- 1 The Role of Law Firms in M&A
- 2 Drafting a Power of Attorney Agreement
- 3 Searching for Potential Acquirers or Sellers
- 4 Preparation of an Information Package
- 5 Letter of Intent and Non-Disclosure Agreement
- 6 Relative Transactions and the Bid Method
- 7 Finalizing the Acquisition Scheme
- 8 Business Transfers and Demergers
- 9 Stock acquisition
- 10 Drafting a Letter of Intent
- 11 Due Diligence
- 12 Contract Negotiation
- 13 Final Agreement
- 14 Closing
- 15 Press Release
- 16 Post Closing
- 17 Notification under the Antimonopoly Law
- 18 Insider Trading
- 19 PMI (Post-Manager Integration)
The Role of Law Firms in M&A
Acquisitions are increasingly seen in all aspects of corporate operations, including business expansion, resolution of succession issues, and business turnarounds. With the current lack of rapid market expansion, the acquisition or sale of a company to another company in the same industry is an important strategy for the survival of a business. We have a very high volume of M&A transactions, and we welcome all prospective M&A clients to come to our office to discuss the type of deal that they are considering. At the initial stage, it is often a vague “I would like to buy such and such a company” or “Is there any company that would buy our company?” but that is not a problem. We may be able to get a sense of direction regarding M&A methods and possibilities by reviewing a company’s financial statements and asking about the nature of its business. Brainstorming sessions may be held to freely discuss options for revitalizing important business partners and dealers without limiting the option to M&A.
Drafting a Power of Attorney Agreement
In order for us to advise you on the M&A process, you will be asked to sign a power of attorney agreement (outsourcing agreement). The power of attorney agreement also includes our fees, and we do not charge any fees that are not stipulated in the power of attorney agreement. Lawyers are obligated under the Lawyers Act to protect client confidentiality, so even if the confidentiality obligation is not stipulated in the power of attorney agreement, no secrets will be divulged by the lawyer. However, we stipulate the duty of confidentiality in the power of attorney agreement and strictly require all attorneys and staff in our firm to maintain confidentiality.
Searching for Potential Acquirers or Sellers
In the M&A world, a potential acquisition is called a target. Although targets are sometimes sought by law firms or accounting firms, the search for targets is often conducted by brokerage firms or other specialized firms that have an unparalleled amount of information about the industry in question. Boutique specialist firms search for potential companies mainly through quarterly reports in public, and confirm their interest in acquisitions by visiting or writing to them. In contrast, major brokerage firms create a so-called long list of well-known companies in the industry, narrow down the list to a few suitable candidates, and then confirm with the selected candidates whether or not they are interested in acquiring the company. It is important to select an appropriate brokerage firm according to the size and nature of the seller company. Once a potential buyer is identified, we ask the potential buyer to submit a letter of intent for the acquisition and discuss a general timeline and due diligence period and methodology.
Preparation of an Information Package
The target company prepares a so-called “information package” for the sale of the company. The information package should include a list of the company’s basic information, such as date of incorporation, location, composition of board members, and major clients, as well as a list of real estate holdings and intellectual property holdings in a tabular format. Since the information package will be an important document for the acquisition target to make an acquisition decision, whether the information is well organized, it is also important to ensure that looks good with effective use of Excel, PowerPoint, and photos. If they appoint a securities firm or other entity as a financial advisor (FA) for the M&A, the FA will prepare an effective information package. The information package may be delivered on a USB memory stick or other device, but to prevent information leakage, the seller may be asked to view the records stored on a stand-alone computer in a data room set up by the seller. The purpose of setting up a data room is to prevent the spread of information and to prohibit third parties from having access to M&A information. In the case of a publicly traded company, this may violate insider regulations, so we will record all information about who had access to what information, when, and which information. Lawyers, accountants, and tax accountants will proceed with due diligence and the calculation of corporate value while conducting interviews with executives to the buyer and the information in the information package.
Letter of Intent and Non-Disclosure Agreement
When information is provided to a potential acquirer, confidential information of the company is also provided, and this information must not be used for purposes other than the acquisition or used by another company for sales or product development after the deal is stopped. Therefore, it is important to conclude a Non-Disclosure Agreement (also known as NDA or CA). In addition to confidentiality and prohibition of use for other than the intended purpose, the NDA should also include detailed confirmation of the method of information management, return of information in the event of a deal is stopped, and disposal method, in relation to the method and scope of disclosure. It is also important not to be satisfied with just signing a nondisclosure agreement, but to make sure to obtain written confirmation that documents have been shredded and that no copies have been made regarding the return or disposal of information.
Relative Transactions and the Bid Method
Since M&A is an event with extremely serious ramifications for the selling company, the very fact that it is being negotiated should be kept as confidential as possible from business partners and employees. However, in cases such as the sale of a bankrupt company, there is a stronger need for fairness in the transaction price than for confidentiality, so it may be advisable to have several potential acquirers submit letters of intent and negotiate in parallel with two or three companies that offer the best terms. In this case, the potential acquirer should confirm the information package, briefly summarize the approximate amount of money it intends to purchase and the conditions of the purchase, etc., and state them in the letter of intent. In the case of the bidding method, the FA prepares a bidding procedure and communicates it to the potential acquirer who has submitted a Letter of Intent. After conducting due diligence in accordance with the acquisition schedule established by the FA, the potential acquirer sends a letter stating the purchase price to the FA by the bid date in a bag and glued together, and the FA opens the sealed envelope on the bid date to negotiate a final agreement with the candidate who submitted the most expensive offer.
Finalizing the Acquisition Scheme
Various types of M&A schemes are possible, including mergers, stock acquisitions, business transfers, company splits, and stock swaps. It is necessary to consider which method is the most appropriate, taking into account the needs of the acquisition and the needs of the seller. From a legal perspective, it is necessary to consider the simplicity of the procedures, the schedule and other time constraints, and the extent to which the potential risks can be accepted. From a tax perspective, it is important to consider which method will provide the most tax savings. For example, even in the case of acquiring an insolvent company, it may be possible to effectively utilize the company’s loss carryforwards to reduce future tax payments. Also, if the difference between the market value of the company and the purchase price is recorded as goodwill, the possibility that future operating income may be reduced by amortization of the goodwill should be considered. In the case of a listed company, tax planning is an important factor in the selection of a scheme because the impact on operating income must be considered in addition to the mere tax reduction effect.
Business Transfers and Demergers
Most acquisitions of companies are made by means of business transfers or stock acquisitions. In the case of a business transfer, specific assets, liabilities, and business partners of the target company can be selected and only necessary portions can be purchased, thus avoiding unexpected losses for the buyer by assuming potential liabilities. Since a company split is a method of succeeding only one division of a company in accordance with the method stipulated in the Companies Act, this system is similar to a business transfer, but it also has the characteristics of a comprehensive succession in that the business related to the division in question is comprehensively taken over. In the case of a business transfer, it is necessary to establish countermeasures for each asset to be transferred. For example, when acquiring real estate, it is necessary to register to transfer caused by sale, and for automobiles and intellectual property rights, it is necessary to register them. For the acquisition of a nominated claim, it is necessary to notify the debtor of the transfer of the claim by content-certified mail. For the transferring company, a resolution of the board of directors or a resolution of the general meeting of shareholders is required if the transfer constitutes a significant transfer of assets. The decision as to when a resolution of a shareholders’ meeting is required must be made on a case-by-case basis in accordance with the actual scale of the business, etc. The amount of the company’s sales, asset scale, and operating income will be taken into consideration in making such a decision.
In contrast, in the case of Stock acquisition, the company is taken over comprehensively as it is, and there is a risk for the buyer to take over the potential risks of the target company (litigation risk, unconfirmed joint and several guarantee liability, etc.). Therefore, when conducting a stock acquisition, it becomes necessary to carefully assess what potential risks there are, including litigation. Naturally, defects discovered through due diligence will be taken into consideration when determining the consideration, but in some cases, defects may not even be discovered through due diligence. On the other hand, stock acquisitions can be carried out through simple procedures such as approval by the board of directors of the company to be transferred, preparation and signing of the transfer agreement, payment of the price, and change of the shareholder register.
Drafting a Letter of Intent
A Letter of Intent is executed when the seller and buyer agree on basic matters such as the acquisition scheme. Although sometimes referred to as a LOI (abbreviation of Letter of Intent) or MOU (abbreviation of Memorandum of Understanding) instead of a Letter of Intent, they are basically the same thing. The basic terms and conditions of the LOI include the seller, the buyer, the subject of the transaction (whether it is a stock or a business, and if so, which and how many shares), the expected closing date, and the consideration for the acquisition, after both parties have confirmed the contents of the agreement, it is signed. The basic agreement itself is generally considered to be legally non-binding, since it is executed to summarize the parties’ previous agreements before the final agreement is reached. Therefore, even if negotiations reach an impasse and a final agreement is not reached after the conclusion of the basic agreement, the parties are not legally liable for payment of damages. However, even though a contract is being concluded, the parties are still seriously discussing the agreement, and if they cancel the contract negotiations without any reason, or if they switch to another potential buyer without the other party’s agreement because a more advantageous candidate for acquisition appears during the contract negotiations, they may be liable to pay compensation for damages as a negligence in concluding the contract.
Due diligence involves a thorough examination of the target company from the business, legal, and accounting perspectives. The basic direction of the due diligence process includes management interviews to hear from executives and other key personnel, and there is legal due diligence and accounting due diligence, which scrutinizes the contents of the company from the legal and accounting aspects based on the submitted documents. The management interview involves confirming key business partners, sales prices, operating profit margins, product and inventory trends, and sales strategies. Legal due diligence involves reviewing documents related to share transfers since the company’s establishment to determine whether share issuance and share transfers have been properly executed in accordance with legal procedures, whether resolutions of the board of directors and general shareholders meetings have been properly executed, including whether notices of meetings have been sent, and whether real estate, intellectual property rights, and other assets are legally validly registered. Whether or not there are any problematic clauses in contracts with business partners that are unfairly disadvantageous; whether or not business licenses have been validly obtained and there is no possibility of legal violations in the business; whether or not there are any potential risks such as lawsuits; and so on. In addition, some contracts that have already been executed may require that the counterparty to the transaction be notified or that the consent of the counterparty to the transaction be obtained if a change of control occurs as a result of the transfer of shares or business operations. This is what is known as a change of control clause. Although it is rare that a contract is actually terminated because of a change-of-control clause, it is necessary to check whether a change-of-control clause exists. Accounting due diligence for a change of shareholders involves checking accounting vouchers to see if the accounting books have been properly prepared, as well as to determine if there are any risks from a tax or accounting perspective. While successful acquisitions can contribute significantly to a company’s development, on the other hand, acquisitions of problematic companies can also carry significant risks, and even threaten the survival of the company with the failure of a single acquisition. In this sense, due diligence is a time-consuming, labor-intensive, and costly process, but it is an extremely important part of the M&A process.
In contract negotiations, the most important issues to be negotiated are what the target of the acquisition will be (in the case of shares, whether all or part of the shares will be acquired) and how much the consideration will be. In the past, the acquisition price was generally determined by the negotiation based on the adjusted net asset value and the amount of goodwill. There was no clear standard for determining how much goodwill to charge, and it was often decided through negotiations between the parties based on a general standard such as seven times operating income. The seller would come to the meeting prepared with several rationales for a higher price. The buyer would also prepare a rationale to persuade them that the price should be lower. In many cases, both sides would come up with a price, and the parties would agree on a price somewhere in the middle. In contrast, more recently, the corporate value is evaluated first, and the acquisition price is often determined based on the corporate value calculated by a tax accountant or an accountant. There are various methods for evaluating a company’s corporate value, including the net asset method, the comparable company method, the capitalization method, and the DCF method, which is based on the present value of future earnings. Generally, two or three of these methods are used to calculate corporate value, and the weighted average of the two or three is often used. Of course, the content of companies vary, and the circumstances that led to the decision to conduct M&A also vary, and especially in the case of a negotiated transaction, the appropriate price is the price at which the transferor’s selling price and the buyer’s buying price match. Therefore, the calculation of business value may be a reference, but it is not necessary to follow it. In addition, since the books of a company are prepared in accordance with the accounting principles as a going concern, they are not necessarily prepared for the purpose of calculating the purchase price of a company, and therefore, in the event of an acquisition, the book value may need to be adjusted. In many cases, such adjustments include the correction of underfunded retirement benefits for directors and employees, the elimination of accounts receivable on the books that are not expected to be collected, inventory value adjustments due to inventory stocktaking, and the reclassification of real estate owned that is recorded at acquisition price to fair market value.
In the case of a stock transfer, a stock transfer agreement is prepared and signed by both parties. Similarly, in the case of a business transfer, a business transfer agreement is prepared and signed by both parties. In either case, it is necessary to clarify the details of the target stock and business, how much the consideration will be, how it will be paid, and when it will be paid. From a lawyer’s standpoint, it is extremely important and mind-boggling how to ensure simultaneous performance in the payment of consideration and the transfer of the business. Also, in any contract, the warranty representation clause is important, where the seller represents and warrants that what is set forth in the contract is correct. If the company’s content differs from what was originally taught, the seller could be held liable for damages for breach of warranty representations. Since the parties will decide through consultation what content to include as a warranty statement, the seller wants to make the warranty statement as narrow as possible, and the buyer wants to make the warranty statement as broad as possible, and if there is a problem, the buyer wants to substantially modify the price by reducing the price or compensating for damages. Since the final agreement will have legal effect, it will then be necessary to take action to implement the provisions set forth in the final agreement. In addition, upon signing the Final Agreement, the company should notify its employees and business partners and prepare for the closing. Please note that prior to signing the Final Agreement, both the seller and the buyer must pass a board of directors resolution that approves the signing of said agreement at a board meeting.
In the final agreement will be set a closing date, on the day, the required documents will be delivered and payment will be made. Since payment of the price is usually expected to be made by bank transfer, both parties should gather at the closing location on the closing date to confirm that the transfer of the price has been completed. When the transfer of payment is completed, the seller is required to deliver the share certificates and the related documents necessary for registration. In some cases, delivery of bank deposits and representative seals may be required. If a change of directors is required, a meeting of the board of directors must be held promptly, the resignation of retiring directors must be notified, a general meeting of shareholders must be held, and new directors must be appointed. If a bank loan is to be obtained for the settlement of the proceeds, the closing procedures will be complicated because new collateral may need to be pledged to the financial institution. With the prior consent of both parties, it is necessary to prepare a closing procedure document, prepare a list of documents to be delivered at the closing, and check the list to ensure that the closing is properly conducted.
When a listed company makes a corporate acquisition, it is subject to disclosure as material information that affects investors’ investment decisions, unless it falls under the minor criteria stipulated in the stock exchange rules. The timing for timely disclosure is the date when the parties have reached an agreement, which would be the date when the basic agreement is concluded. Often a press release is made after the market closes on Friday in order to avoid any impact on the market. Usually, the draft text of the press release is prepared in advance and thrown to the stock exchange, but it may also be disclosed on the website as a voluntary disclosure. Also, as required by corporate law, newspaper advertisements may be required, and if the target company is a listed company, it may be required to go through TOB procedures, file a notification under the 5% rule, submit an extraordinary report, etc. Therefore, it is important to check the relevant laws and regulations such as the Companies Act and the Financial Instruments and Exchange Act.
In the case of an ordinary purchase and sale, the entire transaction is completed at closing. However, during the period between the signing of the definitive agreement and the settlement (closing), changes may occur in the corporate structure, or circumstances may arise that differ from the original plan due to the subsequent retirement of key executives and employees. If the final agreement contains a provision to adjust the consideration if such a situation arises, it will be necessary to adjust the purchase price after a certain period of time after the closing. This is called post-closing. There is often facilitate the post-closing process, a certain percentage of the purchase price (e.g., 100 million yen out of a 1 billion yen purchase price) is deposited into an escrow account, and when it is confirmed that the conditions specified in the definitive agreement have been met, the money in the escrow account is released and delivered to the seller. Since Japanese financial institutions do not handle the opening of escrow accounts, it is possible to open an account in the name of a law firm or brokerage firm, or in the joint names of the seller and buyer, but it is highly likely to become a source of future disputes. In any case, it is necessary to clarify the conditions, etc. of the release of the money in escrow.
Notification under the Antimonopoly Law
Article 10(1) of the Antimonopoly Law stipulates that ” A company shall not acquire or hold shares in another company if such acquisition or holding would substantially restrict competition in a certain field of trade, and shall not acquire or hold shares in another company in an unfair manner.” Therefore, corporate acquisitions that would result in an excessive concentration of control in a certain market are prohibited. The purpose of the regulation is that if a particular company ends up excessively dominating a certain market, the price adjustment function by the market will not work, which is detrimental to the interests of consumers. Therefore, even if a company is not a conglomerate, it may be subject to regulation for violation of the restraint of competition in extremely niche markets. In addition, Article 10(2) of the Antimonopoly Law requires that, in cases where the aggregate domestic sales of the acquirer’s group of companies is 20 billion yen or more, and the sum of the domestic sales of the target company and its subsidiaries is 5 billion yen or more, and if a corporate acquisition in which the acquirer holds 20% or more of the shares (more precisely, 20% as a percentage of voting rights) of the target company, the company must notify the Fair Trade Commission of its plan for such share acquisition in advance. Since the Antimonopoly Law sets sales standards for a group of companies combined, the Antimonopoly Law may be applied in many cases. Therefore, it is necessary to check whether or not prior notification is required in accordance with Article 10, Paragraph 2 of the regulations.
In the case of M&A of a listed company, the fact of M&A itself is a significant matter that affects the investment decisions of investors, and therefore, information regarding M&A falls under the category of insider information. If a company-related person who has obtained such information in advance buys or sells shares of the relevant listed company (either the buyer’s company or the target company) before the press release is made, it is subject to criminal penalties as insider trading. The Securities and Exchange Surveillance Commission (SESC) always checks the fluctuations in the stock prices of companies that have been involved in M&A. If there are any inappropriate stock price fluctuations before a press release is made, the SESC will check the transaction history through the securities company conducting the transaction. Therefore, it is appropriate to assume that the Securities and Exchange Surveillance Commission will eventually find everything, no matter what name is used (e.g., using the name of a wife or friend). It is appropriate for a company conducting M&A to take measures to prevent the spread of insider information as much as possible and to educate employees about insider trading in order to prevent their own employees from taking advantage of insider information and conducting insider trading.
PMI (Post-Manager Integration)
Post-merger integration (PMI) refers to the integration of an organization after an M&A transaction has taken place. Integration of organizations can vary from human resources, sales, systems, and so on. The extent to which synergies from a corporate acquisition can be leveraged depends on PMI. From a legal perspective, it is necessary to change the names of parties to contracts with the approval of business partners and to align working conditions by reviewing work rules.