By: King & Wood Mallesons
Many German companies are very interested in Chinese partners and investors. Often, German companies look for entries to the Chinese market and/or Chinese partners for a future co-operation. After hundreds of Chinese investments in – or acquisitions of – German companies, a market practice has developed, a standard that in certain points deviates from other markets: E.g. Chinese investors (and regulators) have come to accept that MAC-clauses (giving a party a right to withdraw in case of a material adverse change) are not market-standard in Germany.
Both German and Chinese regulatory aspects need attention.
However, once sufficient transparency on regulatory aspects is established between the German and the Chinese party, in almost all cases the regulatory items can be dealt with swiftly. In a few cases, regulatory considerations require careful consideration at a very early stage of the setup/architecture of a transaction.
Avoiding cultural misunderstandings in M&A
In our experience, certain cultural aspects have often resulted in Chinese bidders – involuntarily – missing acquisition opportunities in Germany by not observing particularities in the German market, such as timing requirements and the need to manage seller’s expectations.
In the German market, most large and mid-market M&A processes (starting at transaction values of even less than EUR 50 million) are conducted as auction processes, i.e. the seller negotiates in parallel with a number of bidders.
- Typically, these processes are led by a financial adviser and strict timing requirements are set by the sellers and their advisers, so they can control the bidding process and achieve an optimal result for the seller.
- Sellers typically value deal certainty very highly, so that it is common in the German M&A practice for the purchase agreement to only contain a small number of closing conditions.
- Certain notarization requirements also need to be observed.
Timing of M&A transactions
Where the business has been put up for sale, it is important to understand the practice of the (auction) sales process. To avoid missing out on auction opportunities, Chinese bidders should take timing requirements communicated to them in auction processes very seriously. It will often be possible to side-track the auction process, in particular where the timing issue is addressed very early in the process. One example is the signing of a nondisclosure agreement at the outset of the auction, which should preferably not take more than 2-3 days. In addition, Chinese bidders should, at an early stage, take all preparatory measures with respect to governmental approvals.
In other cases, it is important to invest time in understanding the German entity and the seller(s) before deciding on the M&A approach. It is often necessary to build a relationship with the relevant individuals at the target and to demonstrate a real interest. In particular, owners of family-controlled German businesses generally need time – and sometimes a certain degree of motivation – to come to a decision on a transaction. While for the majority of German businesses, and not just those held by private equity, M&A transactions have become a familiar process, for some other sellers such transaction is a once-in-a-lifetime project. Implementing deals successfully still largely depends on taking into account the particularities of the German market.
Notably, purchasers or merger partners should familiarize themselves with the relevant options, including legal and tax aspects relevant to all sides of the transaction, before deciding on deal structures and other aspects. This applies above all to public M&A and, to some extent, to investments in public companies (PIPEs).
Traditionally, it is common in the German M&A practice for the business purchase agreement to contain a small number of closing conditions. Sellers typically value deal certainty very highly – in some cases even at the cost of accepting a slightly lower purchase price. While this tradition may have cultural roots, it is paramount to be clear that in a number of areas, such culturalbased traditions have to be understood to sign a deal.
- Since deal certainty has such a high priority, sellers will not usually accept a large number of conditions for completion.
- If all closing conditions have been satisfied and a party is still not fulfilling its obligations under the SPA at closing, the other party may either claim damages or demand specific performance. The latter means that the breaching party remains bound by the agreement and can be forced by the court to perform under the agreement (i.e. the other party is not restricted to claiming damages).
- It is not uncommon that a seller chooses a buyer that seems the most likely to perform – even if other bidders have made slightly higher offers.
- To the extent that the performance of an agreement is subject to regulatory approval in China, Chinese buyers are at a natural disadvantage and need to take time and invest resources to inform the seller about the approval process and thus to build trust.
- Foreign investment control clearance is advisable and typically requested by the seller where a Chinese investor acquires 25% or more in a German company (or 10% or more in a German company in a critical sector). This needs to be taken into account in particular with respect to timing. That being said, for well above 90% of all transactions is a procedural item rather than a substantive obstacle.
- So-called break-fees (amounts to be paid by the investor to the seller(s) if certain closing conditions are not fulfilled) in the range between 5% and 15% of the purchase price (most often in the lower range) have become market practice in Sino-German transactions. As, however, almost all transactions once agreed on are subsequently closed, the break-fee provision is typically not an actual expense for the buyer, but rather an instrument to increase the level of deal certainty from the seller’s perspective. By now, although still a heavily negotiated point, this is typically dealt with by way of a bank-guarantee, and usually not a dealbreaker.
In most cases, the German target is organized as a German limited liability company, a so-called GmbH. This is a legal form with high flexibility but also some peculiarities, such as a notarization requirement. The notarization serves to ensure that the parties are fully aware of the significance of the transaction and is thus typically perceived as an anachronistic formality in transactions where both sides are represented by experienced lawyers. Whether needed by the specific parties or not, it is a mandatory requirement and a perfect illustration of the German particularities that need to be understood in order to enter into a successful M&A transaction.
Actions requiring notarization include the sale and transfer of shares in a limited liability company (but not shares in other types of entities), any sale and transfer of real estate, any revision of the articles of association of a limited liability company as well as certain important shareholder resolutions, e.g. regarding the issuance of shares or a statutory merger, all have to be notarized.
Notarization is costly, with an SPA on the sale of a limited liability company with a value of EUR 100m running to approx. EUR 80k (if the deed is in English). During the notarization process in Germany, the notary reads out the entire document (including all relevant annexes) to the parties who have to attend either in person or to be represented by a legal representative.
If notarization requirements are not met, the legal act is void and cannot be enforced. It should, thus, be ensured at an early stage that all prerequisites for a timely notarization are fulfilled.
Further, certain corporate measures have to be filed with the commercial register. Relevant changes, such as an amendment to the shareholding in a limited liability company, alterations to the articles of association, the appointment of a managing director as well as any other important corporate measures, have to be registered or filed with the competent local commercial register. Since some of these measures require registration to be valid, it is always important to apply for registration in a timely fashion to avoid long periods of uncertainty.
While any investment in German entities is quite straight-forward when structured well, an investment in a listed German entity is, from an investor perspective, often particularly appealing as it gives investors the opportunity to invest in tranches.
Such a PIPE (private investment in public equity) transaction needs to be structured and timed somewhat different from a private M&A transaction, and certain market standards should be complied with (e.g. limited due diligence, a staggered control over management, insider rules). As in any market, certain German market standards have developed for such transactions and such PIPE transactions are often implemented in a very successful manner for both sides. From the seller and/or listed entity’s perspective, such PIPE transactions (e.g. block trades and/or investments against issuance of new shares) provide quick access to equity capital at acceptable transaction costs. And, beyond the option to increase the stake, the investor has a liquid investment which potentially does allow for a face saving exit, often implemented in a staggered way.
In the German market, standard approaches to PIPEs such as share subscriptions, block trades and public tender offers have evolved that should be observed by foreign investors. That does not mean that there is only one way to implement public M&A transactions. Certain elements, however, are now accepted in the market as best practice, and overall, the process – in spite of some German particularities – has been assimilated to the process in other jurisdictions.
Under the German Takeover Act, a purchaser is obliged to make a mandatory takeover offer if he gains direct or indirect control over the target company, which is the case if he holds at least 30% of the voting rights in the target company. Both for mandatory and voluntary takeover offers, there are strict rules as to the purchase price for the shares. The purchase price has to be “appropriate” and is calculated based on the average market price of the shares or the price paid earlier by the bidder.
Investments in the financial sector are subject to specific clearance procedures. This applies to acquisitions of stakes in banks, investment firms, fund managers and insurance companies (financial sector entities). The critical threshold which triggers a need for regulatory clearance is 10% of the shares or voting rights of the relevant target. Furthermore, clearance procedures are also required in case a previously cleared stake in a financial company is increased above certain levels.
Clearance needs to be sought from the German Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin), the single regulator for the financial sector in Germany. In the insurance sector, BaFin is the only authority involved in this process. For most banks, on the other hand, under the EU’s Single Supervisory Mechanism, the clearance decision is made by the European Central Bank (ECB); also, during a procedure relating to any bank, BaFin is assisted by the local branch of the German Federal Bank (Deutsche Bundesbank) in the area where the target is located. It should be noted that the obligation to inform BaFin is already triggered by the intention to acquire a relevant shareholding (i.e. prior to the actual acquisition) and also that several persons acting in concert can require notification where each such person, individually, does not reach the threshold. The procedures start with the filing of notification which normally involves considerable paperwork to describe the background of the acquirer, the acquisition and (to a certain extent) the intention behind the acquisition.
Only once BaFin has concluded that the filed notification is complete will a corresponding confirmation be issued to the acquirer. From the date of this confirmation, there is a certain period of review which, in the case of an acquirer from outside the EEA, such as China, is 90 business days and during which BaFin may raise any concerns or approve the intended acquisition.
Pursuant to the rules governing the clearance procedures, BaFin may raise concerns against the intended acquisition (and indeed prohibit the acquisition) if, for instance, it comes to the conclusion that
- the acquirer or its legal representatives are not reliable or for other reasons not able to manage the target in a strong and prudent manner (which is, among other things, the case if the funds used for the acquisition are from illegal sources);
- the target will not be able to meet the supervisory requirements resulting from the relevant European directives and regulations or becomes part of a group of entities which, by its very structure or lack of transparency, can adversely affect supervision of the target;
- the acquirer does not have the financial substance to support the capital requirements and liquidity of the target; and
- a non-EEA acquirer is not subject to effective supervision in its home country or is domiciled in a country where the regulator does not cooperate with BaFin in a satisfactory manner.
Where the ECB is the relevant authority to render the ultimate decision, BaFin will prepare a recommendation, which the ECB usually follows.
In our experience, ultimately, the clearance filing will be successful if the relevant authority can be convinced of the substance and reliability of the acquirer and of the availability of the funds which are used for the acquisition (and, if applicable, capitalization of the target).
Outstanding clearance does not per se prevent the acquisition from being implemented (by a transfer of the shares in the target), but the parties run the risk of the ECB (or, where applicable, BaFin) prohibiting the acquisition retroactively and ordering the shares in the target to be only transferred with its consent forthwith. In such a case, BaFin may also apply to the competent court for the voting rights attached to the shares in the target to be transferred to a trustee, with the trustee being instructed to sell the shares in the target to a sound and reliable third party. Finally, non-compliance with the clearance filing requirements is an administrative offence which can be sanctioned by a fine of up to
Against the backdrop of these far-reaching consequences and considering the uncertainty surrounding the end of the clearance period, it is advisable to contact BaFin and Deutsche Bundesbank sometime prior to the “official” clearance filing to discuss the proposed transaction.