Takeover by Recapitalization: Key Aspects and Legal Guidelines

In the dynamic world of corporate business, company takeovers represent a significant aspect of growth strategies, market consolidation, and business restructuring in the Republic of Croatia. There are several ways in which a takeover can be achieved, and one of the more complex but often effective approaches is a takeover through recapitalization. This blog aims to provide a comprehensive understanding of company takeovers by recapitalization, explaining the key aspects and relevant legal guidelines within Croatian legislation.

What is a Company Takeover?

Definition of Company Takeover in Croatia:

In the broadest sense, a company takeover signifies the acquisition of another company or a significant share in its capital, regardless of whether it is achieved by purchasing assets or equity. In a narrower sense, a takeover implies gaining control over a company by purchasing all of its assets or acquiring a majority stake in its capital. If all assets are purchased, the acquired company usually ceases operations and is legally liquidated.

When we talk about joint-stock companies, the key legal framework in Croatia is the Law on Takeovers of Joint Stock Companies. This law defines a “takeover bid” as a publicly announced offer, mandatory or voluntary, addressed to all shareholders of the target company for the acquisition of all their voting shares. The offer may also relate to preferred shares without voting rights.

The target company is defined as a joint-stock company with its registered office in the Republic of Croatia whose voting shares are listed on a regulated market in Croatia or in another member state of the European Economic Area (EEA), and are not listed in Croatia. Also, the target company can be a joint-stock company with its registered office in another EEA state whose voting shares are listed on a regulated market.

The purpose of a takeover is often to acquire a majority stake and control over the management of the target company. According to the Law on Takeovers of Joint Stock Companies, a mandatory takeover bid arises when a natural or legal person, independently or together with others, acquires voting shares of the target company and exceeds the threshold of 25% of the voting shares.

The takeover process involves an offer made by the bidder to the shareholders of the target company to purchase their shares. The offer must be clear and specify the consideration offered by the bidder in exchange for the shares. The consideration may be in cash, exchange shares, or a combination of both. It is important to note that mergers and acquisitions (M&A) are considered high-risk transactions, but with the potential for high returns. Unlike mergers, where one or more companies merge with another and no liquidation is carried out because the business continues to exist within the acquirer, a takeover may or may not lead to the cessation of the acquired company as a separate legal entity.

The legal framework specifically protects minority shareholders in takeover situations. The legal obligation to publish an offer to all shareholders when the 25% ownership threshold is crossed ensures that all shareholders have the opportunity to sell their shares at a fair price when a significant change in the control of the company occurs. This provision prevents so-called “creeping takeovers” and ensures transparency of the process. Furthermore, the definition of a target company that also includes those listed on stock exchanges of other EEA member states shows that Croatian takeover legislation has a cross-border reach, reflecting the interconnectedness of European capital markets and protecting domestic investors who hold shares in such companies.

Concept of Acquiring Control over the Target Company:

Acquiring control over the target company implies the ability to exert a decisive influence on the company’s decisions, which is most often achieved by holding the majority of voting rights (more than 50% of voting shares). However, the legislator has recognized that significant influence, which requires the protection of minority shareholders, is acquired by crossing the threshold of 25% of voting shares. Control can be exercised directly, by holding shares, or indirectly, through related companies or agreements with other shareholders. The law also takes into account situations where several persons act jointly in acquiring shares, in order to prevent the avoidance of the obligation to publish a takeover bid through coordinated action by several parties.

Types of Company Takeovers

Company takeovers can be classified according to different criteria:

• Friendly and Hostile Takeovers:
  • A friendly takeover occurs when the management of the target company supports the takeover bid and recommends it to the shareholders. Such takeovers usually involve negotiations, due diligence by the acquirer, and cooperation from the management of the target company.
  • A hostile takeover occurs when the management of the target company opposes the takeover bid, believing that it is not in the best interest of the company or its shareholders. In this case, the acquirer directly contacts the shareholders of the target company with a public offer to buy their shares, bypassing the management. Hostile takeovers often involve a higher price offered to shareholders to encourage them to sell despite management opposition. In Croatian business practice, hostile takeovers are rarer and generally less successful than friendly ones.
• Mandatory and Voluntary Takeover Bids:
  • A mandatory bid is legally prescribed when the acquirer, independently or together with others, reaches or exceeds the threshold of 25% of the voting shares in the target company. In this case, the acquirer is obliged to publicly offer to buy the remaining shares.
  • A voluntary bid is submitted by an acquirer who wants to gain a controlling stake in the target company, but is not legally obliged to do so, usually because they have not yet crossed the threshold for a mandatory bid.
• Takeover of Shares with and without Voting Rights:
  • The primary focus of a takeover bid is usually on acquiring shares that carry voting rights, as these determine control over the company.
  • However, the law allows the takeover bid to simultaneously include an offer to acquire preferred shares without voting rights.
• Other Relevant Classifications:
  • According to the relationship between the companies participating in the takeover, we distinguish between horizontal takeovers (between companies in the same industry, often competitors), vertical takeovers (between companies in a buyer-seller relationship), and conglomerate takeovers (between companies in unrelated industries).Also, we distinguish between majority takeovers (acquiring more than 50% of shares) and minority takeovers (acquiring less than 50% of shares).
  • As already mentioned, the consideration in a takeover can be in the form of cash (cash consideration), exchange of shares (exchange consideration), or a combination of both (combined consideration).

What is Recapitalization (Increase of Share Capital)?

Definition of Recapitalization and Increase of Share Capital according to Croatian Legislation:

Recapitalization represents the process of increasing a company’s capital. This is often achieved by investing new funds or assets into the company. Legally speaking, this process is called an increase in the company’s share capital (dionički kapital or upisani kapital) .

The share capital of a joint-stock company must be expressed in the currency of the Republic of Croatia (currently EUR) and must not be less than the prescribed minimum amount. For example, the minimum share capital for a joint-stock company (d.d.) is EUR 25,000, and the nominal value of a share must not be less than EUR 1. For a limited liability company (d.o.o.), the minimum share capital is EUR 2,500, and the minimum nominal value of a business share is EUR 10.

An increase in share capital can be carried out in various ways, including new cash payments, the contribution of assets or rights, the conversion of debt into equity, or the capitalization of reserves .

The recent legal obligation to state share capital in EUR due to the introduction of the euro in Croatia requires all Croatian companies to align their registered capital, which potentially includes adjusting the nominal value of shares or business shares.

Purpose and Reasons for Conducting Recapitalization:

The primary purpose of recapitalization is to strengthen the financial base of the company . Common reasons for recapitalization include:

• Financing new investments in profitable projects or business expansion .
• Acquisition of other companies or businesses.
• Improving the company’s liquidity and cash flow.
• Restructuring the company’s balance sheet, for example by reducing debt.
• Changing the ownership structure and attracting new strategic partners or investors to accelerate growth.
• Increasing the company’s creditworthiness and facilitating access to loans.
• Covering accumulated losses.
• In the case of a simple limited liability company (j.d.o.o.), reaching the minimum share capital of a limited liability company (d.o.o.) and removing restrictions on profit distribution .

Takeover by Recapitalization: Detailed Explanation

Definition and Explanation of Takeover by Recapitalization as a Combined Process:

A takeover by recapitalization is a process in which the acquirer increases its ownership stake and potentially gains control over the target company by subscribing for new shares in the target company. Instead of exclusively purchasing existing shares from existing shareholders, the acquirer invests new capital directly into the target company in exchange for newly created shares. This process simultaneously provides fresh capital for the target company and changes its ownership structure. This method can be particularly attractive when the target company needs capital for restructuring, growth, or overcoming financial difficulties .

This takeover method uniquely combines the transfer of ownership with an immediate strengthening of the target company’s financial position . It represents a strategic move by the acquirer not only to gain control but also to ensure that the target company has the resources needed for future success . Unlike a traditional takeover where funds primarily go to existing shareholders, a takeover by recapitalization directs capital directly into the target company’s treasury. This can be crucial for companies needing investment in operations, technology, or debt reduction. The acquirer’s investment provides the target company with the financial stability needed to implement strategic initiatives and potentially increase its value post-acquisition.

Purpose of Such a Takeover:

The main purpose of a takeover by recapitalization is to acquire a significant or majority ownership stake while simultaneously strengthening the financial position of the target company. The acquirer achieves its ownership goals, while the target company benefits from the inflow of capital.

Additional purposes include:

• Restructuring and rehabilitation of financially distressed companies: Recapitalization can be a crucial tool in rescuing and turning around the business of companies facing financial difficulties, with the acquirer’s capital providing the necessary financial injection.
• Enabling strategic partnerships and synergies: A company may carry out recapitalization with a specific investor who brings not only capital but also valuable knowledge, technology, or access to new markets, fostering strategic alignment.
• Debt-to-Equity Swap: An entity that has previously granted loans to the company can convert that debt into equity through recapitalization, thereby becoming a shareholder and potentially gaining control . This can be a solution when the indebted company is struggling to repay its obligations.
• Avoiding the obligation to publish a takeover bid: In certain specific scenarios, an increase in capital may allow an investor to gain control without triggering a mandatory takeover bid under certain conditions prescribed by law . However, this is subject to strict legal control and exceptions stated in the Law on Takeovers of Joint Stock Companies.

The use of recapitalization as a takeover mechanism in financially distressed companies highlights its importance in corporate restructuring and rescue scenarios, where the acquirer’s capital inflow is crucial for the survival and potential recovery of the target company. When a company faces insolvency or serious financial difficulties, a traditional acquisition may not be feasible or attractive due to the target company’s liabilities . Recapitalization offers a viable alternative by injecting fresh capital to improve the target company’s balance sheet and operational capabilities. This can be a mutually beneficial solution, allowing the struggling company to continue operating and providing the acquirer with an opportunity to gain a stake in a potentially undervalued asset with turnaround potential. Furthermore, the potential of recapitalization in strategic alliances suggests its role in fostering closer collaboration and long-term partnerships between companies, where capital investment signifies a deeper commitment and alignment of interests . When companies aim to establish a strong strategic alliance, investing capital through recapitalization can solidify the partnership. This not only provides the target company with financial resources but also aligns the economic interests of both parties, encouraging greater cooperation and potentially leading to synergies and mutual success.

Situations in which a Company Takeover by Recapitalization is Performed

A company takeover by recapitalization is usually carried out in the following situations:

• Companies in financial difficulties that need fresh capital for recovery .
• In the context of strategic partnerships where one company wants to secure an ownership stake in another while simultaneously strengthening its capital .
• To finance growth projects and business expansion where the target company needs significant financial resources that are secured through recapitalization by an investor who in return acquires an ownership stake .
• As a conversion of existing debt into equity .
• In private equity investments where private equity funds use recapitalization as a method of gaining influence and restructuring target companies .
• In specific cases, as part of a financial restructuring plan agreed with creditors .

The prevalence of recapitalization in financial restructurings underscores its role as a crucial tool for companies seeking to overcome financial distress and achieve long-term sustainability . When a company is burdened by debt or facing operational losses, recapitalization can provide the necessary capital to stabilize finances, repay creditors, and invest in future growth . This often involves negotiations with existing creditors and investors to agree on a restructuring plan that includes capital infusion .

Key Aspects and Legal Guidelines

Legal Framework Governing Takeovers of Joint Stock Companies:

The primary legal framework is the Law on Takeovers of Joint Stock Companies . This law regulates the conditions for making a takeover bid, the takeover procedure, the rights and obligations of participants in the takeover procedure, and the supervision of the takeover procedure by the Croatian Financial Services Supervisory Agency (HANFA) . Key provisions include the obligation to publicly announce a takeover bid when the acquirer reaches or exceeds 25% of the voting rights in the target joint-stock company . The law also prescribes the mandatory content of the takeover bid, the duration of the offer, the obligations of the target company’s management, and the protection of minority shareholders’ rights . It is important to note that there are certain exceptions to the obligation to publish a takeover bid under special conditions prescribed by law.

The detailed provisions within the Law on Takeovers of Joint Stock Companies demonstrate a strong commitment to ensuring fairness and transparency in the Croatian market for corporate control, particularly regarding the rights of minority shareholders . The comprehensive legal framework aims to prevent opportunistic behavior by acquirers and ensure that all shareholders are treated equally during the takeover process . The mandatory bid rule, disclosure requirements, and HANFA’s oversight are key elements in maintaining market integrity and investor confidence .

Legal Aspects of Increasing Share Capital:

The increase of share capital (recapitalization) is primarily regulated by the Law on Commercial Companies . This law prescribes various ways in which a company can increase its share capital, including new cash or non-cash contributions, capitalization of reserves, or debt conversion . The procedure usually requires a decision by the shareholders’ assembly (general meeting) defining the amount of the increase, the method of payment, and any amendments to the articles of association or the memorandum of association . In the case of joint-stock companies, the issuance of new shares as part of the recapitalization process is subject to special regulations, including the potential pre-emptive right of existing shareholders to subscribe for new shares . This right can be excluded under certain conditions with the approval of the shareholders’ assembly . Non-cash contributions (contribution of assets and rights) may require valuation by an independent appraiser, although there are exceptions under certain conditions . The decision to increase share capital must be registered in the court register to be legally valid.

The detailed procedures for increasing share capital outlined in the Law on Commercial Companies ensure a level of corporate governance and shareholder protection during capital raising activities, even when these activities are part of a takeover process . The legal requirements for shareholder approval, potential valuation of non-cash contributions, and registration with the commercial court are designed to ensure that decisions about increasing share capital are made transparently and with due regard to the interests of all stakeholders . These procedures help prevent the dilution of the value of existing shares without proper authorization and disclosure .

Obligations of the Bidder and the Target Company in the Takeover by Recapitalization Procedure:

The acquirer (bidder) must fulfill all obligations prescribed by the Law on Takeovers of Joint Stock Companies, including the potential obligation to launch a takeover bid if its stake exceeds the 25% threshold as a result of the recapitalization . It must also comply with the rules on disclosure of ownership and intentions.

The target company must follow the procedures for increasing share capital prescribed by the Law on Commercial Companies . This includes convening a shareholders’ assembly to approve the capital increase, issuing new shares to the acquirer, and registering the change with the commercial court.

The management of the target company has a fiduciary duty to act in the best interest of the company and all its shareholders throughout the takeover process, including assessing the terms of the recapitalization and its potential impact on the future of the company.

A takeover achieved through recapitalization requires a coordinated effort by the acquirer and the target company to comply with the requirements of both the Law on Takeovers of Joint Stock Companies and the Law on Commercial Companies, highlighting the complexity and the need for careful legal and strategic planning . The acquirer must ensure compliance with takeover regulations regarding thresholds and bid obligations, while the target company must adhere to the legal procedures for issuing new shares and increasing capital . This dual compliance requirement necessitates careful synchronization of actions and documentation to ensure a legally sound and successful transaction .

Protection of Shareholders’ Rights:

Minority shareholders in the target company are protected by the provisions of the Law on Takeovers of Joint Stock Companies, which may require the acquirer to make a takeover bid for their shares if the recapitalization results in the acquirer’s stake exceeding the 25% threshold . Shareholders have the right to receive sufficient information about the proposed recapitalization and its implications for the ownership structure and future prospects of the company in order to make informed decisions about voting at the shareholders’ assembly. The Law on Commercial Companies also provides for the protection of shareholders’ rights during capital increases, such as the potential pre-emptive right to subscribe for new shares (unless this right is legally waived) and the right to challenge decisions of the shareholders’ assembly under certain circumstances .

The legal framework in Croatia provides several layers of protection for minority shareholders in the context of a takeover by recapitalization, ensuring that they are not unfairly disadvantaged by the transaction . The mandatory bid rule ensures an exit opportunity for minority shareholders when a new controlling shareholder emerges . Disclosure requirements ensure transparency of the terms and implications of the transaction . Shareholders’ voting rights on the capital increase decision and potential pre-emptive rights offer additional ways for minority shareholders to protect their interests .

Conclusion

A takeover by recapitalization is a complex but sometimes necessary process in the corporate world. In the Republic of Croatia, this process is subject to strict legal frameworks encompassing both the Law on Takeovers of Joint Stock Companies and the Law on Commercial Companies. Understanding the key aspects of these laws, as well as the purpose and situations in which a takeover by recapitalization is carried out, is crucial for all participants in such transactions. This approach to takeovers can be particularly useful in restructuring financially distressed companies or establishing strategic partnerships, but it requires careful planning and compliance with all relevant legal regulations. Given the complexity of these transactions, it is recommended to seek professional legal and financial advice when considering or implementing a company takeover by recapitalization in Croatia.

If you need legal advice regarding takeover or recapitalization, feel free to contact us at:

info@odvjetnik-bistrovic.hr