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.
Urs Breitsprecher 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?
German law does not distinguish between warranties and representations. Rescission or termination are available for most breaches. However, there is an important distinction between two German law concepts: “Gewährleistung” is a statutory system of remedies, which can be contractually modified.
Some of these remedies are triggered only if the breaching party is negligent (or acting intentionally, which represents a higher level of responsibility under German law), while others are available even where the breach occurs with no negligence.
“Garantie” implies unlimited, strict no-fault liability on the part of the breaching party. Garantie and Gewährleistung can be translated into English as “warranty” and therefore additional wording is strongly recommended in contracts to avoid ambiguity.
Typical warranties refer to: corporate law issues of the seller and the target; the assets, liabilities and earnings of the company, financial statements; intellectual property rights; employment regulations, especially retirement plans and social security contributions; pending or threatened claims or disputes; compliance with laws, data protection, environmental issues; public permits. In addition to negotiating the scope of the individual warranties, buyers will ask for a blanket warranty on the correctness and completeness of the data room or even all pre-transaction disclosures, which sellers reject in view of the broadness of such a warranty.
Sellers try to limit their liability to actual or constructive knowledge of the incorrectness of warranties given, with a specification whose knowledge will be attributed to the selling entity. Attention should be paid to the burden of proof applicable to the prerequisites of a claim or the defence against it, which may be determined by the grammatical details of wording. As the German civil procedure system does not recognise the concept of pre-trial discovery, the proper setting of the burden of proof may be decisive in determining the success of a claim or defence.
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?
Germany is a very important country and often the engine for the European economy. M&A in Germany is at the same time a very local market but also a global business with international buyers.
According to studies by the Institute for SME Research, around 22,000 companies in Germany are looking for a successor every year. More than half fall back on external succession planning. However, in times of Basel III and economic uncertainty, bank lending is more restrictive than ever before. The payment of the purchase price is becoming a problem for some. A sensible solution in many cases is buyer financing: here the purchase price is paid not only via the buyer’s equity and the banks’ debt capital (which is sometimes only made available to a limited extent), but the seller also makes his contribution. Part of the purchase price can be paid from the company’s current cash flow in instalments or, especially in the case of small companies, based on a pension. Performance-related payments based on certain key figures such as gross profit are also common. Tax advantages can be another plus point for buyer financing. Depending on the legal form of the company and the ownership structure, it can be more than attractive from a tax point of view not to receive the purchase price in one sum. The continued employment of the previous owner or the shareholders via consultancy contracts or the remuneration for their work on company bodies such as the supervisory board are just some of the tax-advantageous options.
Is private equity widely available in your jurisdiction? What are the advantages and drawbacks of financing a deal using equity, in your experience?
Depending on the size of the company, private equity is available in Germany. As a rule, private equity transactions are financed largely by bank loans (so-called senior loan or senior credits). Frequently, the primary lending banks (so-called lead arrangers or facility agents) syndicate the loan for their part to minimise risk. In this way, the borrower’s default risk can be partially shifted to other banks within a bank consortium. The term of a senior loan is regularly between seven and nine years. Revolving tranches for working capital can also be included in the senior loan.
In addition to the senior loan, company acquisitions by private equity companies are often financed by mezzanine financing or second-lien loans. In many cases the investment vehicle (AquiCo) is also granted additional shareholder loans by the private equity company to finance the acquisition. The advantage of a shareholder loan compared to a pure equity financing is that it can be repaid in a tax neutral way (profit distributions of the AquiCo are subject to capital gains tax and capital maintenance principles have to be observed). Moreover, the interest expense can be deducted as an expense for tax purposes to a certain extent at the level of an AquiCo.
Partial financing through debt capital is also typical in financing private equity transactions. The reason for financing the acquisition of a company with outside capital is, on one hand, the associated leverage effect. On the other hand, the interest expense associated with the borrowed capital is often tax deductible at the level of AquiCo as borrower.
The term “leverage effect” thus refers to the changing return on equity as the proportion of debt capital increases. The return on equity of a company is calculated by dividing the profit earned by a company by its equity.
Top Tips – For A Watertight Contract
• Identify each party correctly
Include the parties’ correct legal names in the contract so it is clear who is responsible for performing the obligations and whom you have legal rights against if things go wrong.
• Understand each party’s rights and obligations
Unless you understand the parties’ rights and obligations under the contract, you will not know when a party.
• Have all the terms of the agreement in one place
The agreement should be in writing and, as much as possible, contained within the one document.
• Clear contract structure
Make the basic contract structure clear to ensure that if things go wrong, and the parties can’t reach agreement, the agreement governing the relationship provides clear guidance.
• Keep it simple
Use clear and simple language, create short, clear sentences and number paragraph headings.