This year, a number of large-scale purchase and sale transactions have provided much fodder for discussion in the media – Nelja Energia, Luminor and Utilitas are three examples. The large transactions always stand out, but this year has seen many mid-sized and small company acquisitions as well.
The first question a potential buyer should ask themselves is a strategic one: why buy in the first place? What strategic goal do you have in mind? Do you wish to enter a new market and find that you can grow faster if you snap up a local business? Or want to gain new knowledge in some market or field and do so through the know-how of the company being acquired?
Here’s an example from our own company’s history: About ten years ago, Grant Thornton faced a situation where many of our clients were operating throughout the Baltics and needed support from our advisers, accountants and auditors in Latvia and Lithuania. We faced the question of how to enter these markets: should we start from scratch, hiring people and leasing an office, or acquire a company from the same field, one whose culture is a good fit, and use that business as a foundation for our future growth? We chose the path of acquiring a local company, and now we can say it was the right call.
So if the acquisition of a company helps you carry out your strategic goals, the next step you should take is to conduct a market analysis: who are the possible candidates to court and which ones to start negotiating with.
Blind buying – is that what I really wanted?
From my own experience, I see that companies often take on an adviser too late in the acquisition process. When is too late? For example, what if the negotiations have been under way for some time and preliminary understandings are already in place? The advisor’s duty is to give the buyer assurance that they are indeed being sold what they need and desire, and they haven’t been sweet-talked into the total opposite. It’s a good idea, then, to take the pig out of the poke, as it were, give it a hard look, weigh it and decide on the basis of the evidence whether to buy or not.
In the business world, due diligence is what helps in removing the pig from the sack. It involves a thorough financial, tax and legal analysis of the company being acquired, which leads to a detailed overview of the company being acquired and the possible risks.
Sometimes there have been instances where due diligence has resulted in the transaction being scrapped altogether or a lower purchase price, because unpleasant facts have come to light about the company being acquired. For example, maybe the owner seems to have been dipping into the cash till or the company has been bled dry of its key personnel or unwise financial obligations have been assumed. The likelihood of some risks materialising may be quite high, and make the transaction unreasonable from the business sense. In such a case, one can analyse and negotiate with the seller as to whether they’re willing to share the risks with the buyer: perhaps link part of the purchase price or payment to future events, such as whether the company’s forecasted profit will become realised.
How to evaluate the competence of the management?
An important topic that may not always occur to people and which is rarely warned about is the competence of the management of the company being acquired. We always expect that we are dealing with rational people whose operating logic is similar to ours – we have been sitting at a negotiating table together for several months, after all, and everything seemed to be a go. But later it might turn out that the management of the merger candidate has weak skill set and it will end up becoming costly for the acquirer.
It is especially salient in the case of cross-border transactions, where cultural differences, including management culture, may be quite different from what we are used to. Here more thorough research comes in handy – not just regarding the transaction object and the market but also local management practices, helping to gain a better understanding of the local means of management. In the course of due diligence, advisers also conduct interviews with the executives and other key personnel at the company being acquired, but unfortunately it may happen that the seller refuses to disclose the key players.
Taxes, taxes and more taxes
Another thing to be considered when it comes to cross-border transactions is that the tax and legal system of foreign countries may be much more complicated than that of Estonia. We deal with taxes in every stage of transaction advisory, staring from choosing the optimal structure for the company being acquired, in which case free resources elsewhere in the group frequently have to be used for financing, although moving the funds may be problematic due to strict rules and high taxes.
It may be a long journey to a blissful merger
Acquiring a company – i.e., entering into a contract of sale – is like getting married: the engagement might last a month or several years. So, too, when buying a company. Likewise, reaching a preliminary understanding that one part wants to buy and the other is interested in selling and agreeing on the basic terms can take two weeks or several years. Once the preliminary agreement is concluded, the next step is due diligence. Due diligence usually takes two or three months in the case of a smooth and streamlined transaction. The prerequisite for this, however, is that the seller has also hired an adviser who puts together the information needed by the adviser on the buyer’s side to conduct due diligence and who coordinates answers to potential questions. When due diligence has been completed, the details will start to be hashed out on the basis of the analysis. This can also take several months.
One thing I would definitely dissuade you from is conducting due diligence and holding negotiations on the contract of sale simultaneously, even though the seller may desire this in the interests of closing the deal faster. As long as the due diligence is not yet complete, not all the potential risks have come to light yet and thus, not all of the information needed for negotiating the sale contract is at hand.
Emotions have to be dealt with
Advising an acquisition takes quite a lot of time and one way or another it will generate feelings and fears among the staff of the company being acquired. Thus, in addition to the financial, legal and tax side of the transaction, one must also think about the messaging sent out to employees about the transaction. Not very much information can be shared during the negotiations, of course, but it must be discussed with employees as much as possible. If people lack a sense of security about the future, it may lead to an exodus of key personnel.
Also extremely important - when the contract of sale finally does get signed, the focus is placed on fusing the companies in the merger together and generating synergy. Synergy has to materialise and not remain a concept merely on paper, as the success of the purchase-sale transaction depends on it.