Chapter 7: Other Merchant Banking Activities - Mergers, Acquisitions & Takeovers

Corporate restructuring encompasses the fundamental reorganization of an enterprise's operational, financial, or ownership architecture to enhance commercial competitiveness, unlock shareholder value, or navigate financial distress. In modern corporate practice, Mergers, Acquisitions, and Takeovers represent primary strategic vehicles for external corporate growth.

Definitions and Legal Distinctions

M&A STRUCTURAL PARADIGMS AND DISTINCTIONS

Strategic Motivations for M&A Transactions

1. Operating and Economies-of-Scale Synergies: Eliminating redundant administrative departments, centralizing procurement, optimizing supply chains, and consolidating production facilities.
2. Market Power and Horizontal Integration: Acquiring competitors to expand market share, broaden distribution channels, and enhance pricing power.
3. Vertical Integration: Acquiring upstream raw material suppliers or downstream retail distributors to secure supply chains and eliminate middleman markups.
4. Diversification and Risk Mitigation: Entering new geographic markets or unrelated product categories to reduce earnings cyclicality.
5. Tax Optimization and Shielding: Utilizing accumulated tax losses and unabsorbed depreciation of an acquired entity under Section 72A of the Income Tax Act, 1961.

Merchant bankers serve as transaction architects throughout corporate restructurings, mergers, and amalgamations, providing financial valuation, transaction structuring, due diligence, and regulatory management.

Key Advisory Responsibilities of Merchant Bankers in M&A

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|                            M&A TRANSACTION ARCHITECTURE & WORKFLOW                                |
+---------------------------------------------------------------------------------------------------+
|                                                                                                   |
|  [ STRATEGIC PLANNING ]   -->   [ VALUATION & SWAP ]   -->   [ SCHEME DRAFTING ]   -->   [ NCLT ] |
|  • Target identification        • DCF, Comps, NAV            • Draft Scheme of           • Sanction|
|  • Structure transaction        • Swap ratio determination     Arrangement                 by NCLT |
|  • Financial modeling           • Issue FAIRNESS OPINION     • SEBI / Exchange NOC       • Closing |
|                                                                                                   |
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1. Valuation Methodologies

Under SEBI guidelines and international standards, the merchant banker evaluates corporate assets and equity using recognized valuation approaches:

• Income Approach (Discounted Cash Flow - DCF): Projects future Free Cash Flows to Firm (FCFF) discounted at the Weighted Average Cost of Capital (WACC); represents the intrinsic value of the business.
• Market Approach (Comparable Company Multiples - Comps): Analyzes enterprise multiples (EV/EBITDA, EV/Sales, P/E) of peer companies listed on recognized exchanges.
• Asset Approach (Net Asset Value - NAV): Assesses the fair market value of tangible assets less outstanding liabilities; forms the floor valuation.

2. Issuance of Independent Fairness Opinions

• Under Regulation 37 of the SEBI LODR Regulations, every listed company undertaking a scheme of arrangement, merger, demerger, or capital reduction must obtain an independent Fairness Opinion on the share exchange / swap ratio prepared by an independent SEBI-registered Merchant Banker.
• The Fairness Opinion assesses whether the recommended swap ratio is fair, reasonable, and equitable to public minority shareholders.

3. NCLT Scheme of Arrangement Procedure

• Mergers and amalgamations are implemented under Sections 230 through 232 of the Companies Act, 2013, overseen by the National Company Law Tribunal (NCLT).
• Procedural Steps:
  1. Board of Directors approves the draft Scheme of Arrangement and valuation report.
  2. Scheme and Merchant Banker Fairness Opinion submitted to Stock Exchanges and SEBI for formal No-Objection Letters / Observation Letters.
  3. Joint application filed before the jurisdictional NCLT bench.
  4. NCLT-convened meetings of equity shareholders and secured/unsecured creditors to vote on the scheme (requiring approval by a majority in number representing at least three-fourths [75%] in value).
  5. Final NCLT hearing, formal sanction order, and filing with the Registrar of Companies (ROC) to make the merger effective.

The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SAST Regulations / Takeover Code) govern corporate acquisitions and changes of control in listed companies. The Takeover Code balances commercial corporate mobility with the protection of minority shareholders by ensuring transparency, fair exit pricing, and equal treatment.

Foundational Legislative Principles of the Takeover Code

• Fair Treatment of Public Shareholders: Public minority shareholders must be informed of changes in substantial ownership or management control and provided an exit opportunity at a fair price.
• Transparency and Disclosures: Graduated disclosure thresholds alert the market to accumulating shareholdings before control is acquired.
• Informed Decision-Making: Public shareholders receive a comprehensive Letter of Offer containing all material background information on the acquirer, financing sources, and future plans for the target company.

Key Statutory Definitions (Regulation 2(1))

1. Acquirer (Regulation 2(1)(a)):
   • Any person who, directly or indirectly, acquires or agrees to acquire whether by themselves, or through, or with persons acting in concert with them, shares or voting rights in, or control over a target company.
2. Target Company (Regulation 2(1)(s)):
   • A company and includes a body corporate or corporation whose equity shares are listed on a recognized stock exchange in India.
3. Persons Acting in Concert - PAC (Regulation 2(1)(q)):
   • Persons who, pursuant to an agreement or understanding (formal or informal), actively cooperate to acquire shares, voting rights, or control over a target company.
   • Deemed PACs: Promoters, holding companies, subsidiaries, fellow subsidiaries, directors, merchant bankers, portfolio managers, and family members are legally presumed to be acting in concert unless proven otherwise.
4. Control (Regulation 2(1)(e)):
   • Includes the right to appoint a majority of the directors, or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding, management rights, shareholders' agreements, or voting agreements.

The Takeover Code establishes precise statutory triggers requiring an acquirer to make a mandatory public open offer to all existing shareholders of the target company.

TAKEOVER CODE MANDATORY OPEN OFFER TRIGGERS

1. Initial Threshold (Regulation 3(1))

• An acquirer who, along with PACs, intends to acquire shares or voting rights that entitle them to exercise 25% or more of the voting rights in a target company must, before acquiring such shares, make a public announcement of an open offer to acquire shares from public shareholders.

2. Creeping Acquisition Limit (Regulation 3(2))

• An acquirer who, together with PACs, holds 25% or more, but less than the maximum permissible non-public shareholding (75%), can acquire additional shares or voting rights entitling them to exercise up to 5% of the voting rights in any single financial year.
• Any acquisition exceeding 5% in a single financial year triggers a mandatory open offer.
• Gross vs. Net Acquisition: Under SEBI rules, the 5% creeping acquisition limit is calculated on a gross basis without netting out sales made during the same financial year.

3. Change in Control (Regulation 4)

• Irrespective of whether any shares or voting rights are acquired, any transaction resulting in the acquisition of control over a target company triggers a mandatory open offer.

4. Voluntary Open Offer (Regulation 6)

• An acquirer holding at least 25% voting rights (along with PAC) can voluntarily make an open offer to acquire additional shares, provided:
  • Minimum offer size is at least 10% of the voting capital.
  • The acquirer has not acquired any shares of the target company in the preceding 52 weeks without an open offer.
  • The aggregate post-offer shareholding does not exceed the 75% Maximum Permissible Non-Public Shareholding ceiling.

The Takeover Code establishes minimum open offer sizes and pricing formulas to ensure public shareholders receive a fair exit valuation.

Minimum Offer Size (Regulation 7)

• Under Regulation 7(1), the mandatory open offer made by an acquirer must be for at least 26% of the total voting capital of the target company.
• The voting capital is calculated based on the total voting rights as of the tenth working day from the closure of the tendering period (incorporating all potential dilutive conversions of outstanding convertibles).

Offer Pricing Mechanics (Regulation 8)

The open offer price must be not less than the highest of the following parameters:

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|                        OFFER PRICING DETERMINATION (FREQUENTLY TRADED SHARES)                     |
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|                                                                                                   |
|  $$	ext{Offer Price} = \maxegin{cases}                                                         |
|  	ext{Highest negotiated price under Share Purchase Agreement (SPA)} \                          |
|  	ext{Volume-weighted average price (VWAP) paid by acquirer/PAC in preceding 52 weeks} \         |
|  	ext{Highest price paid by acquirer/PAC in preceding 26 weeks} \                               |
|  	ext{Volume-weighted average market price (VWAMP) for 60 trading days preceding PA}             |
|  \end{cases}$$                                                                                    |
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1. Highest Negotiated Price: The highest negotiated price per share under the Share Purchase Agreement (SPA) attracting the obligation to make an open offer.
2. 52-Week Volume-Weighted Average: The volume-weighted average price paid or payable for acquisitions by the acquirer or PAC during the fifty-two weeks immediately preceding the date of the public announcement.
3. 26-Week High: The highest price paid or payable for any acquisition by the acquirer or PAC during the twenty-six weeks immediately preceding the date of the public announcement.
4. 60-Trading-Day Market VWAMP: The volume-weighted average market price of such shares for a period of sixty trading days immediately preceding the date of the public announcement on the stock exchange where the maximum volume of trading is recorded.

Valuation of Infrequently Traded Shares (Regulation 8(2)(e))

• If the target company's equity shares are infrequently traded (trading turnover on recognized exchanges is less than 10% of total shares in the preceding twelve calendar months), market pricing parameters are replaced by a fair valuation determined by an independent merchant banker taking into account book value, comparable trading multiples, and discounted cash flows (DCF).

Under Regulation 12 of the SAST Regulations, the acquirer must appoint a SEBI-registered Category I Merchant Banker as the Manager to the Open Offer. The Manager to the Open Offer oversees the entire execution process and is personally liable for ensuring regulatory compliance.

Procedural Timelines of the Open Offer

OPEN OFFER STATUTORY TIMELINE

Statutory Escrow Account Requirements (Regulation 17)

To guarantee that the acquirer has adequate financial resources to settle the open offer consideration, Regulation 17 mandates creating an Escrow Account prior to issuing the Detailed Public Statement:

$$ ext{Escrow Amount} = egin{cases} 25% ext{ of Total Offer Consideration} & ext{if Consideration } \le ext{INR 500 Crores}
ext{INR } 125 ext{ Crores} + 10% ext{ of Excess} & ext{if Consideration } > ext{INR 500 Crores} \end{cases}$$

• Permissible Forms of Escrow:
  1. Cash deposit placed with a scheduled commercial bank.
  2. Bank guarantee issued by a scheduled commercial bank in favor of the Manager to the Open Offer.
  3. Deposit of frequently traded, unencumbered marketable equity securities with appropriate haircuts.
  • If the escrow is provided via bank guarantee or securities, at least 1% of the total consideration must be deposited in cash with the escrow bank.
• Release of Escrow: The escrow funds can only be released upon written authorization from the Manager to the Open Offer after confirming full payment to all tendering public shareholders.