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Basic concepts Internal finance means profits generated by a company to meet obligations such as interests’ payments, tax liabilities, assets acquisition (also known as retained earnings). External finance can be split broadly into debt and equity finance. They can also be further classified into short-term (less than one year), medium term (between one year and five years) or long term (more than 5 years). Short term finance includes bank overdrafts, trade creditors and short-term loans. Medium to long term finance includes shares and bonds.

Pecking order of finance Pecking Order Theory (Donaldson 1961). Suggests that when a company is looking at financing its long-term investments, it has welldefined order of preference with respect to the sources of finance. Preference: Internal finance, debt, equity. Rationale:  Cost and availability. Retained earnings are readily accessible, have no issue costs and do not involve dealing with third parties. Although, the cost of issuing new debt is much smaller than the cost of issuing new equity. It is also possible to raise small amounts of debt, but not equity.  Asymmetry of information. Negative signalling to the stock market is associated with issuing equity, positive signalling associated with debt.  Tax. Interest payment arising from debt is tax-deductible, but not dividend payment to shareholders.

Optimal capital structure Miller and Modigliani 1958 model. Assuming the absence of tax and bankruptcy risk, the model proposed that, as the level of equity financing replacing by an equal amount of debt, the increased cost of equity is exactly offset by the increased total cost of debt and therefore, the company’s weighted average cost of capital is constant regardless of the ration of debt – equity. Final model 1977 Took bankruptcy costs into account. In reality, at high levels of debt, there is a significant risk of a company defaulting on its interest commitments and hence being declared bankrupt. Therefore, financiers require a higher rate of return, offsetting the benefits brought about by tax saving. There exists an optimal debt – equity ratio.

Valuing an income stream £100 today is not equal to £100 tomorrow. £100 today will generally be worth more than £100 tomorrow (assuming inflation is the norm rather than deflation).

Linking law and finance La Porta – examined legal rules covering protection of corporate shareholders and creditors. Origin of these rules and the quality of their enforcement in 49 countries. They have alleged that the legal environment matters for the size and extent of a country’s capital market. A good legal environment protects the potential financiers against expropriation by entrepreneurs. Investors are willing to surrender funds in exchange for securities and therefore expand the scope of capital markets. Based on their findings, they have claimed that the French civil law countries with the weakest investor protection have smaller and narrower capital markets.

Does the UK have a strong financial market? London is 2nd to NY (according to Global Financial Centre Index). Top 8 largest exchanges of the world.

The UK takeover regime s.554(1) CA 2006. A shareholder is free to transfer his shares in accordance with the company’s articles. A takeover occurs when a company acquires sufficient shares to control the board of another company. A listed company’s shares are freely tradeable – one option is to acquire as many shares as possible on the open market. But there are usually not sufficient shares to affect the takeover of a listed company. The bidder will thus need to send a circular to all of the shareholders offering to buy their shares – a “takeover bid”. Cadbury: a notorious takeover Kraft was the world’s second largest food conglomerate – it launched a takeover bid in 2009. The board resisted and the government expressed concern about the suitability of Kraft.

Bid was eventually successful and takeover went ahead (amidst public outrage). Kraft was criticised for reneging on some of its promises, and some of the takeover rules were changed as a result of the takeover. The deal was heavily criticised in the British press.

Regulation of takeovers Directive 2004 The Takeovers Directive was intended to ensure that the equivalent regulation and protection was present throughout the EU. Currently given effect by CA 2006 s.942-992 and Sch 2. Directive requires each MS to have an authority to supervise bids. UK – body is the Panel on Takeovers and Mergers (independent body). s.943 the panel must issue rules to give effect to the Directive, and for other ancillary purposes. The rules are currently found in the City Code on Takeovers and Mergers.

The Panel on Takeovers and Mergers Had up to 36 members: - Chairman. - Deputy chairmen. - Up to 20 other panel members appointed by the Nomination Committee. - 12 members appointed by certain important financial and business institutions. Has several committees and an independently functioning panel executive. Panel executive carries out daily supervisory and regulatory functions and can provide guidance rulings as regards compliance with the Code. Function May in accordance with its rules “given any direction that appears to the panel to be necessary in order… a. To restrain a person from acting (or continuing act) in breach of rules. b. To restrain a person from doing (or continuing to do) a particular thing, pending determination of whether that or any other conduct of his is or would be a breach of rules; c. Otherwise to secure compliance with rules. The Panel also has powers (under s.947) to “by notice in writing” require certain documents to be produced. Appeals of rulings are to the Takeover Appeal Board (an independent body). Enforcement of the Code and the Panel’s decisions According to s.11(b) Code, Introduction, the Hearings Committee may: – Issue a private statement of censure. – Issue a public statement of censure. – Suspend, withdraw or impose conditions on any exemption, approval or special status that the Panel has granted to a person.

– Report the misconduct to the FCA or another appropriate regulatory body. – Publish a Panel Statement to the effect that the offender is someone who is unlikely to comply with the Code (this will result in ‘cold shouldering’). The takeover code s.2(a).

The Code There are six ‘general principles’, taken from art. 3 of the Directive; and 38 rules with detailed accompanying notes. The Code was significantly updated in 2011 in light of a review of 2010, as a result of the controversial takeover of Cadbury. The principles are broad guidelines, according to Introduction, s2(b), they are “standards of commercial behaviour”. The six general principles 1. All holders of the securities of an offeree company of the same class must be afforded equivalent treatment; moreover, if a person acquires control of a company, the other holders of securities must be protected. 2. The holders of the securities must have sufficient time and information to enable them to reach a properly informed decision on the bid; where it advises the holders of securities, the board of the offeree company must give its views on the effects of implementation of the bid on employment, conditions of employment and the locations of the company’s places of business. 3. The board of an offeree company must act in the interests of the company as a whole and must not deny the holders of securities the opportunity to decide on the merits of the bid. 4. False markets must not be created in the securities of the offeree company, of the offeror company or of any other company concerned by the bid in such a way that the rise or fall of the prices of the securities becomes artificial and the normal functioning of the markets is distorted. 5. An offeror must announce a bid only after ensuring that he/she can fulfill in full any cash consideration, if such is offered, and after taking all reasonable measures to secure the implementation of any other type of consideration. 6. An offeree company must not be hindered in the conduct of its affairs for longer than is reasonable by a bid for its securities.

Specific rules under the takeover code The procedure for bids pre-offer The bidder must identify and possibly informally approach a target.

If the target board is interested in a bid, there will be provision of condifential information to the potential bidder (due diligence). The offeror must first notify the target board or its advisers of a firm intention to make an offer – rule 1(a). All parties must treat confidential information pertaining to the bid as secret, and conduct themselves so as to minimise the chance of a leak – 2.1. An announcement is required where the target is subject to rumour and speculation, or the bidder is taking its discussion about a bid beyond a restricted number of people, or the obligation arises to make a mandatory bid – rule 2.2 The Procedure for Bids- Pre-Offer- the ‘put up or shut up’ principle (rule 2.6) Introduced as a result of the 2011 updates to the Code. An announcement of a “possible offer” (rule 2.4), released by the prospective bidder or by the target, triggers an automatic 28-day deadline. The bidder must either commit to a “firm intention to make an offer” announcement, or withdraw from the offer process. A withdrawal prevents the bidder from making any subsequent approach for a period of (usually) 6 months. The Panel may extend the 28-day deadline on request from the target company. The reason for ‘put up or shut up’ is to prevent potential bidders from announcing successive ‘possible offers’ so as to destabilise the target’s board and shareholders and create market uncertainty Financing the bid If the bidder purchase shares of a class: - In the three months before the offer (rule 6.1). - Or between the commencement of the offer and the firm offer announcement (rule 6.1). - Or between the announcement and the closing of the offer (rule 6.2). For higher than the offer price, then the offer must be increased accordingly. The offer document must lay down how the bid is to be financed. Bid procedure: the offer Once the formal offer documents have been posted to target shareholders, the offer is open to acceptance. The Code provides a long list of items that must be included in the offer (Rule 24)… Owing to the 2011 changes, the offer announcement must be made available to the employees’ representatives or employees, who have the right to have their views included in the directors’ response circular (rule 2.12(a)). The offer must also be published on a website on the same day (rule 24.1(b)).

In response to the Cadbury/Kraft takeover, the offer must (rule 24.2): • Explain the long-term commercial justification for the offer. • Explain intentions for the future business of the target company and its employees and management (including material changes to conditions of employment). • Strategic plans and consequences for employment (including locations of places of business). • Intentions in respect of employer contributions and the target’s pension scheme. If the bidder intends to make no such changes, or that its plans will have none of the aforementioned repercussions, the offer must contain a statement to that effect. Rules requiring equality of treatment Rule 14: • Where a company has more than one class of equity share capital, a comparable offer must be made for each class whether such capital carries voting rights or not. • An offer for non-voting equity share capital should not be made conditional on any particular level of acceptances in respect of that class, or on the approval of that class, unless the offer for the voting equity share capital is also conditional on the success of the offer for the non-voting equity share capital. • Classes of non-voting, non-equity share capital need not be the subject of an offer, except that on an offer for voting equity share capital, an offer or proposal must be made to holders of securities convertible into equity shares (Rule 15). Rule 32.3: • If an offer is revised, all shareholders, who accepted the original offer, must be entitled to the revised consideration Rule 16 • Except with the consent of the Panel, an offeror may not make any arrangements with shareholders if there are favourable conditions attached which are not being extended to all shareholders. Rule 36 • Offers for a proportion only of the shares or a class of shares are only possible if the Panel consents. Rule 6 • An offeror (or persons acting in concert) which purchases shares of a class in the three months before the offer period or during that period must either make or raise the level of the offer for that class to that paid outside it, if it is higher. Bid procedure – timetable The Offer document must be published and sent to shareholders within 28 calendar days of making the announcement of firm intention to make an offer (Rule 24.1). The Target board’s response circular on the offer must normally be posted 14 days following publication of the offer (Rule 25.1).

The Offer must remain open for acceptances for at least 21 days following its publication (first closing date; Rule 31.1). The target board should not, except with the consent of the Panel, announce any material new information after day 39 following the publication of the initial offer document (Rule 31.9). Offer may not be amended after day 46 following its publication, unless the Panel has granted approval for the offer to remain open beyond a period of 60 days following its publication. The offer may be extended beyond the first closing date. Without the consent of the Panel, the offer cannot remain open for longer than 60 days after the publication of the offer if at day 60 the offer is not unconditional as to acceptance (rule 31.6). If the offer has received enough shareholder acceptances to satisfy its acceptance condition at the first closing date or a subsequent closing date, the offer may remain open beyond the 60 day period and until further notice. If a competing bid is launched: the 60-day rule will be measured by reference to the publication of the competing bid. If the offer is extended beyond the first closing date but is not unconditional as to acceptance by day 42, shareholders who have accepted the offer are entitled to withdraw from the offer (rule 34). Once the offer has become unconditional as to acceptances, there must be an additional extended offer period of at least 14 days (rule 31.4). All conditions to the offer must be satisfied within 21 days of either the latter of the first closing date or the date the offer became unconditional as to acceptances (Rule 31.7). Bidder must pay target shareholders the consideration for the shares within 14 days of the later of the first closing date or the date all the conditions to which the bid was subject are satisfied (Rule 31.8). Timetable summary Day 0: Offer is made (< 28 days after firm announcement of offer). Day 14: Target board response circular. Day 21: First Closing Date. Day 39: Last date for target to publish material new information. Day 42: Withdrawal rights available to shareholders. Day 46: Last date for revision of offer. Day 60: Last date for unconditional acceptances. Day 74: Earliest date on which offer can close*. Day 81: All conditions to be fulfilled *. 14 days after offer is wholly unconditional: Consideration paid.

The Code: the No Frustration Rule Rule 21.1(a). Once the ‘no frustration’ rule takes effect, the permissible defensive tactics for the board are:

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Convincing shareholders not to accept the offer; and Persuade competition authorities that the bid should not go through; and Encourage a ‘white knight’ to come forward (NB: it is permissible for the board to agree an ‘inducement fee’ with the potential white knight, notwithstanding the general prohibition of inducement fees).

The response circular The board must circulate its own response circular (usually) within 14 days of publication of the offer document (rule 25). The response circular must also be published on a website on the same day (rule 25.1(b)). The board must obtain competent independent advice on the financial fairness of any offer (rule 3.1)- a summary must appear in the response circular. The opinion need not be based solely on financial matters.

Protection of Minority Shareholders: the Mandatory Bid The bidder must make an offer where it has already obtained de facto control of the company and might not wish to make a general offer to shareholders. Rule 9.1- When: a) Any person acquires an interest in shares which (taken together with shares in which persons acting in concert with him are interested) carry 30% or more of the voting rights of a company; or b) Any person, together with persons acting in concert with him, already holds not less than 30% but not more than 50% and who, alone or with persons acting in concert, acquires an interest in additional shares which increases the percentage of the voting rights held; then… Rule 9.1 (cont’d): Unless the Panel otherwise consents, such person must extend comparable offers, on the basis set out in subsequent provisions of Rule 9, to the holders of any class of equity share capital whether voting or non-voting and also to the holders of any other class of transferable securities carrying voting rights. An offer will not be required under this Rule where control of the offeree company is acquired as a result of a voluntary offer made in accordance with the Code to all the holders of voting equity share capital and other transferable securities carrying voting rights. The mandatory offer must be a cash offer, or with a cash alternative. It must be at the highest price paid by the offeror or a member of the concert party within the past 12 months prior to the commencement of the offer (Rule 9.5). It must not contain any conditions other than it being dependent on acceptances being such as to give the bidder more than 50% of the voting rights (Rule 9.3). Being forced to make an offer may have a major financial impact on companies forced to make an offer.

Parties must seek waiver by the Panel if they wish to be exempted from making a general offer. The Definition of a “concert party” is important as: • All shares of those “acting in concert” are counted towards the 30% threshold. • Every member of the concert party may be forced to make a bid (Rule 9.2). Concert Party: “Persons acting in concert comprise persons who, pursuant to an agreement or understanding (whether formal or informal) co-operate to obtain or consolidate control of a company”. Examples… - A company, its parent and fellow subsidiaries, and their associated companies (20%+ shareholding). - A company and its directors (and their close relatives). - A person and the person’s close relatives.

After the bid – squeeze-out A bidder has a right to buy out minority shareholders (CA 2006, s.974-991) when: • The offer has been accepted by at least 90% in value of the shares bid for and… • If the shares are voting shares, those shares represent at least 90% of the voting rights carried by those shares. • 90% rule relates to the shares bid for, not the total number of shares of the class: excludes shares already held by the bidder. • Shares acquired after the date of the offer but outside the bid may only count toward 90% threshold if acquired at the same price or less than paid under the original offer (s.977). Examples of when a squeeze-out applies • The bidder purchases 32% of shares in the target company. • This triggers a mandatory bid. • The takeover bid relates to 68% of the shares (the bidder has already purchased the other 32%). • For squeeze out to be triggered, 90% of the shares bid for must be accepted. • This is 90% of the 68% - i.e. 61.2%. • When 61.2% of the shares bid for are accepted, this must be added to the 32% that the bidder already owns. • 61.2% + 32% = 93.2%. • The remaining 6.8% can be squeezed out. • A stubborn shareholder with a 6.9% or more shareholding cannot be squeezed out (she may hold out for a higher offer than the takeover (called ‘greenmail’)).

After the bid – sell ou...