Tag: Buyback of Shares

Hostile acquisition occurs when one company attempts to acquire another against its will, typically through the purchase of shares in the open market or by making a tender offer directly to the shareholders. The target company’s management may resist the acquisition, but if enough shareholders agree to sell their shares, the acquiring company gains control. Hostile acquisitions are often characterized by aggressive tactics and can lead to legal battles, changes in corporate structure, or management. Such acquisitions are typically seen in cases where the acquiring company believes the target company is undervalued or poorly managed.

Features of Hostile Acquisitions:

• Unilateral Action by Acquirer

In a hostile acquisition, the acquiring company takes unilateral action to gain control of the target company without its management’s consent. This usually involves purchasing a significant amount of the target company’s shares, often through a public tender offer, where the acquirer directly approaches the target’s shareholders. Since the target’s management typically opposes the acquisition, the acquiring company may use aggressive strategies to gain control, bypassing negotiations and board approval. This characteristic sets hostile acquisitions apart from friendly acquisitions, where management cooperation is present.

• Tender Offer

A tender offer is a common feature of hostile acquisitions. The acquiring company makes an offer to the shareholders of the target company, usually at a premium over the current market price of the shares. The goal is to persuade shareholders to sell their shares, even if the management of the target company does not approve. The offer can be made directly to the shareholders or through a public announcement. Tender offers are often structured as cash offers or stock-for-stock exchanges. The acquirer may also set a deadline for shareholders to accept the offer, adding urgency.

• Resistance from Target’s Management

In hostile acquisitions, the target company’s management typically opposes the takeover. This resistance can manifest through various defensive strategies, including a “poison pill” strategy, where the target company makes its shares less attractive to the acquirer by issuing more shares to existing shareholders. Other defenses may include trying to find a “white knight” (a more favorable buyer) or restructuring the company to avoid the acquisition. Despite this resistance, if the acquirer is successful in gaining control through shareholder support, the target management may be replaced, or forced to accept the acquisition.

• Shareholder Control

In hostile acquisitions, control shifts to the shareholders of the target company rather than the management. The acquiring company attempts to purchase enough shares to gain a majority stake, allowing it to control the target company. Since the target company’s management usually opposes the acquisition, the acquirer focuses on persuading shareholders to sell their shares. This can lead to a shift in corporate governance, as the acquirer may install new directors or management to align the target company with its own business strategies and goals. Shareholder approval becomes the key determinant of the acquisition’s success.

• Potential for Disruption and Conflict

Hostile acquisitions often lead to significant disruption within the target company. The company’s management and employees may face uncertainty due to the acquirer’s attempt to take control. There could be internal conflicts, changes in company culture, layoffs, and restructurings. Additionally, the public nature of hostile takeovers can damage the reputation of both the target and acquiring companies, as the acquisition process becomes contentious and draws media attention. The target company’s defense tactics and the acquirer’s aggressive strategies can lead to prolonged conflict, making the integration process more challenging and unpredictable.

Friendly Acquisitions

Friendly acquisition occurs when one company acquires another with the full consent and cooperation of the target company’s management and board of directors. Both parties negotiate the terms of the deal, which can involve the purchase of shares or assets. In a friendly acquisition, the target company’s management works with the acquirer to ensure a smooth transition, and the deal is often aimed at creating synergies, expanding market share, or achieving strategic growth. This type of acquisition is generally less contentious and is often preferred as it ensures a more collaborative and efficient integration process.

Features of Friendly Acquisitions:

• Mutual Agreement Between Managements

In a friendly acquisition, both the acquiring company and the target company’s management agree on the terms of the deal. Unlike hostile takeovers, which are initiated without the target’s approval, friendly acquisitions involve cooperative negotiations between the two companies. The target company’s board of directors supports the acquisition, and both parties work together to ensure the transaction benefits all stakeholders. This mutual consent ensures smoother negotiations, fewer conflicts, and a more seamless integration process. The deal is often structured to align with both companies’ strategic goals, ensuring long-term growth and synergy.

• Due Diligence Process

A critical feature of friendly acquisitions is the thorough due diligence process. Both companies engage in a detailed investigation of each other’s financials, operations, and legal standing before proceeding with the acquisition. The acquiring company evaluates the target company’s assets, liabilities, intellectual property, and overall business performance to ensure the transaction will create value. This careful scrutiny helps both parties understand the risks and benefits, allowing them to structure the deal more effectively. Due diligence reduces the potential for surprises and conflicts post-acquisition, ensuring both parties are fully informed and aligned before finalizing the deal.

• Strategic Synergies and Growth Opportunities

In friendly acquisitions, the focus is often on creating synergies that benefit both companies. The acquiring company seeks to enhance its market position, expand its product offerings, or access new customer bases by acquiring the target company. Similarly, the target company benefits from the financial resources, technology, or expertise of the acquiring company. Strategic synergies might include cost savings, cross-selling opportunities, or combined market penetration. Both companies work together to maximize these synergies, ensuring the deal aligns with long-term business goals, driving growth, and improving operational efficiency for both parties.

• Smooth Integration and Continuity

Since friendly acquisitions involve cooperative negotiation, the integration process is usually smoother compared to hostile takeovers. Both companies work together to ensure that the transition is efficient and that the combined entity continues to operate effectively. There is a focus on continuity of operations, including retaining key employees, maintaining customer relationships, and preserving brand identity where necessary. The management of the target company often remains in place for a period of time, making the transition less disruptive. This collaborative approach helps minimize organizational disruption, which is crucial for maintaining morale and operational stability.

• Regulatory Approval and Compliance

Friendly acquisitions are more likely to comply with regulatory requirements and obtain the necessary approvals from government agencies. Since both companies agree to the deal, they can work together to ensure the transaction meets all legal and regulatory requirements. This can include antitrust review, approval from shareholders, and adherence to corporate governance rules. The cooperation between the acquiring and target companies streamlines the regulatory process, making it more predictable and less contentious. This ensures the deal proceeds smoothly, avoiding the delays and complications that can arise in hostile acquisitions, where the target company’s resistance may hinder regulatory approval.

Key differences between Hostile Acquisitions and Friendly Acquisitions

Acquisitions refer to the process where one company takes over the ownership and control of another company. In an acquisition, the acquiring company purchases the majority or all of the target company’s shares or assets, gaining decision-making authority and operational control. This can be done through mutual agreement or as a hostile takeover. Acquisitions help companies expand market share, enter new markets, or achieve strategic goals such as technological advancement or cost efficiency. The acquired company may continue as a separate entity or be absorbed completely. Acquisitions are a key tool in corporate restructuring and business growth strategies.

Features of Acquisitions:

• Transfer of Ownership and Control

A key feature of acquisitions is the transfer of ownership and control from the target company to the acquiring company. This can occur through the purchase of shares or assets. Once the transaction is completed, the acquiring company assumes authority over business operations, assets, and decisions of the acquired entity. Depending on the deal’s nature, the acquired firm may continue its operations independently or be fully integrated. This feature makes acquisitions a strategic tool for companies aiming to grow, diversify, or consolidate within their industry or market segment.

• Strategic Business Expansion

Acquisitions are often pursued as a strategy to accelerate business growth and expansion. Instead of building new operations from scratch, companies can enter new markets, gain new customer bases, or acquire technological capabilities by purchasing existing businesses. This feature makes acquisitions especially attractive in competitive markets where time-to-market and access to resources are crucial. It also allows businesses to overcome barriers to entry, such as licensing or regulatory restrictions, by acquiring companies already operating in the targeted space. Hence, acquisitions provide an efficient path for rapid strategic expansion and diversification.

• Valuation and Purchase Consideration

Before an acquisition takes place, proper valuation of the target company is essential. This involves assessing assets, liabilities, market position, brand value, and future earning potential. The purchase consideration can be paid in cash, shares, debt instruments, or a combination. This feature of acquisitions highlights the importance of due diligence, negotiations, and legal structuring to ensure that the price paid reflects fair market value. Valuation affects not only the financials but also shareholder expectations, taxation, and post-acquisition integration. A well-evaluated acquisition minimizes risks and maximizes synergy between both entities.

• Legal and Regulatory Compliance

Acquisitions are governed by legal procedures and must comply with various regulatory authorities. In India, for example, acquisitions must align with the Companies Act, 2013, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, and Competition Commission of India (CCI) norms. Regulatory clearance is often mandatory, especially in cases involving large transactions or companies operating in sensitive sectors. This feature ensures that acquisitions do not lead to unfair trade practices, monopolistic control, or harm to shareholders’ interests. Legal compliance safeguards transparency and protects all stakeholders involved in the transaction.

• Post-Acquisition Integration

After the acquisition is completed, integrating the acquired company into the parent company becomes a critical task. This includes combining operations, aligning corporate cultures, managing human resources, and restructuring departments. Effective integration is essential to achieve intended synergies, cost savings, and strategic objectives. Poor integration may lead to employee dissatisfaction, reduced productivity, or failure to achieve financial goals. Therefore, this feature emphasizes the importance of planning not just the acquisition itself but also the post-acquisition process to ensure long-term success and value creation from the deal.

Types of Acquisitions:

• Asset Acquisition

In an asset acquisition, the acquiring company purchases specific assets and liabilities of the target company rather than acquiring the entire business. These assets may include property, inventory, patents, equipment, or customer contracts. This method allows the buyer to avoid unwanted liabilities and choose only profitable or strategic assets. Asset acquisitions are often used when the buyer is interested in certain parts of the business, rather than the whole entity. Legally, ownership of each asset must be transferred individually, which can be time-consuming. This approach is common in distressed sales or when the seller wants to retain part of the business. Tax treatment can differ from stock acquisitions, often favoring the buyer due to step-up in asset values.

• Stock Acquisition

In a stock acquisition, the acquiring company purchases the majority or all of the target company’s shares from its shareholders. This type of acquisition gives the buyer control over the entire company, including its assets, liabilities, and legal obligations. The acquired company continues to exist as a legal entity, and its contracts, employees, and operations generally remain unchanged. Stock acquisitions are often simpler from a legal perspective since asset transfers are not required individually. However, the buyer assumes all liabilities, known and unknown. This approach is common in friendly or strategic acquisitions where continuity is essential. Tax implications vary and are usually more favorable for the sellers compared to asset sales.

• Horizontal Acquisition

Horizontal acquisition occurs when one company acquires another company operating in the same industry and at the same level of the supply chain. The purpose is often to increase market share, reduce competition, and gain economies of scale. For example, if a smartphone manufacturer acquires another smartphone manufacturer, it is a horizontal acquisition. This type of acquisition allows for resource sharing, greater pricing power, and expanded product offerings. However, it may also attract regulatory scrutiny due to potential monopolistic concerns. Horizontal acquisitions are common in mature industries where growth through internal means is limited.

• Vertical Acquisition

Vertical acquisition involves the acquisition of a company that operates in a different stage of the production process within the same industry. It can be upstream (acquiring a supplier) or downstream (acquiring a distributor). The goal is to create a more efficient supply chain, reduce costs, and gain better control over production and distribution. For example, a car manufacturer acquiring a tire company is a vertical acquisition. This type helps reduce dependency on third parties and can lead to improved quality control, faster delivery, and enhanced profit margins through integration.

• Conglomerate Acquisition

Conglomerate acquisition happens when a company acquires another company in an entirely different industry. The main objective is diversification and risk reduction. By entering unrelated business areas, the acquiring firm can balance financial risks, especially if one sector is facing downturns. For instance, a food processing company acquiring a software firm is a conglomerate acquisition. Though this strategy spreads risk, it also poses challenges in managing unrelated business operations and achieving synergy. Success depends on sound management and strategic vision to ensure each segment contributes to overall profitability.

• Congeneric (or Product-Extension) Acquisition

Congeneric acquisition involves companies that serve the same customer base or operate in related industries but are not direct competitors. It allows businesses to expand their product lines, enhance customer service, and increase cross-selling opportunities. For example, a television manufacturer acquiring a home theater system company represents a congeneric acquisition. This type of acquisition helps companies broaden their market reach and offer a more comprehensive product suite. It also facilitates brand strengthening and improves customer retention by offering related goods or services under a unified brand identity.

Demerger refers to the transfer of one or more undertakings from a company to another, resulting in separate legal entities. The accounting treatment must reflect the fair and accurate transfer of assets, liabilities, and equity, ensuring transparency and adherence to statutory requirements.​

Key Accounting Principles:

• Transfer at Book Value: Assets and liabilities are transferred at their book values unless revaluation is mandated.​

• Recognition of Reserves: Reserves related to the demerged undertaking are proportionately transferred.​

• Share Capital Adjustment: The resulting company issues shares to the shareholders of the demerged company, reflecting the value of the net assets transferred.​

• Compliance with Standards: Accounting treatments align with applicable Indian Accounting Standards (Ind AS) and the Companies Act, 2013.​

Journal Entries in the Books of the Demerged Company

Journal Entries in the Books of the Resulting Company

Allocation of Assets and Liabilities

The allocation process involves:​

• Identification: Determining which assets and liabilities pertain to the demerged undertaking.​

• Valuation: Assessing the book value of these assets and liabilities.​

• Transfer: Recording the transfer in both companies’ books, ensuring that the net assets transferred match the consideration received.​

• Reserves: Proportionately transferring reserves related to the demerged undertaking.​

Compliance and Disclosure

• Regulatory Approvals: Ensuring that the demerger scheme is approved by the National Company Law Tribunal (NCLT) and other regulatory bodies as required.​

• Financial Statements: Presenting the demerger’s impact in the financial statements, including notes on the transfer of assets, liabilities, and reserves.​

• Tax Implications: Considering the tax effects of the demerger, especially regarding the transfer of assets and issuance of shares.​

In India, Demergers are governed by the Companies Act, 2013, specifically under Chapter XV (Sections 230–240), which deals with compromises, arrangements, and amalgamations. Although the Act does not explicitly define “Demerger,” it provides a legal framework for such corporate restructuring activities.

Key Legal Provisions

1. Section 230: Power to Compromise or Make Arrangements with Creditors and Members

Section 230 allows companies to enter into compromises or arrangements with creditors and members. A demerger, being a form of arrangement, falls under this provision. The process involves:

• Application to NCLT: The company must apply to the National Company Law Tribunal (NCLT) for approval of the proposed scheme.

• Disclosure Requirements: The application should include details like the scheme’s terms, valuation reports, auditor’s certificates, and other relevant documents.

• Meetings: NCLT may order meetings of creditors or members to consider the scheme. Approval requires a majority in number representing three-fourths in value of creditors or members present and voting.

• Sanctioning: Upon satisfaction, NCLT may sanction the scheme, making it binding on all stakeholders.

2. Section 232: Merger and Amalgamation of Companies

Section 232 specifically addresses mergers and amalgamations, which encompass demergers. Key aspects include:

• Transfer of Undertakings: The scheme may involve transferring whole or part of the undertaking, property, or liabilities from the transferor to the transferee company.

• Dissolution Without Winding Up: The transferor company may be dissolved without undergoing the winding-up process.

• Continuation of Legal Proceedings: Any legal proceedings by or against the transferor company continue against the transferee company.

• Employee Transfer: Employees of the transferor company become employees of the transferee company on the same terms.

• Accounting Treatment: The scheme must comply with accounting standards prescribed under Section 133.

• Regulatory Approvals: If the transferor company is listed, approvals from regulatory bodies like SEBI may be required.

3. Section 233: Fast-Track Mergers

Section 233 provides a simplified procedure for mergers and amalgamations between:

• Two or more small companies.

• A holding company and its wholly-owned subsidiary.

Key features:

• Board Resolutions: Approval from the Boards of Directors of both companies.

• No Objection Certificates: Obtaining NOCs from creditors and shareholders.

• Registrar and Official Liquidator: Filing the scheme with the Registrar of Companies and the Official Liquidator.

• Approval: If no objections are raised, the scheme is deemed approved without NCLT intervention.

4. Section 234: Cross-Border Mergers

Section 234 allows Indian companies to merge with foreign companies, subject to:

• Prior Approval: Obtaining prior approval from the Reserve Bank of India (RBI).

• Jurisdiction: The foreign company must be incorporated in a jurisdiction notified by the Central Government.

• Compliance: Adherence to rules prescribed by the Ministry of Corporate Affairs.

Procedural Aspects:

1. Drafting the Scheme

The scheme of demerger should detail:

• Transfer of Assets and Liabilities: Clearly specify which assets and liabilities are being transferred.

• Share Exchange Ratio: Outline the ratio at which shares will be exchanged between the companies.

• Appointed Date: Define the date from which the scheme becomes effective.

• Rationale: Provide the business rationale for the demerger.

2. Valuation and Reports

• Valuation Report: Obtain a valuation report from a registered valuer to determine the share exchange ratio.

• Auditor’s Certificate: The company’s auditor must certify that the accounting treatment is in compliance with applicable accounting standards.

3. Filing with NCLT

• Application: File an application with NCLT along with the scheme, valuation report, auditor’s certificate, and other requisite documents.

• Notices: Issue notices to creditors, shareholders, and regulatory authorities as directed by NCLT.

• Meetings: Conduct meetings of creditors and shareholders to approve the scheme.

4. Regulatory Approvals

• SEBI Approval: If the company is listed, obtain approval from the Securities and Exchange Board of India (SEBI).

• RBI Approval: For cross-border demergers, secure approval from the Reserve Bank of India.

5. Sanctioning and Filing

• NCLT Order: Upon satisfaction, NCLT sanctions the scheme.

• Filing: File the NCLT order with the Registrar of Companies within 30 days.

Tax Implications:

While the Companies Act, 2013, does not directly address tax aspects, the Income Tax Act, 1961, provides tax neutrality for demergers under certain conditions:

• Section 2(19AA): Defines demerger and lays down conditions for tax neutrality.

• Section 47: Specifies transactions not regarded as transfers, thus exempting them from capital gains tax.

Compliance with these provisions ensures that the demerger is tax-neutral for both the companies and their shareholders.

Demergers refer to a corporate restructuring process in which a company transfers one or more of its business undertakings into a separate entity. It is the opposite of a merger, where instead of combining, a business is split into independent units. Demergers are carried out to increase operational efficiency, improve focus on core activities, unlock shareholder value, or comply with regulatory requirements. The new entities formed through a demerger operate independently and are often listed separately. It helps companies streamline their operations and achieve better management control over distinct lines of business or geographical divisions.

Need of Demergers:

• Enhanced Operational Efficiency

Demergers help organizations streamline operations by focusing on core competencies. When business units operate independently, management can adopt specific strategies tailored to that unit’s strengths, leading to better performance and accountability. It eliminates complexities that come with managing unrelated businesses under one umbrella. Each demerged entity can then function with dedicated leadership, customized operations, and clearer objectives. This efficiency boosts productivity and responsiveness in competitive markets. Moreover, independent units face fewer bureaucratic hurdles, improving turnaround time for decisions and operations.

• Unlocking Shareholder Value

One of the primary reasons for demergers is to unlock the hidden value of a business segment that might be overshadowed in a conglomerate structure. Investors can better evaluate and invest in a standalone company with transparent financials and focused business models. The separated companies may enjoy higher market valuations compared to their earlier combined form. Demergers allow shareholders to directly hold equity in the newly created entity, potentially increasing wealth. It ensures a fair reflection of value in the stock market for both the parent and demerged entities.

• Focused Strategy and Growth

Demerged companies gain the autonomy to craft and execute their own business strategies. A focused business unit can align its resources, investments, and decision-making processes toward a specific industry or product line. This enhances strategic agility, enabling quicker adaptation to market dynamics. With clearer strategic vision and goals, companies can also attract domain-specific talent and invest more effectively in innovation and R&D. A standalone company has the independence to enter new markets, form partnerships, or diversify in alignment with its specific business goals.

• Regulatory and Legal Compliance

Sometimes, companies opt for demergers to comply with legal or regulatory directives. For instance, competition laws may require companies to separate certain business units to prevent monopolistic practices. Additionally, regulatory bodies may impose structural separation to maintain financial discipline or transparency in industries like telecom, finance, or utilities. In such cases, demergers are undertaken to align corporate structure with legal frameworks. It ensures continued business operation within the boundaries of the law and fosters goodwill among regulators, customers, and stakeholders.

• Attracting Investment and Partnerships

A focused and independent business entity is often more attractive to potential investors, venture capitalists, or strategic partners. Investors may prefer companies that have clear business objectives, transparent operations, and dedicated management teams. Demergers help businesses present themselves as strong standalone units, facilitating targeted fundraising. Additionally, it becomes easier to form joint ventures or strategic alliances when the business is not entangled in unrelated operations. This clear structure builds investor confidence and can result in increased funding and strategic collaborations, accelerating overall growth.

• Risk Management and Containment

Demergers help in isolating financial and operational risks associated with certain segments of the business. If one unit is loss-making or exposed to high market risks, separating it from the parent company protects the more stable or profitable parts of the business. It ensures that losses or liabilities of one segment do not negatively impact the entire group. Moreover, independent units can implement risk management practices best suited for their specific operations. This separation of risks enhances stability, investor trust, and long-term sustainability of all entities involved.

Objectives of Demergers:

• Focus on Core Business Areas

A key objective of a demerger is to allow a company to concentrate on its core competencies. When diverse business units operate under one corporate structure, management attention and resources may be divided. By separating non-core or unrelated units, the parent company can streamline decision-making and improve efficiency. It enables better alignment of strategy, operations, and investments with the core business. This focused approach enhances competitiveness, helps improve profitability, and allows each entity to pursue growth in its respective market segment without distractions.

• Improved Managerial Efficiency

Demergers facilitate enhanced managerial focus by creating independent entities with dedicated leadership. Managers can make quicker decisions specific to their sector without navigating the complexities of a larger, diversified corporate structure. Each demerged unit operates with its own strategies, budget, and policies, enabling better monitoring and performance evaluation. This clear division also motivates accountability, as management performance is directly tied to the unit’s results. In turn, it leads to improved operational productivity, innovation, and responsiveness to market dynamics, resulting in a more agile and efficient organization.

• Unlocking Shareholder Value

In a conglomerate, the value of individual business segments might remain hidden or undervalued due to consolidated reporting. A demerger creates separate listed entities, making the financials of each more transparent to investors. This allows the market to assess and value each entity independently, often leading to better stock market performance. Shareholders gain direct ownership in the demerged company, increasing wealth and investment options. The enhanced visibility, investor confidence, and market-driven valuation often result in a significant increase in overall shareholder value post-demerger.

• Attracting Strategic Investment

A demerged business becomes a more attractive investment opportunity due to its specific focus and streamlined operations. Investors and strategic partners prefer businesses with a clear mission, distinct market presence, and independent governance. Demergers help in creating such standalone entities, each capable of independently attracting capital, forming joint ventures, or entering mergers. This objective is particularly relevant for companies looking to raise funds or collaborate without impacting the broader corporate structure. It opens up new avenues for targeted investments and growth opportunities in specialized markets.

• Regulatory Compliance and Legal Obligations

In certain industries or scenarios, regulatory bodies may mandate the separation of business activities to promote transparency, competition, or financial discipline. For example, laws related to anti-monopoly, financial regulation, or corporate governance might require business divisions to be legally and operationally distinct. Demergers ensure compliance with such requirements while allowing both the parent and the new entity to continue operations efficiently. By meeting legal standards and avoiding penalties, companies also strengthen their reputation and relationship with regulators, which supports long-term sustainability.

• Independent Growth and Expansion

Each demerged unit gains the autonomy to pursue its own growth path without dependency on the parent company. This independence allows the unit to adopt customized strategies, explore new markets, raise funds, and make investment decisions tailored to its industry dynamics. The ability to function as a separate entity encourages innovation and risk-taking. Independent growth boosts competitiveness, increases market share, and supports diversification. A demerger, thus, serves as a growth catalyst for business units with potential that may have been previously constrained under a consolidated framework.

• Risk Isolation and Containment

Another important objective of demergers is to segregate high-risk or loss-making divisions from financially stable operations. By creating distinct entities, companies can limit the exposure of profitable segments to potential losses or liabilities. This risk isolation protects shareholder interests, maintains investor confidence, and prevents operational disruptions across the organization. It also enables better risk management practices specific to each business’s nature. Consequently, the financial health of core operations remains intact, ensuring long-term stability and smoother management of business challenges.

Types of Demergers:

• Spin-Offs

Spin-off is a type of demerger where a parent company separates a business unit and establishes it as an independent company. Shareholders of the parent company receive shares in the new entity in proportion to their existing holdings, without paying anything extra. The newly formed company has its own management, operations, and financial structure. This move is usually adopted when the division has a distinct business model or growth potential. Spin-offs help in unlocking hidden value, improving focus, and providing both entities with greater strategic flexibility. The parent company no longer controls the spun-off unit but maintains value through shareholder ownership.

• Split-Offs

Split-off involves a company offering its shareholders a choice: either retain shares in the parent company or exchange them for shares in a newly formed subsidiary. Unlike a spin-off, not all shareholders automatically get shares in the new entity. Instead, they must give up their holdings in the parent company to acquire shares in the demerged unit. This leads to a more selective and voluntary separation, often used to resolve strategic misalignments or shareholder preferences. The result is two distinct ownership groups. Split-offs help streamline operations, reduce conflicts, and clarify business structures, ultimately enhancing shareholder value and management focus.

• Equity Carve-Outs

An equity carve-out (or partial demerger) is when a parent company sells a minority stake (usually under 20%) in its subsidiary to the public through an initial public offering (IPO). Unlike spin-offs or split-offs, the parent retains control, while the subsidiary gains its own stock listing and partial independence. This approach helps raise capital without giving up full ownership, enhances the visibility of the subsidiary’s performance, and can prepare it for a complete separation later. Equity carve-outs are often used to highlight undervalued divisions, create market value, and attract strategic investors without diluting control or ownership of the parent company.

The preparation of financial statements after a merger involves consolidating the accounts of the transferor and transferee companies into a single entity. The process differs based on the method of accounting used—Pooling of Interest Method or Purchase Method, as per AS-14 (Accounting for Amalgamations) or IND AS-103 (Business Combinations). The merged entity is required to prepare a fresh set of financial statements reflecting the unified financial position, performance, and cash flows.

Identify the Method of Accounting:

There are two main methods of accounting for mergers:

a) Pooling of Interest Method

• Used when the merger is in the nature of amalgamation.

• Assets, liabilities, and reserves of the transferor company are recorded at book values.

• Reserves are preserved and carried forward.

• No goodwill or capital reserve arises.

b) Purchase Method

• Used when the merger is in the nature of purchase.

• Assets and liabilities are recorded at fair values.

• Reserves (except statutory reserves) are not carried over.

• The difference between purchase consideration and net assets is adjusted as goodwill or capital reserve.

Steps in Preparation of Financial Statements:

a) Record Business Purchase

A journal entry is passed to record the business purchase:

Business Purchase A/c Dr.
      To Liquidator of Transferor Company A/c

This entry records the consideration agreed upon for the acquisition.

b) Record Acquisition of Assets and Liabilities

The next step involves incorporating the individual assets and liabilities of the transferor:

Individual Assets A/c Dr.
      To Individual Liabilities A/c
      To Business Purchase A/c

Under the Purchase Method, assets and liabilities are recorded at fair market values, while under Pooling, book values are used.

c) Record Discharge of Purchase Consideration

Payment to the liquidator is recorded:

Liquidator of Transferor Co. A/c Dr.
      To Equity Share Capital A/c / Bank A/c / Debenture A/c

This depends on the mode of consideration—cash, shares, or debentures.

d) Adjust Goodwill or Capital Reserve (Only for Purchase Method)

If purchase consideration is more than net assets:

Goodwill A/c Dr.
      To Capital Reserve A/c

If net assets exceed the consideration:

Capital Reserve A/c Dr.
      To Goodwill A/c

e) Transfer of Reserves (Only in Pooling of Interest Method)

The reserves of the transferor company are carried into the books of the transferee:

General Reserve A/c Dr.
Profit & Loss A/c Dr.
To Respective Reserve Accounts

Prepare Combined Trial Balance

After passing all necessary journal entries, prepare a combined trial balance that includes:

• Assets and liabilities of both companies

• Adjusted capital

• Reserves (only under Pooling)

• Goodwill or capital reserve

• Share capital after issuance (if applicable)

Preparation of Final Financial Statements:

Now, based on the final trial balance, the following financial statements are prepared:

a) Balance Sheet

• Must follow Schedule III of Companies Act, 2013

• Show consolidated values of assets, liabilities, and equity

• Disclose goodwill or capital reserve (if any)

b) Profit & Loss Account

• Combined revenue and expenses of both entities for the applicable period

• Ensure compliance with revenue recognition principles

c) Cash Flow Statement

• Reflects the cash movements resulting from the merger

• Non-cash transactions like share issue must be disclosed separately

Notes to Accounts & Disclosures:

As per accounting standards and Companies Act, the following must be disclosed:

• Nature and terms of the merger

• Method of accounting used

• Consideration details

• Goodwill or capital reserve

• Legal approvals and effective date

Journal Entries of Merger involve recording the acquisition or amalgamation of one company into another, depending on the accounting method used—Pooling of Interest or Purchase Method. Under the Pooling of Interest Method, assets and liabilities are recorded at book value and reserves are carried forward. The journal entry debits assets, credits liabilities and share capital. Under the Purchase Method, assets and liabilities are recorded at fair value; any excess of purchase consideration over net assets is recorded as goodwill, or a capital reserve if the opposite. Consideration is settled through shares, cash, or a mix, and is recorded accordingly.

Components of Journal Entries of Merger:

• Assets Taken Over

Assets of the transferor company are recorded in the transferee company’s books. Under the Pooling of Interest Method, they are recorded at book value, while under the Purchase Method, they are taken at fair value. These include tangible assets like land, building, machinery, and intangible assets like patents or goodwill. The journal entry debits the respective asset accounts, reflecting their inclusion into the acquiring company’s financial statements post-merger.

• Liabilities Assumed

Liabilities of the transferor company, such as creditors, loans, and outstanding expenses, are recorded in the books of the transferee company. These are credited in the journal entry, reflecting the acquiring company’s obligation to settle them. Under the Pooling of Interest Method, they are recorded at their book values, whereas under the Purchase Method, they may be adjusted to reflect fair value. This ensures that the new balance sheet reflects the true financial responsibility post-merger.

• Purchase Consideration

Purchase consideration refers to the amount paid by the transferee company to acquire the transferor company. It can be discharged through shares, cash, debentures, or a mix. The journal entry records it by debiting the Business Purchase Account and crediting the relevant payment method accounts. Accurate calculation of purchase consideration is crucial as it directly affects the recognition of goodwill or capital reserve in the books of the acquiring company.

• Goodwill or Capital Reserve

This component arises when there is a difference between purchase consideration and the fair value of net assets acquired. If consideration exceeds net assets, the difference is debited as Goodwill; if it’s less, the credit is recorded as a Capital Reserve. Goodwill represents expected future benefits from the merger, while Capital Reserve is a gain. These entries are applicable only in the Purchase Method and not under Pooling of Interest, where such differences are not recognized.

Accounting entries of Journal Entries of Merger:

Mergers involve the combination of two or more companies into one entity. The accounting treatment of mergers is governed by Accounting Standard (AS) 14 – Accounting for Amalgamations, and in the context of Ind AS (for companies complying with IFRS-based standards), it is dealt with in Ind AS 103 – Business Combinations.

There are two primary methods of accounting for mergers:

1. Purchase Method

2. Pooling of Interest Method

The method used depends on the nature of the amalgamation—whether it is considered a merger (amalgamation in the nature of merger) or a purchase (amalgamation in the nature of purchase).

Pooling of Interest Method:

✅ Nature:

Used when the amalgamation is in the nature of merger—i.e., the combining entities merge on equal footing and continue as if they were always one entity.

✅ Conditions for Use (As per AS-14):

• All assets and liabilities of the transferor company become those of the transferee company.

• Shareholders holding not less than 90% of the face value of equity shares of the transferor become shareholders of the transferee.

• Consideration is discharged wholly by issue of equity shares, except for fractional shares.

• The business of the transferor company continues post-amalgamation.

• No adjustment is made to the book values of the assets and liabilities except for ensuring uniform accounting policies.

✅ Key Features:

• Assets and liabilities are recorded at book values.

• Reserves of the transferor company (including general reserve, P&L account) are also carried forward.

• No goodwill or capital reserve arises unless there is a need to align accounting policies.

• Amalgamation is viewed as a continuation of business.

✅ Accounting Entries:

✅ Example:

Company A amalgamates with Company B. All assets and liabilities of B are recorded at book value in A’s books. No revaluation is done. The reserves of Company B are also merged with A’s reserves.

Purchase Method:

✅ Nature:

Used when the amalgamation is in the nature of purchase—i.e., one company acquires another, and the transferor company ceases to exist.

✅ Conditions for Use:

• The amalgamation does not meet the criteria of a merger.

• The transferee company may or may not continue the business of the transferor.

• The shareholders of the transferor may or may not become shareholders of the transferee.

• Consideration may be in any form (cash, shares, etc.)

✅ Key Features:

• Assets and liabilities are recorded at fair values.

• Only statutory reserves (like capital redemption reserve, revaluation reserve) are carried forward.

• Goodwill or Capital Reserve is recognized depending on the difference between the purchase consideration and net assets acquired.

• Amalgamation is viewed as an acquisition.

✅ Calculation:

Purchase Consideration – Net Assets (Fair Value)
→ If Positive: Goodwill
→ If Negative: Capital Reserve

✅ Accounting Entries:

✅ Example:

Company X acquires Company Y for ₹50 lakhs. Fair value of net assets is ₹45 lakhs. The excess ₹5 lakhs is recorded as Goodwill.

Comparison of Pooling of Interest vs Purchase Method

Transition to Ind AS 103 – Business Combinations

Under Ind AS 103, India aligns more closely with IFRS 3, which recognizes only the Acquisition Method (similar to the Purchase Method under AS-14). The Pooling of Interest method is used only for common control transactions (e.g., amalgamation between group companies).

✅ Key Steps under Ind AS 103:

1. Identify acquirer

2. Determine acquisition date

3. Recognize and measure identifiable assets and liabilities

4. Recognize and measure goodwill or gain from bargain purchase

Goodwill and Capital Reserve:

• Goodwill is recorded when purchase consideration > fair value of net assets.

• Capital Reserve is recorded when purchase consideration < fair value of net assets.

• Goodwill should be tested annually for impairment (especially under Ind AS).

• Capital Reserve is shown under Reserves & Surplus in the balance sheet.

Accounting Treatment Summary Table:

Securities and Exchange Board of India (SEBI) is the primary regulatory authority overseeing securities markets in India. It plays a vital role in governing mergers and amalgamations, especially when they involve listed companies. Through its various regulations and circulars, SEBI aims to ensure fairness, transparency, and protection of minority shareholders during the process of corporate restructuring, including mergers.

SEBI guidelines help prevent misuse of merger provisions to bypass regulatory requirements and ensure that restructuring activities are carried out in a structured and investor-friendly manner.

Legal Framework for SEBI Guidelines:

The following laws, regulations, and circulars form the core of SEBI’s merger-related guidelines:

1. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations)

2. SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code)

3. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations)

4. SEBI Circular dated March 10, 2017, revised February 3, 2023, regarding Schemes of Arrangement by Listed Entities

These guidelines are in addition to the provisions of the Companies Act, 2013, which regulates the overall process of mergers and amalgamations.

Purpose of SEBI Guidelines:

• To protect the interests of minority and public shareholders

• To ensure disclosure and transparency

• To maintain market integrity

• To prevent unfair practices and regulatory arbitrage

• To promote standardization and accountability in the merger process

Provisions of SEBI Guidelines:

1. Pre-Filing Requirements

Before filing any scheme of arrangement (including mergers) with the National Company Law Tribunal (NCLT), a listed company must:

• Submit the draft scheme to stock exchanges for review.

• Obtain a no-objection letter from the stock exchange based on SEBI’s comments.

• Appoint a SEBI-registered merchant banker to oversee the valuation and fairness opinion.

2. Draft Scheme Submission

The draft scheme must include:

• Detailed background of the merger

• Valuation report prepared by an independent registered valuer

• Fairness opinion issued by a SEBI-registered merchant banker

• Report from the Audit Committee recommending the scheme

• Report from the Board of Directors explaining rationale

This scheme is examined by the stock exchange and forwarded to SEBI for comments.

3. Valuation and Fairness

• The valuation report must be based on internationally accepted valuation methods.

• The fairness opinion must confirm that the share exchange ratio is fair to all shareholders.

• SEBI scrutinizes the valuation methodology, especially in cases where listed and unlisted entities are involved.

4. Disclosures and Transparency

The company must make disclosures to shareholders and stock exchanges, including:

• Summary of the scheme

• Capital structure pre- and post-merger

• Shareholding pattern

• Financials of the merging entities

• Rationale and expected benefits of the merger

These disclosures are made available on the company’s website and in the explanatory statement to shareholders.

5. E-Voting by Public Shareholders

SEBI mandates approval from public shareholders (excluding promoter and related parties) in the following cases:

• When an unlisted company merges into a listed company, and the resulting public shareholding falls below 25%

• When a listed company merges with another company where the promoter group has substantial interest

• In cases involving material changes in the shareholding or control structure

This ensures that the merger is not detrimental to public shareholders.

6. Minimum Public Shareholding (MPS)

Post-merger, the company must maintain the minimum public shareholding of 25% as required by SEBI. If MPS falls below the required threshold, it must be restored within a stipulated timeframe (generally 12 months) through methods such as offer for sale, rights issue, etc.

7. Lock-in of Shares

New shares issued to promoters or related parties during a merger may be subject to lock-in periods to prevent speculative gains. This provision especially applies when unlisted companies merge with listed ones, and the promoters of the unlisted company receive shares of the listed entity.

8. Accounting Treatment and Auditors’ Certificate

The scheme must comply with accounting standards, and a certificate from the statutory auditor confirming such compliance must be submitted to stock exchanges and SEBI.

9. Redressal of Complaints

A provision must be included in the scheme to address any complaints or objections raised by stakeholders. Stock exchanges also place the scheme for public comments on their websites, and SEBI considers these while giving its observations.

10. Listing of Shares Post-Merger

In case of issue of new shares under the scheme, SEBI guidelines under the ICDR Regulations must be followed to ensure smooth listing of the new shares. The company must file an application with the stock exchange for listing approval of new shares within a specified period after receiving NCLT approval.

Recent Developments:

SEBI Circular dated February 3, 2023 introduced significant changes, such as:

• Tightened norms for valuation and disclosures

• Stricter review for mergers involving distressed companies

• Enhanced scrutiny of financials of unlisted entities

• Increased emphasis on minority shareholder protection

Companies Act, 2013, along with the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, governs the legal framework for mergers and amalgamations in India. The relevant provisions are primarily covered under Sections 230 to 240 of the Act. These sections lay down the procedural and regulatory requirements for carrying out mergers, amalgamations, demergers, and arrangements between companies. The aim is to ensure fairness, transparency, and compliance with statutory obligations, while protecting the interests of all stakeholders including creditors, shareholders, and employees.

Key Provisions Related to Mergers

1. Section 230 – Compromise or Arrangement

Section 230 provides the legal basis for compromise or arrangement between a company and its members or creditors. It covers:

• Arrangements related to the reconstruction of the company.

• Compromises involving debt restructuring or shareholding adjustments.

• It is applicable in cases of mergers, demergers, or any form of corporate reorganization.

The process involves filing an application with the National Company Law Tribunal (NCLT) to call a meeting of creditors or members. The scheme must be approved by:

• A majority representing 3/4th in value of creditors or shareholders present and voting.

• The NCLT, which checks the fairness and legality of the arrangement.

2. Section 231 – Power of Tribunal to Enforce Compromise or Arrangement

Once the NCLT is satisfied that all statutory requirements have been complied with, it has the authority to:

• Sanction the scheme of merger or amalgamation.

• Pass orders binding on all parties, including dissenting shareholders or creditors.

• Supervise the implementation of the scheme to ensure full compliance.

3. Section 232 – Merger and Amalgamation of Companies

This section specifically governs mergers and amalgamations. It outlines:

• The procedural aspects of preparing a draft scheme.

• Requirements for notice and disclosures to members, creditors, regulatory authorities like SEBI and RBI.

• Filing of necessary reports and valuation reports to establish the fairness of the scheme.

• The merger must be approved by the NCLT after considering objections, if any, and compliance with all legal formalities.

Once approved, all assets, liabilities, and undertakings of the transferor company stand transferred to the transferee company.

4. Section 233 – Fast Track Merger Process

This section allows a simplified merger process for certain classes of companies, including:

• Two or more small companies.

• A holding company and its wholly-owned subsidiary.

Key features:

• No need for approval from NCLT.

• The scheme needs approval from:

  • Board of Directors.

  • Shareholders holding at least 90% of the share capital.

  • Creditors representing 90% in value.

• Approval from the Registrar of Companies (ROC) and Official Liquidator is required.

• It is a time-efficient and cost-effective process.

5. Section 234 – Merger with Foreign Companies

This section permits mergers between an Indian company and a foreign company in permissible jurisdictions (as notified by the central government). Such cross-border mergers are subject to:

• Approval from the Reserve Bank of India (RBI).

• Compliance with Foreign Exchange Management Act (FEMA) regulations.

• Valuation norms, accounting standards, and consideration mechanisms (cash or shares).

6. Section 235 – Acquisition of Minority Shareholding

When an acquirer holds 90% or more of the equity share capital of a company, they can compel the minority shareholders to sell their shares at a fair value determined by a registered valuer. This facilitates:

• Complete control of the target company.

• Smooth integration post-merger or acquisition.

7. Section 236 – Purchase of Minority Shareholding

This section complements Section 235 and provides a legal route for buying out remaining shareholders by the majority acquirer. It ensures fair exit to minority shareholders through:

• Valuation by an independent valuer.

• Transfer of shares with proper consideration and procedural compliance.

8. Section 237 – Power of the Government for Amalgamation

The Central Government may, in the public interest, order the amalgamation of two companies by issuing a notification. This is usually done in special circumstances like national interest, revival of sick units, or restructuring of public sector undertakings.

Regulatory Approvals Required

Apart from NCLT, other regulators may be involved depending on the type and nature of the merger:

• SEBI: For listed companies.

• RBI: For NBFCs and cross-border mergers.

• Competition Commission of India (CCI): For large mergers exceeding thresholds.

• Stock Exchanges: For compliance with listing norms.