Share Exchanges and Combinations

Terms:

Debt Load / Debt Service:
A healthy company typically has at least some debt on its balance sheet. The reason for this is that it is often cheaper and more efficient to borrow cash than to take cash from operating funds for the purpose of completing transactions. The amount of debt that the company has is known as the company’s “debt load.” The amount of money that the company has to pay on a monthly basis in order to cover that load is known as the company “debt service.”

Corporate Currency:
When a firm is acquiring other companies, it is often trading with more than cash alone. Reputation, stock and business operations, and a variety of other assets are all parts of the package when it comes to evaluating a deal. Thus, it is not uncommon for a company to engage in a transaction that, on its face, is not, from a purely economic point of view, the best deal, in order to garner the advantages of putting a broader strategy of improving corporate value into action.

Introduction

As was stated previously, there are a variety of ways that corporations can effect a business combination. This section simply highlights some of the various means besides the standard merger that are typical in the law and business, and the tools to achieve those means.

Consolidation

A consolidation generally mimics all of the factors associated with a merger with the only difference being that in a consolidation, neither of the original companies survive the merger. Instead, a new company is created. Thus:

EXAMPLE: Go Co. and Slow Co. have planned a transaction in which they will complete a business combination in the form of a consolidation. After the transaction is completed, both companies will have merged their business operations into GoSlow Co. The new firm will have all the rights and responsibilities of the individual constituent firms.

As you can see from the example above, the results of a consolidation as compared to a merger are essentially the same. See 8 Del. C. § 251. The new company has all the rights and responsibilities of the two independent companies; they just come under a different name. See 8 Del. C. § 259. For this reason, consolidations are used in situations where the two original companies are merging with the intent to change their image and are forming the company either to show a new, stronger image, or simply to avoid the damage of a previously tarnished reputation that may have applied to one or both of the firms.

One major difference between a consolidation and a merger is that in a standard consolidation, shareholders from both of the companies will have the right to vote on the transaction. Depending on how a consolidation is presented, it typically creates a situation where shareholders of each of the original firms are exchanging their shares for shares in the new company. As such, the consolidation gives rise to a fundamental change in ownership, and thus, the right of the shareholders of both companies to vote on the transaction. See 18 Okl. St. § 1091.

EXAMPLE: A and B are planning on a corporate consolidation into a new firm – C Co. Prior to the transaction, the boards of both companies complete a consolidation plan and circulate it to shareholders of both firms. Subsequently, at a special meeting held by each firm, the shareholders vote on the transaction. If approved by both shareholder groups, the plan will be approved and the transaction consummated.

Share Exchange

Another means of effecting a business consolidation is via a Share Exchange. In a share exchange, the acquiring corporation exchanges its own stock (as opposed to cash or other property) for all of the remaining stock, in each class, of the target corporation. To effect a share exchange, the boards of both companies must adopt a "plan of exchange," which will ultimately be filed with the state, and then shareholders of the target corporation are allowed to vote.

The reason why share exchanges stand independent of a typical merger or consolidation is the nature of the payment – i.e., the fact that shares rather than cash are paid to the target company’s shareholders. The reason why this situation raises a particular complexity is the fact that if the appraisal rights of the target company shareholders are triggered and asserted, it can result in a particularly onerous task for the court. Not only does the court need to consider the value of the target company’s stock, but it must also consider the value of the acquiring company’s stock in determining whether the exchange is fair to the acquired company's shareholders.

That said, it should be noted that stock deals, or deals containing “mixed consideration” – i.e., both cash and stock – are fairly common in modern business practice and are particularly popular at times when the stock market is strong, because at such times, company managers may view their stock as over-valued in the marketplace (though they would never say such a thing publicly). Ultimately, companies often come to view their stock as a valuable form of currency that can be used very effectively to purchase small companies that are capable of expanding their business line. The benefit of such an exchange is the fact that it does not require the acquiring company to raise bank or other professional financing, and thus does not force the company to incur added costs and liabilities or risk public exposure of the deal prematurely (as can happen when a company tries to raise large sums of cash), while it still does allow the company to complete deals to expand its operations.

EXAMPLE: Acquire Co. has recently been the beneficiary of a great deal of public comment about their operations. The firm has been cited as having strong management, well-tuned operations, and excellent potential. All of these facts have led to an increase in the company’s stock. Given this exceedingly high value, Acquire has recently gone on a buying spree – snapping up a large number of smaller firms that complement their main business line. In these deals, Acquire has been using its shares, rather than cash, to execute the transactions. Acquire’s board has chosen this as a method because raising a sufficient cash supply to complete their acquisitions would be both costly and difficult and it would expose the company to a debt load that would be difficult to handle, given its current operations.

When a company buys enough stock in another firm so that the acquiring company now owns enough of the target company to have effective control over the target’s operations, the acquiring company is said to be purchasing a “controlling block” of the target. When buying a “controlling block” of shares, the purchaser usually has to pay more than fair market value for the shares, because the control that comes along with the shares adds to their value.