Capital - The Factor of Production

Even in good times, correctly structured funding and adequate cash resources are central issues for every firm. In many sectors, medium-sized operators are in a cut-throat fight for survival with the big groups, which are eager for expansion and – unlike medium-sized and small family businesses – have access to massive financial resources and can generally obtain finance without any trouble on the capital market.

The typical advantages of small and medium-sized firms, such as great flexibility, the willingness to take risks and to perform, quick decision-making, and closer proximity to the market, etc., are not able to compensate this decisive competitive disadvantage. In economies where the production factor capital is increasingly becoming the dominant competitive criterion, medium-sized firms are slowly dying out. Because:

• What is the use of market opportunities, inventions or new ideas if there is insufficient cash to exploit them?
• How can you take on large orders if your bank will not pre-finance?

Difficult times – world financial crises, recession and economic revival

There are three phases in the business cycle when inadequate financial resources cause problems for medium-sized firms:

During a recession, the poor payment record of customers, and possibly losses due to low capacity utilisation within the firm, lead to cash shortages. In recent years, the payment record of firms has deteriorated sharply in the majority of countries. It is not unusual to take six months or even longer to settle the bills. If customers actually take longer to pay, then small and medium-sized suppliers will need more working capital.

During an economic downslide losses are sustained faster than one would think. Although smaller firms are not as cost-inefficient as large companies, but nevertheless it usually costs money at first to adjust capacities in line to the lower demand (severance pay, etc.). In many cases, it is not possible to continue covering the overheads (leasing, rents, etc.) if capacity utilisation declines. The resulting temporary losses erode the available cash resources. In the upswing phase, the growing influx of orders increases the need for finance.

During an economic revival large numbers of business insolvencies occur not without reason. Firms which have been bled dry financially during the recession phase must then buy in goods and recruit staff to fulfil the new orders. Often, they are so pleased at the increased demand that they forget that these “investments” also have to be financed.
In 2009 and 2010 economic experts anticipate the worst market downturn since WWII, talking about a worldwide financial crisis, even a world economic crisis. The financial crisis which started in the USA reaches now the real market. Over 80% of the American banks tightened the criteria on borrowings for small and medium-sized firms and in Europe the partially over-tightened Basel II regimentation is added. Medium-sized firms can be driven into a financial squeeze at short notice. Large companies and banks hoard huge money holdings at this time. Also medium-sized businesses should extend their cash assets reserves considerably now.


The cause of the shortage of capital in medium-sized firms

The majority of medium-sized firms have too little capital of their own. The heavy burden of taxation hits them particularly hard by seriously eating into their earning, making it almost impossible to accumulate profits. The days when the golden rule for balance sheets (1/3 own capital) still applied in business practice are long gone for most firms.

In addition, The pressure of competition is squeezing the margins. But problems of the firms’ own making, such as inadequate cost management, inefficient marketing structures etc., reduce the profits and thus also lead to unsatisfactory capital ratios.


Weak Point – Communication with Banks

It is becoming increasingly difficult for medium-sized firms to procure borrowings. Especially now banks are careful with granting loans in times of crises. The banks take a highly critical view of this sector, and particularly the distributive trades. The big banks are especially reticent in dealing with medium-sized firms. The business customer departments of the banks circulate black lists, in which loan exposures for particular categories of business are classed as too risky.

The medium-sized entrepreneur’s lack of experience in dealing with banks is often a serious impediment, too:

Banker and businessman do not always speak the same language, so they do not understand one another’s problems. It is difficult to come to an understanding and therewith a solution which is in the interests of both parties.

The presentation of the business, its plans and cash requirements sometimes fall short of what the banks expect in terms of a professionally prepared set of business documents. Cause: Medium-sized firm’s commercial department is not familiar with bank standards.

Firms often neglect to cultivate their image in relation to the banks. Even in good times, the banks expect reports at regular intervals on the firm’s situation and progress.

Anyone who does not know how to market oneself and one’s business appropriately for the banks has little chance of success.


Totally at the mercy of the banks

In many cases, the medium-sized firm’s dependence on a bank is a serious problem, if the firm has put itself totally at the bank’s mercy by assigning all its collateral (including personal guarantees).

The only way out is to quietly build up relations with other banks by skilful negotiation. Anyone who can create competition between banks on a partnership basis can make best use of their potential for his own business purposes.


Strategic and operational financial advice

Suboptimal financial structures increase the operating expenses and strategic hurdles on the long road to business success. Adjustment of their business finance in line with their strategic goals is a key feature of businesses which achieve lasting success.

Only an experienced financial manager can develop an overall financial concept. Unlike large groups, smaller firms cannot set up their own financial department to deal with this task. They therefore have to rely on external support.


Requirements for an external advisor

When using an advisor you have to bear in mind that many consultancies do not have adequate experience in the field of financial advice.

The advisors at JP Mergers & Finance AG have duly gained expertise and experience in the structuring and procurement of financial resources in excess of EURO 2.5 billion in the course of their professional careers. The volume covers fields apart from financing by banks such as stock exchange issues, private placements etc.

The range of services performed by JP Mergers & Finance AG includes:

• Development of a total financial package for your firm
• Choosing the right banking partner for you
• Procuring equity capital and borrowings (including special central and regional government funding)
• The building up of cash assets reserves in crises situations
• Implementing the package in your business by a specified deadline, using a qualified interim manager.

Having worked for many years on an international basis with investors and banks, JP Mergers & Finance AG can procure you equity capital and borrowings:

• to implement the financial package for your firm
• to build up financial reserves in cases of necessity
• to finance acquisitions
• to execute management buy-outs & buy-ins
• to finance selected projects

Use of an interim financial manager means that your management team can concentrate on the operational management of the business. By taking over a specified range of these tasks for a limited time, JP Mergers & Finance AG exercises stringent discretion in relieving you of additional fixed costs.

Depending on the volume of capital needed and the maturity and nature of the funding, the fees for financial advice range between 1 - 5 % of the equity capital and borrowings procured. Substantial parts of the fees are performance-related.

Our qualified team of advisors is familiar with the modern range of financial instruments (such as feasibility study / cash flow based project analysis, etc.).
The banks acknowledge JP advisors as dialogue partners on account of their background, e.g. as former financial managers of successful firms. This experience and contact with over 400 banks result in constructive solutions in the procurement of borrowings.

In addition, JP Mergers & Finance AG, as a consultancy independent of the banks, operates successfully in procuring equity capital. The volume of business done by JP advisors is in excess of €1 billion. The JP Mergers & Finance AG carries out the entrepreneur’s intentions:

• seeking investment partners (e.g. equity investment companies)
• business acquisitions
• business disposals
• organising succession

For further information contact our managing director, Mr. Heinz Jäger, phone: +49 6182 99 04-83 , or email: Vorstand@JPMergers.com
We will be pleased to arrange a personal meeting to explain what we have to offer.

This article will be continued in the next edition of the JP Director’s Report

The terms “Asset Deal” and “Share Deal”, fundamental organisation forms of business transactions, are without doubt part of the basic repertoire of the M&A business, and give sufficient reason to discuss the subject in our section “Tips & Tricks”.


Share Deal – Principle and Concept

During a so-called Share Deal company’s proprietorship (e.g. shares, limited or private limited company shares) is sold. The legal technicality of the implementation is carried out by an acquisition with a subsequent (material) assignation of shares (transfer). Contractual partners are the present shareholders as seller and the new shareholders as acquirer. The agreed terms of payment take place on the level of seller and acquirer.

The transaction object i.e. the business or shares of the business to be realised, will not be impacted by the new ownership structure through the Share Deal. The advantages of the Share Deal are also based on these circumstances: the transaction object, within the bounds of a Share Deal, can relatively simple and at large to be transferred. All assets and legal relations (e.g. labour contracts, customer - and supplier conditions, etc.) of the business stay untouched by the transaction and are automatically (indirect) turned over to the new owners. An exception to this is the so-called Change of Control clauses in the contracts of the business with a counterparty or financial partner. These clauses could considerably change the ownership structure of a business e.g. grant special rights of cancellation to the respective partner. Often these clauses are used in loan agreements or competition sensitive business partnerships. One part of the “Due Diligence” audit prior to a transaction is usually the analysis of the legal contract for such regulation.

The lawful formal requirements for Share Deals depend on the legal form of the transaction asset. Basically there is a freedom of form design for acquisition of shares from a public limited company or partnership, only the acquisition of private limited company shares must be notarised. It goes without saying that within the M&A practice individual negotiations and sometimes comprehensive agreements govern the rights and duties of the contractual partners.

By the way, we experience daily Share Deals in the broadest sense at our international stock exchange centres, where a share of a company, in terms of shares, change ownership. The before mentioned simple fungibility of shares is the fundamental condition for the trade of shares at the stock exchange.


Asset Deals – Principle and Concept

During an "Asset-Deal" itemized assets and/or legal relationships of a company or a company's share, which together present the assets and liabilities of the business or business parts are sold. Therefore assets could be real estate, moveable objects and legal relationships. The legal technicality of the transaction implementation takes effect through a sales agreement and the subsequent collateral transfer.

Contrary to the Share Deal the selling party is not the shareholder but the company itself. Therefore the purchase price payment is made at first to the company, and then can be passed on to the shareholder within the bounds of a dividend payout, a reduction of corporate capital or a liquidation. If the entire business concern is realised the current company is possibly left as an empty shell company after the transaction.

The motivation for an asset deal is often based on the principle of clarity, which defines, that only explicit and individual assets respectively legal relationships are passed on to the new owner. In practice we often find asset deals by realisation of single business sections/division or also when realising a company with a carrying risk history.

A possible risk field at an asset deal is the circumstance that legal relationships to a third party must not be necessarily passed on to the acquirer, since it is not a legal entity, but only a multitude of individual assets that are realised. If applicable, a third party verification (e.g. debtee) or basically a re-justification of the contractual relationship is also required.

The lawful formal requirements for an asset deal are based on the type of assets. The notarisation for the transaction contract in whole is imperative according to the German Civil Code if real estate is a part of the transaction contract or if a transaction of the entire capital of a company takes place. In principle freedom of formal design is given if the transaction pertains to individual moveable assets and arrears. If the sold business is managed in the legal form as a sole proprietorship, then only an asset deal is to be considered if the business is not brought into a private company.


Labour Law Aspect

During a Share Deal a smooth transaction of the privity of contracts occurs as mentioned before. This also applies for employments: Neither individual- nor collective labour agreements are touched by a Share Deal. Merely the requirements of the Works Constitution Act stipulate the notification of the economic committee within a grace period.

The situation of an Asset Deal is more complex. At first sight one would reach the conclusion that within the bounds of an asset deal possible personnel cuts could be done cost efficiently. But paragraph 613 a of the German Civil Code stipulates that also for an asset deal the acquirer has to take over the rights and liabilities of labour relations at the time of transfer. During a partial business transfer the respective assignment of employees has to follow. Likewise the tariff agreements are passed on to the acquirer if he does not have own tariff agreements. Furthermore the employees have the right to object. If the employees exercise their right, the labour contract remains with the seller. The duty to furnish information and the right of co-determination is governed in the Commercial Constitutional Law.

It is recommended to adequately involve the works council in due time during a business transaction of whatever transaction form regardless of the statutory regulations.


Guarantee and Liability

The decision - Asset or Share Deal - is affected occasionally by the aspect of liability risk.

The liability of old obligations at a Share Deal are clearly regulated by law: With the sale of the company the "history" of the risk area is also passed on to the acquirer.

The situation of an Asset Deal is different for the acquirer who is only liable for assumed risks or later accrued liabilities. An exemption for this would be the afore mentioned paragraph 613 a of the German Civil Code. Above all paragraph 75 of the German Revenue Code, and paragraph 25 of the German Commercial Code control the liability case by business transactions.

Additionally or deviant to the legal regulation the individual negotiated promises of liability and -guarantee are in general a part of transaction contracts. Insofar the liability situation is frequently approached in practice of the above described transaction form.


Balance Sheet- and Fiscal Aspects

Balance sheet- and fiscal aspects affect the discussion over Asset or Share Deals besides the liability aspects.

The interest of the seller is to pursuit, as expected, a preferable low taxation of the profit of realisation and therewith a high cash flow from the transaction price. Guiding principle in this coherence is that Share Deals are the typical designated transaction form by the legislator and mostly fiscally better assessed by the seller (keyword "partial income procedure"). In contrast during an Asset Deal system inherent e.g. hidden assets are exposed and tax paid.

On the other hand, the acquirer's interest is to offset against tax the expenditures for the acquisition of a company or a division as high as possible. That's why acquirers prefer the Asset Deal because paid intangible assets in the bounds of the transaction can be deducted from taxes in the following years.

It should be stated explicitly that the final arrangement of a company's transaction under fiscal aspects in dependence with the respective individual fiscal condition of the contractual partners should be conducted by experts.


Conclusion

As expected there is no general favourite by Asset Deals vs. Share Deals. The decision-making in the bounds of a company's transaction is complex and should not be carelessly carried out. It is advisable to deal at first with a preliminary determination of a position from the view of the seller at the start of an M&A project, and then to optimize it in the course of the project, depending on the respective situation with the transaction partner.
In either case it is imperative to involve professionals at an early stage.

Schillerstr. 101 • 63512 Hainburg • Tel.: +49 (6182) 990483 • Fax: +49 (6182) 990488 • Website: www.jpmergers.com
E-Mail: vorstand@jpmergers.com • CEO: Dipl.-Kfm. Heinz Jäger • Head of supervisory board: Adam Jörges
HRB 22655 AG Offenbach • VAT-Ident-Nr. DE-114 166 970

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