Downturns in macroeconomic conditions and challenges resulting from political turmoil create an environment that tends to make traditional M&A transactions harder to conceive and consummate. However, there is plenty of experience around the world on distressed M&A – that is, transactions where the target is undergoing a significant negative period of performance and is at risk of bankruptcy, shutdown or other inability to operate under its existing model. This chapter will provide some examples of various triggers and features frequent in distressed M&A transactions, using the Venezuelan experience of the past decade.
Venezuela has had its fair share of distressed M&A activity in recent years owing to its well-known and continued political and economic crisis. But this surge in distress only began a few years ago as a result of the worsening of the economic crisis and the lack of alternative viable ways for business owners to exit the Venezuelan market.
In the first two editions of this guide, we reflected upon the lessons from our experience advising buyers and sellers in 2014–2020 in the distressed M&A scene in Venezuela and translated those lessons into the description of the principal features of those Venezuelan distressed M&A deals.
In 2020, the Venezuela M&A scene started to change into a more traditional (yet still distressed) one. Therefore, this chapter also describes the developments of recent M&A deals during 2020 and 2021, amid a less unstable environment.
We believe that comparing such developments with the features of distressed M&A deals in the 2014–2020 period could be useful in other jurisdictions as they face adverse macroeconomic and political conditions, while offering lessons on a path forward after enduring downturns.
Evolution of M&A in Venezuela
The decade that preceded Hugo Chávez’s election to the presidency of Venezuela in 1998 was marked by traditional M&A activity and a wave of privatisations.
The first years of Hugo Chávez’s tenure (1999-2006), while politically unstable, were still marked by traditional M&A activity and the opening of some sectors to foreign investment. These years saw significant takeovers of large listed companies.
From 2006 to 2013, the government nationalised several industries as part of its policy of reducing the influence of multinational corporations. These nationalisations were fuelled by a surge in oil prices, and were carried out either through outright nationalisations (in many cases without compensation to the owners of the nationalised businesses or assets) or negotiated M&A transactions (i.e., mergers and nationalisations (M&Ns)).
The year 2014 was marked by political upheaval, and Venezuela remained politically and economically unstable for many years as a result of the collapse of oil prices and Venezuela’s oil production, the political situation, deadlock and US sanctions (as we explain in the paragraph below, that instability started to change, to a certain degree, in 2020). This situation left the country with a strikingly smaller economy and internal demand for goods and services. The government – now with emptier coffers – lost its appetite for nationalisations and M&Ns. This period was marked by stringent price controls, resulting in significant shortages of most consumer goods, strict foreign exchange controls that criminalised black market foreign currency transactions (all the while, the official exchange rates were kept artificially low, creating huge gaps between the official rate and the black market rate) and one of the highest and most prolonged hyperinflation in contemporary world history. As a result of these challenging conditions, several multinationals decided to exit the country. While some of them decided to shut down their operations in Venezuela, others decided to sell their operations to third parties, triggering a number of distressed M&A transactions.
Starting in 2020, the government began to ease several controls affecting the economy. The government repealed foreign exchange regulations criminalising foreign currency exchange transactions and the sale of goods and services in foreign currency. The Venezuelan economy has become informally dollarised; an increasing number of transactions are settled in US dollars, but banks remain shy from opening US-dollar-denominated accounts due to opaque regulations, and taxes and other duties are still payable in local currency exclusively. Price control regulations have not been enforced as much as in previous years, except for a few notable cases. The government has also aggressively promoted imports by eliminating import tariff and duties.
These changes in the economic conditions gave way to improvements in the performance of certain industries (e.g., dollarisation for the consumer goods industry) and as such, nourished an increasing interest in the country by various players. This increased interest in the country altered some of the fundamentals of a Venezuelan M&A deal, and thus many of the features we saw in M&A deals in the 2014–2020 period (described below) became less frequent or changed altogether.
Triggers of distressed M&As in Venezuela in the 2014–2020 period
On the one hand, exiting Venezuela became necessary for many multinationals because of the challenges to operate a business in Venezuela (the ‘operational trigger’). On the other hand, liquidating or winding down the business, or shutting down operations in Venezuela altogether, is unfeasible or raises significant risks and, therefore, the sale of the operations to a third party became the most viable alternative (the ‘legal trigger’). These two triggers account for the increase in distressed M&A activity in Venezuela in recent years.
Operational trigger
Venezuelan businesses became increasingly difficult to operate for a number of reasons.
While inflation had characterised Venezuela’s economy for many years, the second half of the 2010s was marked by a record-breaking hyperinflation accompanied by a lack of public estimates and data by the Venezuelan government for many of those years (until recently, the Central Bank had plainly stopped issuing such estimates). Needless to say, hyperinflation had pervasive effects on the management of Venezuelan businesses, ranging from increased difficulties in making sense of the entity’s accounting (several multinationals deconsolidated their Venezuelan operations to isolate their adverse financial and accounting effects), coming up with suitable and viable solutions for employees’ compensation (salaries in local currency quickly lost their purchasing power) or the virtual destruction of local currency financing options.
The strict foreign currency exchange system criminalised black market foreign currency transactions, while the government drastically reduced the offer of foreign currency through official auctions and kept the official rate artificially low. This situation, coupled with the collapse of oil prices, triggered one of the greatest currency devaluations in history. The huge gap between the official and black market rates causes significant accounting distortions.
The foreign currency authority virtually stopped accepting requests to remit dividends abroad at the official rate. This often left multinationals with no other option but to reinvest any profit they could generate into their Venezuelan operations to mitigate the hyperinflation’s effect on the value of local currency profits.
Stringent price controls set a 30 per cent profit margin cap and did not allow companies to take into account most of their overhead costs and hyperinflation to calculate their profit. The government also fixed prices for certain goods, which were sometimes frozen over long periods of time, forcing companies to sell goods at a significant loss. Price control regulations were also used as a basis for recurrent and excruciating audits by government officials that, in some cases, ended with the imposition of fines, temporary closures of the business, seizures and criminal prosecution of key employees.
Labour freezes have remained in force for many years. Under Venezuelan law, employees cannot be unilaterally terminated by the employer without cause. Termination of employees for cause (such as theft, absenteeism) has become practically impossible because terminations must be approved by government officials (inspectores del trabajo), who rarely do so. Thus, terminations have to be achieved by negotiating enhanced termination packages with the employees to incentivise their resignation. Union leaders, health and safety delegates and employees on maternity or sick leave are under special protection and may require tailor-made termination packages in exchange for their resignations.
Decreases in the quality of life due to the adverse conditions in the country (hyperinflation, insecurity, food and medicine shortages, long-lasting blackouts or recurrent brownouts) made it harder for companies to retain much-needed talent, which preferred to leave the country seeking more stable environments. Often, key employees were based outside the country for these reasons, posing additional challenges for coordinating internal procedures and dealing with crucial meetings with government officials.
International and US sanctions pose additional challenges for operating in Venezuela, especially for companies owned by US multinationals. Day-to-day commercial or financial transactions clearly out of the scope of sanctions take much more time to close due to KYC and due diligence procedures, and in many cases are stopped from closing altogether out of excess of caution. US companies depend on the issuance of general or particular Office of Foreign Assets Control (OFAC) licences to continue operating, building uncertainty for long-time commitments in the country.
The cost-benefit analysis of operating in Venezuela owing to Foreign Corrupt Practices Act (FCPA) or similar regulations is also relevant to companies owned by foreign multinationals. These companies have to deploy strict compliance programmes and ensure management oversight of the entity’s dealings owing to the levels of reported corruption in Venezuela.
The ever-present nature of the challenges of the Venezuelan political and economic environment made multinationals spend an ever-growing amount of managerial time having to deal with such challenges. Similarly to the cost-benefit analysis of having FCPA compliance programmes, the trade-off between managerial time and profits for the headquarters became less convenient with the passing of time given the shrinking of Venezuela’s economy and its near future uncertainty.
Notably, debt pressure is omitted as an operational trigger due to hyperinflation wiping out the companies’ debt burden.
Legal trigger
From a legal standpoint, the main trigger for the sale of distressed businesses in this period of economic crisis is the lack of other viable alternatives to exit the country.
Under Venezuelan law, it is not possible to unilaterally liquidate a business as a way to exit the country. As mentioned above, employees cannot be unilaterally terminated by the employer without cause, and voluntary liquidation is not a cause for the termination of employees under Venezuelan law.
In light of this, some multinationals exited the country by permanently shutting down their operations in Venezuela while maintaining the legal vehicle, paying all labour obligations with their employees and debt with their suppliers. However, in many cases, the shutdown triggered a strong reaction from the government, including the criminal prosecution of key employees based in the country arguing economic destabilisation, boycott, labour breaches or otherwise. In addition, the government has the legal power to ‘temporarily intervene’ companies to ‘protect employment’. After these interventions, the government has started operating the businesses and even kept manufacturing the same branded products without the consent of the owner of the brand.
Given the risks involved in a shutdown of the operations, the sale of the operations to a third party became an effective way to exit Venezuela.
Principal features of distressed M&As in Venezuela in the 2014–2020 period
Out-of-court sale
One of the most salient features of distressed M&A activity in Venezuela is that it occurs outside of insolvency proceedings for two reasons. On the one hand, businesses have low amounts of debt mainly because local currency financing got diluted by hyperinflation, and the only significant foreign currency denominated debt is generally intercompany debt. On the other, the existing insolvency processes contemplated under Venezuelan law are old and ill-equipped to liquidate the insolvent company. This causes the owner of the Venezuelan business to avoid the lengthy and uncertain insolvency proceedings and aim for an out-of-court sale of their businesses.
Type of buyer
The buyer of a distressed transaction in Venezuela during this period typically had a considerable tolerance for risk and bet on a political or economic change.
Not surprisingly, typical buyers in Venezuela during the 2014–2020 period included family offices of high net worth individuals from Venezuela, Latin America and Europe. The family offices’ streamlined decision-making process, secrecy and focus on investments with an indefinite time frame gave them a significant competitive edge. Other institutional investors and global strategic players were uncommon.
Financial debt
Financial debt generally did not pose challenges for closing because external financing operations rarely occurred during this period. Venezuelan operations had been largely financed by their shareholders merely to stay afloat. In these transactions, inter-company debt was generally capitalised before the sale or was transferred to the buyer. And as mentioned above, local currency financing became diluted by hyperinflation.
‘As is’ transfer
Transfers were typically made on an ‘as is’ basis, with very limited sellers’ representations and warranties and indemnity obligations. Sellers’ representations and warranties were generally limited to ‘fundamental representations’, that is, representations and warranties relating to organisation and standing, capitalisation, powers and authority, consents and approvals and title to the transferred interests or assets, and representations and warranties related to anti-money laundering (AML), anti-corruption, and trade sanctions. Sellers typically required buyers to provide representations and warranties related to organisation and standing, powers and authority, consents and approvals, sources of funds, no financing condition, AML, anti-corruption and trade sanctions, as well as nonreliance provisions.
Asset purchase versus stock purchase
Sales were generally structured as stock transactions. Asset deals were uncommon, as they are very complex to structure and in most cases trigger regulatory approvals that are not required in stock transactions; for example, in an asset deal, environmental, sanitary, industrial and other permits must be amended or reissued by regulatory authorities, which may significantly delay the closing of the transaction. Asset deals may also raise significant tax liabilities. In addition, asset deals may have to comply with local bulk transfer requirements to protect purchasers from pre-closing non-transferred liabilities of the target’s business, and compliance with such bulk transfer requirements does not properly isolate purchasers from labour and tax liabilities of the target’s business. Under local law, purchasers are jointly and severally liable with the seller for the tax liabilities of the target’s business for a certain period following the notice of transfer to the tax authorities.
Purchase price and valuation methods
Purchase prices were distressed mainly because of the country’s uncertain near-term future. The price is generally paid at closing in US dollars or other foreign currency in bank accounts located outside Venezuela, as there are no local foreign currency exchange or other restrictions to do so. Prices were generally not subject to adjustment for working capital, net financial debt or other pre- or post-closing adjustments. Selling at distressed prices sometimes resulted in accounting losses to the selling shareholders. In certain cases, the price was nominal, as sellers’ elimination of their country risk, operating expenses and ongoing liabilities was sufficient consideration.
Valuation methodologies used in distressed M&A transactions taking place in other jurisdictions (such as adjusted DCF valuation, comparable company analysis, precedent transactions, etc.) were seldom used in Venezuela given the extreme difficulty in forecasting future cashflows in hyperinflationary economy fraught with political risk, and given the limited amount of publicly available transaction data. In many cases, sellers quantified the operating expenses and ongoing liabilities they would have continued to incur if they did not sell the business, and buyers estimated how fast they would get the purchase price back and how the company would be valued in a normalised economy. Buyers would often look at the investment as a call option on a Venezuelan political or economic change and recovery that would lead to significant valuation re-rating. In those cases, an analysis of the company’s staying power, market position, and ability to generate cash under all macro conditions was key.
Investment bankers
In some cases sellers engaged the services of investment bankers (commonly local boutiques or regional players) to assist them in the selection of potential buyers, negotiation of price and other financial terms and due diligence process. Purchasers seldom engaged investment bankers. Many transactions did not involve investment bankers at all.
Local management
Given the scarcity of skilled local talent, distressed M&A transactions often include agreements to retain the top management of the Venezuelan business being sold.
Simultaneous signing and closing
Except for transactions involving companies operating in regulated sectors (such as insurance, banking and telecom), signing and closing took place simultaneously. Unlike most of the other countries of the region, antitrust filings are not mandatory in non-regulated sectors in Venezuela. When signing and closing are simultaneous, sellers run the expropriation risk until the transaction is consummated. If signing and closing are not simultaneous (for regulatory or other reasons), then purchasers typically negotiated the inclusion of no expropriatory acts as a closing condition and the occurrence of expropriatory acts as cause for termination of the transaction.
Covenants
As signing and closing usually took place simultaneously, pre-closing covenants (such as conduct of business) were usually not included. In certain transactions, purchasers accepted post-closing covenants relating to continuation of the business and treatment of employees. However, in general, purchasers were reluctant to accept such covenants.
Repurchase options
In certain transactions, sellers negotiated an option to repurchase the Venezuelan business at a significant premium. This option may allow sellers to re-enter the Venezuelan marketplace, and some players may be interested in doing so, considering improving economic trends. Given the significant uncertainties on the political and economic prospects of the country, it was generally very difficult to agree on a valuation method to calculate the repurchase price.
Governing law and dispute resolution
There are no restrictions under Venezuelan law for the sale of the equity interests of a Venezuelan company to be governed by foreign law. Distressed M&A transactions are governed by Venezuelan law, New York law or the law of the jurisdiction of one of the parties.
The parties to the distressed M&A transactions generally agree to subject their contractual disputes to arbitration seated in cities outside Venezuela (Miami is a fairly common choice). Venezuela is a party to the 1958 New York Convention.
Post-closing challenges
As mentioned before, sellers generally provided limited representations and warranties and related indemnity obligations, buyers were willing to agree on very few covenants, and purchase price adjustments were uncommon. Therefore, sellers’ and buyers’ contractual liabilities were limited and so were post-closing challenges, as buyers assumed the risk of several post-closing challenges that were inherent to a distressed business. The few disputes arising from the transactions tend to be solved through negotiation rather than arbitration or litigation.
Developments in recent M&A deals in Venezuela since 2020
Type of buyer
US and Latin American private equity firms have started to become common players in the current Venezuelan M&A scene. This may be due to the fact that certain investment and financial fundamentals are observed again in some Venezuelan businesses, in part due to the dollarisation of the economy and the lifting of exchange and price controls. Also, the current environment offers significant opportunities in terms of rate of return, because the operations of many Venezuelan companies can be streamlined and optimised to generate value in the coming years, should the current trends continue. Other institutional investors and global strategic players are still uncommon, mainly because of the effect of the uncertainty on the lifting of the international and US sanctions in the near future.
One critical task that must be dealt with from the outset of the transaction is to conduct a thorough due diligence on the potential acquirer to confirm that it is not under any international or US sanctions, or otherwise raises reputational issues.
As economic conditions continue to improve, the normalising of historic trade levels with strategic markets, such as Colombia, should be expected to prompt M&A activity as foreign companies seize the opportunity to re-establish operations in Venezuela and cater to a widely underserved market.
Representations and warranties
‘As is’ transfers have become much less common since 2020. Extensive disclosure schedules and thoroughly negotiated representation and warranties provisions are now common, as sellers now seldom ask for nominal prices (as described below).
Tax representations are particularly relevant, as the assessment of contingencies for tax liabilities becomes difficult due to the lack of certainty on the tax authority’s interpretation of tax provisions in most cases.
Representations and warranties related to anti-money laundering (AML), anti-corruption, and trade sanctions continue to be important.
Representations and warranties insurance is not currently feasible in Venezuela given local conditions, and political and economic risk, which insurers are still not prepared to cover.
Purchase price
As mentioned above, prices are no longer nominal, due to the recent changes in economic conditions. Purchase price adjustments for working capital and net financial debt are no longer unusual, though still less common than in other jurisdictions due to complexities mainly derived from exchange rate volatility.
Bidding processes
Between 2014 and 2020, it was common for sellers to select a buyer and proceed with direct one-on-one and often exclusive negotiations for the sale of their Venezuelan operations as swiftly as possible. From 2020, bidding processes for private companies have been once again deployed in some cases, in light of the number of interested players.
Venture capital and start-ups
While considerably smaller than the start-up activity present in Latin America (especially in Mexico and Brazil), 2020 marked the appearance of some start-up companies in Venezuela as a consequence of the dollarisation of the economy. Some have scaled up considerably and are now operating in many cities in the country.,
The success of these start-ups and the possibilities for sustained growth over the years and related development of a venture capital/start-up legal industry will, of course, be contingent on the stability of economic and political conditions in the near future. In any case, we believe that recent developments marked a watershed moment and a change of mindset on the viability of these types of businesses in Venezuela.
Conclusion
The fact that M&A activity continues in Venezuela despite one of the longest and most devastating crises in modern history suggests some cause for optimism in that there are those willing to bet on the country’s future. Only time will tell if such investors are wildly successful contrarians. Investors in other Latin American economies should be heartened that dogged determination will enable them to close deals even in the most trying circumstances.
