Recent years have shown a clear trend towards strong industry focus in the M&A market. This is particularly true for private equity investments. In 2006, more than 20 percent of all transactions worldwide occurred in the industrials and chemicals sector, followed by consumer goods (15 percent), TMT (13 percent) and financial services (12 percent) (by value; source: mergermarket). As regards buyouts by financial investors, the TMT sector leads the list (17 percent), followed by industrials and chemicals (14 percent), consumer goods (9 percent) and business services (8 percent) (by value; source: mergermarket).
These figures appear to indicate that certain financial investors concentrate on certain industries, but in fact this is not the case. While early-stage venture capital financiers and certain buyout funds tend to focus their investments on specific industry sectors (e.g. IT and life sciences the former, media the latter), the majority of buyout funds – for reasons of diversification – bid for targets opportunistically and, thus, cover several (if not all) business sectors. There are some private equity houses that tend to channel most of their investments into a limited number of industries such as media, though this may encompass diverse targets such as print media, broadcasting networks and cable companies – but most financial investors do not want to limit their investment opportunities to a single sector.
Nevertheless, independent of the concentration or diversification of the investment portfolio, a wellfounded know-how of the target industry will be indispensable to a successful investment. Such sector-specific knowledge may not – particularly in times of demanding deal timetables – be covered by the core team of an investor (on the sell as well as the buy side) even if such an investor has a certain industry focus and experience. The core team will need to concentrate on the economic factors of each single investment and in particular on deal management. It is thus logical and efficient that financial investors have moved to employing industry experts on a deal-by-deal basis and engaging business consultants and advisors with specific industry know-how.
In this context, it pays to note that some heavily regulated industries such as infrastructure, telecommunications and media offer secure and stable cash flows which make them particularly attractive for financial investors. Sometimes it is not despite regulation but because of it that some assets attract investor interest, including the interest of debt financiers.
Regarding legal advisers (being the only species of adviser the authors may credibly write about), the question at stake is whether to choose a boutique law firm – the internal structure and size of which will be similar to those of the financial investor itself – or a “full-service” firm, i.e., a law firm offering legal expertise in every investment-relevant legal area in different countries as well as industry sectors, but of a size much larger than the investor itself.
LEARNING CURVE NOT PERMITTED
It goes without saying (but we say it nevertheless) that it is paramount to select a law firm with broad private equity expertise. Today's auction processes are too fast and demanding to allow for a learning curve on the part of the advisers. When conducting a due diligence exercise and negotiating the transaction documents, everyone needs to focus on the important issues and cannot spend time on those aspects which the market does not permit. For example, a mark-up of an SPA which inserts lots of business warranties where the seller has offered none will, in a competitive process, not be taken seriously. In this context, it pays to note that while the professionals at the private equity house are, of course, experienced deal experts, the lawyers who have advised several different bidders on private equity transactions in the past have, in all likelihood, acted on many more deals than the principals. As regards current market practice, the lawyers may be a better source of information than the private equity professionals.
When conducting a due diligence exercise and negotiating the transaction documents, everyone needs to focus on the important issues and cannot spend time on those aspects which the market does not permit
While the size and structure of a boutique firm may – at first glance – be preferable for the buyout fund with respect to co-operation and communication, the fund may end up having to employ two boutique law firms: one with a well-founded M&A expertise and another with specific know-how of the target industry. Only on rare occasions will an M&A boutique be able to offer cutting-edge sector expertise. In any event, engaging boutique law firms might entail having to replace them for the next investment depending on the respective target industry.
On the other hand, a financial investor may feel reluctant to employ one of the large international law firms fearing (rightly or wrongly) impersonal service, inefficiency of communication in large deal teams and having to indirectly finance services not relevant to the investor in question.
The type of industry knowledge required will vary depending on the target industry. Regulatory expertise is indispensable for telecommunications, media, healthcare or financial services investments. In addition, “non-regulatory” but sector-specific expertise may be decisive for investments in these markets (e.g., when negotiating warranties or structuring a transaction). Equally, in “unregulated” markets specific legal knowledge as well as specific industry know-how may make the difference for the client in competitive bidding scenarios (e.g., environmental law expertise in industrial investments). Finally, a legal expert in a specific industry, if included in the deal team at an early stage, may be able to identify major risks which a general M&A lawyer might overlook. The awareness of such risk will not necessarily lead to the investor aborting the sale process but may enable him – on the sell as well as on the buy side – to structure the process in a reasonable way, carving out such risk or reaching a compensatory solution.
BIDDER TURNED SELLER
For the seller, on the other hand, legal advisers with sector-specific expertise may shed light on the different degrees of transaction certainty that different bidders, due to their existing portfolio, origin or personnel, can offer. Also, a well-advised seller can reduce risks early in the sale process (or even before the sale process commences) which avoids bidders requesting onerous representations and warranties or even a price reduction. This will cause any bidder to select advisers carefully, as it is not unusual (and would, for obvious reasons, be highly efficient) for the legal adviser that has represented a bidder on the acquisition of a target to also advise, a few years later, on its sale.
Sellers have always been wary of any completion risk due to regulatory uncertainties on the side of the purchaser
While certain boutique law firms will be able to offer high-quality M&A legal advice plus strong industry-specific know-how with respect to a single investment, it will be difficult for such a firm – simply for reasons of size – to provide cutting-edge legal advice in all transaction-relevant fields of law in addition to M&A, such as antitrust, employments/pensions or IP/IT. An investor would therefore be forced to engage other (boutique) law firms in order to receive, often transaction-decisive, legal advice.
In addition to the fact that engaging more than one law firm will in any event lead to a more complex and less efficient line of communication for the investor, the alleged advantages of working together with a boutique law firm as stipulated above (efficient communication, personal services, cost-efficiency) will vanish.
This is particularly true if the legal services provided by a full-service law firm are handled by a “lean but mean” team of M&A experts, industry experts and specialists in those fields of law that are relevant for the investment at stake, such a team being led by one experienced client relationship partner.
It is not only the buyer which benefits from employing a full-service law firm. Sellers also gain an advantage if the bidder is represented by lawyers with sector-specific expertise. Sellers have always been wary of any completion risk due to regulatory uncertainties on the side of the purchaser. In an extremely seller-dominated market as has prevailed in the last year or two, sellers demand proof of transaction certainty from all bidders in an auction process. It thus becomes imperative for bidders to be able to give meaningful and trustworthy responses to a seller's questions about regulatory expertise.
When the seller, in one of the first meetings, asks how potential regulatory hurdles will be overcome by the bidder (and the seller, owning a target company in the relevant sector, will know about most regulatory issues), clear and concise responses are expected and a bidder will stumble if it has to defer to specialist lawyers which have not yet been engaged. In this context, a bidder can gain an advantage if it can put forward the name of a law firm with a well-known reputation in the industry or relevant regulatory matters. Direct discussions between the seller's counsel and the bidder's lawyers can streamline negotiations and eliminate potential regulatory hurdles at an early stage. Sellers know this, or get to know this early in the sales process, and it can give the bidder who is advised by a full-service law firm the crucial advantage.
HOW SHOULD IT WORK?
A typical example of how the cooperation between private equity clients and their legal advisers should work was a recent acquisition of a European media business. About two months before the auction began, a team of legal experts started investigating whether such an acquisition was feasible for investors at all from the standpoint of media regulation as well as under anti-trust law. Upon the “green light” by these experts and after a joint review of the situation with investors, a team of specialists with TMT sector expertise began preparing the project in all relevant jurisdictions including the collection of all information necessary to expedite the regulatory approval proceedings.
Since the seller was very sensitive to identify and prevent any regulatory or political concerns resulting from the market-relevant activities of the bidders in the sales process, the preparation of a comprehensive regulatory and anti-trust risk assessment became a crucial part of the final bid. Only after acceptance of this assessment by the seller could phase two of the transaction, i.e. the execution of a comprehensive due diligence process which included inter alia a thorough analysis of the company's content, distribution and platform agreements, be initiated. Due to the early stage input of the TMT specialists, all necessary applications could be filed immediately after signing and all necessary approvals were granted without any unexpected delay.
Dr. Judith Völker and Dr. Marcus Mackensen are associates in the Hamburg office of Freshfields Bruckhaus Deringer. They are practice development and knowledge management lawyers, respectively, in the private equity sector group.