Difference of M&A in the US vs Latin America
When you come to Latin America, you normally talk about buying mid-sized companies, usually family-based companies, because when you come from a big corporation from Europe or the US and try to grow in this area, you want to buy those companies. Most of the conversation here would be around those types of companies.
Obviously, there are big local companies in Latin America that are public companies listed on the stock exchange, organized like US standards with proper accounting standards, governance, and so on. But let's focus on the other set of companies I'm talking about: mid-sized, originally family companies.
When you go there, you'll find several differences from the world that you know in the US, starting with the fact that we live in a world of complex regulations from all standpoints.
Brazil is on top of the list of countries with very complicated regulations.
- Labor regulations and lack of flexibility in terms of labor management
- Tax regulations. Brazil has a very complex tax structure at the state and federal level.
If you go to Brazil, you will find that most of these companies have big liabilities in terms of taxes, either with the state or the federal government. I have found through the years that when you sit with the owners and try to adjust the price for the tax liability, they will say, "No, that's not a liability. That's something we have been handling." It's basically a rolling tax liability that they don't like to recognize as a price adjustment. That's very common in Brazil.
Additionally, when you go into labor issues, you will find that there are certain schemes of compensation, or shadow compensation, particularly for the upper management. Most of the companies have these, either paying in another country, another currency, or in other ways.
Unfortunately, that's normal and it happens for various reasons, such as structural reasons, tax reasons, or sometimes looking for short-term cost-saving measures. As you know, there are many taxes associated with payrolls in Latin America, so companies try to save money by avoiding those additional payroll taxes.
When a serious multinational company comes in, they simply cannot accept those kinds of schemes. Our first step in buying those companies is to normalize, regularize, and bring everything up to standards.
Going through that process can be difficult because it might cost the person or the company, and you might lose some people. There are also gray areas when it comes to environmental issues, and it's not because of regulation. On paper, regulation is pretty standard in America, with some countries being more advanced than others. However, compliance is another story.
There are instances where you go to a company, look at the regulation in terms of environmental issues, and it's rare to find a company that is 100% in compliance with what is on paper. Accounting practices are not necessarily standardized either. It's not that you're going to find mid-sized family companies with international accounting standards like IFRS in compliance in those companies.
Another issue I would like to mention is around titles and property. It's very common that you might find problems in this area. The reason for that is most of these family companies have a lot of history behind them. Probably in the process of growing and adding properties, they didn't follow the proper procedures or find the proper titles.
When you are local, it's easy for you to manage that and navigate around it. But when you come with a big name, as a multinational company, you have a reputation to uphold, and you operate strictly according to regulations and local norms. You can't live with gray areas.
While locals tend to be more comfortable operating in these gray areas and managing the day-to-day with authorities and regulations, when you bring your company's reputation and way of doing business into these kinds of companies, the adjustment process can sometimes be complicated.
There are some cultural differences when looking at Latin America from the US perspective. Even though we classify it as Latin America, there are different ways of doing things in Mexico, Brazil, and Argentina. Mexico tends to be much more formal culturally, while Argentina, with its Italian origins, is much more informal. In the middle, you find many ways to do things. As I mentioned before, Brazil is basically a country of regulations, with everything on paper.
To mitigate risks, you need to understand local regulations, and to do that, you need locals—people who understand taxes, labor issues, legal matters, and environmental issues. Those are critical areas, and you need to work with locals and conduct proper due diligence to assess the company.
Sometimes, part of the problem is that information is not necessarily available in the way that you're used to, starting with financial statements. There are delays, so if you want to close a deal based on financial statements on December 30th, you probably wouldn't have that until February or March. So, proper due diligence using local people who understand local regulations and finding as much information as you can is essential.
I don't want to leave the impression that everything is disorganized in Latin America. I'm just trying to be cautious and provide insight based on experience. When you go to a mid-sized, family-owned company with two or three generations, that is what you normally find.
The first generation rarely wants to sell, the second generation is in transition, and by the third generation, it's more likely to find a buyer. These mid-sized family companies tend to be very informal in every country.
You can also find experts that have good reputation. Normall they have reference. Ask around from lawyers in the US and see if they have worked with anyone in Mexico or Argentina. There is a network that can be used.
And then on accounting or the tax side, you always have the big four present in these countries. There are akso experts in environmental issues that also have operations in the different countries.
I don't think there is a specific secret or difference when it comes to dealing with business in Latin America. Mexicans tend to be much more formal, while Argentinians or Caribbean countries are more informal. This includes everything from dress code to the way people are addressed.
When looking for an acquisition in Latin America, you're obviously looking for market growth and potentially strategic assets. However, at the end of the day, you're looking for a team of people that can work with you, maintain the business, and help it grow. You want to bring the best from outside while taking the best from the local business. It's important to maintain the local team as much as possible and integrate them into your existing team.
If you are a US company going into Brazil, for instance, and try to bring only your executives, standards, and practices from the US, it will not be easy. There are limits to what local people are willing to do and how they are used to doing things. You have to be flexible and balance both worlds to get the best of both.
In the process of making acquisitions, the strategic choice, finding the target, conducting due diligence, and negotiating are the easier parts. The complicated part comes in integration. Success lies in balancing what you find with what you bring. Part of the success of a company like Smart Capital Group in making acquisitions has been understanding this and combining the best of both worlds through a proper integration process.
It is very critical to communicate and manage expectations. You need to go there, bring your team, and clearly state your expectations. Get their expectations as well and agree on certain things.
There are several sources for finding acquisition targets, but it's rare for mid-sized businesses to pay the fees and costs associated with using large private investment firms or well-known names in investment banking. It's often not affordable for deals around 250-400 million dollars, as it would take a significant portion of the deal's value.
There are small, private investment firms and boutique firms in Latin America that may find targets and bring deals to the table. However, most of the time, targets are found by the companies themselves. They know their business, have their strategy set up, and are aware of where they want to be. They have information about the reputation of potential target companies in the market.
In many cases, a direct approach is made to the right person in the organization. Sometimes this results in a closed door, but other times the door is open, and a deal can be made. Using big names in investment banking is not the norm for these deals; instead, smaller firms or direct contacts are more common.
Sometimes, finding the right person for an acquisition involves a direct call. By bringing value to the table for both parties, it can lead to potential deals. In the business world, it's often a small community where you know who the key players are in a particular industry, such as the paper business in Mexico. By knowing the owners, managers, or decision-makers, you can approach them in the right environment, ensuring proper protections from an anti-trust perspective.
You can sit with them and discuss the possibility of combining businesses or even ask directly if they are interested in selling. Sometimes, they may be open to such opportunities.
Sometimes the best approach is direct approach. You just tell them that their business is good, and we like it. Are you interested in doing a deal. There’s nothing wrong in asking. If they are not interested, then we can be friends. It’s not that complicated.
Getting companies interested
At the end of the day, it's reputation on both sides that plays a crucial role in acquisitions. People in the business know who Smurfit Kappa Group is, and they're aware of the deals that have been made throughout the years in different countries. The industry community is not that large, so if you go to Argentina, for instance, people in the paper business know who Smurfit Kappa Group is and the deals they've made there.
Ultimately, it's your reputation that precedes you and helps get deals done. If you go into a market and destroy businesses and relationships, you won't find much success. When acquiring family businesses, price is essential, but so is the legacy and the well-being of the employees.
Smurfit Kappa Group has offered protection to employees and preserved the companies they've acquired in various countries such as Mexico, Argentina, Colombia, El Salvador, and the Dominican Republic.
Having a good reputation can create curiosity, opening the door for conversations. If a company doesn't have a good reputation, it becomes nearly impossible to make successful deals. By offering a fair price and steering the company responsibly throughout the years, Smurfit Kappa Group has been able to maintain its positive reputation in the industry.
Dealing with Legacies
Company communication and reputation management are sometimes equally critical to managing the financial aspects of acquisitions. Addressing social issues and treating shareholders well is vital.
Sometimes, these shareholders are also managers, and effectively communicating with them and setting clear expectations for both parties is important. In some cases, it's beneficial to have them help with integration and transition. Ultimately, communication is key at the end of the day.
There are no secrets when it comes to acquisitions; the key is to ask and communicate openly. It's important to be flexible and understand the needs and desires of the people involved. If you approach an acquisition with a rigid mindset, you may risk losing valuable talent and knowledge.
It's crucial to evaluate the existing structure and management, and to understand why things are set up as they are before making any drastic changes. Acting too quickly might lead to mistakes, so it's better to take a more thoughtful approach to ensure a smooth transition and integration.
Red Flags in deals
Sometimes you fall in love with the deal. You've invested time and know that it fits your strategy very well. You go there and find good assets and even a good portfolio of customers. But then you start finding problems in labor issues, compensation, environmental problems that haven't been properly managed, liabilities that you find in the balance sheet without proper explanation, and other issues we just mentioned.
You even find companies that don't have the proper permits to operate in certain areas. They're not updated, and they don't have the necessary permits from fire authorities. Since you're already in love with the deal, you will attempt to fix the issues and try to manage them and expect everyone to change.
But then, you try to justify everything along the line because you've already set your target. That's very dangerous because it may get complicated and make it difficult to get the deal done. So, when you start finding red flags, you better get out because it might be too late.
The easiest way to see it is to transfer it into the price you are paying for the business.
At the end of the day, you are committing yourself, your board, and your management to a certain multiple of EBITDA. When you start finding those issues, it's either more money upfront or less EBITDA in the future because it will cost a lot to fix those problems.
They are fixable, but they need money and time. So you have to ask yourself, what's the impact on price for those issues you're finding, and are you willing to live with that problem and risk for a year or a year and a half that it will take to fix the problem?
Then, are the owners willing to provide the proper representations and warranties for the problems you find? That's very common, for instance, in environmental issues because you can correct the future, but the past can be costly.
A company that has been dumping waste improperly is a real liability. If you're a local company like Martinez and Martinez company, it might not matter, but if you're part of a larger group, the standards are different. You can correct the future, but the past is there, and you need the proper representations and warranties. When you ask the shareholders for guarantees and they say no, that's a red flag.
Maybe there isn't a set of rules, but price is an issue. It's about how the shareholders are willing to work with you in solving the problems and how much time you're willing to live with that risk in the future.
You need to set your own expectations and have a clear understanding of what you want from the business. Sometimes you might have a big strategic plan, like expanding your footprint in Brazil, but it's important to know your expectations in terms of performance, market share, and margins.
Then, sit down with the new management, whether it's the former manager or someone new, and discuss your expectations. Ask for their input and work together to create common goals. It's normal for people to agree to everything at first, but it's crucial to set realistic expectations on both sides and have proper follow-up.
Set targets for the first month, three months, six months, and a year, and make sure to follow up on them. Certain aspects of the business may be urgent, such as implementing a code of conduct or safety standards. You need to establish a timeline for addressing these issues and work with the team to adapt to new standards and expectations in various aspects of the business, such as productivity, financial reporting, and margins.
Once you make the closing, everything starts at a different pace. You need to be there and have a plan for day one. You can't expect to make the closing and then start your plan. Through the years, we have standardized our approach, outlining what we want on the date of the closing, the next day, and the first week.
This includes addressing the basic aspects that the company doesn't have, like safety and other crucial factors. It's important to have a clear plan and timeline in place to ensure a smooth transition and successful integration.
Alignment before closing
I would say the code of conduct is important, and people need to know how the business will operate in the future. Are you willing to work with us under these new rules? Yes or no? If not, that's a given – you're out. We don't have any leeway on that.
Safety is another big issue for us. We're very proud of our safety record in every operation. We're willing to invest in training and resources, but in the end, we need people to operate safely for their own good and for the good of their teammates.
Those are the kinds of things that are black and white for us. Establishing a proper reporting system is also very critical. We try to do that quickly, and that's part of our company culture. We give a lot of autonomy to our different plants and operations, but in return, we expect accountability and reporting.
My main lesson is that the easy part is up to the closing. The difficult part is after the closing, managing expectations, managing culture, guaranteeing proper integration, conducting thorough due diligence with the right experts, and having a proper understanding of local issues. It might cost money, but it's money well invested.
Communication is critical, with the former shareholders, former management, and the management you've decided to keep in place. Language can also be a factor. It's important to have people in your organization who can go to Brazil and speak Portuguese with different levels of the operation.
While upper management and second-level executives might speak English, that limits your knowledge to what they want to share with you. If you want to conduct proper due diligence, go to the plant floor and talk to the people. It's important to speak the language and understand them.
We try to be very clear from the beginning about our offer, and we don't have a lot of room to negotiate. You might initially put forth an offer without proper knowledge of the company, but once you've done your due diligence, your options are limited.
It's not about a significant adjustment, as it shouldn't be, because at the end of the day, you have your targets very clear. You're willing to pay a certain multiple for the business in a particular country based on your evaluation, and that's it. You may find more synergies or opportunities, but there isn't a lot of space in terms of pricing.