How to Acquire a Local Company (Testing the Waters)
By: Noel C Ducusin
This is the first in a series of articles on how to acquire a local company.
Before proceeding, we suggest that you review our earlier articles on How To Vet and Qualify A Local Partner? and our article Why Acquire A Local Company Instead of Setting Up Your Own? In this article, we will discuss the things you can do before you commit yourself to an outright acquisition – testing the waters so to speak. This will significantly lower your risk but at the same time give you a good understanding of how the local industry operates as well as an understanding of its key players and how business is done locally culture-wise and execution-wise.
Strategic Partnerships / Joint Ventures
For this method to work your company must have something significant in terms of value-added that the local company does not have otherwise there would be no incentive to enter into a strategic partnership. For example, you may be holding the intellectual property rights to a certain product that you would like to distribute or manufacture locally. Another example would be specific expertise in a highly technical field such as engineering, pharmaceuticals, power generation, or other fields where there is little to no skilled local manpower to do the work – this would be similar to a technology transfer agreement where your technology and know-how is leveraged (please see a related article on How To Do Business In The Philippines In A Restricted Industry? for additional ideas).
The strategic partnership/joint venture is essentially a contractual arrangement. Both parties benefit and have an incentive to enter into the agreement. For your side, it will be that of finding a new market to enter and for your local partner, to build a new business with virtually no competition. The do's and don'ts of what you should indicate in your joint venture agreement will be discussed in a separate article. The bottom line is that you have a lot of flexibility in setting up the strategic partnership terms and conditions. You can also set it for a time-limited engagement with a specific pre-agreed winding down procedure in case the business proves to be unviable or too cumbersome. The strategic partnership is therefore the best way within which to gather data to make a very good informed decision on whether or not you should acquire a company later on or even whether or not to set up your own company while maintaining the lowest possible risk profile and commitment of resources. Again, the strategic partnership or joint venture is not the end in itself but is a very useful first part of the process before committing to a major project.
Debt to Equity Swaps
You might be in a situation where you don't really have a product that is unique enough that creates a new market locally. Perhaps your products are simply just a little bit better compared to existing local products or merely complementary to them.
On the other hand, the local partner, while already having some traction and a distribution system in place, may lack the capital to scale that system further or lacks the capital to maximize the distribution chain by selling related or complementary products. In situations like these, you can come in as the partner that will provide the capital in such amounts that prove to be worthwhile for the local partner. The preliminary method of entry will be through debt, such that if something goes wrong, then you still have the right to recover as a creditor compared to equity holders who will have no such right other than a share in the remaining assets of the company after the government is paid for taxes and other creditors and company employees have been paid as well. As the name implies, this debt will have the option to be converted into company equity at your option given certain circumstances to be agreed upon. This is also a very good way to test the waters such that if the business does not go as planned, then you can recover as a creditor, and even better if you can recover as a secured creditor with a lien on company assets. On the other hand, if the business is going well, you can then convert debt into an equity position in the company and accordingly reap the long-term upside of the business. You could also structure the agreement in such a way that you would have an option to acquire the remaining equity of the local company but that would be the subject of a separate article.
Business Unit Spin-Off
Perhaps you have already tested the waters via the strategic partnership, or the debt-to-equity method. Oftentimes, however, the long-term intention of your local partner might not be aligned with your own. The alignment might only be with regard to certain products or about certain markets and there is no appetite to do a full sell-out from the point of view of the local partner or a full acquisition from your point of view.
In cases like these, the solution would be to spin off that particular business or product line into a separate company. This way, the local partner can continue to proceed with its business plan, which might not concern you at all. At the same time, you will also not be saddled with obligations or risk for those other business lines that your local partner prefers to continue in which you have no interest.
This situation is ideal for a spin-off company where you can agree on how much equity and capital or technical support each of you will pour into the spin-off company. You could also, again, set an option for you to acquire your local partner's stake in that spin-off company in the future so that if the business proves to be viable, then you can own it 100%.
These are a few of the main ways within which to test the waters before fully committing to an acquisition. We will be producing additional articles related to this topic including topics post the initial testing and exploratory stage discussed in this article.
We hope that this has been useful to you and has provided some options to consider in your planning process.
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About the Author
Atty. Noel C. Ducusin is the senior and founding partner of the N. Ducusin & Partners Law Offices - a law firm based in Metropolitan Manila, Republic of the Philippines that specializes in Corporate Advisory, Cross Border Regulatory Matters, Mergers & Acquisitions, and Commercial Litigation.
Atty. Ducusin is also the President & Sole Director of DoingBusinessPH OPC - a company dedicated to empowering foreign investors to do business in the Philippines through online executive education programs, digital books, seminars, as well as online and offline events.
His mission for this Community is to help foreign investors, business owners, and managers by breaking down complex legal concepts and dense technical material into simple, straightforward, and actionable legal information for better business decisions. For easy reading, articles and briefs will be in simple everyday language without legal jargon.
This is not the place for academic writing and legalese will not be tolerated here.
The simpler and the more practical the better.
“Everything should be made as simple as possible, but no simpler.” – Albert Einstein