What is the place for due diligence in Mergers & Acquisitions.
In the past two weeks, the country has been treated to a circus of destruction of buildings that are on, the new buzz word in town “riparian land.” The green bulldozers by Sany Group which have been baptized “Mr. Sany” are now famous or infamous depending on which shoe you are wearing.
Looking at these demolitions, one disturbing observation has been made. In all cases, the investors of all these buildings and business establishments claim that they has all the necessary approvals and the necessary documentation. Unfortunately some of the buildings were bought with the hindsight that all the approvals were done. The question begs, was there enough and elaborate due diligence done before signing on the dotted line? Was there professional assistance in carrying out the due diligence if at all it was done?
The issue of due diligence is now under special focus from the business community due to the adverse ramifications that come with business disruption as a result of unforeseen happenings. Business acquisition, mergers and financing of major projects or business has been in the rise in the few years as Kenya positions itself as a financial and business hub.
Mergers and acquisition can be an exciting and even critical part of a company’s growth strategy. When done right, a successful merger and acquisition can help two companies gain valuable market share, expand their product portfolios, increase profits and inject more equity into their brands. But when mergers and acquisitions go wrong, it can be quite a different story, involving cultural clashes, litigation, epic losses and even bankruptcy.
In East Africa, the mergers and acquisition deals were valued at over $5.2 Billion with Kenya taking the lion share according to I&M Burbidge Capital’s annual report for 2017. This demonstrates the investors’ appetite and confidence in the economy hence the greater need to more due diligence before signing the deals.
A thorough due diligence should cover the entire spectrum of the company from the more common financial review, customers, competition, regulatory and legal issues to the less common review of the company’s culture. All this go towards giving comfort to the investors that the deal is above board and guarantee that there will be no future surprises from things they were hind sighted from.
When conducting a financial review one of the areas that should be given greater attention is the tax status of the company. In recent years, the tax authority has become more aggressive and sophisticated in their administration of tax hence more and more transactions are being reviewed with a tooth comb.
In recent weeks, many corporates have been in the news on the wrong reasons due to issues raised by the taxman. Some of the issues relating to companies that have undergone restructuring date back to the pre-restructuring period and were not factored in the deal price.
Tax issues pose a major challenge since they are inherent in the daily transactions of the company and for the less obvious, they can skip the mind of the buyer. The repercussions of inherited tax issues can be detrimental to the success of a company. These post-purchase issues can rapidly decrease the value of the deal.
It is therefore critical for investors to conduct tax due diligences before putting pen to paper. As Robert J. O’Neill (the US Navy Seal who is said to have killed Osama Bin Laden) said, you can never be over-prepared.
Some of the benefits that accrue from the tax due diligence reviews include having leverage when negotiating the deal when you know the issues in play. Further in addition to signing an indemnification for undisclosed taxes, the actual and potential tax liabilities can be used to reduce the purchase price or factored in the numbers. The tax due diligence also aids companies to anticipate tax benefits from the restructuring which can be one of the selling point during the negotiation.
Some of the mitigating strategies for unforeseen tax issues during mergers and acquisitions include updating and re-wording the representations and warranties that have been provided by the seller. This can include the specific tax issues identified and the remedial actions. Further, the use of escrow accounts can be used to take care of any liabilities that may crystallize. The amount and period of the escrows may be varied so as to provide the necessary protection for the investor.
Where the tax issues are significant, then the transaction or ownership can be restructured so as to come up with the most efficient structure that has less tax implications. It is also advised that the buyer can take tax risk insurance so as to cover any unforeseen circumstances. While this is not common in Kenya, it should be one of the strategies that investors looking at the East African market should consider.
So, before signing your investment away, have someone look at what is behind the door!
Nathan is a Senior Tax Consultant at Andersen Tax, Kenya.