Diligencing Transactions In Sub-Saharan Africa
By Hugh Naylor
Posted: 26th October 2012 11:54As Europe suffers stagnant growth and the weak recovery in the US appears to be grinding to a halt investors and corporations continue to focus on the high growth opportunities presented by emerging markets. Amongst these Africa is increasingly becoming a favourite. Consistent growth over the last decade, albeit from a low base, combined with greater economic and political stability has resulted in a dramatic increase in investment opportunities, and resultant interest, across the continent. But, despite the opportunities, Africa has not seen the flood of investment experienced by, for example, Brazil, India or China.
One of the keys to investing in Africa is due diligence, the ability to check the numbers which underpin the price an investor is willing to pay and to understand the regulatory and legal environment which can impact an investment going forward. The purposes of this article is to provide some high level thoughts on the due diligence process and how it varies from transactions in the developed world.
Perhaps the most obvious starting point is that there are a lot of countries in Africa – 54 following South Sudan’s independence in 2011. Each country has its own laws and regulations, legal systems range from common law to Civil Code systems as well as Sharia law, and hybrids of different legal systems including African customary law. Strong cultural differences apply, not just between countries but within them. Regulatory regimes vary, some are well established providing clarity and certainty while others are evolving and are more open to different interpretations and lack established processes for obtaining clearances, consents and licences. This makes project management and organisation for multi-jurisdictional transactions on the continent even more important. The key is to establish a clear and efficient reporting framework to consolidate the due diligence results in a way that they are easily accessible and decipherable to the key members of the transaction deal team.
As important is the ability, through initial due diligence, to identify key issues which may impact the deal, be it timing or the structuring of the investment/acquisition or which go to the heart of the commercial agreement. Front-ending the “macro” due diligence in this way, combined with a potentially not insignificant cost, may seem counter-intuitive but carrying out initial “fatal flaw” diligence will identify significant issues at an early stage, enabling them to be taken into account in planning and structuring the transaction. In the long run this saves the cost and angst of seemingly intractable issues coming to light nearer to closing which can then delay the transaction or result in it having to be significantly re-structured or aborted at a time when the parties are under considerable pressure to complete and have incurred substantial advisory fees and management time.
Initial due diligence should identify any foreign investment restrictions which need to be complied with, in particular local content/participation requirements. Examples include local participation requirements in the Nigerian oil and gas sector and the Black Economic Empowerment regulations in South Africa. Awareness of foreign exchange controls are critical, both in relation to the payment of any consideration as well as the ability to pay out profits and spare cash during the investment. Withholding tax needs to be considered, especially in light of the availability in certain countries of double taxation treaties. Other transaction taxes need to be considered, such as stamp duty. Protection against expropriation should also be considered, identifying the extent to which the country in which a target company is located has entered into bilateral investment treaties or whether it provides other comfort for investors. As with any transaction, tax (including historic liabilities) is critical and, again, early identification of issues can then be reflected in the structuring and the allocation of tax risk under the transaction documents. For critical contracts (including the acquisition or investment agreement) are the counterparties based in a jurisdiction which is subject to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. If they are then arbitration is likely to be the preferred means of resolving disputes given the advantage it has over enforcing foreign court judgements.
If the transaction involves any form of acquisition finance these points also need to be considered from the lender’s perspective, along with related matters such as steps required to perfect security, whether through registration or otherwise, and the enforcement of security. While a lender should carry out its own due diligence a proactive approach in identifying issues which impact the debt and related security will hugely benefit a transaction.
To the extent the target is listed on a local stock exchange the rules of such exchange need to be taken into account, particularly concerning any applicable mandatory offer rules/takeover codes, shareholder approvals and public announcement requirements.
The importance of identifying appropriate local counsel and early engagement (even on a limited disclosure basis if there are confidentiality issues) cannot be overstated. While many countries have a highly developed and deep legal community in others the necessary expertise may be thinner on the ground resulting in the risk of preferred counsel being conflicted.
Diligence on the target requires extensive project management to ensure the right documents are reviewed by the right people and needs to be supported by effective warranties and representations. Broadly, there is less publically available information than one would expect in, say, Europe or US - for example information available at property, environmental or company registers. Unpredictable and inconsistent local courts, together with a lack of reliable case law, means on-going ligation which the target company is a party to is hard to analyse effectively and, accordingly, to price accurately and with confidence.
Key areas for legal due diligence, aside the typical commercial issues, include carrying out “know your client” procedures on all relevant parties to the transaction, whether sellers, co-investors or partners, compliance with UK Bribery Act and US Foreign Corrupt Practices Act and evidence of ownership of key assets, including share registers/share certificate, title deeds to real estate and key contracts/licences.
Finally, and while not so much a diligence issue, when it comes to signing the transaction documents take local advice to ensure there are no last minute issues.
In a world where the developed markets are stagnating and experiencing low, if any, growth Africa presents many opportunities but effective due diligence is key to such opportunities. Due diligence costs as a percentage of transaction value are higher than in many other jurisdictions, reflecting the sheer variety of the continent and its position in the development cycle but, while needing to be focused on key areas, cost should not be a reason to cut corners on the diligence process. As Benjamin Franklin once said “distrust and caution are the parents of security”.
Trinity International LLP is a niche projects, finance, corporate and commercial law firm focusing on power, energy/renewable energy, resources, infrastructure, private equity and industry. Trinity advises in the UK and focuses on emerging markets (particularly in Africa) with experience in the Middle East, Europe, Latin America and Asia. The team comprises senior lawyers from large international law firms. Trinity is ranked in both Chambers Global and Legal 500.
Hugh Naylor is a highly experienced corporate lawyer specialising in private equity and growth/ development capital transactions both in the UK and internationally, with a particular focus on Africa and other emerging markets. Hugh has a broad range of experience advising sponsors, management teams, co-investors and companies that are raising funds privately and has extensive experience of private company and business acquisitions and disposals, re-constructions, re-organisations, joint ventures and general corporate work.
Hugh can be contacted by phone on +44 (0)20 7997 7049or alternatively via email at firstname.lastname@example.org