By John Kalampa
Living organisms go through a series of changes across their life cycle. From conception, humans develop into a fetus, then a newborn baby, all the way to an adult until they eventually die. Businesses are much the same way. They also have a life cycle. From their launch or inception, to growth, then shake-out and maturity. Across the various stages of a business’ life cycle, the sales, profit and cash flow of the business vary and in most cases by the time the business reaches maturity, the sales, profits and cash flow significantly decrease leading to the inevitable death of the business.
Unlike a living organism’s life cycle which upon reaching maturity must inevitably die, businesses have an opportunity of extending their life cycle using a variety of tools. One such tool is the Mergers and Acquisitions [M&A] transaction. This brief write-up will provide an aerial view of M&A in Malawi with particular regard to the legal and institutional framework.
- Definition of M&A
Section 2 of the Competition and Fair Trading Act [CFTA] defines the process as follows:
“(a) The acquisition of controlling interest in –
- Any trade involved in the production or distribution of any goods and services;
- An asset which is and may be utilized for or in connection with the production or distribution of any commodity, where the person who acquires the controlling interest has already a controlling interest in any undertaking involved in the production or distribution of the same goods and services; or
(b) Acquisition of controlling interest in any trade whose business consists wholly or substantially in:
(i) Supplying goods and services to the person who acquires the controlling interest;
(ii) Distribution of goods or services produced by the person who acquires the controlling interest”
The term merger is further defined in Section 261 of the Companies Act, No. 15 of 2013 as below:
““merger” means where two or more companies amalgamate and continue as one company, which may be one of the amalgamating companies, or may be a new company.”
Simply put, an M&A transaction is the joining or combining of two or more entities into one or a wholly new entity. In terms of Section 2 above, all that is necessary is that one entity is acquiring a controlling interest or share in another entity.
- Types of M&A Transactions
M&A transactions are generally classified into three: horizontal, vertical and conglomerate. A horizontal M&A transaction is one in which the combining entities are within the same trade or industry and are at similar stages of production. For instance, a tobacco growing business purchasing a controlling interest in another tobacco growing business.
In contrast, vertical M&A is where the combining entities are operating in the same trade or industry but at different lines of production. An illustration would be a tobacco cigarette manufacturing company acquiring a controlling interest in a tobacco growing business. Same tobacco industry but different stages of production: one company grows the tobacco whilst the other processes into cigarettes.
Lastly, conglomerate M&A occurs where there is a joining of enterprises in different industries or trades.
It must further be noted that the Companies Act in Section 261(1)(a) and (b) also classifies M&A transactions according to the manner in which undertakings, property and liabilities are being transferred. If undertakings, property and liabilities are being transferred to an existing company, then there exists a merger by absorption. Whereas if undertakings, property and liabilities are being transferred to a new company, then there is a merger by formation of a new company.
- The M&A Process and Rationale
Typical M&A process generally involves the following steps: acquisition strategy; acquisition criteria; searching for target company; approaching target company; data and detailed valuation; negotiation; due diligence; purchase and sales contract; financing; and integration. The exact legal requirements or steps to be followed will be provided below.
There are several reasons why companies and businesses would want to merge. The first is in order to save an ailing or dying company. M&A transactions have the possibility of increasing the total value of a business by decreasing risk and increasing the growth factor. Starting a new business or product line is generally very risk and most new ventures fail. M&A transactions provide a means of growing a business or diversifying by purchasing an already existing enterprise whose risk factor is low since such a company will have already established itself in the market.
Other justifications include eliminating inefficient management, improving synergies (e.g. cost and tax synergies), gaining greater market power, and allowing the purchaser to ultimately require less capital for the acquisition because acquisitions partly finance themselves through debt and other means.
- Legal Framework
Principle pieces of legislation on M&A transactions include the Companies Act, No. 15 of 2013 [the Companies Act] and CFTA. Part XII, Division II of the Companies Act outlines the general provisions regarding an M&A transaction in relation to companies. To begin with, the directors of both the transferor and transferee companies are required to draw up and adopt draft terms of the merger giving particulars in relation to at least the following things: name and registered address of office of the companies involved; statement on whether the companies are limited by shares or guarantee; the share exchange ratio; the terms relating to the allotment of shares in the transferee company; date when holders of shares on transferee company will be entitled to share in the profits and any other special terms attaching to such an entitlement; the date from which the transactions of a transferor company are to be treated for accounting purposes as being those of the transferee company; any rights or liabilities attaching to allotment of shares or other restrictions in the transferee company; and any amount of benefit paid or given or intended to be paid or given to any expert or any director of the merging company in consideration for the benefit. All of this is contained in Section 267 of the Companies Act.
Additionally, section 268 of the Companies Act obliges directors of each of the merging companies to deliver a copy of the draft terms to the Registrar of Companies who shall then publish notice of receipt of the draft terms in the Gazette. The notice shall be published at least 1 month prior to any meeting of the merging companies, scheduled for the purpose of approving the merger.
In terms of section 269 of the Companies Act, a merger must be approved by a majority in number and 75% in value of each class of shareholders present and voting before it can be carried out. There are however certain circumstances where the approval is not required which are a subject for another time.
Afterwards, the directors of each of the merging companies are required to draw up and adopt a report, which shall, among other things, set out the legal and economic grounds for the draft terms and in particular for the share exchange ratio [Section 270(1) of the Companies Act].
Then an expert report, drawn up by a person eligible to be appointed statutory auditor, shall be written to the members of the company. The report shall include, but limited to, an indication of the methods used to calculate the share exchange ratio and opinion as to whether the method or methods used are reasonable. Other requirements are in Section 271(5) of the Companies Act.
The members of each of the merging companies shall have access to all the documents relating to the merger. Throughout this entire process however, it must not be forgotten that the members and directors are also bound to the Constitution of the Companies i.e. the Memorandum and Articles of Association [Memarts]. As such, when structuring the M&A deal, they must ensure that it is in accordance with the Memarts.
- Institutional Framework
M&A transactions are not without regulation from various institutions. They are regulated by both the Reserve Bank of Malawi [the Bank] and Competition and Fair Trading Commission [CFTC] because of their potential to foster unfair competition.
The Bank mostly regulates M&A transactions between banking or financial institutions. This is because Section 25 (j) and (l) of the Banking Act, requires a bank to obtain prior written approval from the Registrar to arrange for the transfer, sale or disposal of its shares or business, as well as to amalgamate or merge with any other institution wherein the whole or a considerable part of the business or property of the bank will be transferred to that other institution. To that end, the Bank has published “Guidelines for Processing Applications for Bank Mergers and Acquisitions”. In general, before banks can merge, there need prior and final approval from the Bank on the intended M&A transaction.
Further, due to the potential for an M&A transaction to foster unfair competition for instance where it would lead to monopoly over an industry or trade or indeed termination of employment on a large scale, the CFTC also monitors and regulates M&A transactions generally through Sections 33 – 40 of the CFTA. In essence, approval must be sought from the CFTC before any M&A transaction is sought. The CFTC has also published guidelines on the same.
By way of summary, M&A transactions are a great business tool: they may facilitate growth, minimize risk and indeed save a dying business. However, when structuring or undertaking an M&A transaction, regard must be had to the legal and institutional framework governing it.