Going Global: Considerations for Cross-border Mergers

It’s looking like a fiery year for global cross-border deal-making. Acquirers have proposed or announced a staggering 5,041 cross-border deals already this year at a value of $1.17 trillion according to data from Bloomberg Law. That number is already higher than the full year totals between 2008 and 2013 and more than 50 per cent of the cross-border deal volume between 2014 and 2016.

“If this pace continues, total cross-border deal volume will be more than $2.3 trillion, which would surpass the record-high of $2.24 trillion set in 2007,” writes Kristyn Hyland, deputy editorial director for Bloomberg BNA’s Corporate and Transactional unit.

The voracity for overseas and cross-border deals is being driven, predominantly, by an interest in portfolio diversification, according to a recent survey by Deloitte on the risks and rewards of cross-border M&A action. The study drew answers from more than 500 executives from a myriad of regions, industries, and functions.

At the top of the rationale column was the portfolio diversification strategy as acquirers look to combat saturation and/or slowdowns in core home markets, followed by heightened regulatory uncertainty in home markets.

Diversification meets diligence

But deal-making across borders comes with a unique set of due diligence concerns.

“Our experience with multiple cross-border deals suggests that companies should conduct due diligence early in the deal cycle to identify common pitfalls and integrate pre-deal due diligence with pre-close planning activities to prevent handoff misses,” write the report’s authors. “In addition to identifying potential deal breakers, the due diligence process is extremely important when assessing the buyer’s deal rationale and risk mitigation plan.”

Here are several considerations before buying a foreign business:

Global tax differences

Few things are more critical to the physical structure of the transaction than tax issues. Cross-border acquirers will need to be cognizant of global tax differences and antitrust rules when conducting a cross-border deal.

For example, the Organization for Economic Co-operation and Development (OECD) Action Plan on Base Erosion and Profit Shifting (BEPS) targets tax avoidance strategies where companies exploit gaps or mismatches in tax rules by artificially shifting profits to low or no-tax locations. While many countries are a part of the OECD, some follow the rules more stringently than others – certain countries lean towards the more tax-competitive side. Involving counsel from both countries who understand the nuances will streamline the process, especially in situations where the BEPS comes into play. They’ll want to evaluate the effect of rules in other jurisdictions that could impact shareholders, as well as whether or not to use a subsidiary located in a country with a favorable tax treaty network.

Alternative accounting practices

While it’s unlikely different accounting practices will impact a target company’s underlying valuation, two companies could be on a different page when it comes to the metrics surrounding valuation techniques. This could be a simple disconnect like one buyer focusing on a target’s EBITDA, while another is focused on post-acquisition earnings per share. The differences could have an adverse effect on a buyer’s financial reporting and the target’s valuation. Something as simple as pensions and employee benefits could also appear very differently in the financial reporting. Sensitive financial and employee data should always be exchanged within a controlled atmosphere like a virtual data room to mitigate the risk of data leaks and to make it easier for buyers and sellers to securely share confidential information across different geographies and time zones.

Another nuance is with inventory-costing. In the United States, for instance, companies are (begrudgingly) allowed to use last in, first out, or LIFO, as an inventory-costing method, a practice that is banned in most other countries under the international accounting standards body (IFRS).

Product labeling rules

For cross-border mergers within product-driven industries, due diligence will involve developing a thorough understanding of industry-relevant product registration, certification, and labeling requirements especially in highly regulated industries like health care or financial services. For example, a Canadian entity acquired by a U.S. is likely to already include bilingual language but introducing U.S. products to the Canadian market will require new labels. The acquirer will want to do its due diligence to ensure these costs are considered.

A virtual data room is a key tool during this process for exchanging product information, ensuring competitively sensitive information is protected and accessibility is tracked.

Cultural challenges

Cultural integration is a key component of cross-border deals, with divergent backgrounds, languages and different business practices converging in the deal room. When German automaker Daimler merged with American company Chrysler in the 1990s, what began as a “merger” of equals devolved into a bitter failure as discordant culture practices and differences in the German and American culture crippled the businesses’ integration.

These cultural challenges can be bucked by creating a sense of familiarity, continuous collaboration, and communication between both deal teams. But not just the deal teams – in cross-border deals, it can often work to both companies’ advantage to involve the executives and consultants responsible for integration from the early stages so they can “own” the plans they’ll eventually be tasked with executing.

Summing up

The due diligence process can be a drawn out one with plenty of roadblocks along the way but being sensitive to unique, local considerations ranging from financial reporting styles to logistical concerns like product labeling and cultural differences can help streamline the process and ensure the best outcome.

Further Reading

Over at the Valitas Capital Partners blog, Mario Nigro of Stikeman Elliott answers a few questions on how the Canadian – European Union Comprehensive Economic and Trade Agreement (CETA) is a catalyst for cross-border M&A.

Andrew Seale

Andrew Seale is a Toronto-based business writer who contributes frequently to Yahoo Canada Finance, The Globe and Mail's Report on Business and The Toronto Star.