Chapter 14 • Corporate restructuring
Target shareholders receiving shares or loan notes that they do not wish to keep must
incur cost and effort to turn them into cash. The receipt of cash will, however, in most
cases be treated as a disposal for capital gains tax purposes, and many shareholders
would not welcome the possibility of a charge arising from this.
From the bidder’s point of view, cash may not be easily available and it may only
be possible to obtain it by making a public issue of shares or loan notes for cash, or
borrowing in some other form – a course of action that, for various reasons including
cost, the bidder may not wish to follow.Ordinary shares in the bidder business
Ordinary shares may be attractive to the recipients, who would simply cease being
shareholders in the target and become shareholders in the bidder. Before the merger
they hold shares in one business (the target) so are obviously not hostile to equity
investment per se. This is not to say that they wish to hold shares in the bidder, in
which case the problems of disposal, mentioned above, will come into play. From the
bidder’s viewpoint, issuing shares to exchange for those of the target has its attrac-
tions. Cash will not need to be raised, and the business will not be taking on the con-
tractual commitments to pay interest or to repay capital, as would be the case with
loan notes issues.
It is important to be clear that share issues have a cost to the bidder’s original share-
holders. Issuing shares as the consideration in a merger represents an opportunity cost
to the bidder. If the target shareholders are prepared to accept bidder’s shares, they
must see the shares as being worth owning. In view of this, the shares could equally
well have been issued for cash, either as a rights issue or as a public issue.Loan notes of the bidder business
Loan notes have their part to play but may have serious disadvantages from both
viewpoints, depending on the circumstances. As we have seen, loan notes create bind-
ing contractual obligations on the bidder as regards both interest and capital repay-
ment. To the equity holder of the target they represent a distinct change of investment:
a change to a risk/return profile that they may find unacceptable. Switching back to
equities will involve them in inconvenience and cost, possibly including a capital
gains tax liability. The advantages of loan notes in the merger context would seem to
be twofold:l To the bidder they would not have the effect of diluting control as a result of
extending its share ownership (loan notes holders do not usually have votes at the
annual general meeting).
l To the recipient they may have the attraction that, as they will have fixed interest
payments and usually have a fixed capital repayment date, their market value is
supported. Target shareholders who are sceptical about the future success of the
merged business may prefer an investment in it whose returns are more certain
than those from the equity capital.As well as the specific factors referred to in respect of each financing method, the
bidder will need to have regard to its desired level of gearing. Perceptions as to what
this should be may well change with the merger. The bidder’s management may feel
that, owing to perceived changes in risk caused by the merger, the merged business’s
gearing potential is different from that of the bidder alone.