Eversheds Sutherland has 66 offices in 32 jurisdictions and has been recognised as a top 15 and a top 20 global law firm by Law360 and Acritas respectively. The firm’s offices, together with the support that it has from relationship firms make the company an attractive option for clients with cross-border M&A needs. Eversheds Sutherland is a top-five M&A practice in terms of volume of deals in EMEA (Mergermarket 2017).
CEO Today reached out to Robin Johnson, Head of Eversheds Sutherland’s international cross-border M&A team, to hear about trends in the sector, 2018’s M&A activity so far, and the impact of competition law on mergers.
Which sectors were particularly active in 2017? How does 2018 look so far?
The mid-market cross-border M&A market was very active in 2017. We saw considerable volume which was driven primarily by strong corporate balance sheets, private equity sponsors having money at their disposal and sellers confident of attractive exit multiples.
There was considerable demand for attractive technology assets as virtually every sector was developing its digitalisation strategy.
Activist shareholders were forcing boards to consider options both in relation to divestment of non-performing assets (requiring more strategic focus on core activities), as well as requiring the active management of capital in the balance sheet. With strong equity valuations, it was also possible to use equity on deals to bridge seller expectations who/that might look at further risk returns going forward.
In terms of sectors, consumer remained particularly strong in 2017, together with industrials and chemicals. Energy was slightly subdued, reflecting issues around energy pricing in previous years, but we had a large share in the European renewable M&A market. We are now seeing a renewed interest in energy in 2018. The overlap between technology and other sectors meant drawing on-skill sets from across our sectors was vital to the success of transactions.
There were a large number of deals involving ‘locked boxes’ and warranty and indemnity insurance was extremely popular. Private equity sponsors did struggle to compete where strategics were interested in an asset, but there were enough other opportunities for private equity to invest themselves. In three to four years, this will lead to another cycle of activity as private equity sponsors seek to divest of the investments made in 2017.
In terms of 2018, we are seeing the same trends. The US tax reforms, both in terms of reduction in corporation tax and the repatriation of trapped cash, will result in significant M&A opportunities. There is a danger that US corporates will focus primarily on their domestic markets, particularly with the Trump ‘America First’ protectionist stance, but that is only going to create opportunities for non-US buyers outside the United States, particularly in Asia and Europe, to focus on opportunities in their own domestic market.
We anticipate the drive towards technology to continue. There is clearly a desire for the supply chain to be more joined-up and therefore there will be a trend towards increasing M&A in the supply chain, joint ventures and vertical investments.
What differences are you faced with when handling a cross-border M&A, specifically what benefits does this kind of deal have for your clients?
The key issues with cross-border M&A are all around time. Cross-border M&A involves more management time, both in terms of travelling and focus.
Having strong project management is imperative; Eversheds Sutherland has focused on this as a key strength in cross-border M&A for the last ten years.
Using technology to assist in a cross-border M&A transaction is essential and there are a number of artificial intelligence tools available. We are also developing our own bespoke tools such as DealMaster – recognised as ‘stand out’ by the Financial Times Innovative Lawyers Awards, 2017.
Ensuring all jurisdictions recognise their role and have a strong project manager to drive efficiencies and process is required. It is vital that the project manager understands deal dynamics and mechanics so will need to have a good knowledge of cross-border M&A.
Increasingly, we are seeing integration as an important part of any cross-border M&A transaction. The deal does not stop at closing but continues as businesses are integrated or reorganised post-closing of the original transaction.
While in basic terms the transaction documentation between a domestic deal and a cross-border M&A deal may be the same, it is vital to ensure that in any deal every country and jurisdiction has its say on the deal processes and transaction mechanics. There is no point producing transactional documentation which works in a particular host jurisdiction if you have not considered the implications for closing mechanics in a smaller jurisdiction.
Inevitably, potential duplication of efforts and reserves can result in cost pressures and this is where our strong project management skills come into play.
It is fair to say that cross-border M&A is a skill in its own right but more importantly, requires a team effort. We have invested heavily in working together across our jurisdictions so everyone knows the role they are playing. Clear communication and use of technology are essential.
What is the difference between alternate kinds of merger deals, for example conglomerate, horizontal, vertical?
Whether you are looking at a consolidation play or a supply chain play, the issues are similar. Clients that have deep knowledge of their own sector are able to quickly identify what the real risks are in any transaction – scoping these clearly to ensure their legal advisers are focusing on the right issues is vital. Working on this upfront saves much time later on in the process.
Horizontal mergers require detailed antitrust focus. There is no point working down a proposed horizontal merger to then find that the antitrust concerns have not been addressed. Clients need to have up-to-date antitrust draft filings in place which they can use and then need to share that information – often on a lawyer-to-lawyer basis due to the sensitive information that is being provided – with any potential merger partner at the earliest stage possible. Addressing it later on in the process causes significant delay, cost and deal uncertainty.
On vertical mergers, the antitrust issue remains but there is also the focus on what that transaction means for ultimate shareholder and stakeholder value.
Diversification is not popular in 2018; consolidation is. We are not seeing much in terms of conglomerate expansion, but it is fair to say that financial sponsors still see opportunity in diversification as they leverage hidden value out of a carve out transaction.
Are there any common causes that drive business owners to sell their company? What would you say is the biggest reason behind these kinds of transactions?
Without question, there is a baby boomer divestment market. Private entrepreneurs from the baby boom era are now nearing retirement and in many cases, their families do not want to continue the business.
Successful entrepreneurs are invariably extremely close to their own businesses and often, the way the business is run reflects the personality of the entrepreneurs themselves. Most entrepreneurs care as much about their people and their legacy, as they do about value, therefore finding the right home for the stakeholder is vital for an entrepreneur.
Big corporates successfully buying from entrepreneurs are those that spend a considerable amount of time working with the entrepreneurs as they prepare themselves for sale.
Entrepreneurs tend to be extremely secretive about their affairs and will therefore prefer bilateral deals if they have been warmed up appropriately by the large corporate. That is not to say that auction processes still do not take place, but understanding the dynamics of a particular private company seller is as important as understanding the asset that is available for sale.
What complications commonly arise during the negotiation process and how they are overcome?
Targets must prepare themselves properly for sale. There is clear correlation between a company that has successfully prepared itself for sale and the outcome of that sale, compared to one that has simply decided suddenly to sell.
Sellers always underestimate the due diligence process. It is absolutely vital that they view their company from the outside in.
A recent survey by PwC – consistent with other research undertaken by Eversheds Sutherland – indicates that most sellers believe they should have done more sell side due diligence or pre-sale preparation and that doing so would have better benefited the deal outcome. Underestimating the questions that buyers will ask and being unable to get that information together quickly is something that sellers continually misjudge.
In any process, there is always a sponsor within the buyer supporting the business case. If that internal sponsor is unable to support the case they have made to their board, it will adversely affect the deal. A seller must understand what the key drivers are for the potential buyer, as well as understanding their own target business. There is always a reason why a buyer wants to buy and the seller needs to understand what that is to achieve a successful sale. The value that the sellers see in the process can often differ to that of the buyer.
When this situation arises, it can be dealt with in a number of ways. Typically, we would see escrow provisions, but we also see price reductions at the last minute when an issue has not been addressed early enough. We also see earn-out arrangements to bridge value expectations and insurance products coming into the market to provide risk coverage to both sellers and buyers.
Inevitably, a negotiation process requires two-way cooperation and advisers who are able to work together. This doesn’t mean every deal will take place but you need advisers and principals who are not going to spend all their time disagreeing with each other. The more successful deals are the ones where there is a commonality of interest. If there is a major issue on a negotiation process, it is often better to shake hands and part as friends – maybe revisiting the deal again in a year or so’s time.
Given the ever changing landscape of industries customers and competitors, what are the unique challenges of assisting your clients with planning their M&A strategy?
Preparation is absolutely key. Any large corporate must have its ‘black book’ of targets it is following and wishes to acquire. It doesn’t mean they acquire them all but they should have been looking at targets over an extended period of time.
Observing what competitors are doing is also vital to understanding their strategy as they are likely to be competing with a buyer in a particular process. If, for example, a competitor has recently completed a significant acquisition it may be they are unlikely to be competing on another.
Following a competitor’s antitrust policy as well as your own is best practise and understanding how a competitor is looking at a market from an antitrust perspective is important. Antitrust authorities will often challenge filings if they are inconsistent with what a competitor has said on a previous filing. The use of economists in deals where there is a significant antitrust element is a must – though there is a cost.
Technology, however, is by far the most important factor in 2018. Deals are not so much about capacity these days, but about efficiency in the supply chain.
Adopting a consistent approach to an M&A strategy is vital. Understanding the market, and the competitive environment in due diligence are important elements to the success of a particular transaction. However, if something doesn’t look right, it often isn’t and therefore, the deal should not proceed.
What are the critical factors that need to be looked at during a due diligence process?
Sellers often underestimate the information they need to provide to buyers. I personally am a keen advocate on vendor due diligence (VDD). This helps sellers identify the issues that are likely to be relevant to a buyer early on in the process.
While financial VDD is common, particularly where there is private equity interest amongst the buyers, legal vendor due diligence is less common and some of the legal VDD reports that I have read have been far from satisfactory. They have not provided the required detail the buyer would expect.
Good legal vendor due diligence reports often flag issues that need to be looked at in a lot more detail.
Typical issues which arise include the seller’s failure to support the proposition that is put into an Information Memorandum (IM) or teaser. The number of times the information provided in an IM or teaser has been inconsistent with that subsequently provided in a transaction is surprising; sophisticated buyers will often dismiss IMs or teasers and produce their own business case.
Having said that, as stated above, good VDD is a very useful starting point for a buyer. However it does need to be validated, particularly where VDD providers are not prepared to allow reliance on those reports by the ultimate buyer.
Issues that regularly come up include litigation exposure, lack of title (particularly in relation to intellectual property), discrepancies in financial information, insurance gaps and coverage (an area which is often under reviewed), and outstanding tax queries (whilst can be covered tax deeds, could alert the authorities to other issues).
Carve-outs are particularly difficult where businesses have been increasingly put into a central service organisation and then separated out from that to be, in effect, standalone. A business that is part of a larger division is rarely standalone. Notwithstanding this, transitional services arrangements and hidden costs from a carve-out are often underestimated.
It is amazing how often commercial contracts are unavailable for review, and the terms of which have never been addressed from a legal perspective.
Poor corporate governance is another common issue. I will always review board minutes to identify any information that may not have been previously disclosed.
Finally, agreeing a scope of due diligence with the buyer is key to understanding what the buyer is particularly interested in, but it is also important for the advisers to look at other areas so there are no surprises post deal. No-one wants to be involved in litigation after transaction.
Between mergers and acquisitions, which kind of transaction do you handle most often in your position? What unique difficulties does each face?
Acquisitions and disposals are far more common than mergers. However, when mergers do happen, issues mainly arise around senior management positions and who in effect is the lead “merger party”. There is no such thing as a merger of equals.
In acquisitions or disposals, there is a clear separation between the seller and the buyer, whereas with a merger, they are often ‘working together’. Joint ventures are very similar to mergers in this respect. Often in joint ventures, parties do not deal upfront with an exit provision because it is too difficult – this is a mistake.
There might be detailed deadlock provisions in a joint venture, but what happens when that deadlock is actually triggered? In the last 12 months, I have dealt with three major deadlock issues in joint ventures – they are not as uncommon as people might think.
In terms of acquisitions and disposals, the key is full disclosure. Sellers need to do thorough due diligence on themselves and be prepared to answer the questions. An ‘open book’ policy is always preferable. If there is something to hide, you shouldn’t be putting the business up for sale at the valuation you are expecting.
In terms of buyers, the key is to invest the right resource into uncovering and understanding the issues. Sometimes, you will have internal people looking at things that should be looked at by an external provider and sometimes external providers are not doing as good a job as an internal person could do. I always encourage buyers to have an open line of communication into the management of a target; they often know things at a corporate level that sellers don’t, and this is important when it comes to integration post deal.
What effect does competition law have on mergers?
Competition law is becoming an increasingly important part of any M&A strategy. The antitrust authorities around the world are talking to each other more than ever before and looking for consistency in approach, information provided and rulings. While adviser analysis will often be carried out to identify which filings need to be made in which countries, when a filing is made (or not) the antitrust authorities now have increasing visibility (via the monitoring and review of public announcements by companies or advisers) to determine the analysis themselves.
Some antitrust authorities are more process driven than others and understanding the difference of approach is important. There should not be an assumption in Europe that you automatically have to go to Brussels. In fact 90% of all filings are done at a local member state level.
Where an antitrust issue could arise in a particular jurisdiction, it is vital to have considered the strategy between the parties and with the regulators. This is often most effectively done at a lawyer-to-lawyer level to avoid providing confidential information to competitors prior to a deal closing.
Antitrust lawyers need to understand the issues that are relevant to the business and to come up with innovative solutions. An antitrust lawyer that is simply doing the filings and not the strategy is not a useful member of the team.
Increasingly, competition strategy is at the forefront of any deal’s make-up. It will be equally as important as the synergies that can be created, the technology which can be integrated and the markets which can be accessed.
In your experience, what are the biggest obstacles that can stop a deal going through and what precautions should be taken to prevent such problems occurring in the first place?
There are a number of issues that can arise, including regulatory issues, such as antitrust clearance, or other government approvals that might be necessary particularly, for example, in Latin America and Asia, where a number of governmental approvals are often required. But that assumes you have got to a stage where you can actually sign the transaction.
Pre-signing, the biggest issues are often around validation of a business case for the buyer (i) inconsistent information in terms of due diligence; (ii) inconsistent information compared to the information memorandum; (iii) financial statements which aren’t supported by the information that is available during due diligence; (iv) the lack of good strong contractual commitments; and (v) issues around HR, outstanding litigation. All can put a stop to a transaction.
In recent times, there has been some evidence of aggressive tax planning by financial sponsors, being deemed too much of a risk to corporates in this more tax transparent environment.
While a seller does not want to expend unnecessary costs, time and time again a sale process which has been well run by sellers is more likely to have a successful outcome than one that is ultimately run by the buyer’s due diligence needs.
What common challenges arise from merger that a company should be aware of before they embark on a merger process? What would be your top piece of advice of companies considering this?
Ultimately, this is about who actually runs the combined business going forward. There can be a lot of rationale on paper as to why two companies should merge but if their cultures and their management styles are significantly different, the synergies to come from a merger will not materialise.
In my view, any potential merger needs to have started two years before the actual combination occurs. It will take at least that time for the management to understand each other and the business that they are merging with. Competition law obstacles often get raised as an issue on mergers, but if you haven’t got the culture right competition law is not relevant.
What lies on the horizon for cross-border M&A?
Cross-border M&A is developing fast. The sophistication in today’s complex world means that the days of simple deals are long gone. Sellers and their advisers are far more deal savvy and know a good offer when they get one. The chances of a buyer finding a deal at a snip no longer exist.
Increasingly, there is in-house capability to do M&A transactions and therefore, advisers’ roles are increasingly to validate rather than lead. It’s an exciting time to be a cross-border M&A lawyer and with the daily advances in technology, the world of cross-border M&A is changing fast.
Counselling over content is key and a strong experience and track record is vital.
Companies with less deal experience need to get the right advisers. Companies with considerable experience need advisers who understand their business and are prepared to operate as part of their team rather than lead remotely.