M&A Questions Flashcards

Question

What is a staggered board and how does it fend off hostile takeover attempts?

Answer 1

Each board member is intentionally classified into distinct classes regarding their term length. Why: A staggered board is used to defend against hostile takeover attempts as this type of ordering protects the existing board of directors and the management team’s interests. Since the board is staggered, gaining additional board seats becomes a more complicated and lengthy process for hostile acquirers (and deters takeover attempts).

Answer 2

Equity carve-out ("partial IPO"): The subsidiary will be established as a new legal entity with its separate management team and board of directors. The equity is provided also to public investors. (parent company will sell a portion of their equity interest in a subsidiary to public investors. In nearly all cases, the parent company will still retain a substantial equity stake in the new entity (usually > 50%) The cash proceeds of the sale to 3rd investors are then distributed to the parent, the subsidiary, or a combination.

Answer 3

Subsidiary that would be better off as a standalone company. (E.g. Perfect Corporation)

Answer 4

Subsidiary: A subsidiary is when the parent company remains the majority shareholder (50%+) Affiliate Company: An affiliate company is when the parent company has only taken a minority stake

Answer 5

A privately held company undergoes a merger with another company that's already publicly traded in the markets. The public company can either be an operating company or be an empty corporate shell (SPAC) Benefit: The public entity can now issue shares without incurring the costs associated with IPOs.

Answer 6

Filed with the SEC prior to a merger and acquisition activity taking place Information includes: -Deal rationale - Negotiated terms - Risk factors - Pro forma financials - Other related material.

Answer 7

Forms intended to disclose publicly when an investor has taken a significant stake in a company in terms of ownership and voting power (filings notify other investors of the influential investor’s stake (i.e., “beneficial owners”) Schedule 13-D: Filed when an investor acquires a minimum of 5% of a public company's total common equity, and over 2% was acquired in the last twelve months. Schedule 13-G: Filed in lieu of the 13-D as long as the investor doesn't intend to take control of the company or filed when an investor acquires 5%+ of the total equity but less than 2% in the last twelve months.

Answer 8

The tendency for the winning bidder to have paid far beyond the target's fair value. (While a certain premium is expected during competitive processes, this can often be elevated to irrational levels.)

Answer 9

To help mitigate transaction risks, a holdback mechanism can require a portion of the purchase price of an acquisition to be placed in escrow to protect the interests of the buyer post-closing until the terms of the agreement have been satisfied.

Answer 10

Introduction of the Investment Bank and Dedicated Team Members Situational Overview of the Deal and Client Company Prevailing Market and Industry Trends Implied Valuation Range and Combined M&A Model Proposed Deal Strategy Outline and Key Considerations Credentials and Tombstones of Relevant Industry Experience Appendix (DCF Model, Trading Comps, Transaction Comps)

Answer 11

1. Assumptions 1, need to be made about the purchase price and other uses of funds such as refinancing target debt and paying transaction and financing fees. 2. Assumptions 2, about the sources of funds need to be made. The question being answered here is: "Will the acquirer pay for the acquisition using cash, take on additional debt, issue equity, or a combination?" 3. The acquirer’s balance sheet is adjusted to reflect the consolidation of the target. Certain line items such as working capital can be added together, while others require further analysis. The major adjustment to the combined balance sheet involves calculating the incremental goodwill created in the transaction, which involves making assumptions regarding asset write-ups and deferred taxes created (or eliminated). 4. Deal-related borrowing and paydown, cash used in the transaction, and the elimination of target equity all need to be reflected. 5. The income statements are combined to determine the combined, pro forma accretion/dilution in EPS – which is ultimately the question being answered: "Will this deal be accretive or dilutive?"

Answer 12

1. Bottom-Up Analysis: When the post-transaction EPS calculation is done as a bottom -up analysis, this involves starting from the buyer ’s and seller’s standalone EPS and adjusting to reflect the: - incremental interest expense - additional acquirer shares that must be issued - synergies - incremental D&A due to asset write-ups. 2. Top-Down Analysis: Alternatively, the accretion/dilution analysis can be done top-down, whereby the two income statements are combined, starting with revenue and then moving down to expenses while making the deal-related adjustments.

Answer 13

What: Accretion: Pro Forma EPS > Acquirer’s EPS Dilution: When Pro Forma EPS < Acquirer’s EPS Breakeven: No Impact on Acquirer’s EPS Accretive vs. Dilutive Deals: either or don't not guarantee value creation for the acquirer, and a dilutive deal does not necessarily imply value destruction. Investor Perception: Buyers, especially public companies, often view significant accretion or dilution as indicators of potential investor reactions to the transaction. Fear of Dilution: Buyers are wary of dilutive deals because they can lead to a post-announcement decline in share price. This concern arises from the assumption that investors will apply the pre-deal Price-to-Earnings (P/E) ratio to the lower pro forma Earnings Per Share (EPS). Short-Term vs. Long-Term Value: While dilution concerns are valid in the short term due to EPS targets, they are irrelevant when assessing long-term value creation for shareholders. Long-term value depends on the intrinsic worth of the combined entity rather than immediate EPS changes.

Answer 14

Assumes the seller will pay off all the debt outstanding and extract all the excess cash* before the new buyer completes the transaction (Nearly all M&A deals are negotiated on a “cash-free, debt-free” basis.) *Excess cash in this context is defined as the cash remaining after the debt has been paid down and above its minimum cash balance. The acquirer is just paying the seller for the company's enterprise value since the acquirer doesn't have to assume the debt on the seller’s balance sheet or get to use its cash

Answer 15

Buyer’s Perspective: When the buyer’s P/E ratio is significantly higher than the target’s, a stock transaction will be accretive, which is an important consideration for buyers and may tilt the decision towards stock. When considering debt, the buyer’s access to debt financing and the cost of debt will influence the buyer ’s willingness to finance a transaction with debt (LBO). The buyer will also analyze the deal’s impact on its capital structure, credit rating implications, and credit statistics. Seller’s Perspective: Most sellers will prefer cash (i.e., debt financing) over a stock sale unless tax deferment is a priority for the seller. A stock sale is usually most palatable to the seller in a transaction that more closely resembles a merger of equals and when the buyer is a public company, where its stock is viewed as a relatively stable form of consideration.

Answer 16

The acquirer's proposed payment method to the target’s shareholders. The purchase consideration can be categorized as cash, stock, or a combination. The tax consequences represent decisive factors that shareholders consider when assessing an offer: An acquisition paid all-cash has an immediate tax consequence, as a taxable event has been triggered. vs if the purchase method made was all-equity (i.e., exchange of shares in the newly merged company), this would not trigger any taxes. Shareholders’ perception of the post-M&A company and its future can also impact their decision: Negative views: Prefer cash but incur the tax Positive views: Prefer stock and enjoy the possible upside

Answer 17

For partial or all-stock deals, the purchase offer can be structured as either a fixed or floating exchange ratio. Fixed Exchange Ratio (regardless of share price movements=no insurance on price moves): Clearly defines the number of shares of the acquirer’s stock to be exchanged for one share of the target. (X Meta share = Y Perfect Corp Shares). Target’s shareholders bear the risk that the share price could decline post-closing, with no provision in place to protect them in the event this were to occur. Floating Exchange Ratio (specific=protection): Sets a specific amount per share the acquirer has agreed to pay for each share of the target’s stock in the form of the acquirer’s shares. The target's shareholders have downside protection if the share price falls post-closing.

Answer 18

It preserves cash. For buyers short on cash, paying with stock avoids the necessity of using debt to help fund the deal.

Answer 19

cash is tangible, and the value received post-closing is guaranteed. These types of shareholders are more risk-averse and may not view the prospects of the combined company positively. Other shareholders may prefer compensation in stock to take part in the combined entity's upside potential and to delay paying taxes.

Answer 20

An all-stock deal will result in a lower valuation since the target's shareholders get to participate in the potential upside of owning equity in the new entity (more mouses want cheese) If the deal were all-cash, the proceeds from the sale would be a fixed amount (and be capped), but an all-stock deal comes with the possibility of higher returns if the combined entity performs well and the market has a favorable view of the acquisition, leading to share price appreciation.

Answer 21

Dilutive: Target P/E>Acquirer (more shares must be issued, which increases the dilutive impact. Since the denominator (the pro forma share count of the combined entity) has increased, the EPS will decline.)

Answer 22

Yes, stock-for-stock deals where the acquirer’s P/E ratio is higher than the target’s P/E are always accretive. Don't get tricked. A 20% premium just brings the target’s P/E to 13 + (13 x 20%) = 15.6 P/E, which is still below the acquirer ’s P/E.

Answer 23

Refers to the purchase price to acquire the seller's equity on a per-share basis. Offer Value = Fully Diluted Shares Outstanding × Offer Price Per Share

Answer 24

News of the deal or even rumors can leak and cause the price of the companies involved in the deal to rise (or decrease). Therefore, the latest share price may already reflect investors’ opinions on the deal and not be an accurate depiction of the real standalone valuation of the target company.

Answer 25

Control Premium % = (Offer price per share/Current Price Per Share-1)*100 - Use the normalized share price for the current price per share

Answer 26

Transaction Value = Target Offer Value + Net Debt "target’s implied enterprise value given the offer value."

Answer 27

Accounting Side - Goodwill: Eliminate the existing, pre-deal target goodwill and create new goodwill from the new deal. - PP&E and Intangible Assets: Write up assets to fair market value (FMV). - Deferred Tax Liabilities (DTLs): Create new deferred tax liabilities in a stock sale. - Target Equity: Eliminate target equity from the consolidation. Funding Side - Debt: Create new acquirer debt (if the deal was partially funded with debt) and eliminate Target debt (Target debt is often refinanced and reflected in the new acquirer debt financing, although in rare cases, it can carry over). - Equity: Increase the existing value of acquirer equity by the value of new acquirer equity issued. - Cash: Reduce cash by the excess cash used to fund the deal and pay transaction and financing fees, reduce this to equity (the transaction fees) and to new debt (the financing fees).

Answer 28

Line items needing adjustments as part of purchase accounting before acquirer and target income statements are consolidated. Income Statement Adjustments - Revenue: Increase consolidated revenue by any revenue synergies. OPEX: Reduce consolidated expenses by any expected cost synergies. - Incremental D&A: Asset write-ups often result in more non-cash D&A. Thus, incremental D&A expenses from write-ups need to be added to consolidated D&A. - Other Expenses: Transaction fees are expensed on the income statement. - Interest Expense: Acquirer interest expense is adjusted up when debt financing is used to fund the deal. Target interest expense is eliminated when target debt is refinanced. - Financing Fees: Financing fees related to raising debt are amortized over the term of the debt, and the non-cash expense is recognized within interest expense. - Interest Income: Reduce interest income by the impact of excess cash used to fund the deal. - Taxes: All the adjustments above need to be tax-affected at the acquirer’s tax rate. - Pro Forma EPS: Use the acquirer’s pre-deal share count and then add the number of acquirer shares issued in the transaction.

Answer 29

A a document provided by the seller’s investment banker to the seller’s board of directors attesting to the fairness of a transaction from a 3rd party perspective. The purpose of the fairness opinion is to provide the selling shareholders with an unbiased evaluation of the deal. (Yes, in a typical M&A transaction, the seller often engages their own investment banker, who acts as a financial advisor throughout the process. One of the key services this investment banker may provide is a "fairness opinion"-a formal document addressed to the seller’s board of directors that attests to the fairness of the proposed transaction from a financial perspective)

Answer 30

Property, plant, and equipment (PP&E) and intangible assets are often carried at book values significantly below market values. As a result, these two assets are written-up the most in a transaction.

Answer 31

occurs when the acquiring company determines the current value is lower than the original price paid for the target company. Companies are required to estimate the value of their past acquisitions periodically. For example, suppose an acquirer that paid $100 million for a business with $40 million in goodwill now estimates the acquired business's value to be $70 million. Here, the acquirer must recognize a $30 million goodwill impairment via retained earnings, bringing the goodwill balance down to $10 million.

Answer 32

Independent appraisers, accountants, and other valuation firms can help determine the write-up amounts.

Answer 33

An acquirer would prefer $100 in cost synergies because all those cost savings (after accounting for tax) flow through to the bottom line, while revenue synergies have associated costs that reduce the bottom-line benefit. For example, $100 in revenue synergies for a company with 40% pre-tax profit margins and a 25% tax rate would see $100 x 40% x (1 - 25%) = $30 flow to the bottom line, while the same company with $100 in cost synergies would see $100 x (1 - 25%) = $75 flow to the bottom line.

Answer 34

Revenue synergy assumptions are less accurate than cost synergy assumptions. Cost synergies can point towards specific cost-cutting initiatives such as laying off workers and shutting down facilities. In contrast, revenue synergies are driven by higher-level, more uncertain assumptions around cross-selling, new product launches, and other growth initiatives.

Answer 35

Once the owner of a company proceeds with a potential sale, it'll usually be easy to find a group of buyers. So when working on behalf of the seller, the likelihood of completing a transaction is higher. VS For buyers, these engagements and explorations can drag on for months and often end in no transaction.

Answer 36

Transaction fees include IB advisory, accounting, and legal fees, which are expensed as incurred. In effect, the pro forma net income and pro forma EPS will be reduced.

Answer 37

Capitalization & Amortization: Financing fees for acquisition-related debt are capitalized (not expensed immediately) and amortized over the debt’s term, creating incremental amortization expense. This reduces pro forma net income and pro forma EPS over the borrowing period. Balance Sheet Impact: Financing fees are recorded as a contra-liability (deducted directly from the debt liability), rather than being expensed upfront. Modeling Considerations: Classified as “Debt Issuance Costs” on the balance sheet. Amortized as a non-cash expense within interest expense over the borrowing term. Contrast with Transaction Fees: Unlike transaction fees (often expensed immediately), financing fees follow this amortization-based accounting treatment.

Answer 38

Created due to asset write-ups. The assets of the target, most often PP&E and intangible assets, are written-up to their fair value in a deal if appropriate. The increase in D&A will reduce pro forma net income and pro forma EPS.

Answer 39

M&A Income Statement Adjustments: Expected Synergies Capitalized Financing Fees Incremental D&A Additional Interest Expense Loss of Interest Income

Answer 40

Depending on the deal structure, target NOLs are assumed by the acquirer, although their use by the acquirer is capped at an annual limit that's a function of the (purchase price x the long-term tax-exempt rate) Alternatively, target NOLs can be used to offset the seller’s gain on sale, which since the 2017 tax reform act, has been capped at 80% of the target’s taxable income.

Answer 41

Deferred tax liabilities (DTLs) are created because of deal-related asset write-ups. Specifically, when a company is acquired, its assets' book basis often gets written up to fair market value. However, when deals are structured as stock sales, the tax basis doesn't always get stepped up to align with the book basis write up. Here, DTLs are created on the deal date because depreciation on assets written-up will be higher for book purposes than for tax purposes.

Answer 42

The treatment of existing target NOLs depends on the structure of the deal: Asset Sales: NOLs can be used up by the target to offset any gain on sale on the corporate level. The acquirer doesn't get any remaining unused NOLs as they're permanently lost. Stock Sales: NOLs can be used by the acquirer in the future but are subject to an annual “IRC 382 limitation,” which limits the annual carryforward to a regularly published “long term tax-exempt rate” times the equity purchase price.

Answer 43

Primary Context: Common in software M&A deals (e.g., Adobe’s Marketo/Magento acquisitions) due to long-term subscription contracts. Deferred revenue is revalued to fair value at deal close, often resulting in a write-down if the original booked amount exceeds this fair value. (Post-2021 (ASU 2021-08): Deferred revenue can now be carried at its original value if the acquirer adopts the new standard, reducing write-downs. Negotiation Point: Buyers push for write-downs to avoid overpaying for unearned revenue; sellers resist to preserve valuation) Key Causes: Collectability concerns: Uncertainty about receiving payments from customers. Terminated/breached contracts: Invalid agreements reduce future obligations. Customer contract changes: Upgrades, maintenance, or support adjustments alter performance obligations. Revaluation Process: Requires re-estimating: Remaining performance obligations (services/products owed to customers). Costs to fulfill obligations (e.g., delivery, support). Profit margin tied to fulfilling obligations. Impact: Reduces deferred revenue on the balance sheet, lowering future revenue recognition and potentially affecting short-term financial metrics post-acquisition.

Answer 44

An earn-out bridges the gap between the purchase price the seller is looking for and the highest amount the buyer is willing to pay. (A portion of the purchase price will be issued to the seller upon achievement of a certain milestone within a given time frame....To break out of this purchase price deadlock– an earn-out provision is often used as a compromise)

Answer 45

Earn-outs can be viewed as a risk-allocation mechanism as the payment is deferred and the burden of meeting the target is placed on the seller. Primary Beneficiary: Generally favors buyers by: Transferring performance risk to the seller (seller bears burden of meeting targets). Aligning seller incentives with buyer goals (seller motivated to achieve milestones for full payment). Seller Perspective: Reluctance: Sellers often resist earn-outs due to payment uncertainty. Necessity: Earn-outs bridge valuation gaps, enabling deal closure when buyer/seller price expectations differ. Upside: If targets are met, sellers receive full/near-full requested consideration. Risk Allocation: Buyer advantage: Reduced upfront payment risk; pays only if performance criteria are satisfied. Seller risk: Potential underpayment if targets are missed (e.g., market shifts, operational challenges). Structural Influence: Earn-out terms (e.g., milestones, payment timing) determine balance of power. Aggressive targets or narrow metrics may disproportionately benefit buyers.

Answer 46

Earn-outs are highly negotiated and will differ by the deal, but most will last for one to five years and be paid out in installment payments (rather than a lump sum). Percentage of Future Performance: The seller is compensated for each tier met plus the pro rata amount earned over (usually based on how close to meeting a target it was on a percentage-basis). 2. Binary Payments: Often called "all-or-nothing" payments, there will be no payout for a specific tier unless a target is met 100%, which places more risk and pressure on the seller.

Answer 47

Valuation Alignment: EBITDA is the most common valuation multiple in M&A (e.g., businesses priced as a multiple of EBITDA). Earn-outs using EBITDA directly align with this valuation framework, simplifying negotiations. Example: A $1M EBITDA business valued at 4.0x vs. 5.0x by buyer/seller can bridge the gap via a $4M upfront payment + $1M earn-out tied to future EBITDA. Balanced Performance Measure: Combines growth (revenue) and profitability (cost control), incentivizing sustainable value creation. Discourages short-term risk-taking (unlike revenue targets) and resists manipulation (unlike net income). Drawbacks of Alternatives Revenue: Encourages risky, short-term sales tactics (e.g., discounting, lax terms). Net income: Easily manipulated via cost-cutting, reduced capex, or asset sales. Long-Term Focus: Achieving EBITDA targets often requires strategic investments and operational discipline, reflecting genuine value creation for the buyer.

Answer 48

An earn-out will not be reflected on the Sources & Uses table since no cash payment has been paid out yet. However, the returns models from both the buy-side and sell-side perspective would have this earn-out modeled out as a contingency. IS: The change in the value of the contingency payment would be reflected in the non-operating gains/(losses) section. The amount will depend on the probability of the earn-out being paid out. A gain would mean the probability of payout has decreased, while a loss means the probability has increased. BS: The earn-out will be recorded as a contingent consideration in the liabilities section and recorded at its measured fair value as of the acquisition date. An accountant will determine the liability's fair value as the present value of the probability-weighted expected amount of future payment. Thus, as targets are met (or missed), the contingent liability is re-evaluated and adjusted periodically until the earn-out period ends. CFS: If a target is met, the agreed-upon payout will be recorded here. The fluctuating changes in the probability of payout are also shown here, but these non-cash changes in values are not actual cash inflows/(outflows), unlike the payout when a target is met.

Answer 49

Healthcare: Earn-outs are common due to regulatory complexity and compliance risks. Often tied to milestones like FDA approvals, product trials, or patent production. Reflects uncertainty around future events impacting asset value (e.g., regulatory outcomes, development pipelines). Life Sciences (Biopharma): High prevalence (e.g., over 90% of biopharma deals include earn-outs). Metrics often involve clinical trial progress, regulatory approvals, or commercial sales milestones. Technology: Used for early-stage companies with volatile growth rates and valuation challenges. Metrics may include revenue, intellectual property milestones, or customer acquisition targets. Energy: Earn-outs address valuation uncertainty due to commodity price volatility and regulatory changes. Often tied to project development milestones or exceeding specific production thresholds. General Trends: Earn-outs are prevalent in industries with high growth potential, long development cycles, or unpredictable outcomes. They help bridge valuation gaps where future performance is uncertain.

Answer 50

A seller note is when the seller has agreed to receive a portion of the purchase price in the form of debt. The seller note is part of the purchase consideration, similar to an earn-out. (In a seller note arrangement, the seller agrees to receive a portion of the purchase price as debt, which is paid back over time in installments-similar to a loan.) It's the seller's best interests for the new business to be run well, as this increases the probability of receiving the agreed-upon installment payments of the loan (and receive the full purchase price).

Answer 51

Seller notes (or seller financing) are modeled the same way as any other debt instrument. Therefore, it'll show up in the Sources & Uses schedule as a source of funds since these notes helped finance the deal. In most cases, seller notes will come in the form of subordinated debt with a high, fixed interest rate given its position in the capital structure. But often, the option for PIK interest or conversion feature will be attached.

Answer 52

(The working capital peg is "normalized" because it is carefully calculated to reflect the true, recurring working capital needs of the business, stripped of anomalies, so both buyer and seller are treated fairly and the business can operate seamlessly after the transaction closes) (based on the average NWC over a period (often the LTM), adjusted to remove any one-off, non-operating, or nonrecurring items, so it matches what the business typically needs to function day-to-day) The working capital peg is the negotiated sufficient level of net working capital required post-closing of a transaction and should represent the normalized NWC requirements to operate the business on an ongoing basis. Therefore, a working capital peg ensures the business can continue operating with no more capital required upon closing. (From the perspective of the buyer, the purpose of setting this target is to prevent the seller from taking cash beyond NWC requirements.)

Answer 53

If the buyer is publicly traded and the target is a startup being purchased for “acqui-hiring” purposes, the strategic acquirer would pay little attention to the post-acquisition EPS. Instead, the focus would be the onboarding of the new key personnel being brought on and the intellectual property (IP), since the impact on EPS would be negligible given the size disparity

M&A Questions Flashcards

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