Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Risks in Doing M&A in Russia_Anatoly Andriash


Published on

NES/CEFIR Public Seminar: Anatoly Andriash, Partner, Head of Moscow Norton Rose (Central Europe) LLP: “Risks in Doing M&A in Russia”

Published in: Business, Economy & Finance
  • Be the first to comment

Risks in Doing M&A in Russia_Anatoly Andriash

  2. 2. Risks in Doing M&A in Russia2Motivation in M&A transactionsBuyer’s Motivation- Acquisition of relevant asset (real estate,mining licenses, cash flows, etc.)- Access to skilled personnel, resources andgoodwill of the target- Technology and intellectual property(including software, trademarks, patents, etc.)- Expansion of market share – client base- Reduced number of competitors- Economy of scale- Trends in particular sector- Speculative trading- Synergy – reduced organizational costs andenhanced benefits from investments- Diversification- Management ambitionsSeller’s Motivation– The selling price exceeds the estimatedvalue of the business– Uncertainty that positive trend will prevail– Difficulties with management– Pressure from monopolists (infrastructure,buyers, sellers)– Difficulties with liquidity (e.g. forecastedfinancial stress)– Structuring of “withdrawal”: e.g. privateplacement, IPO– Sale of non-core assets– Pressure from creditors– Personal reasons
  3. 3. Risks in Doing M&A in Russia3Share or asset dealPros of a share deal Simple and fairly rapid No profits tax, under specific conditions No VAT charged to Purchaser No Russian taxes for Target CompanyCons of a share deal Transfer of legal and tax risks to Buyer:need for detailed due diligence No step-up in basis of assets foramortizationPros of an asset deal No transfer of tax and legal liabilities of Sellerto Buyer, save for limited exceptions Step-up in basis for assets depreciationpurposes Less favorable for the SellerCons of an asset deal Licenses are non-transferable 20% profits tax on capital No “goodwill” concept for tax purposes 18% VAT on transfer (cash flow issue) Risk of sale of enterprise as a propertyasset (lengthy and cumbersomeprocedure)
  4. 4. Risks in Doing M&A in Russia4Factors that Impact the Structure of a M&ATransaction• If the Seller is a company with no material assets, the Purchaser wouldnormally request security in respect of the Seller’s liabilities disclosed asits representations and warranties• Acquisition of less than 100% of a company’s shares (in this case it isrecommended to have a Shareholders Agreement• Need for the Purchaser to raise financing for the acquisition of acompany’s shares
  5. 5. Risks in Doing M&A in Russia5Typical stages in a buy side M&A processIllustrative timelineWeeks 1-2Phase 1Initialcontact bySeller• Reviewinformationmemorandum(auction)• Signconfidentialityagreement/exclusivityagreementWeeks 3-4Phase 2Indicativebids• Communicateindication ofinterest toSeller• Prepare fordue diligence• AssessfinancingalternativesWeeks 5-9Phase 3Buyer duediligence• Assemble duediligence team• Review dataroom• Site visit• Preliminaryenquiries• Attendmanagementpresentation• Verifyvaluationassumptions• Review SPAWeeks 10Phase 4Binding bids• Submit bidletter/determine finalbid terms• Submitmarked-upSPA• Sellerassesses bids• ObtainpreliminaryBoardapprovalsWeeks 11-14Phase 5Negotiatecontracts• Signexclusivityagreement (ifnot signedpreviously)• Negotiate andsign SPA andothertransactiondocuments• Securefinancing• Obtain finalBoardapprovalWeeks 15-18Phase 6Closing• Satisfyconditionsprecedent• Closetransaction• Post-closingpriceadjustmentsfilings andother matters
  6. 6. Risks in Doing M&A in Russia6Auction sales vs direct sales• Auction sales often involve a more formal process– Established auction process (non-binding for seller)– Preparation of information memorandum (selling document setting out thebusiness and asset description, financial position and estimates of the target)– Vendor’s due diligence may be prepared by the seller and shared with thepotential buyers– Buyers several bidding rounds– Seller drafts SPA and circulates to bidders for comments• Direct sales – more flexibility– Buyer and seller are in close contact– Buyer is less restricted in time for conducting legal and other due diligence– convention dictates that the buyer prepares the first draft of the SPA accordingto its requirements
  7. 7. Risks in Doing M&A in Russia7Confidentiality agreement/NDA• An early transaction step• Usually drafted by Seller• Buyer obliged to keep all “confidential information” strictlyconfidential and not disclose• Negotiation points– Exclusions from the “confidential information”– Permitted disclosure– Validity period (on average 6 months to 5 years)– Obligations after expiration of the validity period• Top tip: little to be gained from negotiating too hard– can spend a lot of time and expense negotiating technical points which are lowrisk for you (some lawyers love to do this)– can start you off on the wrong foot in a competitive process
  8. 8. Risks in Doing M&A in Russia8Exclusivity• Prevents seller from talking/engaging with other parties for a specifiedperiod• Obligations may be incorporated in NDA or heads of terms• Negotiation points– Seller to compensate Buyer for time and expense of due diligence etc incase Seller breaches exclusivity or withdraws from negotiations
  9. 9. Risks in Doing M&A in Russia9Buyer’s Due DiligenceWhy conduct due diligence?• To understand the asset to be purchased (buy / not buy)– Financial, tax and strategic performance– Legal matters– Specialised matters (environmental, technical, etc)• Identify issues– Can problems be rectified before or after acquisition?– Deal with the issues by amending terms of the deal, etc:– Reduce price / hold back / walk away right– Add indemnities– Fine-tune seller’s warrantiesWhen conduct due diligence?• After NDA is signed but before the final version of the SPA isagreed• After SPA is signed – as needed
  10. 10. Risks in Doing M&A in Russia10Buyer’s Due DiligenceLegal matters (typical)Corporate matters Due incorporation and registration, group structure, corporategovernance, shareholders agreementsTitle to the shares History of acquisitions, regulatory approvals, current status,encumbrancesTitle to the assets History of acquisitions/creation, current status, registrations andencumbrancesMaterial contracts Validity and enforceability, liability, term and termination,restrictions on activityFinancing Amounts, maturity, liability, security, creditors’ rights, change ofcontrolLicences and regulatory Existence, validity periods, scope, history of obtaining (ifrelevant)Disputes Pending and threatened litigation, arbitration and out-of-courtdisputes, amounts, status, possibility to challengeLabour and employment Standard terms of employment, terms of employments of keypersonnel, labour unions, labour disputesIntellectual property Own IP, licences to IP (granted and received), lack of rights tothe IP in useInsurance Insurance coverage, insurance claims
  11. 11. Risks in Doing M&A in Russia11Buyer’s Due DiligenceTypical mistakes and problems• Poorly organised documents and information• Lack of necessary documents• No single point of contact/responsible person• Poorly organised Q&A process and delivery of additionaldocuments• Lack of qualified specialists• Too generic (rather than tailor-made) request list• Extremely wide scope• Seller’s unfriendly approach
  12. 12. Risks in Doing M&A in Russia12Benefits of using English law• Flexible and convenient deal structure– Possibility to reflect commercial agreements exactly as agreed– Conditions precedent and conditions subsequent may depend on the parties– Price adjustment may be linked to the target’s performance– Availability of escrow arrangements– Commonly accepted and well developed structure of transaction documents• Additional buyer’s protection– Availability of the seller’s warranties covering the target– Availability of indemnities• Predictability of court practice• Recognition and enforcement of foreign arbitral awards in Russia
  13. 13. Risks in Doing M&A in Russia13Points to note when English law is to be chosen• “Foreign element” is required– E.g., a foreign counterparty• Specific performance in Russia is not guaranteed– Preferably to structure the deal as sale of shares in a foreign company• Controversial practice of Russian courts on arbitrability of corporatedisputes
  14. 14. Risks in Doing M&A in Russia14Structure of the SPA under English lawCommon clausesClauses in bold are the key operative clauses. Others are “boilerplate” and lessheavily negotiated.1. Parties 9. Confidentiality2. Definitions and interpretation 10. Waivers/severance/set-off3. [Conditions precedent] 11. Notices4. [Pre-completion undertakings] 12. Assignment5. Completion 13. Counterparts6. Warranties and indemnities 14. Amendments7. Claims limitations 15. Governing law and jurisdiction8. [Non-compete]
  15. 15. Risks in Doing M&A in Russia15Conditions precedent• Typical conditions– Regulatory consents and approvals– Corporate approvals– Financier consents– Rectification of issues identified through due diligence– Pre-sale restructuring– Waivers of the right of first refusal / pre-emptive rights• Additional risks for the parties– Circumstances change but the parties are bound to complete– Ability of a party to withdraw (e.g. no corporate approval is granted)• Ways to minimise the risks– Long-stop date– Pre-completion undertakings– Repeated warranties– Buyer’s right to withdraw in case of “material adverse circumstances”
  16. 16. Risks in Doing M&A in Russia16Pre-completion undertakings• Seller undertakings to the buyer to restrict the target’s activity inthe period between exchange and completion• Typical pre-completion undertakings:– No activity outside the normal course of business– No major transactions, no disposal of assets– No transactions with shares– No dividends– No termination or amendment of material contracts– No shareholders’ meetings– Buyer to have unrestricted access to the target’s documentation– etc. as the circumstances may dictate…unless approved by the Buyer in advance in writing.
  17. 17. Risks in Doing M&A in Russia17MAC clauses• Allows Buyer to walk away if there is a material adverse change(MAC) in the business between exchange and completion:– company/business MAC– general MAC• Negotiation points– how to measure/what is “material”?– distribution of risks in case MAC is not under control of either party• Rights under MAC clauses are rarely exercised in practice
  18. 18. Risks in Doing M&A in Russia18Price adjustment (1)• Completion accounts• “Locked box”• Earn-outs• Anti-embarrassment• Retentions and escrow accounts
  19. 19. Risks in Doing M&A in Russia19Price adjustment (2)Completion Accounts Locked Box● Price calculation is based on assumptionthat the target has:- agreed net assets on cash free debtfree basis; and- agreed working capital● Upon completion the actual net assets andworking capital are ascertained andcompletion accounts are prepared● Price is adjusted in accordance with thecompletion accounts● Completion accounts are prepared by anindependent accountant, sometimes thebuyer, rarely the seller● Completion accounts rules andprocedures are set out in SPA – involveaccountants early● Purchase price fixed by reference toaccounts at agreed date in advance ofsigning● Seller prevented from extracting value(“Leakage”) from target from the date ofthe “Locked Box” accounts to completion● No price adjustment, but the sellerundertakes to indemnify the buyer if therewas a Leakage
  20. 20. Risks in Doing M&A in Russia20Price adjustment (3)Earn-out Anti-embarassment● The parties may not agree the price● Purchase price is split in two parts:– one part equals to the agreed(conservative) valuation– second part is calculated by reference tofuture performance● Second part is payable only if specifiedtargets are satisfied within specifiedperiods after completion● Performance is ascertained by review ofthe accounts under agreed procedures● Performance may be ascertained by anindependent accountant● Purchase price is increased if the buyeron-sells the assets at a higher price (i.e.the seller is protected against being“embarrassed” by selling cheap)● Used in case of emergency sales (e.g.pre-bankruptcy) or where the seller is apublic or state owned company● Rarely used in Russia
  21. 21. Risks in Doing M&A in Russia2121Pros and cons of Completion AccountsPros for the buyer Ability to true-up. Only pays for what it gets:price will be adjusted if business hasdeteriorated before completion Reduces the risks of unidentified issues Ability to check completion accounts when infull control of businessCons for the buyer Extra costs and potential for dispute Seller can manipulate accounts Takes economic risk of the business rightup to completion Price may turn to be higherPros for the seller Speed of execution as Buyer may need lesscomfort on balance sheet before completion.May speed up negotiations Economic benefit in the business. Gets creditfor running the business and receives profitsright up until completionCons for the seller Extra costs and potential for dispute Less control over the completionaccounts/adjustment process Takes economic risk of the business rightup to completion Price may turn to be lower
  22. 22. Risks in Doing M&A in Russia2222Pros and cons of Locked BoxPros for the buyer Predictability – price is not adjusted(especially relevant when acquisition isfinanced) Cost – no completion mechanism so costsavings Simplicity – no management time spentdebating completion accounts postcompletionCons for the buyer No completion mechanism to exploit –need to rely on warranties and DD Risk of business deteriorating betweenlocked box date and completion Need to debate debt and working capitalearlier, with less detailed knowledge Need a well defined transaction perimeterPros for the seller Gives certainty of price resulting in ability todistribute proceeds quickly Increases control over process Hard-wires consistency with previousaccounting policies – there is no debate overcompletion accounts policies pre completion Simplicity and cost – no management timespent debating completion accountsCons for the seller Price is based on the last accounts andmay differ from the current value Economic benefits are transferred from theaccounts date rather than completion date
  23. 23. Risks in Doing M&A in Russia2323Pros and cons of Earn-outPros for the buyer Values target more accurately and protectionagainst overpaying Defers payment of part of purchase price Where sellers continue to be involved inbusiness, ties them into business andincentivizes them to maximise profit Can be used to offset claims under the SPAagainst the sellerCons for the buyer May restrict its control of target –restrictions on Buyer’s ability to makesignificant changes to Target’s business Can be detrimental to target in the longterm (if seller is managing Target in earn-out period and manipulates business solelyto achieve earn-out targets)Pros for the seller Possibility of getting higher purchase pricethan would otherwise have received Opportunity to benefit from synergiesachieved by the Target being integrated withthe Buyer’s businessCons for the seller Prevents clean break Potential impact of unforeseen external“shocks” Makes seller vulnerable to buyer’s actions Might be used by buyer to offset claims ithas under the SPA
  24. 24. Risks in Doing M&A in Russia24Use of escrow accountsPurpose• Reduce risks if the transfer of shares and payment of purchaseprice are not simultaneous• Security for the performance of obligations– by the buyer to pay deferred part of the purchase price– by the seller to satisfy buyer’s warranty claimsUse in Russia• Analogous Russian law concepts do not allow to utilise the fullpotential of the escrow accounts• In practice, parties open escrow account with a foreign bank (orforeign escrow agent) and settle payments through that account
  25. 25. Risks in Doing M&A in Russia25Buyer and seller’s protections• Buyer’s protections– Warranties– Representations– Indemnities• Seller’s protections– Limitation of liability– Disclosure
  26. 26. Risks in Doing M&A in Russia26Warranties (1)• Purpose– Disclosure by the Seller of outstanding tax and other liabilities,defects, disputes and other tax and legal risks– Make the Seller financially liable before the Buyer for breach ofwarranties• Structure– General warranties– Tax warranties
  27. 27. Risks in Doing M&A in Russia27Warranties (2)• Practical issues– A tax warranty from a Russian seller is usually only a confirmationthat tax returns have been made in a true and accurate mannerand that tax has been fully paid under these tax returns, ratherthan a declaration accepting full responsibility for tax relating tothe pre-completion period– Tax for the pre-completion period may arise as a result of a post-completion event i.e. as a result of allocation of revenue under amulti-period contract– Tax assessment can be initiated directly by the tax office ratherthan by the taxpayer through a tax return, in which case there willbe no technical breach of warranty
  28. 28. Risks in Doing M&A in Russia28Questionable Legal Force of Warranties andIndemnities under Russian Law• Many Russian sellers are not familiar with the practice ofrepresentation, warranties and indemnities• Substantial effort required to educate and convince them• Many Russian sellers are unfamiliar with such concepts which may takethem by surprise at the negotiation stage• As a result, the SPA discussions will usually take longer than plannedand the position of the buyers on these clauses will be weaker thaninitially expected
  29. 29. Risks in Doing M&A in Russia29IndemnitiesPurposeTo oblige the Seller to indemnify the Buyer, by reimbursing fora) Tax and other liabilities related to the periods and instancescovered by the SPA prior to the Completion Date (with limitedexceptions), andb) Associated expenses, including legal fees incurred by the Targetto settle all tax disputes and rectify revealed deficiencies inconnection with additional tax assessments and inspections bygovernmental agencies
  30. 30. Risks in Doing M&A in Russia30The Changing Face of M&As• Rationale– Rationalization of business– Improvement of liquidities• Trends– Disposal of non-core assets & “fast cash” considerations– Rapidity is key to successful distressed M&A deals– More non-cash & “hybrid” transactions– New approach to KPIs (Key Performance Indicators)
  31. 31. Risks in Doing M&A in Russia31Financing of a M&A Deal• Lack of financing for small and medium companies• Swaps are an alternative to cash in a M&A deal• Russian M&A market demonstrated increasing interest in non-cashacquisitions• Conversion of debt into equity is permitted under Russian law
  32. 32. Risks in Doing M&A in Russia32Holdback AmountThe purchase price can be paid / retained in installments (“hold-back”)– Holdback is normally equal to a percentage of the price– The price percentage could be paid before the limitation periodexpires (i.e. 3 years in Russia)– In practice, such arrangements are rare and commerciallyinconvenient for the Seller
  33. 33. Risks in Doing M&A in Russia33Contact DetailsAnatoly AndriashHead of Moscow, PartnerNorton Rose (Central Europe) LLPWhite Square Office CenterUlitsa Butyrsky Val.10, Bldg.AMoscow 125047Russian FederationTel +7 499 924 5101Fax +7 499 924
  34. 34. Risks in Doing M&A in Russia34DisclaimerThe purpose of this presentation is to provide information as todevelopments in the law. It does not contain a full analysis of thelaw nor does it constitute an opinion of Norton Rose (CentralEurope) LLP on the points of law discussed.No individual who is a member, partner, shareholder, director,employee or consultant of, in or to any constituent part of NortonRose Group (whether or not such individual is described as a“partner”) accepts or assumes responsibility, or has any liability, toany person in respect of this presentation. Any reference to apartner or director is to a member, employee or consultant withequivalent standing and qualifications of, as the case may be,Norton Rose LLP or Norton Rose Australia or Norton Rose CanadaLLP or Norton Rose South Africa (incorporated as Deneys ReitzInc) or of one of their respective affiliates.