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As more midsize companies explore overseas M&A options, a little caution can go a long way toward ensuring success.
Alix Stuart, CFO Magazine
June 1, 2011
Making an overseas acquisition is a true test of CFO savvy. Such transactions are rife with things that can go wrong, including due-diligence roadblocks, regulatory missteps, and cultural snafus. In fact, because cross-border acquisitions are "as hard as it gets," says Stephen McGee, head of corporate finance for Grant Thornton, "many companies, particularly midmarket companies, just choke on that risk and bypass such deals."
Of the 41% of privately held companies that plan to grow through acquisition in the next three years, for example, fewer than a third plan to do so through foreign acquisitions, a ratio that, McGee says, has remained fairly constant through different economic cycles. Instead, most companies without a dedicated international M&A team tend to get a toehold in a foreign market by first setting up a sales office or working with a local partner, then slowly adding more people as operations expand.
But not every CFO has the luxury of taking that slow-and-steady approach, particularly in geographies that are booming. "Brazil is growing so fast you can't keep up just by growing organically," says Michael Lucki, CFO of CH2M Hill, a $6.3 billion global engineering and construction firm.
CH2M Hill has had a presence in Brazil for more than 10 years, and now has about 180 employees there, but the company is currently evaluating Brazilian businesses that it could merge with its existing operation. "In a good year, we can double head count from, say, 200 to 400, but the change in Brazil is so great, we probably need 1,000 people there tomorrow," Lucki says, noting the country's projected 9% GDP growth rate for 2011 and equally impressive government construction budgets. (For more on CH2M Hill, see "80 Countries and Counting.")
Exploiting fast-growth markets is certainly one reason to take the cross-border plunge. And with the domestic economy expected to limp along for the foreseeable future, those with aggressive growth goals may be forced to look overseas. CFOs also say they are buying abroad to follow existing clients, or to tap new sources of innovation.
Very rarely, however, are they buying companies with assets that could easily be found or replicated stateside. "To be willing to take on that level of risk and complexity, you've got to have really good reasons, like new markets, new technology, or new sourcing," says McGee.
Approximately 450 U.S.-based companies acquired businesses outside the United States last quarter, up from 370 in the first quarter last year and on track to surpass the 1,666 such deals in 2010, according to Capital IQ. At companies with revenues between $100 million and $1 billion, finance chiefs completed 45 cross-border deals in the first quarter, compared with 31 in the first quarter of 2010 and 136 during all of last year.
Europe is still the hottest place for midsize companies to seek targets, but Asia is quickly gaining ground. "We haven't seen a lot of M&A in China, because of the complexities of acquiring there," says Larry Harding, president of High Street Partners, a firm that helps U.S. companies with back-office functions overseas, "but I would expect that to change in the next 18 to 24 months."
So how can CFOs contemplating their first overseas deal avoid a disaster? Several finance chiefs who have recently been through the process — some for the first time — share their best advice.
1. Find a Stunt Double
Antenna Software, a venture-backed software developer focused on mobile applications, recently bought Volantis, a mobile Internet specialist, based in Guildford, England, in order to complement its core product lines. Antenna CFO Bill Korn's first step along the path to a successful transaction was to find himself a stand-in: a UK-based CFO with M&A experience who could head up due diligence on the company before the purchase.
While Korn himself was on-site for the first week of due diligence, he considers it essential to have a trusted adviser "living" at the company throughout the process. Brian Knight, whom Korn found through the Financial Executives Networking Group, an international cross-industry organization, spent four to five days a week at Volantis for a month, in part to help foster a camaraderie with employees at the target company. He also passed along key insights, Korn says. "When you have a question, you have someone who can walk across the hall and ask, 'Why was this deal structured this way?'" he says, an approach that is much faster and less confrontational than the alternative, "which is to have your lawyers call their lawyers."
Knight's job was done when the deal closed, but Antenna retained Volantis's former CFO as the vice president of finance for the global company, which helped accelerate integration in both directions. The distance "is not a problem," says Korn, and he expects his new UK-based colleague to be "instrumental" in helping prepare the company for its initial public offering.
2. Don't Skimp on the Help
A finance chief considering an overseas acquisition will likely need lots of assistance, much of it not available in-house — particularly at a smaller company or one that is new to international markets. Indeed, a part of the recipe for cross-border success is recognizing the need for a significant amount of help.
In general, a company needs either two sets of attorneys — one based in the United States and one based in the country of the acquisition — or an international law firm with offices in both locations. For its part, Antenna hired a hybrid team of UK- and U.S.-based law firms that were able to work together. Antenna's UK attorneys led the process, says Korn, but with advice from its U.S. lawyers, "who were most familiar with Antenna and comfortable with its process of completing acquisitions."
Of course, lawyers are happy to point out the perils of getting that equation wrong. One attorney with a multinational firm notes that a new client, a private-equity-owned company looking to expand abroad, made such a disastrous initial cross-border acquisition that it is now considering less-radical expansion options. By using only Brazilian legal counsel when it bought a company in Brazil, the company misunderstood some of the regulatory approvals it had to get and was ultimately delayed in its efforts to go to market there. (For more on the specific challenges of expanding in Brazil, see "Brazil Is Booming (and Maddening)," July/August 2010.)
Similar regulatory red tape abounds in other high-growth emerging markets, including China, adds Mark Harris, a partner with McDermott Will & Emery. "Local counsel may understand the landscape, but may not be able to communicate it back [to you]," he says.
Finance chiefs acquiring abroad need other kinds of expertise as well. Earlier this year, InnerWorkings, a $482 million public company that helps manage print procurement for large global companies, bought a company in Chile in order to better meet the needs of its global clients. The company had made many acquisitions — five or six per year — in the past, but this was only its second international deal and its first in South America.
As such, CFO Joseph Busky did something he says he would never do for a U.S. acquisition: he hired a Big Four accounting firm's Chilean office to help investigate the target firm, CPRO.
"The risk for fraud in South America is much greater than in the United States, so make sure you have the right controls and...have someone on your side who knows the pitfalls," Busky says. "Having someone on your side who speaks the same language and who knows what the pitfalls are is invaluable."
That doesn't mean that a company should simply outsource all due diligence, of course. "There's no replacement for having someone in your organization do the technical due diligence [on intellectual property], if the acquisition is within your industry," says Duncan Perry, CFO of PeopleCube, a maker of facilities scheduling and management software. Perry has been involved in several international acquisitions in his career, including one in the United Kingdom for PeopleCube in the past year. "If you don't know what you're getting in terms of intellectual property, you're missing half the value," he says.
3. Don't Ignore Workforce Issues
Many parts of Europe are famous for their labor-protection laws, which generally make it very difficult to fire people. "Reductions in the workforce usually take longer and cost more than you would ever imagine," says High Street Partners's Harding, in part because "the concept of 'at-will' employment doesn't exist outside the United States," he says.
For that reason, PeopleCube's Perry recommends getting a good handle on a workforce strategy preacquisition. "If you're going to be losing people, you should handle it prior to the acquisition, since the seller may have more flexibility on terminations than the buyer," he says. If not, a company may be locked into a higher head count than it needs for longer than it expected.
Case in point: after a recent acquisition, one company chose to close an operation in the UK that was performing well, rather than a somewhat poorer-performing location in the Netherlands, simply because Dutch labor laws made it so "difficult and expensive to terminate employees" that closing the UK operation "was the far cheaper alternative," says Michael Martell, an attorney with Morrison Cohen in New York. Hiring contractors overseas can also be tricky, since short-term contracts can quickly trigger long-term obligations on the company's part.
But while new territories present plenty of new labor laws to digest, understanding local culture is equally important for buyers that want to get off on the right foot with new employees overseas. "Often, you can adhere to all the legislative requirements very carefully, but miss the one factor that employees in the office really care about," says Perry.
In his experience, flexible work hours can be one such perk. "It's easy for U.S. employees, in a car culture, to concentrate on arrival time as something important, but that's not as easy when you're dependent on public transportation," as most UK employees are. "If you were to impose hours that were inconsistent with the train and bus schedules, for example," he says, it could be a disaster.
4. Take Care with Taxes
Tax liabilities count among the greatest hidden risks of cross-border expansion, says Harding, who adds that "it often takes a while — up to three years — before such liabilities arise." Tax issues fall into a couple of buckets, many of which a finance executive will be familiar with if the company already has a sales office or other presence in a country.
Transfer pricing, or the way the company prices the goods and services it receives from the foreign entity, is a major issue, and one that tax authorities are getting more aggressive about scrutinizing. In this case, "the proper documentation of the methodology is almost as important as the methodology itself," says Harding.
While the documentation requirements vary by country, few companies have fully documented their positions, and the task only gets harder as the volume of transactions piles up, so Harding recommends starting early. Companies may also consider setting up an advance pricing agreement with local authorities to avoid later challenges, a strategy that is becoming increasingly popular.
Value-added tax (VAT) in European countries is another important topic to address early, since such tax is "hard to fix retroactively," Harding says. (Rule number one is to never do business in Europe without a VAT registration number; rule number two — ideally and where possible — is to maintain that registration in only one EU country and clear all EU-based goods through customs there.)
One other VAT tip: explore the potential tax benefits of establishing a foreign subsidiary, rather than opening a branch office. The latter could face much higher tax liabilities.
Outside Europe, Brazil and India present particularly thorny tax requirements, "most of them not intuitive to U.S. finance professionals," says Harding. Those countries, as well as China, also have strict rules about repatriating profits and other transfers of currency to foreign destinations, which can affect the overall tax picture.
And if corporate tax rules don't offer enough complexity, potential buyers should also be aware of the personal tax implications for owners and executives of foreign companies. "Personal-compensation tax overseas can be significant, and you can create disgruntled employees very easily if you convert their tax status," says PeopleCube's Perry.
5. Be Patient
Antenna has a track record of completing U.S. acquisitions within four weeks, a strategy Korn feels gives the company an advantage in bidding even though it means a very intensive due-diligence process. "A large company might pay more, but it could take six months to get a term sheet and another six [to close the deal]," says Korn.
He acknowledges, though, that cross-border deals will inevitably take a bit longer — eight weeks in Antenna's case. He also says that companies should devote time to communication, because "in any deal the experience level of the parties will vary, so maintaining a dialogue is key."
The time lag can arise from time-zone differences, but also from cultural differences. "The culture in Chile is such that nothing is a rush, and the level of sophistication of the staff and the accounting systems is much lower than we have here," says Busky. Accordingly, buying CPRO in Chile took InnerWorkings about nine months. Busky estimates that an equivalent domestic deal would have taken two months or less.
Bear in mind, too, that the target firm may feel the due-diligence demands are over the top, even if they are standard for the United States. In general, U.S. investors "ask for much more detailed information than European lawyers would be interested in, like asking to review leasing agreements for photocopiers, agreements with office cleaners, parking spaces, and so forth," notes Martell of Morrison Cohen. "In Europe, counsel tends to be more focused on the important agreements."
Patience, however, has its rewards, including a nice résumé boost for the CFO who can pull off an international acquisition. Companies looking for a new finance chief, particularly in the middle-market revenue range, consider such experience a big plus, says Jim Wong, an executive recruiter with Chicago-based Clear Focus Financial Search. Even if the deal doesn't go perfectly, "if the candidate can communicate his analysis of what to do the next time around, that's just as important as the net result."
Indeed, making an overseas acquisition is a rite of passage both for a company and for a CFO. As we note elsewhere in this issue (see "Movin' On Up"), demonstrating a talent for strategic growth is now a CFO skill highly prized by recruiters. No CFO would pursue a deal simply to burnish a résumé, of course, but it certainly yields a halo effect — if the deal goes well.
Alix Stuart is senior editor for small and midsize business at CFO.