Analyzing How Financial Crisis Has Changed M&A Deals

In 2009 the economic and legal essence of M&A transactions changed markedly from the Russian M&A markets of the last 3-5 years. In previous years the usual reason to take part in an M&A transaction as a seller was a desire to sell one’s business and profit from the effort and resources invested in its creation and development. However, under current conditions, M&A deals are more and more often becoming the only way for an owner to preserve his business or sell it on the best possible terms.

A reliable partner, possessing the necessary financial and other resources, can in many cases act as an effective defense against hostile takeover by third parties, for instance creditors or competitors interested in gaining control over the business by any means. In such circumstances an M&A transaction serves to transfer control over a business “in emergency conditions”, when the owner is in effect forced to choose “the least bad” scenario – forced sale of the business (completely or partially) to a more successful partner, the choice of which is more or less controlled by the owner of the business. The seller’s requirements for the transaction might involve attracting resources for further commercial activity by selling part of the business, or freeing itself of non-core assets that are expensive to maintain in the current economic environment. On the other hand buyers, as well as seeking to acquire a necessary asset at a favorable price, are also interested in investing free funds in “quality” problem assets. Thus, the M&A transactions market in 2009 has become a “buyer’s market” and the buyer for the most part can dictate the conditions of transactions.

Time has become the key factor in M&A transactions. The faster the parties can agree upon their positions in regard to a problem asset, the more chance that the deal will go through. The speed of preparation, signing and closing of deals is an important factor for all parties for various reasons, including the following: (i) access to long-term financing for problem companies is likely to continue to reduce during 2009, (ii) “vulture investors” are ready to enter the market; they have experience of buying up problem assets and are capable of acting much faster than other market participants; (iii) many companies that are experiencing problems at the moment are getting close to the point of no return (default, bankruptcy). Thus, efficiency in preparing a transaction exerts a direct influence on the structuring of M&A deals and the composition and content of the principal documentation.

In essence the main purpose of any M&A transaction is not only the transfer of rights to an asset, but the distribution between the seller and the buyer of the risks connected with acquiring the asset. The distribution of such risks becomes the principal subject of negotiations when agreeing the terms of the transaction, and the main documentation for the transaction and the preparation procedures (for example, the share sale-purchase agreement, due diligence investigation, disclosure letters and so on) are designed to legally distribute the risks as agreed by the parties. Upon acquiring problem assets, as a rule the buyer is willing to accept greater risks in exchange for a substantial reduction in the sale price of the asset. This distribution of risk is implied for the buyer of a problem asset. The process of agreeing another distribution of risks may require additional time, and none of the parties are interested in dragging out the process of acquiring problem assets.

Above all, one should note the changes to the due diligence procedure. Traditionally the due diligence process takes a minimum of several weeks even if the parties have experience of taking part in such inspections, and are capable of efficiently providing all information requested by the buyer and its advisers. Otherwise, the process of providing and analyzing documents can drag on for months.

Taking into account the importance of the time factor, the traditional full-scale due diligence is not effective for transactions involving the acquisition of problem assets. Besides the readiness of the seller and the employees of the company being offered for sale to provide the requested documents, in order to ensure the maximum effectiveness of the due diligence procedure, the buyer must define the most important issues which, if not clarified, will cause the buyer not to take part in the transaction (so-called “deal breakers”). Among such issues are: checking the seller’s title to shares; analysis of the main long-term obligations (composition of creditors, possibility of restructuring debts, restrictions on the acquisition of shares/assets, etc.); inspection of rights to the principal productive assets (including real estate and equipment); analysis of the bankruptcy risk . These matters should be the focus for the seller and its advisers. Such an approach significantly reduces the time required for gathering and analyzing documents. If the buyer considers it necessary, and the parties have enough time, it is possible to study other additional matters (Intellectual Property, environmental, labor matters, etc.).

When preparing a sale-purchase agreement for problem assets there is a tendency to use special wording for the seller’s warranties. As a rule they are formulated in the most general terms possible, which allows for a reduction in their scope and makes them more comprehensible for sellers who may lack experience in concluding this kind of agreement. Furthermore, it is advisable to include additional warranties in the contracts concerning the acquired company’s debts and the presence or absence of signs of bankruptcy.

Reducing the time for preparation of the transaction increases risks for both the buyer and the seller and raises the cost of an error; therefore the choice of an experienced and reliable legal adviser becomes critically important.

*This article was originally published in The Moscow Times.