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Why is statutory valuation important when acquiring assets in China?
Under existing rules and regulations, whenever State-owned assets/equities ("SOA") change hands, a statutory valuation is required for any contribution of assets, such as land use rights, buildings and machinery. The statutory requirements also apply to cases where state-owned equity interests in existing JVs are transferred to non-State-owned investment entities or vice versa.
How do I minimise China M&A Risk during the transaction screening process?
The transaction screening process is a common concern among global corporations whose transaction failure rates are above average. During their initial target screening, such companies often focus on overall strategic fit, while overlooking critical closing and integration risks, which can lead to costly mistakes.
Companies that have a higher number of transactions that fail to close despite full financial diligence tend to under-invest in transaction closing risk assessment.
By screening target companies for strategic attractiveness and transaction effectiveness, acquiring firms can create value by increasing their transaction success rate and allocating resources more effectively. In addition, they can execute their strategic goals faster and with less risk.
How does the IFRS 3 affect my acquisition in China?
The changes brought in by IFRS 3 affect all stages of the acquisition process - from planning to the presentation of post deal results. HKFRS 3 contains principally the same provisions as IFRS 3. The implications primarily involve giving greater transparency and insight into what has been acquired and allowing the market to evaluate management's explanations of the rationale behind a transaction.
IFRS 3 is mandatory for all new transactions from 31 March 2004. First time adopters must apply IFRS 3 from day one of their IFRS track record and can choose to restate past deals. HKFRS 3 applies from 1 January 2005.
What does SarbOx mean for my M&A deal in China?
The Sarbanes-Oxley Act of 2002 ("the Act"), the United States' response to a number of high profile corporate scandals, is having a significant impact on the way US companies are run, and Mergers and Acquisitions ("M&A") have not escaped its effect. While M&A does not get a specific mention in the Act, the implications for deals are far reaching.
What is the function of Tax Due Diligence in M&A?
A tax due diligence review plays a critical role in any M&A transaction. A proper tax due diligence is a key ingredient in assessing whether to proceed with a deal, and if the deal proceeds, how to maximise the overall return achieved.
What valuation methodologies are used to determine a price for a targeted company? Does financial due diligence have an impact on the valuation?
There is no single universal valuation method that provides an appropriate value in every case as each target has unique characteristics that need to be considered. In practice it is usually better to apply several different techniques and then compare the results as this will usually reveal the factors which are adding or destroying value. In addition to valuing a target on a stand alone basis it is also necessary to consider how much the target will be worth to the acquirer as a whole after the transaction is completed. Since most M&A transactions are expected to deliver synergies, a discounted cash flow method is often used as it takes into account future benefits to the acquirer. However, this valuation method would normally be supplemented with other valuation techniques to obtain an appropriate range of values for the target company. Other valuation techniques utilised may include an analysis of comparable transactions in a similar industry to obtain earnings or revenue multiples, an asset valuation focussed on replacement cost or perhaps a Greenfield analysis which would assess the cost to start from scratch a business similar to the target. The actual price paid for the target business is often a function of the negotiating skill of the acquirer and the perceived risks and rewards of the investment which varies significantly for each potential investor.
In acquiring a state-owned enterprise in the PRC, an asset-based valuation must be performed by an authorised appraiser. Does financial due diligence still play a part in this type of transaction after the valuation exercise?
The valuations performed by authorised appraisers are primarily to prevent the loss of state-owned assets at an undervalued price to a foreign investor and frequently do not reflect the true economic value of the entity even though it may be used to price the potential transaction. A potential acquirer of a state-owned enterprise ("SOE") would still perform its own valuation of the business to establish the price range which they are willing to pay for the target business. This is important as the most commonly used asset valuation methods used for SOE assets by official appraisers often produces inflated valuations and the acquirer will need to compare the appraiser's valuation against its own to ensure the deal is still economically feasible. Financial due diligence should still be performed in this type of transaction and it should be done prior to the appraiser's valuation as it will play a key role in identifying factors impacting the acquirer's valuation model as well as identifying opportunities to present evidence to the authorised appraiser which may influence the appraiser's valuation before it is finalised.
How should the areas of potential overlap between legal and financial due diligence be minimised?
An effective due diligence investigation will be a coordinated team effort involving the acquirer and all of the specialist advisors working together towards a common goal. In our experience, the most efficient approach is to identify one person from the acquirer's team to act as project manager, responsible for coordinating the due diligence and ensuring that responsibility for the due diligence work is appropriately assigned with minimal overlap. However, care must be taken to avoid excessive restrictions on each advisor's scope of work. In practice, there are certain key areas, such as reviews for contingencies, where both a legal and accounting perspective are valuable because the differing approaches often yield different findings. For certain review areas, assigning primary and secondary responsibility to the accounting and legal advisors is an effective way to minimize overlap while at the same time retaining the benefit of different perspectives in a particular area. Advisors should also ensure that key findings are communicated to the team promptly as issues identified from the financial due diligence review may require further follow-up in the legal due diligence or vice versa.
What steps are taken in financial due diligence to assist in identifying hidden liabilities and potential exposures?
Hidden liabilities and exposures are a key area of concern in most M&A transactions and this is also one of the most difficult areas on which to obtain comfort. Certainly, there is no single prescribed set of procedures which guarantees that all hidden liabilities and potential exposures will be identified. However, as a starting point, specific characteristics of the target need to be considered to identify key risk areas on which the financial due diligence should focus. Although not an exhaustive list, this would include the nature of the industry, recent major events in the business, operating history, location of operations, the control environment, characteristics of key management and the extent of use of professional advisors in the past.
Will there be a conflict of interest if both the vendor and acquirer appoint the same firm of accountants for due diligence advice?
There are often situations where one firm of accountants is appointed for due diligence for two or more clients with competing interests on a particular transaction. In these situations, client confidentiality is a primary consideration which can be appropriately managed if certain controls are in place. Such controls include robust structures to reduce the risk of confidential information being inappropriately used to benefit clients with competing interests. In these situations, subject to any other confidentiality considerations, it would be usual to inform the clients of the potential conflict of interest and also take steps to erect effective Ethical Walls, acting as a protective barrier, to ensure that adequate safeguards are in place to prevent access to information related to an engagement other than by the members of the relevant engagement team.
There is always a conflict between the vendor and the purchase where the vendor is reluctant to provide all information to the purchaser during due diligence as the vendor cannot be certain whether the purchaser will actually go ahead with the acquisition. On the other hand, the purchaser would like to know as much information as possible to evaluate the business. Are there any practical solutions for resolving this kind of conflict, particularly when the potential purchaser is a direct competitor of the vendor?
In almost every transaction, the vendor must strike a balance between the risks and rewards of providing commercially sensitive information to a potential purchaser. From a purchaser's perspective, obtaining adequate information is essential to evaluate and prepare a bid for the target company. From a vendor's perspective, while providing sensitive information may be detrimental commercially in the event the transaction does not proceed, it does assist in maximising the selling price if the transaction does proceed. The vendor will therefore usually control the release of information with access to the most sensitive commercial information and people only being provided at the later stages when exclusivity has been granted to a potential acquirer and a deal is considered likely. While conflicts can arise, in general if the reasons for the confidentiality are appropriately communicated, purchasers will understand. After all, if the confidential information is disseminated to all potential purchasers the value of the franchise will be diminished to whoever ends up owning it.
How do the US Foreign Corrupt Practice Act (FCPA) and Organisation for Economic Co-operation and Development (OECD) anti-corruption regulation impact the ability to do a transaction in China?
Doing business in Asia and China specific differs from the way business is done in western countries. Cultural norms and attitudes in Asia (e.g. China) are different. Asian business heavily relies upon relationships and building these relationships is a way of life. Building and retaining the relationship will often involve gifts/entertainment/gratuities and "facilitation" payments are common in many countries. Examples of such payments are: Direct payments to customers, payments to customers via agents and payments to customs and tax officials.