The legal playbook for cross-border M&A - A startup guide

Entrepreneurs often find themselves at sea when trying to navigate the legal intricacies of a cross-border M&A. Vinayak Mishra, General Counsel at Lightspeed India, is in the thick of all things cross-border M&A. Here, he takes the readers through some things that are important in these transactions and why good legal advice can be the key differentiator between a good and a great deal.

Dominated traditionally by large corporations, the M&A landscape is evolving around the globe. With the economic rise of India and Southeast Asia, companies in these regions are increasingly targeting global markets. This has spurred the participation of startups in M&A activity, both as targets and acquirers.

Acquisition deals are inherently complex. Navigating different legal and regulatory environments in cross-border transactions adds another layer. Yet, the pre-pandemic years 2018-2019 saw cross-border M&A deal values exceeding $4 trillion.

Post pandemic, global economic concerns - geopolitical conflicts, a slowdown in China, high inflation, and rising interest rates - led businesses to prioritise alternative means of value creation and funding, resulting in a drop in global M&A deal value to a 10-year low of $3.2 trillion.

Easing inflation and interest rate cuts in H2 2024, improving market sentiments (particularly in the US), companies maturing, and pent-up demand following the 2023 slowdown, saw a further upward trend in global M&A activity, resulting in a deal volume of ~$3.6 trillion.

It is key to note that despite the decline in overall deal value, the M&A scene hasn’t been completely stagnant. Smaller M&A deals, often more cost-effective, less scrutinised, and quicker to execute, continued to close in significant numbers. This explains why the total number of deals in global M&A league tables remained relatively stable.

As market sentiment improves and companies mature, we can expect a natural progression towards increased M&A activity.

While commercial motivators are key drivers of M&A, navigating legal aspects is also crucial. Overlooked legalities and regulations may have contributed to the failure of some major M&A deals. This is even more critical for startups, where M&A is not a core competency. Addressing the complex legalities of cross-border transactions early on is vital for ensuring stakeholders' success.

At its core, cross-border M&A serves to either add value to aid the acquiring entity’s future goals. These transactions can be driven by various strategic motives, such as vertical or horizontal integration, geographical expansion into new markets, or the addition of new product lines to diversify offerings. Companies may pursue such deals to access new customer bases, strengthen or broaden their distribution networks, or for technological roll-ups. In some cases, acquisitions are made to absorb startups that may no longer have product-market fit but still hold valuable cash reserves. Cross-border M&A can also help plug gaps in a company’s production or service capabilities, offering a faster, more efficient alternative to building those functions in-house.

It is not uncommon for acquirers and targets to agree to the terms of a deal in informal settings, such as over a cup of coffee. This agreement may sound good at the time, but many details require refinement before formalising the conversation. Understanding which deal structure is best suited for your long-term strategy mandates careful consideration of the pros and cons, and the support of an expert for guidance.

It may be useful for founders to understand the broad strokes of deal structures in M&A:

1. Simple share or equity allocation, which is approved by stakeholders of the target company, by which a strategic player acquires a majority in the target company.

2. Slump sale is where the entire business is sold lock, stock, and barrel to the acquirer.

3. Asset sale is one where selected assets of the target business are sold to the acquirer.

4. Acquiring a part of the target’s business when the acquirer is interested in only part of the business, by way of a hive-off.

5. Court-approved merger/ demerger, wherein a relevant judicial body greenlights the acquisition.

6. Acquihire, where the acquirer cherry-picks the target company's management or key team members to bolster their own workforce, bringing them on as employees or consultants. This can be accompanied by an asset sale or a slump sale. 

Engaging legal and tax experts from the beginning ensures they can maximise value for everyone involved. Here's my golden rule: Execution of a smooth M&A transaction hinges on the quality of your advisors and principals with sound commercial sense. Both sides need sharp minds who understand the deal's complexities. This way, they can navigate requests, propose creative solutions, and steer you all towards a win-win.

When dealing with businesses based outside of your geography, several areas need attention. Some may be more obvious, such as regulatory issues, but there are also some that founders may be less prepared for.

FDI laws

The rules and regulations for startups are still an evolving area globally. Keeping that in mind, the first aspect of cross-border deals that needs legal and tax intervention is foreign direct investment laws, which may be a determining factor in the viability of a deal.

Different countries have different laws around how much capital a foreign investor can invest in a particular sector. Some countries, such as the US, have CFIUS-like regimes, which mandate that certain transactions in strategic areas be reviewed by regulators.

Anti-trust laws

Anti-trust laws applicable to the relevant transaction need to be navigated carefully. While regulators in different geographies seek to promote healthy competition, it is important to preempt their reactions to nuanced situations.

Legal experts help entrepreneurs navigate complex regulations, especially in heavily regulated sectors like fintech and insurance. Clear, accurate communication of relevant facts and compliance is essential to gain regulatory approval.

Tax implications

If you are looking to acquire a business, it is very important to understand its tax liabilities. Getting timely clearance from the tax authorities may become a challenge if the same has not been factored in suitably in the deal timelines.

Lender/ third-party consent

Whether you are an acquisition target or want to buy an entity outside your geography, it is important to consider the running loans and outstanding contractual commitments. You may need consent from your lenders or counterparties before going ahead with the M&A. This can become a roadblock to a successful deal if not planned for.

Effectively entering new markets requires a nuanced understanding and cross-border expertise.

Hiring a local consultant is critical. Legal and regulatory considerations may vary significantly between the acquirer's market and the target’s markets. It may not always be possible for your domestic legal counsel to know or understand these nuances.

Here are a few examples that necessitate a local expert:

• The Committee on Foreign Investment in the United States (CFIUS) monitors mergers and acquisitions (M&A) transactions that could threaten national security. They require mandatory filings before the consummation of certain controlling or non-controlling investments by foreign investors in industries producing, designing, or manufacturing critical technology.

• In Indonesia, all documents presented as part of the due diligence process must be written in English and Bahasa. Translating accurately from Bahasa can be a big challenge for external entities. In Korea, where documents are mostly in Korean, external entities encounter the same linguistic barriers.

• In Japan, the law dictates that documents must be executed in a specific format to be admissible in court.

• India has a limit of 200 shareholders for a privately held company. Singapore requires companies with over 50 shareholders to be treated as public. This can lead to significant legal changes during transactions between these countries.

• In India, both Central and State legislatures have the power to make labour laws. For instance, the laws in New Delhi may differ from Mumbai. If a US-based business acquires a company with operations in both cities, a local partner would be necessary to perform the required due diligence and ensure compliance with local laws.

So, how do you find the right consultant for your M&A? There are no rules set in stone here, but based on experience, some ways to find an effective local consultant could be:

• Search for the best consultant in the target or acquirer geography, who is experienced in M&A in your industry.

• Do thorough reference checks on the advisers before hiring and pressure test if they are also deal enablers, apart from being experts.

• Find someone who has a demonstrated record of optimising the deal value for both sides and not just their client.

A business is not just numbers. It is also dreams, hopes, and hard work. When an entrepreneur agrees to sell the whole or a part of their company, it is natural for them to want to maximize value for their team and shareholders. Similarly, while an acquiring entity would want to further improve its business prospects, it also has to look at integrating culturally with the target company.

In a cross-border M&A scenario, founders should keep several key considerations in mind. Clarity on the transaction's closing timeline is critical, as delayed deals can erode value. It's important to ensure that the timeline isn’t arbitrarily extendable by either party. Founders must also assess whether they are receiving real value in exchange for what they are parting with, particularly in all-stock deals, where issues within the acquiring company can reduce the value of the target’s shares. Additionally, in share swap deals, founders should ensure that any tax liabilities are settled in cash to avoid financial strain later.

Any M&A deal, by its nature, takes longer than a lot of investment deals. People negotiating a deal should be cognizant of the leverage they have in a transaction.

Deals have fallen through because of a mismatch in expectations regarding the legal terms being sought. Often, parties don’t budge on a particular term that may not be as material in the overall scheme of things and protract the negotiations.

Any successful cross-border M&A, in the end, requires a blend of strategic vision, legal expertise, and a willingness to adapt.

Ultimately, it is very important to learn and unlearn, and not get fixated on a certain way of thinking.

About the author: Vinayak Mishra is the General Counsel of Lightspeed India.