If I'd written this article in June, I would have written about how the role of an M&A lawyer had changed and that if this was the way the world was going, I would be looking to change my career to become a writer or a journalist!
In May the world of M&A was such that credit was cheap, financial engineering had gone beyond the furthest imagined process including, for example, one deal where no interest at all was payable on debt and it was all rolled up in PIK (payment in kind) instruments for five years, leverage was at all time levels, synergies counted for little and everyday secondary or tertiary or even quarterly institutional buyouts were taking place (i.e., financial institutions buying from other financial institutions that had bought from other financial institutions as they bought from other financial institutions - I hope you get the thrust!)
A seller could dictate all deal terms as well as impose ridiculous timetables. Acting for the seller, I could insist upon limited due diligence, general disclosure and limited warranties. In one deal in which I was involved I found two financial buyers happy to sign the first draft of a vendor-friendly auction process sale and purchase agreement provided that they were given exclusivity. One financial institution with whom I spoke said that they felt they could do away with external lawyers and could just have an internal lawyer to double check the drafts that had been produced by a bank's lawyers, seller's lawyers, etc. and that they were happy to rely upon vendor financial due diligence, i.e., a vendor having commissioned an accountant to produce a long form report on the business, even though typically accountants limit their liability to a buyer.
Notwithstanding the fact that I act for a number of financial buyers as well as strategics, I thought the world had gone mad and the role of the M&A lawyer both on the sell side and the buy side seemed to be just limited to doing the basic commoditized formalisation of a stock transfer form or transfer of assets. While deal flow was very strong, the actual role of the lawyer was becoming meaningless.
Sitting here, however, on a pleasant evening in the fall, life has returned to normal. Strategics are back in town. Financial buyers now have to compete against synergistic benefits and can't just rely on cheap credit. Deals closed as recently as the summer are already being re-negotiated. (However, a number of financial buyers had agreed that some deals with limited covenants can only be re-negotiated in the event of a major event of default due to the lack of financial covenants that were put into deals.) Due diligence is back in favour - both banks and financial institutions as well as strategic buyers are insisting upon focused due diligence. The role of vendor due diligence remains important with regard to vendor financial due diligence reports, but this time updates are being sought and detailed reviews taking place. A proper balance between risk for the purchaser and reward for the seller is being put in place, and deals now have realistic timetables. This doesn't mean that lawyers can simply go back to increasing fees, but it does mean that the role of a lawyer in deals is now being recognised again.
While I'm not a soothsayer, I suspect there were a number of deals done in the early part of 2007 which could cost general partners a significant amount of money and which bankers would be embarrassed about by the year end.
While there will be a role for PIK deals, these will only now become more appropriate on lower leverage, i.e., quasi-equity instruments deals.
With the world now returning to normal and while that first book of mine still remains unwritten - with the world of the New York Times and Washington Post being relieved of my investigative journalism - I can revert to the key issues which I think remain and will always remain important on multinational deals. Some of you will have read my thoughts before, but these have become more tailored over a period of time, and I have had the benefit of a number of my clients and colleagues as well as providers giving me the benefit of their thoughts in relation to what I consider to be the top ten issues that need to be addressed on a European transaction when you are a U.S. purchaser:
Top Ten Tip 1 is Culture, Culture, Culture. Can you manage an acquisition from 4,000 miles away? Do not underestimate the difference in lifestyle approach, social protection and history. Job security is often key in Europe, and the entrepreneurial spirit is not as alive as it is in the States. A number of Eastern European assets have been acquired from state-owned businesses as recently as 10 years ago. The culture of social protection, the culture of the state providing for all, remains alive in a number of key European territories.
Top Ten Tip 2 . While more typical U.S. style agreements are getting more recognised in Europe, you must understand the difference in transactional documentation approach. There is a lack of litigation post-deal. This doesn't mean due diligence was done better - it means that settling matters out of court and in a "handshake way" is more prevalent in Europe. Escrows or holdbacks have become commonly accepted to deal with issues that arise out of due diligence but unlimited indemnities are rare. Most European deals have closing balance accounts dealing with net working capital and debt, and a lot of Europeans see this as a way of settling warranty and indemnity claims, i.e., through completion accounts mechanisms. There are too many deals which were completed almost a year ago where completion accounts have still not been settled. Finally, in this top tip, the approach to disclosure is very different. Whilst specific disclosures are included, there is a general acceptance in Europe that the buyer has to acknowledge general disclosure of information provided to it during the disclosure process.
Top Ten Tip 3 (Process and Timetable) - Scoping Due Diligence is vital. Europeans hate duplication of due diligence from different vendors. Agreeing and scoping upfront and spending some time with each provider is key. Having a central point of contact on the buyer's side who co-ordinates everything and avoids duplication is a vital role. You need to have control, proper communication, proper reporting structures, and you need to build in time to reflect the distance travel and time zones involved. You must not underestimate the need for physical meetings - this could take three days out of a week, and the disproportionate amount of time and energy that will be expended compared to a domestic deal. Dealing with your "other jobs" could become difficult, and there is a cost associated with travel and management compared to a domestic deal.
Top Ten Tip 4 - In a structured way, and I emphasize the word "structured," don't be afraid to do due diligence to death to replace contractual comfort. Use due diligence as part of your integration plan, don't underestimate the value of vendor financial or legal due diligence, rely upon it, use it, update it, comment on it, use due diligence as part of integration. Integration together with cultural issues are key to the success of a European M&A deal from a U.S. buyer.
Top Ten Tip 5 - Antitrust is a big issue in Europe. Build in enough time into the project plan to assess antitrust. Each EU jurisdiction has different rules on antitrust. Don't assume that you can just simply go to a "one-stop shop" in Brussels. You will find that most Europeans don't understand the need for good compliance going forward. If they have not been exposed to a U.S. purchaser before, their compliance policies, particularly in relation to antitrust and FCPA (Foreign Corrupt Practices Act) will be completely inadequate for your purposes.
Top Ten Tip 6 (Taxation) - Early structuring of deals to create a tax efficient basis should be looked at. There is no equivalent of the 338 in Europe. A mixture of asset deals and stock deals should be looked at, but also, transaction costs associated with the deal, notary fees and stamp duty should not be underestimated. These often come as a surprise to a U.S. purchaser. How do you repatriate future profits? This may not be as straight forward as you think; there may be local withholding taxes. In Europe, transfer pricing has become a very hot topic when selling businesses out of a group. Also, don't underestimate the tax cost of stock options which may be terminated on a sale.
Top Ten Tip 7 - Most U.S. buyers don't understand labour and social law protections that are in place. Europe has very wide social legislation. Most companies will have works' councils or unions. There is no one European law - again these laws, on the whole, need to be looked at on a country-by-country basis. Compliance programmes in relation to labour law should not be underestimated. This could be in relation to data privacy, whistle blowing and a general need to ensure that what you are trying to impose through U.S. exterritorial reach can work in Europe.
Top Ten Tip 8 - If I had taken a dollar for every time that separation issues have been raised six months down the line as being a key integration cost that has been underestimated, I would be a millionaire! Businesses that have to become stand-alone after leaving a group - licences, permits, consents, real estate, IT and pension costs - these are long term structural issues which should have been dealt with up-front and cannot be dealt with through the Sale & Purchase Agreement.
Top Ten Tip 9 - Taking security on a leveraged deal is not as straightforward as it is in the States. There are rules against targets granting security - this is often called financial assistance. There are registration costs associated with taking security and other taxes, and there are antiquated processes about registering security, which often take time to put in place.
Top Ten Tip 10 - Putting compliance processes in place post-deal need to be worked on straight away. Preventative and proactive legal care is going to be the only way in which you can properly manage an acquisition. Getting immediate buy-in as to your compliance ethos, i.e., from a cultural prospective (going back to Top Tip 1, of culture, culture, culture being important) is key. There will be no European organisation (that has not got a U.S. arm) that will have compliance structures as good as you have.
In summary therefore, unfortunately the world of European M & A will still have me for a while. It may be another seven years before the urge to write my next novel resurfaces! In the meantime, follow the Top Ten Tips and your European acquisitions could be more successful than most.
Published December 1, 2007.
