The Path to Successful Equal Mergers

Too often, M&A involves a larger entity acquiring a smaller business. Only a few believe that a merger of equal can be possible, especially considering the power struggle between the two companies. However, a merger of equals can be a powerful strategy that could unlock tremendous value and opportunities for growth if done right. This episode explores the path to successful equal mergers featuring Scott Crofton, Partner at Sullivan & Cromwell LLP.

The Path to Successful Equal Mergers

31 Jul
Scott Crofton
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The Path to Successful Equal Mergers

The Path to Successful Equal Mergers

“Mergers of Equals must be mutual to be successful. What you’re giving is what you’re getting, and you’re basically both the buyer and the seller in the deal.” – Scott Crofton

Too often, M&A involves a larger entity acquiring a smaller business. Only a few believe that a merger of equal can be possible, especially considering the power struggle between the two companies. However, a merger of equals can be a powerful strategy that could unlock tremendous value and opportunities for growth if done right. This episode explores the path to successful equal mergers featuring Scott Crofton, Partner at Sullivan & Cromwell LLP.

special guests

Scott Crofton
Partner at Sullivan & Cromwell LLP

Hosted by

Kison Patel

Episode Transcript

Mergers of equal

A lot of people think that there's no such thing as a merger of equals, but the reality is that there are deals that bear the hallmark of a merger of equals. So when we talk about an acquisition, what we're really discussing is 

  • A deal in which there's a premium being paid to take over control of a company. 
  • The target company stockholders are receiving a 30 to 50% premium on their stock. 
  • The controlling company gets to call the shots, the CEO of the buyer gets to run the combined company, and the company is certainly not changing its name. 
  • Any changes to the board of directors would be modest at most if those take place, and the culture of the combined company is really going to inherit the culture of the acquirer.

A merger of equals is designed to be different from all of that. It's intended to be a transaction in which no one is taking control. So there's no control premium paid to one side or the other. The deal is typically structured as a stock-for-stock deal, so it's tax-free, which gives it a nice economic boost to the deal's economics. 

There are a lot of social issues, because if you're not having one company acquire the other, then there's no one party that gets to call the shots. You need to resolve those social issues in an equitable way that's going to leave both sides comfortable with the idea of combining two companies that have, to at least some extent, a different culture.

These social issues can be thorny. Topics like who's going to run the combined company, who's the CEO, the succession plan at the CEO level, the board's composition at the combined company, how to take two boards and turn them into one, and making that board a manageable size all need to be addressed. 

Other considerations include how to allocate subcommittee positions, the company's headquarters location, the focus of power, and the company's name. There are many different questions that come up, and a lot of times mergers of equals die before they get too far due to intractable issues related to these soft social issues that arise.

Managing mergers of equal

First, on the tax side of things, there are ways to structure a deal so that if you're not receiving cash in exchange for your stock but instead receiving a different form of stock, the government doesn't view that as a taxable event. 

As a stockholder, you maintain the basis you had in Company A in the new Company B or the combined company. You never have a taxable event. It's basically like you just continue to hold your stock. 

If you bought Apple 30 years ago and haven't sold it, you haven't had a taxable event occur yet. The same thing applies to a merger of equals – it doesn't trigger that. There's no involuntary taxable event that takes place. That's fairly easy to structure in an all-stock deal.

From the perspective of the stock premium or the lack of a stock premium, you ultimately need to come up with a third-party way of valuing that. For two public companies, you're going to compare and contrast. For example, Company A's stock is at 37 for a market cap of 5 billion today, and Company B's stock is at 65 for a market cap of 4.8 billion today. There will always be a degree of argumentation as to which measurement to use, such as the volume weighted average price (VWAP), whether it's 20 days, 60 days, or another duration. But you're going to use the two market caps to compare, and you're going to come up with a method to determine an exchange rate that reflects just swapping one stock for the other.

This usually leads to a very small premium, and it depends on what mechanism you use as to whether there is a premium or how it's calculated. Many people do the same math and come up with a slightly different number, but there's no 30 to 50% premium that we see in many M&A takeover type transactions.

Private deals

Private deals are trickier, there's no question. I've done one of those. It involved a company called Inventive, which was private equity-backed, and it conducted a merger of equals with another company called INC, which was public.

The answer is, it's really the same way you conduct any other private deal. You eventually need to find a valuation for a private company. You're going to use the typical tools that bankers use. There will be some sort of discounted cash flow analysis, where they'll look at future earnings and discount those to try to come up with the math that would work.

There's also a sum-of-the-parts analysis, where you try to evaluate individual pieces of the business and decide what it's worth altogether. You look at comparable transactions for companies with similar EBITDAs and other financial metrics, and you try to compare those. You're comparing Company A with Company B.

If Company A has 6 billion in revenues and a billion dollars in profits and Company B is very close to that, you probably recognize that the valuation here is overall pretty close. It may not be quite as scientific as using a volume-weighted average price, but the same idea still applies.

It is certainly more common in the public setting, I would say, and it's a transaction that only works in certain circumstances because of all the soft social issues that I described. It works best in a situation where there are two CEOs with complementary visions of the world and where one CEO is prepared to no longer be the CEO of the combined company. 

Maybe they want to step up to a more senior role to be the chairman of the board and are ready to retire from full-time duties. Or maybe there's going to be a transitional plan in place where one person is going to be the CEO for a few more years, help groom their successor, who would be the other CEO who would then ultimately step into the role of CEO.

You need to have the right mix of CEOs at the right point in their career cycle and the two companies in the right place where it makes sense. There should be a ton of synergy, and their cultures shouldn't be so dissimilar that they can't find a way to make things fit together. It's a tricky dynamic, but I think it's most common in the public space where those factors are in place.

If one CEO doesn't want to step down, it usually doesn’t work. There are examples of some of the world's biggest mergers that have been failures. Mergers of equals, such as AOL Time Warner, have been failures. That particular deal is generally recognized to be one of the worst in corporate history.

There are situations where it doesn't work, and a merger of equals should be viewed as the exception in the M&A world, not the rule. Acquisitions are more common, but there are situations where two similarly sized competitors with complementary businesses can combine in such a way that one plus one doesn't equal two, it equals three. 

It's just a question of finding the right situations and putting in place the right conditions and rules around how the combined company is going to be run, so that it actually works and the combined company becomes a cohesive whole.

The management team under mergers of equals

Different deals make those decisions on different timelines. In some deals, you'll pre-bake everything upfront, where you have decisions on roles like the CFO or the GC. In other deals, these conversations take place at such a high level, with the chairman of the board talking to the chairman of the board, that it becomes a board-driven process, unlike most deals which are more management-driven. Sometimes, you don't get into all of that at the earlier stages.

The two CEOs may have ideas about how it works, and when they have those conversations, there might be some informal understanding, but typically it's only the CEO role that's going to be formally documented and reflected in the public announcement of the transaction. 

In some deals, they take what they call a "best of breed" approach, meaning that they'll have people interview for their same roles at the combined company. One person will take charge of a twice as large company, while the other person may find a different role within the organization or move on to different things.

It's a concept that creates a lot of stress within an organization leading up to a merger of equals. That's why these conversations take place at a high level, and oftentimes they don't move forward at all. But when they do, this is what happens.

Board of directors composition

The board composition is typically not going to end up much larger than one or the other board. There are some key questions around who gets more directors versus the other side, and there are different ways to handle that.

One approach is to legislate exactly how it works. For example, one side has six, and the other side has six, resulting in an even number of directors. One side's company takes the chair role of two committees, and the other takes the chair role of the other two committees. You can prescribe things that way and then put in place supermajority rules so that those rules can't be upset for a period of time.

In other circumstances, you take the approach of "we're all in this together," forming a board with an overall similar number of directors. You hardwire the CEO rules, but otherwise, you have retreats and try to find a common ground so that you view yourselves as a combined company.

It really depends on the approach that people want to take, and we see both in nearly equal amounts.

Mergers of equal is the opportunity to create a company that you could never create in any other circumstance. Because you're functionally two companies that could never buy each other, this is the way to come together and create a much larger competitor. So a lot of the biggest companies in the world today, frankly, have been created by merger of equals in the past.

So the reality is that while it's not always fun for everyone involved in the transaction, it's a transformative deal. And it allows you to do a deal using no cash that creates a company that's twice as large, which is functionally undoable in any other way. 

The process of mergers of equals

In a merger of equals, initial conversations typically occur at the board level rather than the executive level, which can create significant disruption. Usually, a very limited number of advisors are involved, and only the boards of directors and the CEOs have these discussions. The CEOs may involve a couple of their direct reports, but not more than that.

The key social issues don't get hammered out most of the time. But things advance quickly only once an agreement is reached on those threshold issues. Negotiating the deal itself is typically rather easy because the parties know each other's business well. 

The deal is much bigger than any other deal you do, and the materiality thresholds of red flags will be much higher than they would be in any other circumstance. So the diligence is very targeted and focused on big-picture issues.

A bigger and outsized portion of the deal is around communications, as explaining to the markets why combining these two companies makes sense is a very delicate topic. Both parties are putting themselves in play and need a good story as to why this is the best decision and will create the most value for stockholders. Communicating with customers and suppliers is also crucial.

From agreeing on the key social issues to announcing the deal, the process is usually very short, taking only a couple of weeks. The LOI is usually a dinner conversation between the two directors. And it's usually a term sheet that spells out the social issues, such as the headquarters' location, the name of the company, and other key aspects.

The process is mutual, and it's easy to negotiate the contract because what you give is what you’re getting. In a merger of equals, both companies are essentially the buyer and the seller.

Diligence process

In a merger of equals, the diligence process is often more straightforward because both parties understand that whatever they request from the other, they will have to provide the same in return. This discipline helps clients focus on requesting information that truly matters and is relatively easy to produce, making the diligence process more orderly.

However, it's crucial to acknowledge that in large organizations, there might be individuals who have their own concerns and may not be completely on board with the decision. To manage this, deal teams and M&A process managers need to be disciplined about whom they involve in the deal and ensure they get the right advice on what issues matter and which do not.

In a merger of equals, passive-aggressive diligence behaviors might still exist, but the main concern is typically not the diligence process itself. The challenge lies in managing the expectations and concerns of various stakeholders within both organizations and ensuring a smooth transition as the companies merge.

The impact of mergers of equal

In a merger of equals, the goal is often to see a stock price increase for both parties involved in the transaction. The rationale behind this is that the combined entity should create synergies on both the cost side and the revenue side, streamlining operations and leveraging complementary businesses. This synergy should result in a situation where one plus one equals three, creating more value than the individual companies could achieve separately.

However, announcing a merger of equals also puts the companies involved at risk of being targeted by potential acquirers. During the period between the announcement and obtaining stockholder approval, the companies are vulnerable to an interloper offering a significant cash premium for the acquisition. 

This situation can pressure the management and board to justify the merger of equals and convince stockholders that the long-term value created by the merger is greater than the immediate premium offered by an acquirer.

To counteract this risk, it's crucial to communicate the logic behind the merger and the long-term value it is expected to create for stockholders, thereby insulating the companies from potential hostile bids during the approval process.

Real-life story of Hostile Bids

Our firm represented a company called Merck when it came in and bought a company called Versum, which had announced a merger of equals with another company called Integris.

They came in with a price that was a premium to the deal price and a premium to where the stock was trading. The target company, which was in the merger of equals, needed to assess it. So they would call their financial advisors. 

I don't have visibility as to what was going on on their side of the table, but they would talk to their financial advisors, get advice regarding the fairness of the consideration being offered in the stock deal, and examine all the pieces that went into the fairness analysis that underlay the fairness opinion the board had received, and compare it.

They would compare notes against what they were receiving as an all-cash deal, and then they needed to assess which deal was more beneficial to their stockholders financially if they were to complete it. Sometimes, the answer isn't initially a yes.

There can be a back-and-forth. The merger agreement likely includes a series of what we call deal protections. That means when a party to a merger of equals receives an unsolicited inbound proposal, they can consider it.

If they decide that the acquisition deal is superior to their merger of equals deal, then in those circumstances, they would first have to go to their merger of equals counterparty and say, "Hey, this deal is superior to the merger of equals that we're talking about. I'm sorry, we can't move forward with it." 

The merger of equals partner then has a chance to match and say, "I will sweeten the deal for you by doing X or Y in order not to terminate the transaction." Then the subject company, which is the target of the interloper bid and part of the MOE, needs to decide which deal is better for their stockholders.

If they ultimately decide the acquisition proposal is superior for their stockholders, they're going to need to pay a termination fee of, let's say, 3% of the deal value or the company's value. It's a significant number. They ultimately get comfortable with paying that premium because it's essentially the buyer or the interloper in this circumstance who's paying that premium.

They're buying the company, and when they acquire the company, they're actually taking over that premium for themselves.

Poison pill defense

A poison pill is a deal protection device that a company can adopt, effectively creating preclusive dilution for anyone over an ownership threshold. If you set a poison pill at 15% of the company's outstanding stock, they would be diluted in half if someone were to buy over that. It would be a disastrous scenario for them. 

No one has intentionally triggered a poison pill, so it's a powerful weapon to prevent someone from taking over a company. If the poison pill is put in place, anyone interested in acquiring that company won't burn through the poison pill; they'll try to replace the board and remove the pill before they do it. A poison pill is a very drastic weapon, but it can ultimately be overcome by taking over the board.

A poison pill is not typically in place for the average American company. It is something that companies adopt when a hostile acquirer comes in, and they're worried about someone buying up shares over a threshold. 

If they're concerned that an activist might come in and try to buy up control of the company to either vote down an existing M&A transaction or to acquire creeping control, then the board of directors has not only the ability but also the duty to prevent that interloper from taking control of the company without paying everyone a premium.

The poison pill is not in place at the typical company, but it is often something that companies have "on the shelf," meaning they have the ability to adopt it at any point in time. A board of directors can issue very small fractions of preferred stock that attach to every share of common stock, which is the stock traded on public markets. These tiny fractions of preferred stock have special rights that only go into effect once someone goes over the ownership threshold specified in the rights plan that accompanies those tiny fractions of shares of preferred stock attached to common stock.

These rights functionally create value for everyone else, except for the person who went over the ownership threshold. The poison pill is a sharp-elbowed device not designed to be used but to prevent someone from taking control without negotiating with the board.

Fairness Analysis

The concept of a board of directors having fiduciary duties, including the duty of care and duty of loyalty, is rooted in corporate law. When considering an acquisition of their entire company, the duty of loyalty is relatively easy to discharge, as it simply means being loyal to the company. 

In unconflicted transactions, this is straightforward. The duty of care, however, involves ensuring that board members have done their due diligence, which often entails relying on advisors and the management team for guidance.

An old case from the 1980s found that a board had not discharged its duty of care because they had not educated themselves about the value of their company before selling it. Since then, it has become market standard for any public company's board that  agrees to sell itself to get advice from a financial advisor and have that advice documented in a fairness opinion. 

This opinion informs the board that their professional advisors have conducted analyses and believe the transaction is fair to the company's stockholders.

While there are technical legal reasons for obtaining a fairness opinion, it is also valuable for a board to have such analyses. It is essential to have professionals who understand the industry conduct financial analyses, such as discounted cash flows, comparable transactions, and comparable companies analysis, to confirm that the value the stockholders will receive is fair. This not only provides the board with common-sense insight but also acts as a legal shield.

Financial advisors play a significant role in M&A transactions by offering comfort to the board of directors. Although the fairness opinion is a crucial, formal aspect of their role, they also contribute in various other ways.

Even in a private deal, a fairness opinion can be helpful when selling your company. It would be ultimately up to you to get it or not, but it's best to get one and understand what's a good price for the company. 


There is a robust plaintiff's bar in the United States, consisting of law firms that represent stockholders who may hold marginal amounts of shares. They often assert disclosure violations or fiduciary duty claims against the company, its directors, and sometimes its management. We frequently advise our clients that if they're doing a public company deal, they should expect to be sued.

We guide them through the process to inoculate both the company and the clients from any liability arising from those claims. However, they should be prepared for the likelihood of facing such lawsuits. Many of these claims are not particularly robust and often focus on what we would consider immaterial information. These issues can often be resolved through additional disclosure.

Once additional disclosure is made, these lawsuits frequently go away or are settled for a nominal amount or through a mootness fee. While the vast majority of deals face lawsuits, most of them are settled for a relatively small sum.

Pros and Cons of Mergers of Equal

Mergers of equals make deals possible that could never otherwise happen. They don't involve debt financing, so there's no need to access the debt capital markets. Neither company involved likely has the cash to complete such a transaction, so it unlocks an entirely new level of transaction possibilities. It allows highly complementary businesses to combine and create value.

Mergers of equals can also create natural succession plans in situations where a CEO is ready to move on, and there's a logical competitor or complementary business with someone looking to expand. It provides the opportunity to create legacy-building transactions that many senior executives and boards seek.

The biggest advantages of a merger of equals are the potential for value creation and the facilitation of strategic combinations that might not be possible otherwise. However, challenges arise when it comes to cultural fit and integration. Ensuring that the two companies can create a combined common culture that works for everyone can be tricky.

There's also the interloper risk that either company could be exposed to a takeover attempt, potentially disrupting the original plan for the merger. If a private equity firm or strategic buyer acquires one of the companies, the benefits of the combined companies may not be realized, and stockholders might be cashed out without having a say in the company's future.

Time frame of mergers of equal

Mergers of equals often involve a significant amount of regulatory filings due to their size. This is not necessarily different from other M&A deals, but larger transactions tend to trigger more filings. 

Additionally, the industrial logic of the transaction might make regulators take an interest in it, so it's crucial to have a good story as to why the deal is pro-competitive and beneficial for consumers.

Assuming there are no regulatory issues, the timeline for a merger of equals is typically around four months, which is not much longer than a public company acquisition. Both types of deals require a series of SEC filings to facilitate the stockholder meeting and complete the transaction. The key difference with mergers of equals is the potential for increased regulatory scrutiny and filings due to the size and complexity of the deal.

Best Advice

Make sure that there’s a good cultural fit. Considering the potential impact on employees, customers, suppliers, and stockholders is crucial, as the transaction should be value-creating and beneficial for all stakeholders. You don't want to go announce some big transaction and have it be value destructive and demoralizing to your organization.

A merger equals is not a deal for everyone. It is a bespoke transaction that makes tremendous economic sense and makes tremendous strategic sense but only in a very small number of situations, bigger doesn't necessarily equal better.

There must be a good story about why these two organizations fit together. It's going to make customers happy. It's going to make suppliers happy. It's going to create additional value for stockholders. If all those components don't fit together, then it can create challenges and can be value destructive.

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