Serial article regarding M&A on NNA (vol.96)

In this issue, we will discuss the valuation and relationship with business partners in the case of M&A and IPO.

Continuing from the previous issue, this article discusses M&A and IPO (Initial Public Offering) as exit strategies for start-up companies.

1 Valuation

In the case of IPO, the amount of net profit for a certain period is generally required. For example, the requirement for the main market in Malaysia is that the company has been operating in the same business for the past three to five fiscal years, with a total after-tax profit of at least RM20 million and a total after-tax profit of at least RM6 million in the most recent fiscal year. In the case of Ace Market, the requirement is that the company has an after-tax profit of at least RM3-4 million (refer to the article No.76). The reality is that it is therefore difficult for a company with a loss-making structure to be approved for listing.

On the other hand, in M&A there are no set rules on the calculation of enterprise value and the company/business can be sold for an amount agreed by the seller and buyer. In the calculation of enterprise value, we take and compare (i) income approach, (ii) market approach and (iii) net approach and evaluate comprehensively (the calculation of enterprise value will be discussed in a later article). Suppose that the target company is in loss-making situations, even still, (i) when the income approach is taken, the enterprise value will be positive if the future earning capacity is assessed as positive, (ii) when the market approach is taken, the price book value ratio (PBR) and EBITDA (earnings before interest, tax, depreciation and amortisation) ratio may be positive, and (iii) when the net approach is taken, the enterprise value will also be positive if the net asset value is positive. Thus, in some aspects, the calculation of enterprise value in M&A is more likely to come out positive than IPO, and M&A can usually be carried out even if an IPO is difficult.

2 Relationship with business partners

In general, IPO is a welcome development for business partners because a company’s listing increases its credibility.

On the other hand, the realisation of an M&A involving a change of control of a company (especially when shareholder holding more than 51% of the voting rights is changed) often changes the nature of the target company. This can therefore have a significant impact on business partners, who may have entered into business relationship trusting the attributes of the target company’s shareholder. For this reason, so-called change-of-control clauses may be provided in the contract typically in loan agreement between banks, in which case the business partner can forfeit the benefit of time (thereby, for example, forcing the full amount to be repaid in a lump sum instead of in instalments) or terminate the contract between the target company to be M&A. Thus, if a change-of-control clause is included in an important contract of the target company, it can be an obstacle to the realisation of M&A, and the buyer shall carefully investigate whether such clause exists during due diligence prior to M&A execution.

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