With a new year underway and relatively benign economic conditions prevailing (including low interest rates globally and lower US tax rates), cross border M&A is forecast to increase, driven by cashed up corporates out of China, the UK and the US. Similarly, Australian companies will be looking at revenue growth and some will look offshore, in particular to the US and the UK.
While cross border M&A brings growth opportunities, acquisitions out of the jurisdiction bring greater risks, especially when undertaken for the first time. Exposure to new taxation laws, increased regulatory scrutiny of anti-corruption, money laundering and anti-competitive practices, and sovereign risk, can all make overseas acquisitions problematic. Not to mention the usual operational risks and the risk of a business culture clash between the acquirer and the target.
Getting the process and the acquisition team right is critical to ensuring that these potential risks are mitigated. Yet establishing the right team of company executives, financial advisers, accountants and lawyers is not a simple as it sounds. It’s vital that the acquisition team has experience and knowledge of the laws and local customs of the target’s jurisdiction. Any weak links in quality or geographical coverage in the team can prove disastrous for the acquisition, with the team only as strong as its weakest link.
Once a target is identified, and assuming both parties are interested and have come to a broad agreement as to price, the acquirer will commence formal legal, accounting and business related due diligence.
Legal counsel on the acquisition team should first identify the key legal issues relevant to the transaction, including foreign investment restrictions, tax and competition issues in each jurisdiction. Political issues such as the potential impact of a change in government on the regulatory environment, must also be taken into account.
Identifying potential issues early on is essential as they can impact on the negotiations, structuring and the form of the acquisition agreement. Mistakes made early on in the acquisition process and reflected in the initial letter of intent/memorandum of understanding (LoI/MoU) can be difficult to resile from when more formal negotiations commence on the terms of the acquisition document.
Time and time again, the same issues present themselves in cross border M&A. Irrespective of the jurisdiction, acquirers should always, early on in the process:
- examine the corporate culture of the target and abort if there is a mismatch, unless the culture can be changed.
- identify where an acquisition will lead to a duplication of businesses in the one jurisdiction with the operational and legal issues that brings, including the potential for claims from local joint venture partners
- investigate and understand unusual foreign investment restrictions and structures as they may impact on the viability of an acquisition
- quantify any liability of the target to employees through pooled retirement savings structures, as these liabilities can sometimes affect how these structures operate and how the transaction itself is structured
- examine the acceptability of having BVI, Cayman Islands or similar offshore holding companies holding the target business. The legitimate use of these structures can greatly ease the tax complexity associated with an acquisition, however tax advice should be sought as these structures have received a lot of scrutiny in Australia in recent times.
- look at how data protection, cyber-crime, AML, sanctions and anti-corruption laws apply, and how far they extend to the business and its directors. In some jurisdictions these laws are far more onerous than in Australia and the consequences of breach can be severe.
- scrutinise the sovereign risk, particularly in large scale acquisitions, and determine whether the risk can be ameliorated by having a local joint venture partner or by taking advantage of bilateral investment treaties existing between the country where the holding company is located and the country where the target is located.
The target’s governance structure also needs to be reviewed and adapted to the acquirer’s governance requirements, which should include structures that minimise the prospect of fraud. Sometimes new governance structures will be required for offshore jurisdictions, such as the formation of formal or informal governance boards for each major jurisdiction in which the acquirer carries on business. Again, the need to establish such a board should be considered at an early stage.
Finally the acquisition agreement will contain a governing law clause, and dispute resolution clause which will either be the courts or arbitration. These clauses are critical to ensure rights are enforceable. The governing law and dispute resolution mechanism should be agreed upon early in the process and preferably in the LoI/MoU. Buyers need to select a combination which gives them the best prospect of enforcing judgements against a seller who will usually be domiciled outside of Australia.
Offshore M&A by Australian companies can be transformative. It can also be very destructive to shareholder value. The pitfalls can usually be avoided by taking time, undertaking detailed planning, and conducting a targeted due diligence which identifies the key issues early on.