258 5 Equity and Shareholders’ Capital
The Second Directive further provides that “shares must be offered on a pre-
emptive basis to shareholders in proportion to the capital represented by their
shares” “whenever the capital is increased by consideration in cash”.^620 Now, a
share exchange means that the capital will not be increased “by consideration in
cash”. However, the laws of some Member States may provide that existing
shareholders have pre-emption rights even in this case; in addition, they may pro-
vide that the board can be empowered to decide on the withdrawal of those pre-
emption rights.^621 In practice, it would be legally more complicated to let the gen-
eral meeting decide on the withdrawal of pre-emption rights. For example, there is
the question of time. In addition, it would force the board to disclose more infor-
mation. The Second Directive requires that the board present to the general meet-
ing “a written report indicating the reasons for restriction or withdrawal of the
right of pre-emption, and justifying the proposed issue price”.^622
Second, the firm can decide to make an all-cash offer or a combined offer in-
stead. (a) From the perspective of the target’s shareholders, the benefits of a share
exchange offer depend on whether they want to become shareholders of the of-
feror in the first place. Their benefits also depend on the valuation of the offeror’s
shares and the target’s shares. The valuations may change during the offer period.
Generally, a share exchange offer is less transparent than an all-cash offer. If the
target’s shareholders can choose between competing offers, they might prefer an
all-cash offer. (b) A share exchange is, of course, easier when the target is a pri-
vately-owned company, the offer is friendly, and there are no competing offers.
(c) A share exchange offer means that the target’s shareholders will become
shareholders of the offeror. This can be in the interests of the offeror. However,
the offeror’s existing shareholders may prefer not to accept the dilution of their
holdings. A share exchange can therefore be easier when the offeror is a large
listed company with a controlling shareholder block rather than a listed company
with a dispersed share ownership structure and activist shareholders (hedge
funds), or a privately-owned company with controlling shareholders that want to
hold on to their power.
Third, if the firm makes a share exchange offer, the firm should ensure that a
sufficiently large number of the target’s shareholders will accept the offer. (a) One
of the differences between a share exchange offer and a formal merger is that the
target’s shareholders are free to accept the exchange offer or hold on to their
shares. The firm may need a large block of shares in order to control the target.
The size of the block depends on the governing law (Volume I). For this reason,
share exchange offers tend to be conditional on the offeror obtaining, for example,
more than 50%, more than two thirds, more than 75%, or more than 90% of the
capital or votes of the target. (b) In addition, it would be in the interests of the firm
to ensure that the target is contractually bound to co-operate. For example, the par-
ties may agree on the duty to co-operate and the duty to pay a break-up fee should
the deal collapse.
(^620) Article 29(1) of Directive 77/91/EEC (Second Company Law Directive).
(^621) Article 29(5) of Directive 77/91/EEC (Second Company Law Directive).
(^622) Article 29(4) of Directive 77/91/EEC (Second Company Law Directive).