As discussed in an earlier post, cross-border M&A deals are on the rise. Most businesses today are looking to unlock value from technology, emerging markets are flourishing and pursuing global investment opportunities and barriers to information have diminished. These are all factors giving rise to cross-border deals.
Transaction risk in cross-border deals
Cross-border deals come with many advantages, including the ability to expedite time to market, to scale and enhance brand recognition and to mitigate competition. However, cross-border deals are also accompanied by their unique set of disadvantages, making it all the more important to manage transactional risks.
Parties’ perception of risk and due diligence processes must therefore evolve to consider factors accompanying cross-border transactions. Top risk factors in cross-border deals, according to a study conducted by Deloitte (the Study), include tax law, regulatory considerations, political stability, culture and talent as well as business risk.
How to manage transaction risk
Managing risks and successfully closing a cross-border deal starts with conducting thorough due diligence. Parties involved in a cross-border transaction should consider the following when conducting due diligence, which can be divided in the following categories:
- Accounting and tax due diligence: Given the different accounting systems, parties would need to agree on issues such as valuation metrics, costing methods or reporting of pensions and employee benefits. An understanding of tax principles and differences informs the outcome of a deal. Currency differences may also add an additional layer of complexity to the deal. For these reasons, accounting and tax due diligence is considered one of the major sources of risk in a cross-border transaction.
- Operational and commercial due diligence: While operational and commercial due diligence is not unique to cross-border deals, aspects such as cultural differences, communication styles and business practices may make or break a deal. Even if a deal closes, failure to conduct thorough due diligence may negatively impact post-integration processes.
- Regulatory and legal due diligence: For a cross-border deal, it is crucial to identify any applicable foreign regulations as well as any expected developments in local legislation in a timely manner. Regulatory considerations could include foreign investment law approvals, exchange control approvals, antitrust laws as well as mandatory filings required for transferring a business or obtaining a permit. This is also another reason why it becomes important to retain counsel with extensive experience in cross-border transactions.
A certain type of due diligence may be considered more important based on the jurisdictions or the industry sectors involved in the transaction. For instance, the Study found that purchasers from the North America and Asia-Pacific regions rated commercial due diligence as the main determinant in making decisions around an acquisition. On the other hand, purchasers in financial services, insurance and manufacturing industries considered tax and accounting due diligence to be the most important, while regulatory due diligence was more concerning to energy and environmental companies.
Additional considerations in cross-border M&A
In addition to conducting thorough due diligence, the following are a few factors to consider when engaging in a cross-border transaction:
- Take advantage of the pre-signing period: The period leading up to signing of the purchase agreement is the best time to identify and resolve material cross-border issues. Deferred closings because of cross-border due diligence is also a common occurrence in such deals. Therefore, it is important to manage the risk through the purchase agreement itself.
- Consider restrictions or deal protection methods: Given the risks associated with a cross-border transaction, it becomes increasingly important to protect the deal through the various stages of a transaction – before signing a letter of intent, between signing the letter of intent and the purchase agreement, and before the closing itself. However, consider any restrictions on methods used in deal protection such as no-shop provisions and lock-up agreements. For instance, a hard lock-up agreement combined with a ‘no-outs’ merger agreement is illegal in the United States. In Canada, deal protection devices are subject to the business judgment rule while in the United States, they are subject to enhanced scrutiny.
- Develop a strong post-closing integration plan: Poor integration planning may lead to an unsuccessful deal, especially given the risks associated with cross-border transactions. M&A Playbooks as discussed in our earlier post and information gathered through due diligence could be useful in the planning process for post-closing integration.
The author would like to thank Shreya Tekriwal, Articling Student, for her assistance in preparing this legal update.
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