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Five Simple Rules for Getting Deals Done in Brazil
Remember it's Not Kansas
Brazil is not like Kansas nor is it like any other part of the United States. It is a country of 180 million people and it is the tenth largest economy in the world. It is also a country that has been democratic for less then twenty years with governmental and social institutions that continue to evolve. And while Brazilian companies continue to become more transparent often adopting US or Brazilian GAAP accounting standards many social, cultural and economic differences must be recognized.
Unfortunately many American companies often attempt to use the same approach and methodology they use in the US market when doing a deal in Brazil. This is a recipe for failure and more likely then not bruised egos on both sides of the table. For most American entrepreneurs being acquired is often a desirable exit strategy, the positive financial result of building a successful company. However in Brazil being acquired is often associated with a company that is distressed, as many Brazilian entrepreneurs see their business as a way to promote continued prosperity for future generations. As such a significant amount of thought needs to be given to the initial approach as the top performing Brazilian companies may not have any interest in being acquired outright.
Additionally many Brazilian companies are simply not prepared organizationally for the intensity of due diligence especially since many Brazilian CEO's do not have the same level of transparency with their management teams that exists within comparable US organizations. Brazil also maintains an overly complex tax system and while it is improving it still continues to create contingent tax liabilities for many Brazilian companies. In the US this is a black and white issue however in Brazil many contingent liabilities will never become actual liabilities. Obviously no US Company can risk exposure to a potential tax liability however it is important to note that structures can be put in place that can box in contingent liabilities, this protecting the acquirer from potential exposure. By recognizing and addressing this point up front you can avoid killing what could be a lucrative deal.
More often then not Brazilian entrepreneurs will be more interested in what they perceive as an equal partnership with their US counterpart. For the savvy US Company this approach should be greeted with enthusiasm as the right deal structure will insure the long term commitment of the founder to the continued success of the business. Successful Brazilian entrepreneurs also have egos just like their US counterparts. Failure to address this important point early on will quickly result in a loss of interest in any potential deal. Using the country manager or regional VP to lead the discussions without the involvement of senior management to include the CEO will assuredly result in a 'loss of interest' and a dead deal.
Senior management must understand that if they are going to pursue a deal in Brazil it will require a significant amount of time and resources from corporate otherwise the deal will not happen. Developing mutual levels of trust and comfort between senior management teams early on is critical to the success of any deal in Brazil.
Do Not Group Brazil with Argentina or Mexico
I continue to be amazed by the number of Fortune 1000 companies that proudly announce that they have a strong presence in Latin America with operations in Mexico, Argentina and Chile but not Brazil. Considering the fact that Brazil is the largest economy in Latin America this approach would be equivalent to stating that "we have a strong presence in Idaho and Utah but no real presence in California!"
The typical cause of this "encirclement approach" is that Brazil is fundamentally different in language and culture from other Latin American countries. And more often then not the individual that is responsible for Latin America within the organization is from a country in Latin America other then Brazil. This typically leads to a "point of least resistance approach" on behalf of the regional VP or director who then focuses on geographies where he is comfortable often avoiding the largest market in Latin America.
Brazil cannot and should not be grouped with other countries in Latin America. By first recognizing the key differences between Brazil and other Latin American countries you will then be able to approach a potential deal in Brazil with those differences clearly noted. The key differences to note vis-à-vis Brazil include; language (Portuguese not Spanish), size of the market, size of domestic companies and the ethnic makeup of the population.
Language: Brazil was formally a colony of Portugal and as such Brazilians speak Portuguese and while there are certain similarities with Spanish they are in fact different languages. Additionally a certain level of historical rivalry still exists between Brazil and other Latin American countries of Spanish origin.
Size of the market: Brazil is as large as the continental United States in terms of geographical size and with 180 million people it is the largest consumer market in Latin America.
Size of domestic companies: as a result of the size of the domestic market and the Brazilian entrepreneurial spirit many Brazilian companies are dominant regional competitors and in some cases global competitors. Embraer for example is the 5th largest airplane manufacturer in the world.
Ethnic makeup of the population: nothing may differentiate Brazil more from the rest of Latin America then the ethnic composition of it's population. Over fifty percent of the Brazilian population is of African decent, Brazil has the largest Italian population living outside of Italy, one of the largest Japanese populations living outside of Japan and Brazil is home to more Lebanese then those actually living in Lebanon.
By recognizing the key differences between Brazil and other Latin American companies and by resisting the urge to group Brazil with other countries in the region the chances of completing a successful deal in Brazil will increase significantly.
Brazil is a Major Market; Treat it Like One
While Brazil is in fact the 10th largest economy in the world in some sectors its ranking is much higher. Brazil is the 7th largest cosmetics market when globally ranked, in financial services Brazil ranks 8th globally and Brazil is the largest ethanol market on a worldwide basis. Unfortunately the size, importance and complexity of the Brazilian market are often overlooked by senior management teams when a potential deal is being contemplated. In many cases a disciplined methodology that includes; market assessment, target assessment and a quantification of revenue contribution expectations and other strategic benefits is never conducted or the exercise is haphazard in nature.
The market assessment should be the cornerstone of managements approach to a successful deal in Brazil. Without it, it is difficult if not impossible to quantify the appropriate multiple for the deal and as importantly to quantify revenue contribution expectations based on accurate market data. Additionally the market assessment will give senior management a clear understanding of the competitive environment and which companies are outperforming their peers.
The target assessment is equally important but often much more difficult to complete as many Brazilian companies are privately held, not actively looking to be acquired and as such not willing to share the type of data required for a proper target assessment. Some data can be gathered through competitor interviews, website analysis and public records. If the company is a SA corporation as opposed to a simple Ltda they are required to publish their financial records on a yearly basis in the financial gazette.
Once one or more candidate companies have been identified through an objective quantitatively driven approach it will be important to define revenue contribution expectations. Before this exercise can be completed a number of strategic questions need to be addressed: Will the deal expand our geographical footprint? Will we be able to drive our existing products into the market as a result of the deal? Will we be able to leverage a new manufacturing and or distribution platform? Will we have the potential to leverage the target company's products through our worldwide distribution network? Once these questions have been answered a much more accurate revenue contribution model can be developed.
By treating Brazil like the major market it is management will be well informed and well equipped to engage in meaningful and productive conversations with their Brazilian counterparts. It will also facilitate the consideration of alternate frameworks for the deal that could include: joint-ventures, licensing agreements, etc. Additionally, by quantifying the revenue contribution expectations early on management will be able to justify the investment in time and resources that the deal will demand.
Pay Now or You Will Surely Pay Later; Retain and Leverage an Advisor with Proven Expertise
Getting a deal done in Brazil requires an equal mix of market expertise, strategic planning and M&A facilitation skills. Typically US management teams often lack one component of the mix and or they simply do not have adequate in-house resources to commit to the rigorous analysis required at each stage of the project. Unfortunately these points are often glossed over resulting in no deal or worse a bad deal.
In many cases the approach to doing a deal in Brazil is ad hoc in nature with senior management teams relying on old networks or friends that know someone in Brazil "that has a great company." In other cases the target has been identified by the regional manger who often maintains a operational skill set with no relevant experience in strategic planning or M&A. In either case the results can be unpleasant with at a minimum significant amounts of capital being expended on due diligence only to find the proverbial "pig with lipstick"
Retaining an experienced advisor at the beginning of the process that has the market expertise, strategic planning and M&A facilitation skills required to complete a successful deal in Brail is a good investment. And while top tier legal and audit & tax professionals will be essential to the successful structuring of the deal and due diligence these entities should not be leveraged until the optimal target candidate has been identified.
When assessing potential advisors be sure that the senior partners within the firm will be actively involved in the project and not simply providing a resume. It is also important to insure that the engagement is not simply passed on to their Brazilian counterparts who may not really understand what the client requirements are. Additionally look for advisors that are willing to share some level of risk often by agreeing to deduct their professional fees from the transaction fee or by linking a portion of their fees to the financial success of the transaction.
Minimize the Risk to Shareholder Capital; Look Before You Leap
Brazil is in fact one of the largest emerging markets in the world with strong economic performance and a country risk rating that is now approaching that of Chile and Mexico. Nevertheless Brazil is still a work in progress with significant disparities between rich and poor, high levels of corruption within the public sector and a legal system that moves at a slow pace. For these reasons and others it is prudent to develop transaction models that minimize the risk to shareholder capital and optimize the chances for long term success in the market.
As was noted earlier many successful privately held Brazilian companies are not typically looking to be acquired. They will however be keenly interested in developing some type of partnership with their American counterparts. This approach should be leveraged as it will help minimize the risk to shareholder capital if structured properly. The exact model used will be somewhat dependent on the specific sector in question. However for purposes of this paper we generally recommend the development of a joint-venture in the form of a NEWCO.
By creating a NEWCO that is 51% owned by the US Company and 49% owned by the Brazilian entity all financial and operational SOP's can be put in place at the inception of the new company. This would include audited financials prepared by a top tier audit & tax firm. Within the JV agreement valuation metrics and a call option would be put in place that would allow the US Company to acquire the remaining equity in the JV and a majority stake in the Brazilian company at a defined point in time.
The advantages of this approach are numerous and include: minimal outlay of upfront capital as opposed to the cost of a direct acquisition; protection from any potential exposure to contingent fiscal and or labor liabilities that a direct acquisition might entail; ability to develop mutual trust and confidence between the two parties; ability to validate the revenue contribution model that had been previously identified; and the ability to provide the Brazilian partner with sufficient time to bring his own financial and operational SOP's in line with those of the American counterpart prior to being acquired.
The overall acquisition costs associated with this approach will be higher but this is a small trade-off when compared to the costs associated with a bad acquisition and a potentially failed entry strategy.
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