Vietnamese enterprises looking to take advantage of the improving mergers and acquisitions (M&A) situation in Vietnam need to fully appreciate what the process involves, writes Matthew Lourey (*).

With the global economy showing further signs of improvement in recent months and a level of confidence returning to the global equity and investment markets, we have seen a marked increase in the number of strategic and institutional investors seeking transactions within Vietnam.

However, despite the apparent buoyancy in the market, we still see many potential transactions in Vietnam that are not completed for a variety of reasons – many of which could have been avoided.

One of the predominant reasons why transactions are not completed is due to misunderstandings during the transaction process and how to manage this. With planning and better information, there are methods to ensure that the transactions are more likely to succeed.

We have all heard about the term mergers and acquisitions, but what does this really mean to Vietnamese businesses? Simply put, M&As is a term used to describe the process of one entity acquiring all or a substantial portion of another party, usually with control passing to the acquiring party. In other words, selling a business or a majority stake in a business.

As a result the process is often seen by sellers as solely an exercise in maximising the sales price. However, adopting this narrow approach is often itself a cause of failure.

So, what should a business do to ensure that it maximises its value if it is looking to sell, whilst ensuring the transaction is actually completed? The first step is to understand the sales process that is likely to occur.

- Research and identification of the transaction. Making contact between the buyer and seller to ensure both are willing participants. l Negotiate and enter into a heads of agreement (“HoA”), or memorandum of understanding (“MoU”), which are documents identifying the intentions of each party and setting the general rules for the rest of the transaction process.

- Buyer undertakes due diligence, which is the process of obtaining a detailed understanding of the entity being acquired and the transaction generally.

- The contract of sale, either called a share purchase agreement (“SPA”) or sale and purchase agreement (“S&P”), is the final agreement negotiated between the parties.

- Completion is the date or event where all the pre-conditions contained in the contract of sale have been successfully completed and the ownership physically changes.

- Post-completion refers to the obligations of the sellers after the transaction has occurred, but which must be undertaken in accordance with the contract.

Each of these steps takes time and the entire transaction process can be a lengthy one. Appreciating this before commencing anything is a must. Underestimating the time required can force decisions that are not in the best financial interests of one party and can cause transactions to abort.

It is important at the very start to be realistic about values, know what the true worth is and know when to say no and walk away. Make it clear. There is no point spending months on a process where there is no chance of reaching a price agreement.

Information is crucial to the process, as is truthfulness in that information. Investors will conduct due diligence and want to know everything they can. They are buying the business – which will hopefully become their business. If something material is hidden or misrepresented, then this will create problems with likely pricing reductions or penalties for breaches arising as a result.

What exactly is due diligence?
This area is the process that is most often misunderstood in Vietnam. Due diligence is a general term which essentially means that one party investigates the other party to fully understand the business and any risks that may be involved.

The results of the due diligence are usually critical in determining whether the buyer will proceed with finalising the transaction. Due diligence can take many different forms, including financial, legal, tax and commercial due diligence, with different external advisors usually be appointed by the buyer to conduct these and to report back to the buyer with their findings.

It is only after the due diligence is completed that a SPA can be finalised, which will include the conditions that the buyer requires to be met before they can complete the transaction.

For example, the legal due diligence may have determined that the property lease has a clause that if there is a change of ownership, then the building owner has the option to cancel the leases. Therefore, the buyer may want the seller to obtain confirmation that the building owner will not cancel the lease.

The larger the business that is being sold, the more likely it is that more of these matters will need to be attended to, but these are not limited to large businesses alone. Company boards do not want to approve a transaction to later find out that there were material issues that may result in the business they acquire being a very different business.

So why does the term due diligence confuse people? Why is it that staff, when conducting due diligence exercises, get thrown off the premises when the owner changes their mind? Mainly this is a result of a misunderstanding of the process. Private businesses, especially in Vietnam, are very private operations.

General directors and owners of these businesses do not want others to know exactly what has been going on in their operations. However, generally speaking, this approach is not acceptable to buyers as they need to know exactly what has been going on in the business, as they will be the ones buying a stake in the business.

Therefore, if you are interested in selling you must be prepared let the buyer conduct their due diligence to their satisfaction, regardless how uncomfortable it may feel. The protection is that professional advisors are subject to confidentiality agreements and are usually happy to sign additional agreements to ensure that private information remains private.

Depending on the business and the requirements of the buyer, the due diligence can vary, but can be very time consuming for sellers and their staff and can often distract the business. However, there are ways to minimise the impact on a business. Planning ahead and getting everything in order is important. If you are behind in tax filings or preparation of monthly accounts, then get these up to date. We also suggest that sellers develop a data room – a place where copies of all important documents are collected. Everything from tax lodgements, historical financial statements, business licences, contracts are collected and placed in one location. In a due diligence period, there maybe a number of consultants working together and demanding time from staff to locate documents, reports and information. Reacting to these requests and digging out each document that is requested takes substantial time and can be very distracting to a business. Having all these documents in one single place (often online), means less time in sellers offices so that the business can run as normal.
The due diligence process will also involve interviews with key staff which is another important procedure so that the buyer’s consultants can truly understand what is happening in the business and report accordingly. Not everything in an organisation is documented, so access to key staff is also important to complete the due diligence process.

Common problems that occur in Vietnam
l Financial statements not being prepared correctly. Potential acquirers of a business often base decisions on what is disclosed in the financial statements and prepare the MoU based upon these.

However, if they later discover that many of the assets or liabilities are incorrectly stated and the business is not as indicated in the financial statements, then problems arise.

Where the acquiring company has stipulated parameters for a transaction, this could result in an immediate walk-away by them. It could, on the other hand, result in pricing adjustments, the buyer no longer trusts the seller or the seller’s systems, so discounts are applied.

l Cash balances that are not actual balances. We see this very often, primarily as a result of accountants not recording transactions, or where businesses combine private and business assets.

Be aware that one of the first things that an external consultant does when conducting a due diligence is to count the cash. Cash balances need to reflect the actual cash on hand in the business and this needs to be correct historically as well.

Buyers want to know “normalised earnings” and if there are many expenses that never go through the books, but which they know exist (due to the cash balances not being correct), then this will work against the seller, often by the purchase price being discounted for uncertainty.

l Two sets of books. We are regularly asked by business owners whether they should show an acquirer the tax books or real books “as everybody knows that businesses in Vietnam run two sets of books”.

The answer is that there is only one true set of financial information and it is this information that needs to be reviewed as that is what the buyer is acquiring. If different figures have been presented to the tax authorities, then that represents a risk that the buyer will price in to the transaction.

The risk is that if the tax authorities later conduct an inspection (and don’t think just because you have sign-off for one year that the tax authorities cannot re-inspect), then the new owner will have to pay the undeclared tax and penalties. If you have such a situation, then it needs to be either fixed in advance by way of voluntary disclosure and agreement with the tax authorities, or the price will reflect the risk if the buyer is willing to accept the risk.

l Tax matters also present problems. Tax due diligence often uncovers issues with employee taxes, errors in depreciation, late lodgements, tax incentives miscalculated. All these can be dealt with in advance so that they don’t break the transaction – but simply relying on internal staff won’t achieve this. Getting your own tax review and getting someone to assist in identifying and fixing these issues is a real possibility to explore.

How do businesses deal with these and other issues? By planning. Engaging someone to assist in advance and working through potential issues before the buyer starts looking can help in reducing deal breaking issues. If the buyer identifies fewer issues, they will accept the business at face value, resulting in an easier transaction. An advisor will assist sellers with maximising the potential price and minimising business interruption.

That said, advisors or sellers should not appear to be blocking the process, as this will make the other side suspicious. The best process to fix many of the common issues identified above and a general suggestion, for good corporate governance for any business, is to undertake a regular audit and prepare audited accounts. It will give you more confidence in your own business and give a better return on your investment when you sell.

Completion
When the due diligence is finished, and final contract is being negotiated – does this mean that the transaction will occur? Not always and this is where things can get very difficult. What has to be negotiated is, depending what was agreed in the MoU, may include pricing, timing and conditions precedent.

Pricing depends on many factors including the industry, stage of life of the business and size. Pricing can be turnover based, asset based, independent valuation, usually using discounted cash flow basis, but there are others, or other mutually agreed mechanisms.

After all the conditions in the S&P agreement are satisfactory undertaken, the point of “completion” is reached. This is the date of the actual sale and when the bulk of funds are usually paid for the business.

However, normally not all of the funds are paid at completion as there are often post-completion conditions that result in deferred payments. Examples are for the sellers to work for an agreed period following and final payment, a certain percentage of customers must agree to stay with the business (especially if price is based upon customers and revenue), or that earnings commitments are met.

Back to a question raised at the outset of this article, why are few transactions completed in Vietnam? Usually it is a misunderstanding in the process. Not all transactions will be completed, but a better understanding of the process will make it more likely that a transaction will complete and at a price that is more appropriate to the buyer and beneficial to the seller.

* Lourey is the corporate finance director at Grant Thornton Vietnam, where he looks after due diligence services, transaction and lead advisory, valuations and market entry advice for international and local companies. With an emphasis on privately held businesses, Grant Thornton member firms are located in over 110 countries. He can be reached at matthew.lourey@gt.com.vn

(VIR)