Mergers and acquisitions (M&A) for small and medium-sized enterprises are a challenge that requires preparation on the business side and an understanding of the legal aspects of the intended action.
From an economic perspective, there are several types of mergers. The first are horizontal mergers, when the merging companies represent the same industry and produce similar products. Another type is vertical mergers, when the merging companies are involved in different stages of making the same product. A conglomerate merger occurs when companies operating in different industries merge.
Each type of merger can bring different benefits to the business, including the following:
- market expansion - companies may expand their market presence geographically or to access new customer segments. Acquiring or merging with a complementary business allows for broader market reach;
- synergy and cost saving - M&A activities can create synergies that lead to cost saving, increased efficiency, and improved overall performance. Combining resources, technologies, or distribution channels can result in a more streamlined and cost-effective operation;
- diversification of product/service offerings - acquiring or merging with a company that offers different products or services allows for diversification. This strategy helps mitigate risks associated with dependence on a single product or market, enhancing long-term sustainability;
- access to new technologies or intellectual property - companies may seek M&A opportunities to gain access to innovative technologies, patents, or intellectual property. This can provide a competitive edge and accelerate product development;
- financial growth and business synergy - M&A can be a pathway to accelerated financial growth. By combining forces with another company, small to mid-sized firms can achieve economies of scale, leading to increased revenue and enhanced shareholder value;
- strategic alliances and partnerships - M&A can be a means of formalizing strategic alliances or partnerships. By merging with or acquiring a compatible business, companies can strengthen their position on the market and create mutually beneficial collaborations;
Deal Structure
Once the decision to pursue the expansion of a company through M&A is made, consideration should be given to the way in which it is to be implemented. In this context, the expected effect on business operations should be analysed in advance, e.g., seeking synergies in existing operations or expanding the company's operations into new areas.
The basic types of M&A transactions include:
- asset deal – involving the acquisition of specific assets and liabilities of the target company or its enterprise. This allows the buyer to acquire precisely what it wants On the other hand, it also requires consideration of whether there are contracts, employees and/or permits that will need to be transferred to the buyer in order to continue operations. In each case, relevant contracts will have to be identified and transferred separately which may be much more challenging;
- share deal – involving the acquisition of the shares or stock of the target company. As this type seems to be the simplest way of acquiring the target company (since it refers to the shares only), providing smooth continuity of the business operations, its implementation still requires in-depth examination of legal status of the company (e.g., change of control clauses, title to shares, lack of encumbrances);
- merger – involving the combination of two companies into a single entity. This can take the form of a merger of equal companies in a new entity or the takeover of one company by the other by way of a merger. Mergers involve the exchange of shares or stock between the merging companies’ shareholders. On the operational side of the business, this provides more opportunities to look for potential synergies and cost saving.
Each of the above types of M&A transaction will have a different impact on, among other things, the tax implications, legal liabilities and responsibilities of the buyer. Therefore, it is important to consider the model under which such an investment would take place before seeking new investments (from both the buyer's and seller's perspectives).
Legal and Tax Due Diligence
Performing comprehensive and proper due diligence is vital in any transaction, regardless of its size. In small and mid-size transactions, it becomes particularly critical as resources and finances may be limited.
Conducting thorough due diligence allows to identify potential risks, liabilities, and legal issues associated with the transaction. In some cases, it can change previous assumptions as to how to structure the deal.
Properly conducted due diligence involves reviewing contracts, financial records, licenses, intellectual property rights, litigation history, regulatory compliance, and other relevant aspects of the target business. Engaging legal professionals with expertise in small and mid-size transactions can help ensure a comprehensive due diligence process that covers all of the necessary elements.
More information on the legal aspects of due diligence can be found in our previous publication here, and more detailed information on aspects relating to intellectual property can be found here.
From the sell-side perspective, it's important to remember to protect the confidentiality of documents and information for due diligence purposes before releasing them. For this purpose, the parties should enter into a non-disclosure agreement specifying, among other things, the following:
- the scope of information subject to the confidentiality obligation;
- the permissible scope of use of the confidential information;
- liability for breach of the confidentiality obligation (including contractual penalties).
The non-disclosure agreement may also regulate issues such as the exclusivity of negotiations and other matters relevant to the stage of the transaction.
Contract Negotiation and Drafting
Effective contract negotiation and drafting are key to protecting the interests of all parties involved. Clearly defining the rights and obligations of each party is crucial to ensuring a well-rounded and enforceable agreement. Legal professionals can assist in identifying potential risks and negotiating favorable terms, taking into account the unique considerations of the transaction.
Depending on the nature of the transaction and the industry involved, there could be specific legal requirements that need to be addressed. Examples include obtaining necessary licenses and permits, complying with employment laws, ensuring data privacy and security, adhering to environmental regulations, and handling intellectual property rights.
Nevertheless, it is also important to consider the following aspects:
- valuation and financial realities - mid and small companies often have limited financial resources and may be more sensitive to valuation. The negotiation should carefully consider the financial realities of these businesses and seek a valuation that reflects their actual value;
- integration planning - smaller companies may lack infrastructure or experience for managing complex integrations. Negotiations should involve discussions on the integration process, with a focus on minimizing post-closing disruption. Considering that in small and mid-companies, the founders often play a significant role, negotiations should involve discussions about the level of owner involvement post-transaction and strategies for a smooth transition of leadership;
- earn-out structures - due to uncertainties around future performance, smaller companies may find earn-out structures more appealing. Negotiations should explore flexible earn-out arrangements tied to specific performance metrics to align the interests of both parties.
Post-Closing Matters
Even after the transaction is completed, legal challenges may arise during the post-closing phase. Engaging legal professionals to provide ongoing support and guidance can help mitigate any legal issues that may arise and ensure a smooth transition. This can include issues related to operational integration, employment contracts, ongoing compliance, intellectual property protection, and dispute resolution.
Risks in this regard can be mitigated by undertaking certain actions in the course of negotiating the terms of the transaction:
- developing and communicating a clear communication plan and providing support, and incentives for key employees;
- regularly monitoring and reassessing financial performance against projections, implementing cost-saving measures, and adjusting strategies as needed;
- engaging legal advisors early in the process, conducting thorough compliance assessments, and addressing any outstanding regulatory issues promptly.
Navigating the legal challenges associated with small and mid-size transactions requires careful planning, attention to detail, and expert advisory guidance. By conducting thorough due diligence, engaging in effective contract negotiation and drafting, ensuring regulatory compliance, addressing tax implications, and being mindful of post-closing matters, parties can enhance their chances of success in their transactions. Seeking the assistance of legal professionals experienced in small and mid-size transactions can provide invaluable support throughout the entire process, safeguarding the interests of all the parties involved and maximizing the benefits of the deal.
Related Posts:
The Role of Legal Due Diligence in VC Investments (by Leszek Małecki & Michalina Wojacka, Małecki Legal)
Intellectual Property Protection Strategies for VC-Backed Startups (by Leszek Małecki & Damian Staszewski, Małecki Legal)
Term Sheet Demystified: Key Clauses for Founders and Investors (by Leszek Małecki & Tomasz Kiełczykowski, Małecki Legal)
