By Yong Kaichang King & Wood Mallesons’ Corporate&Securities Group
In this Article, we will discuss practical tips in 10 key areas for the better and effective management of outbound M&A transactions by PRC investors. This Article will be published in two parts. In this Part 1, we will first discuss the choosing of lawyers, reviewing legal fees, forming the transaction structure, setting a timetable and managing due diligence.
Choosing your lawyers
Choose an international law firm with the core team servicing you based in China if:
- this is your company’s first (or first few) outbound transaction(s);
- your internal deal team does not have the appropriate international experience/expertise and language fluency; and/or
- the transaction is a complex, multi-jurisdictional matter.
Conversely, you may prefer to go directly to a local law firm in the target country/state if:
- your company has proper experience in outbound transactions;
- your internal deal team has the necessary international experience/expertise and language skills; and
- the transaction is a simple, single-jurisdiction matter.
Some law firms have a network of offices in numerous countries around the world. Others have a wide, loose network of partner firms in various countries. Engaging such law firms would be convenient if your transaction involves multiple jurisdictions. However, the more important thing is to ensure that:
- your lead legal team has extensive M&A experience across a range of sectors, great communication and language skills, and excellent deal management skills; and
- the supporting local teams have the necessary local expertise.
Choose a partner and legal team with the necessary qualifications, expertise and experience. This may seem obvious but it bears emphasizing. For example, if the transaction document is governed by common law, make sure that your lawyer is common law-qualified, such that he understands the relevant legal concepts and can identify the material legal issues. Even if your lawyer is common law-qualified, make sure that it is not just a paper qualification and that he has the relevant experience and expertise in the practice of common law. Be wary of lawyers who claim to have done and to be able to do everything in every practice area in every sector, they don’t exist.
Reviewing legal fees
Capped fees by law firms are commonly requested for by buyers in a bid to control their transaction costs. When negotiating fees with law firms, consider instead which fee proposal provides a genuine, honest and reasonable figure given:
- the necessary work scope;
- the expertise required;
- the level of service your company requires;
- the objective level of complexity of the deal; and
- the value-add that the law firm can bring to your transaction.
It is typically difficult to provide capped fees for outbound transactions due to the large number of variables outside of the law firm’s control (e.g. whether any government/regulatory approvals are required and if so, how complicated the approval processes would be; whether any serious or unusual problems will be discovered during due diligence and if so, what the time and costs to fully assess and address such problem would be; whether negotiations will be long-drawn and extensive document revision will be required). Good legal services are a discernible professional service, not a simple and indistinct retail good.
Capped fees can be more easily provided in certain types of transactions where there is clear industry practice for the transaction documents to adhere to some standard format (e.g. certain bank, securities and derivatives documentation). Some law firms may agree to capped fees to get their foot in the door first, but would charge progressively more for out-of-scope work moving forward. If the agreed capped fee is low, you also run the risk of the law firm allocating less time and resources to your transaction. If you require law firms to provide a fee cap, ensure that the work scope provided meets the transaction requirements and that the stated assumptions do not unduly limit the law firm’s work and responsibilities.
Forming the transaction structure
Discuss with your advisors and set up an appropriate acquisition structure that:
- maximizes tax efficiencies;
- has key holding entities situated in appropriate offshore jurisdictions with a simple and clear regulatory and compliance system; and
- satisfies your business, financial, legal and other considerations.
Consider whether a purchase of shares or assets would better meet your commercial objectives. Generally speaking, a share purchase is faster and simpler than an asset purchase, but is riskier as the buyer assumes the rights and obligations of the target company.
Assess whether a purchase of existing shares or a subscription of new shares would be more appropriate. In a purchase of existing shares, the purchase price goes to the seller. In a subscription of new shares, the target company gets the money, which may be preferable for greenfield projects requiring a capital injection.
Consider whether a complete, partial or staggered buy-out would be more appropriate. In a complete buyout, a buyer gains absolute control of the target company, but would lose the valuable contribution and participation that a seller could provide as an ongoing joint venture partner. A seller who remains as a shareholder and is motivated to continue building the business via earn-outs or other management incentives could create more value for the target company in the long-run.
If you are acquiring or investing in a public listed company, additional considerations relating to listing rules, securities regulation and takeovers code could apply.
Setting a timetable
In our fast-paced market today with increasing competition for dwindling resources, every deal invariably comes with intense time pressure. Every deal is always urgent. Under this pressure, buyers sometimes cut corners by dispensing with certain checks and requirements or by rushing through documentation and procedures, only to have problems crop up later. More haste, less speed. Outbound deals can take more time due to different time zones, co-ordination across multiple jurisdictions, language differences and the need for cross-translation, and governmental and regulatory requirements.
Plan for a realistic and achievable timetable that balances the need for speed against the need for prudence. Getting the deal done properly is just as important as getting the deal done quickly.
Managing due diligence
Discuss with your advisors and ascertain the scope and depth of due diligence required to meet your key objectives and manage your key risks and concerns. Due diligence helps buyers to identify problems and:
- decide whether or not to proceed with the transaction and if so, at what price, terms and structure;
- resolve, or allocate responsibility for the resolution of, such problems; and
- determine how best to protect themselves against such problems.
Choose a full due diligence report if you need to have a comprehensive and detailed understanding of the target for pre-transaction assessment or post-closing integration purposes. This approach is not common nowadays partly due to tight transaction timetables and cost constraints.
Choose a “red-flag” due diligence report if your focus is only to ascertain if there are any material issues which would affect your decision to buy or the terms on which you buy. This approach is more common nowadays, where only material risks and issues are set out, and lawyers are given appropriate discretion to determine which risks and issues are material according to a sensible materiality threshold.
Choose a combination of the two where you primarily require a “red-flag” due diligence report, but need a fuller report on certain aspects of the target or the transaction. For example, where the focus of the acquisition is on specific assets and technology, where the target is in a niche industry subject to special regulations, or where critical problems (e.g. environmental pollution) are present. Special due diligence arrangements may also be needed in certain situations, such as “clean team” arrangements where there are anti-trust implications.
Don’t overlook due diligence. In some small or urgent deals, some buyers skip due diligence or only conduct very limited due diligence, believing that they would only lose their (small) investment if the investment turns sour. This is risky. Some potential risks and liabilities could extend beyond the immediate corporate entities in question. A mismanaged deal could also cause damage to reputation and goodwill that could far exceed the size of the initial investment.