Definition of 'Goodwill'
An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company is purchased by another company. In an acquisition, the amount paid for the company over book value usually accounts for the target firm's intangible assets.
Investopedia explains 'Goodwill'
Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset such as buildings and equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology.

Definition of 'Negative Goodwill'
A gain occurring when the price paid for an acquisition is less than the fair value of its net tangible assets. Negative goodwill implies a bargain purchase. Negative goodwill may be listed as a separate line item on the acquiring company's balance sheet and may be considered income. For the purchased company, negative goodwill often indicates a distress sale, and the unfavorable sale conditions lead to a depressed sale price.

Investopedia explains 'Negative Goodwill'
Negative goodwill is based on the concept of goodwill, an intangible asset that represents the worth of a company's brand name, patents, customer base and other items that are difficult to price but that help to make a company valuable. Most of the time, a company will be purchased for more than the value of its tangible assets, and the difference is attributed to goodwill. When the price paid is less than the actual value of the company's net assets, you have negative goodwill.
Definition of 'De-Merger'
A business strategy in which a single business is broken into components, either to operate on their own, to be sold or to be dissolved. A de-merger allows a large company, such as a conglomerate, to split off its various brands to invite or prevent an acquisition, to raise capital by selling off components that are no longer part of the business's core product line, or to create separate legal entities to handle different operations.
Investopedia explains 'De-Merger'
For example, in 2001, British Telecom conducted a de-merger of its mobile phone operations, BT Wireless, in an attempt to boost the performance of its stock. British Telecom took this action because it was struggling under high debt levels from the wireless venture. Another example would be a utility that separates its business into two components: one to manage the utility's infrastructure assets and another to manage the delivery of energy to consumers.

Definition of 'Sweetheart Deal'
A merger, a sale or an agreement in which one party in the deal presents the other party with very attractive terms and conditions. The terms of a sweetheart deal are usually so lucrative that it is difficult to justify turning the offer down.
Investopedia explains 'Sweetheart Deal'
This term can be used to describe a variety of deals, but in general, a sweetheart deal is a transaction that simply can't be passed up. For example, a merger may be a sweetheart deal for the top executives of the target firm because they get very healthy buyout packages. This kind of sweetheart deal is usually considered unethical, however, because it may not be in the best interests of shareholders.

Definition of 'Merger Securities'
A non-cash asset paid to the shareholders of a corporation that is being acquired or is the target of a merger. Theses securities generally consist of bonds, options, preferred stock and warrants, among others.

Definition of 'Split-Off'
A means of reorganizing an existing corporate structure in which the stock of a business division, subsidiary or newly affiliated company is transferred to the stockholders of the parent company in exchange for stock in the latter. Split-offs often occur when the parent company wishes to draw a greater distinction between itself and the split-off business.
Investopedia explains 'Split-Off'
It is probably wise to treat split-offs with suspicion, as companies will often use them to bolster the balance sheet by shedding underperforming or unprofitable divisions and/or subsidiaries. For example, when Blockbuster started feeling the pinch from other, cheaper DVD retailers and cable companies offering video-on-demand and easy video recording, Viacom announced plans to split-off of its 81.5% stake in the one-time video rental giant and was even willing to absorb a $1.3 billion charge to do it. The split-off was completed in 2004. On Sept. 23, 2010, Blockbuster filed for Chapter 11 bankruptcy protection.

Definition of 'Spinoff'
The creation of an independent company through the sale or distribution of new shares of an existing business/division of a parent company. A spinoff is a type of divestiture.
Investopedia explains 'Spinoff'
Businesses wishing to 'streamline' their operations often sell less productive, or unrelated subsidiary businesses as spinoffs. The spun-off companies are expected to be worth more as independent entities than as parts of a larger business.

Definition of 'Forward Triangular Merger'
The acquisition of a target company by a subsidiary of the purchasing company. The only difference between a forward triangular merger and a direct merger is that a subsidiary of the purchasing company, not the purchasing company itself, is the entity that acquires the target. Forward triangular mergers, like direct mergers and reverse triangular mergers, can be either taxable or nontaxable, depending on how they are executed and other complex factors.

Investopedia explains 'Forward Triangular Merger'
In a taxable forward triangular merger, the subsidiary buys 100% of the target's shares and the target's shareholders receive cash in exchange. In a non-taxable forward triangular merger, also known as a tax-free reorganization, the target's shareholders are compensated at least 50% in shares of the acquiring company. This gives the target's shareholders a continuing interest in the post-merger company and satisfies one of the key criteria for a tax-free reorganization.
Definition of 'Reverse Triangular Merger'
When the subsidiary of the acquiring corporation merges with the target firm. In this case, the subsidiary's equity merges with the target firm's stock. As a result of the merger, the target would become a wholly-owned subsidiary of the acquirer and shareholders of the target would get shares of the acquirer.
Investopedia explains 'Reverse Triangular Merger'
This form of acquisition is often used for regulatory reasons.

Definition of 'Swap Ratio'
The ratio in which an acquiring company will offer its own shares in exchange for the target company's shares during a merger or acquisition. To calculate the swap ratio, companies analyze financial ratios such as book value, earnings per share, profits after tax and dividends paid, as well as other factors, such as the reasons for the merger or acquisition.
Investopedia explains 'Swap Ratio'
For example, if a company offers a swap ratio of 1:1.5, it will provide one share of its own company for every 1.5 shares of the company being acquired.

This can also be applied as a debt/equity swap, when a company wants investors to trade their bonds with the company being acquired for the acquiring company's own shares.

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Definition of 'Acquisition'
A corporate action in which a company buys most, if not all, of the target company's ownership stakes in order to assume control of the target firm. Acquisitions are often made as part of a company's growth strategy whereby it is more beneficial to take over an existing firm's operations and niche compared to expanding on its own. Acquisitions are often paid in cash, the acquiring company's stock or a combination of both.

Investopedia explains 'Acquisition'
Acquisitions can be either friendly or hostile. Friendly acquisitions occur when the target firm expresses its agreement to be acquired, whereas hostile acquisitions don't have the same agreement from the target firm and the acquiring firm needs to actively purchase large stakes of the target company in order to have a majority stake.

In either case, the acquiring company often offers a premium on the market price of the target company's shares in order to entice shareholders to sell. For example, News Corp.'s bid to acquire Dow Jones was equal to a 65% premium over the stock's market price.

Definition of 'Hostile Takeover'
The acquisition of one company (called the target company) by another (called the acquirer) that is accomplished not by coming to an agreement with the target company's management, but by going directly to the company’s shareholders or fighting to replace management in order to get the acquisition approved. A hostile takeover can be accomplished through either a tender offer or a proxy fight.

Investopedia explains 'Hostile Takeover'
The key characteristic of a hostile takeover is that the target company's management does not want the deal to go through. Sometimes a company's management will defend against unwanted hostile takeovers by using several controversial strategies including the poison pill, crown-jewel defense, golden parachute, pac-man defense, and others.

Definition of 'Poison Pill'
A strategy used by corporations to discourage hostile takeovers. With a poison pill, the target company attempts to make its stock less attractive to the acquirer. There are two types of poison pills:

1. A "flip-in" allows existing shareholders (except the acquirer) to buy more shares at a discount.

2. A "flip-over" allows stockholders to buy the acquirer's shares at a discounted price after the merger.
Investopedia explains 'Poison Pill'
1. By purchasing more shares cheaply (flip-in), investors get instant profits and, more importantly, they dilute the shares held by the acquirer. This makes the takeover attempt more difficult and more expensive.

2. An example of a flip-over is when shareholders gain the right to purchase the stock of the acquirer on a two-for-one basis in any subsequent merger.

People pill A defensive strategy to ward off a hostile takeover. Management threatens that, in the event of a takeover, the entire management team will resign.

Definition of 'Flip-Over Pill'
A type of poison pill strategy in which shareholders have the option to purchase shares in the acquiring company at a deeply-discounted price. A flip-over pill is a shareholder rights plan used as a defense against hostile takeovers, and is one of the more commonly-used poison pill strategies. The rights plan can be included in the bylaws of the company, meaning that it must be permitted by an acquiring company.

Investopedia explains 'Flip-Over Pill'
Poison pill rights are usually worthless, until a hostile takeover or merger plan comes into play. In the event of a potential or actual merger, the flip-over plan encourages all shareholders to purchase shares of the acquiring company, which would dilute the equity interest of existing shareholders in the acquiring company who are not permitted to participate.

Definition of 'Flip-In Poison Pill'
A type of poison pill strategy in which existing shareholders, but not acquiring shareholders, are allowed to purchase shares in the target company at a discount. A flip-in poison pill takeover defense dilutes the value of the shares purchased by the acquiring company by flooding the market with new shares, while also allowing investors who purchase the new shares to profit instantaneously from the difference between the discounted purchase price and the market price.
Investopedia explains 'Flip-In Poison Pill'
Poison pill provisions are often found in a company's bylaws or charter as a public display of their potential use as a takeover defense. This tells any company thinking about a hostile takeover that they will face a lot of difficulties. Companies looking to fight this strategy may try to have a court dissolve any program providing the deep discount, but the chances of success are uncertain.

Suicide pill A defensive strategy by which a target company engages in an activity that might actually ruin the company rather than prevent the hostile takeover.

Pac man A form of defense used in a hostile takeover situation. The target firm turns around and tries to take over the company that has made the hostile bid.

Definition of 'Sleeping Beauty'
A company that is considered prime for takeover, but has not yet been approached by an acquiring company. A company may be considered a sleeping beauty for a variety of reasons, including large cash reserves, undervalued real estate, undervalued share price, attractive assets, or strong growth and earnings potential. A takeover, or acquisition, is typically characterized by the purchase of a smaller company by a larger firm. The acquiring company generally offers a cash price per share, thereby purchasing the target outright for its own shareholders.

Investopedia explains 'Sleeping Beauty'
In relation to mergers and acquisitions (M&A), a sleeping beauty is a company that is "sleeping"; that is, one that is ripe for takeover to achieve its full potential. A sleeping beauty might be a new company that has great potential but has not yet been noticed, or it could be an established company that has not been managed well, and is therefore not maximizing its potential. A sleeping beauty essentially lies in wait until a takeover occurs, at which point the company theoretically would be able to live up to its potential.

Definition of 'Dawn Raid'
When a firm or investor buys a substantial number of shares in a company first thing in the morning when the stock markets open. Because the bidding company builds a substantial stake in its target at the prevailing stock market price, the takeover costs are likely to be significantly lower than they would be had the acquiring company first made a formal takeover bid.

Investopedia explains 'Dawn Raid'
Like the dawn raid in war, the corporate dawn raid is done early in the morning, so by the time the target realizes it's being attacked, it's too late - the investor has already scooped up some controlling interest. However, only a minority interest in a firm's shares can be bought this way. So, after a successful dawn raid, the raiding firm is likely to make a takeover bid to acquire the rest of the target company.

Definition of 'Crown Jewels'
The most valuable unit(s) of a corporation, as defined by characteristics such as profitability, asset value and future prospects. The origins of this term are derived from the most valuable and important treasures that sovereigns possessed.

Investopedia explains 'Crown Jewels'
Despite the fact that crown jewels are often the most valuable part of a company, some companies opt to use their crown jewels as part of a takeover defense. A company can employ this crown jewels defense by creating anti-takeover clauses which compels the sale of their crown jewels if a hostile takeover occurs. This deters would be acquirers from attempting to take the firm over.

Definition of 'Golden Parachute'
Lucrative benefits given to top executives in the event that a company is taken over by another firm, resulting in the loss of their job. Benefits include items such as stock options, bonuses, severance pay, etc.
Investopedia explains 'Golden Parachute'
A golden parachute can be used as a measure to discourage an unwanted takeover attempt.

Definition of 'Macaroni Defense'
An approach taken by a company that does not want to be taken over. The company issues a large number of bonds with the condition they must be redeemed at a high price if the company is taken over.
Investopedia explains 'Macaroni Defense'
Why is it called Macaroni Defense? Because if a company is in danger, the redemption price of the bonds expands like Macaroni in a pot!

Definition of 'Fat Man Strategy '
A takeover defense tactic that involves the acquisition of a business or assets by a target company. The strategy is based on the premise that the bulked-up company - the "fat man" - would have reduced appeal to a hostile bidder, especially if the acquisition increases the acquirer's debt load or decreases available cash.
Investopedia explains 'Fat Man Strategy '
This is a type of "kamikaze" defense tactic, which inflicts potentially irreversible damage on a company to prevent it from falling into hostile hands. However, it involves adding assets rather than divesting them as is the case with other kamikaze defense strategies. A disadvantage of this tactic is that acquisition candidates need to be identified well in advance of a hostile bid, otherwise there may be insufficient time to complete a fat man transaction.

Definition of 'Whitemail'
A strategy that a takeover target uses to try and thwart an undesired takeover attempt. The target firm issues a large amount of shares at below-market prices, which the acquiring company will then have to purchase if it wishes to complete the takeover.
Investopedia explains 'Whitemail'
If the whitemail strategy is successful in discouraging the takeover, then the company can either buy back the issued shares or leave them outstanding.

Definition of 'Greenmail'
A situation in which a large block of stock is held by an unfriendly company. This forces the target company to repurchase the stock at a substantial premium to prevent a takeover.

It is also known as a "bon voyage bonus" or a "goodbye kiss".
Investopedia explains 'Greenmail'
Not unlike blackmail, this is a dirty tactic, but it's very effective.

Definition of 'Bankmail'
An agreement made between a company planning a takeover and a bank, which prevents the bank from financing any other potential acquirer's bid.
Investopedia explains 'Bankmail'
Bankmail agreements are meant to stop other potential acquirers from receiving similar financing arrangements. | | |

Definition of 'Friendly Takeover'
A situation in which a target company's management and board of directors agree to a merger or acquisition by another company. In a friendly takeover, a public offer of stock or cash is made by the acquiring firm, and the board of the target firm will publicly approve the buyout terms, which may yet be subject to shareholder or regulatory approval. This stands in contrast to a hostile takeover, where the company being acquired does not approve of the buyout and fights against the acquisition.

Investopedia explains 'Friendly Takeover'
In most cases, if the board approves a buyout offer from an acquiring firm, the shareholders will vote to pass it as well. The key determinant in whether the buyout will occur is the price per share being offered. The acquiring company will offer a premium to the current market price, but the size of this premium (given the company's growth prospects) will determine the overall support for the buyout within the target company.

Black knights attempt hostile takeovers of target firms. A company that makes a hostile takeover offer for a target company. In mergers and acquisitions, a black knight attempts a takeover that the target company deems unwelcomed.

A white knight can help the target firm by offering terms for a friendly takeover. When a company is facing a hostile takeover by a black knight, a white knight may appear to offer a way to avoid the hostile takeover with a friendly takeover.

A company that was once making a takeover attempt but ends up discussing a merger with the target company. Yellow knights have various reasons for backing out of the takeover attempt, but frequently are attributable to the target company's ability to fend off takeover. The "yellow" in "yellow knight" may refer to the color's association with cowardice. Since a yellow knight backs down from a takeover attempt and retreats to merger discussions, a yellow knight may be viewed as weak.

A second, unsolicited bidder in a corporate takeover. A gray knight enters the scene in order to take advantage of any problems between the first bidder and the target company.

A corporate-takeover strategy with which a third party poses as a white knight to gain trust, but then turns around and joins with unfriendly bidders

Consolidation * Two companies coming together * None of them exists after Consolidation * Forms a new company Types of Consolidation * Statutory Consolidation * Voluntary Consolidation

Definition of 'Special Purpose Vehicle/Entity - SPV/SPE'
1. Also referred to as a "bankruptcy-remote entity" whose operations are limited to the acquisition and financing of specific assets. The SPV is usually a subsidiary company with an asset/liability structure and legal status that makes its obligations secure even if the parent company goes bankrupt.

2. A subsidiary corporation designed to serve as a counterparty for swaps and other credit sensitive derivative instruments. Also called a "derivatives product company."
Investopedia explains 'Special Purpose Vehicle/Entity - SPV/SPE'
Thanks to Enron, SPVs/SPEs are household words. These entities aren't all bad though. They were originally (and still are) used to isolate financial risk.

A corporation can use such a vehicle to finance a large project without putting the entire firm at risk. Problem is, due to accounting loopholes, these vehicles became a way for CFOs to hide debt. Essentially, it looks like the company doesn't have a liability when they really do. As we saw with the Enron bankruptcy, if things go wrong, the results can be devastating.

Definition of 'Transfer Price'
The price at which divisions of a company transact with each other. Transactions may include the trade of supplies or labor between departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities.

Also known as "transfer cost".
Investopedia explains 'Transfer Price'
In managerial accounting, when different divisions of a multi-entity company are in charge of their own profits, they are also responsible for their own "Return on Invested Capital". Therefore, when divisions are required to transact with each other, a transfer price is used to determine costs. Transfer prices tend not to differ much from the price in the market because one of the entities in such a transaction will lose out: they will either be buying for more than the prevailing market price or selling below the market price, and this will affect their performance.

Definition of Transfer Pricing
What is transfer Pricing ? Transfer Pricing in India relates to determination of correct market price of the transaction a.k.a Arm’s length price.
It helps in ensuring that profits taxable in India are not understated (losses overstated) by declaring low receipts or higher outgoings than those actually liable to be declared.
Application of Transfer Pricing in India
As per section 92 (1) of the Income Tax Act, 1961 – Income from an international transaction shall be computed having regard to the Arm’s length Price (correct market price).
And it is not only the sale price that shall be determined as per Arm’s length price but even the allowances for any expenses and interest arising from an international transaction will be computed evenly.
The above rule applies even where the international transaction shall comprise of only outgoings i.e expenses, interest .
Example of Transfer Pricing
An enterprise in India sells good/services to an associated enterprise in USA for Rs. 1,00,000where as the Arm’s length Price is Rs 3,00,000. Therefore the income of Indian Enterprises shall be determined with respect to Arm’s length Price i.eRs 3,00,000.
When a transaction qualifies to be International Transaction?
The definition of International transaction under the transfer pricing regulations is very wide and in tis scope it includes transaction between two associated enterprises in the nature of:
(i) Purchase, sale or lease of tangible or intangible property or
(ii) Provision of services or
(iii) Lending or borrowing of money or
(iv) Any other transaction having a bearing on the profits, income, losses or assets of such enterprises.
It would also include a mutual agreement or arrangement between two or more enterprises for allocation of cost/expenses incurred in connection with a benefit, service, facility provided or to be provided.
When are two enterprises – associated enterprises?
Two enterprises shall be deemed to be associated enterprises if, at any time during the previous year-
(a) one enterprise holds, directly or indirectly, shares carrying not less than 26% of the voting power in the other enterprise; or
(b) any person or enterprise holds, directly or indirectly, shares carrying not less than 26% of the voting power in each of such enterprises; or
(c) a loan advanced by one enterprise to the other enterprise constitutes not less than 51% of the book value of the total assets of the other enterprise; or
(d) one enterprise guarantees not less than 10% of the total borrowings of the other enterprise; or
(e) more than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or
(f) more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; or
(g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or
(h) 90% or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or
(i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise; or
(j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or
(k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative; or
(l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten per cent interest in such firm, association of persons or body of individuals; or
(m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed. By invoking transfer pricing regulations, sections government has managed to plug in a lot of loopholes that MNC’s used for their advantage

Various Laws governing merger in India are as follows:
1. Indian Companies Act, 1956
This has provisions specifically dealing with the amalgamation of a company or certain other entities with similar status. The most common form of merger involves as elaborate but time-bound procedure under sections 391 to 396 of the Act.
Powers in respect of these matters were with High Court (usually called Company Court). These powers are being transferred to National Company Law Tribunal (NCLT) by companies (second Amendment) Act, 2002.
The Compromise, arrangement and Amalgamation reconstruction require approval of NCLT while the sale of shares to Transferee Company does not require approval of NCLT.

2. Monopolies and Restrictive Trade practices Act, 1969 (MRTP 1969)
Certain Amendments in the MRTP Act were brought about in 1991. The Government has removed restrictions on the size of assets; market shares and on the requirement of prior government approvals for mergers that created entities that would violate prescribed limits. The Supreme Court, in a recent judgment, decided that “prior approval of the central government for sanctioning a scheme of amalgamation is not required in view of the deletion of the relevant provision of the MRTP Act and the MRTP Commission was justified in not passing an order restraining implementation of the scheme of amalgamation of two firms in the same field of consumer articles”.
3. Foreign Exchange Regulation Act 1973 (FERA 1973)
FERA is the primary Indian Law which regulates dealings in foreign exchange. Although there are no provisions in the Act which deal directly with transactions relating to amalgamations, certain provisions of the Act become relevant when shares in Indian companies are allotted to non- residents, where the undertaking sought to be acquired is a company which is not incorporated under any law in India. Section 29 of FERA provides that no foreign company or foreign national can acquire any share of an Indian company except with prior approval of the reserve Bank of India. The Act has been amended to facilitate transfer of shares two non residents and to allow Indian companies to set up subsidiaries and joint ventures abroad without the prior approval of the Reserve Bank of India.
4. Income Tax Act, 1961
Income Tax Act, 1961 is vital among all tax laws which affect the merger of firms from the point view of tax savings/liabilities. However, the benefits under this act are available only if the following conditions mentioned in Section 2 (1B) of the Act are fulfilled:
a) All the amalgamating companies should be companies within the meaning of the section 2 (17) of the Income Tax Act, 1961.
b) All the properties of the amalgamating company (i.e., the target firm) should be transferred to the amalgamated company (i.e., the acquiring firm).
c) All the liabilities of the amalgamating company should become the liabilities of the amalgamated company, and
d) The shareholders of not less than 90% of the share of the amalgamating company should become the shareholders of amalgamated company.

Valuation in a merger: Determination of share exchange ratio
An important aspect of merger procedure relates to valuation of business relates to valuation of business in order to determine share exchange ratio in merger. Valuation is the means to assess the worth of a company which is subject to merger or takeover so that consideration amount can be quantified and the price of one company for other can be fixed. Valuation of both companies subject to business combination is required for fixing the consideration amount to be paid in the form of exchange of share. Such valuation helps in determining the value of shares of acquired company as well as acquiring company to safeguard the interest of shareholders of both the companies.
Broadly there are three(3) methods used for valuation of business:
1. Net Value Asset (NAV) Method
NAV is the sum total of value of asserts (fixed assets, current assets, investment on the date of Balance sheet less all debts, borrowing and liabilities including both current and likely contingent liability and preference share capital). Deductions will have to be made for arrears of preference dividend, arrears of depreciation etc. However, there may be same modifications in this method and fixed assets may be taken at current realizable value (especially investments, real estate etc.) replacement cost (plant and machinery) or scrap value (obsolete machinery). The NAV, so arrived at, is divided by fully diluted equity (after considering equity increases on account of warrant conversion etc.) to get NAV per share.
The three steps necessary for valuing share are: 1. Valuation of assets 2. Ascertainment of liabilities 3. Fixation of the value of different types of equity shares.
NAV = All assets (value by appropriation method – all liabilities – preference shares) / Fully diluted equity shares
2. Yield Value Method
This method also called profit earning capacity method is based on the assessment of future maintainable earnings of the business. While the past financial performance serves as guide, it is the future maintainable profits that have to be considered. Earnings of the company for the next two years are projected (by valuation experts) and simple or weighted average of these profits is computed. These net profits are divided by appropriate capitalization rate to get true value of business. This figure divided by equity value gives value per share. While determining operating profits of the business, it must be valued on independent basis without considering benefits on account of merger. Also, past or future profits need to be adjusted for extra ordinary income or loss not likely to recur in future. While determining capitalization rate, due regard has to be given to inherent risk attribute to each business. Thus, a business with established brands and excellent track record of growth and diverse product portfolio will get a lower capitalization rate and consequently higher valuation where as a cyclical business or a business dependent on seasonal factors will get a higher capitalization rate. Profits of both companies’ should be determined after ensuring that similar policies are used in various areas like depreciation, stock valuation etc.
3. Market Value Method
This method is applicable only in case where share of companies are listed on a recognized stock exchange. The average of high or low values and closing prices over a specified previous period is taken to be representative value per share.
Now, the determination of share exchange ratio i.e., how many shares of amalgamating company, are to be exchanged for how many shares of amalgamated company, is basically an exercise in valuation of shares of two or more of amalgamating company. The problem of valuation has been dealt with by Weinberg and Blank (1971) by giving the relevant factors to be taken into account while determining the final share exchange ratio. These relevant factors has been enumerated by Gujarat High court in Bihari Mills Ltd. and also summarized by the Apex court in the case of Hindustan Levers. Employees union vs. Hindustan Lever Ltd. (1995) as under. 1. The stock exchange prices of the shares of the companies before the commencement of negotiations or the announcement of the bid. 2. The dividends presently paid on the shares of two companies. It is often difficult to induce a shareholder to agree to a merger if it involves a reduction in his dividend income. 3. The relative growth prospects of the two companies. 4. The cover, (ratio of after tax earnings to divided paid during the year) for the present dividends of the two companies. The fact that the dividend of one company is better covered than the other is a factor which has to be compensated to same extent. 5. The relative gearing of the shares of the two companies. The gearing of an ordinary share is the ratio of borrowings to equity capital. 6. The value of net assets of the two companies. 7. The voting strength in the company of shareholder of the two companies. 8. The past history of the prices of two companies.
There are however, no rules framed specially for the working out of share exchange ratio in case of amalgamations. According to Delhi High Court statement, “The valuation of shares is a technical matter which requires considerable skills and expertise. There are bound to be difference of opinion as to what the correct value of the shares of the company is. If it is possible to the value the shares in a manner difference from the one adopted in the given case, it cannot be said, that the valuation agreed upon has been unfair.”
In CWT vs. Mahadeo Jalan (1972) 86 ITR 621 (SC), Supreme Court has evolved the following guidelines and aspects which should be considered: * Regard should be had to price of shares prevailing in stock market * Profit earning capacity (yield method) or dividend declared by the company (dividend method) should be considered. If result of two methods differs, a golden mean should be found. * In computing yields, abnormal expenses will be added back to calculate ‘yield’ (e.g. company incurring expenses disproportionate to the commercial venture, possibly to reduce income tax liability) * If lower dividend or profits are due to temporary reasons, then estimate of share value before the set-back and proportionate fall in price of quoted shares of companies which have suffered similar reverses should be considered * If company is ripe for winding up, break up value method to determine what would be realized in winding up process should be considered. * Valuation can be done on basis of asset value, if reasonable estimation of future profits and dividend is not possible due to wide fluctuations in profits and uncertain conditions.
Valuation of shares on book value method is proper and valid mode of valuation of shares- Tinsukhia Electric Co. Ltd. vs. State of Assam. Often share value cannot be finalized on basis of one parameter only. Thus, final decision depends on judicious consideration of usual methods of valuation i.e. break –up value, yield value, market value or on net worth basis. Qualitative factors like market fluctuations, competition, Government policy, managerial skills are also relevant for the purpose-Sanghi industries Ltd