The economic rationale for a transaction arises when a new owner or the combined company can use the business differently or more efficiently than before.

One of the principal sources of value creation is synergy — a situation in which the value of the combined business exceeds the standalone value of the two companies.

Synergies may arise from scale, the elimination of duplicated functions, the combination of technologies, customer bases, distribution channels, production capabilities and expertise, or access to new markets.

Another source of value may be improved management efficiency. A company or asset may have greater potential than its existing owner or management is able to realize. In such circumstances, a change of control can become a mechanism for changing the strategy, structure and quality of management.

The economic rationale for an M&A transaction may be driven by four principal objectives:

One of the fundamental questions in an M&A transaction is whether it creates additional value and how that value is allocated between the parties.

In simplified terms, the economic logic can be expressed as follows:

PRICE ≠ VALUE

→ the seller, through a higher purchase price
→ the buyer, through future synergies
→ both parties

However, the existence of synergies does not necessarily mean that the transaction will create value for the buyer.

Part of the expected value is usually transferred to the seller through the acquisition price. The higher the acquisition premium paid by the buyer, the greater the share of the potential transaction value captured by the seller.

It is therefore important to distinguish between two separate questions:

• Does the transaction create additional value?

и

• How is that value allocated between the seller and the buyer?

Even the acquisition of a high-quality business may destroy value for the buyer if the expected synergies are not realized or if the acquisition price is too high.

A good company is not necessarily a good deal.

M&A should be viewed as more than the simple purchase and sale of an asset.
A transaction changes the allocation of ownership and corporate control: who makes key decisions, determines strategy, allocates capital, and bears the economic consequences of those decisions.

This is why different interests may exist around the same transaction:

• shareholders;
• the buyer;
• management;
• creditors;
• investors and other stakeholders.

Интересы участников сделки не всегда совпадают. Сделка может создавать стоимость для одной группы и одновременно перераспределять её от другой. Поэтому результат M&A нельзя оценивать исключительно по цене продажи компании или краткосрочному изменению стоимости её акций.

The economic rationale of a transaction depends to a significant extent on the type of buyer.

The same economic outcome may be achieved through different legal structures.

In private M&A transactions, one of the key choices is typically between acquiring the company itself and acquiring particular assets or the business.

Price is one of the most important parameters of an M&A transaction, but it is far from the only one.

The parties need to determine not only how much the business is worth, but also:

• how the final purchase price will be determined;
• what form the consideration will take;
• when payment will be made;
• whether any part of the consideration will depend on future performance;
• which risks will be assumed by the buyer;
• which obligations will remain with the seller;
• under what circumstances the transaction may fail to close.

Consideration may consist of cash, shares in the buyer, or a combination of both.
Where shares are used as consideration, the seller effectively retains an economic interest in the future performance of the combined business.

Private M&A transactions may also use different pricing mechanisms and earn-out arrangements, under which part of the consideration depends on the future performance of the business.

As a result, two transactions with the same headline price may produce substantially different economic outcomes.

Every sale of a business involves a fundamental problem:

THE SELLER KNOWS MORE ABOUT THE COMPANY THAN THE BUYER.

The seller has greater knowledge of the history of the business, its customers, contracts, employees, liabilities, problems, and potential risks.

This creates information asymmetry - one of the central problems in private M&A transactions.

The buyer therefore needs to reduce this information gap before ultimately assuming the risks associated with the acquired business.

This is the purpose of due diligence.

Due diligence is often understood simply as a technical review of a company prior to acquisition. In practice, its purpose is considerably broader.

The information obtained should enable the buyer to answer at least three fundamental questions:

• Should we acquire the business?
• How much should we pay for it?
• On what terms should we enter into the transaction?

Due diligence may cover legal, financial, commercial, and other business risks.

An issue identified during due diligence may affect the company’s valuation, the transaction structure, the contractual terms, or, in some circumstances, lead the buyer to walk away from the transaction.

Risk cannot be eliminated - it can be identified and allocated.

It is impossible to obtain complete information about a business and eliminate every risk before the transaction.

One of the most important functions of M&A documentation is therefore to determine which party bears a particular risk and under what circumstances.

Various contractual mechanisms are used for this purpose:

• Disclosure - disclosure by the seller of information about the business and known risks;
• Representations & Warranties - statements and assurances made by the seller regarding the state of the business;
• Indemnities - mechanisms for allocating and covering specified risks or losses;
• Pricing Mechanisms - mechanisms governing the determination and adjustment of the final purchase price;
• Earn-out - an arrangement under which part of the consideration is linked to the future performance of the business;
• Pre-closing Covenants - obligations of the parties during the period between signing and closing;
• MAC Clauses (Material Adverse Change Clauses) - provisions governing the consequences of a material adverse change in circumstances.

Importantly, risk allocation should not simply be an attempt by one party to shift as much risk as possible to the other.

The objective is not to eliminate all risk, but to allocate it between the parties taking into account their respective information, control, and ability to manage its consequences.