Merger

What is a merger?

Merger (in German: Verschmelzung or Fusion) describes a combination in which one company transfers all of its assets, together with contracts and debts, to another and ceases to exist without winding up. Its shareholders receive shares in the acquiring company in return. Legally, this transfer in a single step is called universal succession (Gesamtrechtsnachfolge): unlike the purchase of individual assets, nothing has to be transferred one by one. It is as if two households move in together: the entire household moves along, and the second apartment is given up.

In Germany, the German Reorganisation Act (Umwandlungsgesetz, UmwG) regulates mergers. It speaks generally of legal entities (Rechtsträger), because forms other than the GmbH (German limited liability company) and the AG (German stock corporation) can also be involved.

In business practice, "merger" often stands for any combination of companies, including the acquisition of a majority in another company. The collective term M&A (mergers and acquisitions) covers both. In the legal sense, only the merger in the strict sense is meant. For growth companies, it occurs above all in the combination of two companies in return for shares, in the integration of an acquired subsidiary after a share deal and in the simplification of group structures. It is documented in a merger agreement, merger resolutions and registrations with the commercial register.

Forms of merger

Legal forms

• Merger by absorption (Section 2 UmwG): The transferring company is absorbed into an existing company. When two GmbHs combine, the acquiring company generally increases its share capital for this purpose and grants the new company shares to the shareholders of the transferring company.
• Merger by formation of a new company: Both companies transfer their assets to a new company and cease to exist. This form is chosen when neither side is to appear as the acquirer, for example in a combination among equals (merger of equals). It is more complex because the formation rules for the new company additionally apply.
• Group merger: The parent company absorbs a wholly owned subsidiary. A capital increase is not needed, because no new shares are to be granted to third parties, and a merger report and audit are not required.

Economic forms

Economically, a distinction is made between the horizontal combination of competitors at the same market level, the vertical combination with an upstream or downstream company and the conglomerate combination with no business connection between the activities. Horizontal projects are most likely to raise questions of merger control. Depending on revenue, the Federal Cartel Office (Bundeskartellamt) or the European Commission is responsible; until clearance, a prohibition on closing applies.

Course of a merger under the UmwG

1. Merger agreement: The managements conclude an agreement with the statutory minimum content under Section 5 UmwG. This includes the exchange ratio, that is, how many new shares there are for each old share, and the consequences for employees. In addition comes the merger reference date, from which the business is deemed to be conducted for the account of the acquiring company. The agreement is notarially recorded (Section 6 UmwG). The draft must be sent to the competent works council at the latest one month before the shareholders' meeting.
2. Merger report: The managements explain the agreement and the exchange ratio in legal and economic terms (Section 8 UmwG). The report is not required if all holders of shares waive it in notarial form.
3. Merger audit: For a GmbH, a court-appointed merger auditor reviews the agreement only if a shareholder requests this in good time (Section 48 UmwG).
4. Merger resolutions: The shareholders' meetings of both companies approve with at least three quarters of the votes cast, unless the articles of association require a larger majority (Section 50(1) UmwG). The resolutions are notarially recorded.
5. Registration and entry: A closing balance sheet must be attached to the registration for the transferring company, the reference date of which is no more than eight months before the registration (Section 17(2) UmwG). The merger takes effect with the entry in the register of the acquiring company (Section 20 UmwG).

An action can be brought against a merger resolution within one month. For the entry, it must therefore be declared that no action is pending. Otherwise, a court release order must be presented, under which the action does not stand in the way of the entry (Section 16 UmwG). An action cannot be based on the exchange ratio being inadequate; since the 2023 reform, this applies to the shareholders of both companies. They are referred to the appraisal proceedings (Spruchverfahren), a separate court procedure in which the court can fix a cash compensation payment. Creditors whose claims are endangered by the merger can demand security within six months after publication (Section 22 UmwG).

Consequences of universal succession

With the entry, assets, contracts and liabilities pass without individual transfer, and counterparties do not have to consent. Contractual change-of-control and termination clauses can nevertheless apply and therefore belong in due diligence. Permits tied to a person do not pass in every case. Employment relationships pass to the acquiring company under Section 613a of the German Civil Code (BGB), the application of which the UmwG expressly provides for.

Taxes on a merger (UmwStG)

For income tax purposes, a merger is initially treated as a disposal at fair market value (gemeiner Wert). The hidden reserves, the difference between book value and market value, would thereby be taxed. A merger is tax-neutral only under the conditions of the German Reorganisation Tax Act (Umwandlungssteuergesetz, UmwStG). For corporations, the transferring company can, on application, carry forward the book values (Section 11(2) UmwStG). The condition is that the hidden reserves are later subject to corporation tax at the acquiring company, that German taxing rights are not restricted and that at most shareholder rights are granted as consideration. For the shareholders, the new shares replace the old ones tax-neutrally under corresponding conditions (Section 13 UmwStG).

Cash compensation payments are not consideration in shareholder rights and lead to the disclosure of hidden reserves to that extent. Tax loss carry-forwards and interest carry-forwards of the transferring company, that is, losses and interest expenses of earlier years not yet used, do not pass to the acquiring company. For tax purposes, the merger takes effect retroactively to the reference date of the closing balance sheet (Section 2 UmwStG), which affects planning and settlement between the companies. If the transferring company holds real estate, real estate transfer tax arises, unless a relief for group restructurings applies.

Worked example: exchange ratio in the merger of two GmbHs

A-GmbH is to take over B-GmbH by merger by absorption. Both companies are valued using the same business valuation method. What matters is the value of the shares, not that of the operating business: debt is deducted from the respective enterprise value and cash is added (equity bridge). This gives EUR 24 million for A-GmbH, with share capital of EUR 60,000 divided into 60,000 company shares of EUR 1 each. B-GmbH is worth EUR 8 million and has 25,000 company shares of EUR 1 each.

• Value per company share of A-GmbH: 24,000,000 / 60,000 = EUR 400
• Value per company share of B-GmbH: 8,000,000 / 25,000 = EUR 320
• Exchange ratio: 320 / 400 = 0.8, that is, 0.8 new shares in A-GmbH for each share in B-GmbH
• New shares: 25,000 × 0.8 = 20,000 company shares; A-GmbH increases its share capital by EUR 20,000 to EUR 80,000
• Holdings afterwards: existing shareholders of A-GmbH 60,000 / 80,000 = 75%, existing shareholders of B-GmbH 20,000 / 80,000 = 25%
• Check using the values: 8 / (24 + 8) = 25%

If the parties expect synergies of EUR 4 million, the value of the combined company rises to EUR 36 million. At the agreed ratio, 25% of the synergies, that is EUR 1 million, go to the existing shareholders of B-GmbH; their stake is then worth EUR 9 million. If they want a larger part, they have to negotiate a higher exchange ratio. With 22,000 new shares, their stake would be 22,000 / 82,000, around 26.8%, which would correspond to around EUR 9.66 million. Rounding differences can be settled by cash compensation payments. For a GmbH, the UmwG limits compensation payments fixed in the merger agreement to one tenth of the total nominal amount of the shares granted, in the example EUR 2,000. A merger can therefore not replace a cash purchase price.

Post-merger integration: where value is created

The value of a merger is created only when the organisations have been brought together (post-merger integration, PMI for short). Cost synergies from joint administration, infrastructure and procurement can be planned relatively reliably, but often materialise later than assumed. Revenue synergies from selling to the other side's customers are less certain, because sales, pricing models and contracts first have to be aligned. Integration planning therefore begins before closing, with clear responsibilities for the first months afterwards.

Distinctions: merger, share deal, asset deal and spin-off

• Share deal: In a share purchase, both companies continue to exist, the target company becomes a subsidiary of the acquirer, and the consideration is mostly paid in cash.
• Reverse triangular merger: A structure under US law in which an acquirer's subsidiary is merged into the target company. There is no direct equivalent for German target companies.
• Spin-off: The demerger under the UmwG runs in the opposite direction. Part of the assets is transferred to another legal entity, instead of assets being brought together.
• Asset deal: Individual transfer of selected assets against a purchase price instead of universal succession against shares.

Common mistakes

• Deadline for the closing balance sheet missed. If its reference date is more than eight months before the registration, no entry is made. A new balance sheet and a later tax reference date are the consequence.
• Exchange ratio without uniform valuation. If both companies are valued using different methods, the ratio is open to challenge and can lead to compensation payments in appraisal proceedings.
• Loss carry-forwards planned for. The loss carry-forwards of the transferring company are lost. Conversely, if the merger is into the loss-making company and a new shareholder receives more than 50% of its shares in the process, its losses are in principle also forfeited under Section 8c of the German Corporation Tax Act (KStG).
• Works council involved too late. Timely delivery of the draft agreement must be proven to the registry court; a missed deadline delays the entry.
• Joint steering before clearance. Until merger control clearance, the companies remain independent market participants and may neither coordinate prices nor run the business jointly.

Frequently asked questions

Does a merger need the consent of all shareholders?

No. For a GmbH, a majority of three quarters of the votes cast is sufficient, unless the articles of association provide something stricter. If individual shareholders have special rights, their consent is additionally required in certain cases.

How long does a merger of two GmbHs take?

In simple cases without merger control, a few months. The timetable is determined by the one-month period for the works council, the shareholders' meetings, the period for bringing an action and processing by the registry courts.

What is the difference between a merger and an acquisition?

In an acquisition (takeover), one company buys shares or assets of another, which continues to exist as a subsidiary or business. In a merger in the legal sense, one company ceases to exist, and its shareholders become shareholders of the acquiring company.

Is a merger tax-free?

Not automatically. It is tax-neutral only if the conditions of the Reorganisation Tax Act are met and the book value approach is applied for. Cash compensation payments and real estate can trigger taxes even then.

How can shareholders challenge an inadequate exchange ratio?

Only in appraisal proceedings; since 2023 this also applies to the shareholders of the acquiring company. The court there reviews adequacy and, where appropriate, fixes a cash compensation payment, without the merger itself being reversed.

The Roemer Capital view

We encounter a merger mainly when two companies combine in return for shares or when a buyer wants to integrate the acquired company. Our contribution is the valuation of both sides using the same method and the derivation of the exchange ratio on which the negotiation rests.

We treat synergies separately: cost synergies with a time discount, revenue synergies only in the optimistic case of the financial model. Implementation under the UmwG and UmwStG lies with the law firm and tax adviser; we coordinate with them the timetable of closing balance sheet, works council deadline and registry process.