Foreword by Andrew Chilvers
For ambitious companies eager to expand into overseas markets, often the
conventional route of organic business development is simply not fast enough. The other option to invest in or buy a business outright is far quicker but often fraught with unforeseen dangers. And even the biggest, most experienced players can get it badly wrong if they go into an M&A with their eyes wide shut.
If you search for good and bad M&As online the Daimler-Benz merger/acquisition with Chrysler back in 1998 is generally at the top of most search engines on how NOT to undertake a big international merger. Despite carrying out all the necessary financial and legal measures to ensure a relatively smooth deal, the merger quickly unravelled because of cultural and organisational differences. Something that neither side had foreseen when both parties had first sat down at the negotiating table.
These days the failed merger of the two car manufacturers is held up as a classic example of the failure of two distinctly different corporate cultures. Daimler-Benz was typically German; reliably conservative, efficient, and safe, while Chrysler was typically American; known to be daring, diverse and creative. Daimler-Benz was hierarchical and authoritarian with a distinct chain of command, while Chrysler was egalitarian and advocated a dynamic team approach. One company put its value in tradition and quality, while the other with innovative designs and competitive pricing.
Adriano Chaves and Martim Machado discussed The Art of Deal Making: Using External Expertise Effectively as part of the M&A chapter.
Which warranties and indemnities are most valuable as part of an M&A contract in your experience? Do you have a process that helps to formulate an effective schedule for either buy or sell-side clients?
In M&A transactions in Brazil, the sellers’ liability is not necessarily or solely tied to breaches of representations and warranties. In fact, representations and warranties are used in Brazil less often as a risk allocation tool and more frequently as a disclosure mechanism.
In a typical Brazilian M&A contract, sellers are usually required to indemnify buyers for any losses resulting from facts or events occurring prior to the closing date, even if such facts or events were known to buyers and there was no breach of representations and warranties. This far reaching indemnity affords buyers a key, “clear-cut” protection against most of the risks they face in Brazil (particularly labour and tax-related risks), which puts it amongst the most valuable indemnities of the contract.
However, that does not mean that indemnities associated with breaches of representations and warranties do not make their way into transaction documents. Normally, M&A contracts in Brazil also require sellers to indemnify buyers for breaches of representations and warranties. But there is no doubt that such indemnity is less relevant than the more comprehensive indemnity related to losses resulting from facts or events occurred during the pre-closing period.
The fact that representations and warranties play a less relevant role for indemnity purposes does not mean that they can be overlooked in Brazilian M&A transactions. Representations and warranties are also important as a disclosure tool since they compel sellers to reveal information on their businesses. In this context, representations and warranties on employment and tax matters are perhaps the most valuable ones in Brazil. Owing to Brazil’s very strict labour laws and complex tax laws, labour and tax problems are frequently not only the most common, but also the most material ones to be dealt with by parties in M&A transactions. Therefore, well-crafted, detailed representations and warranties covering these matters are a must in every M&A contract in Brazil.
What methods of financing a deal are most common in your jurisdiction, for instance private placements, asset finance, mezzanine debt? What advice can you provide around structuring debt into a transaction?
The traditional financing methods, such as private placements, asset finance, mezzanine debt, are available in Brazil in the context of M&A transactions. However, transactions that rely on them are not the norm in Brazil, particularly in the middle market. Leveraged buyouts, which may be more typical in more mature and larger markets such as the US and Western Europe, are not as common in Brazil. That has to do with the relatively small size of most M&A transactions, many of which involve family-owned/controlled companies, and the characteristics of the Brazilian financial market, which is highly concentrated (there are very few large banks operating in the market) and focused on more traditional banking products and services. In view of that, the most common way of financing M&A transactions in Brazil is by implementing payment in instalment schemes and/or earnout arrangements, which must be negotiated and agreed between sellers and buyers on a case-by-case basis.
Is private equity widely available in your jurisdiction? What are the advantages and drawbacks of financing a deal using equity, in your experience?
Private equity players are usually well-capitalized and tend to have more appetite for risk, which makes them more prone to invest in businesses that may not be thriving, but are perceived by them to have great growth potential and be capable of yielding good returns. The Brazilian market has many companies that fit that profile and could benefit from private equity investments. For that reason, private equity has played – and is expected to continue to play – an important role in the context of M&A transactions in Brazil.
Private equity players often acquire minority ownership interests (less than 50%) in the companies in which they invest and sometimes do so through preferred shares and/or convertible debt instruments that put them in a more advantageous legal position vis-à-vis the controlling shareholders. However, they normally seek and obtain economic and political rights (through shareholders’ agreements and other means) that are no worse than the ones held by the controlling shareholders, which may have much more at stake. Private equity players tend to interfere in all major decisions and be very active in the management of the companies. Accordingly, the cheaper capital, the expertise, and the credibility that private equity players bring to businesses come with a cost to controlling shareholders: less control.
Furthermore, private equity players operate under investment goals that always contemplate an exit strategy (through an IPO or a sale of the business to a well-established market player).
Accordingly, their investments usually have an expiration date. This is not always a problem, especially if the controlling shareholders have similar goals and/or see the private equity players as “medium-term” partners that are capable to leverage their businesses. But in certain situations the involvement of private equity players in the day-to-day management and their different vision of the paths to be pursued by the companies they invest in could lead to tensions and even disputes with the controlling shareholders.
Top Tips – For A Watertight Contract
• From a legal standpoint, a contract will have greater chances of being “watertight” if it
(i) takes into account the peculiarities of the transaction (i.e. the characteristics, interests and goals of the parties, and the complexity and materiality of the various risks identified during due diligence) and
(ii) translates them into terms and conditions that give the parties the right economic incentives to behave as expected.
• Payment terms, conditions precedent, representations and warranties, closing actions, post-closing covenants (including non-compete provisions) and indemnities (including indemnities dealing with labour and tax issues and provisions regulating the right of the parties in connection with the defence of third party claims) will differ depending on whether the buyer is purchasing shares or assets, or a majority or minority stake.
• M&A transactions are complex and intense and it is natural that, during their negotiations, sellers and buyers will constantly seek opportunities to obtain advantages for themselves in furtherance of their own interests. But this drive must be tamed. The negotiation process is not about winning or losing, but about bridging gaps and building fruitful relationships.