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.
Matthias Meitner discussed The Art of Deal Making: Using External Expertise Effectively as part of the M&A Advisory chapter.
How has the M&A landscape changed in the aftermath of the Covid-19 pandemic? Has it changed the nature of deal making in your jurisdiction and which industries have seen most activity?
While availability of capital due to low interest rates and lack of alternatives and the ongoing need for succession solutions, in particular in the German ‘Mittelstand’ (i.e. SMEs), keep M&A activities on track in general, we also see a couple of new trends in Germany.
First, due to lower visibility during Covid-19 due diligence and decision-making processes are taking longer – for the buyer and the seller side. This is an important point to take into account, particularly if deadlines apply. Second, the relevance of contingent acquisition price clauses (e.g. earn outs) has strongly increased. Also due to the lower visibility and the accompanying inability to make sound forecasts, buyers are less willing to agree to a fixed price at time of acquisition. They rather want to pay for the target contingent on this target’s actual future operating performance. In such cases, if both parties agree, a base price is paid and milestones or hurdle rates for the target’s future performance are set at the time of acquisition. Over time, further payments are made by the buyer dependent on the performance of the target as compared to the milestones – the better the performance, the higher the payment duties for the buyer. Third, the use of technology during the due diligence process has strongly gained ground. Not only do many negotiations sometimes now take place via video conferencing tools, we also see a strong step-up in the use of drones for virtual factory tours and initial physical asset scrutiny.
In terms of M&A industry focus we mainly observe trends that mirror the Covid-19 impact on business models. This means med-tech, pharma, software and construction see ongoing strong activities. Capital goods activity restarted after the lockdown was lifted. Tourism and similar industries are – not a big surprise – very weak currently.
What advice could you give potential clients on effective pre-deal planning? For instance, preparing a business for sale in your jurisdiction or ensuring transparency for a buyer?
I think the basic rules of professional deal preparation are international. So, I would rather focus on the Covid-19 particularities. For sellers and buyers some important things have changed in recent months. First, professional valuation and analysis advice has become ultra-important. The times are gone where investors focused on a more or less comparable set of peer group companies and simply applied an average multiple of this group to the target (admittedly, this never was a very smart way of valuation but now it is even less so). Most target companies are currently not in a ready state, their fundamentals are at an imbalance, and many risk parameters are out of the normal range. So investors currently have to think far beyond simple multiples-arithmetic. They have to turn to more complex though still practically applicable valuation approaches.
Second, valuation expertise is also needed for the increasing number of contingent consideration clauses. These clauses are structured financial instruments which could not always be understood
intuitively. Independent of Covid-19, I have seen several transactions where one side did not fully comprehend the clause details and consequently ran into a very bad deal. The same is true in cases where complicated vendor financing instruments are applied.
Third, and this is a trend independent of Covid-19, potential buyers should properly prepare the due diligence process. Sellers today more and more restrict the access time and number of people with access to the digital data rooms. In many cases even the number of questions allowed is restricted. So a good preparation is mandatory to take the most out of the data rooms.
What deal structures prove most effective in your jurisdiction (e.g. asset vs share deals)? Are there any important legislative anomalies that international clients considering a merger or acquisition in your jurisdiction should be aware of?
In normal times, share deals are the dominant deal variant in Germany as they are less complex to structure. However, in times of crisis asset deals gain in attractiveness for buyers. The reason
for this is that share deals usually require the buyer to stand in for the liabilities of the acquired company and hence to face the whole insolvency risk. In asset deals, however, the buyer can pick the preferred assets and liabilities and consequently can limit the downside risk. For sellers, the opposite is true: asset deals are less attractive in times of crisis. However, as sellers of crisis-companies are often in a weaker position than buyers, we see a general increase in asset deals when the economy suffers.
In terms of legislative anomalies, from my experience, what surprises most international investors is the German corporate governance system. In Germany, the board follows a two-tier structure with a clear separation of supervisory and management board. Additionally, Germany puts a lot of weight on co-determination. E.g., in stock corporations up to 50% of the supervisory board seats have to be held by employee representatives. This aspect is particularly relevant for investors that plan to acquire restructuring candidates.
With specific regard to Covid-19 international clients should be aware that in Germany the duty to file for insolvency remains suspended until the end of 2020, but only for over-indebted businesses that are still solvent. Hence, investors should take extra care when going for target companies that are in crisis.
Top Tips – Effective Negotiation Strategies In Your Jurisdiction
- Have a clear agenda!
Define your goals! Define the range of acceptable outcomes. Stick to this framework!
• Be prepared!
Even if you stay within your framework, negotiations do not follow predetermined paths. Only if you know the economics and details of the underlying case very well, and if you also understand your counterparty’s position, you can properly move within your framework.
• Stay honest!
Mutual trust is the key to successful negotiations. Your chances of a great outcome increase with your level of integrity and honesty.
• Use team power!
If possible, always have a colleague/partner that joins the negotiation and is in listen-and-watch-only mode. This allows you to better understand moods, tensions and motivations of your counterpart.