According to the words of the gurus of business development, there may only be two main business strategies: either building an empire or developing a company in order to sell it later. And ideally, even when nobody is actually going to sell a company, it «must be ready for sale any given Friday».
However, being a regular participant and giving legal advice on various transactions related to purchase and sale of companies, including mergers and acquisitions, i, unfortunately, often witness situations where companies are absolutely unprepared for sale. And in many cases a company must have all the characteristics of a company ready for sale, even when nobody’s buying. Such as when applying to development banks for financing.
Overall, given the conditions of expensive credit resources, increasing competition and market development, it appears that sale of companies or their parts will become the prevailing strategy, preferential to foreign investors or professional players in the financial market (investment and venture capital funds, business angels, development banks).
Market players know the basic requirements for buying or investing in a company (the term «target company»). Among these are independent evaluation, adherence to International Financial Reporting Standards, corporate structuring, corporate governance, etc. Many people already know what «due diligence» means, and they know that it means, among other things, a «pre-investment company check». However, most sellers don’t look at their companies with the eyes of a prospective buyer and don’t think of what may be most important in such check for them.
The experience in dealing with buyers and investors, especially foreign, used to structuring M & A transactions according to their own clear and well-established patterns, allows to conclude that one of the main requirements of the buyer is identification, assessment and minimization of various risks: financial, tax, operational, legal.
Current technologies, assessment matrices and the expertise of specialists allow to present a fairly objective picture of the target company to the potential investor. And such «due diligence» will not necessarily result in buyer’s general refusal to make a deal. If buyer wants a certain company (and the decision to buy has often already been made in advance), identified risks will only serve as the objective basis for an adequate price reduction.
Unfortunately, a seller can do little at this stage, because the information regarding their company has already been gathered, securely copied and locked in a data room (database of documents provided for a potential investor’s review).
There seems to be only one way out: spending time on pre-sale preparation in advance. Although the generally accepted method of preparation is to quickly rearrange material assets and make it look neat before sale, the tasks of assessment and management of financial and legal risks are often neglected.
As the saying goes, if they want it, they’ll buy it “as is“, why then spend extra money and time. But they won’t buy! And those who do are most likely financial speculators (not really interested in the state of comany’s affairs), who will buy cheap to resell to a real investor or eliminate a competitor in the global market (and such purposes are also not too uncommon these days).
In this regard, it is encouraging to see that the importance of this process is understood at the state level:
Thus, in the framework of the «Support For Privatization» project implemented by the government’s «National Investment and Privatization Agency», our company together with other legal and financial advisors takes part in the legal analysis of activities of four state-owned enterprises in the construction industry, with the aim to identify, analyze and resolve legal, financial and investment risks for the purpose of attracting a strategic investor.
But much more often we act as lawyers on buyer’s side and inspect the target company, focusing on the identification and classification of the various risks.
All risks may be conditionally grouped into several large groups.
On one side, risks may be:
1) resolvable (such that can be eliminated, for example, by preparing the appropriate documents) or
2) unresolvable (such that one can only declare and continue to live with, waiting for reprimand).
Each of those are either
1) minor or acceptable (sometimes even if there is an unresolvable risk factor, its presence alone will not lead to a significant loss of revenue or market share, major legal punishment or significant financial costs), or
2) major or critical (risk of losing a significant part of the revenue or whole business or an absolute impediment to acquisition of the company).
Examples of minor resolvable risks are:
— deficiencies in contracts (both with clients and with own staff), which may result in court cases or compensation payments, or deficiencies in corporate solutions, which may lead to corporate disputes and paralysis of the company in the future.
Minor unresolvable risks include most of the violations already committed in the areas of payment of wages and late payment of certain taxes and duties. Most of those carry a maximum administrative penalty of up to 100 basic units, which is not a significant financial burden, but there is no way to delete a violation when the information about it has already passed out of control: all the information related to delayed wage payments has already been stored in the bank, and all the information related to underpaid taxes is in the tax inspectorate.
Some corporate, tax or customs violations may, however, result in serious consequences and huge fines, but be impossible to resolve (those may be called major unresolvable risk cases). For example, improper formation of the authorized capital by inclusion of objects imported in violation of the customs laws, or gross violation of the licensing requirements in the course of implementation of activities for which a license is required. This category may also include errors in the process of privatization of state property and irregularities in the tender process.
Major (critical) risks may be resolvable.
Such risks may include, among others: possible departure of top management, lack of orders (loss of market share) after a change of ownership or absence of registered trademarks.
It may be concluded based on experience that a large number of identified risks may be eliminated or transferred to the category of minor. But this requires taking measures in advance. Otherwise, they will have to be resolved by the buyer, and, unfortunately, with the money that the seller will not receive.
Valery Papakul, specially for ‘Business Review’