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#Corporate Finance #Takeover #Mergers & Acquisitions

Pitfalls in due diligence in international acquisitions

Tuesday 11/04/2023
Valkuilen in due diligence bij internationale overnames

In any business acquisition, due diligence is a crucial - if not, the most crucial - part of the complex process leading up to it. This level of complexity increases exponentially with cross-border transactions. In order to correctly assess the risks and opportunities associated with the company that is to be taken over, an analysis of the accuracy of its financial, tax and legal information is an absolute minimum. This in itself is a complex undertaking, but there is even more to consider with a cross-border transaction if you want to avoid potential pitfalls.

"An international company takeover requires sound knowledge of the foreign market, which makes such takeovers a lot more complicated than a transaction in your own country," David Valenne, a Partner at Moore Corporate Finance, explained. "After all, knowledge is the foundation for the analysis of the risks associated with any acquisition and the search for solutions to manage these risks. In a market outside your home market, you inevitably lack a degree of knowledge concerning legislation, taxation and sector specific regulations. Moreover, there are the language and cultural differences. There are many factors that make international deals far more complicated."

Local knowledge

In order to gain a clear insight into a foreign market and to perform a successful risk analysis of the company you intend to acquire, it is essential to increase your knowledge via reliable, local advisers who are specialised in the different areas. Valenne: "What you definitely need to get a grip on are the international tax aspects, international regulations and governance. It is not unusual for a prospective buyer to be so focused on the flow of the takeover process and wanting to complete a deal at all costs that they want to act too quickly and consequently lose sight of the actual risks involved. You really need to accurately assess and manage them."

"Take the accuracy of financial data, for example. Belgium has implemented agreements and rules that guarantee that the data you gain access to is reliable. Even then, there is still room for interpretation, which is where due diligence comes in. Within Europe, the risks are still relatively limited, but in Africa, South America and some Asian countries, accuracy may not always be relied upon. The question then arises as to how reliable the financial data are on which you are basing your decisions? To interpret these figures correctly you need a specialist adviser in situ, you cannot do this solely operating from Belgium."

Cultural differences

Although cultural diversity contributes to a richly diverse world, it can make cross-border transactions more complicated. "You have to deal with language barriers, regional customs and habits, as well as organizational differences – different practices on the shop floor. You could, for example, have companies in the same country that cannot be merged because the cultural differences cannot be overcome."

"The greater the difference between the culture of the parent company and that of the target company, the more time you have to invest in integration subsequent to the acquisition. Anyone involved in an international business acquisition but not focusing on cultural due diligence will more than likely encounter unwelcome surprises."

Cultural differences also have an impact on the acquisition process and the transaction itself. "Again good local advisers will prove their worth here, because they know the potential pitfalls and can use their bridging role to make a difference. For example, they may point out that in some countries you should not be fazed by emotional reactions, or by the fact that people don't show up..."

Operational, financial and political risks

The broader context also plays a significant role. Valenne: "A company is never a stand-alone entity, it is always part of a network involving customers, suppliers and other stakeholders. If you don't understand a foreign market, you run the risk that suppliers could cut off their supply lines or impose other conditions that reduce your competitive advantage. Operational due diligence to analyse the market is a necessity, not a luxury."

The same applies to financial aspects, the risk of non-payment. With both customers and suppliers, for example, you need to gain insight into the number of days outstanding: who are the good and bad payers? Valenne: "With international deals you often find that the payment deadlines are much longer and that bad debts are assessed differently."

"Political risks must also be taken into account when validating a company. In Europe and the US they are relatively minor, but elsewhere in the world they can be quite substantial. We factor them into the validation."

With a focus on future success

Anyone who fails to conduct human resources due diligence runs the risk of losing a large share of the company’s value immediately after the takeover. Valenne: "This kind of due diligence reveals who are the key figures in the company in question. In most cases a company is carried by no more than ten or fifteen employees. They are indispensable for various reasons: one has a special relationship with the customers, another has indispensable operational skills, ... You need to list them in advance and keep them on board."

There are two levers you can use to win over the right people after a takeover: financial incentives and a vision for the future. "First and foremost you have to devise an attractive financial package using retention bonuses, share options or other means to ensure that key people have every interest in helping to support the new company. Make sure you bridge at least two years with the system, i.e. the time you need to get to know the company, put the right people in the right places and take drastic action if necessary."

"Equally important, and often underestimated, is to introduce a vision for the future as soon as possible. Usually, the key people you want to keep on board are also the formal or informal leaders who can convince the rest of the team to join the merger process. Employees of a company that is the subject of a takeover experience recurring cycles of uncertainty anyway. And this uncertainty tends to motivate people to leave. To put it bluntly and looking at it from the other side: if you know that one of your competitors is being taken over, call the key people as soon as the takeover plans are communicated. Present them with a tempting contract and they may well decide to take their leave. Even more than for financial reasons, it will be because the new company has not yet had the chance to explain its vision for the future, to present a new structure and to include them in the narrative. Those contemplating a takeover are, therefore, advised to present the plans for the future not only to the other company’s top management, but also to all hierarchical levels below. In practice, this often happens too late, which makes you vulnerable to losses in human resources. Those who are familiar with the new vision and their role in realizing it are much less likely to leave the company."

Moore Corporate Finance is able to bridge the gap between a strong local presence and global execution power, thanks to the integrated network of worldwide expertise within Moore Global Corporate Finance.

Contact one of our experts

Philippe Craninx

Philippe Craninx

Managing Partner Corporate Finance

David Valenne

David Valenne

Partner Corporate Finance | Transaction Services