Cash-Out Merger - Explained
What is a Cash Out Merger or Freeze-Out Merger?
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Table of ContentsWhat is a Cash Out Merger?How does a Cash Out Merger Work? Cash-Out Provisions Legal Controversies Surrounding Freeze-out MergersAcademic Research for Cashout Merger
What is a Cash Out Merger?
A cash out merger refers to a merger between two companies where the shareholders of the target firm don't want to be involved with the acquiring organization. Cash out mergers are sometimes referred to as squeeze out mergers or freeze out mergers when shareholders are coerced into selling off their shares in the company being acquired to the acquiring firm. Important details to consider in a cash out merger includes:
- In a freeze-out merger, the majority shareholders attempt to make the opinions of the minority shareholders to be invalid. This subsequently puts to naught the voting and decisions of the minority shareholders on how the business is managed.
- Sometimes, the minority shareholders can challenge the majority shareholders in court. However, care should be taken as the majority shareholders can exploit this is settle issues that they have with the minority group
- Each legislation is the United States has a list of the actions that can be taken and those that are forbidden in a freeze-out merger.
How does a Cash Out Merger Work?
Freeze out mergers are usually found in closely-held companies, that is firms where the majority shareholders maintain a close relationship with each other. Here, the majority shareholders will connive with each other to cut off the minority from decision making processes, which in turn will make minority votes invalid and non-implementable.
However, this is an illegal process that can be reversed when challenged in court, since the ownership of stakes in a company, no matter the size gives you a say in how things are run there. Freeze-Out are mostly used in acquisitions, as the majority shareholders would want to dismiss the points of the minority if they're against the merger. Different legislations have various actions that are legal during a freeze-out, and these actions are available in their corporate merger and acquisitions laws.
Freeze-Out mergers have a tedious process of acquisition. In this system, the majority shareholders which larger control over a business will create a new corporation (not a subsidiary) that they'll be in charge of. This new corporation will then make a tender offer to the main company with the intentions of having the minority shareholders to give up their shares.
If this is possible, the acquiring company can choose to merge their company into the new corporation. For non-tendering shareholders in this case, they'll lose their company stakes since the firm no longer exists (remember it has been merged with the new corporation), thus voiding any right to minority ownership which they once had. These shareholders will be given cash or security compensation which is equal to the value of the shares they once owned in the company.
A freeze-out provision can sometimes be used in a corporate charter and it allows an acquiring firm to buy out the stocks of minority shareholders for a fair value (usually paid in cash) during a specified duration after the completion of the merger.
Legal Controversies Surrounding Freeze-out Mergers
Freeze-Out mergers have their own legal critics just like all things popular and existing. Most cases on freeze-out mergers have gone to court. In 1952, a case of freeze-out merger between Sterling and Mayflower Hotel Corp appeared in Court. Here, the Supreme Court declared a fairness that must be implemented in all frees-out mergers. The court stated that the acquiring firm and its board of directors is required to stand on both sides of the transaction and they're required to make sure that the merger is fair to every party. It also stated that freeze-out mergers must pass scrutiny tests imposed on it by the courts.
Formerly, it seemed like the law wasn't in favor of freeze-out mergers since it almost denied all freeze-out cases brought to courts. However, they're now more accepted by courts provided that the definition of fairness meets the following; the acquisition should have a business purpose and shareholders must be compensated fairly for their stakes. The nature of freeze-out mergers sometimes can make them look tricky and unethical to the minority shareholder. Given below are some information you might find important about freeze-out mergers:
- The majority shareholders usually establish a new corporation which they own and control personally.
- This new corporation might submit a tender offer with the hopes that the minority shareholders will sell their shares.
- If this tender offer is accepted, minority shareholders will lose their minority ownership in the company since it'll no longer exist. This is because the new corporation will merge with the old, thus making the old one non-existent in financial sense. However, these minority shareholders will be paid the cash or securities value of their stakes in the old company, and sometimes given additional benefits.
- Some company charters include provisions for a freeze-out merger, which makes sure that shareholders will be fairly compensated in a situation where they're acquired by another firm, or if they happen to merge with one.
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