Financial engineering : Question 10
What are the financial, tax and legal constraints involved in a merger between the target company and the acquirer’s holding company in LBOs?

Financial constraints: if there are minority shareholders in the target company, a merger will dilute the stake of the holding company’s shareholders significantly. This is because the holding company’s debt has made the value of their shareholding small compared with the value of the target company;

Legal constraints: in addition to standard merger procedures (EGM, report by special mergers auditor), a merger soon after an LBO may give rise to legal issues in certain European countries for a company which will have to provide guarantees for buying back its own shares. In the event of a quick merger however, the debts of the holding company will appear on the balance sheet of the acquired company.

Tax constraints – if the two companies are merged, the tax authorities might contest the deductibility of the interest expense on loans initially contracted by the holding company on the grounds that the subsidiary has no interest in merging and that the merger was forced on it by its majority shareholder, the holding company.

For more information, see chapter 45 of the Vernimmen.