Freeze-out merger

A freeze-out merger is a technique by which one or more shareholders who collectively hold a majority of shares in a corporation gain ownership of remaining shares in that corporation.

The majority shareholders incorporate a second corporation, which initiates a merger with the original corporation. The shareholders using this technique are then in a position to dictate the plan of merger. They force the minority stockholders in the original corporation to accept a cash payment for their shares, effectively "freezing them out" of the resulting company.

Criticism

The legal community has criticised the present rules with regard to freeze-out mergers as being biased against the interests of the minority shareholders. For example, if a gain in stock value is anticipated by the majority, they can deprive the frozen-out minority of its share of those gains.

Although a LBO is an effective tool for a group of investors to use to purchase a company, it is less well suited to the case of one company acquiring another. An alternative is the freeze-out merger: The Laws on tender offers allow the acquiring company to freeze existing shareholders out of the gains from merging by forcing non-tendering shareholders to sell their shares for the tender offer price. Here is how it is accomplished. An acquiring company makes a tender offer at an amount slightly higher than the current target stock price. If the tender offer succeeds, the acquirer gains control of the target and merge its assets into a new corporation, which is fully owned by the acquirer. In effect, the non-tendering shareholders lose their shares because the target corporation no longer exists. In compensation, non tendering shareholders get their right to receive the tender offer price for their shares. The bidder, in essence, gets complete ownership of the target for the tender offer price. Because the value the non-tendering shareholders receive for their shares is equal to the tender price (which is more than the premerger stock price), the law recognizes it as fair value and non-tendering shareholders have no legal recourse. Under these circumstances, existing shareholders will tender their stock, reasoning that there is no benefit to holding out: if the tender offer succeeds, they get the tender price anyway; if they hold out, they risk jeopardizing the deal and forgoing the small gain. Hence the acquirer is able to capture almost all the value added from the merger and, as in the leveraged buyout, is able to effectively eliminate the free rider problem. This freeze-out tender offer has a significant advantage over a LBO because an acquiring corporation need not make an all-cash offer. Instead of paying the target’s shareholders in cash, it can use shares of its own stock to pay for the acquisition. In this case, the bidder offers to exchange each shareholder’s stock in the target for stock in the acquiring company. As long as the exchange rate is set so that the value in the acquirer’s stock exceeds the premerger market value of the target stock, the non-tendering shareholders will receive fair value for their shares and will have no legal recourse.