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Pre–M&A corporate restructuring of the target: Legal rules and investors' preferences
The ongoing political, military and economic crisis in Ukraine has significantly affected M&A activity, including types, value and size of deals and investors' business expectations. The most obvious trends include decrease of the number of projects, lack of transparency in acquisition and ownership structures, growing number of cash-in transactions and investments in distressed assets. Deals are not always as smooth as planned. Caution in the M&A market remains the watchword. Political events, relations with the Russian Federation and macroeconomics are expected to have a big impact, however, dealmakers will likely be bolder in a still uncertain environment. While conditions remain unstable, some investors are more willing to look at joint ventures rather than outright acquisitions while asset deals are more frequently considered as a less risky acquisition technique than taking equity. Likely areas of M&A activity include agriculture, food processing and production, retail assets, infrastructure and energy (oil and gas, electricity, and renewables), pharmaceuticals, financial services and IT.
Agriculture might top the list due to its significant potential and relatively low level of asset consolidation. The long expected liberalisation of the land market, including abolishment of moratorium on the sale of farmland, might give a renewed impetus and attract significant investors' attention.
Due to lack of certainty in local acquisitions, many Ukrainian businesses and high net worth individuals consider and pursue investments in foreign assets.
Steps and considerations
Corporate restructuring is the term used to describe the reorganisation of business group's legal and operational structure to raise profits and attract investors.
Corporate restructurings preceding M&A projects traditionally have four stages.
Stage one includes (a) review of the existing group’s structure, (b) analysis of relevant corporate, tax and antimonopoly issues, and (c) preparation of recommendations on the group's best restructuring options. At this stage close cooperation between beneficiaries, prospective investors and legal advisor is needed to create clear and effective structure suiting the group's business model and parties' goals.
Attention should be paid to possible antimonopoly infringements at the stage of group formation. For these purposes a legal advisor conducts limited legal due diligence. Identified violations can be cured at stage four.
Stage two – incorporation of the holding company. Most M&A transactions are structured as acquisition of equity (shares) in a foreign parent of a Ukrainian subsidiary for the following main reasons: weakness of Ukrainian corporate governance rules and legislation on protection of minority shareholders, possibility of shareholders' agreements governed by foreign law with the potential disputes submitted to foreign forums (not allowed if shareholders' agreement is with respect to a Ukrainian company), simplicity of withdrawal from the investment and flexibility in practical implementation of the escrow arrangements. Based on our recent experience, equity investments are commonly structured through holding companies incorporated in the Netherlands and Cyprus. A holding company can be established by the group’s foreign counsel or by a foreign law firm engaged by the group’s Ukrainian legal counsel.
For the purposes of cash-in M&A transactions the holding company's authorised capital (maximum amount of share capital that the company is allowed to raise by its constituent documents) must be sufficient to attract the intended equity investment. Shares can be issued at a premium.
In certain cases beneficiaries establish sub-holding companies for each segment of the group’s business (e.g. cattle breeding, production of milk, and crops harvesting in agriculture).
Stage three – structuring control over the holding company. Under Ukrainian exchange control rules, acquisition of foreign shares by a Ukrainian resident may be made only after obtainment of an individual license from the National Bank of Ukraine (NBU). As of today, transfer of funds abroad by Ukrainian residents under the NBU's license is prohibited. The license is not required if shares of the holding company are transferred to the beneficial owners through the deeds of gift. Control over the holding company can be also structured through nominee shareholders – natural persons or legal entities holding shares on behalf of the beneficial owners under a trust deed.
In certain foreign jurisdictions there are requirements as to the minimum number of the entity’s founders. For instance, from the moment of incorporation a Cypriot public company must have at least seven members.
Stage four – transfer of equity in Ukrainian companies of the group to the foreign holding company. This transfer is commonly conducted as a sale and purchase transaction. To minimize tax risks the purchase price must be at least equal to the amount of the target's charter capital. Notably, sufficient funds must be available in the acquirer's bank account to be used for payment of the purchase price. Considering Ukrainian currency control restrictions, the preceding transfer of funds to the foreign holding-acquirer can be a serious problem if the charter capital of a Ukrainian target company exceeds, for instance, several million dollars, as we witnessed several times in practice.
Ukrainian law contains certain requirements in relation to transfer of shares in joint-stock companies, such as delivery of a notice to the National Securities and Stock Market Commission of Ukraine and mandatory offer on the buy-out of shares to minority shareholders. Applicability of relevant requirements shall be assessed on a case by case basis.
In addition, the following Ukrainian corporate law restrictions should be taken into consideration: (a) Ukrainian company may not be solely owned by a founder that has only one participant (shareholder) and (b) an entity cannot be a sole participant in more than one Ukrainian LLC.
Ukrainian law contains a number of requirements and restrictions, which have to be considered in the course of preparation of target to the anticipated M&A transaction. Corporate restructuring may take up to half a year depending on the scope of required procedures. All material issues, such as jurisdiction of the holding company and final transactional structure, shall be discussed with the prospective buyers and require significant corporate, tax, currency control and antitrust analysis by the legal advisor.