A practical guide to ensuring success in Latin American partnerships

Latin America is a region with a complex mix of markets of different sizes and various cultures. As such, it is natural for an investor that intends to invest in the region – or an investor from a Latin American country that looks to expand into other neighbouring markets – to consider partnering as a logical pathway to achieving their goals.

Given Latin America’s reputation as an emotional and family-centred region, it may be fitting to use marriage as an analogy for strategically thinking about partnerships in the region: business partnerships require a lot of work before and after ‘heading to the altar’. In both situations, it is key to make sure that the ideal partner has been found. A company cannot afford to ‘fall in love at first sight’, and a thorough diligence process is required to ensure the fit is adequate for a particular investment opportunity; a poorly functioning partnership may annihilate the returns of even companies that are the most well-underwritten, have the most positive cash-flow and are growing the most intensively.

This chapter focuses on key items to bear in mind when considering partnerships in relation to a business opportunity in Latin America. The approach taken in this chapter is in the context of a joint bid arrangement in an M&A opportunity, but most of the topics discussed herein are useful for partnerships generally, including mergers and joint ventures.

Why partnering?

When looking at M&A opportunities in Latin America – as well as in the rest of the globe – it is not uncommon to find within the pool of interested parties for an asset two separate investors bidding jointly as one single bidder. There are several possible reasons behind partnering with another player in an auction process. This chapter categorises these reasons into four subsets: (1) access to capital, (2) strategic value, (3) unlocking of a transaction and increase of the chances of success in an auction, and (4) access to further opportunities.

Access to capital

Access to capital is one of the main reasons why players decide to join together to submit a bid. At the time of writing, despite recent improvements in microeconomic conditions and the downwards trend of interest rates in many jurisdictions, market conditions in recent times have been very challenging for many players as higher inflation and interest rates have increased the cost of capital required to acquire businesses, and the access to capital for M&A, especially equity, has become scarce. These conditions limit liquidity available to many prospective bidders in M&A processes, and with restraints to access bank credit or the debt capital markets, more bidders have been resorting to clubbing and joint bid agreements to remain competitive and match sellers’ expectations in sale processes. This is not new and has been the case countless times in the past, following the ebbs and flows of the economic cycles.

Nevertheless, it can be risky to partner with an external group just to reduce costs. It is recommended that the need for capital be accompanied by at least one of the three other reasons in this section to partner for the risk-reward equation to tilt towards forming a partnership.

Strategic value

When considering joining another player in bidding for an asset, companies should contemplate the specific value that the prospective partner brings to the table: is there anything that this partner can provide or do that the company would not be able to achieve on its own?

There are many angles to focus on when it comes to the strategic advantages and synergies a partnership can offer. For instance, partnering with a leading operator with key sector expertise could potentially help to grow a business faster and on a larger scale and take advantages of opportunities that could otherwise be neglected or not fully exploited. Alternatively, joining a local partner with deep understanding of the geography and on-the-ground dynamics can be useful in industries or jurisdictions that require first-rate local market knowledge.

A partnership can also provide strategic solutions that are otherwise unattainable, such as joining forces with a competitor of the target company for post-closing market consolidation, with due regard to antitrust considerations so as not to materially reduce transaction certainty, which is normally one of the most critical considerations from a seller’s perspective.

Unlocking transactions and increasing chances of auction success

There are many reasons why a transaction can go sideways. In certain cases, partnering can be a way to unlock a transaction and increase the chances of success in a competitive process.

In situations where a player fails to advance to the binding phase of a private process but continues to have high appetite for the asset, reaching out to one of the remaining bidders to propose a partnership might be one of the only options to maintain chances of securing a stake in the asset. Likewise, even if the company is selected to move forward in the auction process, there might be value in it partnering with a bidder that is out of the race – or even one that was not participating in the process – to increase its competitiveness.

Alternatively, it is not uncommon for a seller to wish to maintain a stake in the business as a condition to sell or, similarly, for a key contract of the business (e.g., a concession agreement) to require sponsors with characteristics or qualifications that a bidder may not possess and, therefore, to require the current owner to stay invested, thereby forcing a partnership.

Finally, another common bidding group configuration is the combination of two or more bidders interested in different parts of the company or portfolio on sale. In this situation, only a partnership would facilitate there being a destination for most or all parts of the assets for sale.

In short, partnering can be a tool to access transactions that would not otherwise be available or to increase the chances of success in a competitive process.

Access to further opportunities

Another appealing reason to partner is to initiate or further develop a relationship with a reputable, well-positioned peer that may generate valuable future opportunities that may otherwise be out of reach. A top-rate partner may have access to opportunities open to few companies in the relevant field. Such a partner may also be open to the idea of replicating the partnership with the company in other opportunities if the partnership has been working well.

Of the four reasons to partner cited in this chapter, in most situations this is probably the one that should be considered exclusively as an upside, as its entire value would reside in hypothetical future business opportunities, outside the scope of the original transaction that gave rise to partnership.

Further considerations

In addition to understanding why to partner and the reasons behind a potential partnership, it is also important to take into consideration that certain classes of assets are better suited for partnerships than others, and this should be taken into account when considering whether to partner for a transaction. Like a marriage, partnerships are not easy, and not everything will be perfect all the time; in all likelihood, there will be a number of matters on which the partners will have different opinions.

For those reasons, partnerships are generally better suited for businesses with a lower number of potential conflicts of interest and, if possible, businesses that do not demand a constant flow of hard strategic decisions, as fewer tough decisions to make means fewer opportunities for disagreements. In infrastructure, for example, assets with lower operational complexity are more befitting than assets with higher operational complexity. As such, highly contracted assets, with long-term take-or-pay agreements, are better candidates for partnerships than businesses that are uncontracted or prescribe high growth, or that have high operational complexity, which can be tricky to manage with a partner.

All the above is to say that before ‘heading to the altar’ or signing the definitive transaction documentation, it is important to have a very clear conviction of why, and with whom, partnering makes sense.

Steps to achieving a successful partnership

Forming a successful partnership requires prudence. To that end, this chapter considers three items, in the order they are listed, as key points of consideration before committing to a partnership: (1) selection of the right partner, (2) the existence of a strong bond with the potential partner and (3) agreement on appropriate governance.

Partner selection

Achieving a successful partnership requires selecting the right player to partner with ahead of, or during, an M&A process. The main consideration in this regard is alignment. A company must partner with a player that is aligned with its view on the most relevant aspects of the business and that shares the company’s investment perspective.

A number of factors should be considered, and partners do not necessarily need to be perfectly aligned in all these factors. For example, financial sponsors consistently partner with strategic buyers that have no intention to ever exit; however, if the partners’ views diverge on most accounts, the partnership is bound not to work.

Due diligence is the best way to mitigate such risk. Whenever considering a partnership, performing due diligence on a prospective partner is almost as important as performing diligence on the target company. Among other key matters, diligence should be focused on the following:

• Investment profile: it is important to understand the type of buyer the prospective partner is. In addition to differentiating strategic from financial players, companies should understand how the potential partner would benefit from the investment: is this an asset that is critical to the potential partner’s core business or investment strategy? Would the partner be willing to inject more capital into the business as necessary to meet its operational or expansion objectives? Will the partner dedicate time and resources to work together with management in meeting those objectives? Is the partner’s investment horizon perpetual, long term or short term?^[2] Confirmation of meaningful alignment between partners beforehand is crucial.
• Operational expertise: it is important to assess the level of experience that the prospective partner has in the industry of the target before counting on its ability to add value, foster synergies and accelerate strategies in the target business. If dealing with a financial sponsor, the company should consider whether the potential partner has experience investing in this particular field and dealing with management teams in the relevant asset class.
• Track record on partnerships: the company should study the potential partner’s track record on partnerships. A company with a history of failed partnerships, private or public disagreements or even litigation with partners is an ominous foreshadowing of a relationship that could bring about a bad investment.

Two additional thoughts on partner selection:

• One is better than more. A monogamic, two-party partnership already presents challenges, and a partnership with multiple partners has more chances to present problems than a two-party alliance.
• The downside of 50-50 partnerships should not be underestimated, as deadlocks will be more frequent and could generate constant friction between the partners. Notwithstanding potential discussions around supermajority matters, day-to-day decisions should be more straightforward if it is clear which of the partners is sitting in the driver’s seat.

Strength of the relationship

The second step to a successful partnership is having a strong bond with a partner’s principals. Before engaging with a partner, the company should inquire whether there are established, solid connections between senior members of each organisation. If there are none, it is important to work towards building them before joining forces. This is crucial since having a direct channel to escalate potential disagreements in key decisions is likely to be the first, and most harmonious, path towards resolving deadlocks.

It is vital that these deep ties between partners be developed not only at the most senior levels but also at less senior levels because it is often the more junior or mid-level professionals that are involved in the day-to-day management of a business.

There should be clear channels of communication between the highest ranked officials of each organisation to resolve essential matters of the business, while more junior members should also establish solid relationships to secure day-to-day efficiencies and productivity.

Rules of engagement

Critically, establishing appropriate rules of engagement within the partnership is as important as choosing the correct player to partner with and having an established relationship. Players should find creative solutions to address each of the parties’ priorities and concerns in the shareholders’ agreement. The two key issues in which partners should align before sealing an alliance are governance and liquidity.

Governance

Although there is no universal recipe to be followed, there are some general parameters partners should look to address early in the discussions.

Board composition

The board should be appropriate for the asset, and it is usually advisable to keep the board process as simple as possible. Subject to applicable local laws, board meetings should be scheduled on a regular basis (e.g., quarterly or monthly) depending on the asset and be used as an opportunity to update the board members (typically senior officers of each of the partner groups) on the asset’s performance, key objectives and challenges ahead.

Advisory committees at the asset level may also be useful for most companies, with representatives of each partner that are more directly involved with management in the running of the business helping the company navigate potentially complex shareholding structures, facilitating the role of the board members and ensuring a more seamless decision-making process.

In terms of the structure of the board and the committees, a majority partner generally has the right to appoint a majority of the members of the board and each of the committees. Fifty-fifty partnerships require more work to come up with creative solutions on the number of directors, committee members and decision-making processes.^[3]

Selection and supervision of management team

It is important to understand the characteristics of each partner and how much leeway each party prefers to give to the management team to operate the business or, alternatively, how involved the party would like to be in the running of the asset. Governance documents should also address in detail the mechanisms not only for the selection of the management team but also their renewal and termination.

The somewhat common approach of assigning to each partner the right to appoint different executives may not be advisable for most companies; this mechanism often leads to disjointed management teams that fail to collaborate.

Supermajority matters

Intrinsically related to board composition and the selection and supervision of the management team is the definition of a list of matters that require consent from a qualified majority to be executed. Typically known as ‘supermajority matters’, this list sets out key issues in relation to the operation of the asset (e.g., approval of the annual budget and business plan) and other material aspects of the business (e.g., capital structure, acquisitions, divestitures and dividend policy) that, given their importance, require support from most of if not all the shareholders.

The perspectives vary depending on the type of investors involved and their respective stakes in the business. For instance, strategic buyers tend to seek more control on the operating aspects of the business as, in principle, they should have more experience on running the asset, while a financial sponsor might be more focused, for example, on the financing plan and the dividend policy.

Nevertheless, the strategic investor will definitely want to have a say on the dividend policy as the rate of reinvestment may impact the operation of the business, whereas financial sponsors will also be very interested in closely monitoring the operation of the business to ensure that it is run in a way that will allow it to deliver the underwritten returns.

Partners should agree on a balanced list of supermajority matters that give each other certain vetoes and negative control over the business but that avoid paralysing the asset each time a material decision needs to be taken.

Deadlock mechanisms

Depending on the approval threshold defined for the supermajority matters, in situations in which consensus is required to approve the decisions, deadlocks are practically inevitable. There are various mechanisms to address deadlocks in shareholders’ agreements. A balanced approach may be to initiate the deadlock resolution protocol by using consensus-seeking processes, such as escalation to senior officers of each partner or third-party mediation, and to resort to more extreme proceedings, such as a compulsory ‘en bloc sale,’ ‘Russian Roulette’ or ‘Texas Shootout’ mechanisms,^[4] only if no resolution is achieved.

Injections and dilutions

When investing in a business, each partner should be aware of the magnitude of the capital needs of the business in the subsequent years. Even when no fresh equity injections are expected to be required, it is key for there to be clear rules for the company to have access not only to financing but also to equity injections from the shareholders. Accordingly, the shareholders’ agreement should establish clear rules for capital raises and defined rules with respect to the dilution of shareholders that decide not to participate in a round of equity raising.

Liquidity

The M&A toolbox contains various mechanisms to accommodate the needs of various types of investors with respect to liquidity. As in governance, much depends on the particularities of the partnership and the characteristics and priorities of each partner. Some of the most commonly implemented liquidity rules are detailed below.

Lock-up periods

The determination of a period in which no shareholder is able to divest is not uncommon in partnership agreements. This can be an important tool in situations, such as when an investor is initially relying on the other shareholder’s expertise and know-how.

ROFO v. ROFR

It is quite common for governance agreements to contain preferred rights for incumbent shareholders to acquire the shares of an outgoing partner, and the right of first offer (ROFO) and right of first refusal (ROFR)^[5] are perhaps the most common ones. Investors should be aware that ROFOs and ROFRs tend to have strikingly different impacts on a possible sale process of a stake.

From the perspective of an investor that sees itself seeking liquidity in the future, an ROFR may negatively impact third-party interest in participating in a future sale process: prospective bidders may decide not to dedicate time and resources in a process in which one or more incumbent shareholders possess a better set of information and might easily take the asset if the price offered was fair.

In contrast, such an impact on a sale process is much less prominent when there is an ROFO in place, as third-party bidders would not have to be concerned with an actual matching right from incumbent shareholders that are much better acquainted with the asset.

There are other possible factors in the ROFO v. ROFR dynamic. For example, an investor that prioritises shareholder base stability over liquidity avenues may have a strong preference for an ROFR.

Tag-along rights

Tag-along rights are typically included in shareholders’ agreements as a protection right to a minority shareholder, as it not only allows the minority shareholder to participate in potentially advantageous transactions even if its stake does not tilt the scale from the acquirer’s perspective, but it also provides the minority shareholder with a mechanism that allows it to exit in case of discomfort with the prospective change in the shareholding base.

A variation to consider could be providing for a joint-sale right instead of a tag right, whereby the minority shareholder would have the ability to join the sale process initiated by the majority shareholder up front, as opposed to a back-end tag-along. This provides more clarity to potential bidders on the transaction perimeter or size, and capital needs to execute an acquisition from the start of the process, increasing the chances of a successful transaction.

Drag-along rights and en bloc sales

There are variations to a typical drag-along right,^[6] including pre-established parameters to be able to trigger it, such as a guaranteed minimum return on the investment of the partner that is being dragged on as a result of a proposed sale. A minimum period before a drag-along right can be triggered is also common. These parameters can also be added to an en bloc sale right, and there may be different approval thresholds depending on the time the right is being triggered.^[7]

Registration rights

Registration rights or rights to trigger an initial public offering are less common in Latin America and are usually not the preferred route to exit because of the lack of depth in the capital markets. Nevertheless, these options are still within the spectrum of opportunities and are worth exploring and addressing in partnership documentation.

Summary

Governance and liquidity arrangements must be at the forefront when considering a joint bid for an asset. Each partnership is different, and these considerations must be addressed in each situation. Without adequate governance and liquidity principles, the partnership is likely to struggle.

Joint bidding arrangements

Once the most suitable partner has been selected, there are steps and considerations to take before presenting a joint bid for an asset.

First, in structured and sophisticated M&A processes, non-disclosure agreements typically include language by which a bidder is prohibited from contacting third parties, effectively blocking bidders’ ability to enter into an agreement with a third party to act as joint bidders. This is understandable as sellers want to increase the number of bidders to maximise competitive tension. Players must be careful not to breach that limitation; any bidder that intends to explore a group or consortium arrangement should make that intention clear from the start and ideally embed it in the non-disclosure agreement, or obtain specific authorisation to explore such arrangements during the process.

Once cleared by the seller to proceed, partners should formalise their joint bid agreements. One key item to consider in this type of agreement is whether they are exclusive and what happens if one of the partners decides not to continue in the bidding process. A partner may ‘fall out of love’ with the other but want to continue in the process alone or with a different bidder. Alternatively, as diligence is conducted, one of the partners might become less convinced of the attractiveness of the asset and want to exit the process. Ideally, joint bid agreements should address how these situations will be handled and clearly state rules for the withdrawal of a partner and what the parties can do thereafter in respect of the auction. This type of agreement should also contain a cost-sharing protocol that regulates how expenses will be covered. Parties should be cautious about information sharing and make sure that strong confidentiality provisions are included in the clubbing arrangement.

During an auction process, particularly through the due diligence stage, partners should aim to have fluent and constant communication to discuss any issues with the target that might be uncovered during the diligence exercise. In an eventual negotiation phase, clear single sets of instructions to joint counsel will ease the process and help to prevent mistakes owing to contradictory instructions.

It is also important to consider whether one of the partners will take the role of the lead investor before the seller and its advisers.

Finally, if their bid is successful, partners will need to decide how to execute the joint acquisition. Mostly for tax-driven reasons, since the chosen structure needs to be tax efficient, but also for liability purposes, partners may execute the transaction through a newly incorporated entity by both partners that has been established especially for the acquisition and future operation and capitalisation of the asset, or they may directly acquire an interest in the target entity, each individually through their own corporate vehicles and, in the future, capitalise the asset directly. Either way, this analysis should be done early by each partner.

Conclusion

While each M&A deal is different, and priorities vary when considering a joint bid arrangement, for a partnership to have a ‘happily ever after’, it must be based on three main principles: alignment with each other, strong relationships, and clear governance and exit strategies.

Endnotes