In the first of a two-part series, legal expert Nathan Banks outlines the key considerations for companies on either side of the table
The critical stages of a successful M&A transaction for SMEs
Nearly 80 per cent of regional small to medium enterprises have shown interest in portfolio transformation, according to the latest EY Capital Confidence Barometer.
Included in the reasons given for their interest, SMEs stated they were exploring merger and acquisition options to prepare themselves for the future while simultaneously becoming more equipped to deal with potential market volatility. Despite the underwhelming success rate of global M&A transactions, regional SMEs remain confident, with 37 per cent actively pursuing M&A activities over the next 12 months.
The UAE accounted for 65 per cent of all Middle East M&A deals during the first six months of 2018, according to a recent report by multinational law firm, Baker McKenzie. The same report showed the UAE was the most attractive target country in the region to overseas investors during the same period, with a total of 34 inbound M&A transactions valued at $6.6 billion (Dh24bn) .
Despite the growing number of M&As, many SMEs fail post-transaction due to the complicated nature of the process. Harvard Business Review recently reported between 70 and 90 per cent of M&A transactions fail to meet expected synergies. Some of the most common errors businesses make when undertaking such transactions are not carrying out sufficient due-diligence, mismanaging the transition process resulting in an interruption in operations, setting unrealistic performance expectations and failing to optimise synergies.
It is therefore prudent for anyone considering an M&A transaction to be aware of the mechanics of key phases, if the transaction is to be successful:
Negotiation, non-disclosure agreement and timeline
• Before proceeding with an M&A transaction, both parties should sign a non-disclosure agreement (NDA) (which may also include exclusive dealing and non-circumvention provisions) to ensure details of the deal and related discussions remain confidential and interests are protected.
• In most cases, the next step is to enter into a negotiation phase to determine the type of deal. The key here is to identify if parties are looking for a merger or an acquisition. Mergers take place when two entities bring their resources together and create a new entity or business venture. Whereas acquisition takes place when an entity ‘absorbs’ or acquires the assets and liabilities of another entity and continues the business of the acquired entity under its own flagship or there is some form of equity investment in an entity. Once this is identified, this will form part of a term-sheet or memorandum of understanding - which includes other key facets, such as the process or key terms of the deal - to start the acquisition or merger process.
• The MOU is a critical document as it records such items as: key commercial terms of the deal - to the extent that these have already been identified leading into the due-diligence phase; the process or roadmap for the parties’ negotiations and conduct over the initial phases of the transaction; key documents to be put in place; an overview of the acquiring entity’s commercial objectives, and other factors to consider as the deal progresses to the next stage. Depending on how a specific transaction evolves and timing considerations, some of the above may be progressed in parallel with due-diligence and transaction document negotiating phases.
Due-diligence and negotiating terms of agreement
Once a thorough M&A strategy has been determined and the initial key documents implemented, the due-diligence phase focuses on examining the suitability of a potential M&A transaction. The purpose of due-diligence is to qualify the prospective deal’s value proposition and identify future risks that may affect or devalue the deal
Although the due-diligence for both mergers and acquisitions may largely remain the same, here are some of the key considerations:
• Review of licenses: particularly to note license activities for any updates/changes, and Memorandum and Articles of Associations and whether any external regulatory approvals will be required;
• Proposed shareholding: review constitutional and shareholding documents to identify the shareholding and capital structure and consideration of the documentation required in case the ensuing transaction requires a majority local shareholding;
• Management control and powers: review and prepare a plan of action regarding managerial powers and control, post-transaction;
• Employment issues: identify any historical or ongoing employment issues and identify a strategy to deal with them;
• Contracts: review key contracts for any onerous provisions, such as change of control provisions, which are triggered when there is a change of control or owner of a company which require counter-party consent;
• Litigation and arbitration: identify if the entity being acquired or merged has any ongoing litigious issues and prepare a strategy to deal with any such issues
• Intellectual property (IP) issues: identify ownership of brand names, trademarks, copyrights or patents and review of any IP licensing agreements to identify any issues;
• Debts and bank guarantees: determine the status of the company balance sheet and the existence of any liabilities and how this may affect consideration.
Nathan Banks is the managing partner of UAE legal firm Banks Legal