M&A – The Legal Angle

The solution and problem in a merger or acquisition is regulatory in nature. In all cross-border deals, there is no go-around to regulations. Laws are enacted to essential protect life and property of its citizens. Therefore, it will always be the aspiration of law to protect them. Understanding this will focus the negotiations in a direction that eases M&A deals.

M&As require a successful combination of businesses, technologies, regulation handling and relationships. A clear vision and strategy must involve a legal approach as well as alternatives to legal problems. Relationships can be managed across cultures. Interchange the players in the M&A. Cultural negotiations should adopt a bottom up approach.

Pricing of the transaction will form part of deal structuring. Whether leveraged, unleveraged, debt, participating debt or JV. The deal structure should be clearly spelt out in that particular document. Focus should not only be on the seller’s RNWs or WNIs, but also on local compliance. Non-compliance can have an effect on the price of acquisition.

Many companies decide to dive in first and solve the problems on the go; or application of the words of Rear Admiral Grace Murray Hopper, a U.S. Naval officer and an early computer programmer in 1986 – it is easier to ask for forgiveness than permission. While quick fix non legal solutions may result in fast action and shortterm benefits, it is a highly expensive and disastrous decision and will result in penalties, fines or even jail by law. This shotgun approach may work well for small companies which can wind up fast, but large and listed companies have much deeper roots to uproot. It is always advisable to be over- and self-regulated.

Pre- and post- M&A legal and tax considerations for different jurisdictions are an important angle and determines most M&A deals. What changes the equation will be matters relating to DTAA – double taxation avoidance agreements between relevant countries, DTAA, dividends, royalties, profits, capital gains, legal issues relating to anti-money laundering and anti-terrorism funding as well as international relations. These considerations need to be applied in detail. Involving the proper international legal minds from inception results in cost savings not cost overruns. Good lawyers also bridge connections between the companies involved as well as the regulators. Different angles of approach, including bringing in legal at the right times, can produce time saving and higher chances of success.

Alternative Legal Recourse

Avoiding litigation in any area of business is preferable. Court litigation requires plenty of time, effort on company representatives in court and is highly expensive. Simple transactions to be settled in court can start from USD 200,000 and grow exponentially. 

 

Mediation

Mediation works only if both parties have a good relationship and require a third party to adjudicate on a fair price. This is because mediation is voluntary. The only place where mediation works is if it has the sanction, implied or express, of the court in a country, which can be neutral. 

 

Arbitration

Arbitration is equally expensive in the initial stages, but since the result can be much faster, it will save in long term costs. However, arbitration provides for a neutral venue as well.

 

Transaction Liability Insurance

Transaction Liability Insurance is available for Buyers covering legal liabilities and is an excellent alternative legal recourse. Where transaction liability insurance for sellers is available, it would form a probable win-win situation for both parties. 

 

Alternative Legal Recourse

Another alternative legal recourse is to engage third parties who can either subrogate claims. For example, litigation and recovery arms of banks and III party litigation funders. These maybe in-house or outsourced. third parties would Since the main or prominent part of their business is litigating on a regular basis, a premium of sorts can be negotiated. This will eliminate the M&A parties from expending too much time, effort and money and they can continue with their business.

A third alternative legal recourse is not so much a direct one, but to quantify the liability or have liquidated damages measured to the closest extent. For instance, convert a negative covenant to a positive on. Instead of vague consequences to breach of a contract, a fixed amount may be agreed between the parties on violation or breach. A party may be permitted to circumvent, compete or solicit provided they pay a fixed amount or fees for the same. Where the certainty of a claim exists, there will be better outcomes for both parties, for good or bad.

Acquisitions that are rushed can result in problems and challenges after closing in a transaction:

Some of the reasons why M&As go wrong are:

 

1. Assumption Asymmetry

Leaders and owners may over value a target by making assumptions including over-valuation, over-optimistic assumptions in revenue, cross-selling and cost synergies by the target may create expectations higher than the real value of the business or company. These may be contrary to what a due diligence or post-integration may reveal. If the former address the asymmetry, it will address some issues. But if it occurs post-integration, then it would be too late.

Most legal issues center around disclosures and reps and warranties during and after DD. But some interesting legal questions are whether a buyer should provide his assumptions to the seller or can a party can be held legally responsible if the facts do not match the assumptions. This is what leads to moral hazards where a party to the transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or attempts to earn a profit in a questionable manner. While such legal considerations may be covered in the NDA (and the Overture Documentation – discussed later) signed in the initial stage, actual control over assumptions and facts and enforceability thereto may become sticky issues.

The Parties need to have honest approaches during negotiations in their expectations, disclosures, representations and warranties on both sides to make a successful M&A.

 

2. Having a “take” mentality

M&A is a bi-lateral proposition. Both parties need to be honest and should share equally in the responsibility of making the M&A work. M&A to merely increase share price or increase of income and status of acquirer’s management or professionals can create hurdles and challenges. Such approach reduces shareholder wealth largely over a period of time.
Post-integration, the acquirer should take care to ensure it contributes to the target company and not merely exhaust the latter’s resources.

 

3. Lack of emphasis on post M&A integration

Acquisitions do not end with Closing. It is a continuing process of business building. As part of post-integration will be corporate policies, new HC related contracts, replace as opposed to displace employees, active management alignment and participation. These documents should have corporate sanctions for non-compliance. However, deep consideration should be given to local laws.

Many acquirers slack off once Closing has taken place and leave it to the rank and file to take care of integration. Lack of emphasis or poorly executed steps on post M&A integration will not reap dividends, but create issues that gradually builds up to sure failure. Post M&A integration between the acquirer and target includes not only bringing harmony and coordination, but efficiencies in management, change and cultural integration, application of corporate psychology, adaptation to common vision and equitable distribution of resources. The original leaders and teams of the two companies need to continue work closely together to implement the vision and strategies.

 

Most M&As fail due to a lack of a sound post-integration plan.

4. Shareholder issues

There are two stages. Before and after an M&A. Existing and new shareholders’ expectations need to be brought in alignment to the objective of the M&A in both stages. Some issues would include buying out existing shareholders, reclassification, exchange or combination of shares. The expectations may also need sensitive alignment amongst cross-border shareholders.

5. Employee issues

Analogous to shareholder issues are employee treatment. In an ideal scenario, no employees are displaced, but are successfully reallocated. However, where employees have to be let go despite efforts, clear negotiation objectives need to be in place before the M&A takes place. In addition to this, there will be matters relating to key employee or key management personnel. Negotiations need to cover retention of such persons to ensure successful transition in the acquirer-target combine.

The legal consideration from the seller point of view is whether there has been any effect on the contracts entered into between the main business owner / founder – in particular if there are earn-outs.

6. i-contact

When there is no i-contact – both in terms of seeing eye to eye and discarding egos, the M&A may be doomed at the start; or if it were to sound legalese, mortuus ab initio. In most M&A discussions, getting the parties to agree is a daunting task. There will be differences in terms of valuations, revenues or profits, or potential growth. When the captains of the business come to an understanding, the professionals or advisers will come in with their own set of needs and wants to potentially scuttle the deal. The M&A negotiations should be devoid of emotional baggage. In negotiations, it is not enough to merely have the leaders discuss. The leader should develop a good team that can work in parallel. Personal relationships and persuasive skills between the teams should be balanced. A good legal “team” need not necessarily play bad cop all the time and can assist in diplomacy and righting wrong assumptions.

In addition to the aforegoing, consideration should be given to media attention. The higher the media attention during the negotiations, the larger the variation in price. Smaller deals create more value than bigger deals where expectations are high. Another consideration during negotiations is that even if the M&A goes through despite the above, it can lead to litigation.