B. Transaction Procedures
I. Acquisition Procedures
Sales processes in Germany are typically set up as a private sales process or an auction process. In both cases, the seller must be well-prepared prior to starting a transaction process with one or more potential purchasers. This includes the prior identification of risks and opportunities, as well as the feasible repair of identified deficits. In some cases, the seller decides to carry out its own vendor due diligence to obtain the aforementioned information about the target company in preparation for the upcoming transaction and to speed up the intended sales process.
1. Private Sales Process
a) Typical Procedures
A private sales process is characterized by a sales process with only one potential purchaser. In Germany, a private sales process typically begins with a letter of intent/memorandum of understanding between seller and purchaser with respect to the intended purchase of the company, which is essentially non-binding (see II.2.a) below). However, the potential purchaser is interested in negotiating a binding exclusivity period prior to starting its costly due diligence work. After signing a separate confidentiality agreement or, respectively, a confidentiality clause within the letter of intent or the memorandum of understanding, the potential purchaser obtains the possibility to execute due diligence, including an interview with the management of the target company. After scrutinizing the company, the parties negotiate a sale and purchase agreement on the basis of the terms agreed upon in the letter of intent/memorandum of understanding, appropriately modified by the findings from the due diligence process and the management presentation.
b) Disadvantages for Seller
The option for the seller to sell its company by means of a private sales process bears two major disadvantages for the seller:
- On the one hand, the seller is typically not in the position to facilitate the sale of its business at the highest price on the best possible terms due to the simple fact that there is no market and therefore no market price determined by supply and demand.
- On the other hand, the acquisition process is necessarily terminated if the only existing potential purchaser decides, for whatever reason, to terminate the negotiations with the seller. Furthermore, a broken deal leads to reduced market value of the target company (following a failed transaction the market assesses the target company as shelf warmer) at least for a short/medium-term.
c) Advantages for Seller
- Only one potential purchaser will receive confidential information on the target company.
- However a private sales process may be less expensive than and not as time-consuming as the execution of an auction process with respect to the generated transaction costs.
2. Auction Processes
a) Typical Procedures
An auction process is quite common in order to achieve a higher price by generating higher demand with multiple potential purchasers. Consultants (e.g. a M&A consultant or an investment bank) provide their business contacts to many potential financial and/or strategic bidders and prepare a company teaser describing the company to be sold in general without disclosing any individual information identifying the target company. In case potential bidders are interested in obtaining more information about the target company through receipt of an information- memorandum, they must first sign a separate confidentiality agreement/non-disclosure agreement. At the same time, the seller and its consultants have completely assembled the (in most cases virtual) data room with all available information on the target company (see III.5. below). All potential bidders who are interested in purchasing the company are invited to submit a non-binding offer letter containing a first proposal for the purchase price and answers to specific questions requested by the seller. The seller is particularly interested in how the respective bidders are financed and how they can secure the purchase price. The seller then decides to grant a limited group of potential purchasers access to the data room and to the management of the target company in this second phase of the process. After execution of the due diligence and interviews with the management have been conducted, all further interested potential bidders are invited to submit a final (but also typically non-binding) letter. After evaluation of all final offer letters and comments on the sale and purchase agreements, the seller decides which potential bidders will proceed to the third phase of the auction process. Those potential purchasers will have the opportunity to negotiate the respective sale and purchase agreements with the seller. Sometimes, bidders request an exclusivity period during this last phase to enhance their position.
b) Disadvantages for Seller and Purchaser
The auction process is a very time-consuming and costly process. The seller often has to negotiate two sale and purchase agreements simultaneously at the end of the last phase of the auction process. Due to the existing demand among the potential purchasers, each purchaser has to figure out which purchase price and which amendments to the sale and purchase agreement are essential to obtaining the target company.
II. Getting Started
In an auction process potential bidders receive the first detailed information on the target company upon receipt of an information-memorandum (after signing a non-disclosure agreement and often after receipt of a first transaction teaser). The information-memorandum generally contains commercial, financial, legal and tax-related facts on the company. The business description and the organization of the target company are the most important pieces of information for the purchaser. Typically, the information-memorandum is prepared by the seller together with its consultants (e.g. M&A consultant or investment bank).
2. Preliminary Agreements
a) Letter of Intent/Memorandum of Understanding
The letter of intent and the memorandum of understanding are instruments used to bring together the seller and potential purchaser in a private sales process. Those (sometimes only one-sided) declarations are typically the first written documents in which the seller and potential purchaser announce their initial intention with regard to the execution of the transaction and their current negotiation results. Most statements made in a letter of intent or memorandum of understanding are non-binding, unless explicitly stated otherwise.
Such letter of intent or memorandum of understanding often contains a few explicitly binding clauses regarding the granting of a period of exclusivity, including legal consequences in case of a breach, a confidentiality clause, clauses dealing with the payment of costs in case of a broken deal (e.g. break up fees or reimbursement of expenses) and non-solicitation and non- competition clauses.
b) Confidentiality Agreement/Non-Disclosure Agreement
Irrespective of whether it is a private sales process or an auction process, the seller is interested in having an extensive confidentiality agreement with the potential purchaser or bidder. The confidentiality agreement protects the seller and the target company against any transfer of information resulting from the potential purchaser’s access to all transaction documents (in particular to the documents in the data room). Within this context, it is important for the seller to define special terms for the confidential information, the purpose of the disclosure, as well as the disclosure and receipt of information. At the end, the seller is well advised to actually disclose information only on a need-to-know basis and only step by step depending on the importance of such information for the
- business to be sold; and
- potential purchaser, bearing in mind the position of this purchaser in the business market (e.g. in case the seller is a strategic investor acting on the same or similar markets as the target company). Critical information (e.g. agreements with customers showing the margins of the target company) are only disclosed shortly before or at the signing, or to a (neutral) third party bound by law to maintain confidentiality.
III. Due Diligence
1. Purpose of a Due Diligence
Due diligence is an investigative process designed to evaluate the commercial, financial and legal situation of the target company. The extent of the process varies from case to case depending on the type of company being acquired. By conducting a due diligence investigation, the potential purchaser of a business attempts to reveal all material facts and identify any material risks associated with target's business. On the basis of the findings of the investigation the potential purchaser will decide whether to complete the transaction and how to structure it. Moreover, the findings of the investigation have a bearing on the documentation to be negotiated, e.g. the purchase price and seller's representations and warranties. Finally, due diligence provides the purchaser with information of the target company significant for post- closing integration measures. Pursuant to German case law, the seller is obliged to fully disclose ￼all essential facts which may have an impact on the potential purchaser’s decision on whether to complete the acquisition or refrain from it.
Most due diligence processes are initiated by the potential purchaser. However, the number of vendor due diligence processes, i.e. the seller and his advisors conducting due diligence on the target company, has increased in recent years. The advantages of conducting vendor due diligence for the seller can be considerable. Foremost, it gives the seller the chance to identify and react to any issues, which may have an impact on the value of the assets about to be sold before the sale process has started. In addition, the preparation of the vendor’s own due diligence report may also save precious time, in particular in a tightly scheduled auction process.
2. Components of a Due Diligence
Usually, the due diligence investigation consists of financial, legal, tax and commercial elements. Depending on the business of the target company, the due diligence process may also cover environmental examinations, technical issues, human resources and/or insurance issues. In general, due diligence is carried out by the potential purchaser himself and his legal, tax, commercial and financial advisors and – if applicable – other consultants.
3. Focus of Legal Due Diligence
The topics of legal due diligence may vary from transaction to transaction. However, the scope of legal due diligence generally includes corporate and commercial legal documentation of the target company, financing of the target company, material contracts (in particular leases and agreements with suppliers and customers), human resources, real estate, intellectual property and information technology, litigation, public affairs, environmental issues and insurance policies.
4. Focus of Tax Due Diligence
Tax due diligence is conducted to obtain information on tax risks at target company level which might (e.g. in the course of a subsequent tax audit conducted by German authorities) result in a tax burden of the target company or the purchaser. Such tax issues are not only relevant in the course of a share deal, but also in an asset deal where the purchaser may – under certain circumstances – become liable for business taxes on the assets. Moreover, tax due diligence provides details on the target company in respect to a tax-efficient acquisition structure, as well as post-acquisition reorganization.
5. Due Diligence Process
As outlined above, the due diligence process is usually conducted in cooperation with several participants, such as the management of the target company, external financial advisors, lawyers, tax advisors and other consultants. The due diligence investigation inevitably exposes conflicts of interest between seller and potential purchaser. For obvious reasons the seller does not want to disclose detailed information about the target company before being certain that the potential purchaser will actually complete the acquisition, while the purchaser typically requests comprehensive disclosure of all relevant information and documentation about the target company at an early stage of the due diligence process. To satisfy both sides, in most auction processes only basic information is provided in the beginning, with more confidential information to be disclosed at a later stage to the shortlisted bidders. However, regardless of whether the transaction is executed as a private sales process or an auction process, a successful due diligence process always requires the close cooperation of every party involved, including the management and the key personnel of the target company.
The information disclosed by the seller is usually presented in a virtual data room. Such a virtual data room easily enables international networking and collaboration among the potential purchaser and his advisors. Generally, the consultants (in particular tax advisors and lawyers) prepare request lists tailored to the specific transaction and due diligence questionnaires to be delivered to the management of the target company. The requested material is then presented for review in the data room.
6. Due Diligence Report
Depending on the potential purchaser’s demand, legal due diligence may either result in a comprehensive due diligence report or a red flag report. A comprehensive due diligence report describes the documents reviewed by the advisors in detail. It also includes an executive summary that concentrates on the material risks and legal issues that may have an impact on the final bid, the preparation and negotiation of the sale and purchase agreement, as well as on the structure of the envisaged transaction. Contrastingly, a red flag report does not describe each disclosed document in detail, but rather summarizes the legal material risks and issues relevant for the terms, the structure and the completion of the acquisition, as well as for post- closing measures.
In principle, a due diligence report is primarily prepared for the client. The report may only be used for the envisaged transaction and may not be circulated to third parties without the prior approval of the respective advisor. In case of a leveraged transaction, the financing bank usually also requests a due diligence report before providing necessary funds to the purchaser. Commonly, the bank requests that a due diligence report prepared for the purchaser is forwarded for review rather than to entrust its internal and/or external advisors to conduct a due diligence on the target company. Permission to forward the due diligence report to the financing bank is typically provided in a reliance letter concluded between the advisor and the financing bank.
IV. Sale and Purchase Agreement (SPA)
1. German vs. Anglo-Saxon Contracts
Traditionally, commercial contracts under German law are substantially shorter than those Anglo-Saxon investors are used to in their own jurisdictions. To a certain degree, this also applies to SPAs in the mergers and acquisitions context, although the influence of Anglo-Saxon legal culture has been significant over the past two decades. Anglo-Saxon style SPAs are most frequent (and have become the market standard) in large and mid-cap private equity transactions, where the need for international syndication of debt or equity instruments has a strong impact on market practice. On the other hand, comparatively short "German style" documents continue to prevail in many all-equity-financed transactions (even very large ones) and in many transactions involving typical German medium-sized companies, as well as most transactions involving insolvency receivers. Or, as the CEO of a German corporation wishing to make a mid-cap acquisition stated when confronted with the seller's five-page German style SPA draft: "We only use this type of contract for the very small and for the very big acquisitions."
2. Relevance of Statutory Law
The brevity of German-style documentation should not be misread as sloppiness. Rather, it should be noted that most key areas of German corporate and contract law are dominated by extensive statutes such as the German Commercial Code (HGB), first enacted on May 10, 1879, and the 2,385 sections of the German Civil Code (BGB), most of which date back to January 1, 1900. Statutory law makes many of the definitions and much of the explanatory language of Anglo-Saxon style contracts redundant (or in many cases even misleading) under German law. On items like remedies for violation of warranties, calculation of damages, contributory negligence and the like, German contracts often rely on statutory law (including long-standing case law interpreting it). On the one hand, this makes German contracts shorter and easier to read than their Anglo-Saxon counterparts; on the other hand, the wording of the contract sometimes gives little guidance on practical handling issues as the wording is to be understood within the context of statutory law and general legal principles (which may or may not be known to the person actually dealing with the execution of the contract).
3. Interpretation of Contracts; Substance over Form
Principles of interpretation of contracts under German law differ substantially from common law principles. In particular, the purpose and intention of a clause is often predominant in interpretation (with results which may even be contrary to the wording, if taken literally). This explains why boiler plate language such as headings being for reference only, masculine terms including the feminine, plural including the singular, etc. are missing in typical German SPAs. In many cases, the parties choose German law but use English as the language of the contract. This requires great care by the lawyers involved because many standard terms in English- speaking M&A practice, such as "representations and warranties", "best knowledge" and the like, are by no means identical to the usual German counterparts or are ambiguous under German law. Such terms need to be clearly defined in the agreement in accordance with categories of German law.
4. Notarization Requirements and Fees
A peculiarity of German law is the importance of notaries public in transactional practice. Any German law agreement involving the transfer of GmbH shares or real property must be notarized. This means that the entire document, including any ancillary agreements related thereto and including any exhibits that, are substantially part of the agreement (other than lists and tables, to which an exception applies) must be read aloud by or in front of the notary. Therefore, allow a whole day for signing of a detailed German law SPA containing many exhibits! Foreign investors often avoid this by sending their German lawyers with a power of attorney. Note that for some purposes (such as capital increases in GmbHs and real estate purchases) the power of attorney itself needs to be notarized.
German notary fees are governed by a mandatory, non-negotiable fee schedule and are calculated on the basis of transaction value. Accordingly, they range from EUR 15 (e.g. for the notarization of a 200 page SPA involving the purchase of a heavily indebted GmbH for EUR 1.00) to a maximum amount of approximately EUR 55,000 (at a transaction value of EUR 60,000,000 or more, even if the SPA is only five pages long). Notary fees are customarily borne by the purchaser. In order to avoid the costly German notary fees, parties used to flee to Switzerland to have SPAs notarized by Swiss notaries (who are allowed to negotiate fees in accordance with the actual work load and usually charge only a fraction of the German fees). Note that this practice is impossible for real estate transactions (for which notarization by a German notary is mandatory for the transfer of ownership) and has become less common with regard to GmbH shares following certain amendments of the GmbHG in November 2008.
5. Substantive Standards and Market Practice
In substance (although often not in style and wording), German law SPAs are similar to standards used elsewhere. When reading German SPAs, foreign investors may be confused by the distinction between the sale and the transfer which are described as two separate transactions. The sale constitutes the obligation to transfer the share while the transfer constitutes the actual passage of title. The same applies for the sale and the conveyance of property (see A.III.4.). The transfer (but not the sale) is usually subject to the condition precedent of payment of the purchase price. In cases in which antitrust filing requirements apply, the transfer (but not the sale) must be subject to antitrust clearance. A typical German SPA contains the sale as well as the transfer, but the transfer may be subject to certain closing conditions. A German closing therefore consists of mutual acknowledgements regarding satisfaction of such conditions, but no actual instrument on the transfer of title is executed upon closing.
Note that, under German law, only an AG may issue share certificates; titles to GmbH shares or KG interests pass by virtue of the agreement only, which is unusual for many foreign investors and makes them feel somewhat uncomfortable given that, as a matter of law, neither entries in the commercial registry nor a chain of previous transfers evidenced by notarial deeds inspected in legal due diligence constitutes conclusive evidence of share ownership in a GmbH. Amendments to the GmbHG enacted in November 2008 have improved the status of bona fide purchasers relying on the share register, which can be inspected online in the commercial register. A bona fide acquisition is now possible if the alleged owner has been registered as owner for at least three years, and no objections have been filed against such registration.
As in any jurisdiction, purchase price and adjustment clauses are core elements of the SPA. Since the beginning of the subprime crisis in 2007, net financial debt and working capital adjustments as of closing had become more frequent and locked box schemes (with fixed purchase prices determined on the basis of past figures and purchasers being protected only by restrictive covenants between signing and closing) had been on the retreat. In current (2013) transaction practice, both types of purchase price concepts are about equally frequent.
Representations and warranties are usually as detailed and comprehensive as in most other jurisdictions. During the financial crisis, market standards have changed and more comprehensive warranty catalogues have become standard practice (except in deals through insolvency for which the receiver will not usually give any business warranties at all). In recent years, the standards on warranty catalogues, caps, etc. have developed to a middle ground between the extremely purchaser-friendly standards of 2008/09 and the rather seller-friendly standards of the boom years 2005-2007.
V. Public Tender Offers
A particular way of acquiring control over a listed company is by way of a public tender offer. In cases in which a controlling position cannot be reached merely by the purchase of block holdings in off-market transactions, a public tender offer is often the only viable way of acquiring a majority stake in a listed company without purchases on the open market. In addition, if a private transaction or purchases on the open market cause the acquirer to reach or exceed the threshold of 30 % of the voting rights, an obligation to make a public tender offer will result from the transaction (so-called mandatory offer, see 2. below). As a consequence, the acquisition of a listed company is, in practice, often structured as a combination of purchases on the open market, the acquisition of one or more blocks of shares in private transactions, and the issue of a public tender offer.
2. Types of Public Tender Offers
Public tender offers can be made by way of two main types of offers, namely voluntary offers and mandatory offers. Voluntary offers aiming to acquire control over a listed company are so- called takeover offers. As opposed thereto, a mandatory offer must be made to the outside shareholders upon the acquisition of control in any way other than by a takeover bid, e.g. by an off-market purchase of shares, by way of purchase on the open market, by subscription in a capital increase or by merger.
"Control" is established by directly or indirectly holding 30 % or more of the voting rights. To determine whether the 30 %-threshold has been met, the voting rights directly held by a shareholder and certain voting rights imputed to him must be combined. For example, voting rights which are owned by a subsidiary of the respective shareholder, or voting rights which are owned by a third party for the account of the shareholder, are deemed to be voting rights of such shareholder. In particular, the voting rights of two shareholders who "coordinate" their conduct with respect to the company are added up and imputed mutually to both shareholders, with the exception of agreements in individual cases (acting in concert). "Coordination" between two shareholders is deemed to exist in cases in which they reach a consensus on the exercise of voting rights or otherwise collaborate with the aim of effecting a permanent and significant change to the company’s business strategy.
3. Issue of the Offer and Pricing
a) Offer Procedure
Once the bidder has decided to make a takeover offer, or once the 30 %-control threshold has been met, the bidder must immediately publish the decision or announce the fact that the control threshold has been met. Such publication must be made via the internet and via an electronic data dissemination system widely used by credit and financial institutions. Thereafter, as a rule, the bidder has a period of four weeks to prepare an offer document containing the full terms of the offer, and to submit the offer document to the German Federal Financial Supervisory Authority (BaFin) for verification. Upon approval of the offer document by the BaFin, the bidder must immediately publish the offer. The publication marks the beginning of the acceptance period. The acceptance period may generally not be less than four weeks and not more than ten weeks. At certain intervals during and after the expiry of the acceptance period, the bidder must publish the respective acceptance level. In the event of a takeover offer, in order to protect those shareholders who have not accepted the offer within the regular acceptance period, there is generally a mandatory "extended acceptance period" of further two weeks during which the offer can still be accepted. Upon expiry of the acceptance period or, if applicable, the extended acceptance period, the transaction is settled by way of payment of the consideration for the shares in the target company.
For both takeover and mandatory offers, the bidder generally has the choice between offering adequate consideration to the other shareholders either in cash or in liquid shares. The consideration must at least be equal to the higher of (i) the highest consideration which the bidder, persons acting in concert with the bidder, or their subsidiary undertakings have, during a period of six months preceding the publication of the offer document, granted or promised for the acquisition of shares of the target company, or (ii) the weighted average domestic stock market price of the shares during the three month period preceding the publication of the bidder’s decision to make a takeover offer or of the bidder’s attainment of the 30 %-control threshold. However, the consideration is adjusted to a higher price if the bidder, persons acting in concert with the bidder, or their subsidiary undertakings acquire further shares in the target company, either during the acceptance period or by way of an off-market transaction, within one year after the acceptance period, in case the consideration promised or granted for such shares exceeds the value of the consideration specified in the offer. An exemption thereto exists for the acquisition of shares in connection with a statutory obligation to grant compensation to shareholders of the target company, e.g. after the implementation of a domination and profit and loss transfer agreement, or in the case of a squeeze-out of the remaining shareholders.
4. Typical Takeover Strategies in Germany
Both takeover offers and mandatory offers basically follow the same legal regime. An important deviation, however, is that a mandatory offer may not be made subject to conditions, whereas for voluntary offers – and thus also for takeover offers – conditions are generally permissible. In particular, a takeover offer may be made subject to achieving a certain acceptance level. As a consequence, in order to ensure that a certain percentage of voting rights is obtained, bidders will usually make their offer conditional upon tendering the relevant number of shares into the offer. Most bidders try to reach a percentage of at least 75 % of the voting rights. Such majority is required for structural measures of the target company, such as changes to the articles of association, mergers, conversions, domination agreements and profit and loss transfer agreements.
Based on the fact that a mandatory offer cannot be made subject to conditions, bidders will typically try to avoid reaching the 30 %-threshold. The combination of a private transaction of 30 % or more with a takeover offer, subject to a certain acceptance level, is typically achieved by signing the private transaction prior to the announcement of the offer and closing the private transaction after the announcement. In so doing, the purchaser ensures that the offer is not a mandatory offer, but rather a takeover offer with conditions being permissible. In addition, the offer price can be based on the price agreed upon in the private transaction, whereby the risk that the offer may become more expensive due to rising stock prices is mitigated.
As an alternative to a private transaction, it is possible for the seller and the purchaser to enter into an agreement in the form of a so-called irrevocable undertaking (to tender). The seller hereby undertakes vis-à-vis the purchaser – the future bidder – to tender its shares into an upcoming takeover offer. The main commercial difference from a private transaction is that, in so doing, the seller will be amongst the shareholders tendering their shares, and will thus be protected by all rules which are applicable to the offer, most importantly those with regard to any potential price adjustments after the completion of the takeover procedure, as set out above.
After a successful takeover with at least a 75 %-margin of the voting rights, the bidder will be able to take full control of the company, e.g. by way of implementation of a domination and profit and loss transfer agreement, by merger or – if the thresholds of 90 % or 95 % have been met – by way of a merger-related squeeze-out (at 90 %) or a regular squeeze-out (at 95 %) of the remaining shareholders.