Referring to Baker McKenzie’s recent report, Taking Center Stage: The Rise and Rise of M&A Compliance Due Diligence (CDD), Darryl Bernstein, partner and head of the Dispute Resolution practice group in Johannesburg, looks at the challenges for M&A investors in Africa in terms of compliance risks and what can be done to address this.
The African continent is one of the most challenging regions in which to do businesses from a compliance standpoint, according to Baker McKenzie’s new report, Taking Center Stage: The Rise and Rise of M&A Compliance Due Diligence (CDD). The report surveyed more than 300 global corporate leaders and legal advisers throughout the world who are involved in mergers and acquisitions (M&A) and joint venture (JV) transactions. It showed that while 29% of respondents were looking to grow their businesses via M&As and JVs in Africa, 48% of respondents thought that it was the most challenging region in which to do business. From the commentary, it was found that many countries in Africa were considered to have opaque legislative and regulatory frameworks, less predictable legal processes, and less consistent enforcement.
According to the report, pre-transactional or pre-acquisition CDD, which is fundamentally the examination of both the regulatory obligations and risks facing an organization and how this organization manages them, is an essential component of any major transaction and is demanded by investors and buyers, especially for cross-border M&As and JVs. The key areas normally covered by CDD include anti-money laundering, bribery and corruption, antitrust regulations, trade and export controls, environmental, employment and human rights laws, and cybersecurity and data protection. While clearly some businesses will have more inherent risks in specific areas, a holistic solution that assesses each area was found to be optimum, as compliance risks could cause untold damage to a company's reputation and/or bottom line if not properly addressed. This is particularly true in an era of much greater global and local regulatory enforcement.
The report noted that increasingly, dealmakers were recognizing that US Foreign Corrupt Practices Act (FCPA) enforcement, the UK Bribery Act and various local anti-corruption efforts, mean that consideration of compliance risks before the deal is done, as well as post-acquisition compliance assessment and remediation, is a must. Companies operating in Africa must therefore ensure they are not only compliant with local laws but also are aware of the extraterritorial legislation that may impact their operations and business outside of their regional headquarters.
Further, the report found that increasingly for buyers, proper CDD has exposed risk that simply makes deals untenable. In fact, 26% of respondents say that more than half of their recent deals have failed or been abandoned due to discovery of compliance issues or risks over the past three years. An additional 41% say that more than a quarter of their deals faced similar fates. Without investing in CDD, many of these companies may have ended up in transactions that could have left them vulnerable, possibly destroying value in both the acquirer and acquired organizations. Many of those that walked away say their CDD discoveries acted as a key stop-loss mechanism. For these reasons and others, due diligence is today given considerably more time and resources, by a large margin, than other tasks in the M&A process.
Equally large is the percentage of respondents in the report who say due diligence is the most challenging part of the M&A process. It seems the understanding around the importance of due diligence is well ingrained, but there is still a gap between people's expectations of the challenge and how much time and resources are dedicated to it. Despite recognition of the need for prioritizing compliance, only 51% of respondents said they had a set of standard protocols or procedures specifically to address compliance issues in M&A or JVs. A further 56% wish they had dedicated more time to conducting compliance due diligence. Further, most respondents agree that improvements are being made to CDD within their organizations — but this journey is far from complete. While 60% say their CDD programs are more effective today than two years ago, more than a third of businesses (35%) believe these programs do not yet reach effective standards.
The report outlined how weak CDD leaves parties exposed to unnecessary and avoidable risks that could negatively impact pricing, profitability and even call into question the fundamental rationale of the deal. It also creates possible post-acquisition civil and criminal liability that could threaten the very viability of the newly acquired asset or newly formed venture, not to mention the burden and cost of a potential investigation and monetary penalties.
In Africa, particular areas of interest to law enforcement and other regulatory authorities includes the appointment of third parties, whether as agents, distributors or other general contractors, as well as the integration of newly acquired operations. Companies who rely on the support of third parties in their regional business operations, whether these third parties are procuring local licenses, rendering services or obtaining and maintaining business, need to be aware that the unlawful conduct of such third parties can become grounds for prosecutions of the companies that appoint them. Similarly, a failure to integrate newly acquired business following mergers and acquisitions also results in significant fines and penalties arising out of the historic conduct of these new business units.
Compliance diligence has become an absolute necessity in the context of due diligences carried out either on the appointment of a new third party in a high-risk environment, or in the context of an intended acquisition, as is making sure that there is comprehensive integration plan in place following a corporate acquisition. Conducting ongoing risk assessments should not be overlooked and businesses should be periodically kicking the tyres to ensure operations are running smoothly.
Additionally, in the current opaque environment, an entity's links to parties potentially involved in misconduct are not always easily ascertainable. A thorough due diligence review of business partners and, in certain circumstances, customers is critical. Given the potentially significant damage to a company's reputation by affiliation, companies should screen their business partner and customer lists against organizations that have been implicated in recent corruption scandals, and indirect beneficiaries should be scrutinized.
Companies should also ensure that their compliance with local content law is legitimate and upholds the purpose of the framework, and that the local criminal offense of "fronting" is not committed (the feigned use of a black economic empowerment partner to obtain contracts without actual value-add by the partner).
As the report indicates, CDD is critical to pricing a transaction, completing a transaction and ensuring its long-term success. While corporates' efforts and expenditures continue to increase in these areas, the figures suggest more work can, and will, be done. As such, organizations doing business in Africa should prioritize a practical, risk-based compliance assessment of all their operations in Africa, tailored to the company's operation and following best practices.