Transactions Blog

In today’s world, regulatory and compliance demands on businesses are many and varied. The need for accurate accounting and tax records that comply with the multitude of rules and regulations applied in different jurisdictions by different authorities can place a great pressure on limited in-house resources.

Very often, companies are confronted with compliance issues (such as late or non-filing of statutory accounts or tax returns leading to penalties and additional taxes, etc.) during the due diligence phase or the post-deal integration.

If e.g. a purchaser carrying out a due diligence discovers that the target has fallen behind and regulatory returns are not fully up-to-date, then the entire deal can be at risk. The purchaser may want a discount on the purchase price to reflect the risk element of the uncertain tax position or require warranties, etc.

Whatever the outcome, it is likely that the vendor’s position will be worse than if the compliance had been up to date.

If, on the other hand, you as buyer discover these issues during the post-implementation phase of the target, time and money will be wasted to remedy the situation.

In summary, when you are planning a deal, it is not an option not to be in control of your compliance.

On 19 November, we hosted the second session of our M&A Academy with a hot and present issue: How to keep the management of private equity backed companies motivated in and after the financial and economic downturn?
Luc Legon, Director Personal Tax at PricewaterhouseCoopers, presented the different solutions available according to the various expectations of management.

Download “Dealing with underwater management equity arrangements“.

More info about the M&A Academy season (programme, subscriptions, etc.).

Whilst credit markets have improved since the beginning of the year, borrowers continue to find raising or extending existing credit lines challenging. One of the big stories of the year has been the bond market.
Banks remain cautious and often reluctant to advance loans to new customers. However, during the third quarter, upward pricing pressure on bank lending has abated. Although we have yet to see significant falls in bank pricing, in the absence of further major economic shocks, the peak for pricing may now have passed.

Key findings of Q3-09 Debt Market Update:

Corporate Lending - a focus on existing customers but cautiously open for new business. 
Any new lending proposal will be heavily scrutinised and banks are reticent to refinance lending with others to avoid taking on their “problems”. A slight recovery in confidence could signal potential for a competitive tendering process for modestly-sized debt. We are seeing a strong strategic drive within some state-backed banks to increase their lending, albeit within more stringent credit quality parameters.

Leveraged Finance – difficult for the remainder of the year but innovative thinking means deals are possible.
The leveraged market will remain subdued for the remainder of the year, although there are pockets of activity at the smaller end of the market.

Corporate Bonds – an increase in activity and risk appetite.
In contrast to the banking market, the public bond market has seen a significant increase in activity this year. Investor risk appetite has also increased with an increasing proportion of BBB issuance. Corporates have been attracted to the bond market not only because it is an available source of credit but also because they have been able to secure longer tenors than on bank loans.

Convertible Bonds – a significant increase in issuance of this cheaper, more stable form of debt financing.
In recent months, there have been a number of household names issuing convertible debt. Convertibles have a cheaper cost of carry than conventional bonds because the implied value in the option to convert reduces the cash coupon. Companies with a stretched credit position may be able to issue convertible bonds when conventional debt markets are closed and in difficult credit markets the spread between standard cash coupon bonds and convertible bonds is likely to increase, making the latter more attractive.

Asset Based Lending - remains well positioned to capitalise on lack of credit from traditional sources.
Lenders have adopted a “back to basics” approach in recent months and are focusing more financing on physical assets and good quality receivables and less on cashflow-based facilities. Notwithstanding this the size of deals which asset based lenders are willing to finance has decreased in terms of individual hold levels.

Restructuring - expect a substantial re-pricing of facilities.
Even if lenders are only resetting covenants rather than rescheduling repayment profiles and/or maturities, companies can expect a substantial re-pricing. Most restructurings involve a negotiation between the existing lenders and shareholders thanks to the limited availability of credit from new providers and depressed M&A values. Whilst lenders are seeking to re-price facilities to what they perceive as heightened credit risk, they do not tend to pursue debt-for-equity swaps unless they are being asked to write down debt by the borrower or its shareholders. The amount of new money required and the jurisdiction of the borrower are also major determinants of the outcome of a restructuring.

For further details, read the Debt Markets Update  from our UK colleagues.

The European Court of Justice (‘ECJ’) ECJ has ruled that the input VAT on the costs of selling shares in a subsidiary may be recoverable on the basis that they are residual, either because the sale is equivalent to a transfer of a going concern (TOGC) or because (if the sale is an exempt supply) the principle of neutrality requires it to be treated as if it were a TOGC.

Whilst the ECJ was unable to determine, on the facts before it, whether input VAT recovery would apply in the specific case, the principles set forward are highly significant because it casts doubt on many tax authorities’ longstanding policy that the input VAT on the costs incurred in disposing of a subsidiary is wholly irrecoverable because the costs are directly attributable to an exempt supply.

Hence, this decision has important implications for any business disposing of shares in a subsidiary to which it has supplied services, whether the disposal is forthcoming or whether it has happened in the past. It also impacts on how corporate groups should structure themselves in order to maximise their VAT recovery position.

Issues to consider include:

• which disposals fall within the scope of this decision (and which do not);
• what types of costs are not “incorporated in the cost” of the share disposal such that the input VAT not initially recovered may now be claimed;
• what effect (if any) does the presence of a VAT group have on the position;
• how should shares be held in order to maximise the chances of input VAT recovery on a future sale; and
• what remedies are available to businesses which have wrongly suffered blocked input VAT on share sales?

Businesses potentially affected by this decision, should as a matter of urgency assess:

• the application of this decision to their particular circumstances;
• the possibility of recovering input VAT on costs incurred in relation to future share disposals (in accordance with the VAT recovery profile of the business); and
• the identification of historic disposals on which input VAT recovery may have been wrongly denied and reclaiming it (together with interest).

In the end, this ECJ court case may lead to an unexpected December VAT cost saving.

The current economic climate leaves a lot of companies exposed to lower trading volumes, pricing pressure, stretched client payments and cost structures that can not easily be aligned. Consequently cash flows come under a significant pressure and are sometimes insufficient to pay back debts or worse interest payments. Combining this with a banking sector that remains very prudent and needs to align their own risk and capital structure, and we have the perfect scenario for potential stand off between the two major pillars of our economy.

Can this be avoided?

The answer to this question can be positive but this requires immediate pro active action from the companies facing these difficulties.

The first step would be to create that common information platform that answers some key questions about the strategy, the alignment of the operational cost base, the short and medium term liquidity needs and the projected cash flows. An independent view on these matters is imperative to create that platform and to take away part of the unrest amongst stakeholders.
A second step would be to think about options and solutions that can be brought to the table, these options may include further need for restructuring, a debt push equity swap, debt covenant adjustments, disposal of non core business, etc….
A third step would be to implement the solutions and to keep all stakeholders informed about the solution process.

Would this approach avoid the clash? Future will tell, however its shows that there are ways to avoid it.