Cross border mergers and acquisitions are playing an important role in the growth of international production. Not only they dominate FDI flows in developing countries, they have also begun to take hold as a mode of entry into developing countries and economies in transition.
Although the basic merger or acquisition is the same worldwide, undertaking a cross-border transaction is more complex than those conducted ‘‘in market’’ because of the multiple sets of laws, customs, cultures, currencies, and other factors that impact the process.
How should the Transaction be Financed?
The financial structure of the transaction might be impacted by which country the target is in. For example, from a valuation perspective, ‘‘flowback’’ can have a negative impact on the acquirer’s stock price and cause regulatory problems (i.e. stock ‘‘flowing’’ back to the acquirer’s home jurisdiction). Other types of considerations include the change in the nature of the investments held by institutional investors caused by a stock exchange merger — these investors may be compelled under their own investment guidelines to sell newly acquired stock in the acquirer; and the possible change in the tax treatment of dividends that encourages the sale of the stock (e.g. foreign tax credit is useless to US tax-exempt investors).The following are issues for an acquirer to address when structuring the transaction.
- If the transaction involves issuing stock, will the stock be common or preferred stock, and will the stock be issued directly to the target the transaction. or to the target’s stockholders? Is the acquirer prepared to be subject to the laws of the target’s country if it issues stock in the transaction, particularly the financial disclosure laws?
- After issuing stock, how will the acquirer’s stockholder base be composed? How many shares are held by cross-border investors? Does the new composition shift stockholder power dramatically? Will any of the new stockholders cause problems?
- If the transaction involves debt, where will the debt be issued, from ‘‘in country’’ or cross-border? What type of debt will be issued — senior, secured, unsecured, or mezzanine?
- If the transaction involves cash, will cash be raised by raising capital in the public markets, and if so, in which market will the stock be issued? If cash financing is obtained in the target’s country, can the acquirer comply with any applicable margin requirements, such as those promulgated by the Federal Reserve Board in the US?
How are the Customs and Cultures of the Parties Different?
Before contemplating the transaction, the acquirer should be able to express a clear vision of how the target will be operated and funded. This will be necessary to share with the target and its employees and shareholders, as well as with its own shareholders.
Public relations are important in winning the hearts of the target’s employees, communities, and shareholders. One cultural issue is whether the target will still be managed ‘‘in country,’’ or whether it will be part of a regional center or managed solely from the acquirer’s headquarters. Employees worry about overseas managers and communities wonder about loss of jobs. From a financial perspective, investors will want pro forma information to understand how the combined company will operate going forward. This may require disclosure of financial information to which the target’s investors are accustomed, but which is new for the acquirer.
How do the Applicable Laws Govern the Transaction?
If the transaction is public, such as a tender offer, the parties generally must abide by the law of the country where the offer will be made. In comparison, the parties can choose which law governs if the transaction is private. They can select ‘‘ground rules’’ that are the laws from either of the home countries, or even a third-party country with established merger laws like the US. If two sets of laws are involved, particularly if one is based on a code system and the other is common law, it is common for both the acquirer and target to have two sets of advisors, one from the country of each party. It is also fairly routine for non-US parties to have their own US investment banker and law firm as advisors in a transaction — even if neither party is from the US.
Even if the parties do not use the target’s country’s laws as the ‘‘ground rules,’’ an acquirer must consider the laws of the target in deciding whether to pursue a combination. For example, there could be laws that pose substantial obstacles to consummating a deal, such as restrictions on ownership. There are more than a few instances of cross-border bids that have failed because the target’s government blocked the transaction to stop a company from falling into the hands of another country.
The following are issues for an acquirer to address before a deal is struck with a target.
- Will the target insist on ‘‘in market’’ customs, and if so, will these customs be used as a shield to stall or prevent a transaction?
- How difficult will it be to obtain complete financial information? Are there laws that prohibit disclosure or enable the target to share data that are not reliable?
- What is the role of regulators in the target’s country? Do they have tools to effectively stall or prevent a transaction, such as requisite governmental approval under exchange control or national security laws? For example, in the US, under the Exon-Florio provisions of the Trade Act, the President of the United States has the power to block the acquisition or to render it void after it has been completed.
- Will the acquisition have to be approved by the target’s shareholders, and does the target’s country have laws that make this difficult?
- Does the target have subsidiaries or do business in countries other than its home country, such as Canada, Australia, or Germany, that makes the transfer of those subsidiaries difficult so that they will have to be forcibly divested to consummate the deal?
- Is the target or any of its subsidiaries in a heavily regulated industry (e.g. defense contracting, banking, or insurance) that requires regulatory approval, and if so, will the regulatory delays make it appropriate for the acquisition to take the form of a one-step merger (i.e. without an initial tender offer)?
- How will the formal merger or acquisition agreement be drafted? Will it be local to the acquirer or the target, or a US agreement with one of the local laws governing, or a pure US agreement?
What Level of Due Diligence is Appropriate?
Due diligence is critical in a cross-border transaction since there is a greater likelihood for undesirable surprises to surface after an agreement has been reached initially. It is important to establish in the formal agreement what type of due diligence is permitted and what the consequences are of finding certain types of surprises.
The acquirer should ensure that it has adequate access to the target’s documentation and personnel to facilitate the due diligence process. In addition to access to all financial information, the acquirer should review the target’s loan agreements, severance plans, and other employee agreements to see if the target’s change in control would impose any previously undisclosed costs or obligations (e.g. constitute an event of default so as to accelerate outstanding indebtedness).
Similarly, any other major agreements should be reviewed, such as licensing and joint venture agreements, to determine whether any benefits may be lost due to the pending change in control.
The target’s charter and bylaws should be checked to see if they have any peculiar provisions that might make it more difficult for the acquirer to gain full control of the target. For example, the acquirer should determine whether the target has a shareholder rights plan or poison pill, or has a provision that requires a super-majority vote to approve mergers.
Are there any Significant Antitrust or Non Competition Issues?
Although the US generally has the most aggressively enforced antitrust laws in the world, the European Union has become quite aggressive (e.g. blocking the General Electric-Honeywell merger). Overall, more than 70 countries have their own competition laws, and there are a number of regional economic organizations that have competition law frameworks. If the target is involved in operations out of its home country, the acquirer should conduct a review of the relevant antitrust laws.
Even if a significant antitrust problem is not present, it may be necessary to report the acquisition in advance to a governmental agency. In the US, the Hart-Scott-Rodino Antitrust Improvements Act requires a notice and waiting period unless the transaction is below specified minimal levels.
The following are issues for an acquirer to address before pursuing a target.
- To what extent do the acquirer and target compete in a line of business?
- Will the acquisition substantially lessen competition in any line of business in any particular country?
- What products or services does the acquirer sell to the target now, or vice versa?
Are there any Significant Tax or Currency Issues?
The acquirer should structure the transaction with a complete understanding of the tax implications. This requires an analysis of the interplay of local law and tax treaties as well as the expectation of where future revenues and deductions will be derived. Based on the acquirer’s own tax preferences, it may desire current income (i.e. dividends) or capital gain, and should structure the transaction accordingly.
The acquirer must also take care to consider the volatility of any currencies that are implicated in the transaction and ensure that it has adequate protection from downward swings in them before the transaction is closed. If it cannot tolerate the currency risk that is involved in the target’s operations, the acquirer should consider the ongoing impact of a volatile currency after the transaction is complete.