2020 proved that predicting the future is a risky business, but it is not only fortune tellers who predict that the food sector is likely to see an explosion of Mergers & Acquisitions (M&A) activity in 2021. The owners of medium/large food producers who continue to be squeezed between manufacturing costs and the power of the large retail players are looking for synergy and cost solutions through mergers and acquisitions. Some private equity owners are reported to be looking to exit the food sector as returns fail to improve. At the same time the unprecedented amounts of cash available to private equity means that there are many parties looking for targets, also in the food sector.
COVID-19 has had vastly differing impacts on different players in the sector. The distribution of our food has changed: online and physical supermarkets as well as take away delivery have grown while the catering industry, restaurants and on the go shops and their suppliers have suffered tremendously.
In addition to COVID-19, consumers and their changing demands, have a major impact on M&A transactions in the food sector. Consumers want transparency; they want to know where their food comes from and how it is produced. They want healthy foods, with less sugar, fats and E-numbers. They want more convenience. Sustainability is a huge trend; consumers want food produced with less impact on the environment, with less waste and more attention to animal welfare. And while consumers are willing to pay for a[n] unique personal experience, they are also increasingly choosing for the cheapest provider when doing their daily shopping. These are the trends that investors are also looking at in deciding on transactions. Private equity can often assist companies and their management in these areas, leveraging their experience and network. In other words, it does not always have to be an obstacle if these aspects are underdeveloped in the target company and it may be seen as a unique opportunity.
In this article, we will give some tips and tricks to sector players who may be buying, selling or investing in the non-listed food market in 2021.
NDAs and confidentiality agreements
The starting point of any M&A transaction is ensuring that all parties involved undertake to keep information concerning the transaction confidential. This is particularly important when the target has valuable proprietary intellectual property. Bear in mind that the sharing of commercially-sensitive information between competitors is strictly prohibited under EU competition rules. The parties can consider setting up "clean teams" and restricting access to information as appropriate to the stage of negotiations.
The choice of how to structure a deal will depend on a range of factors such as tax implications or for example, the desire to split off certain parts of the business. Certain objectives may be better achieved through an asset sale rather than a share purchase transaction.
We expect to see more share purchase transactions in 2021 being based on completion accounts rather than locked box provisions. A locked box structure values a business at a point in the past often based on audited accounts. That point in time is often called the “locked box date”. At the date of the actual transfer of the business to the purchaser (the “closing date”), it is determined how much value has leaked to the seller in the period between the locked box date and the closing date (the “leakage”). The purchaser is then compensated for any leakage of value out of the business to the seller during the period from the effective date (the locked box date) until completion (the closing date). In the COVID-19 era, valuations based on a date in the past might be a difficult pill to swallow and a purchaser may want a set of accounts drawn up at the time that ownership passes leading to possible purchase price adjustments – so-called completion accounts.
The continuing uncertainty of the impact of COVID-19 creates a challenge for purchasers and sellers to reach agreement on price. Sellers will be looking at the double digit multiples that were seen in 2019 in particularly food ingredient transactions while purchasers will want pricing that reflects the current uncertainty. Many parties currently reach for the earn-out mechanism to bridge this gap. An earn-out is an arrangement whereby the purchaser agrees to pay an additional amount to the seller if certain milestones are reached. The HelloFresh acquisition of Factor75 in the US announced on 23 November 2020, reportedly includes earn-outs of up to USD 100m on performance-based and ongoing management incentives out of a total consideration of up to USD 277m.
Earn-outs are often a recipe for disputes as the purchaser may try and manage the newly acquired business in a manner which minimises the earn-out, while the seller may try and push for measures that maximise the earn-out even if these are not in the best interests of the company. Both sellers and purchasers may be better off compromising on price rather than avoiding the topic by agreeing on an earn-out. If an earn-out is agreed then watch out for the following:
- Keep the earn-out to a small percentage of the purchase price. The seller should see it as a windfall and the buyer not be incentivised to avoid the payment by playing around with the recognition of revenue and costs. Also consider limiting the length of time of the earn-out. This because the earn out parameters might restrict the new owner in how it expands the business.
- Measure the earn out thresholds according to objective and uncontroversial standards. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is often used as a proxy for cash to evaluate a company’s operating performance. Although EBITDA may seem an attractive metric it raises a myriad of issues as to the allocation of costs and the benefits of post-transaction synergies.
- Make sure that the obligations of each party in relation to the achievement of the earn-out is clearly spelt out in the agreement. Even in the absence of a contractual obligation, a buyer may be obliged to take into account the reasonable interests of the seller in achieving the earn-out when taking strategic business decisions.
A key starting point in any M&A transaction is due diligence. Sellers who have prepared and packaged company information in a way which can easily be uploaded into a comprehensive electronic data room will save enormously on transaction costs and a more efficient process. Increasingly data room providers will use artificial intelligence tools to analyse company information. This analysis is useful to sellers and purchasers in understanding material exposures that may need to be dealt with in transaction documentation.
We also expect to see an ongoing use of warranty and indemnity insurance in M&A activity in 2021. Particularly if private equity parties are involved, then it has become almost customary for the seller to be protected by an insurance policy which caps the liability of a seller at a low level for breaches of warranties. This has the advantage of simplifying the negotiation process and increasing the comfort of purchasers that they will have recourse for claims and of sellers that they can walk away from a sale without warranty liabilities hanging over them for years to come.
2021 Due Diligence red flags in food sector
COVID-19 revealed the fragility of the just-in-time globalised supply chain. Due diligence should consider whether the legal framework for a robust supply chain is in place. Compliance regulation also requires producers to know their supply chain and particularly international buyers will want warranties in this regard. For example, the Dutch law on Child Labour (Wet zorgplicht kinderarbeid) is one of many similar European legislative initiatives, which requires companies to investigate their supply chain, in order to prevent that products and/or services are produced/performed with the use of child labour.
Innovation and sustainability
Given the trends in the food sector and the demands of the consumer as mentioned in the introduction (transparency about production, healthy foods and sustainability ), due diligence will also pay attention to relevant aspects such as efficient production, marketing (including brand strength), innovation and sustainability. The Netherlands Authority for Consumers and Markets (ACM) has announced that it intends to step up enforcement against the use of misleading claims and labels with regard to sustainability.
Intellectual property and protection of branding
For many companies in the food sector intellectual property, patents and brands are key value items. Buyers will be asking for evidence of the proper management of intellectual property and registration where possible of patents.
In addition, compliance with legislation by a food company is also of importance to interested parties. For example, compliance with the Dutch Food Hygiene (Commodities Act) Decree, Preparation and Processing of Foodstuffs (Commodities Act) Decree, the Food Information (Commodities Act) Decree, the advertisement rules, Regulation (EC) No 852/3004 on the hygiene of foodstuffs, Regulation (EC) No 178/2002 laying down the general principles and requirements of food law, Regulation (EU) No 1169/2011 on the provision of food information to consumers, Regulation (EC) No 1924/2006 on nutrition and health claims made on foods etcetera. After all, non-compliance can lead to recalls, (administrative) enforcements by authorities and claims from customers. Therefore, non-compliance could impact the brands, the reputation and as a result, the value of the company. This will be no different in 2021.
GDPR and privacy
The substantial fines that can be imposed on parties that do not manage and protect personal information adequately means that this will remain a hot topic. Any food sector player which processes customer data such as online delivery services will be under close scrutiny for infringement of the data protection and privacy regulations
Foreign Investment Review
Dutch companies wanting to expand into foreign markets will need to take account of any restrictions on foreign investors in the foreign market. Across Europe, but also in China and the United States new legislation has been introduced to test the "suitability" of foreign investors sometimes with a threshold investment of as low as 15%. The same applies to inward bound investment into the Netherlands where the Dutch government has introduced legislation allowing for review of controlling investments in vital sectors. While traditionally this may have only applied to sensitive sectors, the COVID-19 crisis has revealed how healthcare and food production and distribution can be seen as vital sectors. This should therefore be investigated as part of any preparation for a transaction.
Interest from parties outside the Netherlands
We also see many mergers with and acquisitions of food companies by parties established in other countries. After all, the Netherlands has a lot to offer. The excellent connectivity to Europe and all continents provides access to 244 million consumers within a 1,000 km radius. Pro-business customs processes and strong infrastructure, logistics and distribution network and deep-water ports help transport food products from point A to point B. The Netherlands is the second largest exporter of agricultural products in the world, second only to the U.S. The Netherlands is also known for its innovation and R&D in the agri-food sector and the Dutch government is keen to stimulate this leadership with for example research incentives.
How can AKD Benelux lawyers help?
Our added value is that we have experience and knowledge of the sector. Some recent transactions in the food sector, in which we were involved, are for example the sale of a mushroom compost producer and distributor which required merger control approval, a private equity investment in an indoor farming developer and manager, and advising management and founders with regard to the participation of US investors in a non-animal protein production facility. In addition our firm received the highest ranking – Top Tier 1– in the field of Food & Beverages from Legal 500 and AKD's Barbara Mutsaers, is ranked as a Leading Individual in this field in the Netherlands. AKD's M&A team is highly ranked in a number of league tables and was recently nominated as one of the leading M&A teams in the Netherlands, while Lennart Crain is recognized by Legal500 and IFLR for M&A and private equity. Therefore, if you have any questions or if you would like any advice, please do not hesitate to contact us.
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