus the buyer may feel more reassured regarding the acquisition. In addition, share acquisitions are very advantageous in terms of taxation; the sale of shares is totally exempt from all taxes in Cyprus (apart from the case of a sale of shares of a Cyprus company which owns immovable property, that is subject to capital gains tax).
The Share Acquisition might be beneficial for the seller as well, because it totally releases it from its relationship with the business, and thus, the seller does not have to worry about any liabilities that remain with the company, or deal with possible future employment issues.
Considering both types of acquisition and the realities of the Cypriot market, a tendency to opt for share acquisitions is observed and thus this article is mainly focused on this type of acquisitions.
Preliminary Stage (Pre-Agreement)
Memorandum of Understanding (‘MOU’)
The Memorandum of Understanding is a formal letter, usually prepared by the buyer’s legal adviser, that sets out the various parties’ intentions, the type of acquisition, the conditions that need to be fulfilled by the acquisition date, the price and payment terms, and an outline of the timetable for the acquisition.
The MOU itself is not legally binding, and it is in fact an optional stage in the transaction. The buyer in particular would prefer the MOU to not be legally binding as its signing usually takes place before the buyer investigates thoroughly the target to decide whether it is actually worth pursuing. However, the preparation of a MOU is a method often used for the comfort of the parties once negotiations have reached a certain degree of certainty. Any provisions of MOU that are intended to be legally binding, then these need to be expressly stated in the MOU itself. Such provisions might be related to liability of costs in case of an abortive transaction, or related to exclusivity and confidentiality.
Exclusivity, in fact, is one of the main terms of MOU that is intended to be legally binding, as the buyer would need to secure exclusive bargaining given to it for a specific period of time. This period of time should be reasonable, (usually 30 days), and the MOU needs to expressly specify that the parties have the obligation to negotiate only with each other for that fixed period of time. In case that the parties do not use a MOU, they may include an exclusivity clause in the Confidentiality Agreement.
It is in the interest of both parties to keep the terms of the deal confidential. Especially for the seller, it is very significant to secure confidentiality as it may be expected to provide a wide range of sensitive information to the buyer for due diligence purposes.
The Confidentiality Agreement needs to include a comprehensive definition of ‘confidential information’ and expressly state to whom documents can be disclosed and how the confidential information that these documents contain should be used by authorised persons. In addition, a common clause of the Confidentiality Agreement is an undertaking by the buyer to return or to destroy any confidential information. Finally, the Confidentiality should specify the duration of its effect, any exclusions, as well as the remedies in case of breach.
Legal Due Diligence
The buyer would need the assistance of a Cyprus law firm to gain concise information regarding the target. The legal due diligence focuses on the constitutional framework of the target, the terms on which it is trading, ownership of assets and any restrictions on their use and the extent of any potential liabilities of the target. Cyprus law firms may have adopted various approaches regarding the process of due diligence, however there are some practises that are commonly used.
The investigation usually starts with public searches on the target. These searches may include a full company search with the Registrar of Companies, a search with the Land Registry if the target owns any immovable property, and a search with the public files of any regulator under the regulation of which the activities of the target company may fall. In addition, searches in relevant websites and commercial organisations may be advisable.
Apart from conducting those public searches, the legal advisers of the buyer should prepare a due diligence questionnaire addressed to the seller, asking for as much information as possible in regards to the target. A good tactic would also be to liaise with the business and tax advisers of the seller, so that the seller’s legal advisers do not get too overwhelmed with double requests for information.
The legal adviser of the buyer would also need to ensure that they have looked into all the necessary documentation that is relevant to the transaction. For instance, it is significant to investigate the objectives of the Memorandum of Association of the target in order to ensure that the company has the power to carry on the business that the buyer is interested in purchasing. Furthermore, it is important to look into the register of members and register of directors, in order to ensure that all allotments and transfers of shares, and any changes of the board of directors were always carried with the correct procedures. Moreover, it is crucial to ask for adequate information and/or documentation in regards to the shareholders so that the correct persons are entered into the Sales Purchase Agreement (the ‘SPA’).
The legal advisers of the buyer should also evaluate some financial information as well. Specifically, the audited accounts of the target should be checked in order to ensure that they have been filed for at least the past three years and that they fulfil all the relevant legal requirements. The legal advisers should also ask for copies of all loan documentation in order to ascertain the nature and extent of the target company’s borrowing commitments and obligations.
The key contracts of the target are another example of the documents that should be investigated for any ‘change of control clauses’, which may render the contract terminable on the sale of the target. This is an important issue to clarify on, as the buyer could consider to renegotiate the price of the transaction if it is going to lose certain valuable contracts.
Other areas of investigation for due diligence purposes might be intellectual property rights (IP), employment conditions and pensions, environmental matters, and pending and threatened litigation. The list of the areas of investigation is not exhaustive; depending on the special circumstances of each case, the legal advisers may ask for any documentation that is believed to be relevant and necessary, and given that a Confidentiality Agreement has already taken place between the seller and the buyer, the seller will be willing to provide this documentation.
After reviewing the results of the due diligence report, the buyer can make an informed decision as to whether to proceed with the acquisition. Once the buyer informs the seller that it would like to proceed with the acquisition, the SPA can be drafted.
Even though the structure of the SPA is not fixed, there are some operative provisions that should be included so the rights and obligations of each party are clearly stated.
Under Cyprus law, in order for an SPA to be valid, it needs to expressly state all the parties involved, the date of the agreement, the consideration and conditions of sale.
The SPA should also include comprehensive definitions of all the terms used throughout the agreement. In situations where completion will not occur on exchange, it is crucial for the SPA to state the conditions precedent to the agreement, i.e., the SPA may be entered into on the basis that it will be completed if certain conditions are fulfilled. Depending on the circumstances, a timeframe for the fulfilment of those conditions may also be added.
The consideration might be fixed or a provision may be included to allow for price adjustments in the case where the exchange will not occur simultaneously. Typically, part of the purchase price is agreed to be paid at completion, to be followed by further payments made depending on the profits of the target within the period specified. This prevents the buyer from paying too much for a target which fails to perform as expected.
In addition to this, a material adverse change (MAC) clause could be added to protect the buyer. This provision essentially means that the buyer has the right to terminate the agreement in the event of a MAC in the business, assets or profits of the target during the period between signing the agreement and completion.
Furthermore, the SPA should specify the warranties granted by the seller to the buyer. If the target is wholly owned subsidiary, then the parent company will be giving the warranties. In other situations, the individual shareholders will be giving those warranties.
When completion does not occur simultaneously with the exchange, the warranties will be re-confirmed at completion. Moreover, warranties often go hand in hand with indemnities. Indemnity usually refers to compensation on a ‘Euro for Euro’ basis for the loss that the buyer has suffered, even though a threshold and/or a pre-agreed maximum may be fixed.
It is important to note that if a warranty has induced the buyer to enter into the contract, it will be considered as a representation. From the buyer’s point of view, such representations should be stated in the SPA as warranties, in breach of which the buyer will have the right to rescind the contract, and/or be entitled to damages in case of misrepresentation. On the other hand, from the seller’s point of view, the seller would seek to insert an acknowledgement in the SPA that the buyer has not relied on any representations which are not contained in the contract.
Finally, an integral part of the acquisition transaction is the disclosure letter. Its purpose is to disclose matters related to the target, which if they were not disclosed would result in the seller’s breach of warranty. The disclosure letter serves the interests of both parties. For the buyer, it contributes to the due diligence process as it provides more concise information in regards to the target, while for the seller, disclosing as much information as possible, may protect it from a possible breach of warranty claim on the basis that the buyer did not know about certain facts.
Our qualified Cyprus lawyers may assist you with:
- Legal advice on Mergers & Acquisitions;
- Legal due diligence on the target of acquisition;
- Drafting of necessary legal documents such us the Memorandum of Understanding, and the Sales Purchase Agreement.