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M&A Transactions

Dear Daniel:

Our company is in the food processing business and we have been importing our processed goods from Western Europe and now are finding it difficult to be competitive on the Russian market. We have hence decided to purchase a company in our business sector. I have heard that buying companies in Russia is fraught with various risk factors which are unique to Russia. Can you outline what those might be?

Dear Buyer:

I was lucky enough to go to Davos this year and take the pulse of industry captains that have investments here in Russia. The consensus seems to be that as the ruble continues to depreciate it is translating into a boost to local investment for two reasons: lower local costs and increased importation costs of foreign made goods. Your intentions are obviously very welcome and I wish you the best of luck!

If you haven’t already found this out, investors with cash are in the driver’s seat as prices have fallen sharply and buyers are now in a hurry to sell. As a result, the dynamics of mergers and acquisitions have been turned inside out creating a frenzied environment of hasty acquisitions that are often made without indepth due diligence of selling concerns. Due diligences in Russia differ from due diligences in the west as they tend to provide less accurate reading of a company’s real value and risk profile. This is a result of reduced transparency, rule of law and higher instances of fraud. Some of the general guidelines relating to acquisitions which are peculiar to the Russian market are as follows:

Court Records. In Russian unlike the west there is no public system relating to law suits filed and judgments so it may be quite difficult to get a full profile of a company’s judicial history.

Credit Rating Agencies. Agencies like Dun & Bradsteet may exist in Russia but the system of profiling a company’s payment record is virtually non-existent. Since Russian businesses are reluctant to share information, there is no reliable resource to determine a company’s payment practices. Credit checks in the west also help assess the types of debts a company may have with its suppliers, a fact that may be completely undiscoverable in any reliable way in Russia.

The Russian “Promisory Note.” In Russia, management can borrow money without establishing a documented document trail. This can come back to haunt an unsuspecting buyer.

Employee Rights. If there are on-going or potential law suits by former or current employees, these issues may be difficult to determine even with the most thorough due diligence. Employee strike suits can be so severe in Russia that they can potentially cripple a company’s finances. This is more of a red flag in Russia than in other countries with freer labor markets.

Reliability of a Sellers books

Tax Liabilities Tax liabilities have dominated Russian headlines and have crippled more large Russian companies than one can shake a stick at. Reviewing a company’s books may only reveal part of a company’s real business activity. As tax compliance is not very common in Russia, it is not that uncommon for a company to have two parallel sets of books, the so called black books and white books. During a due diligence companies with both sets of books may or may not provide all the relevant information hence leaving the buyer with a potential contingent tax liability not to mention an investment with an exaggerated valuation. Time permitting it is advisable to conduct as thorough an independent audit as possible. A buying company often does not know what he/she is buying and may find itself paying massive fines and back taxes post-transaction. It may not be useful to ask the tax authorities either since that effort alone may attract undue attention to the target company resulting in unwanted attention and audits.

Seller Guarantees As the rule of law is not what it is in the West seller guarantees may not be worth the paper they are written on since bringing a law suit in Russia may not be easy, cheap, or fun. One advantage of seller guarantees in Russia is that sellers who fraudulently misrepresent what they are selling may find themselves subject to criminal action, and that can always be used as a bargaining tool if civil enforcement of a seller guarantee proves difficult.

Daniel Klein is a partner at Hellevig, Klein & Usov. His column is intended as commentary and not as legal advice.

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