<span>M&A and Real Estate Transactions</span>

We experience that many people consider acquisitions of real estate and acquisitions of other types of businesses (referred to here as M&A transactions) as two different worlds, with distinctly different contractual and market practices. But are they actually that different? The answer is that there are more and greater similarities than many might think. But there are of course some differences that are useful to know about. In this insight article, we take a closer look at these similarities and differences.
 

But first, a little about the two different methods that all transactions are based on.

Share transactions: Both businesses and commercial real estate are usually acquired indirectly through the acquisition of all or a controlling interest in the company that operates the business or owns the commercial real estate.  

In M&A transactions, this is often a matter of expediency, as the purchase of the shares in the company (or a company higher up in any corporate structure) initially provides indirect control over the entire business that the buyer is necessarily interested in, but also because the transfer of the "innards" that make up the business itself is often significantly more complicated than simply transferring ownership of the shares in the company that runs the business.  

For example, the company often has customer agreements that may be crucial to the buyer's interest. If these contain change of control restrictions, you may be dependent on the customer's consent in order to avoid the risk of renegotiating the commercial or legal terms of the agreements, or in the worst case that they lapse.     

Input transactions: An alternative to acquiring the business through the purchase of the shares in the company that operates it is for the buyer to take over all or part of the rights, liabilities and assets that in total enable the buyer to continue to operate the business (often referred to as an "input transaction"). Note that agreements in this case are in a special position, since an agreement cannot in principle be transferred in connection with an input transaction without the consent of the contracting party. Input transactions may also raise tax issues (typically capital gains tax) that are not as relevant in the case of share transactions. In many cases, buyers will therefore probably prefer to acquire the business through the shares in the company that operates it.

What about commercial real estate? What has been written so far also applies in general to commercial real estate transactions. The alternative to buying the shares in the company that owns the property is to buy the property itself. In that case, the buyer will probably be interested in registering a deed in order to obtain legal protection for their acquisition. This will trigger an obligation to pay stamp duty of 2.5% of the property's market value at the time of registration. Perhaps even more crucial to the choice of transaction form (assuming the seller is in a position to choose) is that property sales will often result in a significant tax bill for the seller. The difference between the property's current tax value and the property value in the transaction will in many cases constitute a taxable gain.

The purchase agreement - many similarities: A consequence of what we have been through so far is that the object of purchase in the purchase agreement is typically shares, both for businesses and commercial real estate, and the term SPA (share purchase agreement) is often used for the share purchase agreement. The purchase agreement for commercial real estate and M&A transactions largely share the same structure. In both cases, the agreement will regulate the calculation of the purchase price, any debt repayment, closing conditions (CPs), obligations before (and after) closing, warranties, indemnities, and other rights and obligations related to the transaction.  

And some differences: Although the structure of the various purchase agreements share many similarities, the different elements are regulated somewhat differently, both in content and scope. For example, the purchase agreement in M&A transactions will typically contain a more extensive list of warranties and certain other obligations. This reflects the fact that the underlying business is typically more complex in M&A transactions. Such a business often has employees, intellectual property rights, handles more personal data, has a greater variety of customer and supplier agreements, etc. The company's ability to generate revenue and profit, and thus value, depends on how these work together.

Businesses based on real estate are often linked to a single building, and the location of the property, its technical condition and the tenant often have a major impact on its value. Since a business is typically more complex than a commercial property, the purchase agreement in an M&A transaction often requires more extensive regulation than for a commercial property transaction.

Valuation: Valuation is a demanding area with many methods and approaches. In general, it can be said that valuation in real estate transactions is typically limited to factors relating to the property, such as the rent level, market rent trends, lease duration, the solidity of the tenants, the location of the property, the technical condition of the building and potential value upside ("value add"). Given a solid tenant, our impression is that many professionals consider the cash flow to be relatively straightforward to value since the costs are fairly predictable, the location is given and the income (rent over the lease term) is more or less known.

In general, valuation in M&A is more complex because the value of the business often depends on several and a greater variety of Asset factors, and thus more complicated to assess the value of. The valuation also needs to take into account the prospects for future earnings, seasonal revenues, market position, technological advantages and possible synergies. These are examples of factors that can also be included in the valuation of real estate companies, but which are often more relevant for other types of businesses. It is important to distinguish between the valuation of the business agreed by the parties (the so-called "enterprise value") and the actual purchase price to be paid by the buyer - more about this in the next section.  

Calculation of purchase price: The purchase price calculation when acquiring real estate companies is often based on an agreed property value combined with a subsequent closing balance sheet settlement. This means that the settlement is carried out on the basis of estimated amounts, with settlement of agreed balance sheet items some time after the transaction is closed.  

In an M&A transaction , the calculation of the purchase price will normally take place in two stages: First, the parties negotiate an enterprise value on a so-called "cash and debt-free basis", i.e. an agreed present value of expected future cash flow. This enterprise value is then adjusted by adding cash, subtracting debt and adjusting for deviations between agreed "normal" working capital and actual working capital. In practice, the agreed future value is taken and adjusted for balance sheet items that are a consequence of the company's operations in the period leading up to the transaction.  

The final purchase price is either determined based on a known balance sheet (for example the company's last monthly balance sheet), and is thus known to the parties when the purchase agreement is signed (so-called "locked box"). Alternatively, the purchase price calculation is based on the company's balance sheet on the day the transaction is completed (so-called "closing balance"), which means that the amount paid on the completion date is an estimate that is later corrected when the balance sheet on the completion date is finally determined (i.e. principally the same as for real estate transactions).  

Market practice: Although there are local and regional variations, market practices for M&A transactions are quite similar in many countries, and thus relevant to consider in Norway. While M&A market practice has an international aspect, real estate transactions often have a somewhat more local market practice due to local laws, regulations and market conditions related to real estate.

Due Diligence (DD): Due diligence has the same purpose regardless of the type of business, namely to assess the legal risk profile of the business and identify whether there are unexpected risks that should be reflected in the purchase price or regulated in some other way - or, in the worst case, indicate that the transaction should not be completed. In M&A transactions, a number of factors beyond the company's financial condition are typically considered. This includes, for example, mapping change of control restrictions, assessing employment conditions, pension obligations, customer and supplier agreements, intellectual property rights such as patents and trademarks, privacy (GDPR), and often also the company's social and environmental footprint.

In real estate transactions, due diligence is mainly focused on the technical condition of the property, the lease agreements, the landlords operational costs and capital expenditure, zoning and that the use of the property is legal, as well as tax and VAT matters. This includes a number of issues that can also become complicated if, for example, there are issues that involve public authorities.

Conclusion. M&A and real estate transactions therefore have many similarities, while there are also several differences that are important to be aware of. These differences are particularly evident in the due diligence process and the detailed negotiation and drafting of the purchase agreement, which is thus characterized by the underlying complexity of what is being acquired: Whether it is a company with a more complex business or a business based on real estate.

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<span>AGP is a law firm specializing in transactions, capital markets and corporate. Corporate law advice is one of our core competencies.</span>

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