Business Combinations
Never invest in something, you do not understand.
In my recent post I wrote about mergers and acquisitions.
Today, I want to show you that the risk appetite, ambitions, and money on hand matter, yet alone, are not sufficient for powerful investment decisions.
In a classical case, an investor obtains control by acquiring the majority of voting rights embedded in equity instruments (shares) of an investee.
The concept of control in accordance with IFRS is outlined by IFRS 10 Consolidated Financial Statements and is written for business combinations (IFRS 3 Business combinations). In this respect, control includes:
The power element, which is the right to decide and direct relevant activities of an investee (i.e. sales, asset management, product development, funding sources, key management) and,
The risk element, which is an exposure to variability of returns from an investee.
The concept of control is a complex one.
Let`s have a look at the (now bankrupt) Silicon Valley unicorn - Theranos. Albeit not a business combination itself, this infamous case highlights some issues related to control.
Theranos, once valued at $9 billion, plummeted to zero market value in 2018 and was closed shortly thereafter.
The company was founded by then 19-year-old Stanford dropout Holmes, claimed to revolutionize medicine by offering affordable tests on multiple health conditions from a single drop of blood.
In terms of “control” two issues are noticeable:
Voting rights are power:
After obtaining more than $700 million of investments from high profile investors, Holmes created two types of common stock, class A (1 vote right) and class B (100 vote rights).
Holmes transferred all class B shares to herself and sealed in the 99% control of the Company giving her free pass for questionable decisions.*
Knowledge is power:
None of the experienced investors and Board Members at Theranos had any background in medical science (e.g. Rupert Murdoch: media, Waltons: retail, Henry Kissinger: politics). Board Members were not knowledgeable enough to direct or challenge relevant decisions of the company.
Conclusion and lesson learned from this example can be found within the third control criterion of IFRS 10.
The control over an investee can only be conveyed if an investor has both the ability - meaning enforceable rights (votes) AND the knowledge (own or purchased) - to exercise the power.
*beyondgovernance.com