Mihail Vishanin and Yordan Naydenov, Boyanov & Co
Economic recovery across the EU has been encouraging M&A activity, including in the smaller economies across the EU. EU sources of funding for Bulgarian small- to medium-sized enterprises (SMEs) are also among the significant factors providing a boost to the Bulgarian M&A market.
Investors are typically interested in the acquisition of majority shareholdings in market leaders in different sectors of the economy or in companies with serious optimisation potential. Often, they look for consolidation opportunities where they would first invest in one of the local market leaders and subsequently use the investment as a platform to acquire more companies in the same business sector in order to consolidate and optimise the market. Consolidation in the banking sector also represents a significant trend.
Over 2017-18 we saw several serious acquisitions of Bulgarian shopping centres and shopping malls by foreign investors. These deals completely dominated the market and set a record that is unlikely to be beaten in the coming few years. This came in addition to sectors that are of typical interest for foreign investors, including IT, agricultural land and telecommunications.
Private M&A transactions prevail on the Bulgarian market, whereas notable public M&A transactions are very rare. The most serious problem facing the Bulgarian Stock Exchange is low liquidity and the number of shareholders in Bulgarian companies has generally declined in recent years. Investors in public Bulgarian companies are people with a monthly income of more than BGN3,000 ($1,730), most of whom are programmers, while long-term international investors are missing.
The acquisition techniques that are employed depend on many factors, such as the aims of the M&A transaction, whether it is a first investment in Bulgaria, whether the target has a good management team in the respective sector and what position the investee company has in the market, etc. In general, transactions can be summarised as: acquisitions of a majority shareholding; acquisitions of a 100% shareholding; minority investments; or acquisitions of ongoing concerns or assets.
In the majority of the cases, a foreign investor will set up a local subsidiary and use the subsidiary as an investment vehicle or holding company for its interests in the country. Depending on the optimisation structure, the investor can hold its investments in separate companies, consolidate them under one holding company or merge all of the investee companies into one entity.
Majority or 100% stake investments give to the investor very strong corporate control and decisive influence over the investee company. These are very important for achieving the optimisation of the business structures, the corporate governance and for the preservation of the investors' rights. At the same time, the majority investment allows the investor to keep and incentivise the management of the company, thus creating options for further increase of its value.
The investment in shares also makes an exit easier and can be associated with tax benefits and allow the investee company to be listed (also facilitating the exit), etc.
Investment in assets (through an SPV) usually result from issues or irregularities found in the due diligence process.
In recent years we have seen the creation of several private equity (PE) funds looking to invest in high-growth Bulgarian SMEs with support from EU investment initiatives (for example, funding coming from the European Investment Fund, part of the European Investment Bank, through the JEREMIE initiative to support Bulgarian SMEs).
Many current global trends can be observed in Bulgaria's recent M&A transactions. One of the most interesting new developments is the use of R&W insurance policies to cover potential sellers' liabilities for misrepresentations or breaches of warranties. Such products are not offered by Bulgarian insurance companies and it is not that easy to find foreign insurers that are willing to agree to cover these risks, due to low interests involved in most of Bulgarian M&A deals and the unpopularity of the Bulgarian markets. Yet, in almost every large-scale transaction on which our office has worked recently, R&W insurance is being at least raised and very seriously considered especially where the selling party is a PE fund, be it Bulgarian or foreign. Sometimes, this is the most difficult part of the negotiation, especially if the buy side is less experienced and used to more exotic proposals. Yet, we firmly believe that R&W insurance policies will become more a popular instrument to deal with the delicate issues of a seller's liability.
Another interesting trend that we have observed over the last two to three years is a gradual preference for locked-box mechanisms (LBM) over closing account deals. LBMs offer more simplicity in the closing mechanics, and predictability fewer closing expenses. They are very often combined with the retention of a portion of the price in an escrow account, thus covering the assumingly higher risk of the purchaser of unauthorised leakages or other events that may erode the price.
Brexit is also opening new doors of opportunity and leading to unexpected discussions during M&A deal negotiations. Until recently, the laws of England and Wales and the English courts were seen as a standard feature in an international M&A deal involving Bulgarian parties. Now, due to the uncertainty surrounding Brexit, (an off-the-cliff Brexit, versus a Brexit via an agreement versus the possible extension of Brexit period or a possible new referendum, etc.) many Bulgarian counterparts are reluctant to agree to the jurisdiction of the English courts, as they do not know whether their decisions will uphold their direct enforceability and are looking at different law options to govern their relations.
LEGISLATION AND POLICY CHANGES
M&A transactions in Bulgaria are not subject to any special legislation and are regulated by general company law. Therefore, the main acts that would affect the formation and management of a PE fund are the Commerce Act and the Obligations and Contracts Act and, possibly, the Collective Investment Schemes and Other Undertakings for Collective Investments Act. The requirements of the Markets in Financial Instruments Act and the Public Offering of Securities Act also settle important issues where an investor operates in the capital markets. Likewise, investments in certain regulated entities must observe the rules applicable to those activities – for example, the Insurance Code, the Social Insurance Code, the Credit Institutions Act, etc.
Recent changes in law
There have been no recent pieces of legislation aimed at promoting or constraining M&A transactions.
In 2014, Bulgaria adopted the Act on the Economic and Financial Relations with Companies Registered in Preferential Tax Treatment Jurisdictions, the Persons Controlled by Them and Their Beneficial Owners. It introduced restrictions aimed at limiting the participation of offshore structures in some of the most important sectors of the economy, such as banking, public procurement, concessions for underground resources, etc. These restrictions can impact investors using such structures but can be overcome subject to complying with some additional disclosure / registration requirements.
At the end of 2016 and 2017, several amendments to the Commerce Act provided more formalistic requirements for transfers of going concerns and shares in LLCs, which increased the time and paperwork needed for the perfection of these M&A transactions.
Measures against Money Laundering Act (promulgated in the State Gazette No. 27/27.03.2018, effective as of March 31 2018) contains measures to protect the financial system from money laundering activities, as well as requirements to identify of clients and improve reporting requirements. This Act provided for an obligation on the part of companies incorporated within the territory of the Republic of Bulgaria to disclose, on the commercial register, information on the natural persons who are their beneficial owners until end of May 2019.
Regulatory changes under discussion
Currently, there are no rules, legislation or policy frameworks under discussion that may impact M&A in Bulgaria.
In current market practice, a weak awareness of the options PE investments offer is prevalent. The awareness is growing, especially in Sofia and in other large business centres around the country, but is still at rather low levels.
It can be difficult to communicate with family-owned businesses. This type of business owner is often quite suspicious when dealing with foreign investors. They often also lack proper and competent advisors, which slows down or sometimes ruins the investment process.
Frequently overlooked areas
An M&A transaction includes a negotiation and a transaction stage. The questions asked during the negotiation stage tend to relate to the status of the other party, the status and the condition of the target, how confidentiality is to be guaranteed, how and when the purchase price will be paid, what are the actions before and after the closing and what representations and warranties the seller must make. In the transaction stage, the main terms that parties negotiated must be documented in detail and the main questions in that stage are related to both the structure and the wording of the sale agreement. Entrusting the preparation of the transaction documents to inexperienced lawyers usually has a negative consequence for the parties when it comes to receiving the money promised and, equally important, keeping the money received.
Any person that acquires more than one-third of the votes in the General Meeting of a public company must register, through the Financial Supervision Commission, a tender offer to the remaining voting shareholders to purchase their shares or the for exchange of their shares for shares which will be issued by the offeror for this purpose within 14 days of the acquisition date; or, when the threshold has been exceeded due to a conversion or withdrawal of shares, within one month of registering the conversion or capital decrease with the Commercial Register.
Conditions for a public takeover
The tender offer regime referred to above is to: ensure equal treatment of the shareholders that enjoy equal status under law; allow sufficient time and information for an informed assessment of the offer in order to make a reasoned decision; prevent market manipulation; ensure full payment or exchange of shares to the shareholders that accept the offer; and not inhibit the target company's activity for an unjustifiably long period of time. The law provides for mandatory content of the tender offer, including a justification of the proposed price or rate of exchange.
Break fees payable by the target company in a public acquisition are not typical. Contractual break fees can be agreed where a majority shareholder in a public company sells its stake outside of the stock exchange, in which case the deal must simply be registered at the stock exchange.
One practice that is growing in popularity and becoming increasingly frequent is the inclusion of locked-box mechanisms in deals over the once prevalent closing accounts mechanism.
In many cases, acquisition provide for a transfer of shares but also for the assignment of the debts owed to the former owner (for which the price of the shares would be adjusted and accordingly reduced). In these cases, we see a consideration clearly split between two elements, and this will normally have positive tax consequences for the transferor.
Also, parties may agree that the leaving shareholder will receive as many dividends as possible, which may also reduce the price for the shares but have beneficial tax effect (dividends are in general taxed at 5% and the capital gains at 10%).
In recent years, in more and more deals warranties and escrowed amount issues have been addressed by warranties' insurance policies. This is particularly valid upon exiting an investment.
Conditions for a private takeover
The usual conditions comprise the scope of the acquisition, price calculation and payment, conditions precedents, including satisfaction with the results of the due diligence and the securing of merger control clearance, covenants between signing and completion, timeline, exclusivity and confidentiality.
Foreign governing law
If one of the parties to an M&A transaction is a foreign investor, it is common practice to provide for a foreign governing law and jurisdiction in private M&A share purchase agreements. The negotiation of arbitration under the International Chamber of Commerce (ICC) is also common practice. Despite the choice of foreign law, the transfer of the shares in rem is regulated by the mandatory provisions of Bulgarian law (notarisation of the transfer deed is required if the target is an LLC).
The exit environment
The Bulgarian market has good liquidity and divestment from Bulgaria is rarely a problem. In many cases in recent years exiting foreign investors have been replaced by Bulgarian ones.
IPOs as an exit strategy are available only to investors in joint stock companies (JSC). If invested in another type of company, for example an LLC, the company would need to be converted first.
The IPO has to be completed following the procedure set out by the Public Offering of Securities Act, under which the investee company has to prepare a prospectus. The prospectus must be approved by the Financial Supervision Commission, the investee company needs to be registered as a public company with the Central Depository, the Financial Supervision Commission and the Commercial Register, and its shares must be listed on the Bulgarian Stock Exchange.
The M&A market in Bulgaria for the next 12 months will be dominated by the sellers and by local investors replacing the foreign ones. Consolidation in the banking sector will continue. M&A activity is anticipated as well in the IT sector, office spaces, media sector and food industry.
|About the author|
Mihail Vishanin is a senior associate at Boyanov & Co. He specialises in corporate, M&A, procurement, litigation and ADR. He obtained his master of laws degree from Sofia University and specialised his studies in the Academy of American and International Law, The Centre for American and International Law, Dallas, US. Mihail has authored several publications in his area of specialisation.
|About the author|
Yordan Naydenov is a partner in Boyanov & Co and head of the M&A and corporate practice groups. He obtained his master of laws degree from Sofia University and developed his practice via an international secondment to Clifford Chance, London and Budapest. Yordan has extensive experience across M&A and financing matters. He frequently advises clients in the banking and real estate sectors on local transactions and restructuring issues. Yordan has authored several publications in his area of specialisation.