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.
Altug Guzeldere 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?
The warranties and indemnities that matter most to the sell-side and the buy-side are different from each other. The first and foremost important warranty for the buy side aims to ensure that the target company; (a) has provided all necessary documents during the legal due diligence conducted; (b) not breached any corporate, financial, tax, labour, environmental etc. rules; (c) has a balance sheet which is transparently reflecting the financial standing of the company and; (d) all legal and contractual obligations of the company have been fulfilled.
Finally, we may add, if one of the above is not true, the sellers will be responsible from the losses that may stem from such a breach. One very important task for the lawyer here is not only to make sure that the contractual undertakings are watertight, but also that they are and will be enforceable when necessary.
It has to be kept in mind that it may take years for any tax or contractual breach to surface and when they do, are we still going to be able to reach the sellers to claim compensation or whether or not such sellers will still have any assets that can be seized? For this purpose, if the sell side is no longer a shareholder in the company and if they do not have other businesses or large assets, then the buy side may have to think about certain securities to ensure that their prospective losses are compensated when necessary. Typically, there are less warranties granted to the sell side as the main contractual obligation of the buy side is to remunerate the purchase price of the share that mostly takes place simultaneously with the closing. In such situations, we encourage our sell side clients to gain a better understanding about the mid to long-term business plans of the buy side.
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?
In terms of financing a deal, acquisition finance from financial institutions is the most common way in Turkey. However, due to the restrictive nature of financial assistance rules in Turkey, debt financing is used on a very limited basis for share sales. Therefore, most of the acquisitions that are structured as share sales are based on equity financing and are in the form of straight equity.
Asset sales transactions often use debt financing structures in the form of senior debt. In a typical debt financing, the senior debt will be in the form of a term loan. In rare cases, this senior debt is combined with a relatively new structure: mezzanine financing. Even if the mezzanine finance is a new term of finance in Turkey, it is expected to be more commonly used in the future.
Additionally, payment-in-kind debt is also one of the preferred finance methods, which is only used in Islamic finance transactions, as Turkey is getting more attractive for southern investors.
With regards to security options, mergers may be disadvantageous compared to an asset acquisition, as the assets of the target cannot be used as security for the financing (with few exceptions), due to financial assistance prohibition. The typical exception is the pledge of shares of the target in an acquisition financing, but the shares are not the assets of the target.
Investors should also be reminded on prohibitions regulated under Article 380 of the Turkish Commercial Code, which regulates the maintenance of share capital and aims to prevent the circumvention of the share buy-back restriction, in which share buy-backs that exceed 10% of the capital are prohibited. It applies when; (i) Shares are acquired by a third party; (ii) Financial assistance is provided in favour of the buyer or; (iii) Financial assistance is provided for the acquisition of shares. This regulation, which creates a material obstacle on leveraged acquisitions and directly affects the future of acquisition financings in the Turkish market, is untested in the Turkish courts and there is no secondary legislation for the application of this provision.
Is private equity widely available in your jurisdiction? What are the advantages and drawbacks of financing a deal using equity, in your experience?
Turkey has been and remains attractive for private equity (“PE”) firms seeking to raise funds for investment, despite the economic turmoil that has affected Turkey, where a sharp decline in the value of the lira has fallen more than 30% against the US dollar and an inflation rate above 20%, and after the devastating effect of the pandemic. Private equity money is invested in new companies or startups that have significant growth potential, which contributes to the economic growth of Turkey.
On the other hand, Turkish PE funds are relatively new for Turkish laws. Due to the newly established domestic PE funds, foreign PE funds appear to be more active in Turkish M&As.
The most frequent method of investment for PE transactions in Turkey is to establish a Special Purpose Vehicle (“SPV”) in a jurisdiction that is tax efficient, often offshore. These then acquire shares in Turkish companies directly or through a local SPV established by the offshore PE fund in Turkey.
Private equity investing has gained traction due to its history of high returns, which is not easily achieved through more conventional investment options. However, private equity carries a different degree of risk than other asset classes due to the nature of the underlying investments. This includes liquidity risk, since private equity investors are expected to invest their funds with the firm for several years on average, and market risk, since many of the companies invested in are unproven, which can lead to losses if they fail to live up to the early hype.
Top Tips – For A Watertight Contract
• Lawyers may draft watertight contracts and then the clients may find out that the contract is flawless but may fail to serve their needs to be fully secured in the transaction. Therefore, the lawyers try to adopt a 360-degree view of the entire picture. For example, being the lawyer of the buy side, we may fill the contract with all the necessary representations and warranties in favour of the buyer. But then, even years after closing, it may be understood that the target company had off-balance sheet liabilities, which could not be detected during the legal and financial due diligence.
• In certain cases I have even seen bad faith sellers issue promissory notes for post-closing dates that remain a ticking time bomb in the hands of the buy side and create destructive results. signals of the other side in the transaction in addition to ensuring that all legal precautions are duly taken.