5 Golden Rules for Transactions and M&A

Is the market sending you an investment signal? A legal due diligence may also help determine whether you are looking at a flash of real gold or merely a deceptive mirage hiding unnecessary costs.

In the following article, we briefly outline the fundamental steps that can help you approach any investment with due consideration, ensuring that your business decisions are grounded on solid foundations.

1.   Thorough but Concise Due Diligence (DD Report)

In our previous article, we outlined the typical risks a legal due diligence should identify.

A DD report must be a practical tool for the client, not a legal labyrinth.

The true value lies in clearly naming the identified risks and recommending specific actions. It should not capture every internal reflection or thought process the lawyer went through during the review. Furthermore, answers like "it is complicated and could be interpreted otherwise" are of little use to a client.

In any case, a DD report represents an essential basis for making an informed decision on the transaction, with its quality and practical value depending in particular on the expertise of the legal adviser conducting the review, the level of cooperation between the parties involved, as well as the time and resources devoted to the due diligence process.

Ultimately, a DD report is an essential foundation for informed decision-making. Its quality and practical benefit depend primarily on the expertise of the legal counsel, the level of cooperation between the parties, and the time and resources invested in the process.

A balanced interplay of these factors results in reliable documentation upon which the transaction and, ultimately, the final binding agreement are built.

2.   Term Sheet and Proper Archiving of Communication

A considerable period may elapse between the initial intent of the parties and the closing of the final deal. Therefore, it is crucial to agree on the basic framework of the transaction and cooperation — the Term Sheet, at the very beginning of negotiations.

The Term Sheet should include an agreement on the manner and timing of providing access to documentation and other materials required for the conduct of legal due diligence, as well as provisions governing the method, timing and venue of negotiations (especially in multi-stage processes), the conditions for access to the other party’s premises for inspection purposes, and agreement on any other material procedural matters.

Such agreements often also include provisions governing pre-contractual liability for damages (for example, by stipulating a so-called break-up fee or by agreeing on a lump-sum reimbursement of costs incurred in connection with an aborted transaction).

We strongly recommend that all material facts be recorded in writing, ideally in electronic form. Relying solely on oral representations may lead to unnecessary ambiguity and disputes in later stages.

In M&A practice, it is well understood, that negotiations of the transaction agreement are far from concluded upon completion of the DD report.

The DD report's findings are often the subject of subsequent red-flag meetings tended by the advisory teams of both the seller and the buyer, where individual risks are examined in greater detail, clarified, or addressed through measures aimed at their elimination or mitigation.

Where the identified deficiencies cannot be partially or fully remedied, the red-flag meeting may result in a purchase price discount or, in the worst case, the investor’s withdrawal from the transaction.

However, if the diligent recording and archiving of these steps is neglected, one of the parties may lose track of which risks remain outstanding and which have already been resolved, which may result in a negotiating disadvantage.

3.   Failure to Notify a Concentration Can Be Costly

If you are a party to a concentration defined by law, you are obliged to notify the relevant competition authority.

Failure to notify a concentration may result in a fine of up to 10% of the total global turnover for the preceding accounting period. Given the serious legal consequences of such failure, we recommend consulting a competition law specialist on these matters.

A concentration refers to the process of an economic merger of undertakings on a lasting basis, which may take the form of a merger (e.g., the amalgamation of two companies) or the acquisition of control over an undertaking (e.g., by acquiring a majority of voting rights).

Which authority will review the concentration depends on turnover thresholds — lower turnovers generally fall under the Antimonopoly Office of the Slovak Republic, while higher turnovers are subject to the jurisdiction of the European Commission.

In addition to fulfilling the formal requirements of the notification, the correct timing of the notification is also crucial. The notification obligation must be fulfilled after the occurrence of the relevant legal fact giving rise to the concentration (typically upon execution of the agreement), and prior to the exercise of rights and obligations arising from the concentration.

If you are unsure whether the notification obligation applies to you, it is recommended to seek legal advice. It is also possible to make use of pre-notification contacts with the Anti-Monopoly Office of the Slovak Republic, which in practice help clarify these issues in a timely and efficient manner.

4.   Leverage Identified Risks in Negotiations and Transaction Documents

The results of the due diligence should be one of your strongest negotiating tools. It is, therefore, essential that its conclusions are thoroughly reflected in the transaction documentation — whether it is a Share Deal or an Asset Deal.

Risks identified during due diligence that were not resolved during red-flag meetings and for which no other adequate solution exists, must be considered when the investor decides whether to proceed with the transaction.

If the seller is unable, in the course of the transaction, to satisfactorily demonstrate that the target asset possesses the required qualities (for example, that it has duly paid the full purchase price to a prior transferor for the transfer of a business interest), and the investor nevertheless decides to proceed, such circumstances should be expressly reflected in the transaction agreement.

One of the most effective tools is the inclusion of representations and warranties (R&Ws). Within the R&Ws, the seller declares that the target asset has the agreed characteristics; if such representations prove to be untrue, the seller is liable for defects in the target asset.

Such liability may be further reinforced by mechanisms such as indemnity undertakings, contractual penalties, obligations on the seller to defend the buyer’s rights in disputes with third parties, or by obtaining specific insurance coverage (R&Ws insurance), under which the buyer may be entitled to an insurance payout if the representations prove to be untrue.

Transaction practice also recognizes other instruments through which ongoing risks may be mitigated.

If risks are quantifiable, the buyer may request a proportionate price reduction. Where a risk is demonstrably remediable, the effectiveness of the transaction agreement may be deferred by means of a condition precedent until such risk has been eliminated (e.g. the purchase agreement shall not become effective until the seller proves that the environmental contamination has been removed from the land).

5.   Choose an Advisor Who Fits Your Needs

You will inevitably face the question of how to find the right team of advisors, which typically consists of legal, financial, tax, or technical experts.

It is advisable to rely on references, personal experience, or market research. However, the best results are achieved when you align the nature of your business objective and the target asset with the specialization of the lawyer.

For example, if you plan to acquire a multinational construction and development company, the ideal choice is a lawyer experienced in construction law, commercial law, and M&A transactions who has been tested in numerous business negotiations.

If you are planning to acquire an energy company, it is highly beneficial to engage an advisor who is thoroughly familiar with this sector and its specific characteristics.

When comparing proposals from different law firms, consider not only the proposed fee, but also the exclusions that apply to it.

These often relate to the scope of the legal due diligence and may include, for example, limitations on the number of contracts reviewed or the exclusion of certain types of documents (such as insurance policies or older contractual relationships).

We therefore recommend negotiating such exclusions so that they reflect the specific nature of your needs and the relevant market sector of your business objective, as their appropriate calibration will ensure that the legal due diligence is truly tailored to your requirements. 

Conclusion

Some business opportunities may appear attractive and merit consideration for investment. However, experience shows that not every deal that initially looks exceptional is necessarily advantageous in reality.

This article provides only a general overview of the typical course of a transaction. Each transaction is unique and requires an individual approach. Accordingly, this article does not constitute a comprehensive legal assessment of specific legal issues and risks and cannot replace tailored legal advice in respect of any individual matter.