Although the past year has been full of challenges for both the global and local economy, there have been no major changes in the business ecosystem – businesses of various scales continue to form, develop, companies are bought, sold and merged.
This will not change in 2023 either, however, there are several factors that must be taken into account when the time has come to sell the company and an influential investor has also been found.
Andra Rubene, partner of the law firm “TGS Baltic”, has summarized the eight most important aspects that should be paid attention to when implementing the plan for the purchase and merger of companies.
Differences of opinion could grow this year
One of the biggest challenges in the field of mergers and acquisitions of companies, both in Latvia and elsewhere in 2023, will be to overcome the differences of opinion between the seller and the buyer regarding the value of the target company and, accordingly, the purchase price of its capital shares (shares). The sellers will want to determine the price at which they could have sold the company before the Russian invasion of Ukraine. Buyers, on the other hand, will be ready to offer a price that they consider reasonable at the moment, taking into account inflation, the increase in credit interest rates and other changes. In order for the transactions to take place, the parties will have to adapt to the conditions or structure the transactions in such a way that the price proposed by the seller can be combined with the one offered by the buyer, for example by providing for deferred payments and making part of the payment dependent on the achievement of certain results (earn outs).
Increasing the value of the company by divesting its less successful parts
When planning the sale of a company, the seller can timely separate and dispose of the less successful parts of the company in order to improve the value of the target company. However, the less successful parts may be of interest to investors planning their strategic growth in the same, similar or vertically related market. For example, a profitable competitor may be interested in acquiring a less profitable competitor. Or a strong market player may want to buy the wholesaler it buys from or the retailer it supplies to because it sees synergies and cost savings from consolidating its supply and distribution chains.
In-depth research is more important than ever
Given the changing circumstances (increasing interest rates, inflation, energy, financing, labor, etc. costs), it is even more important than before to conduct accurate in-depth research. Potential investors will look to ensure the stability of supply and demand, rational operation, costs, revenue flow and profitability, innovation, the right partners and growth. Key aspects of in-depth research will include exposure to sanctions, a continuous and diverse supply chain, energy price stability, efficiency, emissions, financing costs (taking into account rising interest rates), adequate leverage, sustainable financial performance, the ability to set prices so that, if necessary, they can adjust according to costs, intellectual property (recognizable brands, intellectual property rights), IT performance and security, data processing.
Lower prices – higher risks
Distressed mergers and acquisitions allow for the acquisition of a target company that would otherwise not have come up for sale, or at a lower price, assuming additional risks. Due to geopolitical and macroeconomic reasons, situations may arise when the target companies or their owners face financial difficulties: commercial activities may become unprofitable, debt defaults, negative equity or immediate liquidity needs may occur. If it is not possible to attract additional financing, including by offering capital shares (shares), the owners of the target company will be interested in selling the company before the creditors realize the pledges or insolvency occurs. The target company’s purchase price shrinks when the opportunity to conduct comprehensive due diligence diminishes because it no longer has the time, resources or sense to provide it; cannot obtain appropriate representations and warranties; there is no coverage, because the members (shareholders) of the target company no longer have any assets to direct recovery.
Assume that a solvent seller sells a target company in a timely fashion that does not yet show any signs of financial distress, subject to due diligence and appropriate representations and warranties. In that case, the seller can get a reasonably good price. The price will be lower if the target company shows signs of financial distress, but a solvent seller will still be able to ensure a proper M&A process. However, if the seller is in financial difficulties and lacks time, the available price will be relatively much lower. Even lower prices and higher risks will only occur if the company is sold by secured creditors through a collateral sale, or if the company or its parts are sold as part of legal protection or insolvency proceedings.
Despite the added risks and complexities, at any of the above stages, strategic investors may be interested in acquiring a competitor struggling to achieve further growth and consolidation, or upstream (manufacturers, suppliers) or downstream (distributors, wholesalers, retailers) market players . In mergers and acquisitions of distressed companies, payment of the purchase price may include debt rollovers, making part of the payment dependent on the achievement of certain results.
Certificate and insurance – mandatory requirement
In order to facilitate and speed up negotiations on the conclusion of the contract for the purchase of capital shares (shares), the seller’s declaration and guarantee, as well as W&I insurance (Warranty and Indemnity) can be used. The availability of W&I insurance depends on the value of the transaction, but insurance is a prerequisite for in-depth research and the inclusion of appropriate representations and warranties of the seller and W&I obligations in the equity purchase agreement.
Involvement of experts already at the start of the transaction
The involvement of competition law experts already at the initial stage of the transaction will make it possible to foresee the receipt of the merger permit in the transaction documents as a prerequisite for the execution of the transaction and find solutions for its receipt in time.
If, as a result of the transaction, the market shares in the markets in which both parties to the merger operate are significantly increased, and these markets cannot be redefined more narrowly or broadly, the buyer must develop appropriate binding commitments in time to reduce or prevent the negative effects of the merger on competition in the relevant markets.
To facilitate merger approval without binding terms, the buyer can argue that it is acquiring a failing firm and would leave the market anyway if the buyer did not acquire it. Therefore, the acquisition is in the consumer’s interest, provided that the target company meets the criteria of a company in difficulty. It is also essential in the transaction documents (equity purchase agreement, company purchase agreement or other documents) to agree on obtaining a merger permit as a prerequisite for the execution of the transaction, as well as on risk sharing measures in case this prerequisite is not fulfilled, for example, the obligation to make payment in any case (hell and high warter clause) or the obligation to pay for non-performance of the contract if the merger permit is not received.
Verification of investment permits
Foreign direct investment permit requirements should be verified in order to acquire target companies of importance to national security. Acquisition of a commercial company important to national security requires government approval. The target company can be a commercial company important for national security, if it operates in the fields of electronic communications, media and natural gas processing, or is a liquefied natural gas production plant, a producer of electricity or thermal energy, provides electricity transmission, owns forests or agricultural land, trades strategic or dual-use goods, is a military manufacturer, or processes data included in a country’s critical infrastructure systems.
ESG – “the new normal”
Given that investors are increasingly demanding the effective implementation and compliance of environmental, social and governance (ESG) requirements and that additional funding is available for sustainable businesses, adopt and implement ESG policies to ensure ESG and sustainable development.
