As business objectives evolve, Japanese companies are increasingly looking to sell their non-core subsidiaries and business lines abroad (Target Business). Once the strategic decision has been made to sell the Target Business, there are still a number of potential issues for seller management (Seller) to consider regarding how the sale could impact other existing businesses or future business. It is important for management and their legal advisors to discuss these issues up front so they are ready to deal with them in the sales process.
Identify the Key Issues
One of the key aspects to selling a Target Business is being prepared well before the sale process starts. It is important to recognize that you, as Seller, are in a position to identify key issues and manage the process of dealing with them prior to engaging in negotiations, and either try to resolve them or position them as being something the buyer must take on as part of the transaction. Some common issues and factors to consider include:
- Material disputes: is the total risk known, how certain is the potential loss, can they be settled prior to selling or will the buyer need to take those over?
- Key debt instruments and other credit support arrangements: are these cross-collateralized with other assets or businesses, are they guaranteed by the Seller or its other group companies, do they need to be replaced by the buyer or paid off by the Seller prior to closing?
- Significant capital or debt commitments: any long term obligations that a buyer would want to know about and are such commitments fixed or terminable?
- Existing business partnerships, strategic alliances, etc.: are these key relationships for the Seller’s other businesses that should be retained or should they be sold with the Target Business?
- Are there any transfer restrictions or other restrictive covenants such as non-competes that need to be considered?
- Contracts with certain third parties that have historically been difficult and/or material accounts receivable delays: how will these be priced into the transaction, can they be settled prior to the transaction?
- Intellectual property, including licenses, ownership rights and retention of rights (discussed further below).
- Material tax issues based on the Target Business’ profile or potential transaction structures.
- Long-term obligations such as payment, guarantee or warranty obligations: will these be treated as indebtedness of the Target Business and reduce the purchase price?
- Anticipated indemnification obligations in connection with any of the above: while initially the Seller will seek to have the buyer take all of these over, it is helpful to quantify the risks and decide if they could accept bearing any of the risks.
- Any potential ESG risks, which are increasingly an issue for buyers especially for PE buyers and buyers from jurisdictions where there are current or pending regulations in place that could be applicable to a buyer (discussed further below).
There is almost always some form of licensing or other intellectual property sharing arrangement involving the intellectual property portfolio of the Target Business and the other group companies, and potentially with unrelated third parties as well. Understanding where in the group companies any intellectually property of the Target Business is currently used or planned to be used (and vice versa with respect to the other group companies’ intellectual property used by the Target Business) and where the intellectual property is licensed to third parties will be key to determining what rights the Seller needs to retain and what issues it may present to a buyer who will, not surprisingly, expect to have full rights to (including in many cases ownership of) the intellectual property used in the Target Business. More generally, it is important for group companies to have an understanding of where licenses and sublicenses have been provided or received, and the scope and terms therein, as potential buyers will want to get comfortable with the scope of existing licenses or otherwise the Seller may have to cover for losses related to the outstanding licenses. Clearly documenting these considerations at the outset and understanding the structure of the arrangements up-front can help avoid bigger issues as the transaction gets finalized.
For large Japanese corporations, there are typically sales, services, and/or logistics from the Seller’s various group companies supporting the Target Business. A buyer may expect or need to carve-out those functions and personnel and include them in the underlying transaction to ensure they continue to support the Target Business. Prior to starting the sales process, it is important to map out the roles performed by other group companies in relation to the Target Business and also consider what would be essential for the Target Business and what the Seller is willing to part with. Common intercompany arrangements include:
- If there are assets located in group companies, such as intellectual property or inventory, consider if those are something you are able to sell or if there would need to be a license, use rights or other arrangement.
- Contracts that need to be assigned to the Target Business or buyer that sit in your group companies (e.g., parent guarantees, subcontractor arrangements, secondary agreements such as equipment supply or manufacturing contracts).
- Intercompany financing arrangements and how those will be terminated or otherwise paid off prior to closing.
- Insurance, employee benefit plans, support services, equipment, services or property shared between the Target Business and other group companies.
- Personnel of other group companies that support the Target Business through an interparty arrangement or by way of normal business operations (discussed further below).
Certain intercompany arrangements may be addressed through a transition services agreement, although there may be instances when an existing intercompany arrangement is an arms-length commercial transaction that the parties want to continue (or contract a similar arrangement to continue post-closing). Also, it is critical to address any gaps in overall business operations as a result of selling the Target Business post-closing, such as key personnel or resources that you previously relied on the Target Business for and will still need going forward.
Group Company Employees
If the Seller has seconded people into key roles at the Target Business it will need to be determined whether such individuals should be transferred back to the respective entity, retained by the Target Business post-closing or retained by the Target Business for a designated period of time (via a contractor or transition services arrangement). There may also be individuals or business groups located in other group companies that support the Target Business who may need to be transferred, especially if they were hired for the purpose of supporting the Target Business. Specific negotiations may thus be needed with such seconded employees and their respective group companies, ideally prior to signing the definitive purchase agreement. With respect to all employees regardless of location or affiliation to the Target Business, it is necessary to understand the relevant labor laws, which are unique to each jurisdiction and will be of relevance regardless of the number of employees involved.
Another factor to consider is whether the Seller or other group companies overlap in business operations with the Target Business, as this too will impact the deal structure and transaction terms including any non-compete that a buyer may request or the seller’s ability to service and maintain other businesses. Upon closing the sale transaction, the Target Business will no longer be in your control and it will no longer be a group company. Accordingly, just as buyers want assurance of the business it is acquiring, Sellers should take steps to implement necessary measures to address and control any risks you are keeping post-closing.
New Emerging ESG Diligence
One final note for Sellers to consider is the increasing focus and regulatory requirements on foreign buyers, especially PE and European buyers, on ESG risk around human rights and environmental due diligence (HREDD) including obligations for buyers to take measures to identify actual and potential adverse human rights and environmental impacts related to operations and their supply chain. Countries such as Germany and the Netherlands already have implemented these and the European Commission has proposed a directive for all European Commission countries.1 As such, a Seller should understand if there are any potential red flags in the Target Business or its supply chain related to HREDD and supply chain management generally.
Selling a Target Business with independent operations can be a fairly straightforward process, but, as discussed above, there are often many interconnections between the Target Business and the Seller and its other group companies that need to be understood and addressed up-front. The better understanding of the Target Business early on, the better prepared you can be in both managing risks and finding solutions to address potential issues. Having a prepared yet flexible plan before you get started in negotiations can help you maximize the value of the sale while minimizing transaction-related risks.