Viraj Bhogle of KNAV participated in The Art of Deal Making: Using External Expertise Effectively

Atul DeshmukhLead Partner, KNAV

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.

Viraj Bhogle 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?

We are living in unprecedented times where the Covid-19 pandemic has impacted the due diligence protocols and risk landscape for the majority of M&A transactions, and the ripple effect is likely to last for some time for buyers and sellers, mainly due to the fear of the unknown.

Though it is not the first time the M&A world has experienced such major economic and financial upheaval, this time we believe things are different; going beyond the conventional financial and valuation impact, the pandemic has affected numerous other aspects of the transaction world, including the manner in which due diligence is conducted, how deal terms are developed and negotiated and how technology and other collaborative tools are utilized, while deal participants are practicing social distancing.

While global M&A activity has tumbled to its lowest level in more than a decade in the wake of the Covid-19 outbreak, the US M&A market contraction has been even steeper with a YoY decline of over 50% compared to 2019 . Even though certain transactions proceeded as planned, many deal discussions and sales processes have been placed on indefinite hold or abandoned

altogether. Buyers are more focused on evaluating the short and long-term impact of Covid-19 on the target’s business and financial condition and reviewing the parties’ rights and remedies under the acquisition agreement.

As we approach the end of 2020, we anticipate a turnaround and robust recovery in M&A activity and have strong reasons to believe that when deal negotiations kickstart, it is likely to be a buyer’s market where they will get more conditionality and perhaps better terms.

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?

Crisis creates opportunities. Cash-rich acquirers and investors, including private equity funds, will seek to take advantage of this adversity to make acquisitions of fundamentally strong businesses

at suppressed valuations. Buyers will need to be extra diligent in their approach, while sellers will need to prepare for increased scrutiny. Buyers and sellers may even refrain from entering or even negotiating a traditional letter of intent until the buyer has performed a limited scope customary due diligence on the extent to which Covid-19 has adversely affected the seller’s business, financial performance and other areas the buyer deems relevant.

We would advise potential buy-side clients to limit their use of cash and offer deferred consideration to the extent possible until operations return to some level of normalcy. Innovative use of contingent pricing structures involving earnouts and milestone payments would be the flavor of the season. From a US tax perspective, contingent and deferred payments can have their own complexities, especially whether it constitutes capital gain or ordinary income for the sellers, and it is important for the buyer and seller to pre-agree on future tax treatment.

If the seller receives a loan under the Paycheck Protection Program, established by the CARES Act, we would advise buyers to seek additional representations and warranties. The buyer should take into consideration the tax implications of a PPP loan, firstly the interaction with other CARES Act provisions such as employee retention credit and the eligibility for full or partial forgiveness. In case of high possibility of forgiveness, buyers must examine the taxability and timing of PPP forgiveness,

especially in the light of tax disallowance of expenses incurred out of the PPP loan. The success of transactions going forward will depend on how effectively buyers and sellers define and allocate risk between them at each transaction stage.

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?

While contemplating the structure of the transaction, both buyer and seller should consider the tax implications of an asset purchase vis-a-vis a share deal, the legal and accounting complexities involved, and most importantly the quantum of regulatory approvals required. Given the potential delays in obtaining governmental approvals, it is plausible that buyers and sellers might prefer structures that involve the least regulatory interfaces.

The US tax laws provide flexibility to structure a deal as a stock acquisition from a legal perspective but still treat it as an asset acquisition from a tax perspective (often referred to as a deemed asset acquisition) subject to the transaction meeting certain conditions, often leading to a win-win situation for both buyer and seller. Factors such as restriction on utilization of carryover

tax attributes especially carry forward of net operating losses, step up tax basis in amortizable intangibles, bonus depreciation on qualified property and equipment and tax equalization need to carefully considered while deciding on a tax optimal structure.

In addition, the CARES Act has made certain changes to the U.S. bankruptcy law which makes distressed sale a better option as compared to bankruptcy, for the seller. On the other hand, buyers may find it opportunistic to acquire distressed targets at values well below pre-covid-19 levels that effectively results in a win-win situation for both parties involved.

Top Tips – Effective Negotiation Strategies In Your Jurisdiction

• US M&A deals have a fair share of contingent consideration included in the consideration. Leveraging future performance of the target allows buyers to finance the transaction through target

profitability and gives sellers the opportunity to increase deal value.

• Structuring a transaction as a deemed asset is a key tax negotiation strategy for buyers and sellers.

• Negotiating a transaction as a tax deferred versus a taxable transaction is a plausible alternative where the buyer is a public company and/or the seller wants to maintain a meaningful stake in the business post-sale.

• The most effective negotiation strategy is preparation. Do your homework and know the transaction inside out and identify the main potential deal breakers so you negotiate with solutions in mind.

• Making concessions to find a place of mutual agreement is essential for successful deal making.

• Buyers should defer the purchase consideration to the extent possible based on achievement of earnouts/ milestones.