Commercial Transactions: Mergers & Acquisitions

CORPORATE RE-ORGANISATION

This is synonymous to corporate rearranging. It is the structural change and amounts to a corporate change of a company. It is organizing the legal, operational or other structures of a company. It can take the form of;
Mergers
Acquisitions
Take-overs
Mergers and acquisitions refer to an act of corporate strategy, corporate finance and management dealing with the buying, selling and combining different companies under one management.
The aim of a merger or acquisition is to aid, finance or help a growing company in a given industry to grow rapidly without having to create another business entity.
Two or more companies with the same objectives may decide to come together to enjoy economies of scale. Schemes involving reconstruction amalgamations, takeovers, arrangements and other forms of reorganization are carried out for the following purposes:
To reorganize the company capital structure.
To overcome the company financial difficulties.
To increase revenue and market share.
Economy of scale – this refers to the fact that the combined companies can often reduce its fixed cost by removing duplicate departments, the cost of the company and increasing profit margin.
To control and drive away the competitors.

LAWS APPLICABLE
Competition Act
Capital Markets Authority Act Banking Act
Insurance Act Company's Act 2015
COMPETITION (GENERAL) RULES, 2019
On 6 December 2019, the Kenyan Competition (General) Rules, 2019 (General Rules), containing the Merger Threshold Guidelines (Threshold Guidelines) and a new merger notification form, were gazetted and are now in effect pursuant to the provisions of the Statutory Instruments Act, 2013.
Significant changes resulting from the adoption of the Threshold Guidelines are:
no further requirement to notify a merger to the Competition Authority of Kenya (CAK) where the Common Market for Eastern and Southern Africa (COMESA) Merger Notification Thresholds are met;
no further requirement to notify a merger to the CAK where the Kenya merger thresholds (see below) are not met; and
in line with international standards, consideration of the higher of turnover or asset value for purposes of threshold calculations.
Categories of mergers
In terms of the Threshold Guidelines, three categories of mergers now exist:
mergers requiring a comprehensive/ full merger notification;
mergers requiring an exclusion application; and
mergers not requiring any notification.
Comprehensive/ full merger notifications must be submitted to the CAK:
where the undertakings have a minimum combined turnover or assets (whichever is higher) in Kenya of KES 1 billion (USD 10 million), and the turnover or assets (whichever is higher) of the target undertaking in Kenya is above KES 500 million (USD 5 million);
where the turnover or assets (whichever is higher) of the acquiring undertaking in Kenya is above KES 10 billion (USD 100 million), and the merging parties are in the same market or can be vertically integrated, unless the transaction meets the COMESA Competition Commission Merger Notification Thresholds;
in the carbon-based mineral sector, if the value of the reserves, the rights and the associated assets to be held as a result of the merger exceeds KES 10 billion (USD 100 million);
where the COMESA Competition Commission Merger Notification Thresholds are met and two-thirds or more of their turnover or assets (whichever is higher) is generated or located in Kenya.
2. Exclusion applications must be submitted to the CAK:
where the combined turnover or assets (whichever is higher) of the merging parties in Kenya is between KES 500 million (USD 5 million) and KES 1 billion (USD 10 million);
if the firms are engaged in prospecting in the carbon-based mineral sector, irrespective of asset value.(EXCLUSION NOTIFICATION)
3. No notification to the CAK:
For the first time, certain mergers are exempt from notification to the CAK. These are mergers:
taking place wholly or entirely outside of Kenya which have no local connection;
where the combined turnover or assets (whichever is higher) of the merging parties in Kenya does not exceed KES 500 million (USD 5 million); or
where the COMESA Competition Commission Merger Notification Thresholds are met, and at least two-thirds of the turnover or assets (whichever is higher) is not generated or located in Kenya.
ACQUISITION

This takes place when the controlling position of a company is transferred from one shareholder group of interest to another. There is usually a bid/offer/placement in the market for an acquisition to happen. The bidding company is known as the acquiring company and the other is the target company.

Acquisition may be:
Friendly acquisition
In this type, one company takes over the management of the target company with the permission of the board of directors. e.g in mergers
Hostile acquisition
In this type, one company(acquiring company) takes over the management of the target company without its knowledge and against the wish of their management. eg in takeovers.
Takeovers & Mergers of listed companies are regulated by The Capital Markets (Takeovers and Mergers) Regulations, 2002 (“the Takeovers and Mergers Regulations”).
MERGER

This occurs when two or more companies combine together into one company. The merger of two or more companies usually occurs through mutual agreement between the combining companies.
Sec 2 Competition Act- “merger” means an acquisition of shares, business or other assets, whether inside or outside Kenya, resulting in the change of control of a business, part of a business or an asset of a business in Kenya in any manner and includes a takeover.

Merger/Amalgamations takes 2 forms:
Merger though absorption – combination of 2 or more companies into an existing company. A + B= A
Merger through consolidation -A combination of two or more companies into a new company.A+ B= C
KEY TAKEAWAYS

A merger occurs when two separate entities combine forces to create a new, joint organization.
An acquisition refers to the takeover of one entity by another.
The two terms have become increasingly blended and used in conjunction with one another.

Types of Company Mergers

There are five commonly-referred to types of business combinations known as mergers: conglomerate merger, horizontal merger, vertical merger , market extension merger and product extension merger. The term chosen to describe the merger depends on the economic function, purpose of the business transaction and relationship between the merging companies.
Conglomerate
A merger between firms that are involved in totally unrelated business activities. There are two types of conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with nothing in common, while mixed conglomerate mergers involve firms that are looking for product extensions or market extensions.
Example
A leading manufacturer of athletic shoes, merges with a soft drink firm. The resulting company is faced with the same competition in each of its two markets after the merger as the individual firms were before the merger.
Horizontal Merger
A merger occurring between companies in the same industry. Horizontal merger is a business consolidation that occurs between firms who operate in the same space, often as competitors offering the same good or service. Horizontal mergers are common in industries with fewer firms, as competition tends to be higher and the synergies and potential gains in market share are much greater for merging firms in such an industry. Example
A merger between Coca-Cola and the Pepsi beverage division, for example, would be
horizontal in nature. The goal of a horizontal merger is to create a new and larger organization with more market share. Because the merging companies' business operations may be very similar, there may be opportunities to join certain operations, such as manufacturing, and reduce costs.
Vertical Merger
A merger between two companies producing different goods or services for one specific finished product. A vertical merger occurs when two or more firms, operating at different levels within an industry's supply chain, merge operations. Most often the logic behind the merger is to increase synergies created by merging firms that would be more efficient operating as one.
Example
A vertical merger joins two companies that may not compete with each other, but exist in the same supply chain. An automobile company joining with a parts supplier would be an example of a vertical merger. Such a deal would allow the automobile division to obtain better pricing on parts and have better control over the manufacturing process. The parts division, in turn, would be guaranteed a steady stream of business.
Synergy, the idea that the value and performance of two companies combined will be greater than the sum of the separate individual parts is one of the reasons companies merger. Synergy definition is - the increased effectiveness that results when two or more people or businesses work together.
Market Extension Mergers
A market extension merger takes place between two companies that deal in the same products but in separate markets. The main purpose of the market extension merger is to make sure that the merging companies can get access to a bigger market and that ensures a bigger client base.
e.g Bata and Nike
Product Extension Mergers
A product extension merger takes place between two business organizations that deal in products that are related to each other and operate in the same market. The product extension merger allows the merging companies to group together their products and get access to a bigger set of consumers. This ensures that they earn higher profits.
EABL and Keroche making a cider.
KEY PROVISIONS OF THE COMPETITION ACT SECTION 41
Sec 41 (1) For the purposes of this Part, a merger occurs when one or more undertakings directly or indirectly acquire or establish direct or indirect control over the whole or part of the business of another undertaking.
A merger may be achieved through;
the purchase or lease of shares, acquisition of an interest, or purchase of assets of the other undertaking in question;
the acquisition of a controlling interest in a section of the business of an undertaking capable of itself being operated independently whether or not the business in question is carried on by a company;
the acquisition of an undertaking under receivership by another undertaking either situated inside or outside Kenya;
acquiring by whatever means the controlling interest in a foreign undertaking that has got a controlling interest in a subsidiary in Kenya;
in the case of a conglomerate undertaking, acquiring the controlling interest of another undertaking or a section of the undertaking being acquired capable of being operated independently;
vertical integration;
exchange of shares between or among undertakings which result in substantial change in ownership structure through whatever strategy or means adopted by the concerned undertakings; or
amalgamation, takeover or any other combination with the other undertaking.

SECTION 42- Control of mergers
The Competition Authority may, in consultation with the Cabinet Secretary and by notice in the Gazette, set the threshold for any merger.
No person, either individually or jointly or in concert with any other person, may implement a proposed merger unless the proposed merger is;
approved by the Authority; and
implemented in accordance with any conditions attached to the approval.
No merger as described in section 41 carried out in the absence of an authorizing order by the Authority, shall have any legal effect, and no obligation imposed on the
participating parties by any agreement in respect of the merger shall be enforceable in legal proceedings.

TERM SHEET, EXCLUSIVITY AND CONFIDENTIALITY AGREEMENTS
A term sheet (sometimes referred to as a memorandum of understanding, heads of agreement or letter of intent) is an important document which sets out the commercial terms upon which persons or entities agree to transact with one another. The term sheet is often the first record of a proposed transaction and is the document which forms the basis of the negotiation of the formal agreements required to implement the transaction. Before entering into a term sheet, the following considerations should be taken into account:
Commercial issues
The purpose of a term sheet is for the parties to agree upon the material commercial terms which constitute the proposed transaction. The relevant commercial terms will depend on the nature of the proposed transaction. As such, it is important that the parties identify and agree on each of the material commercial issues pertaining to the proposed transaction. A failure by the parties to agree on one or more of the material commercial issues may result in a breakdown of negotiations down the line and a failure to conclude the transaction.
Binding vs Non-binding
A term sheet may be fully or partially binding or non-binding. Many parties prefer entering into non-binding term sheets, with the aim of concluding binding agreements later. However, term sheets are often entered into on a partially binding basis. The commercial terms, whilst agreed in principle, should not be binding on the parties until detailed agreements containing all of the relevant rights and obligations are concluded. Other rights and protections such as exclusivity, due diligence, confidentiality, costs and governing law, however, can be made binding on the parties from the conclusion of the term sheet. This is the basis upon which most parties, in our experience, conclude a term sheet. A term sheet must clearly provide which terms, if any, are binding and enforceable.
Exclusivity
Parties may agree to provide a unilateral or reciprocal exclusivity period, during which the parties agree not to engage with any third parties in respect of the proposed
transaction or any substantially similar transaction. This is often an important right because significant costs may be incurred by the parties in preparation for, and during, the negotiation and conclusion of the transaction. Typically, parties will expect to receive a limited period of exclusivity prior to incurring these costs. The duration of the exclusivity period is dependent on the nature of the transaction.
Due diligence
The acquiring entity/ A prospective purchaser or investor may require legal, financial and/or technical due diligence reviews of the target entity and its operations prior to the drafting of definitive agreements and the conclusion of the transaction. The nature, extent and duration of the due diligence review, where applicable, should be agreed between the parties and recorded in the term sheet.
Confidentiality
Where the parties have not entered into a confidentiality and non-disclosure agreement, it is imperative that the term sheet contains a confidentiality provision which protects each party’s confidential information and the exchange of information during the negotiation and implementation of the transaction.
Costs
The parties should agree who will be liable for the costs incurred by each (or all) of the parties in respect to the preparation, negotiation and implementation of the term sheet and all agreements.
Governing law
The parties should agree and record the governing law applicable to the term sheet and the agreements required for the transaction.
Seek advice
Appropriate legal, financial and technical advice should be sought before concluding a term sheet. A good term sheet should save the parties time and money in negotiating and concluding the transaction. A bad term sheet, on the other hand, will have the opposite effect. All financial and technical elements should be confirmed by each party when entering into the term sheet, as the re-negotiation of these provisions at a later stage, whilst possible, will result in a protracted negotiation process with increased costs incurred by both parties. It is strongly recommended that legal advisors provide input before the term sheet is finalised in order to ensure that each party’s rights and interests are adequately protected and clearly articulated.

LEGAL DUE DILIGENCE
Legal due diligence is the process of collecting, understanding and assessing   all the legal risks associated during a M&A process. During due diligence, the acquirer reviews all the documents pertaining to a target company and interviews people associated with it.
What is a Due Diligence Report?
This paper outlines what a due diligence report should cover and what questions need to be answered with mergers and acquisitions. A due diligence report is sent as an internal memo to persons who are evaluating the transaction and is a requirement for closing the deal.
What are the Sections of a Due Diligence Report? #1 Corporate Records
State of incorporation and in good standing with the state
Capitalization and authorized and issued shares of stock and seller of each subsidiary
Articles of incorporation and bylaws
Copies of all correspondence with shareholders and obtain a shareholder list
Existence of any warrants, options, or other potentially dilutive securities
Company trading information.
Financial Information
Copies of financial statements for the past five years that have been audited, including all notes and management’s discussion and analysis
Copies of correspondence between management and auditors
Tax details.
All board of directors’ presentations
All internally generated financial models and forecasts
Indebtedness
Investigate indebtedness or seller and subsidiaries, including loan agreements, notes, mortgages, and security agreements
Review correspondence with lenders demonstrating compliance with financial covenants.
Employment and Labor
List and biographies of officers, directors, and employees of a certain level
List of all employees, their job function, department, location, and compensation
Documents detailing any profit sharing, pensions, deferred compensation, stock plans, and other non-salary compensation or benefits
Copies of all employee handbooks, codes of conduct, and policies
Copies of employment, consulting, termination, parachute and indemnity agreements
Pending litigation related to labor and employment law
Real Estate/Conveyancing
Address and legal description for all real property
Copies of title issuance policies with respect to real property
Copies of all studies, site evaluations, and government filings and reports prepared by consultants.
Agreements
All agreements entered into by the company and its subsidiaries
All real estate leases
All partnership or joint venture agreements
All marketing, sales, commission, distributor, franchise agreements
All brokerage or investment banker agreements
All customer or client agreements
All licenses and subscriptions
All material contracts not otherwise obtained from this list

Supplier and Customer Information
List of all material customers and volume of sales
List of all material suppliers and volume of purchases
Correspondence with customers or suppliers related to complaints or disputes
Legal
Copies of each report or document filed with government agencies
Descriptions    of    all    litigation,    administrative    proceeding,    governmental investigations
Copies of all government licenses.
Environmental liability assessments and environmental compliance audits.
DUE DILIGENCE QUESTIONNAIRE
A due diligence questionnaire is useful in any type of M&A transaction. It typically covers the following categories:
Company Information
Financial Information
Employee Information
Legal Information
Product Information
Consumer Information
Intellectual Property Information
Physical Asset Information
Depending upon the target and the transaction, additional categories, including a “miscellaneous” category, may be warranted.

Specific due diligence questionnaire categories & questions
Compa