Cash Out Merger – Definition

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Cash Out Merger Definition

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.

A Little More on What is a  Freeze Out Merger

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: The Working Process

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.

Freeze-Out Provisions Definition

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.

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.

References for Cashout Merger

https://www.investopedia.com/terms/f/freeze-out.asp

http://www.businessdictionary.com/definition/cashout-merger.html

https://thelawdictionary.org/cash-out-merger/

https://www.quimbee.com/keyterms/cash-out-merger

Academic Research for Cashout Merger

The Standard of Care Required of an Investment Banker to Minority Shareholders in a CashOut Merger: Weinberger v. UOP, Inc., Haigt, C. B. (1983). Del. J. Corp. L., 8, 98. The DCC (Delaware Court of Chancery) decided Weinberger v. UOP, Inc. on 9th Feb 1981 which addressed the problem of duty of an investment banker to shareholders in the minority when he provides a fairness opinion to the stock value in a cash-out merger. Particularly, the court considered whether it is a fiduciary duty of the banker to the minority shareholders when it comes to knowing that the opinion is going to be used for soliciting a cash-out merger approval. The cash-out merger is actually a transaction eliminating the minority shareholders equity interest in the enterprise by making them cash payment for the former interests in the obtained instead of issuing new stock.

Balancing Interests in CashOut Mergers: The Promise of Weinberger v. UOP, Inc., Weiss, E. J. (1983). Del. J. Corp. L., 8, 1. Corporations continue working whatever changes occur in the shareholders’ identity. This is because it is a separate legal entity. Cases are there with regularity where the corporation’s majority shareholders desire to continue their control and participation in its business forcing out the participation of minority shareholders in the enterprise. For hundred years or more, minority shareholders have reached the courts for help with the claim that it should allow continuing their status as shareholders or they should get more compensation as compared to the one offered by the majority shareholders. The response of the courts varies over the years.

Valuation waves and merger activity: The empirical evidence, Rhodes–Kropf, M., Robinson, D. T., & Viswanathan, S. (2005). Journal of Financial Economics, 77(3), 561-603. This paper presents a decomposition to break the ratio of market-to-book (M/B) into 3 parts: the company-specific price deviation from the industry prices of short-run, short-run deviations throughout the sector from company’s prices of long-run and the prices of long-run to book as well. This research gets the support of several authors. So, company-specific deviations from industry prices of short-run, long-run parts of this ratio counter to the traditional wisdom, low long-run VB (Value-to-Book) firms purchase high long-run VB firms, misvaluation influences, who purchase whom and payment method. It incorporates neoclassical interpretations for elaborating the activity of aggregate merger.

Agency costs of free cash flow, corporate finance, and takeovers, Jensen, M. C. (1986). The American economic review, 76(2), 323-329. The incentives and interests of shareholders and managers conflict over the problems as the firm’s optimal size and the cash payment to shareholders. These conflicts specifically become severe in companies with greater free cash flows- more cash as compared to profitable investment opportunities. This paper covers the advantages of debt in minimizing free cash flows agency costs, how loan can be an alternative of dividends, for what reasons, the diversification programs tend to yield losses as compared to expansions or takeovers in the same business line or liquidation-motivated takeovers, why the activity of factors generating takeover in the diverse activities like tobacco and broadcasting are the same as in oil.

Elimination of Minority Interests by Cash Merger: Two Recent Cases, Kessler, M. K. (1975). The Business Lawyer, 699-711. Corporation statutes allow issuing cash and non-equity securities or property in place of stock in situations of the statutory merger while presenting the opposed shareholders the option to keep claiming cash appraisal rights. The cash merger is becoming very popular in general and publicly-held corporations that use the technique of ‘going private’. 2 latest federal cases of cash mergers have made new and old queries in the context of a very complex issue confronting the corporate lawyer, the one we call as the ‘minority interests elimination’ and in a pejorative manner as the ‘freeze-out’ or squeeze-out’.

A model of venture capitalist investment activity, Tyebjee, T. T., & Bruno, A. V. (1984). Management science, 30(9), 1051-1066. This study overviews the venture capitalists activities as an orderly process containing 5 sequential steps: (a) deal origination by which deals are considered as investment prospects (b) deal screening which is a delineation of main policy variables delimiting investment prospects for deep evaluation to a manageable few (c) deal evaluation, an estimate of expected return and perceived risk based on the weighting of many features of the prospective venture and also on the decision to invest or not as analyzed by the relative levels of expected return and perceived risk. Deal structuring, the negotiation of the deal price, i.e. the relinquished equity to the investor and the covenants limiting the investor’s risk.

Going private: Minority freezeouts and stockholder wealth, DeAngelo, H., DeAngelo, L., & Rice, E. M. (1984). The Journal of Law and Economics, 27(2), 367-401. In several minority freezeouts and going-private transactions, present managers retain public corporation’s majority control and achieve absolute equity possession of the surviving private corporation. In a few cases, managers share equity ownership subsequently with external private investors assisting in financing the publicly held stock acquisition. A number of legal vehicles affect corporate ownership reorganization. Its most common example is a public firm’s cash-out merger into a shell corporation created for the transaction expressly and the management group owns completely. Conflicts of interest on managerial level in going-private transactions are broadly considered to lead public stockholders unfair treatment.

The effects of taxation on the merger decision, Auerbach, A. J., & Reishus, D. (1988). In Corporate takeovers: Causes and consequences (pp. 157-190). University of Chicago Press. This article analyzes the tax benefits achieved from a sample of United States acquisitions and mergers having 2 public corporations from 1968 to 1983. The authors evaluate the ‘Marriage Model’ on the basis of differences in these mergers and pseudo mergers, another sample which does not estimate the effect of tax benefits on the probability of 2 companies combining. The results are opposed to the hypothesis that there is a vital role of leverage in fostering such transactions and the acquired firms’ credits and tax loss left no effect on merger activity. The findings suggest having a Lille effect of tax provisions changes w.r.t mergers on acquisitions and US mergers.

Fiduciary Duties and Reasonable Expectations: CashOut Mergers in Close Corporations, Crago, D. C. (1996). Okla. L. Rev., 49, 1. A discussion has been made in the close corporate studies and case law about who owes the fiduciary duties in a close corporation, to whom these are owed, whether it is a duty of traditional corporate or of a heightened partnership and also, whether corporations having less shareholders may merit identity as a close corporation without holding statutory elections for this status. The case law in Delaware and Massachusetts rules represent multiple viewpoints known as the majority rule. Characterizing these rules as the majority rules can be regarded as a greatly suspect classification since this rule’s support by case law is highly misinterpreted and exaggerated. Since the latest progress in business law has consistency with the minority rule philosophy, the recent minority rule of Delaware will ultimately dominate the close corporate law.

  • The truth about reverse mergers, Sjostrom Jr, W. K. (2007). Entrepreneurial Bus. LJ, 2, 743. This paper explains the concepts of the merger and the reverse merger. It examines the method of reverse merger known as ‘going public’. The main characteristics of the reverse merger include legal compliance and deal structure. Though reverse mergers are pitched routinely as inexpensive and quicker as compared to conventional IPOs (Initial Public Offerings), the author presents an argument that these pitches mislead and are irrelevant for several companies.

Cash and Property as Consideration in a Merger or Consolidation, Fillman, J. A. (1967). Nw. UL Rev., 62, 837. A merger is basically a transaction where a corporation absorbs into another one named ‘surviving corporation ‘ whereas the consolidation is primarily a transaction where 2 existing corporations absorb and combine into a single newly-created 3rd corporation, named ‘surviving’ or ‘consolidated corporation. Both of these are of many forms. In several instances, a combination or an acquisition may cast as a consolidation, merger, sale and purchase of assets or stock buying and selling without changing the transaction’s economic consequences. These corporate fusion forms are specified in the IRC (Internal Revenue Code) as the same transactions requiring similar tax treatment in specifically defined circumstances.

ows- more cash as compared to profitable investment opportunities. This paper covers the advantages of debt in minimizing free cash flows agency costs, how loan can be an alternative of dividends, for what reasons, the diversification programs tend to yield losses as compared to expansions or takeovers in the same business line or liquidation-motivated takeovers, why the activity of factors generating takeover in the diverse activities like tobacco and broadcasting are the same as in oil.

  • •    Elimination of Minority Interests by Cash Merger: Two Recent Cases, Kessler, M. K. (1975). The Business Lawyer, 699-711. Corporation statutes allow issuing cash and non-equity securities or property in place of stock in situations of the statutory merger while presenting the opposed shareholders the option to keep claiming cash appraisal rights. The cash merger is becoming very popular in general and publicly-held corporations that use the technique of ‘going private’. 2 latest federal cases of cash mergers have made new and old queries in the context of a very complex issue confronting the corporate lawyer, the one we call as the ‘minority interests elimination’ and in a pejorative manner as the ‘freeze-out’ or squeeze-out’.
  • •    A model of venture capitalist investment activity, Tyebjee, T. T., & Bruno, A. V. (1984). Management science, 30(9), 1051-1066. This study overviews the venture capitalists activities as an orderly process containing 5 sequential steps: (a) deal origination by which deals are considered as investment prospects (b) deal screening which is a delineation of main policy variables delimiting investment prospects for deep evaluation to a manageable few (c) deal evaluation, an estimate of expected return and perceived risk based on the weighting of many features of the prospective venture and also on the decision to invest or not as analyzed by the relative levels of expected return and perceived risk. Deal structuring, the negotiation of the deal price, i.e. the relinquished equity to the investor and the covenants limiting the investor’s risk.
  • •    Going private: Minority freezeouts and stockholder wealth, DeAngelo, H., DeAngelo, L., & Rice, E. M. (1984). The Journal of Law and Economics, 27(2), 367-401. In several minority freezeouts and going-private transactions, present managers retain public corporation’s majority control and achieve absolute equity possession of the surviving private corporation. In a few cases, managers share equity ownership subsequently with external private investors assisting in financing the publicly held stock acquisition. A number of legal vehicles affect corporate ownership reorganization. Its most common example is a public firm’s cash-out merger into a shell corporation created for the transaction expressly and the management group owns completely. Conflicts of interest on managerial level in going-private transactions are broadly considered to lead public stockholders unfair treatment.
  • •    The effects of taxation on the merger decision, Auerbach, A. J., & Reishus, D. (1988). In Corporate takeovers: Causes and consequences (pp. 157-190). University of Chicago Press. This article analyzes the tax benefits achieved from a sample of United States acquisitions and mergers having 2 public corporations from 1968 to 1983. The authors evaluate the ‘Marriage Model’ on the basis of differences in these mergers and pseudo mergers, another sample which does not estimate the effect of tax benefits on the probability of 2 companies combining. The results are opposed to the hypothesis that there is a vital role of leverage in fostering such transactions and the acquired firms’ credits and tax loss left no effect on merger activity. The findings suggest having a Lille effect of tax provisions changes w.r.t mergers on acquisitions and US mergers.
  • •    Fiduciary Duties and Reasonable Expectations: CashOut Mergers in Close Corporations, Crago, D. C. (1996). Okla. L. Rev., 49, 1. A discussion has been made in the close corporate studies and case law about who owes the fiduciary duties in a close corporation, to whom these are owed, whether it is a duty of traditional corporate or of a heightened partnership and also, whether corporations having less shareholders may merit identity as a close corporation without holding statutory elections for this status. The case law in Delaware and Massachusetts rules represent multiple viewpoints known as the majority rule. Characterizing these rules as the majority rules can be regarded as a greatly suspect classification since this rule’s support by case law is highly misinterpreted and exaggerated. Since the latest progress in business law has consistency with the minority rule philosophy, the recent minority rule of Delaware will ultimately dominate the close corporate law.
  • •    The truth about reverse mergers, Sjostrom Jr, W. K. (2007). Entrepreneurial Bus. LJ, 2, 743. This paper explains the concepts of the merger and the reverse merger. It examines the method of reverse merger known as ‘going public’. The main characteristics of the reverse merger include legal compliance and deal structure. Though reverse mergers are pitched routinely as inexpensive and quicker as compared to conventional IPOs (Initial Public Offerings), the author presents an argument that these pitches mislead and are irrelevant for several companies.
  • •    Cash and Property as Consideration in a Merger or Consolidation, Fillman, J. A. (1967). Nw. UL Rev., 62, 837. A merger is basically a transaction where a corporation absorbs into another one named ‘surviving corporation ‘ whereas the consolidation is primarily a transaction where 2 existing corporations absorb and combine into a single newly-created 3rd corporation, named ‘surviving’ or ‘consolidated corporation. Both of these are of many forms. In several instances, a combination or an acquisition may cast as a consolidation, merger, sale and purchase of assets or stock buying and selling without changing the transaction’s economic consequences. These corporate fusion forms are specified in the IRC (Internal Revenue Code) as the same transactions requiring similar tax treatment in specifically defined circumstances.

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