Sergio Michelsen Jaramillo, Darío Laguado Giraldo and Ángela García, Brigard Urrutia Abogados
This is an extract from the first edition of The Guide to Mergers & Acquisitions published by Latin Lawyer. The whole publication is available here.
Family-owned and controlled companies are the backbone of Latin American economies. More than 85 per cent of the companies in the region are family owned, accounting for 60 per cent of the region’s GPD and employing more than 70 per cent of its workforce. In Colombia, for example, as at 2018, 86.5 per cent of operating companies were family owned. These statistics mean that if you work in M&A in Latin America, chances are you will largely be dealing with family-owned targets. Therefore, understanding the particularities of these transactions is key for any practitioner involved in M&A in Latin America.
These deals have many of the same characteristics and challenges of any M&A transaction, with the added complexity associated to the family’s strong attachment to the target. Guisser and Gonzalez note that ‘insensitivity on the part of buyers and advisers to particular issues that arise in the context of the family-held company has created real problems in many transactions’. These issues can be grouped in three categories: the (understandable) lack of M&A experience of the family facing what is likely a once-in-a-lifetime transaction; the deep economic entanglement between the family and the company; and the strong emotional bond with the business. The combination of these three variables will determine the complexity of the deal and will permeate the deal-making process. If they are not properly managed, the dynamics of the deal may become problematic to the point of affecting, delaying or even frustrating signing or closing. However, if the process is well handled, these challenges will be compensated with factors such as the transfer of knowledge of the business and its market as well as the relative ease resulting from not having to comply with capital markets regulations applicable to publicly traded companies.
Within this framework, at the intersection of these three variables, this chapter explores the particularities and complexities of M&A transactions involving family-owned companies. The first section describes the deal dynamics and the main challenges in that respect. The second section focuses on substantive points of negotiation that are relevant and perhaps unique to this type of deal. The third section sets forth certain considerations regarding partial sales, particularly shareholders agreements and exit rights. The fourth section concludes.
Deal dynamics: no two families are alike
Data shows that family owned businesses generally do not get involved in acquisitions. The aversion to acquisitions may be explained by the fact that families may not want to risk their financial autonomy or are not willing or do not have the financial means to inject into the business large amounts of capital usually required to complete an acquisition. In contrast, sell-side transactions can ‘provide family firms with a successful exit in the case of generational transitions, as well as possibilities for rapid external growth’
Even though no two families (and no two transactions) are alike, the following are certain matters to consider when working with families on either side of the equation.
Is the family ready to sell?
Unlike other institutional shareholders, families think in terms of years, decades or even generations. Therefore, it is not surprising that M&A deals involving families take a long time to build up. Even when a handshake agreement is in place, execution may lag for months or years. In approaching a family, it is extremely convenient to ask if they are truly ready to sell. This can be a function of some of the following variables. First, succession is critical. If the younger generations are not actively involved in the company, this may be a signal that a sale may be in the horizon. Second, families will typically look at long-term market conditions, with a view to strike the best possible price for their lifetime investment. This equation will probably combine the maturity of the business with good market prospects. Third, country risk, especially in Latin America, will play a major role in a family’s decision to exit an investment. Fourth, a family will look at its legacy, seeking to assure that the company they consider their life’s work will endure through time. Failure to understand if a family is ready to sell or not may be frustrating for buyers, and it is, therefore, advisable to fully assess these and other circumstances before putting the pedal down at full speed.
When should counsel be engaged?
The short answer is the sooner the better. Engaging counsel early in the process can help the family understand and organise the process efficiently from the beginning. It may also assist the family in identifying the issues that will be pivotal in the transaction. Even if counsel is not engaged at the very outset of the process, families should reject the temptation of entering into preliminary agreements (see Chapter 11 of this guide on preliminary agreements) without adequate legal advice. A somewhat common challenge that M&A counsel face when they are hired after the execution of a preliminary agreement is finding that it contains agreements on matters that would otherwise be stock purchase agreementmaterial (typically not precisely in the benefit of the family). These may include procedural terms, such as exclusivity periods, pre-signing covenants, or substantive terms, such as commitments regarding conditions precedent or the indemnity package. In these circumstances, attempts to reestablish the balance at a later point must be carefully proposed because they can affect the trust and credibility of the parties in the process.
Legal advice may also prove useful for the family in the negotiation of mandate agreements with bankers and other advisers.
Identify the decision-makers and potential sources of tension
Whether you are advising the seller or buyer side, you need to understand the dynamics of the family and the decision-making process within it. This knowledge will enable counsel to anticipate possible sources of tension and be prepared to solve them when they arise. Very early in on the process you need to understand who will be leading the negotiation and what is the scope of his or her authority, the clusters of family alliances, the generation to which the respective family members belong, and the majority required to approve corporate actions. For instance, the dynamics of the deal are completely different when you are dealing with parents and their siblings, than when you are dealing with the extended family.
In this context, it is particularly relevant to understand if all the members of the family are aligned in connection with the transaction. If they are not aligned, you must be sure that the family members that are on board with the sale have the majority required to approve it or to transfer control (or the desired stake). Also, although rare, it is crucial to understand if there are rogue family members that may oppose the transaction or may seek to behave opportunistically to extract non-proportional value. In any event, early active discussion with the financial and legal M&A advisers to address any opposition to the transaction is highly recommended. More often than not, opposing family members are better persuaded if they are brought closer to the deal team and actively provided information to build up their trust in the process.
Once the decision-making process has been nailed down, the following tools may be useful to navigate it. When trust among the family members is strong and there is a salient leader, all the family members may grant a proxy to that person and this may be the best way to guarantee deal certainty….