Merger of Equals: Achieving Synergy Without Sacrificing Balance

A merger of equals, when executed with a strategic approach to maximize synergies, can result in multiple advantages. The surviving company can maximize revenues and profits and grow quickly thanks to streamlined operations. It can access better funding sources and pool its talent resources.

To take advantage of the benefits, completing the transaction smoothly with complete transparency is crucial for both parties. A great example of a successful merger of equals is Citi and Travelers, which occurred in 1998. Both companies are banking industry titans and led to the building of Citibank.

Another notable example is AOL and Time Warner, which resulted in the go-forward company, AOL Time Warner. Although this was a merger of equals, it is also an excellent example of what not to do. Participants in the merger should be clear on the integration procedures post-merger.

Cultural differences led to the deal’s failure, but anticipating integration challenges could have helped achieve success. Read ahead for more information about how to execute this transaction to ensure success and long-term scalability.

Understanding the Concept of a Merger of Equals (MOE)

A merger of equals (MOE) is when two companies with similar sizes and values collaborate to form a new company. Shareholders in both companies surrender existing shares in the original companies and receive new shares the legacy company issues.

The market values of the newly issued shares are similar, making them equal. Participants may have several goals for entering into the deal. These objectives may include a more prominent market presence and share or expansion into vertical or horizontal verticals.

Other reasons include operational synergies, eliminating competition, acquihires, accelerated growth, and economies of scale. Such transactions typically result in a higher share value and can even result in the legacy company going to IPO.

Although a merger of equals is a collaboration of companies of similar sizes, they may not be on similar levels. Chances are that one company has a somewhat higher market standing than the other. Instead of the conventional 50:50% partnership, the deal could be more than 60:40%.

In that case, the deal will involve legal and technical nuances that must be handled carefully. The underlining factor to remember here is that one company is not taking control of the other. Such deals are not acquisitions.

However, like a conventional M&A transaction, handling seamless integration and company restructuring is crucial for the deal’s success.

How a Merger of Equals Works

Here are some of the key aspects of MOE deals:

• Since MOE deals are unlike conventional acquisitions, where the acquirer takes control of the target, no control premium is payable.
• The going-forward company structure reflects a “stock-for-stock tax-free exchange,” meaning share recipients need not pay taxes.
• The new company’s legal structure is designed with regard to tax considerations.
• The new board of directors will comprise members from both participating companies. Both companies agree to share decision-making rights as part of the deal’s terms and conditions.
• Participating companies must carefully assess whether they are a good fit for a merger of equals. They must ensure that the transaction will drive value and benefit all the concerned stakeholders. For example–customers, suppliers and vendors, employees, and stockholders.
• Companies entering MOE deals typically operate within the same sector, providing similar or complementary products.
• Such deals are successful only if they result in enhanced growth, higher revenues, and access to funding with favorable terms. A robust balance sheet is also a goal.

 
Merger of equals deals come with risks that dealmakers must plan for, such as execution, regulatory compliance, and integration. Executing these transactions is complex, and the possibility of cultural differences and employee redundancies is high.

When entering into a merger of equals transaction, dealmakers should keep the details confidential until they have resolved core aspects. Setting up a fixed timeline for executing the deal helps avoid unnecessary delays in decision-making.

Once participants have finalized the terms, they can design the definitive agreement, which should include representations and warranties. These terms, along with covenants, should ensure that both companies’ interests are protected.

MOE transactions can be structured as:

• Asset sale
• Reverse triangular merger
• Share purchase
• Double merger
• Section 351 exchange

 

Cultural Integration After a Merger of Equals

Seamless cultural integration is the one of the most significant challenges of any M&A transaction. More so in an MOE deal. Dealmakers must create a tactical approach to handle this aspect. The first step in the right direction is clearly defining both teams’ roles, strengths, and weaknesses.

They must identify the cultural characteristics of both organizations and institute a new culture, leveraging their best assets. The most crucial step is to open communication lines with the employees. Inform them about the upcoming changes and how they will impact jobs and positions.

Since members from both companies will sit on the board, it is important to define their roles and responsibilities. Dealmakers must also prepare for invariable ego clashes, corporate politics, and company loyalty issues. The focus should be entirely on logic and reasoning to move the company forward.

Managing cultural integration should be a top priority since transitional delays can cost the legacy company. Unclear decision-making rights can lead to confusion and operational breakdowns. Production, marketing, sales, and other functions may stall or slow down, leading to losses.

Most importantly, employee motivation and morale should be upbeat. Communicating with them and giving out relevant information ensures job security and enthusiastic participation in the merger of equals. Their buy-ins are crucial for a successful transition.

Employees will also be concerned about their salary packages, benefits programs, and future training opportunities. Dealmakers must set up compensation structures using ideas from both companies. Strategies like these ensure trust and loyalty toward the surviving brand and its management.

Managing Share Valuation

Although, in theory, MOE deals are between companies of similar valuation, some differences in valuation will always exist. Before the agreement, each company should value its shares relative to each other. This strategy will allow dealmakers to make the necessary adjustments in value.

That’s how they can determine the percentage of the go-forward company shareholders will own. Adjustments may need to be made in the working capital, cash, and debt, which can be challenging. Such complexities typically don’t exist in a conventional M&A transaction.

Participants in the merger of equals deal can agree on including covenants to ensure fairness in calculating share value.

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Appointing the Executives and New Board of Directors

Typically a merger of equals is results from two companies agreeing to collaborate for financial and strategic synergies. Since the core executives share a complementary vision and goal, allocating decision-making and management power should be streamlined.

Appointing C-Suite executives will involve people from both companies agreeing to step down and take on advisory roles. However, working out which executives will stay on can result in cultural clashes and disagreements.

Negotiating these issues and arriving at solutions quickly is crucial. Without streamlining the process, the transition and integration become complicated and involve multiple hurdles. These facets must be anticipated and planned for to ensure the merger’s success.

The board composition in the legacy company is one of the most crucial decisions. Dealmakers must agree on the board size and the incumbent directors from both companies joining. Their number will depend on the proportion of the percentage of directors from both companies.

If the number of board seats is not equal, determining the decisions that require a supermajority board vote is a great workaround. Other options include rotating the chairperson role or delegating control and decision-making to different subcommittees.

Adding new, independent directors to round out the skill sets is also advisable. Having non-biased people on board helps maintain balance and lower disagreements. Dealmakers can also assign tie-breaking votes to the new members to ensure the company operates cohesively.

Structuring Pre-Deal Funding Obligations

Since both companies are well-established in a merger of equals, they will have raised funding from external sources. Before entering the merger, they must work out how to handle these obligations and structure the securities previously issued.

For instance, they may have awarded employees with option pools and issued SAFEs, convertible notes, and warrants. Prior to executing the merger, the management must calculate the per-share valuation of each instrument.

Based on the value, they can determine whether the holders will receive shares in the legacy company and their relevant proportion. Employee option pools typically have vesting periods. Managers must calculate the vested to unvested shares outstanding in each company.

As a rule, any outstanding equity awards employees have already vested in transfer to the surviving company. The vesting schedule and related terms and conditions will also remain the same. However, the number of shares and the exercise price will depend on the pre-determined exchange ratio.

Both companies must also agree on structuring future equity awards and option pools. They must design a common game plan to treat both teams fairly and create a new format moving forward. However, this equity structure will also proportionally dilute shareholder ownership.

Clarifying all these nuances in the definitive agreement of the merger of equals eliminates confusion.

Treating Preferred Stock Awarded to Investors

Companies raising capital from investors often issue preferred shares to compensate for the capital. These shares award investors with rights over the company’s assets and revenues. However, owners must work out how to handle these preferred shares when the company enters a MOE deal.

At times, the common stock value is lower than the preferred stock value. In that case, the preferred stockholders stand to receive a higher payout per share. As a result, the common stockholders may receive a very low or negligible payout.

Management must choose to make adjustments or cutbacks to ensure that all shareholders receive fair and equitable treatment. This strategy lowers the preferred share value but also honors the preferential rights of preferred stockholders.

Alternatively, the management can issue “mirror securities” in the go-forward company. This strategy awards proportional preferred shares in the new company, which will feature in the cap table. Or, the management may convert all the outstanding preferred stock into common stock.

This approach streamlines the surviving company’s ability to raise future funding rounds after the merger of equals. However, before executing the conversion, the management may have to negotiate with the stockholders for approval.

They will also have to agree on other nuances, like conversion rates for each class of preferred stock. Another aspect under discussion is determining the conversion’s tax liabilities.

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Navigating Anti-Trust and Regulatory Considerations

Participating companies in a merger of equals are typically competitors or complementary brands. This is why they will likely come under regulatory and anti-trust scrutiny to ensure the deal does not violate any laws.

Dealmakers should be cautious about ensuring that their partnership protects consumer interests and does not restrict competition. Before closing the deal and initiating integration, they should identify sensitive areas and work out solutions.

For instance, complying with ESG rules ensures that the legacy company will be compliant. Adopting an inclusive culture and creating equal opportunities promotes the brand and adds value to the market. Customers also appreciate the company’s efforts.

Other nuances that can influence success include adopting a brand name that resonates with teams on both sides. It should encourage and motivate them to work toward the new vision. Consider a name that combines the two brands or an entirely new company persona.

The Takeaway!

A merger of equals deal can have strategic advantages and multiple synergies for the participants. Such transactions face the usual integration challenges that most M&A deals go through. Extensive planning can help streamline the collaboration so the surviving company is up and running quickly.

However, executing a MOE integration may involve additional complexities because of the share exchange and compensating stockholders fairly. Accounting for the possible pitfalls can ensure that the transaction proceeds with a high probability of success.

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