Tax vendor due diligence is an attractive tool in the M&A transaction process
M&A tax
Tax vendor due diligence is an attractive tool in the M&A transaction process
Thu 07 Oct 2021
Background – the current market
The disruptive effect of the Covid-19 pandemic and the economic recovery currently underway in many jurisdictions has driven strong momentum in the M&A market in recent months. Among the factors that drive this demand may be the need to enhance growth, diversify, raise finance or refocus on core activities. Commercial and economic circumstances surrounding these needs may mean the available timescale to prepare a business for sale can be relatively short.
If you are selling your company or part of the business, and a number of potential purchasers have been identified, a sales process that allows you to control the flow of information and the timing of the sale can be key to achieving the best divestment conditions.
The preparation of credible independent vendor due diligence (VDD) by a seller will help to speed up the disposal process and achieve the best outcome for the shareholder. VDD is a method to help potential buyers efficiently gain better knowledge of the target and its strength through the access to a set of reports prepared by financial, tax, legal and other advisors, who will be responsible towards the final buyer for the content of their reports. The VDD can also improve the chances of successful disposal by presenting early opportunities for structuring the disposal, though this may be impacted by a number of other factors, one of which might be the particular status and characteristics of the purchaser.
Tax is usually one part of a VDD exercise, alongside finance, legal, IT, environmental, HR and carve-out topics, depending on the divested business complexity and specificities. However, there can be particular instances, for example with certain assets or businesses with pre-agreed future income streams, where the focus of a VDD concerns primarily the tax issues as the other commercial and financial issues are reasonably well identified.
This article aims to remind you of the value of a VDD exercise and not to overlook tax as an important topic when carrying out that exercise.
Practicalities of the VDD
VDD can be carried out very early in the sale process. It can also take the form of ‘vendor assistance’ where the scope and depth of investigation is lighter than a standard VDD, and where the advisors bear less responsibility towards the final acquirer of the business. The advantage of this exercise is to streamline the schedule of operations and control the communication of confidential information.
As with standard due diligence, VDD is primarily a tool for providing an independent view of the business financial performance and opportunities, whilst also identifying risks (quantification and likely occurrence) and anticipating any potential mitigating action. The objective is to explain the value drivers and protects against value erosion for the seller during the negotiation process. Often this preliminary work continues during the due diligence phase carried out by a potential acquirer in order to provide updates and/or additional material. An option for a potential acquirer may be to review the vendor’s due diligence. In this case, a VDD report will support the bidders’ assessment of the seller’s positions on material issues.
Tax aspects of VDDs
Identifying tax risks objectively and transparently before the sale or investment process can help formulate ideas and possible corrective measures that could be put in place before the sale process, or before closing to maintain and enhance the sale process. This can assist any discussions or negotiations on price adjustment or liability guarantee clauses in the share purchase agreements (SPA).
The added value of a VDD exercise concerning tax can go beyond the simple identification of risks. Establishing an inventory of the tax liabilities of the target may highlight the need for restructuring the target(s) in question. Thus, the VDD exercise can be an opportunity to carry out diagnostics on certain organisational aspects and therefore help prospective purchasers to factor in the impact of post-acquisition restructuring work.
Additionally, if the identified tax risks attached to a subsidiary entity scheduled for disposal are significant, the value of undertaking the transaction as an asset deal instead of a share deal may become apparent. Whether an asset deal, a share deal, or a hive-down into a new entity, is more beneficial for disposal from a tax perspective can depend on the characteristics of the buyer and the seller and the particular tax rules in the relevant jurisdiction.
Conclusion
The value of a VDD is in making the transaction process more efficient, while also enabling the vendor to remain in greater control. It is a useful way to disrupt the balance of power during the negotiation process for the benefit of the sellers.
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