Deal makers: key considerations for mergers and acquisitions in Africa

East Africa remains a top choice for investors and the countries in the region have witnessed an increase in overall mergers and acquisitions (M&A). According to Tanzania news outlets, Tanzania recorded merger and acquisition deals worth USD 284.9 million last year (2023).

Overall, sub-Saharan Africa expects to see more deals undertaken in the respective African jurisdictions. This brings a critical question: What should deal makers consider in such M&A transactions?

Identification of key advisers

Every M&A deal requires competent, experienced, and trustworthy advisers. The key advisers are legal, financial & tax, valuers, and business experts. The legal adviser will assist with legal due diligence on all aspects of the target’s business to ensure their compliance with the local laws because incompliance can expose the business and the acquirer to penalties which may negatively impact the acquisition and the overall plans for the business. Financial & tax advisers play a key role in reviewing the financial side of business because the critical point is to have a well-priced acquisition in a business with positive prospects, even if it may not be profit-making during the acquisition. The tax aspect is critical, not only on the tax obligations relating to the acquisition e.g. capital gains tax, stamp duty, etc. but tax compliance and any liabilities outstanding against the target at the local tax authority. Penalties that accrue overtime due to tax incompliance can prevent the approval of the acquisition and even if approved, they can continue to be a burden post-acquisition. Valuers assist with the valuation of the business, its assets, and overall operations to obtain the current market price for the business at the time of acquisition to avoid overpriced deals that do not reflect the existing market conditions. Finally, the business experts play the role of advising on the business prospects following the acquisition, and the sensitive areas and may advise on how to restructure the operations for the positive outcome in the coming years after acquisition. If the acquisition involves an entity that has real estate properties, it is critical to retain surveyors for site visits to ensure verification of the properties and any potential issues that may interfere with operations or acquisition.

Financing, regulatory, and tax nuances

Most deals in Africa's emerging markets, including the East Africa region, prefer cash as opposed to debt financing or a combination of cash and debt (local or international). Due to high rates of inflation and limited liquidity, cash deals are preferred compared to debt financing. While some local banks may be willing to finance an acquisition on a debt basis, the preference is to offer partial debt while the acquirer pays cash to co-share the risks. In limited instances, such acquisition can be financed through loan notes and securities e.g. issuance of bonds to the public but this has its regulatory compliances before they can be implemented for acquisition purposes and may take a considerable period to materialise whilst M&A deals are usually subject to time constraints. International debt financing must take into account any local regulatory requirements before disbursing such debts e.g. Tanzania requires all debts with a tenure of more than a year to obtain prior approval from the Central Bank of Tanzania. Due to taxes and regulatory requirements imposed for M&A deals, it is important to assess how much of the financing (debt or cash) will go towards taxes payable for such acquisitions and any anti-trust approvals that have to be obtained. In some jurisdictions e.g. Tanzania the time when such taxes become due and payable is before the regulatory approvals i.e. anti-trust approvals are issued which poses a risk that if a merger approval is denied, tax refunds will have to be processed which may take years to be paid.

Regulatory changes and inflation

Deal makers must take these matters into account because some jurisdictions may have stable regulatory environments but some African countries have witnessed an increasing change in regulatory environment meaning if the M&A is implemented in phases with the possibility of taking more than 12 months to be finalised, there could be regulatory changes that affect the relevant deal which may either lead to the collapse of the transaction or recalibration of the entire transaction. The constant change in the regulatory framework can be mainly related to tax, anti-trust, regulatory approvals and fees payable to the respective Government Authorities for such approvals. Whilst it is difficult to foresee the changes that are likely to occur, the deal makers need to limit the timeframe within which the acquisition will occur to limit the risks associated with prolonged deals or deals that occur in multiple phases. It is worth noting that, some anti-trust legislations define 'merger' to include the acquisition of whole or part of shares and/or assets of a target notwithstanding that following completion of the acquisition, the target continues to legally exist separate from the acquiring firm i.e. it does not merge with the acquiring firm. Inflation affects a lot of deals that take longer or are to be undertaken in phases and this must be taken into account when such deals are implemented in African jurisdictions.

Interaction with Government Authorities

For large ticket-size acquisitions, especially in sectors that are regulated under a specific Government Authority, it is advisable to have introductory meetings with officials from such Government Authorities. Whilst due diligence (legal, financial, and tax) may disclose information on the operations of the target, discussions with the relevant officials from the Government may disclose pertinent information that may not be found in the due diligence exercise. Eventually, approvals may be required from one or more of the Government Authorities depending on the sector in which the target operates and it will be beneficial if the relevant Government Authority(ies) are consulted about the potential acquisition to avoid rejection of approval after considerable costs have been incurred in due diligence and finalising of the transaction documents. If there is considerable resistance from the respective Government Authority, then the next steps must be approached with caution bearing in mind that further discussions with the Government Authority may be required before the inking of the transaction documents. This issue must be taken into account if the target is owned by politically exposed persons and/or partial shareholding is by a Government Authority. Also, there are some legislations which expressly require disclosures to be made to the respective Government Authority about any potential acquisition or restructuring exceeding a specified percentage of the existing ownership structure, whether or not such acquisitions materialise.

Employment and labour matters

This is critical for the deal makers to take into account because an acquisition may involve the acquisition of assets or shares, the latter usually retains the employees and contracts of the target entity. Employment and labour matters must form a critical part of the due diligence exercise, particularly if there is the intention to downsize the team or to replace some key positions with new employees following completion. For example, Tanzania has labour-friendly laws which, if not taken into account during the negotiation stage, can lead to serious issues following the closure of the deal. It is standard for the acquirer to bring its personnel (especially for senior positions) following completion but this may require termination of senior management. Their termination may attract substantial payouts or encounter labour disputes with or without a stay of steps to complete the acquisition. Factoring in such terminations and replacements during the negotiation stage and agreeing on the responsibility for such termination and the applicable pay-outs is important to prevent such personnel from sabotaging the deal and/or the operations leading to the devaluing of the target.

Localisation requirements

Over the last decade, African countries have witnessed an increased appetite for local ownership, which involves either partial ownership by the respective Government and/or ownership by locals, either individuals or companies with majority local ownership. This appears to be a trend in specific sectors mainly energy, extractives, PPPs, and tourism. A deal maker must understand any local ownership requirements imposed in the relevant jurisdiction in the specific sector. If the local ownership requirement requires the Government's participation, usually it is on a free carry basis whilst the international investor foots 100% of the costs and if it is a local person (legal or natural), it can be based on fair investment for equity held but liquidity may still be an issue, meaning the foreign investor must pay for all the costs of operations and mechanisms for refund and have to be included in an agreement with the local person. Having the right local partner is critical otherwise experience has shown that such local partners can disrupt operations of the target following completion if their requirements (which can be unreasonable) are not met. At the same time, risks for corruption and unwanted actions may occur contrary to the will and control of the international acquirer. As the deal maker seeks to push the acquisition through, it is important to ensure that there is identification of a suitable local person and clear roles and expectations must be agreed in writing.

Interim support arrangements

In between the signature of the transaction documents, completion, and approximately twelve months post-merger, it becomes critical to ensure a smooth integration and handover process between the team exiting and the new team taking over. This may involve training of new hires, the introduction of new systems, handover of day-to-day operations of the target, introductions to the key contractors and officials, etc. This is where transitional operations agreements come into play to prevent a halt of operations due to a gap created in the handover process. For smaller operations, this may not be necessary but for large ticket acquisitions, this is critical especially if the target's main operations are strongly regulated and involve dealing with third parties (customers or otherwise) daily. Also, this is important to ensure that the customers are comfortable with the continued support they have received before the acquisition and prevent panic which may negatively affect the overall performance and operations of the target.

Warranties, indemnities, and exits

What warranties are required, what indemnities should be provided, and for what duration? Warranties are important because they push the seller to disclose full information so it is important to categorise the specific disclosures required and the warranties to be provided. Indemnities are equally important to ensure that the buyer is protected in case there is any liability that may arise following completion. The duration always poses a conflict between the seller and the buyer – the buyer wants a longer period and the seller wants a shorter period. The duration can vary from jurisdiction to jurisdiction and deal to deal but overall, it is best not to be less than the timeframe imposed under the respective laws. For example, tax laws may entitle the tax authority to audit the records of the target for the past six years and impose taxes, fines, and penalties for any breaches. This means that it is fair for the seller and buyer to agree to six years' duration where the seller may be called back to discharge the liability provided it accrued before closing/completion. It is common for parties to have a term sheet to agree on a lock-in period within which neither party can walk away from the negotiations but it is critical to factor in that the seller or buyer may change their mind whether or not the due diligence has disclosed material issues. Costs are usually incurred from the onset which include payments to advisers and approvals from regulatory bodies hence when a party seeks to exit, considerable costs would have been incurred, usually higher on the buyer side. The term sheet or the acquisition documents have to be clear on what happens when either party wants to exit before completion/closing and the consequences for the same.

If you have any questions about the topics discussed in this article, please contact Amalia Lui.