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CAIIB Paper 3 ABFM Module C Unit 6 : Deal Structuring And Financial Strategies (New Syllabus)
IIBF has released the New Syllabus Exam Pattern for CAIIB Exam 2023. Following the format of the current exam, CAIIB 2023 will have now four papers. The CAIIB Paper 3 (ADVANCED CONCEPTS OF FINANCIAL MANAGEMENT) includes an important topic called “Deal Structuring And Financial Strategies”. Every candidate who are appearing for the CAIIB Certification Examination 2023 must understand each unit included in the syllabus.
In this article, we are going to cover all the necessary details of CAIIB Paper 3 (ABFM) Module C (Valuation, Mergers & Acquisitions) Unit 6 : Deal Structuring And Financial Strategies, Aspirants must go through this article to better understand the topic, Deal Structuring And Financial Strategies and practice using our Online Mock Test Series to strengthen their knowledge of Deal Structuring And Financial Strategies. Unit 6 : Deal Structuring And Financial Strategies
- An agreement between two parties (the acquirer and the target firms) specifying their rights and obligations is known as a deal structure. The procedure that leads to the formation of this agreement is referred to as the deal-structuring process.
- The process of deal structuring entails establishing how risk will be distributed and achieving as many of the major objectives of both the acquirer and the target as possible. The extent to which the acquiring company takes on the liabilities of the target organisation is referred to as risk sharing.
Payment And Legal Considerations
- The overall consideration, which can come in the form of cash, common stock, or debt, or even a combination of all three of these things, can be considered the method of payment.
Form of Acquisition Vehicle and Post-closing Organisation
When deciding on an acquisition vehicle or post-closing organisation, it is necessary to take into consideration the elements listed below:
- The cost and level of formality involved in the organization
- The ease with which ownership can be transferred
- The continuous existence of the organization
- Management control
- The convenience of obtaining financial support
- Ease of assimilation into the system
- The manner in which earnings shall be distributed
- The scope of individual responsibility
Selecting the Appropriate Acquisition Vehicle
- The corporate structure that is most frequently utilised, is the acquisition vehicle, because it provides the majority of the attributes that buyers want, such as limited liability, flexible financing, continuity of ownership, and transaction flexibility.
- An ESOP structure may be an easy way for small privately held businesses to transfer the owner’s equity in the company to the employees while providing significant tax benefits.
Selecting Suitable Post-closing Organization
- Structures such as divisional and holding company arrangements are frequently used after closing. The goals that the acquirer hopes to accomplish should guide the selection of the post-closing organization. The acquiring company may opt for a structure that makes post-closing integration easier, reduces the risk of the target’s known and unknown liabilities, minimizes taxes.
- Because it allows for the greatest amount of control, the corporate or divisional structure is frequently chosen when the acquirer plans to immediately integrate the target after the transaction has been finalized. Because of the distributed ownership in joint ventures and partnerships, decision making may be slowed down or made more controversial.
- A financial buyer can choose a holding company structure because the buyer has no intention of really running the target company for any significant amount of time after the acquisition.
- If the value of the tax benefits is large and the risk is high, a partnership or joint venture form can be the best option. Everyone contributes to the whole cost of achieving the goal. The acquired company can stand to benefit from the various partners’ or owners’ access to specialised knowledge and experience. The current operational losses, tax credits, and loss carry forwards and carry backs are all passed on to the owners when a business is structured as a partnership or an LLP. This also prevents the possibility of double taxation.
Different Types of Payment Consideration
- Cash may be used by acquirers if the target company has a considerable borrowing capacity, a high credit rating, cheap shares, and the desire to preserve control of the company after the acquisition.
- When a company has a high credit rating and relatively low borrowing costs, it is more likely that a cash transaction will be financed by borrowing rather than being paid for in cash.
- Highly leveraged acquirers are less likely to offer agreements that consist entirely of cash and are more likely to pay less cash in mixed payment offers that include both cash and stock.
- It is possible that the acquirer will prefer to pay for the acquisition with its own shares if it is deemed that the target company is overvalued, the acquirer has limited borrowing capacity.
- Companies whose actual leverage is higher than their desired leverage are more likely to make acquisitions using a form of payment other than cash.
- Acquirer’s stock may be a beneficial type of payment in situations where it is difficult to value the target company, such as when the target has intangible assets that are difficult to value, new product entrants, or high R&D expenditures.
Mix of cash and stock
- If a target company’s shareholders are unsure about the prospective appreciation of the acquirer’s shares, they may prefer a transaction that includes a combination of cash and acquirer stock.
- acquirers who are either unable to borrow money to finance an all-cash offer or hesitant to take on the dilution that comes with an all-stock offer may opt to make an offer to the target company that is a combination of cash and shares.
- When both the buyer and the target lack vital knowledge about one another, convertible securities have the potential to alleviate the concerns of both parties.
- People who are interested in bidding but think their shares are worth less than they should be, hesitant to use stock so they don’t dilute the ownership of their existing shareholders. It is possible for such bidders to offer convertible debt as a kind of payment in order to indicate their belief. Target shareholders may find such offers appealing because they provide a floor equal to the value of the debt at maturity plus accumulated interest payments and the potential for participating in future share appreciation.
Tax Reliefs & Benefits In Case Of Amalgamation In India
If an amalgamation takes place within the meaning of section 2(1B) of the Income Tax Act, 1961, the following tax reliefs and benefits shall be available:
Tax Relief to The Amalgamating Company
Exemption From Capital Gains Tax [Sec. 47(Vi)]:
- Under section 47(vi) of the Income-tax Act, capital gain arising from the transfer of assets by the amalgamating companies to the Indian Amalgamated Company is exempt from tax as such transfer will not be regarded as a transfer for the purpose of Capital Gain.
The two conditions that must be satisfied, are;
- The scheme of amalgamation satisfies the conditions of Section 2(1B); and
- The amalgamated company is an Indian Company
Allotment of Shares In Amalgamated Company To The Shareholders Of Amalgamating Company [Section 47(Vii)& 49(2)]
- Any transfer by a shareholder in a scheme of amalgamation of shares held by him in the amalgamating company shall not be regarded as transfer if –
- Transfer is made in consideration of allotment to him of shares in the amalgamated company; and
- Amalgamated company is an Indian company.
Section 49(2)-provides that in above case the Cost of Shares of the amalgamating company shall be the Cost of Shares to the amalgamated company.
Tax Relief to The Shareholders of The Amalgamating Company
Exemption from Capital Gains Tax [Sec 47(vii)]
Under section 47(vii) of the Income-tax Act, capital gains arising from the transfer of shares by a shareholder of the amalgamating companies are exempt from tax as such transactions will not be regarded as a transfer for capital gain purpose, if:
- The transfer is made in consideration of the allotment to him of shares in the amalgamated company; and
- Amalgamated company is an Indian company.
Tax Relief to The Amalgamated Company:
Section 72A of the Income Tax Act, 1961 deals with the mergers of the sick companies with healthy companies and to take advantage of the carry forward of accumulated losses and unabsorbed depreciation of the amalgamating company.
But the benefits under this section with respect to unabsorbed depreciation and carry forward losses are available only if the followings conditions are fulfilled:
i)There should be an amalgamation of –
- A company owning an industrial undertaking or ship or a hotel with another company, or
- A banking company referred in section 5(c) of the Banking Regulation Act, 1949 with a specified bank or
- One or more public sector company or companies engaged in the business of operation of aircraft with one or more public sector company or companies engaged in similar business.
ii)The amalgamated company should be an Indian Company.
iii)The amalgamating company should be engaged in the business, in which the accumulated loss occurred or depreciation remains unabsorbed, for 3 years or more
iv)The amalgamating company should hold continuously as on the date of amalgamation at least three-fourth of the book value of the fixed assets held by it two years prior to the date of amalgamation.
v)The amalgamated company holds continuously for a minimum period of five years from the date of amalgamation at least three-fourths in the book value of fixed assets of the amalgamating company acquired in a scheme of amalgamation
vi)The amalgamated company continues the business of the amalgamating company for a minimum period of five years from the date of amalgamation.
vii)The amalgamated company fulfils such other conditions as may be prescribed to ensure the revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purpose.
viii)The amalgamated company, which has acquired an industrial undertaking of the amalgamating company by way of amalgamation, shall achieve the level of production of at least 50% of the installed capacity of the said undertaking before end of four years from the date of amalgamation and continue to maintain the said minimum level of production till the end of five years from the date of amalgamation.
ix)The amalgamated company shall electronically furnish to the AO a certificate in Form 62 duly verified by an accountant, with reference to the books of account and other documents showing particulars of production along with the return of income for the AY relevant to FY falling within a period of five years from the date of amalgamation.
Note: In case the above specified conditions are not fulfilled then that part of brought forward loss and unabsorbed depreciation which has been set off by amalgamated company shall be treated as income of the amalgamated company for the year in which failure to fulfil above conditions occurred.
Availability of MAT credit
- Section 115JB of the ITA levies MAT on a company if the amount of income-tax payable under general provisions of the ITA is less than 15% of the company’s ‘book profits’. In such case, the ‘book profits’ computed are deemed to be the total income of the company and income-tax is levied thereon at 15%.
- However, the excess of MAT paid over normal tax liability for the year is permitted to be carried forward under Section 115JAA of the ITA for set-off in future years in which normal tax liability exceeds MAT liability.
Capital Gains Taxes
- If the shares qualify as capital assets under Section 2(14) of the ITA, the gains arising upon transfer of the shares would attract capital gains tax liability.
- As per Section 45, capital gains tax must be assessed at the time of transfer of the capital asset, and not necessarily at the time when consideration is received by the transferor or on the date of the agreement to transfer.
Tax issues in Domestic M&A
Tax issues arise in domestic M&A transactions when the conditions stipulated under the ITA are not fulfilled. These issues typically cover the following cases:
- Allotment of securities or payment of cash consideration to shareholders of amalgamating company
- Part consideration paid directly to shareholders of demerged company
- Availability of MAT credit
- Merger of Limited Liability Partnership into a company
Tax issues in Cross-border M&A
- In cross-border transactions, tax concerns emerge when two countries seek to tax the same income or the same legal entity, resulting in double taxation of the money. Countries enter bilateral DTAAs to limit their taxing rights voluntarily through self-restraint, thereby avoiding overlapping tax claims.
- For a buyer, it is essential to determine whether a tax withholding duty exists when making a payment to a seller. India is undergoing a transformation of its current investment climate. Foreign Direct Investments (“FDI”) from Mauritius, Singapore, and Cyprus accounted for more than fifty percent of all FDI in India. India appears to be altering the status quo and limiting investors’ access to tax benefits by amending its DTAAs with each of these countries. Moreover, worldwide concern over treaty violations is growing.
Financial Reporting of Business Combinations
An entity shall account for each business combination by applying the acquisition method. Applying the acquisition method requires:
- Identifying the acquirer
- Determining the acquisition date
- Recognising and measuring the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree
- Recognising and measuring goodwill or a gain from a bargain purchase.
- Under I-GAAP, shares acquired by the buyer would be recorded at cost and continued to be done so in subsequent years as well. However, under Ind-AS method of accounting, investments will be recorded at fair value, unless the buyer opts to record its investments in its subsidiaries and associates at cost.
- The purchase method must be used to account for business combinations by a company that maintains its financial statements in accordance with International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP)
- According to the purchase method of accounting, the purchase price or acquisition cost is calculated, assigned first to tangible net assets and then to intangible net assets using a cost-allocation strategy, and then recorded on the books of the purchasing business.
- Acquired assets less assumed liabilities are referred to as net assets. Any difference between the purchase price and the acquired net assets’ fair market value is recorded as goodwill. Acquirer must record assets, liabilities, and any non-controlling interest in the target at their fair value as of the acquisition date in accordance with current accounting rules.
Recognising Acquired Net Assets and Goodwill at Fair Value
- Current accounting standards mandate recording 100% of the assets bought and liabilities assumed, even if the acquirer buys less than 100% of the target, in order to facilitate comparisons across various transactions.
- Non-controlling/minority interest is shown separately from the parent’s equity in the equity account of the consolidated balance sheet. Additionally, the consolidated income statement should include the revenues, expenses, gains, losses, net income or loss, and other income related to the non-controlling interest.
- M&A deals are frequently financed using cash, stock, debt, or a combination of all three.
- The choice of financing source or sources is influenced by a number of variables, such as the state of the capital markets, the liquidity and creditworthiness of the target and acquiring companies, the combined borrowing capacity of the target and acquiring companies, the size of the transaction, and the target shareholders’ preference for cash or acquirer shares.
The various financing options, available to an acquirer are:
- Issue of equity and/or preference shares
- Internal accruals
- Long Term loans from banks or other lenders
- Issue of convertible/non-convertible debentures or other types of domestic or foreign debt instruments.
- The potential for debt to boost earnings per share and returns on equity are two factors that contribute to the desirability of long-term debt.
- Convertible bonds are a type of debt that can be converted into shares of stock in the issuing firm at a predefined ratio. They often have a coupon rate that is not particularly high. The ability to convert the bond into common stock at a significant discount from the company’s market value is the primary form of compensation that is provided to the buyer of the bond. When bondholders convert their bonds into new shares, it will have the effect of diluting the earnings of current shareholders as well as their ownership of the company.
- An indenture is a contract that is made between the corporation that issues the long-term debt instruments and the lenders. The indenture provides specifics regarding the form of the offering, the manner in which the main obligation must be repaid, as well as the affirmative and negative covenants that are relevant to the long-term debt offering.
- Credit-rating agencies assign a numerical value to each debt issue based on how high of a risk it poses in comparison to other debt issues. The rating agencies take into account a variety of factors, including the consistency of a company’s earnings, interest coverage ratios, debt as a percentage of total capital, the degree of subordination, and the company’s historical performance in meeting the requirements of its debt service obligations.
Financing Of Cross Border Acquisitions In India
- The Reserve Bank of India (RBI) has announced guidelines that limit an Indian bank’s capacity to finance the acquisition of equity shares. Under general, a bank cannot finance a promoter’s contribution to equity, and banks cannot finance the acquisition of equity shares.
- Financing for a domestic acquisition is typically obtained from non-banking financial companies (NBFCs) or through the issuance of non-convertible debentures (NCDs) by the acquirer, which can be subscribed for by foreign portfolio investors (FPIs), mutual funds, and alternative investment funds (AIFs).
In India, cross-border acquisitions are typically divided into the following two categories:
- In which an international acquirer purchases the shares of an Indian target.
- The acquisition of an Indian target by a foreign-owned and controlled operating company (FOCC) incorporated in India is a modest variant on this structure (which is a subsidiary of an offshore entity).
- In which an Indian acquirer acquires a company incorporated outside India directly or through an outside India-incorporated special purpose vehicle (Offshore SPV).
- For an inbound acquisition where the acquirer is located abroad, the loan market consists mostly of international banks, capital markets, financial institutions, and overseas debt funds.
- Due to Indian exchange control restrictions, such acquisition financing cannot be secured by a pledge on shares of the Indian target, a charge on the assets of the Indian target, or assurances from the Indian target. In addition, Indian banks, Indian financial institutions, and domestic funds cannot lend to an offshore organisation for the acquisition of shares in an Indian company.
- It is possible for an Indian business to obtain finance in foreign currency from offshore lenders in the form of external commercial borrowings (ECB), but this type of funding cannot be put toward equity investments within the country.
- The issuance of NCDs that are open to subscription by FPIs is the major source of debt capital that a FOCC can utilise in order to acquire an Indian target. This funding can be obtained by the FOCC in order to complete the acquisition.
- An Indian acquirer has the ability to borrow money from Indian banks, financial institutions, and other lenders for the purpose of an overseas purchase. In addition, if the acquisition of the offshore target is being done through an offshore special purpose vehicle (SPV), then the offshore SPV is able to borrow funds from offshore lenders, and other financial institutions located offshore
- The Insolvency and Bankruptcy Code of 2016 (IBC) has made it possible for distressed enterprises in India to be acquired through a statutory process, which opens up new purchase opportunities. These kinds of acquisitions on the domestic front have, in some instances, taken the form of leveraged buyouts.
- The Reserve Bank of India (RBI) has also launched the Prudential Framework for Resolution of Stressed Assets on June 7, 2019. This framework mandates that banks resolve a stressed asset in a manner that is time-bound and may involve resolution through a change in the ownership of the borrower. It is possible that some leveraged buyouts will take place during these restructurings.
Use of LMAs or Other Standard Loans
- Credit agreements and inter-creditor agreements for any acquisition financing will typically be based on the most recent forms published by either the Asia Pacific Loan Market Association (APLMA) or the Loan Market Association (LMA), depending on whether the financing is in a foreign currency and was obtained from foreign lenders.
- When it comes to the distribution of NCDs, the Companies Act of 2013 stipulate a few requirements for the debenture trust deed that must be met. If the NCDs are traded on a stock exchange, then the debenture trust deeds are also subject to the various requirements that are set forth by SEBI. In addition, the information memorandum or the offering memorandum for NCDs must be in a format that is required by the Companies Act and applicable SEBI regulations.
The Fund Raising Structures
The funds can be raised through the following modes:
Inbound Acquisition Finance: Offshore Acquirer:
- The offshore purchaser will establish a special purpose vehicle outside of India known as an FDI SPV for the purpose of acquiring shares of an Indian target through the channel of foreign direct investment (FDI) into India.
- In order to provide funding for the acquisition, the FDI SPV obtains senior loans from financial institutions located in other countries. These loans are backed by the whole FDI SPV’s asset portfolio as well as their shareholdings (other than the shares of the Indian target and any other Indian asset).
- A non-disposal undertaking is generally obtained in relation to the Indian target shares held by the acquirer, in conjunction with a pledge on the acquirer shares, because there are restrictions under Indian exchange control laws on pledging shares of an Indian target to secure acquisition finance availed by the FDI SPV.
Inbound Acquisition Finance: FOCC
- Foreign Owned and Controlled Company (FOCC) is not permitted to use leverage in the Indian market in order to purchase shares, hence a FOCC is unable to obtain acquisition financing from Indian banks, financial institutions, or Indian funds.
- If the acquisition is made through a FOCC, then the debt that is needed to finance it can be issued by the FOCC in the form of NCDs, which are then purchased by FPIs. NCDs are organised as senior debt and are secured by all of the assets owned by the FOCC in addition to a pledge on the shares of the target company.
Outbound Acquisition Finance
The following types of finance structures are commonly utilised when an Indian acquirer is the one to directly complete an outbound acquisition.
- Onshore financing: Indian company is able to raise loans from Indian banks in order to complete an outbound acquisition. The Indian business may put the funds from these loans toward the purchase of equity in foreign joint ventures or wholly owned subsidiaries An Indian acquirer can also raise finances from NBFCs in India or raise funds via issuing of NCDs, which can be subscribed to by domestic mutual funds, AIFs, and FPIs. Both of these methods can be used for the purpose of financing such an acquisition.
- ECB: ECB can be used by Indian companies for acquisition of shares of an overseas joint venture or wholly owned subsidiary.
Financing from Offshore Sources:
- In some instances, the Indian acquirer will establish an offshore special purpose vehicle (SPV) in order to purchase the target in accordance with the criteria pertaining to overseas direct investments that were published by the RBI.
- After that, monies are borrowed by the Offshore SPV from offshore lenders, funds, capital markets, and other financial institutions.
Domestic Acquisition Finance
- The majority of the time, financing for domestic acquisitions is organised as NCDs or loans from NBFCs.
- Investors are not permitted to use the proceeds from unlisted NCDs to purchase securities on the capital market. In addition, the proceeds from a public offering of listed NCDs cannot be used to purchase the shares of any person who is a member of the same group or who is managed by the same organisation as the issuer of the NCDs.
- At the time of investment by the FPI, non-convertible debt obligations (NCDs) are required to have a minimum maturity or length of one year. Any investment in NCDs made by a foreign portfolio investor (FPI) is subject to the RBI’s concentration limits, as well as any other individual or group investor limits that may apply.
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